Patent-Term Extension and the

Pharmaceutical Industry

August 1981

NTIS order #PB82-100918
Library of Congress Catalog Card Number 81-600113

For sale by the Superintendent of Documents,

U.S. Government Printing Office, Washington, D.C. 20402
Foreword

This report examines the relationships between patent-term extension and pharmaceutical innovation. Particular attention is paid to the social implications of patentterm extension. The report was prepared in response to a request from the Chairman - .

of the House Committee on the Judiciary and supporting

and the Ranking Minority Member of the Subcommittee

ment of the House Committee on Energy and Commerce.

The Office of Technology Assessment was assisted

prised of pharmaceutical industry representatives,

requests from the Chairman

on Health and the Environby an advisory panel comconsumer interest group

spokesmen, medical professionals, lawyers, and others concerned with health care and

pharmaceutical innovation. Reviewers from universities, Government, consumer interest groups, industry, and the law provided helpful comments on the draft report.

The Office expresses sincere appreciation to all those individuals.

Director

. . .

I l l
Patent-Term Extension Advisory Working Group

Marcia Greenberger

Center for Law and Social Policy

Peter Barton Hutt

Covington & Burling

Kenneth N. Larsen

Zenith Laboratories, inc.

David H. MacCallum

Paine, Webber, Mitchell & Hutchins

Robert Moser

American College of Physicians

Contributors and Reviewers

Gwynn C. Akin

Syntex Corp.

Rudolph J. Anderson,

Merck & Co., Inc.

Kenneth W. Clarkson

University of Miami

Joseph A. DeGrandi

Beveridge, DeGrandi,

Jr.

Kline & Lunsford

Fay Dworkin

Food and Drug Administration

Alfred B. Engelberg

Amster, Rothstein & Engelberg

James F. Flug

Lobel, Novins & Lamont

Robert Frankel

Food and Drug Administration

Benjamin Gordon

Public Citizen

Joseph Oddis

American Society of Hospital Pharmacists

Michael A. Riddiough

Pharmaceutical Manufacturers Association

Lewis W. Sarrett

Merck & Co., Inc.

William Vodra

Arnold & Porter

Fred Wegner

National Retired Teachers Association

American Association of Retired Persons

William F. Haddad

Generic Pharmaceutical Industry Association

Patrick C. Joyce

Chemical Manufacturers Association

Alan D. Lourie

Smith Kline Corp.

Willard Marcy

Research Corp.

Gerard J. Mossinghoff

U.S. Patent and Trademark Office

Wayne Roe

Health Industry Manufacturers Association

William Warden

University of Rochester

Sidney M. Wolfe

Public Citizen

John R. Virts

Eli Lilly & Co.

William A. Zellmer

American Society of Hospital Pharmacists

iv
Patent-Term Extension Project Staff

John Andelin, Assistant Director, OTA

Science, Information, and Natural Resources Division

Sam Hale, Acting Program Manager

Communications and Information Technology Program

Norman L. Balmer, Project Director

Donna L. Valtri, Assistant Project Director

Barbara Davies, Senior Analyst and Editor*

David F. Lean, Detailee from the Federal Trade Commission

Marjorie Jacobsf Research Assistant*

Jean G.

Administrative Staff

Monroe Elizabeth Emanuel

Contractors

Charles River Associates Inc.

Henry Grabowski, Duke University

Ronald W. Hansen, University of Rochester

Leonard G. Schifrin, The College of William and Mary

OTA Publishing Staff

John C. Holmes, Publishing Officer

John Bergling Kathie S. Boss Debra M. Datcher Joe Henson

‘OTACont ract petwlnnel

v
Contents

Chapter Page

1.

2.

3.

4.

5.

6.

EXECUTIVE SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

The Controversy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Findings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Innovation in the Pharmaceutical Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Trends in the Factors Affecting Pharmaceutical Innovation . . . . . . . . . . . . . . . . . . . . 5

Implications of Patent-Term Extension for Pharmaceuticals . . . . . . . . . . . . . . . . . . . 6

The Mechanics of Patent-Term Extension . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

THE ISSUE IN BRIEF . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...11

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .......11

The Patent System and Pharmaceutical Innovation. . . . . . . . . . . . . . . . . . . . . .....11

The Lifecycle of a Successful NCE Pharmaceutical. . . . . . . . . . . . . . . . . . . . . .. ....12

An Overviewof the Pharmaceutical Industry . . . . . . . . . . . . . . . . . . . . . . . .......16

The Issue of Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .......19

The Positions of the Parties Interested in Patent-Term Extension. . . . . . . . . .......21

FACTORS AFFECTING INNOVATION IN

THE PHARMACEUTICAL INDUSTRY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .25

Decisionmaking in the Industry. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .......25

Trends in Pharmaceutical Innovation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .......26

The Knowledge Base . . . . . . . . . . . . . . . . . . . . . . . . . .

Factors Affecting Returns to Research Investment . . . .

Trends in Revenues and Profits . . . . . . . . . . . . . . . . . .

The Costs of Research and Development. . . . . . . . . . .

Summary of Findings . . . . . . . . . . . . . . . . . . . . . . . . .

THE IMPLICATIONS OF PATENT-TERM EXTENS:

. . . . . . . . . . . . . . . . . . . . . . 26

. . . . . . . . . . . . . . . . . . . . . . 27

. . . . . . . . . . . . . . . . . . . . . . 28

. . . . . . . . . . . . . . . . . . . . . . 33

. . . . . . . . . . . . . . . . . . . . . . 35

ON

FOR PHARMACEUTICALS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .......39

Patent-Term Extension and Innovation . . . . . . . . . . . . . . . . . . . . . . . . . . . . .......39

Patent-Term Extension and the Cost ofPharmaceuticals . . . . . . . . . . . . . . . . . . . . ..41

Implications of Patent-Term Extension for Society . . . . . . . . . . . . . . . . . . . . .. ....43

Summary of Findings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .......45

THE FUNDAMENTALS OF THE PATENT SYSTEM . . . . . . . . . . . . . . . .......49

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .......49

The Role of Patents in Pharmaceutical Innovation. . . . . . . . . . . . . . . . . . . . . .. ....49

A History of U.S. Patent Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..50

The Pharmaceutical Patent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ....50

Securing a Patent. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .......53

Foreign Patents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .......55

THE MECHANICS OF PATENT-TERM EXTENSION . . . . . . . . . . . . . . .......59

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

Limitations in Scope and Enforcement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .......59

Limitations in Remedies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. ....64

The Duration of Extension. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64

Other Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .......66

Appendix: PATENT-TERM EXTENSION FOR OTHER INDUSTRIES . . . . . . . . . . . ..71

The Medical Devices Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .......71

vii
The Pesticide Industry ., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. ....73

The Chemical Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .74

LIST OF TABLES

Table No. Page

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

11,

12.

13.

14.

15.

16.

After-Tax Rates of Return on Average Stockholders’ Equity 1956-79 . . . ., . .......16

Sales Ranking of the Top U.S. Pharmaceuticals in 1980 . . . . . . . . . . . . . . . . .......18

Percentage of Corporate Pharmaceutical Sales Accounted for by

Three Leading Products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. ....27

Sales of Pharmaceutical Products of U.S. Based Firms 1965-78. . . . . . . . . . . .......28

Research and Development Expenditures and Sales Revenues of

U.S. Ethical Drug Industry. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .......28

Producer Price Indexes for Selected Years . . . . . . . . . . . . . . . . . . . . . . . . . . . ....,..29

Average Percentage Change in Producer’s Prices by Therapeutic Category, 1969-79 .29

Top Selling Drugs by Volume in 1980 and Year of NDA Approval . . . . . . . . .......30

Effective Patent Lives of 1980 Top Sellers by Revenues. . . . . . . . . . . . . . . . . . . . . ...31

Number of Firms Receiving FDA Approval and Number of Drugs Approved,

by FDA Drug Category . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .......31

Average and Median Number of Years Between IND Filing and NDA Approval

for NCEs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .......34

Trends in R&D Expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .......34

Relative Funding of Basic and Applied Research in the Pharmaceutical Industry ....35

Percentage of R&D Funds Spent by Therapeutic Class . . . . . . . . . . . . . . . . . . . . . . . . 35

Sensitivity of the Consumer Cost of Patent-Term Extension to Three Variables .....43

Activities Permitted Before and After Patent Expiration. . . . . . . . . . . . . . . . . . . . ...52

A-1. New Pesticide Chemicals Registered in the United States, 1967-79..............73

A-2. U.S. Pesticide Sales in 1970 Constant Dollars. . . . . . . . . . . . . . . . . . . . . . . .......74

LIST OF FIGURES

Figure No. Page

1. The Drug Development Process and the Patent Process . . . . . . . . . . . . . . . . . . . . . . 13

2. Annual Approvals of New Chemical Entities Reflecting FDA’s Judgment of

Therapeutic Potential.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

A-1. Pesticide R&D Expenditures, Domestic Manufacturers Reporting to NACA,

1967-78 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ., . . . . . . .......73

. . . Vlll
Chapter 1

Executive Summary
Chapter 1

Executive Summary

INTRODUCTION

Patents were designed to promote innovation

by providing the right to exclude others from

making, using, or selling an invention. They

enable innovators to obtain greater profits than

could have been obtained if direct competition

existed. These profits act as incentives for innovative activities.

Although the patent term in the United States

is 17 years, the period during the patent term in

which products are marketed (the effective patent term) is usually less than 17 years because

patents are obtained before products are ready

to be marketed.

Effective patent terms are influenced by many

factors, including Federal premarketing and premanufacturing regulations. The products covered by these regulations include pharmaceuticals, medical devices, food additives, color additives, chemicals, and pesticides. These products are subject to different regulations that

have had varying impacts on effective patent

terms.

The regulations governing the pharmaceutical

industry have contributed to a decline in the

average effective patent term of prescription

drugs. Pharmaceuticals cannot be marketed in

the United States until they have been approved

THE CONTROVERSY

Pharmaceutical firms that are heavily involved in basic research (research-intensive

firms) support legislation to extend patent

terms. These firms claim that the costs of R&D

are rising, effective patent terms are declining,

and the rates of return to pharmaceutical expenditures are becoming unattractive. They

maintain that, under these circumstances, a

decline in innovation would not be unlikely and

point out that future health care in the United

by the Food and Drug Administration (FDA).

To obtain such approval, drugs must undergo

extensive testing to prove they are both safe and

effective. While the pharmaceutical awaits approval, its patent term keeps running.

Concern exists that the decline in the average

effective patent term of pharmaceuticals may

result in diminishing profits, decreased research

and development (R&D) expenditures, and an

eventual decline in the introduction of new

drugs. Furthermore, to many, it appears inequitable that products subject to premarketing or

premanufacturing requirements are marketed

under patent protection for briefer periods than

products that are not subject to such regulation.

To address the concerns that have arisen

about innovation and equity, legislation has

been proposed that would extend the patent

terms for products affected by premarketing

and premanufacturing regulations.

Although this report briefly describes the

equity issue, its focus is on the relationship between patent-term extension and innovation in

the prescription drug industry. The effects of

patent-term extension on the members of the industry and on consumers are also examined.

States would suffer if pharmaceutical innovation declines.

Research-intensive firms believe that patentterm extension will provide encouragement for

research activities, raise the profitability of drug

research for successful innovations, and ultimate ly result in more innovative products.

They contend that the additional drugs will increase pricing competition among different

3
4 . Patent. Term Extension and the pharmaceutical Industry

products used fox the same or similar ailments

and that the consumer will actually save money

as a result of patent-term extension.

The firms that derive most of their revenues

from nonpatented, generically equivalent drugs

(production-intensive firms) believe that patentterm extension will delay their entry into the

market and that they will be economically

penalized for each year that the extension

prevents them from marketing drugs. They also

contend that for some drugs, the product life remaining after the extension may be too short to

justify their entry into the market. They believe

that competition will decline as a result of patent-term extension and that the costs of drugs

will therefore increase.

The production-intensive firms contend that

many drugs are covered by more than one patent and that the combined patent terms often result in patent protection for the drug in excess of

17 years. They also point out that as a result of

nonpatent barriers to market acceptance of

generically equivalent products, patented products often maintain an exclusive market position

even after their patents expire.

Production-intensive firms believe that some

extensions might be equitable in certain situations in which the combined period of protection from all patents on the drug during its

marketing is significantly less that 17 years due

FINDINGS

This study examines the issues raised by the

various interest groups. Unfortunately, much of

the data needed to differentiate between belief

and fact are unavailable or unreliable. The evidence that is available neither supports nor refutes the position that innovation will increase

significantly because of patent-term extension.

Thus, the net effects of patent-term extension on

pharmaceutical innovation cannot be ascertained. However, findings have been developed that

should serve to clarify or explain many of the

individual factors that have played, or will

play, a role in pharmaceutical innovation.

The following is a list of our major findings,

which will be discussed in more detail in the

later sections.

to excessive regulatory delay. They urge that

any legislation for patent-term extension

minimize any adverse effects on their industry

and facilitate their effective entry into the

market upon expiration of the extension. They

are opposed to any legislation that would enable

products covered by more than one patent to be

protected by patents for more than 17 years,

and they believe that the duration of the extension for any product should not exceed the actual marketing delay caused by premarketing

regulations.

Spokesmen for consumer interest groups believe that patent-term extension will result in

higher drug prices without providing better

health care. They point out that increased drug

costs will fall disproportionately on the elderly

and chronically ill (whose incomes tend to be

lower than average). They argue that the pharmaceutical industry is extremely profitable and

needs no additional incentive to conduct research, These groups are concerned that the legislation proposed to date provides no guarantees that additional revenues derived during

patent-term extensions will be invested in R&D

activities. Concerns are also expressed that expenditures made for R&D may not be directed

toward research areas that provide the greatest

benefit to society. Therefore, many consumer

spokesmen oppose patent-term extension.

● The costs of R&D for the average new

chemical entity drug have increased.

● Since 1966, average effective patent terms

have declined; some factors influencing effective patent terms are, however, changing and there is reason to believe that the

decline may be halted in the future.

● Revenues of the pharmaceutical industry

have increased steadily and the relationship

between revenues and R&D expenditures

has remained stable.

● The effects of governmental actions that

encourage use of generically equivalent

drugs have thus far been minimal on the

postpatent revenues of research-intensive

firms but could become substantial in the

future.
Ch. I—Executive Summary ● 5

●

●

The prices of drugs whose patents are ex- ●

tended are likely to be higher during the extended period than they would have been if

patent protection had ended.

Competitive pressures on patented drugs ●

from generically equivalent drugs will be

delayed and in some cases prevented by

patent-term extension.

The extension will increase the attractiveness of research on drugs that have

large markets but will not increase the

economic attractiveness of research on

drugs whose potential markets are small.

The effects of patent-term extension on innovation, the industry, and society will depend in part on the nature of the patent

rights during the extension.

INNOVATION IN THE PHARMACEUTICAL INDUSTRY

Pharmaceutical innovation has resulted primarily from the activities of private industry,

most of the expenditures being made by large,

multinational companies.

In the pharmaceutical industry a long period

exists between the initiation of research and the

marketing of new products. Thus, the rate of innovation observed today may reflect decisions

made 10 or 15 years ago, and decisions made today will affect innovation for the next decade.

The results of the innovative process in the

pharmaceutical industry are often measured by

the number of new chemical entity (NCE) drugs

that are introduced into the market. By this

measure, a sharp decline in innovation occurred

with the adoption of the 1962 amendments to

the Food, Drug, and Cosmetic Act, which substantially increased the stringency of the drug

approval process. The number of NCEs judged

by FDA to offer important or modest

therapeutic gain has, however, been relatively

stable. Although different measures produce

different results, by most measures innovation

does not appear to be increasing.

TRENDS IN THE FACTORS AFFECTING

PHARMACEUTICAL INNOVATION

Innovation will not occur unless industry

undertakes R&D activities. Many factors that

influence R&D decisions appear to favor innovation: the industry continues to enjoy high and

stable profits in terms of return to stockholder’s

equity; research techniques have improved; and

competitive pressure for innovation has not

diminished.

Nonetheless, there is a widespread belief that

the return to R&D investment is declining, and

this belief can affect R&D decisionmaking. Because data are insufficient to measure accurately

the return to research investment, we have focused on the underlying factors influencing the

returns. The major factors are the costs of R&D

activities, the amount invested in R&D, and the

revenues and profits of the firms conducting

research.

The costs of R&D activities associated with

an NCE drug have been increasing rapidly as a

result of inflation and more stringent and timeconsuming testing requirements. Because the

time spent in obtaining FDA approval may be

leveling off and new research techniques are

being developed, R&D costs should increase

more slowly in the future.

Real growth has occurred in expenditures for

R&D. The relationship between revenues and

R&D expenditures has remained highly stable

over the past 15 years. For the years 1965

through 1978, research expenditures averaged

about 8.5 percent of total sales.

The revenues and profits are influenced by the

competitive pressures exerted on drugs. The

competition may be from other patented drugs,
6 ● patent-Term Extension and the Pharmaceutical Industry

from nondrug therapies, or from generically

equivalent drugs that are produced by either

research-intensive firms or production-intensive

firms. Of the drugs having generic competition,

about 80 to 85 percent are sold by researchintensive companies.

Despite the decrease in the average effective

patent term that may have allowed generic competition to enter the market earlier, the revenues

and profits of research-intensive firms have thus

far not been significantly affected by generic

competition. But recent governmental actions

could result in increased competition from generically equivalent drugs. Most States now

have laws that allow or require generic equivalents to be substituted for brand-name drugs

specified in prescriptions. FDA has adopted procedures to facilitate approval of generically

equivalent drugs. The Federal Government now

bases its reimbursements for prescriptions paid

for under medicaid on the lowest wholesale

price of generically equivalent drugs. Furthermore the Supreme Court has ruled that laws

prohibiting the advertising of drug prices are

unconstitutional.

