Why pharma's 'anti-competitive' practices may actually be good

Is it Worth it for Generics to Challenge Patented Drugs. Copyright © Building Biotechnology
Is it Worth it for Generics to Challenge Patented Drugs? Copyright © Building Biotechnology

The FTC is reportedly seeking $1 billion from pharmaceutical companies for the role in paying generic companies not to challenge their patents. Despite first appearances, these agreements for a generic company not to challenge a patent, called ‘reverse settlements’, may actually be good for innovation.

The rationale for reverse settlements is discussed in my textbook, Building Biotechnology, and the box “Is it worth it for generics to challenge patented drugs?” summarizes some of the financial considerations behind patent challenge.

Is it too Easy to Challenge a Patent?

Consider the case of Abilify, which had sales in excess of $6 billion last year. Under provisions the Hatch-Waxman Act, the first generic challenger to defeat a patent on a drug is eligible for 180 days of generic exclusivity. In this period, the generic tends to sell for roughly 80% of the price of the branded drug, due to there being no other alternatives.

So, the math for a generic company is pretty clear. In an ideal case, on winning a patent challenge, the generic would get 80% of the revenues (due to the lower sale price) of half the market share of the patented drug for six months, or roughly $2.4 billion dollars (I realize the math is very rough here, but it’s simply to illustrate a point). The cost of litigation may be roughly $10 million dollars (AIPLA Economic Survey). And there are stage-gates along the litigation path that enable a patent challenger to limit their legal expenses, meaning they can ‘test’ their patent challenge before committing to the full amount.

The potential for generic challengers to obtain a better-than 100-fold return-on-investment on patent litigation creates the potential for innovative firms to become mired in potentially frivolous patent litigation. While the cost for each challenger may be $10 million dollars, the innovator could face dozens of lawsuits and therefore face substantial budget drains to reactive patent protection, which would limit their ability to invest in new drug development. Accordingly, innovative firms have been paying generic companies not to challenge their drugs. This effectively changes the financial incentives for the generics. If they feel that they have a particularly strong case, then they should certainly go ahead and challenge a patent to obtain their 100-fold ROI. But if they feel that there is a chance they will not win the challenge, then obtaining a financial settlement to withdraw their challenge may be preferable.

But isn’t this anti-competitive and monopolistic behavior?

Perhaps, but consider that patents themselves are essentially tools that create temporary monopolies. The reason why the government provides these temporary monopolies is to incentivize innovation. To quote Building Biotechnology once more:

…patents provide a means by which the public can gain valuable cutting-edge scientific knowledge and abilities in exchange for a temporary grant of monopoly, which allows innovators to recoup their investments in research and development.

So, while reverse settlements, and patents, may negatively impact competition in the near-term, they are part of a large scheme which drives long-term innovation by providing temporary benefits to innovators. When these benefits expire, society as a whole wins because the innovations become freely available and normal competition can drive down prices and ensure wide-spread adoption.

What do you think? Is there a case for reverse settlements? Sound off in the comments below.

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