Patents are Critical to Pharmaceutical Innovation

prescription-bottleOne of the reasons why Sovaldi, for example, costs so much is that competitors cannot copy the pill and just churn it out at a lower price. It is protected by patents. Clearly patents have costs, and this blog has discussed alternatives.

No alternative has demonstrated that it can do what patents do: Attract R&D capital investment to pharmaceutical development. Will Rinehart of the American Action Forum has written a primer on the role of patents in pharmaceutical innovation:

Clinical trials provide an example of the costs to develop a market ready drug. As the Tufts Group has shown, the average length of a clinical trial increased by 70 percent from 1999 to 2005. In that same time period, the average number of routine procedures per trial increased by 65 percent. To add to that, the average clinical trial staff work burden increased by 67 percent. To top it all off, enrollment criteria and trial protocols resulted in 21 percent fewer volunteers being admitted into trials and 30 percent more enrollees dropping out before completion of the tests.

Overall, the regulatory process of drug approval levies a heavy risk for manufacturers and innovators. For every one drug that passes through the regulatory approval process, manufacturers usually assess 5,000-10,000 substances.

Despite the increasing regulatory burden on R&D, investors keep plugging away: Pharmaceutical R&D spending is now almost $40 billion per year. Investors would not do this without patent protection.

 

Comments (13)

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  1. Dan Carroll says:

    I agree with the implied point of the post: the FDA over-regulates drug discovery, which impedes innovation and drives up the costs of drugs. I believe the FDA should focus on safety, marketing claims, and risk disclosure, but not on efficacy in the approval process.

    However, patent law for pharma is inefficient. Instead of patent protection for a specified time period under current law, drug patents should protect a volume of sales (or some combination of volume and time). Thus, innovation is incentivized for all types of drugs, not just blockbuster drugs, and the incentive for prohibitive pricing is mitigated. I am also in favor of the government offering large rewards for critical public health innovations where the market fails to invest due to low profitability, such as with antibiotics.

    • John R. Graham says:

      Thank you. I think I see where you are going with that idea. I’ve thought of something similar myself. However, if you make patents too complicated, then that introduces other problems.

      • Dan Carroll says:

        The key change would be to tie patent life to a specific cumulative US$ sales volume (cumulative gross profit margin could be used as an alternative, as some drugs are more costly to manufacture than others, though that introduces manufacturing inefficiencies). The complications come with concessions – should grandfather clauses be allowed? should higher volume drugs get longer patents (because they have a bigger impact on public health)? should extreme low volume drugs have a time limit? A public choice problem is whether this would invite price controls as the government would be in effect offering longer patent protection in the future in exchange for lower prices now. The big benefit is incentivizing R&D dollars for low volume and/or niche markets. Another benefit is incentivizing a higher prioritization of safety, as manufacturers would willingly trade lower “safer” volumes today for future profitability. It might even induce companies to scale back DTC advertising and aggressive/corrupt marketing and distribution tactics, as it would no longer be necessary.

        • John R. Graham says:

          That means he patent office would regulate “gross profit margin” – a calculation which would be subject to all kinds of tampering.

          And I am not sure which way you are going on this. Do you want drugs will the largest sales to get the longer patents? In that case, I don’t see what problem is solved, because a blockbuster will have higher total lifetime profitability than a niche drug will, given the same patent life.

          If it is the drug with the smaller market, longer patent is effectively the way we do it today, via Orphan Drug Act, although it is binary and not textured like you advise.

          And that does not address the drug that might be good for a large population that has little income to pay for it, i.e. in sub-Saharan Africa.

          Also, if the market is competitive, there will always be sales and marketing. There is a positive relationship between sales budgets and R&D budgets, as I’ve demonstrated in research I did in the early 2000s.

          If companies are prevented from selling and marketing optimally, they reduce investment in R&D.

          • Dan Carroll says:

            I have the unfortunate tendency to try to address objections before my audience has fully understood the core proposal. Most of the concessions I cited were in anticipation of possible objections, and are not vital to the proposal. They can be dispensed with if they don’t work.

            The idea of gross profit is to take into account the higher cost of manufacturing for more complex drugs (future innovations are likely to be more complex). I don’t favor it over sales, for the reason you cited, but it would be a concession that could be considered if it could be done pragmatically.

            The other concession is a tiered approach – more sales for a larger patient population. This is essentially a concession that goes back partway to the current approach. I haven’t thought through the kind of formula that would be needed if this were to work. It attempts to address a theoretical problem that if the playing field is leveled between small and large market drugs, then investment in larger market drugs may be reduced. There are other ways to adjust the patent regime to address this problem, and it may not be a big enough problem to bother with.

