Pharmaceutical Patents: Innovation and Product Pricing; Helping or Hurting?

Every member of our industry is aware of the significance of the high profile patent expirations that have occurred in 2011, and will occur in 2012.  Twenty of those expirations impact blockbuster products, whose profit margins were substantial sources of revenue for development activities.  While the relationship between profits generated by drugs protected by patents and the development of new therapies is well understood within the industry, it is not as apparent to the average American consumer.
Within this blog, we hope to illustrate the nature of this relationship to the consumers of our products – to provide a deeper understanding of the process that generates the fuel of the engine of innovation.
What is a Patent?
A patent is the grant of a property right to the inventor; granting the right to manufacture and sell without competition for a limited period of time.  Such patent grants are issued by the United States government.  Patents, when issued, have a defined term of expiry, measured in years from the date on which the application for the patent was filed in the United States.  In the United States, a patent for a drug expires 20 years from the date of filing.
Why Protect Invention?
The patent system in the United States was designed to promote innovation; it literally ensures financial reward for those willing to invest in the development of new technologies.
Why Allow Protection to Expire?
Issuing protection from competition incentivizes invention, fostering growth of technologies and progress.  Granting this protection for a limited amount of time ensures competition which, in a free market model, also provides the delivery of the technologies to the consumer at the lowest possible cost.  This ensures that the progress realized is accessible to every sector of the marketplace.
The government legislation of these objectives within a single program, incentivizing innovation AND ensuring affordable products, balancing one need against the other, required a fundamental understanding of a free marketplace.
While the fundamentals of the free market theory have not changed since the inception of the patent program, the complexities of the market place have increased significantly.
Does the system still work?  Let’s examine whether or not the model developed delicate balance.
How Does the Patent System Impact Drug Product Pricing in Today’s Market?
The financial investment required to bring a truly innovative pharmaceutical product to market cost is staggering.  Current figures place the total cost somewhere around 22 to 350 million USD.  The elapsed time from development to marketplace is currently averaging 15 years.
Our readers that are also industry members may not be shocked by this figure, but our readers that are consumers may be asking themselves why this process should be so expensive??  For the consumers, the following is a high level outline of the steps any developer must take before introducing a new medical therapy (drug or device) to the American public:
Approval Process:
  • Scientific research and development
  • Regulatory submission to the government requesting permission to conduct testing of the developed product
o   Rigorous and multi-phased clinical testing with regulatory submissions after each phase
o   FDA detailed review of results of clinical testing after each phase
  • The design of facilities to produce the product on a commercial scale
o   Construction and qualification of that facility
o   Development processes designed to control the facility and routine manufacturing
o   Development of post-distribution surveillance techniques and programs
  • Rigorous testing of the facility and the process intended for large scale manufacturing
o   Detailed regulatory submissions to define the product, the facility and the manufacturing, control and surveillance processes
o   FDA detailed review of facility and process testing
  • Pre-approval inspections of the facility
Most companies will wait until a patent is issued before applying for permission to conduct clinical testing.  As this means the patent clock is ticking during clinical testing, many of the facility and process steps above are invested in before clinical testing completes so that the amount of time left on the patent clock is as large as possible when commercial manufacturing begins.   However, current statistics demonstrate that:
    • Only 1 in 1,000 drugs that undergo development testing will undergo human clinical testing
    • Only 1 of 10,000 developed candidates will be approved for patient use by the FDA.
When these realities are factored in, this means that a substantial financial investment in production planning is lost every time a drug fails to successfully complete clinical testing.
The impact of this combination of facts is that each drug that does make it to market usually bears the burden of recouping investments made into hundreds, if not thousands of drugs, that did not make it to market.
