The Economics of Drug Discovery and the Impact of Patents
The pharmaceutical industry’s reliance on patents to incentivize innovation has far-reaching implications for drug discovery, pricing, and public health. While patents provide crucial incentives for companies to invest billions in research and development, they also create a system that can sometimes prioritize revenue protection over innovation. This essay examines the impact of patents on research incentives and innovation in order to better understand the tension between patents that foster pharmaceutical advancements and those that focus on extending market power by deterring competition.
The Cost of Drug Discovery
Bringing prescription drugs to market is an expensive and time-consuming process. Pharmaceutical companies screen some 5,000 to 10,000 chemical compounds for each new drug approved for human use. This initial process involves high-throughput screening of compounds against specific biological targets, followed by more detailed studies on promising candidates.
Regulatory approval adds another layer of cost and complexity to drug development, as companies must navigate a series of rigorous clinical trials to establish safety and efficacy for Food and Drug Administration (FDA) approval. These trials typically occur in three phases.
Phase I involves testing for safety in a small group of healthy volunteers to assess factors like tolerance and maximum dose.
Phase II focuses on evaluating efficacy and side effects in a larger group of patients that are experiencing the condition.
Phase III aims to confirm effectiveness, monitor for potential adverse effects, and compare the new drug to commonly used treatments in a large, diverse patient population.
This extensive research and testing process contributes significantly to the overall time and expense of bringing a new drug to market, and only 12 percent of drugs that make it to the initial stage of clinical trials ultimately gain FDA approval. This process is often followed by additional post-market trials to monitor longer-term effects on the broader population.
Due to these built-in expenses, the costs of bringing a drug to market vary widely, but they are substantial: One study, for instance, found a range of $161 million to $4.5 billion (in 2019 dollars) per drug. This wide range reflects differences in factors like therapeutic targets, development complexity, and firm size. Cumulatively, the U.S. pharmaceutical industry spent $83 billion on research and development in 2019 alone. These costs are often legitimately cited as one justification for strong patent protection and higher drug prices. However, a recent study of 60 FDA-approved drugs found little correlation between research and development spending and treatment costs, suggesting that other factors also shape the economics of the pharmaceutical industry.
Drug Discovery: Patents, Markets, and Regulations
Regulatory and market forces both influence drug discovery. In addition, competition from rival companies shapes investment decisions, as firms must consider not only the potential market for a new drug but also the likelihood of competing products emerging. Market size and other factors, such as unmet medical needs, insurance, and rebates, play crucial roles in determining profitability as well. A patent can protect a pharmaceutical product, but if another company can enter the market with a similar product that achieves the same or better result, the original patent’s value is reduced significantly. This dynamic encourages companies to invest in areas in which they believe they can maintain a competitive advantage. Often, this means investing in extensions to existing drug portfolios to create new patents that may delay competition.
The business model for drug discovery follows directly from the patent system. Patents allow pharmaceutical companies a period of time to recoup their initial investments, typically lasting 20 years from the application filing date. However, by the time a drug is brought to market, it usually has an average of 12 to 15 years of exclusivity remaining. This period is crucial for companies to generate revenue and profit from their investments. And yet the FDA’s approval process—which also must be navigated in order to ensure drug safety and efficacy—adds even more time and cost to development. This regulatory framework interacts with the patent system, as the effective patent life of a drug is reduced by the time spent in clinical trials and awaiting approval.
To offset the costs of drug approval, the FDA may grant additional exclusivities that can further delay generic entry, thereby potentially increasing the return on investment and encouraging specific areas of pharmaceutical development. These areas of exclusivity include, among others, New Chemical Entity Exclusivity, which lasts for five years; Orphan Drug Exclusivity, which offers seven years of additional protection; and Pediatric Exclusivity, which adds an extra six months to existing exclusivity periods.
Patents, Secondary Patents, and Lifecycle Management
Patent protection significantly influences drug-pricing strategies throughout a product’s lifecycle. During the exclusivity period, a lack of direct competition allows companies to set higher prices. After patent expiration, generic competitors typically lead to substantial price reductions; one study, for example, found that, in markets with 10 or more competitors, generics can lower prices by as much as 80 percent after three years.
