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Drug Companies Facing ‘Patent Cliff’

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Baseball players are sometimes used to illustrate the elusive nature of success. Players who maintain a batting average of .300 throughout their careers – meaning they failed to get a hit 70 percent of the time – often are named to the sport’s hall of fame.

If the pharmaceutical industry enjoyed a similarly lofty rate of success, we would live in a very different world. But it doesn’t, and the looming “patent cliff” that drug companies are facing is pushing the issue of patent protections for medications into the national spotlight.

Many of the industry’s blockbuster drugs, from AstraZeneca’s Nexium to Eli Lilly’s Cymbalta to Merck’s Nasonex, will be going off patent in 2014. This wave of patent expirations, referred to by some industry watchers as the patent cliff, has scared off some investors and prompted a round of consolidation among some of the world’s largest firms. Businessweek reports that this year alone, drug companies will lose patent protection on medications that bring in about $50 billion in annual revenue.

While consumers likely will benefit from the introduction of less-costly generic formulations of these drugs, some observers worry that the loss of revenue will hurt the research and development of new medications.

The reality of today’s drug industry is sobering: fully 95 percent of the drugs in development at any given time are doomed to failure, according to a recent Forbes article. Each failed drug, which will never be sold to a single patient or generate a penny of revenue, represents a lost investment of many years and hundreds of millions of dollars that never can be recovered. In the most spectacular cases, a failed drug can render a pharmaceutical company vulnerable to takeover by competitors or even put it out of business entirely.

That is why, when you pay for your brand name prescription at the pharmacy counter, you are, in effect, paying for 20 different drugs. When a pharmaceutical company does succeed in producing a drug that proves both effective and safe for humans, the revenue it generates must cover not only the costs of its own development but those of its failed siblings.

When that exclusivity period elapses, the proprietary chemical compound that comprises a drug’s active ingredient goes off patent, losing patent protection. The drug might remain in the marketplace, and often does, but any company that can produce the active ingredient is permitted to manufacture and sell a competing product that is substantially identical to the original brand.

In reality, 20 years significantly overstates the amount of time a drug has to earn back the money its manufacturer spent to develop it, according to Innovation.org. When a drug company successfully prosecutes a patent on a chemical compound, the drug may still need years of development before the completed medicine may be sold to the public. The development cycle for a single medicine, starting from the earliest experiments and progressing through multiple phases of animal and human testing to eventual FDA approval typically takes 10 years or longer.

As a result, a typical patented drug compound has only about 11 years of its original 20-year intellectual property protection left by the time it receives a branded name and reaches pharmacy shelves. Even then, the exclusivity provided by patent protection does not guarantee exclusivity within the market. The first drug of a particular type is typically on the market for less than two years before a competitor’s product arrives in the marketplace.

As ferociously competitive as the pharmaceutical market is, the narrow umbrella of economic opportunity provided by patents and other intellectual property protections may be the most important factor in ensuring that business interests have a financial incentive to fund the expensive research and development of new drugs.

In our next post, we’ll explore the interaction between this new business environment and the cost that patients and insurers pay for access to prescription drugs.