These development figures, along with actual production costs, can be directly calculated, and are all considered when determining product pricing.  However, some of the other critical variables considered while calculating product pricing must be estimated over the remaining life of patent protection.  They include estimates of:
  • interest rates
  • inflation
  • market demand
  • technical risks (production and supply chain issues)
Let’s recap the fundamental impact that patent protection + the regulatory process for drug approval has on determination of the final pricing of the approved product:
20 years ( of Patent protection)   –   15 years (of time spent in R&D and gaining FDA Approval) =
~ 5 years (to recoup R&D Costs and generate profit)
Where R&D + Profit costs =
·         Cost of R&D of the approved drug +
·         Cost of R&D of related drugs that did not make it to market +
·         Cost of regulatory interaction +
·         Cost of facility design, construction, and qualification +
·         Cost of process design, implementation, and qualification +
·         Cost of routine production (including margins to fund potential issue resolution)
Does limited Patent Protection have an impact on anything other than pricing?
The greatest impact is on how companies choose which medical conditions to research.
The size of the market:
In addition to having direct and significant impact on the pricing of new therapies, the reality of the 5 year window laid out above eventually must break down into a real cost per unit of product.  The more units produced, the lower the unit cost; the fewer the units, the higher the end unit price.  Calculation of a unit price assumes that 100% of units produced are sold.
Additionally relevant is the fact that large percentages of units manufactured will sell only if the market can bear the unit price.  That being said, companies must consider the size of the projected market prior to beginning research into therapies aimed at that market.
Simply put, if the market (afflicted patients) is small, the unit price will be large.
From this perspective, the fact that only 5 years are left on the patent time clock after the regulatory approval process completes means that:
Conditions that affect a small portion of the population will never be considered viable targets for research efforts[1].


The nature of the market:
Also relevant from this perspective is the nature of the marketplace.  When making decisions as to which illnesses will be researched, not only must companies consider the demand (number of units that could be sold), they must also consider the buying power of the marketplace.  A unit price that is sustainable in a developed market may be completely out of reach of a developing or underdeveloped market.
For example, a $20 per unit dose would be happily paid by an American insurance company, but would be completely out of reach for a villager in Africa.  The impact of this reality is that:
Conditions that affect large portions of poor populations will never be considered viable targets for research efforts[2].
What have we learned so far?
  1. Patent protection was designed to incentivize innovation
  2. Limiting patent protection was implemented to encourage competition and keep prices low
  3. Filing an application to begin the process of clinical testing on new drugs requires the developer to publish formulations (forcing developers to first obtain patent protection)
  4. Completing the drug testing and approval process can consume on average more than 75% of the protected time
  5. The small window of protection once approval is granted directly affects product pricing
  6. The size and affluence of the market effects the choice of where companies invest R&D budgets
What happens across the industry when protection nears expiration?
In 1984, the FD&C Act was amended in such a way as to incentivize competing companies to manufacture a generic form of an innovative drug.  These amendments allowed for an abbreviated application process (i.e., an application process that took less time to complete).
The general public seems to believe that generics are “exactly” the same as the innovative therapies they replace; they are not.  They are legally as classified as “biosimilars.”  The 1984 Act does not require the generic to use the same formulation, or the same manufacturing processes, or employ the same manufacturing controls.  The average consumer does not always recognize the significance of the differences between innovative drugs and their generic competitors.  However, defining those differences in an understandable manner would require an entire series of blogs.
For the purposes of this blog, the most meaningful difference that has medical impact is the fact that the abbreviated application process passed into law into 1984 requires only that the generic manufacturer prove that their formulation results in the delivery of the “same level” (+/- 20%) of metabolized active ingredient, as does the pioneering formulation.  This allowable variance between formulations alone tells us that the generic and the innovative drug are not identical.
The supply-side impact of this amendment (i.e., The Drug Price Competition and Patent Term Restoration Act) ensures that, years before the patent expires, competing generic companies are reverse engineering patented products, racing to reach a point that would allow them to apply as quickly as possible for a license to market a generic version of the innovative drug.