Despite Government action to encourage use

of generically equivalent drugs, barriers to the

acceptance of these products still exist. Physicians, who determine the market for prescription drugs, tend to write prescriptions for the

easily recalled brand-name drugs. Pharmacists

fear they will be liable if they fill a prescription

for a brand-name product with a generic equivalent that later causes injury. Furthermore, consumers tend to prefer drugs that look exactly the

same as the drugs they are accustomed to using.

Thus, the effect of generic competition on the

revenues and profits of research-intensive firms

in the future is uncertain. If generic competition

increases significantly, such revenues and profits could decline and R&D expenditures could be

reduced. There is a possibility that additional

generic competition could encourage research- —

intensive firms to increase their

itures in an effort to maintain

shares through drug innovations.

R&D expendtheir market

IMPLICATIONS OF PATENT-TERM EXTENSION

FOR PHARMACEUTICALS

Patent-term extension can encourage the development of new drugs through the incentives

it provides to the patent owner (patentee). But

by delaying use of the patented technology by

the public, it may also delay some improvements in patented drugs.

Patent-term extension specifically addresses

the prime concern of the research-intensive

firms: the perceived decline in the rate of return

to R&D investments attributed to the reduction

in effective patent terms. Whether R&D activities actually increase as a result of longer effective patent terms will, however, depend on decisions made in the private sector.

Since patent-term extension will not provide

additional revenues until original patents expire

and extensions begin to run, the immediate incentive provided by extension legislation is the

potential for obtaining greater returns on R&D

investment in the future. Once extensions do

begin, revenues for some firms will be greater

than they otherwise would have been, thus providing additional incentive for R&D activity.

The price of drugs whose patents are extended

will be higher during the extended period than

they would have been if patent protection

ended. The magnitude of the additional cost to

the consumer will be significantly influenced by

the extent to which generic competition would

have existed had the patent term not been extended.

The bulk of revenues generated by patentterm extension will accrue to a few firms who

have developed financially successful drugs.

The increased revenues may serve to perpetuate

their dominance in particular research areas,

and other firms, lacking expertise, may be

discouraged from entering these areas.
Ch. I—Executive Summary ● 7

Since the economic incentives provided by

patent-term extension will be greatest for drugs

with high income potential, the tendency of

firms to direct their research toward drugs with

large market potential will be reinforced. Some

therapeutic areas that are apt to produce economically marginal drugs may receive greater

attention as a result of patent-term extension

but patent-term extension will not affect research on drugs with small market potential.

The patent owner and the research-intensive

firm will generally benefit from patent-term extension. To the extent that a research-intensive

firm relies on revenues from the sale of generically equivalent drugs, its benefits may be

reduced.

Patent-term extension poses risks for

production-intensive firms. Although they depend on innovative new drugs to expand their

product lines, the remaining product lives of

drugs coming off patents will detemine their

long-term revenues. In some cases product lives

may be insufficient to justify their entry into the

market.

Consumers will benefit if more and better

pharmaceuticals are developed. These pharmaceuticals can provide substantial savings over

other forms of health care. The cost of drugs for

consumers will be higher than it would otherwise have been unless patent-term extension results in the introduction of more new drugs that

exert a downward pressure on the prices of existing drugs. It is expected that both the benefits

and the additional costs will affect the elderly

and the chronically ill more than other segments

of society; but patent-term extension will have

no effect on either benefits or costs for at least a

decade.

THE MECHANICS OF PATENT-TERM EXTENSION

The effects of patent-term extension can only

be fully assessed in terms of specific proposals,

because the effects will vary depending on the

particular form the extension takes. This report

has examined several proposed forms of patentterm extension to determine their possible implications for innovation.

Patent-term extension involves a modification of the present patent system. Therefore, in

order to understand extension proposals, one

must have a basic understanding of how the patent system works. In brief, a patent is granted

for an invention which may be, for instance, a

new drug, a new process for making a drug, or a

new method for using a drug to treat an illness.

A patent provides the right to the patentee to exclude others from making, using, or selling the

invention in the United States for 17 years, In

return, the patentee discloses his invention.

Once the patent expires, anyone is permitted to

use the invention.

The invention that is patented is defined by

claims which establish the boundaries of the invention, much like a deed establishes the boundaries of a piece of land. A claim for a particular

invention may thus include many potential

products or processes. When a patentee attempts to enforce a patent, the claim is compared with the product or process against which

the enforcement action is directed to determine

whether it is included within the definition of

the invention contained in the claims.

The effects of patent-term extension on the

rights of the patentee and on the ability of others

to use the invention will depend in part on

whether patent protection is extended for the entire invention defined by the claims or for only a

portion of the claimed invention. Effects will

also differ depending on whether limitations are

placed on the products, processes, and methods

for use against which the patent can be enforced.

Numerous proposals that affect patent claims

and their enforceability during the extension are

examined in this report. Of these proposals,

three enable the patentee to maintain an exclusive market position for the drug, while’
8 ● Patent-Term Extension and the Pharmaceutical Industry

allowing others to use the invention for some

purposes during the extension.

1.

2.

In the first of these proposals, the extension is provided for only those aspects of

the claimed invention that involve the

specific chemical contained in the drug approved by FDA and the patent is enforceable only against products, processes, or

methods-for-use that must be approved

by FDA. Of the three proposals, this one

provides the greatest protection to the

patentee.

It permits others to use the patented invention for anything except drugs and

allows others to make, use, or sell variations of the patentee’s specific chemical for

any drug therapy even though the variations may be included within the entire invention defined in the claims. It prohibits

use of the patented invention for a drug

therapy only if the patentee’s specific

chemical is used.

In the second proposal, the patent rights

are extended for the entire invention defined by the claim, but enforcement is limited to the specific therapeutic use approved by FDA. This proposal is broader

than the previous one in terms of the active chemicals that are protected, but the

patented technology can still be used for

other drug therapies.

This proposal permits the development

of the patented invention for all uses other

than the specific therapy approved by

FDA. Under this proposal, enforcement of

the patent would be difficult. A competitor could manufacture and sell the identical drug for a different therapy; the competitor’s drug might then be prescribed

and used for the patentee’s therapy. The

only remedy available to the patentee

would be to sue each of the prescribers or

users for patent infringement.

3. In the third proposal, the extension is provided only for those aspects of the claimed

invention which involve the specific

chemical contained in the drug approved

by FDA, and enforcement is limited to the

specific therapeutic use approved by FDA.

Of the three proposals, this one provides

the least protection to the patentee.

This proposal permits others to develop

the technology for all uses and allows

others to make, use, or sell variations of

the patentee’s specific chemical for any

drug therapy. Furthermore, others can

make, use, and sell drugs using the

patented technology and the patentee’s

specific chemical for any drug therapy but

the one for which the patentee obtained

FDA approval. Enforcement under this

proposal is difficult for the same reasons

that it is difficult in proposal 2.
Chapter 2

The Issue in Brief
Chapter 2

The Issue in Brief

INTRODUCTION

The U.S. Constitution vests in Congress the

power “to promote the progress of science and

the useful arts by securing for limited times to

authors and inventors the exclusive right to

their respective writings and discoveries” (art. I,

sec. 8). Since 1861, U.S. patent law has specified

that these rights shall be secured for a period of

17 years, beginning at the time the patent is

granted by the Government. The period during

the patent term in which a product is sold (the

effective patent term) is, however, usually

shorter than 17 years because patents are generally obtained before discoveries are ready to be

marketed.

Thus, although all patented inventions receive protection for the same amount of time,

the effective patent terms for the inventions

vary. The length of an effective patent term

depends on the amount of time needed to bring

an invention to market; this time is influenced

by numerous factors including the availability

of capital, the pace of product development,

and the ease with which distribution channels

can be established.

In recent years, Federal premarketing and

premanufacturing regulations have also played

a role in determining the effective patent terms

for particular products. These products, which

include pharmaceuticals, medical devices, food

additives, color additives, chemicals, and

pesticides, are governed by different regulations

that have varying impacts on effective patent

terms. Although there are some exceptions,

most of these products cannot be marketed until

they have been approved by the Federal Government. In some cases, such as pharmaceuticals, this approval is granted only after the

product has undergone lengthy clinical testing

and extensive review to ensure its safety and efficacy. Since the patent term keeps running during the testing and review period, the effective

patent term for the regulated product is reduced.

To remedy this situation, legislation has been

proposed that would extend the patent term for

products affected by premarketing and premanufacturing regulations. As proposed, these

extensions would provide compensation for the

period of time spent on testing and review of the

product but would not exceed 7 years.

The purposes of the proposed legislation are

twofold: to provide equitable protection to

products whose marketing is delayed by regulatory requirements and to encourage innovation

in industries affected by these requirements.

This study focuses primarily on the implications of patent-term extension for innovation in

the prescription drug industry. The subject of

equity to the patent owner is discussed only

briefly to provide the reader with a background

understanding of the issue.

THE PATENT SYSTEM AND PHARMACEUTICAL INNOVATION

Why are changes in the patent system viewed and excludes discoveries that do not reach the

as a mechanism for addressing concerns about market.

pharmaceutical innovation? The answer to this

question is rooted in the basic relationship be- According to theory, the primary incentive

tween the patent system and innovation. As provided to the patent owner (patentee) by a

used in this report, innovation means the in- patent is the ability to prevent for a limited time

production into the market of something new competitors from selling products of the same

11
12 ● Patent-Term Extension and the Pharmaceutical Industry

type as the invented product. If the market accepts the product, the patentee can enjoy an exclusive market position, which enables him to

charge prices that are higher than those he could

have charged if direct competition existed. The

potential for obtaining these higher prices can

justify the risks and expenses involved in innovative activities.

The patent system has many attributes as a

mechanism for promoting innovation. The patent system does not directly involve the Government in research and development (R&D) activities and does not necessitate complex regulatory or oversight activities on the part of

Government. Whatever rewards occur derive

from the marketplace. Because the patent system has undergone few changes in its 200-year

history, a change in patent policy, such as

patent-term extension, would probably be regarded as permanent, whereas a new program

to provide incentives for innovation might be

viewed as a temporary measure and therefore

provide little security to the industry.

The use of patents as an incentive for pharmaceutical innovation does, however, have

some limitations. Not all inventions can meet

the standards established for patentability. Furthermore, although patents are granted for

products, process for making products, and

methods for using products, product patents can

be more readily enforced than the other types of

patents and are, therefore, more meaningful.

The patent system may provide little or no incentive for the R&D of drugs that would be beneficial to society but that cannot be meaningfully patented. Furthermore, patent incentives

alone may be insufficient to encourage the R&D

of drugs that have a potentially small market.

In reading this report, the reader is cautioned

to remember that the patent system is only one

of many mechanisms available to the Government for promoting innovation. Innovation

could be encouraged by changes in tax policy,

increases in governmental funding of R&D,

alterations in the Food and Drug Administration’s (FDA) approval procedures, and improvements in the general economic climate.

This report does not address these other policy

options for promoting innovation, nor compare

them with the patent options.

THE LIFECYCLE OF A SUCCESSFUL NCE PHARMACEUTICAL

Before effective patent terms and innovation

are examined, it is useful to have a basic understanding of the drug development process. For

this reason a description of the lifecycle of a

drug from the discovery of a new chemical entity (NCE) to the end of its marketing life is provided. This description is not intended to be

representative of all innovative activity within

the pharmaceutical industry; rather, it is presented so that the reader will have a framework

for understanding later chapters.

Although important pharmaceutical innovations may result [rem new therapeutic applications of existing chemicals, new processes for

making chemicals, or new combinations or formulations of existing chemicals, this study concentrates primarily on innovations resulting

from the discovery or synthesis of NCEs. This

approach is used for several reasons. Many of

the pharmaceutical breakthroughs that have occurred have resulted from NCE research and the

development of NCEs generally has required

more time and money than other types of innovation and has involved greater risks. Moreover, because FDA testing requirements generally have been more time-consuming for NCEs

than for other types of innovation, they have

had their greatest impact on the effective patent

terms of NCEs. By focusing on NCEs, the most

extreme reductions in effective patent terms can

be determined, but these effects are not representative of the average effects for all new pharmaceuticals.

The drug development process for NCEs is

time-consuming and expensive and is characterized by a high probability of failure. A decade

or more may elapse between the time a chemical

having promising biological activity is identified
Ch. 2—The Issue in Brief ● 13

and the time it is marketed as a new drug. The

odds against developing a marketable pharmaceutical are great: on the basis of historic

trends, only 1 out of 7,000 to 10,000 new]y synthesized chemicals will be found to have promising biological activity.1 Only 1 out of 10 promising chemicals will survive to marketing. z Taking into account the R&D costs of chemicals that

fail to reach the market, one investigator has

estimated that discovery and development costs

per marketed NCE are in the neighborhood of

$33 million (1976 dollars). 3 This estimate applies only to NCEs discovered, developed, and

marketed by the same firm and includes only

direct costs.

1 William M. Wardell, “The History of Drug Discovery, Development and Regulation, ” i n issues itt Pllartlluceu fzcal Eco?Ionlics,

Robert I. Chien (cd. ) (Lexington, Mass.: Lexington Books, 197’9).

‘Ibid.

‘R. W. Hansen, “The Pharmaceutical Development Process:

Estimates of Development C{>sts and Times and the Effects of Proposed Regulatory Changes, ” in Issues in Phurmaceuticul

EcotIottIiL-s, Robert 1. Chien (cd. ) (Lexingtonr Mass.: Lexington

Books, 1979).

Knowledge of the relationship between the

drug development process and the patent process is essential for an understanding of the issues

surrounding patent-term extension. Figure 1

shows the steps involved in both of these processes and indicates that these steps are taken

concurrently. The patent process and the drug

development process are, however, independent

of each other and each progresses at it own

pace. Although the figure accurately depicts the

stages that a patented drug will pass through,

the duration of each of the stages varies.

Therefore, the relationship between the timing

of the drug process and the timing of the patent

process will also vary. A successful NCE must

pass through five stages of the drug development process: the discovery phase, the preclinical stage, the safety and efficacy testing stage,

the NDA (new drug application) stage, and the

marketing stage. In most cases, the NCE will

also be subjected to the patent process.

Figure 1.— The Drug Development Process and the Patent Process

alND notice of clalmed Investigational eXeI17pt10n for a new drug

bfq DA new drug appll CatlOn

SOURCE Off Ice of Technology Assessment
14 . Patent-Term Extension and the Pharmaceutical Industry

Drug Development—

The Discovery Stage

The discovery stage involves the synthesis or

isolation of new chemicals. 4 Initial screening

tests are conducted to determine whether the

new chemicals possess sufficient biological activity to be worthy of further investigation. This

stage may be relatively short if the research is

quickly fruitful. On the other hand, many years

or even decades may pass before a suitable candidate is discovered.

Drug Development—

The Preclinical Stage

Once a promising new chemical is identified,

the preclinical stage begins. In this stage, the

new chemical is tested in animals to determine

its short-term toxicity. Results of these tests are

studied carefully for indications that the chemical might not be safe to use in tests on humans,

The preclinical stage generally lasts from 1 to 2

years.

Patent Process—The Application

Although the patent process is independent

from the drug development process, in many

cases a patent application for an NCE will be

filed in the U.S. Patent and Trademark Office

(Patent Office) when a drug is at the discovery

or preclinical stage. Sufficient information exists

at this time to prepare a patent application

which fully complies with the patent laws. An

early filing of a patent application is encouraged

by the patent laws of the United States and most

foreign countries, since when two or more investigators independently arrive at the same

discovery, the investigator who first files a patent application generally has an advantage in

obtaining the patent. Also, early filing is encouraged since a disclosure of the invention

4

For a more detailed discussion of the discovery stage, the preclinical stage, the safety and efficacy testing stage, and the NDA

stage, see: R. W. Hansen, ‘Pharmaceutical Development Process, ”

William Warden, “History of Drug Discovery, ” and J. R. Virts and

J. Fred Weston, “Expectat ons and the Allocation of Research and

Development Resources, ” in Drugs aHd Health, R. B. Helms (cd. )

(Washington D. C.: American Enterprise Institute for Public Policy

Research, 1$%0).

before the patent application is filed can bar a

patent. (For clarification, see ch. 5.)

Several inventions may be made when an

NCE is discovered and developed such as the

chemical itself, the process for making the

chemical, and the method for using the chemical

to treat an illness. Separate patent applications

could be filed on each of these inventions.

Drug Development—The Safety and

Efficacy Testing Stage

The third stage of drug development involves

clinical testing and long-term animal toxicity

testing. These tests are conducted to satisfy the

premarket approval requirements of FDA.

These requirements that include the types of

tests, the procedures to be used, and the standards to be met, may vary among therapeutic

classes (groups of drugs used for similar purposes) and even among drugs for use within a

therapeutic class.

The third stage begins when a request for

authorization to begin human testing is filed

with FDA. The request is termed a notice of

claimed investigational exemption for a new

drug (IND). Once authorization is received, the

first of three clinical testing phases can be initiated. In phase I chemical testing, a small group

of volunteers receive dosages of the investigational drug for a short period of time. The

primary purpose of the phase I clinical testing is

to look for evidence of toxicity or undesirable

reactions. Phase I clinical testing can usually be

conducted in less than 1 year. Only about onehalf of the promising new chemicals identified in

the discovery stage survive through phase I

clinical testing.

