how should we reward pharmaceucal innovaon? · • fixed cost of making album is ... incurred. no...
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Howdoesafirmrecoversunkdrugdevelopmentcosts?
• Twowaystodoso withoutgovernmentassistance
withgovernmentassistance(includingpatents)• Problemswithpatents
• Alterna0vestopatents– Subsidizedrugdevelopmentcosts
– Lumpsumawardsfordevelopingandsellingnewdrug
Natureofdrugproduc0oncosts
• Manygoodsareexpensivetodevelopbut,oncedeveloped,arecheaptomake
• Inotherwords,largefixedcosts,smallmarginalcost(MC)
Example:DigitalrecordingofaU2album
• Fixedcostofmakingalbumishigh(U2’s0me,studio0me,producers,etc.) Thispar0cularfixedcostis
‘sunk’meaningthatitcannotberecoveredaTeritisincurred.
NowaythatU2cangetarefundontheircostofmakingthealbum.
• Digitalcopiesofthealbumcanbeproducedanddistributedatverylowcost
Example:gasoline
• Highfixedcostofexplora0on,oilwells,pipelines,refineries,gassta0onsneededtosellgastoconsumers
• Rela0velylowmarginalproduc0onanddistribu0oncostpergallon
Example:newpharmaceu0caldrug
• Largesunkcost DiMasietalJHE2003suggestscostisashighas$800Mincludingthecostoffaileddrugsandinterestonfunds0edupduringlengthyR&Dprocess
• Rela0velylowmarginalproduc0on,marke0nganddistribu0oncostforcopiesofthedrug
Ingeneral,howcanfirmsrecoversunkcosts?
• Twowaysmightbepossible: Withoutgovernmentaid
Withgovernmentaid
• BoldrinandLevineintheirbook“Againstintellectualmonopoly”h_p://www.dklevine.com/papers/imbookfinalall.pdf
notethatinnova0ngfirmscanoTencoversunkcostswithoutgovernmenthelp
Coveringsunkcostswithoutgovernmentaid(B&LChapter6)
• Firstmoveradvantages• Innovatorcanextractprofitswhensupplyofgoodislimited
• Capacityconstraints• Saleofcomplementaryservices
• Tradesecrets• Collabora0onbetweenfirms
Innovatorcanearnprofitswhensupplyislimited
• SupposeBobhasproducedseedsforanimproved,disease‐resistantvarietyofcornthathespent$500,000developing
• BobcancommandapricewellaboveMConini0alsales.Why?
• Firstseedshesellsaresoldtobuyerswithhighestwillingnesstopayforseeds Theseareindividualsforwhom
improvedcornismostuseful Thesebuyerscanalsogrowthis
cornandproduceandselltheirowncopiesofthenewseedsandcouldbewillingtopayforthisprivilege
Otherfirstmoveradvantages
• Ittakes0meforimitatorstoreverseengineerthenewgood,developproduc0vecapacity,produce,promoteandsellthegood Duringthis0me,theinnovatoristhemonopolist
Tradesecretsperpetuatemonopoly
Otherfirstmoveradvantages
• Innovatorhaslongertoestablishabrandreputa0onamongconsumers CocaCola,TylenolandAmazon.comcon0nuetohavehighmarketsharesduetotheirbeingfirsttomarket
• Innovatorcaninvestinsufficientproduc0vecapacitytofloodthemarketwithlowcostcopiesofgood.Atthisprice,marginsaretooslimforimitatorstoincurfixedcostofdevelopingtheirowncapacity. Walmarthasspreadsorapidlythattherearefewmarketsremainingwherearivalcanearnsufficientmarginstocoverfixedcostsofdevelopinginfrastructure
Capacityconstraints
• Howcangasolineproducerscovertheirveryhighfixedcosts?
• Answeristhatquan0tyofgassoldislimitedbyoilrefininganddistribu0oncapacityconstraints
• Atthisconstraint,gasprice>MC
• DifferencebetweenpriceandMC,called‘rent’or‘margin’,coversfixedcosts
litresofgassold
Price,M
Cofgas
GasDemand
MCofproducing&distribu0nggas
IndustryRefiningCapacity
P
Q
margin
Saleofcomplementarygoods
• Firmproduces2goods.1. subjecttolowduplica0on
cost(e.g.U2album)2. isnot(e.g.U2concert)
• SupposethatU2albumwidelydownloaded
• Thiswillincreaseconsumers’WTPtoseeU2performlive.
