When Is Prevention More Profitable than Cure? The Impact of Time-Varying Consumer Heterogeneity - Working Paper 334

We argue that in pharmaceutical markets, variation in the arrival time of consumer heterogeneity creates differences between a producer’s ability to extract consumer surplus with preventives and treatments, potentially distorting R&D decisions. If consumers vary only in disease risk, revenue from treatments—sold after the disease is contracted, when disease risk is no longer a source of private information—always exceeds revenue from preventives. The revenue ratio can be arbitrarily high for sufficiently skewed distributions of disease risk. Under some circumstances, heterogeneity in harm from a disease, learned after a disease is contracted, can lead revenue from a treatment to exceed revenue from a preventative. Calibrations suggest that skewness in the U.S. distribution of HIV risk would lead firms to earn only half the revenue from a vaccine as from a drug. Empirical tests are consistent with the predictions of the model that vaccines are less likely to be developed for diseases with substantial disease-risk heterogeneity.