Legal Threats to Strong Returns on Pharmaceutical Patents Grow, Threatening Innovation

By Alden Abbott
January 17, 2016

wrong-way-335Pharmaceuticals is the industry sector where a strong patent system, promising substantial returns to successful innovation, is of paramount importance. A large proportion of R&D in pharmaceuticals fails to yield new approved drugs, so pharmaceutical companies must earn substantial profits on the drugs that are successful to support their continuing drug development efforts. Legal rules that ratchet down on such profits, in the name of limiting “profiteering,” are counterproductive. Whatever static short term price reductions they may achieve are swamped by the harm they create in softening incentives to invest in R&D – a result which reduces pharma innovation, harming future patients and undermining the long-term vitality of a critically important industry.

Nevertheless, legislators and antitrust theorists continue to peddle dubious “solutions” to the “problem” of “overly high-priced” branded and patented drugs, seemingly oblivious to the harm to dynamic competition and innovation that their nostrums entail. Writing in Truth on the Market, Emory University Law Professor Joanna Shepherd recently highlighted two recent troublesome examples that nicely illustrate this point.

First (see here), bills proposed in various states would require drug manufacturers to disclose detailed and sensitive information about the production and materials costs, profits, and history of pricing changes for drugs whose prices are above a certain level. As Professor Shepherd points out, technical cost data for drugs on the market fail to account for the enormous costs involved in developing the 90 percent or so of drugs that fail to make it through government clinical trials (costs which must be covered to some degree if a firm is to remain in business as part of a “risk-return tradeoff”). Furthermore, the allocation of high joint research and regulatory expenditures that may be aimed at developing a large potential portfolio of drugs (an issue at the heart of pharmaceutical development efforts) is not addressed by legislative technical cost reporting requirements. Moreover, a legislative focus on narrow technical production costs totally ignores a wide variety of other factors that are key to the setting of pharmaceutical prices, including conditions of demand, therapeutic value, substitute drugs, market size, and patent life. (I would add miscellaneous government regulatory constraints, found in Medicare and other statutes, that constrain private sector price-related decision-making.) What’s worse, this legislative approach threatens to raise the cost of pharmaceutical production, to the detriment of producers and consumers. In short, as Professor Shepherd aptly puts it:

[Such legislative proposals] will impose extensive legal and regulatory costs on businesses. The additional disclosure directly increases costs for manufacturers as they collect, prepare, and present the required data. Manufacturers will also incur significant costs as they consult with lawyers and regulators to ensure that they are meeting the disclosure requirements. These costs will ultimately be passed on to consumers in the form of higher drug prices.

Second (see here), Professor Shepherd ably critiques the new-found enthusiasm (by both private U.S. plaintiffs and the U.S. Government) for bringing antitrust suits that challenge “product hopping” – a term used to describe the process by which brand name pharmaceutical companies shift their marketing efforts from an older version of a drug to a new, substitute drug in order to stave off competition from cheaper generic drug producers. As stated by Professor Shepherd:

This business strategy is the predictable business response to the incentives created by the arduous FDA approval process, patent law, and state automatic substitution laws. It costs brand companies an average of $2.6 billion to bring a new drug to market, but only 20 percent of marketed brand drugs ever earn enough to recoup these costs. Moreover, once their patent exclusivity period is over, brand companies face the likely loss of 80-90 percent of their sales to generic versions of the drug under state substitution laws that allow or require pharmacists to automatically substitute a generic-equivalent drug when a patient presents a prescription for a brand drug. Because generics are automatically substituted for brand prescriptions, generic companies typically spend very little on advertising, instead choosing to free ride on the marketing efforts of brand companies. Rather than hand over a large chunk of their sales to generic competitors, brand companies often decide to shift their marketing efforts from an existing drug to a new drug with no generic substitutes.

Pharmaceutical product hopping often involves the introduction of new and valuable product features (for example, an extended release feature) that benefits consumers. Thus antitrust courts risk undermining incentives for improving medications if they readily allow product hopping lawsuits, premised on theories of harm to competition, to proceed. As Professor Shepherd further explains:

Product redesign is not per se anticompetitive. Retiring an older branded version of a drug does not block generics from competing; they are still able to launch and market their own products. Product redesign only makes competition tougher because generics can no longer free ride on automatic substitution laws; instead they must either engage in their own marketing efforts or redesign their product to match the brand drug’s changes. Moreover, product redesign does not affect a primary source of generics’ customers—beneficiaries that are channeled to cheaper generic drugs by drug plans and pharmacy benefit managers. . . . Product redesign should only give rise to anticompetitive claims if combined with some other wrongful conduct, or if the new product is clearly a “sham” innovation.

