The Problem. Burroughs Wellcome has developed a drug that is effective in the treatment of acquired immune deficiency syndrome (AIDS). Although the drug has been successful, Burroughs Wellcome is now under pressure to reduce its price. The problem facing Burroughs Wellcome is
- What should be Burroughs Wellcome’s pricing strategy as a result of increasing pressure from various public and private constituencies for a price reduction?
Recommendation. Burroughs Wellcome has dropped the price of Retrovir multiple times since 1987. Although the most recent price drop occurred in late 1989, Burroughs Wellcome should drop the price of Retrovir one more time to bring the profit margin of the product in line with the rest of their products. This would mean dropping the current price from $1.20 per unit to $1.13.
Falling Costs. As the case study mentions, the estimated cost per unit of Retrovir is between 30 and 50 cents. As Burroughs Wellcome has perfected the manufacturing process of Retrovir, it is likely the cost of production has dropped between 1987 and 1989. As Table 1 indicates, a drop in cost from 1987 to 1988 with a similar drop in price has maintained a profit margin of just less than 23 percent. Therefore, it is not hard to imagine that an additional improvement in manufacturing in 1989 has led to further cost savings and precipitated the late 1989 price reduction to $1.20.
Profit Margins. As Table 1 indicates, profit margins for Retrovir have been just slightly less than 23 percent between 1987 and 1988. Table 2 details cost and price reductions between 1987 and 1989. During this timeframe, Retrovir underwent an estimated cost reduction of 20 percent bringing the cost from 50 cents per unit to 40 cents. Going into 1990, Retrovir experienced another cost reduction from 40 cents per unit to 30 cents; a decrease of 25 percent. Burroughs Wellcome dropped the price of Retrovir from $1.50 per unit to $1.20. This 20 percent decrease in price combined with the 25 percent decrease in costs resulted in net profit margin increasing to 24.4 percent. In order to maintain the 22.73 percent profit margin from 1988 and 1989, Burroughs Wellcome would need to drop the price of Retrovir a total of 25 percent from the 1989 price of $1.50 per unit. This would result in a price of $1.13 per unit rather than the current $1.20.
Return on Investment. Developing new drugs is an expensive business requiring heaving investment in research and development. As Table 3 indicates, Burroughs Wellcome has spent $115 Million on the development of Retrovir. Based on these costs and assuming a price adjustment to $1.13 per unit, Burroughs Wellcome will pay off their investment in Retrovir in 1990 and earn an additional $36 Million while still maintaining the net profit margin from the previous three years. It is important for Burroughs Wellcome to pay off the investment in Retrovir quickly, and this will be accomplished in 1990 even with the recommended price decrease to $1.13 per unit.
Social Responsibility. Having developed a life-saving drug, Burroughs Wellcome is in a unique position. Although they have cut the price of Retrovir twice, they are still being pressured by various groups to decrease their price even more. Despite the protests, Burroughs Wellcome does have the right to receive a fair price for their product. Based on the data in Exhibit 4, Retrovir’s gross margin of 73 percent in 1989 is comparable to the gross margins of other pharmaceutical companies. This indicates that the price for Retrovir is not uncharacteristic. Unfortunately, the product seems more expensive because of the high dosage necessary. Fortunately, the FDA has approved a lower dosage for some cases. Although this will not reduce the cost of Retrovir for everyone that needs it, it will be welcome relief for some. In order to maintain pricing that is both fair for Burroughs Wellcome and socially responsible, the price of Retrovir needs to be cut 25 percent from $1.50 to $1.13 rather than only 20 percent.
Inelastic Demand. The demand for Retrovir is inelastic. Everyone that needs Retrovir and can afford will purchase it. The product exists in a unique market that no other product can satisfy. This situation would normally encourage the company to keep prices high and maximize profit. Unfortunately for Burroughs Wellcome, a life-saving drug does not operate in a normal situation. Despite inelastic demand for their product, Burroughs Wellcome must temper the urge to charge exorbitant prices with a social responsibility to make the drug available to the largest possible market at a reasonable rate of return.
I would have included the tables mentioned above, but converting them was a big PITA.