Phase 11 clinical testing is similar to phase I

testing, but more human subjects are used and

the investigational drug is administered for a

longer period of time. The primary purpose of

phase II testing is to ascertain the effectiveness

of the investigational drug. Phase 11 clinical

testing may require about 2 years to complete.

Phase III clinical trials are conducted on a

large scale; they often involve several hundred

human subjects and are conducted for substan-
Ch. 2—The Issue in Brief ● 15

tial periods of time. These tests are designed to

determine the efficacy of the investigational

drug and to uncover any unanticipated side effects that the drug may have. Generally, phase

111 clinical trials last about 3 years.

While the phase III trials are underway, longterm animal toxicity studies are also conducted.

The purpose of these studies is to determine the

effects of prolonged exposure and the effects on

subsequent generations, The duration of the

studies and the animals used vary widely among

therapeutic classes. For drugs that affect the

reproduction system or that will be used over

long periods of time, the animal toxicity studies

will be expensive and of long duration.

Patent Process—Examination

and Grant

If the patent application was filed during the

discovery or preclinical stage, it is not unlikely

that the patent will be issued during the safety

and efficacy testing stage. Before a patent can be

issued, a patent application is examined by the

Patent Office to determine whether the invention is patentable (e. g., novel and not obvious in

view of the state-of-the-art). If the invention

meets these requirements, a patent is granted

(issued) by the Patent Office. The average

pendency of a patent application in the Patent

Office is about 2 years; however, the pendency

is subject to wide variations as will be discussed

in chapter 5. If more than one patent application

were filed in order to cover several inventions

made during the discovery and development of

a drug, these applications could issue as patents

at different times.

Drug Development—The NDA Stage

Before a drug may be marketed, an NDA

must be submitted to and approved by FDA.

Frequently, the NDA is filed before phase III

clinical tests and long-term animal toxicity tests

are completed. However, all the safety and efficacy tests must be completed before FDA will

approve an NDA. During the NDA stage, FDA

may require additional clinical or animal tests to

be conducted. The time required for processing

an NDA depends on the completeness of the

testing data, the performance of the drug, and

the speed with which FDA reviews the data. In

1980, the duration of the NDA phase (for NCEs)

varied from about 1 to 7 years and averaged

slightly less than 3 years. 5

The NDA is approved by FDA for a specific

drug that will be made by a specific process and

used for a specific therapy. If the innovator

wishes to change the composition of the drug or

its manufacturing process or if he desires to sell

the drug for a different therapy, he must file a

supplemental NDA and obtain FDA approval

for these changes.

Drug Development—

The Marketing Stage

By the time the NDA is approved, part of the

patent term usually has expired. The remaining

patent term may be the only time that the drug

has an exclusive market position.

The marketing stage is usually characterized

by three periods: the market-development stage,

the stable-market stage, and the declining-market stage. In the market-development stage, the

demand for the new drug increases. In the

stable-market period, the demand for the drug is

relatively steady. Later, the market for the drug

declines as new and better therapies and drugs

are discovered, and eventually the manufacturer takes the drug off the market. Depending

on the length of the effective patent term and the

product lifecycle, the patent may expire during

the market-development stage, the stablemarket stage, the declining-market stage, or

after the product has been removed from the

market. Once the patent has expired, others can

manufacture and sell the drug if they have

secured premarket approval from FDA. The approval procedure for generically equivalent

drugs is discussed in chapter 3.

5Departmen t of Health and Human Services, NeILt Drug Eualuat[otI Pro]ect, Brlefit~g Book (Washington, D. C.: Food and Drug

Administration, Bureau of Drugs, 1980).
.

16 ● Patent-Term Extension and the Pharmaceutical Industry

AN OVERVIEW OF THE PHARMACEUTICAL INDUSTRY

Pharmaceutical innovation has resulted

primarily from the activities of private industry.

Of the new drugs introduced in the United States

between 1960 and 1969, 91 percent were discovered and developed by the industry. b Government, nonprofit research organizations, and

universities were responsible for the remainder

of the new drugs. Because the public relies so

heavily on the industry for improvements in

drug therapy, efforts to increase innovation

must be based on a thorough knowledge of how

the industry operates.

Throughout the past four decades, pharmaceutical sales have increased steadily, with the

greatest growth occurring in the sales of ethical

drugs (products prescribed by health care professionals). The 1978 sales revenues (wholesale)

for ethical drugs were approximately $9.5 billion. Total U.S. expenditures for health care

were $192 billion of which $15 billion or 7.9 percent were for drugs and medical sundries.7 Although drug expenditures have increased dramatically over the past decade, they have increased much less rapidly than total health care

expenditures.

Since the 1950’s, the U.S. pharmaceutical industry has been considered one of the most

profitable of all major manufacturing industries. As shown in table 1, the industry’s aftertax rate of return on average stockholder’s equity has remained stable at a relatively high level

and has exceeded the average after-tax rate of

return for all manufacturing.8

The Industry Members

In 1979 the Federal Trade Commission staff

estimated that the U.S. pharmaceutical industry

consisted of 1,300 Firms, of which about 7 5 0

Table 1 .—After-Tax Rates of Return on Average

Stockholders’ Equity 1956-79 (in percentages)

Pharma- All Pharma- All

ceutical manufac- ceutical manufacYear industry turing Year industry turing

1956 . . . . . 17.6 12.3 1969 . . . . . 18.4 11.5

1957 . . . . . 18.6 11.0 1970 . . . . . 17.6

1958 . . . . . 17.7 8.6 1971 . . . . . 17.8 9.7

1959 . . . . . 17.8 10.4 1972 . . . . . 18.6 10.6

1960 . . . . . 16.8 9.2 1973 . . . . . 18.9 12.8

1961 . . . . . 16.7 1974 . . . . . 18.7 14.9

1962 . . . . . 16.8 9.8 1975 . . . . . 17,7 11.6

1963 . . . . . 16.8 10.5 1976 . . . . . 18.0 13.9

1964 . . . . . 18.2 11.6 1977 .., . . 18.2 14.2

1965 . . . . . 20.3 13.0 1978 . . . . . 18.8 15.0

1966 . . . . . 20.3 13.4 1979 . . . . . 19.3a 16.4

1967 . . . . . 18.7 11.7 1980 (1st 3

1968 . . . . . 18.3 12.1 quarters) 20.8 13.9

alndustrlal classifications were changed The percentage of compantes

reclassified In the drug Industry is unknown

Note For the purpose of this table, the pharmaceutical industry IS defined as

corporations prlmanly engaged In manufacturing tnoioglcals, inorganic

and organic medlclnal chemicals, pharmaceutical preparations, and

grading, grtnding, and mllllng of botanlcals

SOURCE: Quarterly Flnanclal Reports, U S Federal Trade Commlsslon

produced prescription drugs. ’ The prescription

drugmakers generally fall into two categories:

1) firms specializing in branded drugs (including

patented and generically equivalent drugs), and

2) smaller firms specializing in nonbranded

generically equivalent drugs. Throughout this

report, firms in the first of these categories are

referred to as research-intensive companies and

firms in the latter category are referred to as

production-intensive companies.

It should be noted that the line between

research- and production-intensive firms cannot

be easily drawn. Many research-intensive firms

produce generically equivalent drugs as well as

their own patented branded drugs. Both research- and production-intensive firms manufacture pharmaceuticals for each other, and

both may purchase the active chemicals that

they use in their products from other firms. In

“Federal Trade Commisit)n, “Drug Product Selection,” Washingtt~n, D. C., 1979 (staff report to FTC).

7U.S. Department of He,ilth, Education, and Welfare, Hcw/t)~

/.J~~Itd SIute-IW~, HEW publication No. (PHS) 80-1232 (Hy -

attsville, Md.: Public Health Services 1980, Office of Health, Research, Statistics, and Technology).

“The rates of return shown in table I were determined using an

accounting procedure that treats R&D expense as current expenditures rather than capital inv(’stments. Regardless of the accounting

procedure employed, the rale of return for the pharmaceutical in-

——. -—-

dustry is higher than that for all manufacturing. For further discussion see: Kenneth Clarkson, ltftat~gible Capital at~d Rates of

Returw (Washington, D. C.: American Enterprise Institute, 1977),

p. 64.

‘Federal Trade Commission, “Drug Product Selection, ” op. cit.
Ch. 2—The Issue in Brief ● 17

some instances production-intensive firms, such

as Generics Corp. of America, Biocraft Laboratories, and Philips-Roxane Laboratories, Inc.,

have engaged in NCE research.

Among the research-intensive firms, the size,

type, and scope of research activities vary considerably. Based on these activities, researchintensive firms can be divided into three rough

groupings:

1.

2.

3.

In

sales

The large multinational companies. —

These firms account for the dominant

share of pharmaceutical R&D expenditures. About a dozen domestic companies

fall into this class, including Eli Lilly,

Merck, SmithKline, Upjohn, and Pfizer.

Together, the companies account for over

one-half of U.S. ethical drug sales and

well over two-thirds of the private- pharmaceutical research in the United States.

The midsized companies, —These firms

are primarily domestic, have research programs of a much smaller scale, and account for about one-quarter of the U.S.

ethical drug sales. Included within this

group are A. H. Robins and Richardson

Merrell (Merrell National Division was

recently purchased by Dow).

The small research companies. —Thes e

firms often conduct research in a limited

therapeutic area. Firms, such as Marion

Laboratories, that license drug technology

and develop drugs for marketing in the

United States also fall in this class.

1978, 24 firms had U.S. prescription drug

that exceeded $100 million. 10 Foreign- .

based firms, such as Roche and Ciba Geigy, accounted for at least 25 percent of the firms in

this group. In recent years foreign-based firms

have increased their share of the U.S. market,

but these efforts by foreign firms are not surprising since the United States represents the largest

single market for pharmaceuticals.

In terms of worldwide sales, 10 of the 2 0

largest multinational pharmaceutical firms are

based in the United States. U.S.-based firms and

“’Henry Grabowski and John Vernon, “Government Policy and

Innovation in the Pharmaceutical Industry, ” draft report (Durham, N. C.: Duke University, 1980).

their affiliates account for more than 30 percent

of total world sales .1’ Pharmaceutical R&D of

U.S.-headquartered firms is, however, increasingly being carried out in other countries, which

may have less stringent controls on R&D activities than our own. In 1978, more than $220 million was spent for R&D conducted by U.S. firms

in foreign countries. *2

In contrast with the research-intensive firms,

about 600 production-intensive companies derive revenues primarily from the sale of nonpatented products marketed under the generic

name of the drug, rather than under a trademarked brand name. 13 Consequently, these

companies are often referred to as generic companies. Most of these companies have sales

amounting to less than $10 million per year.

They usually sell within limited territorial areas

and together account for only about 15 to 20

percent of the sales of drugs available from

more than one firm. *4

Because these firms generally do not engage in research or heavy drug

promotion, the price of their products need not

reflect such expenditures. Furthermore, the

markup on these products may be lower. Therefore, production-intensive firms frequently sell

drugs at prices that are considerably lower than

the prices charged by innovator firms. Although

some of these firms do engage in R&D activities

for the purpose of formulating and compounding existing drugs to improve their activity and

benefit to the patient, they generally do not

direct their research activities toward finding

NCEs.

The sales of U.S. production-intensive firms

are generally exclusively domestic. Many

production-intensive firms purchase drugs from

foreign manufacturers.

In recent years, the market for generic drugs

has been increased by some Government actions. For example, many States now allow or

require pharmacists to fill prescriptions for

‘ ‘Private communication with Henry Grabowski on July 3,

1981.

‘‘Charles River Associates, “The Ettects of Patent Term Restoration on the Pharmaceutical Industry, ” Boston, Mass., May 4, 1981

(report to OTA).

1‘Federal Trade Commission, “Drug Product Selection, r’ op. cit.

141bid,
. .

18 . Patent-Term Extension and the Pharmaceutical Industry

brand-named drugs with generically equivalent

drugs. Under medicaid, reimbursements to

pharmacists are limited to the cost of the lowest

priced drug among; generic equivalents plus a

dispensing fee. The FDA approval procedure for

drugs that are generically equivalent to existing

drugs has also undergone changes favorable for

generic competition. FDA plans to reinstate its

“paper NDA” procedure in which published

data of reliable safety and efficacy tests will be

accepted in lieu of actual tests conducted by the

second entrant. Also, in 1970, FDA adopted an

abbreviated NDA (ANDA) procedure for certain drugs approved prior to the 1962 amendments to the drug regulation law. Under the

ANDA procedure some drugs are able to obtain

premarket approval without the submission of

safety and efficacy data.

The Market for New Drugs

Industry undertakes R&D in areas that it believes will be profitable. The size of the potential

market plays an important role in the selection

of these areas. Two factors that influence the

market size for any particular new drug are the

number of people suffering from the ailment

treated by the drug and the advantage the drug

provides as compared with other drugs for the

same ailment.

For an ailment that is relatively uncommon,

the potential market may be so small that any

drug, regardless of its therapeutic value, will

have little chance of financial success. On the

other hand, drugs offering significant or moderate therapeutic advantages to a large number of

potential users will generally be financially successful because their advantages will enable the

drugs to capture significant market shares. Even

drugs that offer little or no therapeutic advantage to most users may be commercially attractive in a large market. Because physicians,

rather than consumers generally determine the

financial success of a drug, the creation of

markets involves a great deal of advertising

directed at physicians. On occasion, these marketing strategies can create a large market for a

drug that offers only minimal advantages. ’s

Drugs are frequently divided into categories

according to the types of ailments they are

designed to treat. The market share of different

therapeutic categories varies over time, but in

1978, sales of drugs directed at central nervous

system disorders were 23,6 percent of total U.S.

ethical drug sales; sales of anti-infectives were

15 percent. l6

Drugs that obtain major shares of the market

can meet with extraordinary success. Table 2

shows a ranking of the top eight prescription

pharmaceuticals in the United States by sales in

1980. Although the sales figures have not been

confirmed, they provide a relative indication of

total sales.

The sales figures for the most successful drugs

give little indication of average sales. In a study

of a group of 119 NCE pharmaceuticals introduced in the United States between 1967 a nd

ISROna]d Bond and DaVid Lean, “Sales Promotion, and Product

Differentiation in Two Prescription Drug Markets, ” Washington,

D. C., 1977 (staff report to the Federal Trade Commission. )

Ibchar]es River Associates, op. cit.

Table 2.—Sales Ranking of the Top U.S. Pharmaceuticals in 1980a

U.S. sales (in millions

Drug (trade name) Therapy Manufacturer of dollars)

Tagamet. . . . . . . . . . . Duodenal ulcers Smith Kline $250

Valium . . . . . . . . . . . . Antianxiety Roche $230

Inderal . . . . . . . . . . . . Antiarrhythmic Am. Home Pdts. (Ayerst) $200

Motrin. . . . . . . . . . . . . Antiarthritic Upjohn $150

Aldomet . . . . . . . . . . . Hypertension Smith Kline $145

Dyazide (dyrenium) . . Hypertension SmithKline $145

Keflex. . . . . . . . . . . . . Antibiotic Lilly $140

Clinoril . . . . . . . . . . . . Antiarthritic Merck $125

aBy revenues.

SOURCE: New York Trees, Sunday, May 17, 1981, quoting Oppenheimer and Co.
Ch. 2—The Issue in Brief ● 19

1976, the sales data (wholesale) were collected

for the years during which the drugs were sold.

Sales figures for products which were sold for

less than 10 years were projected on the basis of

historical trends. The top 25 percent of the new

drugs had average annual sales of $21.1 million,

and the lower 75 percent had average annual

sales of $2.3 million. 17 By doubling these

figures, one can approximate their value in 1980

dollars.

There are two important points that are not

portrayed by the simple sales average. First is

the extraordinary range of sales revenues for

different drugs. Second is the large percentage

of sales, attributable to a small percentage of

drugs. According to the study cited in the previous paragraph, 25 percent of the drugs on the

market accounted for about 90 percent of sales

revenues. These figures suggest that there is a

very large difference between the market shares

and earning power of the few top drugs and the

great majority of drugs. Throughout this study,

drugs that have sales of more than $75 million

per year will be termed high-income drugs.

Purchasers of Drugs in

the United States

In the United States, ethical drugs are purchased by patients, Government agencies, and

by pharmacists and hospitals (which resell them

‘“Virts dnd Weston, t>p. cit.

THE ISSUE OF EQUITY

A major argument for patent-term extension

is that it is unfair that products subject to

premarketing regulations have shorter effective

patent terms than products that are unregulated. The point is made by proponents of patent-term extension that industries required to

act in a socially beneficial manner should not be

penalized for their actions.

On the basis of this argument, it would appear that the patent period should be extended

purely as a matter of equity. Undoubtedly if

patent-term extension involved no costs to

to patients). In 1979, 53 percent of manufacturers’ sales were made to wholesalers (who

distributed mostly to retail pharmacies), 22.5

percent were sold directly to retailers, 14.9 percent to private hospitals, 6.3 percent to Government (including State and local government

hospitals), 1.4 percent to other Federal Government agencies, and 1.2 percent directly to

physicians. 18

The users of drugs do not necessarily reflect

the population as a whole. People over 65, who

are generally on fixed and limited incomes, constitute 11 percent of the population but make 25

percent of all drug purchases. Similarly, persons with chronic diseases such as arthritis,

angina, or epilepsy, will have above average

health expenditures, but, because of their ailments, may have below-average earnings.

Although third-party payments (Government, philanthropy, industry, and private

health insurance) constituted about two-thirds

of the payments for personal health care in

1978, only about 16 percent of the payments for

drugs and medical sundries in 1979 were covered by insurance or by Government reimbursement programs. 20

I ~pharmaceu t ica ] Manufactu rers Associa t lon, “20th Annual

Survey Report, ” Washington, D. C., 1980.

l~T’he office c~f Technology Assessment Workshop on Mar. 24,

1981, American Association of Retired Persons.