• ProfitsfromU2’stourcancoversunkcostofproducingalbum
Collabora0onbetweenfirmswhenindustryyoung&innova0onisrapid
• Whenindustryisyoung capacityconstraintsarebinding:P>MC
• Wheninnova0onisrapid “Theinnovatorcorrectlyfiguresthatbysharinghisinnova0onhelosesnothing,butmaybenefitfromoneofhiscompe0torsleapfrogginghistechnologyandloweringhisowncost.Theeconomicgainsfromloweringowncost,orimprovingownproduct,whencapacityconstraintsarebinding,aresolargethattheyeasilydwarfthegainsfrommonopolypricing.”(B&Lpage153)
Coveringsunkcostswithgovernmentaid
• Patentsallowinnova0ngfirmtocontrolhowitscustomersusethegoodorservicethattheyhavepurchased thisiswhatBoldrinandLevinecall‘intellectualmonopoly’
• Paymentsfordeliverables(i.e.newdrugs): paymentsarehigher,largerthehealthgainsofnewdrugs
(Hollis) paymentsforsupplyingsay1,000,000dosesofaneffec0ve
vaccine(Kremer)• Subsidiesforcostofdrugdevelopment
Supportforbasicresearch(CIHR,NIH) R&Dtaxcredits Supportfordrugclinicaltes0ng(B&L)
Patents
• Patentsgiveinnovatortemporarymonopolysothatitcanprofitablyincreaseprice Withoutpatent,innovator’scustomerscancompetewithit,causingpricetofallandprofitstodissipate
Numberofpillsofdrugsold
Price,M
R,M
Cofdrug
Demandfordrug
MCofproducing&distribu0ngdrug
MarginalRevenuetoinnovatorP
Q
Profitmaximizingnumberofpillstosell:MR=MC
Patents
• Atthemonopolyprice,innovatorcanrecoupsunkR&Dcostandvariableproduc0on,marke0ng&distribu0oncosts:VC(Q)
• Inthisexample,revenuesmorethancoversunkR&Dandvariablecosts Firmearnsmonopoly
profitsaswell
Numberofpillsofdrugsold(Q)
Demandfordrug
MC
AC=[R&D+VC(Q)]/Q
Monopolyprofits
TotalCosts=AC*Q
Price,M
R,M
Cofdrug
ProblemswithPatents
1. Createdeadweightlosses2. Innovatorcannotappropriatemuchofthe
profitsdueto‘rentseeking’
3. Increasethecostofinnova0on4. Othersocialcosts• Bo#omline:noempiricalevidencethatstrongerpatentsproducemoredruginnova0on(B&L)
DeadweightLossofPatents
• DeadWeightLoss=netbenefitoftransac0onsthatdidnottakeplaceonaccountofthepricebeingsetaboveMC
• Example:lowincomeAfricanswillnotpurchasedrugsatmonopolyprice Numberofpillsofdrugsold(Q)
Demandfordrug=MB
MC
AC=(R&D+VC)/Q
DWL
Price,M
R,M
Cofdrug
Rentseekingdissipatesprofits
• Compe0torswilla_empttoappropriatesomeofinnovator’sprofits Counterfeiters Resellers Otherdrugcompanies Drugpayers
• Innovatorandcompe0torswillspendmoneyinba_leovercontrolofprofits
• Inequilibriumcostofba_leisequaltowhatpatentisworth
Counterfeiters
• Highmarginsencouragetheprolifera0onofcounterfeitdrugs.
• Stealmarketshare• Thesedrugsmightbe
unsafe,harmingtheconsumer/pa0entandthereputa0onofthepioneerfirm.
• Requiresinnovatortoinvestincostlyan0‐fraudmeasures
Source:GaoFeng/ImagineChina(h_p://www.newscom.com)‘CounterfeitdrugsbeingdestroyedinChina.Thousandsofdeathsandillnessesduetocounterfeitdrugshavepromptedauthori0estodestroylargequan00esofdrugs.’
Drugresellers
• Drugsellerswillexploitpricedifferencesacrossjurisdic0ons
• Requiresinnovatortoinvestincostlymeasurestopreventresale differentdrugforms supplychaincontrols
Me‐toodrugs
• Innovatorwillfacecompe00onfromtherapeu0callysimilardrugsthataresufficientlydifferen0atedtoavoidpatentinfringement
• Pioneerandme‐toosba_leformarketsharewithcostlypromo0onofdubioussocialvalue
Drugpayers
• Highdrugpricestriggergovernment‐imposedpriceregula0onandotherrestric0onsthatdefeatpurposeofpatents PMPRB CommonDrugReviewof
costeffec0veness Costsharingandformulary
restric0ons
• Drugcompaniesthenhiremarketaccesslobbyists
Increasesthecostofinnova0on
• Standardtextbookmodelofpatentsappliestoa‘standalone’inven0on
• Increasingly,however,druginnova0onissequen0al,buildingonpreviousdiscoveries therapeu0cproteins,diagnos0ctestsforgene0cdiseases,rawgenomicDNAsequences,andreceptorsusefulforscreeningpoten0alpharmaceu0calproducts.