However, drug companies often utilize secondary patents, evergreening, and similar tactics to keep generics at bay and thereby preserve elevated prices for longer periods. These strategies may include developing new formulations for existing drugs, such as extended-release versions; combining existing drugs into new “combination therapies;” finding new uses for existing drugs; and patenting peripheral aspects of the drug like manufacturing processes or dispensation form. This strategic use of secondary patents can effectively prolong market exclusivity and maintain monopoly prices well beyond the initial patent period by delaying the entry of more affordable generic alternatives.
Deploying secondary patents over a product’s lifecycle is not uncommon. In fact, one researcher found that “78% of the drugs associated with new patents in the FDA’s records were not new drugs coming on the market, but existing drugs.” Not surprisingly, this secondary-patent strategy tends to focus on top-selling blockbuster drugs, which generate the greatest profits. The study goes on to note that, of the 100 most-prescribed drugs, 70 percent had their exclusivity extended at least once, and 50 percent were extended more than once.
The authors of another study examined the patents on 432 new drugs approved between 1985 and 2005 and found that secondary patents were extremely common with these drugs as well. Moreover, secondary patents were often filed after the drug’s approval, providing an average of six to seven additional years of patent protection. Higher-selling drugs are more likely to obtain secondary patents post-approval, which suggests a strategy of evergreening intended to extend market exclusivity.
In many instances, secondary patents are weaker than the primary patent and may not display novel or non-obvious qualities, making their validity ripe for legal challenge. Nonetheless, secondary patents still can delay generic competition for many years, highlighting their significant role in deterring generic entry. The authors argue that focusing solely on primary patents underestimates the true extent of pharmaceutical patent protection. They conclude that “[o]ur analysis of patents filed after drug approval reveals that independent secondary patents are not randomly distributed. Firms’ propensity to obtain independent secondary patents after drug approval increases over the sales distribution, suggesting [that] they reflect deliberate attempts by branded firms to lengthen their monopoly for more lucrative drugs.”
Another recent study examining the patent portfolios of the 10 highest-grossing prescription drugs in the United States for 2021 revealed that a significant majority (72 percent) of patent applications for these drugs were filed after FDA approval. The density of what’s known as the patent thicket was greatest around 13 years after FDA approval, with a median of 42 active patents per drug—two-thirds of which were filed post-approval. The study additionally found that the majority of post-approval patents covered aspects other than the drug’s active ingredient, such as methods of use, formulations, and manufacturing processes, which demonstrate how post-approval patent applications contribute to patent thickets and delay generic competition without offering substantive innovations. These authors suggest that closer scrutiny of patent applications, particularly those filed after FDA approval, may better facilitate generic entry and competition. Additionally, inter partes review conducted by the Patent Trial and Appeal Board provides an efficacious system that weeds out invalid secondary patents that impede rivals from entering the market.
Lifecycles and Portfolio Management
Pharmaceutical company strategies to manage drug portfolios and protect market position may include intentionally slowing the development of new drugs to safeguard existing patented products. Companies also engage in pipeline manipulation, or “portfolio management” carefully timing the development and release of new products independent of societal need or therapeutic value.
For example, a study of “killer acquisitions” found that pharmaceutical firms behave strategically when making acquisitions, with acquiring companies less likely to complete the development of drugs in the acquired company’s pipeline if they overlap with their own portfolio. This effect was strongest in instances of limited competition, such as drugs with long periods of exclusivity remaining.
Additionally, firms can engage in “product hopping,” which involves switching to a newer version of a product with a longer period of exclusivity. Through these methods, pharmaceutical companies aim to maximize their market monopoly and maintain profitability, though such practices can sometimes postpone the introduction of potentially beneficial new treatments or more affordable alternatives.
Conclusion
The economics of drug discovery are intricately linked to the patent system. Patents can encourage investment in innovative research through the promise of significant financial returns. But they also can detrimentally lead companies to focus on extending patent protection for existing drugs by filing multiple patents or secondary development of patents on different aspects of a drug or slightly modify formulations without significantly contributing to therapeutic value.
The debate over pharmaceutical patents and innovation is likely to intensify as health care costs continue to climb and as new, expensive therapies enter the market. Policymakers will need to grapple with the tension between providing strong incentives for innovation and facilitating competition to drive down prices of life-saving medications. Striking the right balance will require thoughtful reform of patent laws, regulatory processes, and market incentives to ensure continued innovation while improving affordability and access to essential medicines.