At the same time, the pioneering manufacturer of the innovative drugs are assessing the financial impact of allowing the generic competitors to take over the market vs. the impact of pursing creative options designed to maintain as much of the revenue stream as possible (e.g., to manufacture generic versions of their own product, or perhaps to market the existing drug to alternate markets under a new protected license).
No matter which of these occurs, one thing is certain – once any generic form of the innovative product reaches the market place, the unit price drops dramatically, as pricing of the bio-similar product does not need to consider the substantial investments made in research and development activities.
Does limited protection negatively impact innovation?
Additionally relevant are the harsh realities of today’s global economy; operating budgets are shrinking as investors become increasingly focused on quarterly profits.  As many large pharmaceutical companies’ patents expire, this perfect storm of financial realities present today’s decision makers with difficult choices.
Contemporary concerns are resulting in substantial cuts to Research and Development and, in some cases, complete elimination of R&D divisions.  As R&D groups either shrink or disappear, so does the prospect of future medical innovation that would allow future generations to live longer, healthier lives.
A huge percentage of the medical progress mankind has benefited from in the last 100 years has been a direct result of American innovation.  FDA records show that the number of NDA approvals has declined by more than 50% since 1994.
What does the industrial response to the current patent cliff (2001/2012) show us?
A Patent Cliff is defined as a sharp decline in revenues upon patent expiry of one or more leading products.  In 2011 alone, 10 patents for mega-medicines with combined annual sales of $50 billion USD have expired.  In 2012, 10 more will do the same.
Prior to 2011, records already indicated that nearly 80 percent of all prescriptions in the US were being filled with generic versions of drug formulations.  That reality added to the 2011/2012 patent cliffs is resulting in dramatic shifts in our industry.
Each of these shifts in our industry present unique concerns.  Collectively, they should be a cause for concern for all Americans.
These are but a few notable examples:
  • Pioneers collaborating with Generic Manufacturers
o   Recently after Pfizer’s Lipitor patent expired, Pfizer made a deal with Watson to contribute product expertise in exchange for 70% of Watson’s revenue from its generic version.
  • Pioneers discounting innovative drugs and competing head to head with the Generic Manufacturers
o   In the past, drug manufacturers would most often maintain their product pricing when generic versions hit the market, using their expertise with the product and the patients to maintain market shares.  In this economy however, and as doctors become less involved than insurance companies in selecting brands of medications for patients, full price options cannot effectively compete. The choice is then to abandon the product or cut costs dramatically, in order to cut by unit pricing.  Cutting costs usually means cutting experienced labor, using lower costs raw materials and products, investing less in Quality systems and process controls and/or eliminating the sales force dedicated to those products.
  • Pioneers offering rebates to insurance plans if they require pharmacies to dispense brand-name Lipitor rather than generic versions
o   Pfizer has partnered with Diplomat Specialty Pharmacy to mail Lipitor directly to patients who receive the product through the mail.  Diplomat then bills the insurance companies and Pfizer issues a rebate for each prescription filled, representing a lower cost to Pfizer than would the loss of those prescriptions to a competing generic.
o   This, though technically legal at this point, has some asking if Pfizer has now become the pharmacy?
  • Eliminating American jobs and purchasing generic companies in China, India, and other low-wage, slightly regulated countries
o   AstraZeneca recently cut over 1000 jobs and expanded in China
o   In 2009 Eli Lilly cut over 5000 US jobs and doubled its workforce in China
o   Novartis recently cut over 1000 US jobs and added 700+ jobs in China and India
  • Pioneers creating generics to compete with their own innovative products
o   Pfizer lost 90 % of its market share when Neurontin’s patent expired.  When they began manufacturing a generic version of their innovative product, they made back 50% of their losses
  • Pioneers cutting Research and Development funding
o   Pfizer is refocusing R&D efforts on smaller niches in cancer, inflammation, neuroscience and branded generics and cutting as much as 30 percent of its own research and development spending as they focus on only the most promising candidates.