Unfortunately, product hopping as a theory is very much alive in the real world. In July 2015 the Second Circuit upheld an injunction requiring the continued production of an older obsolete drug in New York v. Actavis, while the Third Circuit currently is considering an appeal of a district court’s grant of summary judgment in favor of a brand name product hopper in Mylan Pharmaceuticals v. Warner Chilcott. In the event of a circuit split, the Supreme Court should intervene to clarify that the introduction of an improved drug product, in and of itself, cannot give rise to antitrust liability – even if it involves the withdrawal of an earlier version of the medication.

Regrettably, the weakening of pharmaceutical patent rights through legislative means and antitrust lawsuits is symptomatic of a broader and more general policy attack that antitrust enforcers have directed against patents in recent years (see, for example, my article here). Antitrust enforcers and legislators clearly need a few remedial lessons in the economics of innovation before their myopic meddling cripples the (up-to-now) highly successful American pharmaceutical sector and other key U.S. industries, which have stood as a testament to the value of strong patent rights. Stay tuned.

The Author

Alden Abbott

Alden Abbott became Rumpel Senior Legal Fellow and Deputy Director of the Meese Center for Legal and Judicial Studies at The Heritage Foundation in April 2014. He previously served as Director of Patent and Antitrust Strategy for BlackBerry, and in a variety of senior government positions, including director of antitrust policy for the Federal Trade Commission; Acting General Counsel of the Commerce Department; Chief Counsel for the National Telecommunications and Information Administration; and senior counsel in the Justice Department. Alden is also an Adjunct Professor at George Mason Law School, a member of the Leadership of the American Bar Association’s Antitrust Section, and a Non-Governmental Advisor to the International Competition Network. Alden was a Visiting Fellow at All Souls College, Oxford University, in 2005, and a Wasserstein Fellow at Harvard Law School in 2003. He is active in the Federalist Society.

CLICK HERE for Alden's bio page on Heritage.org.

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Discuss this

There are currently 12 Comments comments.

  1. Anon January 17, 2016 10:59 am

    I reject the premise of this article for two separate reasons.

    1) buying this view enables a divide and conquer approach to subverting patent laws. Patent law is largely – and should be – noncommittal to one art field over any other art field. Making fundamental “exceptions” based on art field only invites gaming of the system, and an improper emphasis on fundamentals better left whole and complete.

    2) the “but we are not successful elsewhere” line of thought is a false logic. By this, I mean that nowhere else is it even attempted to have as sacrosanct and unmovable the notion that “failure” needs to be supported. There is an underlying message in this faux-support “necessity:” making the process of drug-development “stagnant” and a business unto itself. By removing the “pain” of failure, we also remove ANY urgency for making the development process itself better, more robust, more fruitful, cheaper, or any other advances that Necessity (being the mother of invention), would then turn around and demand of the process.

    Making new drugs is important. Sure. No argument there. But we should NOT let that importance hold hostage the betterment of the drug development system. We should not let ourselves be shackled with subsidizing failure. We should not allow EXTRA benefit (just because of “this art field“) above and beyond ANY OTHER art field.

    Leastwise, not through the patent system. In fact, there are other non-patent legal mechanisms in place. Let’s not compromise an already under-siege patent system with any more “special interest” types of complications.

  2. Bemused January 17, 2016 12:36 pm

    Anon,

    Agree completely with your post. The author of this article mentions the weakening of patent rights but the article seems to be focused on antitrust and legislative rules that require greater disclosure without once explaining what weakening of patent rights he’s referring to. If the author means the weakening of patents rights as a result of the AIA, here’s my response: So sad; too bad. If pharma hadn’t supported the patent (de) reform bill that resulted in the AIA, it would have never passed Congress. So instead of using its massive lobbying dollars war chest to get an exemption from the AIA for pharma patents, how about pharma use some of its clout to get significant changes made to the AIA so we can get some balance back into the system?

  3. nat scientist January 17, 2016 2:37 pm

    Let it be noted that this discussion is taking place almost exactly 100 years since the War on Natural Molecules and the Professions that serve them was begun just previous to World War 1. “Oh. what a tangled web we weave when we first practice to deceive.”

  4. Paul F. Morgan January 18, 2016 12:10 pm

    This is not a comment on the merits of the specific anti-trust litigation noted above. But as to the general allegations of being picked on, it is important to note that several pharmaceutical companies have brought an anti-trust onus on themselves by very abnormal patent litigation settlement agreements like “pay for delay” of low cost generic drug competition that were objectively bound to eventually be held to be potential anti-trust violations.

