From Barron’s …
Editorial Commentary
Fouling Up Our Pharma —- The inventive drug industry is a victim of the endless search for a free lunch
By Thomas G. Donlan
7 August 2006
Some of America’s most inventive companies have been presented with dire necessity to invent in new ways. Their industry is extremely competitive, with companies large and small struggling to come up with new products to meet almost insatiable consumer demand. Those products have a relatively short life, as some competitors bring similar products to market and others simply manufacture imitations.
This industry is not entertainment or fashion or publishing or software, although it has characteristics in common with them. It is the pharmaceutical industry, and its members must invent more than just drugs. They have to invent legal and business strategies to cope with a plague of regulators.
The U.S. Food and Drug Administration ranks as one of the more important and ineffectual federal regulatory agencies. Not that any are as important as they think or as effective as they might be, but the FDA really does handle matters of life and death — and does it capriciously yet slowly.
The U.S. Patent and Trademark Office is devoted to legal minutiae and overwhelmed with more minutely inventive applications than its enormous staff can handle. Patents are granted without adequate review, on theories that ought to be questioned before they get to court rather than invented at trial or appeal.
Combining the two agencies’ flaws begins to explain the tangled mess that is the pharmaceutical industry of the United States, in which patents on drugs are endlessly open to challenge, in which promising drugs are held up for excessive regulatory review, in which profit must be made quickly.
But there’s more: Congress has a natural interest in the drug industry, arising from constituents’ desire to get more medicine and pay less for it. Since the federal Medicare and Medicaid programs pay for a lot of those constituents’ medications, Congress also has a budgetary interest. So far, Congress has resisted the temptation to follow the rest of the industrialized world and impose overt price controls. Instead, it has created a morass of incentives and disincentives and marketing restrictions.
And still more: Collusion and market manipulation are natural responses of any industry to over-regulation; the Federal Trade Commission is ever-vigilant but only occasionally effective at detecting and challenging restraints of trade.
Rules of the Game
The segment of the pharmaceutical industry that concentrates on drugs with patent protection was once known as the ethical drugs industry, but ethics is just too far out of fashion these days. Now it’s called the brand-name drugs industry, which distinguishes it from the generic-drugs industry.
Brand-name, bad. Generic, good. It’s as simple as that for some people, because brand-name drugs are expensive and generic drugs are cheaper. Such people are especially abundant on Capitol Hill, where Congress has spent more than 20 years passing laws to promote generic drugs.
The first and greatest milestone of generic-drug promotion was the Hatch-Waxman Act of 1984, by which Congress told the FDA to accept abbreviated new drug applications for generic drugs that are chemically identical to brand-name drugs, rather than forcing makers to go through the same testing that preceded approval of the original inventor’s drug. (Patented-drug makers were given a longer patent term, partly to offset the harm that generics would do their products and profits.)
Among the results: lower prices for consumers of certain older drugs, an increase in generic market share, wild competition among generics to be the first in the market for each drug and a scandal at the FDA as officials took bribes to expedite some generic approvals and slow down others.
Another feature of Hatch-Waxman that was not widely appreciated at the time allowed generic-drug companies to go to court to overturn patents without actually having to put their own imitation into the marketplace first. The usual process for challenging a patent is for the imitator to enter the market and then be sued by the patent holder. This poses risk of triple damages for the imitator that loses, and the patent holder controls the pace of the process. Under the changed law, successful challengers also win the race to be the first generic in the market, for which the prize is a six-month marketing head-start ahead of all other generics — a lucrative temporary monopoly created by destroying the original patent.
Endless Battles
The result, of course, was a large increase in the number of patent challenges.
In 2002, the Federal Trade Commission reported that three out of four challenges to patents protecting brand-name drugs were successful if litigated to a final verdict. This may have something to do with the competence of the Patent Office examiners. Or it may reflect the willingness of brand-name manufacturers to drag out their losing cases as long as possible, because not even a year’s worth of huge legal fees can overshadow a year’s worth of huge profits on patented drugs. Generic challengers, on the other hand, have a financial incentive not to throw good money after bad. A patent challenge can take five years and cost $10 million. They settle weak cases and move on.
The FTC, however, charges that often there is a different reason: an illegal restraint of trade.
In dozens of recent cases, the patent holder and the patent challenger have reached settlements in which they agree that the challenger’s generic will be allowed into the market before the patent expires.
To the FTC and other critics, such authorized generics are against consumers’ interests, because they are sold at a smaller discount than “real” no-holds-barred generics.
In some such cases, the patent-holders have even paid the patent challengers to gain a settlement to their advantage. These the FTC terms “abusive,” and it has sued to block several such deals. Last year, however, two federal appeals court panels ruled in favor of the companies making deals, on the grounds that parties contesting a case have the right to make peace on terms that satisfy them. The FTC, which believes the terms should satisfy consumers, is asking the Supreme Court to take up the cases and it’s continuing to bring cases in other appellate court districts. Bristol-Myers Squibb headquarters recently was raided by FBI agents seeking documents for such a case.
Meanwhile, Sen. Charles E. Schumer, D-N.Y., and some colleagues have introduced a bill to limit authorized generics. Schumer said they are “wolves in sheep’s clothing,” because they push out generics that might be cheaper.
Unexpected Consequences
The pursuit of lower prices by any means available is an old game played by sheep in wolves’ clothing. People who make no contribution to the advancement of technology nevertheless claim a right to have the fruits of invention at a price of their choosing.
Results of this hunger for a free lunch:
All U.S. patents are less reliable. The FTC’s opposition to authorized generics effectively presumes that patents are invalid and that regular generics should always be allowed to move in. Authorized generics come into the market years sooner than the patent expiration, which would be good for consumers’ short-term cash flow unless the patent would otherwise be found invalid.
Prices of patented drugs have risen far faster than inflation. Now that a patent is no guarantee of monopoly rights for a certain term, companies that invent drugs face a new incentive to hike prices to make as much as they can as quickly as possible.
Prices of drugs in general, both patented and generic, are wildly unpredictable and unstable. For their biggest customers, manufacturers discount heavily.
The United States is nominally the last free market for pharmaceuticals because it does not have price controls. With a legal and regulatory regime like this, it doesn’t need them.