2oFreeland and Schencller, “National Health Expenditures:

Short-Term Outlook and Long-Term Projection, ” HLwlt/I Care

Fit~atIci~zg RtmIQUI (winter 1981).

anyone, there would be little disagreement that

regulated products deserve extensions. But there

are costs and there are disagreements.

Critics of the extension argue that what is

equitable for the larger pharmaceutical firms

may not be equitable for society. They urge that

the issue of patent extension not be decided solely on the basis of equitable treatment to the

large manufacturers but also on the basis of the

social costs and benefits that will result from the

extension.
20 ● Patent-Term Extension and the Pharmaceutical Industry

Although this report focuses on the innovation issue, nonetheless, it is useful to have some

understanding of both the nature and extent of

any inequities that may exist.

The Nature and Extent of the Inequity

There is concern that industries subject to

premarketing regulations are not receiving

equitable treatment from the Government. The

extent of the inequity is often equated with the

extent to which premarketing regulations delay

commercialization of the product. However, by

issuing a patent, the Government grants the

patentee the right to exclude others from making, using, or selling the invention; it does not

grant the patentee the right to sell, use, or

market the invention himself. Thus, even when

a patentee is awaiting premarketing approval,

his patent rights are exactly the same as the

rights of patentees who are not required to seek

premarketing approval.

However, the research-intensive firms do not

believe that the inequity derives from their patent rights, but rather from the marketing delays

caused by FDA regulations. Estimates of delays

caused by FDA are based on the average duration of the FDA approval process. One study

found that, on average, NDA approval for a

patented NCE was granted 6 to 9 years after an

IND had been filed.21 As seen earlier, however,

few products are ready for commercialization at

the time an IND is filed. Thus, that portion of

the FDA review period that would, even without FDA regulations, be used for testing and development cannot fairly be included in the FDAinduced marketing delay. Although the actual

marketing delays attributable to FDA (e. g.,

through regulatory proceedings, testing procedures, and performance standards) are not

precisely known, one can conclude that, in most

cases, the delays are less than the 6 to 9 years

consumed by the drug approval process.

Whether these delays actually result in an inequity is probably best determined by a comparison of the average effective patent terms for

pharmaceuticals and the average for all

products.

“Charles River Associ,ites, op. cit., p. 3-2.

According to a study of patented NCE drugs

receiving NDA aproval, the average effective

patent term for drugs approved in 1979 was less

than 10 years .22 Unfortunately, there are no

figures for the average effective patent terms for

all products, but a rough estimate can be made,

based on data on average lag time (the time that

elapses between the discovery and marketing of

a product). One study showed that the average

lag time for 319 significant innovations originating in the United States and introduced between 1953 and 1973, was about 7 years.23 If it is

assumed that in most instances the time between

the conception of the invention and the granting

of the patent was about 4 years, it can be hypothesized that the average product was not

marketed for 3 years of its patent life and that

the average effective patent life was, therefore,

probably greater than 13 years but less than 17

years. Based on these calculations, the conclusion can be drawn that the average effective patent term for significant innovations in general is

probably 3 to 7 years longer than the average

term for NCE pharmaceuticals.

This differential in the effective patent terms

of pharmaceuticals and other products has led

many to believe the extension should be provided, purely as a matter of equity. Others

point out that marketing of products is delayed

by many types of Government regulations, such

as those governing zoning permits or environmental impact statements and that the Government cannot possibly guarantee equitable treatment to all industries at all times.

Because of the time value of money, the revenues generated during an extension that was

equal to the actual delay caused by the FDA approval process would not fully compensate

firms for the revenues lost during the period that

marketing was delayed .24

ZZM, Eisman and W. Warde]l, “The Decline in Effective patent

Life of New Drugs, ” Reseurc)l Mat?agenlet~t, January 1981.

j~Ge]]man Research Associates, “Indicators of International

Trends in Technological Innovation, ” Jenkintown, Pa., April 1976

(final report to the National Science Foundation).

z~private Communicaticln with Henry Grabowski on Mar. 24,

1981.
Ch. 2—The Issue in Brief ● 21

THE POSITIONS OF THE PARTIES INTERESTED

IN PATENT-TERM EXTENSION

Legislation to extend patent terms has been

proposed and supported by the research-intensive firms. They argue that the FDA premarket

approval procedure for new drugs has inequitably and unintentionally shortened the effective

patent lives of pharmaceutical products. These

firms further contend that the costs of pharmaceutical R&D have been escalating rapidly,

effective patent lives have been declining, and

the rates of return to pharmaceutical R&D expenditures are becoming unattractive. They

point out that the ratio of R&D funding (deflated by the NIH biomedical deflator index for

research costs) to total sales (deflated by the

producer price index for ethical pharmaceuticals, Bureau of Labor Statistics) has declined by

over 35 percent from 1963 to 1979. They express

concern that incentives for R&D are eroding at

the very time that advances in science have created the possibility of major improvements in

drug therapy. In view of these trends, they contend that the rate of R&D investment will be insufficient for the rapid transition of scientific

advances. In such circumstances, they believe

that the user of drugs, and not necessarily the

pharmaceutical industry, will be the loser.

Some research-intensive firms argue that the

present trends have driven many companies

away from pharmaceutical R&D and diminished the commitment of others. Many research-intensive companies have shifted R&D

expenditures away from self-originated NCEs

and towards new delivery systems for existing

products because FDA approval can be obtained

if companies demonstrate that the potency of

the new product is equal to or better than the

potency of the existing product. Some of these

firms have increased their licensing of NCEs

from others and suggest that this increase indicates that basic research is being viewed with

increased caution.

It is the thesis of the research-intensive firms

that patent-term extension will raise the expected profitability of drug research. It will

therefore offset current pressures on decisionmakers to reduce the size of their research project portfolio and provide a positive incentive for

undertaking research activities. These activities,

in turn, would increase the rate of innovation.

The research-intensive companies welcome

an analysis of patent-term extension from an

overall health-care perspective. They point out

that innovative drugs save lives, reduce pain

and suffering, and provide substantial healthcare savings. Examples cited include an $11

pneumococcal pneumonia vaccine that can prevent a $3,300 treatment of the disease; a 22¢ per

day glaucoma drug that saves $590 in surgery

costs as well as hospitalization costs; and a

rubella vaccine that for $25 million in costs has

been estimated to provide a net savings to society of more than $1 billion. They believe that

patent-term extension will provide drugs that

offer better and less expensive health care, and

that it will result in the introduction of more innovative drugs. They contend that the additional drugs will increase the competition among

patented drugs and cause a downward price

pressure on patented drugs with a resulting savings to the consumer .25

The production-intensive firms believe that

patent-term extension will delay their entry into

the market and that they will be economically

penalized for each year that the extension

prevents them from marketing a drug. They further contend that the market for some drugs

may have declined to such a degree during the

extension that their entry into the market will

not be economically feasible. They point out

that they play an important role in providing

low-cost pharmaceuticals to consumers.

The concerns of the production-intensive

companies are that patent-term extension will

increase the ability of research-intensive firms to

ZSTh~ research.intensive i irrns’ positions have been gathered

from private communications from the Pharmaceutical Manufacturers Association, May 1981 and July 1981: private communication from Lewis Sarett, Vice President (>t Merck and Co., May

1981: testimony ot L. Engman, President ot the Pharmaceutical

Manufacturer’s Association” betore the House Subcommittee on

Health and Environment (}I the C(~nln~ittee on Energy and Commerce, Apr. 1, 1981, and bet{}re the Senate Committee on the Judiciary, Apr. 30, 1981,
22 Patent-Term Extension and the Pharmaceutical Industry

achieve overall effective patent terms that exceed 17 years if these firms secure more than one

patent on a product. They are also concerned

that nonpatent barriers to acceptance of their

products will prevent them from successfully

competing against products whose patents have

expired. They believe that a national formulary

that listed the generic and therapeutic equivalency of drugs would encourage use of their

products. They also believe that if the FDA premarketing requirements for generic equivalents

of drugs coming off patent were simplified,

more generically equivalent drugs would be

marketed. From the point of view of the generic

firms, one of the greatest barriers to market acceptance of their products has been court decisions inhibiting their use of the size, shape, and

color of drugs whose patents have expired.

The production-intensive firms see the need to

provide an equitable, effective patent term to innovator firms in certain situations in which the

combined period of protection from all patents

on the drug during marketing is significantly

less than 17 years due to excessive regulatory

delay. They do not believe that it is desirable for

the pharmaceutical industry to have longer patent terms than other industries. Nor do they believe that extensions should compensate for time

spent on testing that would have been conducted by the innovator firm whether or not

FDA premarket regulations existed. Furthermore, production-intensive firms believe that

efforts should be directed toward making regulatory proceedings more efficient in order to

increase effective patent terms. They believe

that any legislation to extend patent terms

should not weaken their market position and

that such legislation should eliminate the

nonpatent barriers that can prevent them from

successfully competing against products whose

patents have expired.26

‘OThe production-intensive firms’ positions have been gathered

Irc)m private communicatilms from Kenneth Larson, President of

Zenith Laboratories, April 1981, and July 1981; Mr. William Haddad, member of the board of the Genenc Pharmaceutical Industry

Association, April 1981, JL ne 1981, and July 1981; and Mr. James

Flug, counsel tor the Generic Pharmaceutical Association, July

1981, and the testimt~ny CJ[ Larson and Haddad before the Senate

Committee on the Judiciary, Apr. 30, 1981.

Spokesmen for consumer interest groups believe that patent-term extension will result in

higher drug prices without providing better

health care. They point out that increased drug

costs will fall disproportionately on the elderly

and the chronically ill (whose incomes tend to

be lower than average).

The spokesmen argue that the pharmaceutical

industry is extremely profitable and needs no

additional incentive to conduct research. These

groups are concerned that the legislation proposed to date provides no guarantees that additional revenues derived from patent-term extensions will be invested in R&D activities. There is

concern that patent-term extension may encourage less R&D because market exclusivity will be

assured for a longer period of time.

Concerns are also expressed by spokesmen

that expenditures made for R&D may not be

directed toward research areas that provide the

greatest benefit to society. A central concern is

the degree to which patent-term extension will

encourage minor innovations having only nominal therapeutic importance rather than major

pharmaceutical advances.

Therefore, many consumer spokesmen oppose patent-term extension,27

~~The consumer interest groups”

from private communication” from

positi~~ns have been gathered

Fred Wegner, pharmaceutical

specialist, National Retired Teachers Association and American

Association of Retired Persons, June 1981; and Sidney Wolfe,

Director, and Benjamin Gordon, Staff Economist, Public Citizen,

Health Research Group, July 19t31; the testimony of Wolfe and

Gordon before the Senate C{]mmittee on the Judiciary, Apr. 30,

1981; and statements by Marcia Creenberger, attorney, Center forLaw and Social Policy, during the OTA w(~rksh(~p on patent-term

restoration, Mar. 24, 1981,
8

i

Chapter 3

Factors Affecting Innovation in

the Pharmaceutical Industry
Chapter 3

Factors Affecting Innovation in

the Pharmaceutical Industry

Innovation in the pharmaceutical industry is increase or decrease the likelihood that innovadependent on many factors including scientific tion will occur.

knowledge, profit levels, research and development (R&D) expenditures, and expected re- in this chapter, trends in both pharmaceutical

turns to research investment. Clearly these fac- innovation and the determinants of innovation

tors are interactive and dependent on decisions are examined so that the effects of patent-term

made in the private sector. Government action extension on innovation may be assessed in

can, however, affect these factors and thereby chapter 4.

DECISIONMAKING IN THE INDUSTRY

Before examining any of these trends, some

characteristics of decisionmaking in the industry

will be noted briefIy, for, no matter what the actual trends, it is how the trends are perceived in

the decisionmaking process that determines

R&D activities. If decisionmakers foresee declines in the returns to research investment, they

will invest less and innovation levels may decline. The decline, however, would not be

noticeable for several years because of the time

that elapses between research discoveries and

product marketing. Decisions made today,

therefore, will affect the supply of drugs over

the next 10 to 15 years.

The current decisionmaking environment for

pharmaceutical innovation has been compared

to the “gamblers ruin” problem, in which investment is made with an uncertain distribution of

returns, and the objective of the investor is to

win often enough to avoid experiencing severe

cash-flow difficulties in the interim. No matter

how high the return to investment, a firm that

experiences a sufficient number of research

failures in a row will not have adequate capital

to hold out for the eventual “big win. ” In an environment of increasingly uncertain returns to

pharmaceutical research, only firms with R&D

budgets that are large enough to fund several

projects at a time can survive the periods of little

return and achieve eventual success.1

Because of the nature of pharmaceutical research, the characteristics of the decisionmaking

process can be very important. One study notes

that scientists have less control over research activities than they did in the 1960’s and that the

decisionmaking process has become more financially oriented. z

As a result, research projects undertaken today may receive closer scrutiny than in the past,

and assessments of the likelihood of financial

and therapeutic success may become more important in corporate decisionmaking. However,

the decisionmaker’s expectations for different

projects may vary, and different firms will

perceive the market in different ways.

‘Thomas R. Stauffer, “Discovery Risk, Profitability Performance, and Survival Risk in a Pharmaceutical Firm, ” in Regulation, Ecotlomies, ~Hd Plmr}tluceufical IHtIoI~utIotI, J[>seph Coope r

(cd. ) (Washington, DC.: The American University, 1976), p p .

93-122.

‘Steven N. Wig,gens, “The Pharmaceutical Research and Development Decision Process, ” Drugs a}ld lfealtl~ (Washington, D. C.:

American Enterprise Institute for Public Policy Research, 1980).

25
26 ● Patent-Term Extec<sion and the Pharmaceutical Industry

TRENDS IN PHARMACEUTICAL INNOVATION

Pharmaceutical innovation is usually measured by the number of new chemical entities

(NCEs) introduced, Although this information

can be obtained easily, it fails to reflect innovations resulting from new formulations, new

combinations of active ingredients, or new uses

for existing drugs. Of the 1,916 notices of

claimed investigational exemption for a new

drug (INDs) pending at the Food and Drug Administration (FDA) on October 1, 1980, only

43.4 percent were for NCEs. Of the 209 candidates judged by FDA to offer important therapeutic gains, 86 were not NCEs. Thus, NCE introductions provide an incomplete measure of

innovation and one that gives no weight to differences in therapeutic value.

Figure 2 depicts the number of NCEs approved by FDA over the last 30 years, along

with FDA’s judgments on their therapeutic

value. Although the criteria used for assessing

the value of the innovations have been subjective and have varied over time, FDA’s judgments can provide some perspective on the

trends in NCE introductions.

Although the total number of NCEs approved

by FDA has dropped significantly since 1950,

the number of NCEs approved since 1963 has remained relatively constant. The bulk of the

decline in FDA approvals occurred in the early

1960’s and involved NCEs considered to offer

little or no therapeutic gain. This decline may

have been the result of the more stringent FDA

drug approval process adopted in 1962. The

FDA data indicate that approvals of NCEs offering important or modest therapeutic gain have

remained relatively stable.

Trends in innovation have also been measured by NCE sales as a percentage of total ethiTHE KNOWLEDGE BASE

New drugs will not be developed unless scientific progress is made. Advances in the understanding of drug therapy and the physiological

interactions in the body, along with advances in

Figure 2.—Annual Approvals of New Chemical

Entities Reflecting FDA’s Judgment of

Therapeutic Potential

1950 1955 1960 1965 1970 1975 1980

NCEs having modest gain

NCEs having important gain

SOURCE: Testimony of J. Richard Crout before the Subcommittee on Health

and the Environment of the House Committee on Energy and

Commerce. April 1, 1981.

cal drug sales. By this measure, innovation is

declining. NCE sales accounted for 20 percent of

total sales in 1957 to 1961, 8.6 percent in 1962 to

1966, and 6.2 percent in 1972 to 1976. 3 Actual

sales of NCEs have, however, grown since 1962

because total sales have grown,

Thus, interpretations of trends in innovation

depend on the measures used and the time period being measured, but, by most measures, innovation does not appear to be increasing.

‘Henry Grabowski and John Vernon, “Government Po] icy and

Innovation in the Pharmaceutical Industry, ” draft report

(Durham, N. C.: Duke University, 1980).

molecular biology, have opened up important

frontiers in pharmaceutical innovation. Technological advances have improved pharmaceutical research techniques for identifying the
Ch. 3—Factors Affecting Innovation in the Pharmaceutical Industry ● 27

types of chemicals that should be synthesized

for biological testing, and screening tests have

been developed to determine whether a chemical

has a good probability of being safe and efficacious.

ever, have to meet tougher standards. Furthermore, as testing procedures become more sophisticated, more drug candidates will be rejected earlier because problems will be detected

sooner.

As the therapy provided by drugs continues

to improve, new pharmaceuticals will, howFACTORS AFFECTING RETURNS TO RESEARCH INVESTMENT

The anticipated rate of return is believed to

play a major role in the pharmaceutical industry’s decisions to invest in innovative activities.

Several studies have indicated that the rates

of return to research investment have declined

significantly over the last two decades. 4 T h e

assumptions made in these studies about costs,

product lives, and profit margins have, however, been questioned.5 Because of the unavoidable uncertainties involved with assumptions

which must be made to project rates of return,

this report focuses on the underlying factors affecting returns to research investment.