  5. xtian January 19, 2016 11:39 am

    I see by the substance of the comments, none of the commentators actually practice patent law on behalf of a pharmaceutical company.

    @ Paul – please read the fine print of the “pay for delay” cases. Most, if not all, of those settlements results in the brand allowing a generic product on the market prior to expiration of the brand’s patent. outside of the pharmaceutical space, this is called licensing and it not an antitrust violation.

  6. Anon January 19, 2016 3:43 pm

    Xtain,

    Please provide substance since you seem to be implying a lack thereof in my post.

    Where exactly – and why – do you take issue with what I have stated?

    And yes, I do know of particular details which support my views. It is just not necessary to be strictly a practitioner in the pharma arts to understand how the system works (and I do have litigation experience in that particular art field in which I was privy to documents backing up my views.

  7. Paul F. Morgan January 19, 2016 4:18 pm

    Xtian, you are beating a dead horse on “pay for delay” agreements following the Supreme Court Actavis decision and the subsequent decisions. Just as one reported example, the FTC* reaching a $1.2 Billion disgorgement deal with Teva, [which now owns Cephalon] on the eve of trial over FTC allegations that the drugmaker paid four generics makers about $300 million to hold off on launching cheaper versions of the narcolepsy drug Provigil.
    No, patent suit settlement agreements where the patent owner pays the infringer, instead of the normal opposite, were NOT normal patent licensing agreements.
    *The FTC had publicly challenged these agreements ever since they first started to be used, so it cannot be argued that they were ever innocently contracted as free of AT risk.

  8. xtian January 20, 2016 8:12 am

    @Paul – Look at the history of the “pay-for-delay” settlements. The Provigil case settlement stems from a 2008 FTC lawsuit, which charged that Cephalon unlawfully protected its Provigil monopoly through a series of agreements with four generic drug manufacturers in late 2005 and early 2006.

    So, ten years ago this may have been the practice. My point is that I believe pharma has moved way past the settlement terms of the Provigil case (i.e., plunking down cash for generics to settle). However, my beef with the current theme from the FTC is that the FTC view’s any settlement that is something other than letting a generic on the market as soon as the generic wants as anticompetitive (even when the brand lets the generic on the market prior to patent expiry.)

    What this means is that the Brand’s cost of completing litigation (until final appeal) is now less than the FTC’s punishment (disgorgement of profits). Thus, the unintended consequence of FTC enforcement (to protect consumers) is that generics are actually kept off the market longer than they would have been absent a settlement (and actually harming consumers). (Assumed in this analysis is that the Brand has a composition of matter patent on the product)

  9. Xtian January 20, 2016 8:26 am

    Anon – I interpret your post to mean that you believe pharma should not be allowed to consider the costs of its failures when pricing a successful product. The only way one gets to a “fair” pricing in your view is to take only successful products and then retrospectively account for the cost directly to that product to determine its pricing.

    This is pure hindsight bias which assumes past events (getting a successful drug product to market) were predictable. I fundamentally reject this view. I truly believe that if you had first hand experience in the pharma industry, you would hold different beliefs.

  10. Anon January 20, 2016 9:39 am

    Xtian,

    You take my post incorrectly.

    I do not speak of the normal practice of choosing a price (which may or may not amortize any number of things) at all.

    Instead, I speak directly to the fallacy of trying to obtain special patent treatment because of “gee, this is so hard.”

    The first has nothing to do with patents.
    The second is a logically bogus argument that would have (and has had) deleterious effects and hides behind patents that which should NOT be hidden.

  11. Eric Berend January 20, 2016 10:25 pm

    I have no sympathy for trite elitists acting like spoiled children – e.g., “big pharma”. Especially when, said “children” provided the ‘heavy lifting’ which resulted in the entire apple cart being tipped over (so to speak).

    Boo hoo. Pompous, self-entitled overgrown brats imagined that they would always ever be favored in patent law affairs, even when they supply the critical difference in forces that control legislation and influence the legal bar so as to poison the well for everyone.

    Then to put a new height on egregiousness, these *enfants terribles* whine and moan for a special exemption, in their cavalier myopic elitism. I have absolutely no sympathy for their plight – NONE WHATSOEVER!

    In fact, a reasonable reading of these circumstances in justice, could fairly assert that if any special exemption should be applied henceforth, then it should manufest as said mendacious ‘big pharma’ entities being the only patent applicants subject to AIA laws, while all others are reverted to the conventions and establishments of the former (U.S.) regime.

  12. Eric Berend January 20, 2016 10:30 pm

    @11: Note, small device affected ‘typo’ “manufest” above; should be spelled “manifest”.