Thursday, 3 July 2014

Drug deals gone bad

I was shocked - shocked! - to read in the Economist last week that drug companies, faced with the prospect of superprofits on patented drugs evaporating when the patents expire and the off-patent drugs can be substituted by much cheaper 'generics', have been paying generics producers not to enter the market.

The Economist says "Since the early 2000s “pay for delay” agreements have become more common. A company with a patent due to expire strikes a deal: it pays potential entrants a fee not to compete, preserving its monopoly. A pay-for-delay deal between AstraZeneca and three big generic manufacturers helped to protect Nexium from competition between 2008 and May 2014".

I don't know what the legal status of these contracts is in the US, but I do know what our competition law says. "No person", says s27 of the Commerce Act, "shall enter into a contract or arrangement, or arrive at an understanding, containing a provision that has the purpose, or has or is likely to have the effect, of substantially lessening competition in a market", and if "pay for delay" isn't one of those contracts, agreements, or understandings, then I don't know what is.

The American Constitution wisely forbids "cruel and unusual punishments", which is just as well, as otherwise there would be a good case for tattooing the words of s27 or its American equivalent in large letters on the foreheads of the corporate executives involved.


  1. Isn't this Coasean bargaining?

  2. Do the patentholders and the generic makers solve a problem and strike a deal that sees them both better off than not striking a deal? Yes (if that's Coasean bargaining). It also happens to be illegal (here, for certain, and if not overseas, then should be). I've been having a similar sort of conversation in another context about incumbents using the RMA to block competitors opening new outlets: you can see why they do it, and in this case it's a perfectly legal use of their rights, but it's also designed to obstruct competition and rort consumers.

    1. Well, I would imagine this wouldn't be happening unless both the patentholders and the generics were better off dealing than not dealing. I certainly wouldn't claim this is morally justified. But what I am trying to get to, purely as an economics question, is whether this is a genuine market failure which genuinely requires Government intervention (and if so where exactly is the failure), or whether it's something that market forces would eventually sort out for themselves. As patentholder profitability rises, so too does the potential for profit by slightly cheaper competitors, and so too does the cost of paying to keep those competitor out. There must come a point when it's actually cheaper for patentholders to compete than to keep paying off /all/ of their competitors (for there's no point only paying off a few of them)?

    2. Thanks for the comment and apologies for delay in replying, I've been having a detached retina fixed. Anyway. Two market failures, I would suggest: I'm kind of sceptical of market failures and generally believe markets can work solutions out (as you suggest), but I think there are two here. The first is the well-known one behind the case for patents - less innovation will occur than is socially optimal because free-riders will reverse engineer or copy the innovator, who won't, without some protection (patent, copyright) be able to earn back the R&D costs if faced with competitors who never bore them. So some innovations won't be undertaken, and society loses. Patents enable the R&D recovery and also the positive externality of knowledge spillover as patent info is published. You could do it other ways (prizes, for example) and reward innovation that way, but however you do it, you protect the innovator from free riders. That's all conventional stuff. The other market failure here is that there doesn't seem to be a deep market in generic manufacture since the patentholder can buy off the small number of potential competitors. If say the patent drug had a profit of $10 a pill, and the generic $1 a pill, the patentholder could buy out 3 generics at $2 each and still be able to earn $4. But it wouldn't be able to cut any deal that worked for both sides if there were 10 or more potential generics. There aren't "enough" generics when "pay for delay" is observed.
      On the morality or ethics of it, my main beef is the obstruction of the competitive process, but I also don't warm to the undermining of the social contract around granting a patent. The deal is, generous protection, for a limited time. Side deals effectively extending the protection time (albeit not at full patent protection level) strike at a socially useful device.

  3. That's a good bunch of comments/questions. I'm at the NZAE conference at the mo so can't give a stab at answers right away. I'll put my thinking cap on. Comments or assistance from others also welcome...

  4. contradicts the predatory pricing literature

  5. Thanks Jim and and apologies for delay in reply, as noted above I'm just out of eye surgery. I'm not sure I wholly get your drift here. Are you saying that in these circumstances, we'd expect to see predatory pricing by the patentholder as a first response to see off generic entry, we don't and see "pay for delay'"instead, so predatory pricing isn't a good general theoretical idea in the first place?


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