The major determinants of returns to research

investment are the costs involved in R&D activities, the levels of R&D expenditures, and the

revenues and profits of the industry. These factors are not only interrelated but are also dependent on other influences. The costs of R&D

are controlled by inflation, regulatory actions,

and technological advance. R&D expenditures

are influenced by current revenues of the firm,

by rates of returns, and by the decisionmaker’s

expectations for the future. Revenues are determined by prices and the quantities sold which,

in turn, are determined by market demand, patent protection, and the number and types of

competitors.

In the following discussion, the conclusions

drawn pertain to the industry as a whole; but

‘Charles River Associates, lnc., ‘‘The Effects of Patent Term

Restoration on the Pharmaceutical Industry, ” prepared for OTA,

May 4, 1981, pp. 4-1 to 4-3.

‘Ibid.

the reader is reminded that R&D costs, prices,

sales volume, and profits vary among pharmaceutical products. Most companies are dependent on a few high-income drugs for substantial

portions of their revenues. Table 3 provides the

sales of the three leading products of selected

manufacturers as a percentage of the manufacturers total sales. The effect of the determinants

on these high-income drugs may be of particular

concern to the pharmaceutical industry.

Table 3.—Percentage of Corporate Pharmaceutical

Sales Accounted for by Three Leading Productsa

1970 1975 1979

Abbot. . . . . . . . . . . . . . . . . . .

American Home Products:

Ayerst . . . . . . . . . . . . . . . .

Wyeth ., . . . . . . . . . . . . . .

Bristol-Meyers:

Bristol . . . . . . . . . . . . . . . .

Mead-Johnson . . . . . . . . .

Burroughs-Wellcome. . . . . .

Ciba. ... , , . . . . . . . . . . . . . .

Lederle . . . . . . . . . . . . . . . . .

Lilly . . . . . . . . . . . . . . . . . . . .

Merck . . . . . . . . . . . . . . . . . .

Pfizer. . . . . . . . . . . . . . . . . . .

Robins. . . . . . . . . . . . . . . . . .

Roche ... , . . . . . . . . . . . . . .

Searle . . . . . . . . . . . . . . . . . .

Shering . . . . . . . . . . . . . . . . .

SmithKline . . . . . . . . . . . . . .

Squibb. . . . . . . . . . . . . . . . . .

Upjohn. . . . . . . . . . . . . . . . . .

Warner- Lambert:

Warner. . . . . . . . . . . . . . . .

Parke-Davis. . . . . . . . . . . .

36

64

37

69

40

NA

47

48

46

35

52

43

80

45

42

44

28

47

53

25

33

74

44

46

38

56

NA

31

60

44

65

45

80

49

48

42

31

50

NA

27

28

84

43

28

37

51

55

32

43

44

65

46

70

44

40

66

23

56

NA

22

NA = not available

aU S sales

SOURCE: Charles River Associates, Inc , “The Effects of Patent-Term Restora.

tlon on the Pharmaceutical Industry, ” a report to OTA, May 4, 1981.
28 ● Patent-Term Extension and the Pharmaceutical Industry

TRENDS IN REVENUES AND PROFITS

The revenues and profits of the industry have

direct bearing on the amount of funds available

for R&D activities. As seen in chapter 2, profits

in the pharmaceutical industry have been relatively stable. As shown in table 4, the revenues

of U.S.-based firms from the sales of ethical

pharmaceuticals have grown significantly since

1965, even on a constant-dollar basis. Real

growth has occurred in both foreign and domestic sales.

As shown in table 5, the relationship between

revenues and R&D expenditures in the U.S.

pharmaceutical industry has also been stable.

For the years 1965 through 1978, research expenditures ranged between 8.2 and 8.8 percent

of total sales. The stability of this relationship

suggests that trends in revenues may be a good

indicator of trends in R&D expenditures.

Table 4.–Sales of Pharmaceutical Products of U.S. Based Firms 1965-78

Total domestic and DefIated Real growth

foreign sales sales in sales

Year (millions) DefIator (millions) (percent)

1965 . . . . . $ 3,939 103.2 $ 3,817 Base year

1966 . . . . . 4,340 102.6 4,230 10.8%

1967 . . . . . 4,744 100.0 4,744 12.2

1968 . . . . . 5,302 99.0 5,356 12.9

1969 . . . . . 5,837 99.5 5,866 9.5

1970 . . . . . 6,425 99.3 6,470 10.3

1971 . . . . . 7,009 99.0 7,080 9.4

1972 ... . . 7,739 99.1 7,809 10.3

1973 . . . . . . 8,722 99.9 8,731 11.8

1974 . . . . . . 9,956 104.2 9,555 9.4

1975 . . . . . . 11,554 113.2 10,207 6.8

1976 . . . . . . 12,775 120.3 10,619 4.0

1977 . . . . . . 13,838 125.4 11,035 3.9

1978 . . . . . . 15,978 131.9 12,114 9.8

SOURCE Derived from Pharmaceutical Manufacturers Assoclatlon.OPA, April 1981, using BLS, producer price deflator for

pharmaceuticals

Table 5.—Research and Development Expenditures and Sales Revenues of U.S. Ethical Drug Industry (1965-78)’

Foreign sales Domestic R&D

(including exports) current dollars Foreign R&D current Ratio of R&D to sales in

Year Domestic sales total total (millions) dollars (millions) current dollarsb (percent)

1965 . . . . . . $2,940 $ 999 $ 304.1 $ 24.5 8.30/o

1966 . . . . . . 3,178 1,162 344.2 30.2 8.6

1967 . . . . . . 3,393 1,351 377.9 34.5 8.7

1968 . . . . . . 3,808 1,494 410.4 39.1 8.5

1969 . . . . . . 4,135 1,702 464.1 41.7 8.7

1970 . . . . . . 4,444 1,981 518.6 47.2 8.8

1971 , . . . . . 4,796 2,213 576.5 52.3 8.6

1972 . . . . . . 5,136 2,603 600.7 66.1 8.6

1973 . . . . . . 5,644 3,078 643.8 108.7 8.6

1974 . . . . . . 6,273 3,683 726.0 132.5 8.6

1975 . . . . . . 7,086 4,468 828.6 144.9 8.4

1976 . . . . . . 7,867 4,908 902.9 164.9 8.4

1977 . . . . . . 8,434 5,404 984.1 197.7 8.5

1978 . . . . . . 9,411 6,567 1,089.2 222.0 8.2

aveterinav.use phw’naceuticalresearch and development IS excluded for the years 1965 through 1974.

bGlobal pharmaceutical R&D and sates of U.S flrmS.

SOURCES Henry Grabowskl and John Vernon, “Government Policy and Innovation in the Pharmaceutical Industry, ” draft report, November 1980, and Pharmaceutical

Manufacturers Association, “Annual Survey Report– 1979-80” (Washington, D C : PMA, 1980),
Ch. 3—Factors Affecting Innovation in the Pharmaceutical/ Industry ● 29

Prices of Drugs Sold

Revenues are determined by the prices and

quantities of drugs sold. Pharmaceutical prices

have risen very slowly since 1967, but, because

the quantity of drugs sold has increased there

has been real growth in revenues (see table 4).

The Firestone Report of August 1980 indicates

that pharmaceutical producers’ prices (wholesale) have risen 46.1 percent since 1967. Prices

of all industrial producers have risen, on average, 136.5 percent since 1967. Table 6 indicates

that producer price indexes for all industries

have typically been considerably higher than

producer price indexes for pharmaceuticals.

Producer prices vary among therapeutic

classes. Table 7 shows the average change in

producer prices by therapeutic category. From

tables 6 and 7, it can be seen that the average

growth in price across all therapeutic classes

was 46.1 percent and that the average price

change ranged from – 17.8 to + 187.0 percent.

According to a study of price statistics of all

NCEs introduced into the United States between

1958 and 1975, prices also vary with the therapeutic value of the drug. Of the NCEs classified

as important therapeutic gains, 44 percent had

prices that were more than double the prices of

the closest competitive products; of the NCEs

providing modest, little, or no therapeutic gain,

about 10 percent had prices more than double

the prices of the closest competitors. Similarly,

30 percent of the former had prices that were

less than 120 percent of the closest competitors’

prices and about 72 percent of the latter had

prices that were less than 120 percent of the

Table 6.—Producer Price Indexes for Selected Years

(1967 = 100)

Pharmaceutical

Year All industries industry

1949 . . . . . . . . . . . . . . 75.3 117.3

1969 . . . . . . . . . . . . . . 106.0 100.1

1974 . . . . . . . . . . . . . . 153.8 109.3

1975 . . . . . . . . . . . . . . 171.5 116.2

1976 . . . . . . . . . . . . . . 182.4 123.8

1977 . . . . . . . . . . . . . . 195.1 131.7

1978 . . . . . . . . . . . . . . 209.4 138.8

1979 . . . . . . . . . . . . . . 236.5 146.1

SOURCE The F/restone Reporf, August 1980, p 4

Table 7.—Average Percentage Change in Producer’s

Prices by Therapeutic Category, 1969-79

Group Percent

Contraceptives, oral. . . . . . . . . . . . . . . . . . . . . . .

Sedatives. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Antiobesity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cough and cold. . . . . . . . . . . . . . . . . . . . . . . . . . .

Bronchial therapy. . . . . . . . . . . . . . . . . . . . . . . . .

Hormones. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Diabetic therapy. . . . . . . . . . . . . . . . . . . . . . . . . .

Antiarthritics. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Antispasmodic. . . . . . . . . . . . . . . . . . . . . . . . . .

Cardiovascular . . . . . . . . . . . . . . . . . . . . . . . . . .

Vitamins . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Dermatologicals. . . . . . . . . . . . . . . . . . . . . . . . . .

Analgesics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Diuretics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Psychotherapeutics. . . . . . . . . . . . . . . . . . . . . . .

Anti-infectives . . . . . . . . . . . . . . . . . . . . . . . . . . .

Broad and medium specialists . . . . . . . . . . . .

Penicillin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Sulfa and antibacterial. . . . . . . . . . . . . . . . . .

All others. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SOURCE. The Firestone Fieporf. August 1980, p 2

+-187.0

108.6

81.3

72.6

66.7

63.2

63.0

62.3

60.7

53.9

46.5

41.1

38.0

34.7

17.5

– 1.4

0.0

– 17.8

+ 24.6

57.1

46.0

closest competitors’ prices. b This study also indicates that prices for NCEs vary widely: introductory prices ranged from about one-quarter

of the price of the closest competitive product to

15 times the price of the closest competitive

product. 7

The prices and quantities of drugs sold are

determined by several factors: market demand,

patent protection, and the number and type of

competitors. In chapter 2 demand was examined, in this chapter other determinants of

revenues are examined.

Product Lives.—Product lives do not necessarily parallel patent lives. Irrespective of the

patent, a drug will be prescribed and consumed

as long as no other drug or therapy comes along

that is better and as long as the disease or condition for which the drug is prescribed continues

to be prevalent in the society.

Table 8 lists the 15 top selling drugs in the

United States in 1980 and their new drug application (NDA) approval date. The table in-

‘Duncan W. Reekie, “Price and Quality Competition in Drug

Markets: Evidence From the United States and the Netherlands, ”

Drugs a~ld Healt}/ (Washington , D. C.: American Enterprise Institute for Public Policy Research, 1980), p. 132.

‘Ibid., p. 134.
30 ● Patent-Term Extension and the Pharmaceutical Industry

Table 8.—Top Selling Drugs by Volume in 1980 and

Year of N DA Approval

Drug (trade name) Year

Valium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1963

lnderal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1967

Dyazide (dyrenium). . . . . . . . . . . . . . . . . . . . . . . . 1964

Lanoxin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (a)

Tylenol with codeine . . . . . . . . . . . . . . . . . . . . . . (a)

Lasix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1966

Dimetapp. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (a)

Motrin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1974

Tagamet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1977

Darvocet-N . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1972

Dalmane . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (a)

Aldomet. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (a)

Ortho Novum . . . . . . . . . . . . . . . . . . . . . . . . . . . . (a)

Actifed. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (a)

Keflex . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1971

aApproval priorto 1963

SOURCE. Arner/carr Drugg/sL February 1981, for ranking; FDA, prwate communlcation, forNDAapproval data forNCE(June 1981)

dicates that 9 of the 15 drugs have product lives

of 17 years or more.

Product lives are shortened by competition

from other drugs and nondrug therapies, but a

widely accepted drug may be able to retain a

significant market share when competition

emerges.

Since the 1950’s, the average product life of

drugs has increased. Product lives, however,

vary widely depending on the competition

within the therapeutic class.

Patent Protection. —Patents protect against

competition from other generically equivalent

products. (For a discussion of patents, see ch.

5.) Patents do not protect against competition

from nonequivalent drugs or nondrug therapies.

Effective patent terms for pharmaceuticals

have been declining. The average effective patent life for patented NCEs receiving FDA approval has reportedly declined from 13.6 years

for drugs approved in 1966 to 9.5 years for

drugs approved in 1979. 8 Three factors have

contributed to this decline: an increase in the

duration of the clinical and regulatory period required for drug approval; a slight increase in the

time between the filing of a patent application

and clinical testing; and a decrease in the time

between patent application filing and patent

“M. Eisman and W. Warden, “TheDeclinein Effective Patent

Life of New Drugs,” Resrarch Managemeflh January 1981, p.

18-21.

issuance. Sixty percent of the decrease in effective patent life has been attributed to the increased testing and regulatory period and 40

percent to the other two factors.

Effective patent lives vary widely among

products. Table 9 indicates that the effective

patent lives of the drugs with the highest revenues ranged from 11 to 17 years.

Some of the factors influencing effective patent terms are undergoing change. The duration

of the FDA regulatory procedure may be stabilizing. The average time between the filing and

issuance of a patent application is increasing

slightly as a result of a backlog of patent applications in the Patent Office. Thus, there is

reason to believe that the decline may not continue in the future. Furthermore FDA is now

giving highest priority to the drugs that it believes will provide significant therapeutic advances, hence, these drugs may fare better than

the average drug in the future.

Competition and Concentration.—Competition, whether it comes from generically equivalent drugs or nonequivalent drugs, affects both

the prices of drugs and the quantities sold. One

indication of the degree of competition in an industry is the extent to which sales are concentrated among the leading firms in the industry.

The relationship between innovation and concentration is disputed. According to some, high

levels of concentration favor innovation since

the more highly concentrated the market structure, the greater the ability to obtain higher

profits. The higher profits can serve as incentives for innovation and make additional revenues available for R&D.

According to others, concentration can have

negative consequences for innovation. In a very

competitive market, consumer demands interact

with costs of production to determine what

drugs firms will produce and what the prices of

these drugs will be. In highly concentrated markets, some or much of that power shifts to the

producers, and innovation may therefore be determined by corporate needs, rather than consumer needs. The producers may be able to

maintain high levels of profitability without

innovation. Innovation may also suffer because

the factors leading to the more highly concen-
Ch. 3—Factors Affecting Innovation in the Pharmaceutical Industry ● 31

Table 9.—Effective Patent Lives of 1980 Top Sellers by Revenues

——

1980 U.S. sales Patent NDA approval Patent Effective patent

Drug (trade name) (millions) approval (date) expiration (years)

Tagamet . . . . . . . .“. . . . . . . . . . . $250 1976 1977 1993 16

Valium. . . . . . . . . . . . . . . . . . . . 230 1968 1963 1985 17

Inderal. . . . . . . . . . . . . . . . . . . . . 200 1967 1967 1984 17

Motrin . . . . . . . . . . . . 150 1968 1974 1985 11

Aldomet . . . . . . . . . . . . . . . . . . . 150 1964 (a) 1981 17

Dyazide (dyrenium) . . . . . . . . . . 145 1963 1964 1980 16

Keflex . . . . . . . . . . . . . . . . . . . . . 140 1970 1971 1987 16

Clinoril . . . . . . . . . . . . . . . . . 125 1972 1978 1989 11

—— ~A~proved prior to 1963

SOURCE For ranklnq and sales New York T/rnes, Sunday, May 17, 1981, quoting Oppenheimer and Co For NDA approval date and patent !nformatlon prtvate

communlcjtlon from FDA

trated market can discourage the entry of new

firms.

The measurement of concentration has been a

subject of controversy. When market shares of

firms are calculated as a percentage of total

pharmaceutical sales, concentration is relatively

low in the pharmaceutical industry. When market shares are measured as a percentage of sales

in particular therapeutic categories, concentration in some categories is quite high. When one

looks at market shares over time, one finds that

the firms in the leadership positions change considerably. 9 Since the shift in market positions is

attributed to new product introductions, some

economists suggest that this measurement is the

one most relevant to innovation.

Competition From Nonequivalent Drugs.—

Competition from nonequivalent drugs was

somewhat higher between 1972 and 1980 than

between 1963 and 1971. Table 10 shows the

number of firms receiving NCE approvals and

the number of NCEs approved, by FDA category, for those two periods. By aggregating

NCE approvals for two 8-year periods, it was

found that both the number of firms and the

number of NCEs have increased for all but one

category of drugs. The table does not explore

entries and exits, but considerable turnover has

occurred in the firms producing NCE drugs. For

example, of the 20 firms producing cardiorenal

drugs in the 1972-80 period, 15 had not produced such drugs in the earlier period.

‘Douglas Cocks, “Product Innovation and the Dynamic Elements of Competition in the Ethical Pharmaceutical Industry, ” in

Drug De~lc/op/r~e~zt ut~d Markefit~g (Washington, D. C.: American

Enterprise Institute, ]975).