  • Pioneers paying generic manufacturers to delay delivery of their product to market
o   Some pharmaceutical companies pay generic companies to delay releasing generic product to market for a certain period of time.  This works out well for both the pharmaceutical and generic companies, but the consumer is delayed the option of purchasing the generic drug.
What does all of this mean for generic manufacturers?
The big winner in this historic time should be the generic manufacturer. However, they are facing unique challenges as well:
  • Over saturation of the market
o   Currently, there are more generic companies than ever before causing intense competition and less market share for each.
  • Pioneers have begun to create their own generics
o   As noted above, the pioneers of the industry have begun to exercise their ability to manufacture their own generics.  Due to their experience with the product, the technologies and the patients, this reality puts the small generic companies at a serious disadvantage.
  • Big Pharma is buying generic companies
o   Big Pharma also knows that it may be more cost effective and easier to purchase a generic company rather than create a new line within an existing company.  Many generic companies find themselves the targets of hostile takeovers as a result.


What does this mean for the American consumer?
While this time poses great challenges to both the pioneer and generic drug companies, the sector in the most vulnerable position appears to be the American public.
Some of the most immediate consequences are likely to be:
  • The downgraded outlook for medical progress and innovation.
  • The imminent loss of thousands of American jobs.
  • The potential for the degradation of the quality of medical therapies for sale in the US
What do we make of this?  It seems clear that laws (patent limitation, drug approval, and amended drug approval) that were individually designed to protect the American public, have had unintended consequences when combined and now clearly stand to cause great harm.
It seems equally clear that unless the country acknowledges the need for legal change that fosters medical innovation and protects American jobs, we by default:
  • abandon our hope for medical progress
  • ensure that diseases that affect small populations go untreated
  • ensure that diseases that primarily affect poor populations go untreated
  • ensure that we weaken an industry that employs 1 in every 6 Americans
These consequences, if realized, will harm not only generations of Americans, but generations of the worlds’ citizens.
If we are to enact legal change, it must come quickly.
Industry is nimble; it adapts, very, very quickly.  If government is going to play a role in this, it must be at least as aware, and adapt at least as quickly.  The patent process and the medical therapy approval process, as well as their effect on each other, must be considered and possibly redesigned.
America was made great by the contribution and spirit of innovators.  With that greatness came responsibility; we sought to protect those in our midst that were less fortunate.  We sought to provide an environment in which the benefits of innovation could be accessed by all.
Those are lofty goals that should not be abandoned.  However, it is clear that the system we have in place currently is not meeting those goals and, in fact, may deprive everyone instead of supplying everyone.
We at Coda encourage everyone involved in the regulatory process to re-examine this issue.  We encourage them all to approach laws that interact with supply and demand in the same way that we approach treating disease:
  1. Study the problem
  2. Think creatively
  3. Adapt
  4. Innovate
  5. Solve
“The patent system added the fuel of interest to the fire of genius.”
— Abraham Lincoln
© Coda Corp USA 2011.  All rights reserved.
Gina Guido-Redden and Corrine R. Knight


[1]The US Federal government recognized this reality, and in an attempt to mitigate the impact, in 1984 passed “The Orphan Drug Act.” This Act was designed to encourage drug treatment development for rare diseases, (see Coda’s blog, “Proactive Agency Initiatives Promote the Development of Treatments for Rare Diseases, January 2010).
[2]For example, widely contracted diseases such as malaria or tuberculosis are classified as neglected diseases.  Many neglected diseases have known treatments but the funds necessary to control these diseases in large populations is estimated to be between $2 – 3 billion USD.  Since these diseases affect low income groups, which offer a low probability of recouping even routine manufacturing costs, pharmaceutical companies elect not to invest in usage of corporate capital to deliver treatments to these markets.
[3]Therapies whose annual sales consistently exceed 1 billion USD.
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