Pharmaceutical innovations are the ultimate public good. They are ideas that make it possible for society to address otherwise unmet health care needs. As ideas, however, they are also hard to find and easy to copy.
As such, fostering valued, pharmaceutical innovation is a policy paradox. In a truly “free market,” no firm would have incentive to invest in drug development. Yet, without competition, the value created by innovation accrues only to firms – and not to the health systems that pay for them.
Let us explain.
At the risk of stating the obvious, pharmaceutical innovation is seldom easy or cheap. Innovating is like searching for something without knowing exactly what you are looking for… or even knowing exactly where to look!
Though, as Louis Pasteur put it, “fortune favours the prepared mind” in such a search, there is no guarantee of success. Even when publicly funded basic science has identified potentially fruitful lines of inquiry (where to look), hundreds if not thousands of candidate drugs need to be tested to find one sufficiently safe and effective to be sold on the market.
Published estimates place the total cost of developing one successful drug, including the cost of attempts that fail en route to discovery, on the order of CAD$100-million to CAD$1-billion. No for-profit company would invest such sums of money if the fruits of their labour could readily be copied and sold cheaply by competitors.
Enter the patent.
Patents are arguably the most heavily relied upon mechanism for fostering technological innovations in our economy. The pharmaceutical industry would be virtually nothing without them.
Despite their broad use, however, patents are commonly misunderstood policy instruments.
Contrary to popular belief, the purpose of a patent is not simply to reimburse firms for research and development costs or to compensate them for losses on failed projects. Patents are intended to give firms incentive for efficient innovation, which requires that firms carefully weigh their investment decisions *before* (and during) research activities.
Patents – like other market mechanisms for stimulating valued economic activity – are “forward looking” in the sense that they reward success not effort. Specifically, patents provide a prospective reward for successful innovation that is in portion to the value of the innovation itself – not the cost of research.
Patents create the prospective reward by giving innovators government-sanctioned, time-limited monopolies for novel and useful technologies. In exchange, the innovating firms must place the technologies in the public domain following patent expiry so that anyone can freely copy and build upon them. This bargain – short-term monopoly followed by public access to the technology – is the crux of the patent system.
With a monopoly, a firm can charge a price well above the levels that would be possible in a truly competitive marketplace. Specifically, the firm can charge a price limited only by the market’s willingness to pay for the drug they offer. Thus, during the life of a patent, the patent holder will secure a total profit in proportion with the market’s willingness to pay.
If willingness to pay is proportional to societal value for technology (a big “if” when viewed from a global perspective), the patent system gives firms a near optimal incentive for efficient R&D investment. Firms will not engage in risky R&D if the market value of a therapy is too small relative to expected research costs – or if expected research costs are too large relative to market value.
While a firm profits during the life of a patent, society pays a premium price. Most – if not all – of the societal value of the product is thereby recouped by the firm, not the health care systems that use the product. Further, the artificially high price of the technology during patent protection precludes some uses of it – again, most troubling from a global perspective.
These problems – firms recouping most of the benefit while excluding some from benefiting through monopoly pricing – can be justified provided that competition prevails following the patent. When competition drives prices down – ideally to the cost of production – the net benefits of the technology begin to accrue to the health system.
The importance of post-patent competition is often overlooked in our zeal for innovative new products. However, it is in cheap but effective old medicines and technologies that health systems find the greatest value for money spent.
Resources are scarce and health needs virtually unlimited. Maximum health benefits are generated when health care systems optimize the use of competitively priced technologies so that higher-cost technologies are only used when necessary, and only when priced appropriately. In the face of scarcity, to do otherwise is to do more harm than good to your population.
Because the mark-ups possible for a patent-holding brand are so high, post-patent drug prices can and should fall dramatically. In highly competitive markets for medicines – including New Zealand, the Netherlands, the US VA Health System, and Canada’s hospital sector – prices of generic drugs can fall by 85% or more relative to the previously-patented brands they copy.
While post-patent competition leaves little or no more monopoly profit on the table for the firm that held the patent, it is the ideal outcome of a system that relies on patents to stimulate innovation. The innovating firm was rewarded with profits in proportion to societal value during the patent and the post-patent competition allows society to purchase far more health outcomes in the long run.
Post-patent competition in Canada’s pharmaceutical sector is as important as ever. Globally, we are in the midst of a five-year period wherein over USD$120-billion worth of traditional (small molecule) pharmaceuticals will lose their patents. With evidence that Canadians continue to pay much more than comparable countries for generic drugs, policy reforms to encourage value-creating price competition are desperately needed.
Moreover, currently the biggest drivers of total drug spending in Canada are biologic drugs. A wave of biologic drugs with global sales over USD$67-billion will lose their patents by 2020. Though fostering price competition for such products poses unique challenges, the policy goal for Canada remains the same: significant price reductions following patent expiry. Best minds and best efforts need to be put to the task.
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