Table 10.—Number of Firms Receiving FDA

Approval and Number of Drugs Approved, by FDA

Drug Category (1963-71 and 1972-80)

1963-71 1972-80

FDA division Firms NCEs Firms NCEs

Cardiorenal . . . . . . . . . . . 10 13 20 23

Neuropharmacological . 20 25 17 23

Metabolism and

endocrine . . . . . . . . . . 11 14 13 19

Anti-infectives. . . . . . . . . 34 47 36 49

Oncology and radiopharmaceutical. . . . . . 12 24 23 45

Surgical-dental . . . . . . . . 12 13 13 16

SOURCE Food and Drug Admlnistratlon, private communlcat!on, June 1981

Competition From Generically Equivalent

Drugs.—After a patent expires, competition

may emerge from generically equivalent drugs.

Such drugs are manufactured by productionintensive firms who market nonbranded drugs

under generic names and by research-intensive

firms who market branded drugs either under

trade names or under generic names accompanied by firm names. The reputation of researchintensive companies may enable their products

to command higher prices than products marketed under generic names alone.

The revenues of branded and nonbranded

drugs which either had not been patented or had

patents that expired were about $4.4 billion in

1979; some of those drugs, however, did not

have competition from generically equivalent

drugs. Only about 7 percent of the revenues for

branded and nonbranded drugs were earned by

production-intensive firms with the remainder

earned by the research-intensive firms.10

l~lnterview with Wll]larn Haddad, Generic Pharmaceutical industry Association, Apr. 21, 1981.
32 . Patent-Term Extension and the Pharmaceutical lndustry

Branded and nonbranded drugs compete

among themselves, as well as with the originally

patented products. For example, a pharmacist,

to avoid a large inventory, may carry only one

branded and one nonbranded product. Competitive factors including price influence his

choice of products.1

The Federal Trade Commission estimated

that between 42.1 percent and 74.3 percent of

the wholesale price of branded drugs could be

saved by the dispensing of nonbranded products

instead of more expensive branded drugs. 12

Counter-Competitive Forces.—An important

influence on the level of competitive activity

when patents expire is the ease of market entry

for generically equivalent products. Barriers to

market entry arise from the requirements for

FDA approval of generically equivalent products and from nongovernmental factors.

As stated in chapter 2, FDA plans to reinstitute its paper NDA procedure. This practice

should significantly lower the barriers to second

entrants. However, many firms seeking approval will not be able to provide such data and the

FDA requirements for them will continue to discourage entry. FDA has also announced that it

plans to consider changing its regulations so

that its abbreviated NDA procedure could apply

to some post-1962 drugs .13

FDA bioavailability tests also can act as barriers to market entry. Bioavailability relates to

the absorption of drugs into the body. Tests for

bioavailability are required in cases where

precise dosage is critical because of narrow

margins separating ineffective, effective, and

toxic doses. When such tests are required, they

may be difficult and time-consuming, and therefore act as disincentives to second entrants.

Nonregulatory barriers to successful market

entry also exist. A principal barrier is the thirdparty aspect of consumer drug selection. The

physician, who prescribes a drug for his patient,

frequently cannot keep informed about alternative versions of a particular drug and their

“Federal Trade Commissicm, “Drug Product Selection, ” Washington, D. C., 1979 (staff report to FTC).

‘

z

Ibid.

1346 Federa] RegiSter 24445, Apr. SO, 1%1.

relative prices, and may prefer branded products because he believes them to be safer. This

preference for trademarked brand-name drugs

tends to give strong marketing advantages to

first-entrant drugs that are therapeutically effective. These advantages can endure over time,

and latecomers may need to wage vigorous promotion campaigns or offer improved substitute

products to overcome these advantages. With

gradually increasing product selection by pharmacists, this timing-of-entry barrier may be

weakening.

Pharmacist preference can, however, also act

as an entrance barrier. Pharmacists may be

reluctant to fill prescriptions for brand-name

drugs with generic equivalents because they fear

they may be liable if generic equivalents cause

injury.

Although pharmacists and physicians play a

key role in determining the market for drugs,

they are frequently influenced by consumer

opinion. Thus, consumer preference also acts as

a barrier to entry. Many drugs, have a particular size, shape, and color which are claimed

by the innovator firm to be proprietary. A

generic product that looks different from the

product that the consumer customarily uses

may be rejected in favor of a familiar product.

Forces Favoring Competition.—As discussed

in chapter 2, actions taken by the Federal and

State governments over the past decade have

facilitated the development of the low-cost generic market. More than 40 States have repealed

laws which prevented pharmacists from substituting generic equivalents for prescribed brandname drugs. Some of the State substitution

laws, such as New York’s, require pharmacists

to fill prescriptions with the least expensive

generic products available according to a State

formulary. Other States permit substitutions

only when physicians specifically note that substitutions can be made.

The Federal Government’s Maximum Allowable Cost (MAC) program, which affects reimbursements to pharmacists under medicaid, also

encourages competition, Under the MAC program, the lowest wholesale price of a generically

equivalent, multisource drug is identified. The
Ch. 3—Factors Affecting Innovation in the Pharmaceutical Industry ● 33

MAC regulations limit the reimbursement to the

pharmacist to that lowest identified wholesale

price plus a reasonable dispensing fee. Because a

growing percentage of all prescriptions are paid

by medicaid, MAC is expected to have a significant effect as more drugs fall within the MAC

program. Because MAC encourages pharmacists to stock low-priced generic products, pharmacists may be more inclined to use these products when filling prescriptions of nonmedicaid

patients.

Several other Federal actions also favor competition: the Government-wide Quality Assurance Program is designed to increase competition among drugs purchased by the Department

of Defense, the Veterans Administration, and

the Public Health Service; the Model State

Prescription Drug Product Substitution Act is

designed to assist States in developing laws that

encourage the dispensing of generically equivalent drugs; and the FDA list of therapeutically

equivalent drug products is designed to provide

an authoritative statement regarding generic

drug quality. The Supreme Court has also had

an impact by voiding, as unconstitutional, laws

which prohibited the retail advertising of drugs

and drug prices.

The full impact of the repeal of the antisubstitution laws and the Federal Government actions may not yet have been felt. One study

reported the market share of 12 selected paten-ted drugs before and

THE COSTS OF

Thus far, the factors

after patent expiration

RESEARCH AND

that influence revenues

have been discussed. The returns to R&D investment, however, also depend on R&D costs and

expenditures.

The average absolute R&D costs for new

chemical entities are difficult to ascertain.

Several average R&D cost estimates have been

made. One estimate projected the R&D cost for

a self-originated NCE (one not licensed from

another source) to be $54 million (in 1976 dollars). This calculation included $21 million in

opportunity costs of capital (the money that

for drugstore and hospital markets through

1978. After patent expiration, each of these

drugs retained more than a 90-percent share of

the drugstore market and more than an 80-percent share of the hospital market. Six of the

drugs retained more than a 97-percent share of

both markets in 1978. The retail price, in constant dollars, of 4 of the 12 drugs declined; the

greatest decline was about 35 percent .14 It is not

clear if price declines were due to generic competition or other factors, such as competition

from new patented drugs or the waning of product life.

Trends in Generic Competition. —The trends

in generic competition activity levels after

patents expire are uncertain. The full impact of

recent actions by the Federal and State governments facilitating generic competition has not

yet been felt. While these actions have thus far

had relatively minimal effects, they could

potentially have substantial effects on t h e

revenues and profits of innovator firms. Barriers to subsequent entrants can provide a

countervailing force to these Government actions. Over the next few years, as the patent

terms end for many high-income drugs, the

trends will become more obvious.

14Meir Statman, “The Effect of Patent Expiration on the Market

Position of Drugs, ” in Drugs and Health, Robert B. Helms (cd. )

(Washington, D. C.: American Enterprise Institute for Public Policy Research, 1980), pp. 140-151.

DEVELOPMENT

could have been earned by investing in an alternative venture at an 8-percent return for the

number of years between the initial investment

and the start of sales income) and the costs of

failures (7 failures for each success at the clinical

stage). 15

“R. W. Hansen, “The Pharmaceutical Development Process:

Estimates of Development Costs and Times and the Effects of Proposed Regulatory Changes, “ in issues in Pharmaceutical Economics, Robert 1. Chien (cd. ) (Lexington, Mass.: Lexington books,

1980).

82-883 0 - 81 - 6
34 Patent-Term Extension and the Pharmaceutical Industry

Rather than relying on estimates of R&D

costs, the factors influencing R&D costs to

ascertain trends in R&D costs have been reveiwed in this report. The costs of R&D have increased. Part of the increase is due to inflation;

facilities, equipment. and salaries are all subject

to inflationary pressures. The Biomedical Research and Development Cost Index of the National Institutes of Health (NIH) has outpaced

both the Consumer Price Index and the Bureau

of Labor Statistics Producer Price Index for

Pharmaceuticals. Many commentators expect

such pressures to continue in the future.

Some of the increase in costs has been due to

regulatory actions. Testing standards have

become more stringent and have required longer

amounts of time to conduct. FDA is, however,

trying to expedite its approval of new drugs and

the duration of the drug approval process may

therefore stabilize. Table 11 shows the time required for FDA approval of NCEs between 1976

and 1980. The average time and the median

number of years needed to obtain approval

dropped in 1980.

Table 1 1.—Average and Median Number of Years

Between IND Filing and NDA Approval for NCEs

Year Average years Median years

1976 . . . . . . . . . . . . . . 5.8 5

1977 . . . . . . . . . . . . . . 7.8 7

1978 . . . . . . . . . . . . . . 5.2 5

1979 . . . . . . . . . . . . . . 8.9 9

1980 . . . . . . . . . . . . . . 8.2 7.5

SOURCE: Prwate communication from FDA, June 1981

Technological advances have helped to counter the upward trend in R&D costs. By all accounts, the sophistication of pharmaceutical

R&D has increased. Some of these advances

may provide more efficient (and therefore less

costly) ways of conducting research. Although

we have no data on this trend, technological advance can be expected to stem some portion of

the rising costs in the future.

In an attempt to keep R&D costs down, U.S.

firms are committing increasing amounts of

research expenditures abroad where regulatory

procedures often permit more rapid and less

costly drug development.

Expenditures in Research

and Development

Real growth has occurred in expenditures of

funds for R&D. In table 12, the current foreign

and domestic dollars spent on R&D have been

deflated for the years 1965 through 1978, using

the (NIH) biomedical R&D cost deflator (1967

= 100). R&D expenditures have apparently

kept up with and surpassed the rate of inflation

for biomedical research. This upward trend may

be expected to continue in the near future. Many

research-intensive firms have indicated that

they are increasing R&D expenditures. For example, Merck & Co. expects to spend $280 million on R&D in 1981, 20 percent more than in

1980. 16

Ibwi]]iam Fal]we]l, “U.S. Drug Companies Held UP Well in

Recession, ” Chemical and Engineerirlg News, Mar. 9, 1981, p. S.

Table 12.—Trends in R&D Expenditures

Total domestic and foreign R&D Deflated R&D (millions

Year (millions current dollars) Deflator constant dollars)

1965 . . . . . . . . . . . . . . . . 329 92.5 356

1966 . . . . . . . . . . . . . . . . 374 95.8 390

1967 . . . . . . . . . . . . . . . . 412 100.0 412

1968 . . . . . . . . . . . . . . . . 449 104.7 429

1969 . . . . . . . . . . . . . . . . 506 110.4 458

1970 . . . . . . . . . . . . . . . . 566 117.5 483

1971 . . . . . . . . . . . . . . . . 629 124.1 507

1972 . . . . . . . . . . . . . . . . 667 130.3 512

1973 . . . . . . . . . . . . . . . . 753 136.5 552

1974 . . . . . . . . . . . . . . . . 859 145.2 592

1975 . . . . . . . . . . . . . . . . 974 160.7 606

1976 . . . . . . . . . . . . . . . . 1,068 172.7 618

1977 . . . . . . . . . . . . . . . . 1,182 186.4 634

1978 . . . . . . . . . . . . . . . 1,311 200.3 655

SOURCE Tabls 5 and tnformatlon obtained from the Pharmaceutical Manufacturers Assoclatlon, April 1981,
Ch. 3—Factors Affecting Innovation in the Pharmaceutical Industry 35

Of concern is the allocation of funds between

basic research and product development. Declining expenditures on basic research could result in a reduced number of new drug introductions in the future. Industry officials have indicated that a shift from basic research to product development is taking place. Lewis Sarett

(1981) of Merck& Co. reported in congressional

testimony that a recent survey of U.S. firms by

the Organization for Economic Cooperation

and Development indicated that pharmaceutical

firms are reducing the research share of their

R&D budgets. To avoid the risks of research,

firms are increasingly licensing technology from

other sources and are spending more on development. 17 Nevertheless, preliminary information provided in table 13 suggests relatively little

change in emphasis.

Rising costs can also be expected to shift R&D

program emphasis among therapeutic classes

because some types of drugs can be developed

less expensively than others. In periods of rising

costs, firms can be expected to emphasize the

less costly research areas. Table 14 shows the

percentage of R&D expenditures for different

therapeutic categories for the years 1975-79.

Although some shifts in expenditures are evident, the shifts tend to be more toward areas in

which significant therapeutic advances are occurring (e. g., cardiovascular) than toward

areas which involve lower costs (e. g., anti-infectives).

These shifts in expenditures, however, may

not indicate any shift in decisions about R&D

spending. Expenditures vary depending on

where the innovation is in the development

process, and these shifts may therefore only

reflect normal research progress.

I TFor another example,

Pharmaceutical Industry;”

tations and Allocation of

Vernon, op. cit.

see: D. Schwartzman, “Innovation in

J. R. Virts and J. Fred Weston, “ExpecR&D Resources;” and Grabowski and

SUMMARY OF FINDINGS

Research-intensive companies are committing

increasing amounts of funds toward pharmaceutical R&D, and therefore, the potential exists

Table 13.—Relative Funding of Basic and Applied

Research in the Pharmaceutical Industry

(millions of dollars)

(1) (2) Column 2 as

Year Basic research Applied R&D percent of total

1968 . . . . . . . . 60 375 86.2

1969 . . . . . . . . 67 417 86.2

1970. . . . . . . . 93 474 83.6

1971 . . . . . . . . 77 535 87.4

1972. . . . . . . . 78 501 87.2

1973 . . . . . . . . 90 605 87.1

1974 . . . . . . . . 107 683 86.5

1975. . . . . . . . 112 783 87.5

1976 . . . . . . . . 119 883 88.1

1977 . . . . . . . . 131 959 88.0

NOTE: For the purpose of this table. the pharmaceutical industry IS deftned

as corporations primarily engaged in manufacturing blologlcals, Inorganic and

organic medicinal chemicals, pharmaceutical preparations, and grading, grind.

lng, and milling of botanlcals.

SOURCE. Derived from National Science Foundation, National Patterns of

Science and Technology Resources 1980, tables 42 and 45

Table 14.—Percentage of R&D Funds Spent

by Therapeutic Class (1975-79)

Percent of total R&D spendinga

Therapeutic class 1979 1978 1977 1976 1975

Anti-infectives . . . . . . . . . . . 18.7 18.3 19.2 19.5 20.1

Central nervous system and

sense organs . . . . . . . . . . . 16.3 16.9 17.0 16.2 18.0

Cardiovascular. . . . . . . . . . 18.6 17.3 15.2 13.2 14.9

Neoplasms, endocrine

system, and metabolic

diseases . . . . . . . . . . . . . . . 15.3 16.1 15.7 14.7 15.5

Gastrointestinal and

genitourinary system. . . . . 6.3 6.7 6.0 5.8 5.1

Respiratory. . . . . . . . . . . . . . 4.0 4.4 4.0 4.1 5.5

Biological . . . . . . . . . . . . . . 2.5 3.0 3.1 3.1 3.0

Dermatologicals. . . . . . . . . . 2.9 2.8 3.2 2.8 2.8

Vitamins . . . . . . . . . . . . . . . . 2.5 2.2 2.5 1.5 1.1

Diagnostic . . . . . . . . . . . . . . 0.5 0.6 0.8 1.2 1.2

Other human preparations . 6.7 5.6 6.3 10.5 6.1

Veterinary preparations. . . . 5.3 5.7 6.6 7.2 6.5

Veterinary biological . . . . . 0.4 0.4 0.4 0.2 0.2

aln the united Sti?N?S Only

SOURCE” Pharmaceutical Manufacturers Assoclatlon

for major pharmaceutical discoveries. Factors

have been highlighted which, based on historical trends, will affect pharmaceutical innova-
36 Patent-Term Extension and the Pharmaceutical Industry

tion. Below is a summary of these major trends.

Following that is a summary of factors whose

effects are uncertain.

Historical Trends That May

Discourage Innovation

●

●

●

●

The costs of research and development are increasing significantly.

The price of drugs has generally not kept pace

with the increase in R&D costs.

Effective patent lives have declined, but may

be stabilizing.

A decline in the returns to R&D investment is

widely perceived.

Historical Trends That May

Contribute to Innovation

●

●

●

The pharmaceutical industry continues to enjoy high and stable profitability in terms of

return to stockholder’s equity.

Recent technological advances have improved research techniques and enhanced the

efficiency of research activities. Researchers

are no longer totally dependent on the expensive hit-or-miss method for screening new

drugs.

The competitive environment for innovation

appears stable for most therapeutic classes,

●

and there is no lessening of competitive pressure for innovation.

Markets and sales of drugs are growing.

Uncertainties Affecting Innovation

in the Future

Historical trends do not reflect recent governmental actions that may affect the postpatent

exclusivity of many drugs. These actions include the repeal of antisubstitution laws, adoption of FDA procedures that facilitate approval

of generic equivalents of previously approved

drugs, adoption of Government reimbursement

programs favoring use of low-priced generic

equivalents, and court rulings that allow advertising of drug prices.

Although these actions have, thus far, had

only minimal effects on the rates of return to

R&D investments and on the revenues and

profits of research-intensive companies, they

could have substantial impact in the future.