• Inthisworld,patentscanbemixedblessing Goodifyoucangetapatentbutgeungoneismoreexpensiveifnewdrugbuildsonpatentedtechnologies.
Increasesthecostofinnova0on
• Evidencethatanyincreasedincen0vetoinnovateismorethanoffsetbytheincreaseddifficultyofdoingso
• PeterRingrose,chiefscien0ficofficeratBristolMyersSquib,toldtheNewYorkTimes:therewere‘morethan50proteinspossiblyinvolvedincancerthatthecompanywasnotworkingonbecausethepatentholderseitherwouldnotallowitorweredemandingunreasonableroyal=es’
(B&Lpage250)
Increasesthecostofinnova0on
• Innova0oninbiotechandsoTwarenowincurssubstan0alli0ga0onrisk.Solu0ons: Waitforpatentstoexpire Arrangeintolicensingarrangementswithpatentholders
Amassyourownpatentporwoliosothatyoucancrediblythreattocountersueforinfringementofyourownpatents• Createsapatentsarmsrace
Othersocialcostsofdrugpatents
• Costofapplyingforpatent Legalfees,patentofficecosts
• Useofpatentsystemtoblockgenericentry E.g.profitableto0eupgenericincourt,delayinggenericentry
andpossiblypaydamagesbasedongenerics’foregonesales• ‘Evergreening’strategiestoextendpatentlifeonmolecule
bytweakingitandcrea0ngnewlypatentedmolecule.Examples: Nexium(esomeprazole)isthe(S)‐IsomerofLosec(omeprazole) Clarinex(deslora0dine),ametaboliteofClari0n(lora0dine) Valtrex(valacyclovir)ismetabolizedtoZovirax(acyclovir)
Desirablecharacteris0csofadruginnova0onassistancesystem
• Revokes‘intellectualproperty’rights Avoidsba_lesoverpatents Reducescostofinnova0on
• DrugpricesclosetoMC Avoidsrentseekingac0vi0es AvoidsDWL
• Rewardsdevelopmentofmore‘important’drugs• Contribu0onsbydonorstatesaretransparentandrenegingoncommitmentsnotpossible
Proposedformsofassistance
• Paymentsfordeliverables(i.e.newdrugs): paymentsarehigher,largerthehealthgainsofnewdrugs(Hollis)
paymentsforsupplyingsay1,000,000dosesofaneffec0vevaccine(Kremer)
• Subsidiesforcostofdrugdevelopment Supportfordrugtes0nginhumans(B&L)
BoldrinandLevine’sidea
• Tes0ngofsafetyandefficacyofnewdrugsonhumansisaclassicpublicgoodandshouldbefundedbygovernments Thiswoulddrama0callyreducethecostofdrugR&Dtodrugcompanies
Alsowouldproducemoreinforma0veclinicaltrials• Meaningfulhealthoutcomescouldbecompared• Trialscouldcompareefficacyofnewdrugsvsstandardtherapies
– Currentlyalltrialsneedtodoisestablishthattheyworkbe_erthannothing
Makinggovernmentpayforthetrialwouldcurbgovernment’stendencytomaketrialsmorecostlybyaddingmoreandmoreregula0onsandcondi0ons.
Kremer’sidea
• Kremer:awardfundstodrugcompaniesthatdevelopeffec0vedrugs
• Problemisspecifyingthetechnicalcharacteris0csofthedrugbeforehandandtheamountofmoneyneededtoinduceeffort
• Amountofmoneywouldbeatleastasmuchasitcouldearnwithoutfund.
• Alsoproblemwithsponsorrenegingoncommitments
Hollis’idea
• Heopera0onalizesKremer’sideabygivinginnovatorsashareofapharmaceu0calinnova0onfundthatispropor0onaltotheincreaseinNetBenefitsthattheirdruggenerates IncreaseinNetBenefitfromyourdrugAcomparedtoexis0ng
drugB=(Netbenefit)A‐(Netbenefit)B (Netbenefit)A=[p*QALYA‐cA]*qA
• Where p=standardizedvalueofaQALY(QualityAdjustedLifeYear)
producedbyaunitofyourdrug cA=produc0oncostofunitofyourdrug qA=unitsofyourdrugconsumed Thefirmwouldobtainpointsforeverysaleofitsdrug,no
ma_erwhoproducedorsoldit
Limita0onsofHollis’idea
• PrimaryproblemisoneofmeasuringtheQALYgainsofeachnewdrug Howtomeasureu0lityweightsforvarioushealthstates?
Howtoes0mateeffectofdrugfromotherfactors?• Rewardswouldnotbedeterminedun0lenough0mehadelapsedforQALYgainstoberealized.
• Alsoracestobefirstsothatthebar(i.e.netbenefitfromexis0ngdrug)issetrela0velylow
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