            You are right, it does not address the Africa problem effectively. Charity is really the only way to address that problem short of miraculous economic growth. A concession could be offered to not count charity (or zero-gross profit sales) towards cumulative sales total. Prize money is the only other way I can think of to address that problem, but who will pay, US taxpayers? Prize money might work for antibiotics, but for Ebola I see public choice problems.

            There will always be sales and marketing, but right now the incentive is to sell as many pills as possible in the time frame allowed, as the primary way to maximize profit. This rewards risk-taking (selling stuff with higher health risks) and it rewards corrupt sales practices (bribing doctors). While current sales is always preferable to future sales due to the discount rate, under a cumulative sales regime the incentive to maximize short-term volume at the expense of patients is mitigated (though admittedly not eliminated) because the company doesn’t lose nominal sales if they are less aggressive or more risk-adverse. Adjusting the cumulative sales total for inflation will mitigate the discount rate effect as well (an established drug would act like a variable annuity probably with a discount rate of 4-6% plus inflation, depending on the availability of current and future alternatives).

            I haven’t read your research on sales and R&D budgets, but I am not surprised at the relationship. I would venture to argue that the relationship is at least in part a function of the time-based patent – larger sales budgets drive higher short-term volume, driving higher total drug profitability, thus lowering the hurdle for R&D projects and making available more dollars to invest in R&D. In contrast, a cumulative sales regime fixes total drug profitability in nominal terms irrespective of the sales budget. It has the advantage of predictability. In fact, I would expect greater investor interest in directly funding R&D given the annuity-like profit stream an approved drug would represent and the lower risk due to the larger number of opportunities.

            Of course, the actual amount of cumulative sales to fix would be the subject of much debate. My starting point would be to take the average lifetime profitability of an approved drug today, back into the sales total, and adjust it up or down based on the desire for investment funding.

            • John R. Graham says:

              Economic freedom for Africa would lead to all kinds of benefits!

              As for the relationship between pharma R&D and promotional spending – those articles are older than dirt. One from 2002 is at http://tinyurl.com/po3m8uq.

              I should probably update.

              • Dan Carroll says:

                I support charity and missions in Africa, and my daughter was born there. The suffering on that continent is immense. Without economic (and other) freedom and security, most charity is like scooping out the ocean with a measuring cup.

                I saved your article. What it appears to show, primarily, is that DTC ad spending serves a significant educational function, rather than a manipulative function that detractors charge (though it may not be a binary either-or outcome). Recent DTC ads I’ve seen come with a laundry list of risk disclosures that would neuter any persuasive effect.

                The key objective of my patent proposal is to increase investment in small-to-mid market drugs, and mitigate the need for high prices to recoup investment costs. Curbing excesses in marketing and risk-taking is likely also a benefit, even if the benefit is not as big as it appears.

  2. Thomas says:

    “Despite the increasing regulatory burden on R&D, investors keep plugging away: Pharmaceutical R&D spending is now almost $40 billion per year. Investors would not do this without patent protection.”

    They keep plugging away because there is such high payoff in manufacturing a pharmaceutical drug, especially specialty drugs. While it is flawed, we need patents to continue to incentivize R&D in medicine.

  3. James M. says:

    Patents are crucial to getting new drugs out on the market. However, I am not quite opposed to the prize grants that have been discussed in the past here. Patents can certainly be improved upon, but they do limit access with such high cost.

  4. Dale says:

    “Clearly patents have costs”

    The costs are very high for consumers, which is limiting access for patients. However, there needs to be an alternative that provides incentives for innovation and increases access to these drugs.

    • Bill B. says:

      There lies the problem with Sovaldi. They capitalize on the power from their patent and charge extraordinarily high prices. But at this point, how else would the manufacturer make back its R&D costs?

      • John Fembup says:

        Bill B, is it enough simply to “make back” the costs of R&D on any particular drug? I say no.

        Pharmaceutical companies lose money-usually pretty big money-on R&D that is ultimately unsuccessful. If the best they can hope for is to “make back” their costs on successful R&D, they will be unable to recover the costs of R&D into drugs that don’t pan out. What then?

        In other words, observing that successful drugs must pay for their own R&D is true but does not go far enough; successful drugs must also pay for other R&D that never results in anything the company can sell at any price.

  5. Bob Hertz says:

    For the moment, let’s accept the fact that pharmaceutical R and D costs $40 billion.
    I have some doubts about that number, but to save time I will accept it.

    It sounds like Sovaldi will cover perhaps 25% of the R and D number by itself!
    One drug.

    Pharma’s profit can cover $40 billion with ease, and have a lot left over for executives and shareholders.

    I still dislike and distrust the idea of anyone in health care ‘charging what the traffic will bear.’ Medicine is at heart a gift relationship.

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