If the effects prove to be substantial, firms

will probably be unable to maintain their current levels of research. The public, however,

will not perceive a decline in innovation for

many years. By the time such a decline is noted,

the public will face a period of lagging innovation, since new research efforts will not bear

fruits for at least a decade.
Chapter

The Implications of Patent-Term

Extension for Pharmaceuticals
Chapter 4

The Implications of Patent-Term

Extension for Pharmaceuticals

This chapter examines the possible impact of pharmaceutical innovation; the second explores

patent-term extension on the numerous factors the costs associated with patent-term extension

that affect pharmaceutical innovation. The first and the implications of patent-term extension

portion of the chapter concentrates on whether for the patent owner, the research- and propatent-term extension will result in beneficial duction-intensive firm, and the consumer.

PATENT-TERM EXTENSION AND INNOVATION

A patent provides the right to exclude others

from making, using, or selling an invention.

The primary incentive provided by this right is

the opportunity to derive economic benefits that

result from an exclusive market position. By extending the patent term, Congress would extend

the period in which these benefits could be

derived, and thereby increase the incentives for

research and development (R&D) activities.

Whether R&D activities actually increase as a

result of these incentives will depend on decisions made in the private sector, and patent

terms are but one consideration in these decisions. Patent-term extension will not provide a

mechanism for reducing R&D costs, it will not

enhance the likelihood of research breakthroughs, and it will not ensure that the results

of innovative activity will meet with commercial success. Nor will it stem the trend of domestic companies conducting pharmaceutical R&D

overseas.

To the extent that patent-term extension demonstrates Government support for R&D activities, it will provide psychological encouragement to decisionmakers; the effects of such encouragement might, however, be temporary.

Since patent-term extension cannot provide

firms with additional revenues before the extensions actually begin and the first extensions will

not, under the proposed legislation, begin until

the 1990’s, the immediate incentive provided to

the research-intensive firms by patent-term extension is the opportunity to obtain greater

returns on R&D investment in the long term.

Although an exclusive market position for a

drug can exist beyond the expiration of the

original patent term, patent-term extension provides a longer and more certain period in which

exclusivity can be assured.

Whether firms will actually increase R&D expenditures on the basis of anticipated increases

in returns is, however, highly speculative. On

the one hand, the increased economic attractiveness of R&D investment could encourage

firms to reallocate corporate funds or obtain external funds in order to increase R&D expenditures. On the other hand, the historic stability

of the relationship between R&D expenditures

and revenues would suggest that R&D expenditures would not increase unless revenues increased.

In the long term, firms obtaining additional

revenues in the extended period will have additional funds available for R&D investment. If

historic trends prevail, they will spend on

average 8 or 9 percent of these additional

revenues for R&D. A major portion of the additional revenues will be used for purposes other

than R&D. Taxes will need to be paid, production costs allocated, and dividends distributed.

The funds may be used for product promotion

or diversification. In talking about additional

revenues, it should be noted, however, that such

revenues will never be able to be quantified

since we can never know what revenues would

have been generated if the patent term had not

been extended.

39
.

40 ● Patent-Term Extention and the Pharmaceutical Industry

Despite the fact that revenues generated by

the extension cannot be measured, firms with

drugs whose patents are extended will probably

derive additional revenues since they will have a

longer period of exclusivity in which to market

their products at premium prices. Therefore,

both sales and prices should be greater than they

would have been if no extension existed unless

the supply of new drugs increases and exerts a

downward pressure on prices. After extensions

lapse, sales by research-intensive firms may

continue to be higher than they would have

been had competition entered the market when

the original patent expired. In some cases, second entrants may consider the remaining product lives of drugs coming off extended patents

insufficient to justify start-up costs and thus

may not enter the market. Furthermore, by the

time the extensions end, the patented products

may be so firmly established in the market that

generically equivalent products could not obtain as great a market share as they would have

obtained if the extension had not occurred.

Thus, the revenues of research-intensive

firms, particularly firms having high-income

drugs, should receive a boost from patent-term

extension. Nonetheless, pricing pressures are exerted by other patented drugs and nondrug therapies. Whether these pressures will override the

research-intensive firms’ ability to charge premium prices will depend on circumstances in the

relevant therapeutic markets.

The distribution of additional revenues

among firms can affect both the level of research

activities that will be undertaken and the types

of innovation that may result.

The bulk of additional revenues probably will

be earned by high-income drugs. The possibility

exists that the relatively few firms who develop

those drugs will develop more sophisticated

research techniques and more extensive research

programs than other firms since they will have

more funds available for research and development. Their successes may particularly encourage them to undertake additional R&D activities, some of which may be directed at therapeutic areas that go beyond their present expertise. Under these circumstances, innovation

would be expected to increase.

On the other hand, other firms may be discouraged from conducting research in the areas

pursued by these successful firms which have

been able to increase their research dominance

in these areas. In such cases some forms of innovation may suffer.

Furthermore, as a result of patent-term extension, specific types of innovation may be

delayed. An originator of a drug may have little

incentive to improve his product while it is

benefiting from patent protection. Second entrants, when they engage in R&D activities, concentrate on manufacturing processes, drug formulations, combinations of active ingredients,

or minor, unpatentable modifications of existing drugs. By delaying the entry of firms who

engage in such activities, patent-term extension

may delay the introduction of this type of innovation.

On balance, there is a reasonable likelihood

that firms may undertake or increase pharmaceutical R&D activities because of the increased

incentives provided by the longer effective patent term. If this occurs and drugs are developed

more rapidly, a downward pressure might be

exerted on the price of some drugs and the product lives of some drugs might decrease.

Although R&D expenditures are expected to

increase, they will not increase evenly across all

therapeutic areas. Since high-income drugs will

derive the greatest benefits from patent-term extension, the tendency of firms to direct their

research efforts torward developing drugs for

large markets will be reinforced.

To the extent that patent-term extension affects the potential rate of return, drugs that

might otherwise be economically marginal may

become economically attractive. But this will

occur only occasionally, particularly if opportunities exist for developing drugs with

greater profit potential. For the many marginal

drugs that do not have generic competition after

their patents expire, patent-term extension will

not generate additional revenues.

Patent-term extension could be a significant

factor in encouraging certain types of pharmaceutical R&D. In some therapeutic areas, the

loss of effective patent term due to the drug ap-
Ch. 4—The Implications of Patent-Term Extension for Pharmaceuticals . 41

proval process can be great, and research-intensive firms may not initiate R&D activities in

these areas. Patent-term extension may reduce

or eliminate the discrepancy between the effective patent terms of drugs in these therapeutic

areas and drugs in other areas.

Patent-term extension may also encourage

second uses for existing drugs. Not infrequently

an existing drug is discovered to have a therapeutic use other than the one approved by the

Food and Drug Administration (FDA). FDA approval must be secured for the additional use

before the drug can be sold for that use. Because

of the period of exclusivity provided by the exPATENT-TERM EXTENSION AND

THE COST OF PHARMACEUTICALS

Drugs whose patents are extended are expected to command higher prices during the extension period than they would have, had their

patents been allowed to expire. Despite these

higher prices, the drugs may cost less than alternative therapies.

This section, however, does not evaluate the

cost-benefit relationship of drug therapies, but

is solely concerned with the additional costs of

drugs during the extended period. The benefits

of innovation that might result from patentterm extension are not taken into account in

evaluations of cost. Furthermore this section

does not take into account the fact that the

prices of drugs with extensions can influence the

prices of competitive drugs nor the fact that

patent-term extension can affect the prices of

drugs after extensions end.

There is a distinction between the additional

costs to the consumer due to patent-term extension, and the additional revenues to the innovator firm. First, the additional costs to the

consumer due to patent-term extension may not

be directly comparable to the additional costs at

the wholesale level. The drug is dispensed to the

consumer by the pharmacist who assesses a prescription fee or a percentage markup. Nonetheless, substantial price benefits could be gained

tended patent term, the development of the additional use of the drug may be financially attractive.

The balance between research spending and

development spending is not likely to be significantly changed by patent-term extension. Generally, the results of research activities are less

certain than the results of development activities, and patent-term extension will not alter

the relative levels of uncertainty. However, if

additional revenues are generated because of

patent-term extension, the firms may be more

willing to undertake the risk involved with

research activities.

by the consumer from the purchase of generic

drugs. Second, generic competition will have a

greater effect on the additional revenues to the

innovator firm than on the costs to consumers:

when a consumer purchases a low-cost equivalent drug, he saves the difference between the

cost of the generically equivalent drug and the

cost of the branded drug; but the innovator

firm, receives no revenues for the drug he might

have sold.

The degree of difference between investment

revenues to the innovator firm and increased

costs to the consumer cannot be estimated and

may vary widely, depending on the portion of

the market that would have been captured by

generic competition, and whether the innovator

firm would have lowered its price in view of the

competition. A portion of the revenues derived

by the innovator firms can be viewed as the

recovery of revenues that would have been generated had the historic postpatent periods of

market exclusivity continued to exist.

Projections of the costs of patent-term extension based on historic trends alone overlook

some important factors that may influence costs

in the future. Some of the determinants of costs

are currently undergoing changes, but the magnitude of these changes is not yet known. This
42 ● Patent Exten:;jon andthe pharmaceutical Industry

section discusses the uncertainties in the factors

determining the costs of patent-term extension

and the sensitivity of cost projections to variations in assumptions about the determinants.

Numerous uncertainties limit attempts to

predict the increased costs to the public of pharmaceuticals under patent-term extension. The

revenues that drugs would have generated without an extension and the revenues they will

generate with an extension are not known. The

number of drugs that have product lives sufficiently long to extend into the extension period

and the average duration of the patent-term extension are not known. Revenues from patented

drugs after original patent terms expire depend

to some degree on whether competition enters

the market. The length of the extension is

another unknown factor. There are a number of

proposals (discussed in ch. 6) for limiting the

duration of the extended patent term.

The general effect of variations in these uncertainties on the costs of patent-term extension

can be derived from a sensitivity analysis with

three variables: 1) the duration of the average

extension; 2) the percentage of drugs, on a sales

weighted average, having product lives continuing into the extension; and 3) the percentage by

which total sales revenues would have been reduced because of generic competition if patentterm extension did not exist.

The following assumptions have been made

to simplify this analysis: the innovator firm

charges the same price for drugs during the extension that he charged before the extension; the

number of units sold is constant throughout the

extension period; the effective patent life for all

drugs is 10 years; and the supply of new drugs is

continuous, providing the same revenue each

year. These assumptions are not intended to reflect actual conditions; the sensitivity analysis

is, therefore, not a proper basis for projecting

actual costs of patent-term extension to the consumer. However, recognizing this bias, some

understanding can be developed from the sensitivity analysis of the effects of the uncertainties on the costs associated with patent-term

extension.

For the sensitivity analysis, the values for the

duration of the average extension are 3 years,

which approximates the average time between

the filing of a new drug application for a new

chemical entity (NCE) and the FDA approval; 7

years, which approximates the loss of effective

patent term now experienced by patented NCEs;

and an intermediate value of 5 years. The values

for the percentage of drugs, on a sales weighted

average, having product lives continuing into

the extension are 75 and 100 percent. This variable indirectly reflects the rate of innovation in

that as more drugs are developed, product lives

are expected to decline. The values for the

reduction in total sales revenues that would

exist because of generic competition if patentterm extension did not exist are 10, 30, 50, and

70 percent. The 50 and 70 percent values are

within the range of the maximum potential

wholesale savings projected by the Federal

Trade Commission if generic-named products

were dispensed instead of more expensive

branded drugs.

The results of the sensitivity analysis are provided in table 15. The results are provided per

$1,000 of yearly wholesale sales of patented

drugs during the original term of the patent.

Thus, if it is assumed that: 1) the average extension will be 7 years, 2) 100 percent of the

patented drugs will be sold during the extension,

and 3) the average total sales revenue would

have been 70 percent less without patent-term

extension; then the additional cost to consumers

of patent-term extension will be $490 per $1,000

of unextended, patented-drug sales or about 140

percent of the cost without patent-term extensions. If the average extension is 3 years, if only

75 percent of patented drugs are sold during the

extension, and if the average revenue reduction

is 10 percent; then the additional costs would be

$22.50 per $1,000 of unextended, patented drug

sales, or less than 5 percent of the costs in the

preceding example.

Evident from the sensitivity analysis is the

fact that the additional cost to consumers due to

patent-term extension will be highly dependent
Ch. 4—The Implications of Patent-Term Extension for Pharmaceuticals 43

on assumptions made about generic competi- without patent-term extension, the increased

tion. Unless the total sales revenues for the revenue to the innovator firms may be relatively

drugs would have been significantly reduced insignificant on an aggregate basis.

Table 15.—Sensitivity of the Consumer Cost of Patent-Term Extension to Three Variables’

Variable 1:

Average extension (years) 3 5 7

Variable 2:

Percentage of drugs that have product lives during the extension

period (sales weighted average) . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 100 75 100 75 100

Annual sales revenues of drugs under patent extension (dollars). 225 300 375 500 525 700

Variable 3:

Average total sales revenue reduction with competition, percent Additional cost to consumers

10 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 22.5 $ 3 0 $37.5 $ 50 $ 52.5 $ 70

30 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67.5 90 112.5 150 157.5 210

50 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ~ . . . . 112.5 150 187.5 250 262.5 350

70 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157.5 210 262.5 350 367.5 490

aThe ~en~lt ,V, ty analy~l~ , ~ based on an annual $1,000 ~~rth of ~holesale purchases of patented drugs during the ortgtnal term of the patent The followln9 assumptions are used [n this table The innovator firm charges the same price for drugs during the extension as before, the number of units sold per year IS constant

throughout the extension period. the effechve patent term for all drugs during the orlgtnal patent period IS 10 years, and the supply of new drugs IS continuous, pro

vldlng the same revenues each year

bit ,s assumed that $100 worth of new drugs were ,ntroduCed annually to malntaln $1,000 worth of revenues per year of drugs In their orlglnal patent terfTl The amOUnt Of

sales of drugs during patent extension would be ($100) x (the sales wetghted average) x (the average extension)

C(,cales of drug under patent extension) x (percentage reduction In revenue)

SOURCE Off Ice of Technology Assessment

IMPLICATIONS OF PATENT-TERM EXTENSION FOR SOCIETY

The major groups in society that will be

directly affected by patent-term extension are

the patentee, the research-intensive firm, the

production-intensive firm, and the consumer.

Although in most cases the research-intensive

firm is the patentee, in some instances the

patentee is a separate entity who grants a license

to the research-intensive firm to develop and

produce the patented drug. In this section we

define the consumer as the person for whom the

drug is prescribed whether or not payment for

the drug is made by a third party (e.g., insurance company or the Government).

The Patentee

Patent-term extension would benefit the

patentee by providing a longer effective patent

term. If the patentee develops and markets the

drug, patent-term extension provides the

patentee with the benefits of an exclusive market

position during the extension period. If the

patentee licenses the patent to another, the

patentee can benefit from royalty revenues during the extension period.

Because decisions to develop or market drugs

are often based on the length of time remaining

in the patent term, the patentee may find that

patent-term extension allows him more time to

develop a drug or arrange with someone else to

develop the drug. In this regard, patent-term extension may be particularly beneficial to universities, medical centers, research foundations,

small firms, or foreign companies that may not

be able to develop drug candidates in the United

States. Therefore, they may arrange for licensees to develop and market the drug candidates. These organizations typically pursue

drug candidates only to the preclinical phase;

hence the innovator firm is faced with considerable expense and risk should it decide to

develop the drug. Finding someone willing to

develop the product and working out a licensing

arrangement frequently requires up to 2 years.

Without patent-term extension, the time spent
44 ● Patent-Term Extension and the Pharmaceutical Industry

on licensing activities may reduce the expected

patent term to such a degree that the candidate

is no longer commercially attractive.

The Research-Intensive Firm

The research-intensive firm may be a patentee, in which case the effects described for the

patentee apply. The primary benefit of patentterm extension will be additional revenue obtained due to the exclusive market position during the extension. Although the pharmaceutical

industry traditionally has relied on internal

funding for R&D activities, patent-term extension could be a favorable factor in securing external funding. This may be of particular advantage to the smaller company.

The costs of patent-term extension to the

research-intensive firm are two-fold and appear

to be nominal. First, many research-intensive

firms market generic and branded-generic

drugs. For firms which have not developed new

drugs with regularity, these products can be a

significant source of income. Patent-term extension may delay the entry of these firms into the

generic and branded-generic markets. Second, if

patent-term extension increases the rate of innovation, it is possible that the additional competition in innovative drugs could result in some

downward pressure on prices and a reduction in

the sales of the patented product.

The Production-Intensive Firm -

Patent-term extension offers benefits to

production-intensive firms only if the rate of innovation is greater than it would have been

without patent-term extension and product lives

continue beyond the extension period. Production-intensive firms have conflicting interests

with respect to patent-term extension. On the

one hand, these firms must rely on researchintensive firms as sources of new products. A

favorable environment for R&D could benefit

them. On the other hand, patent-term extension

delays their entry into the market.

The effect of the delay on the productionintensive firm will be particularly acute when

the effects of patent-term extension first take

hold and the supply of drugs coming off patent

protection dwindles. Later, when extended patent terms expire, production-intensive firms

may find that the number of drugs with sufficient markets to justify investment has decreased. For those drugs worth marketing, sales

potentials will have been reduced, since, in most

cases, their remaining product lives will have

been shortened. Furthermore, the longer period

of exclusive marketing provided by patent-term

extension may increase the strength of nonpatent barriers such as brand loyalty and thus

reduce the ability of the production-intensive

firms to establish their drugs in the market.

