Pharmaceutical Product Recalls: Category Effects and Competitor Response

In the pharmaceutical industry, a product recall financially impacts not only the firm undertaking the recall but also other competitors in the category since it affects physician and consumer perception of the category as a whole. Often, such competitors have to engage in defensive marketing at the category level without complete certainty about whether a recall will occur or not. Such defensive effort could then lead to a change in postrecall sales effort directed at capturing market share in that category. This decision is affected by the probability of the recall and the size of the loyal segment in the category facing the recall, i.e., physicians who will continue to prescribe the category even without marketing effort. We focus on competitor reaction to product recalls where the competitor participates in multiple product categories that exhibit (dis)economies of scope in sales effort across them. Equilibrium analysis of our game-theoretic model uncovers several managerial insights that illustrate the importance of scale (dis)economies on the competitor’s promotional strategy in the wake of a recall. First, economies of scope across the two products leads to either an increase or decrease in postrecall sales effort for both products simultaneously depending on the loyal market size for the category. Second, diseconomies of scope can lead to a complete withdrawal of postrecall sales effort from one of the two products depending on the size of the loyal market, the cross-category price, and the recall probability. Third, as the recall probability increases, category-defense effort and postrecall sales effort are unequivocally complementary given economies of scope across the two products but may be substitutes given diseconomies of scope.