Explaining Vertical Integration in the Generic Pharmaceutical Industry

This paper explores the motives for vertical integration in the US generic pharmaceutical industry. There is some evidence of strategic complementarity: a firm is more likely to enter a generic drug market in a vertically integrated manner if it expects a higher degree of vertical integration among rivals. This suggests that vertical integration is characterized by bandwagon behavior. While bandwagon effects have been widely discussed in the vertical integration literature, this is one of the first studies to present empirical evidence on its existence. The analysis also indicates that vertical integration is driven by the need to promote a particular form of relation-specific investment – the early development of the intermediate good by upstream units to support patent challenges by downstream units. This explains why the increased prevalence of patent challenges – called “paragraph IV certifications” – has coincided with an increase in vertically integrated entry.