Howshouldwerewardpharmaceu0calinnova0on?

PaulGrootendorstUniversityofToronto

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