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By Jeremy Glaser | 03-28-2011 11:49 AM

Has Health-Care Reform Eroded Pharma's Economic Moat?

Pricing power may be diminished somewhat, but patent protections should continue to bolster big pharma's competitive advantage, says Morningstar's Damien Conover.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

Has health-care reform eroded pharma's moat? I'm here today with Damien Conover--he is associate director of pharmaceutical research at Morningstar--take a look at this question.

Damien, thanks for joining me today.

Damien Conover: Thanks for having me, Jeremy.

Glaser: So, let's take a step back and look at why pharma firms have moats in the first place. How much competitive advantage do these businesses really have?

Conover: I think that's a really good and an important question. At Morningstar, we rank all the large pharmaceutical firms as wide economic moats, and the main reason behind that is really the patent protection on their drugs. So, as pharmaceutical firms develop new drugs, they get patent protection, and in that time period, while the drug is still under patent protection, they can charge any price they want, and hence get very strong returns on invested capital. That's kind of the key point to why these firms have wide economic moats.

But it's also important to remember that these firms are also very good at research and development, albeit the research and development productivity has declined over the last few years, there is still very strong new product flow coming out of these firms.

Then also, it's important to remember the distribution network. While not as important as the patent protection, it is critical to have a big pharma firm to really launch a new drug because of the power of their salesforce.

Again, over the last few years, this has been a trend that's been declining, not as strong as it once was, but really the key to remember here is the patent protection on why these firms have wide economic moats.

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