Thus patent-term extension may have a negative psychological impact on the productionintensive firms.

The Consumer

The consumer will benefit from patent-term

extension if more and better drugs are commercialized with patent-term extension than would

have been commercialized in its absence. If this

happens, the consumer will get better therapy

earlier. However, an increase in drug innovation does not necessarily result in improved

drug therapies.

An increased supply of new medicines could

exert downward pressure on the price of existing

drugs. But during the extension, consumers will

pay more for most drugs whose patents are extended. Thus, the net effect of patent extension

on consumer expenditures is unclear. Furthermore, some groups of consumers, the elderly

and chronically ill, will be disproportionately

affected, and these groups may be less capable

than the population as a whole of bearing the

increased costs.

Besides the obvious cost to the consumer of

the delayed entry of lower priced generic drugs,

patent-term extension may also provide two

more subtle costs. The magnitude of these ancillary costs are difficult to ascertain, and they

may occur only in isolated cases. First, in some

instances, production-intensive firms develop

new formulations or compounds which are therapeutically advantageous. These developments

may be delayed. Second, to the extent that the
Ch. 4—The Implications of Patent-Term Extension for Pharmaceuticals . 45

innovator firm is reluctant to market improvements of the patented drug until the patent

SUMMARY OF FINDINGS

Patent-term extension will enhance the incentives provided by patents for pharmaceutical

research and development. Although patentterm extension lacks a mechanism that would

assure increases in R&D activities, the incentives it provides may be sufficient to encourage

additional R&D expenditures.

Chief among these incentives are the increased revenues that will occur when extensions begin to run. However, the first extensions

will not begin for at least a decade. Thus, in the

immediate future, patent-term extension will

have no effect on revenues. Although historic

trends indicate that R&D expenditures are closely related to revenues, research expenditures

could increase before extensions begin if decisionmakers base their funding decisions on anticipated rates of return.

The extension will be most beneficial to firms

selling high-income drugs and will therefore encourage research on drugs with potentially large

markets. However, it will not increase the economic attractiveness of research on drugs with

small markets. More research efforts may be

directed toward second uses for existing drugs

and towards drugs subject to extensive testing

requirements as a result of patent-term extensions.

The bulk of revenues generated by patentterm extension will go to a relatively small

number of firms who have a history of success

in particular research areas. The successes could

increase their dominance in these areas and

discourage other firms from conducting similar

types of research.

is about to expire, the consumer will have

longer to wait for these improvements.

Competition from generically equivalent

drugs will be delayed by patent-term extension.

In some instances, the remaining product lives

on drugs whose patents are expiring may not be

sufficient to attract competition from generically equivalent drugs.

The prices of drugs whose patents are extended will be higher during the extension

period. The magnitude of the increased costs of

these drugs to consumers will depend on the extent to which generic competition would have

existed had patent terms not been extended.

Generic competition will have a greater effect

on the revenues of innovator firms than on consumer costs.

Patent-term extension will benefit the

research-intensive firm and the patent owner.

However, to the extent that research-intensive

firms rely on branded generics for revenues, the

benefit will be diminished.

Production-intensive firms have the most to

lose as a result of the extension. Although they

cannot expand their lines of products if innovation does not occur, patent-term extension will

delay their entry into markets and reduce their

revenues. In the case of some drugs, productionintensive firms will not enter the market since

the remaining product lives after the extensions

expire will be insufficient to justify startup

costs.

The consumer will benefit if new and better

products are developed; however, some drugs

will cost more, and the costs will fall disproportionately on the elderly and the chronically ill.
—

Chapter 5

The Fundamentals of

the Patent System
Chapter 5

The Fundamentals of the Patent System

INTRODUCTION

This chapter provides background information on the patent system that will facilitate

understanding of the implications of the various

proposals for patent-term extension that are

discussed in chapter 6.

A patent is the grant by the Government of a

right for a limited period of time to exclude

others from making, using, or selling an invention.

Patents promote the progress of science and

the useful arts in several ways:

● they encourage research since they can provide a mechanism for protecting research

results from commercial use by others;

● they encourage the development of products since they can provide an exclusive

market position or competitive advantage

that enables the patent holder to earn a

greater profit and recover his research investment costs;

they provide a mechanism for the transfer

of technology to others who may put the

invention to practical use; and

they enhance the rate at which technology

grows by requiring that the invention be

promptly disclosed to the public in return

for the grant of the patent.

The effectiveness of patents in promoting innovation may vary depending on the other factors influencing the invention and innovation

processes. This chapter discusses the patent

system in the context of the pharmaceutical industry and examines the role of patents in promoting pharmaceutical innovation. It also provides a brief history of patent law in the United

States and examines the practices of those administering and using the patent system.

THE ROLE OF PATENTS IN PHARMACEUTICAL INNOVATION

As stated earlier, once a drug has been

discovered, developed, and marketed by a firm,

other firms can produce and sell the drug at a

price that is considerably lower than that of the

innovator since their price need not include the

cost of research and development (R&D) or the

cost of creating a market. Thus, if there are no

restrictions on market entry, later entrants may

have a significant competitive advantage.

In view of these facts, research-intensive

pharmaceutical firms consider patent protection

as a prerequisite to innovation. From the

perspective of these firms, patents are valued

most highly because they provide a means for

restricting the entry of competitors. But patents

are also important to pharmaceutical innovation because they allow for the transfer of technology in a valuable form to those capable of

putting the technology to practical use.

Historically, a substantial portion of pharmaceutical innovations have been marketed by

firms that did not make the original discoveries

but instead obtained licenses (i.e., the rights

given by patentees to permit others to practice

the inventions) to commercialize the inventions.

For example, more than one-third of the new

chemical entity drugs are commercialized by

firms that hold a license for the new technology

but do not hold the patent. ]

The value of a pharmaceutical technology in

the business world is significantly influenced by

the risk-to-reward ratio and the certainty of the

reward. Patents, because of the exclusivity

which they provide, may, therefore, be critical

factors in corporate decisions to license patents

and then complete development of new pharmaceutical technologies.

‘Private communication from W. Warden, University of Rochester, July 1, 1981.

49
——

50 ● patent-Term Extenstion and the Pharmaceutical Industry

A HISTORY OF U.S. PATENT LAW

From the power vested in it by the U.S. Constitution, Congress has enacted the patent law,

which establishes the following general principles:

● an invention, to be patentable, must be

useful and must be a process, machine,

manufacture, or composition of matter

(statutory classes);

● a patent can be granted only for an invention that is novel and not obvious (patentability y requirements);

● a patent gives the owner the right to exclude others from making, using, or selling

the invention in the United States; however, if the invention is made or used by or

for the U. S. Government, the patentee cannot prevent the infringement but can only

seek reasonable compensation; and

● a patent term shall run for 17 years.

In the Act of 1790, Congress established a 14-

year patent term. The selection of the term was

somewhat arbitrary and was said to be equivalent to the length of two apprenticeships. The

Patent Act of 1836 permitted the Commissioner

of Patents, in certain instances, to extend the 14-

year term by 7 years. In the Patent Act of 1861,

however, Congress repealed the extension provision and established the 17-year patent term,

which stands today. From accounts of the

THE PHARMACEUTICAL PATENT

The cornerstone of the patent system is the

patent document. By law, the patent document

must provide a teaching of the invention such

that others can make and use the invention and

contain claims that define the boundary of the

invention. To be patentable, the invention defined by these claims can be neither known nor

obvious to others.

The portion of the patent application that

teaches the invention is commonly termed the

specification. The specification serves several

functions. First, it describes the invention. Second, it discloses the utility of the invention since

history of the Act, it appears that the term of 17

years was a compromise between the House bill,

which provided for a 14-year term with a possible extension of 7 years, and the Senate amendment, which provided for a 14-year term with

no extension.

Since 1861, numerous bills have been introduced to change the patent term: proposed

terms have ranged from 5 years to 34 years (17

years with a possible 17-year extension). The

first proposal for changing the 17-year patent

term was made in 1881 and authorized the Commissioner of Patents to extend patents for which

no reasonable compensation had been received;

under this proposal, licensing was compulsory

and royalties were limited by law. Most of the

other proposals for patent extensions provided

for a 17-year term which would be extended for

17 years if the patentee, through no fault of his

own, had received an insufficient financial

return. The determination of the adequacy of

the financial return resided, depending on the

specific bill, either with the Commissioner of

Patents or with the Court of Claims.

Despite these proposals, patent-term extensions had not received serious congressional attention until the patent-term restoration bills

S. 255 and HR. 1937 were introduced in the first

session of the 97th Congress.

patents are only granted for useful inventions.

Third, it describes how to make and use the invention since, in part, the purpose of the patent

is to secure a disclosure of the invention from

the inventor in exchange for the patent right.

Fourth, it discloses the best mode of practicing

the invention, insofar as it is known to the patent applicant at the time the application is filed.

The specification concludes with one or more

claims defining the boundary of the patent

rights.

The claims serve much the same purpose as a

deed to a piece of land. When a patentee at-
Ch. 5—The Fundamentals of the Patent System . 51

tempts to enforce a patent, the claim is compared with the product or process against which

the enforcement action is directed to determine

whether an infringement exists.

On the other hand, if other parties can show

that the claim encompasses subject matter

which was known or was obvious prior to the

invention, the claim is invalid in its entirety and

no part of the claim can be enforced.

Consequently, patent applications frequently

contain a plurality of claims that vary in scope.

Some claims may be very broad and encompass

many possible products or processes. However,

the broader the scope of a claim, the greater the

likelihood that the claim will encompass subject

matter which was known or obvious prior to the

invention. Thus as the scope of a claim increases, so does its chances of being declared invalid. Claims of narrower scope may be adequate to protect the particular aspect of an invention that will be commercialized and may be

less vulnerable to attacks on validity.

Claims in pharmaceutical patents may be

directed to a product, a method for using the

product, or a process for making the product,

Product claims may be directed to invented

chemicals (chemical claims) or to compositions,

i.e., mixtures of chemicals. Claims directed at

all of these categories could be made for a single

pharmaceutical. To illustrate this fact, an example of each type of claim is provided:

● A chemical claim. —A compound having

the structural formula C 2H 5O – @

NHC(O)R wherein R is – CH3 or – C2H5.

• A composition claim. —A composition

useful for treating headaches when administered orally to a human suffering from a

headache in a unit dosage form consisting

essentially of 5 to 95 weight percent of

phenacetin and 5 to 95 weight percent of

aspirin.

● A process claim. —A process for making

phenacetin comprising reacting a compound of the formula C2H 5O – @ – NH2

with glacial acetic acid at a temperature of

5 0

o to 8 0o C in the presence of an effective

amount of dehydrating catalyst.

● A method-for-use claim, —A method for

treating headaches comprising orally administering to a human suffering from

a headache a therapeutically effective

amount of phenacetin.

A headache drug containing 40 weight percent phenacetin and 60 weight percent aspirin is

covered by each of these claims. Although these

claims might be contained within one patent, it

is possible that each of the claims might involve

a separate invention and therefore a separate

patent. Consider the following hypothetical

example:

Inventor A discovered a group of compounds expressed in the chemical claim

(when R is – CH3

, the compound is

phenacetin). In A’s specification a method

was disclosed for making the compounds

and a use (as antioxidants to preserve rubber).

Later Inventor B discovered an improved

process for making the compound invented

by A. B received a patent claiming the improved process (represented by the process

claim).

Inventor C subsequently discovered that

one of the compounds (phenacetin) invented by A was useful in treating headaches and received a patent claiming the

method for use (represented by the methodfor-use claim).

After C’s invention, Inventor D found

that the mixture of phenacetin and aspirin

provided a better treatment for headaches

than phenacetin or aspirin alone. Inventor

D could obtain a method-for-use patent

(claim not illustrated) and a composition

patent (represented by the composition

claim) for his discovery.

Each of the four patents can affect what the

other patentees can do with their inventions.

Table 16 is provided to assist in illustrating the

activities which each of the patentees can undertake. It is assumed that the patents to A, B, C,

and D were issued, and will therefore expire, in

chronological order. While all four patents are
52 Patent-Term Extension and the Pharmaceutical Industry

Table 16.—Activities Permitted Before and After Patent Expiration

Before expiration After expiration

of any of the A, B, C,&D’s

Activity patents A’s patent A&B’s patents A,B,&C’s patents patents

Make, use, or sell phenacetin. . . . . . . . . . A anyone anyone anyone anyone

Use B’s process to make phenacetin . . . no one B anyone anyone anyone

Use phenacetin to treat headaches. . . . . no one c c anyone anyone

Make, use or sell combination of

phenacetin and aspirin to

treat headaches. . . . . . . . . . . . . . . . . . . no one no one no one D anyone

SOURCE: Off Ice of Technology Assessment

in effect, only A can make, use, and sell

phenacetin; no one including A, B, C, or D can

use B’s improved process or C’s method-for-use,

and no one can make, use, or sell D’s composition. B, C, and D cannot practice their inventions since the practice would infringe A’s patent on phenacetin, i.e., B, C, and D would be

making or selling phenacetin.

When A’s patent expires, anyone (including

B, C, and D) can make, use, and sell phenacetin.

Since B’s patent is still in effect, only B can use

the improved process, but B cannot use C’S

method for use nor make, use, or sell D’s composition. C, however, can use phenacetin to

treat ‘headaches, but he cannot use B’s improved

process, or make, use, or sell, D’s composition.

No one, including D, can make, use, or sell D’s

composition since that would infringe C’s patent

because phenacetin, albeit in combination with

aspirin, would still be used to treat headaches.

When the patents to A and B expire, anyone

can practice A’s and B’s inventions. C’s methodfor-use patent prevents others from using C’s invention and C’s patent also prevents use of D’s

invention. When the patents to A, B, and C expire, D can practice his invention, and exclude

all others from practicing his invention. Anyone

can practice the inventions of A, B, and C,

Not all types of patents have equal value. Infringements on chemical and composition patents generally are easier to detect than infringements on other types of patents. Infringements

on chemical and composition patents occur

when manufacturers or distributors make or sell

the drugs, and can be readily detected, because

neither sales nor distribution can be kept secret.

Infringements on process patents take place in

relative privacy and may be impossible to discover.

Additionally, a product made abroad using

the patented process can be imported into the

United States without providing an actionable

infringement of the patent. The patentee, however, does have recourse against the infringer

through the International Trade Commission

but must prove that the importation of the product results in substantial economic harm to a

domestic industry and that the process practiced

in the foreign country infringes the patent.

Proving either of these points can be quite difficult.

The enforcement of method-for-use patents

provides unique difficulties. First, the direct infringer is the ultimate user and not the manufacturer. For the manufacturer to be found liable

for infringement, the patentee must prove that

the manufacturer induced the user to infringe

the patent. Second, except in instances in which

the drug has no other use, the owner of a method-for-use patent cannot stop the manufacturer

from making and selling the drug. For example,

if the method-for-use patent were for the discovery that aspirin could be used as a contraceptive, the patentee could not stop existing

manufacturers from making and selling aspirin.

Because of the vast number of individuals who

may use aspirin for its contraceptive activity,

and because enforcement of the patent would involve a suit against each user, the enforcement

of the patent would not be financially feasible.

Because of their potential for enforcement,

chemical and composition patents are generally

preferred by the inventor, but method-of-use

and process patents could, on occasion, be sufficient to ensure an innovator an exclusive market

position.
Ch. 5—The Fundamentals of the Patent System ● 53

SECURING A PATENT

The progress from an invention to an issued

patent is characterized by three stages: the

preliminary evaluation stage, the patent application drafting stage, and the patent examination stage.

Preliminary Evaluation

In the preliminary evaluation stage, the inventor attempts to determine the importance of

his invention. For example, once an inventor

has discovered a new chemical, he must attempt

to discover its utility and determine its potential

economic value. The length of the preliminary

evaluation stage may range from 1 week to 5 or

more years, depending on the perceived importance of the invention and the ability of the inventor to develop the invention to a point that

he can sufficiently fulfill the requirements for

patenting.

Drafting of the Patent Application

The patent application drafting stage usually

takes between 6 months to 2 years, but this

stage can vary greatly. During this stage, the

breadth of the invention is investigated. For example, is the invention one chemical or a group

of related chemicals? The potential patentability

of the invention is also considered. Is the invention novel? Is it obvious? The patent application

is prepared according to statutory requirements

and the legal, regulatory, and procedural requirements of the Patent Office.

If the invention appears to be of economic

significance, substantial incentives exist for pursuing the invention diligently and filing a patent

application at an early date. The primary incentive is to reduce the potential of losing the patent

right to another who has made the same invention. In the United States, if two or more inventors independently discover a patentable invention, a proceeding termed an “interference” is

declared to determine which of the inventors

was the first to conceive the invention. If,

however, the inventor has not diligently pursued the invention, he may be precluded from

using his date of conception for determining

who was the first to invent. Moreover, procedural advantages are provided to the inventor

who files the first patent application. The advantage of an early filing is even more important if foreign patents are sought since almost all

foreign countries award the patent to the inventor who files the first patent application. By

treaty with many countries, if certain requirements are met, the U.S. filing date serves as the

critical filing date for this determination in those

countries.

A second incentive for speedy filing of a patent application is to enable the technology to be

disclosed to others without the loss of proprietary rights to the invention. In most foreign

countries, if the invention is disclosed prior to

the filing of a patent application, a patent is

barred. In the United States, a l-year grace period exists in which a patent application can be

filed after the invention has been disclosed to the

public. This secondary incentive is usually most

important in the university environment where

pressure is placed on the researcher to publish.

Examination of the Application

Once the third stage is reached, the rate at

which the application proceeds is no longer solely dependent on the inventor and his patent attorney but also on the Patent Office.

The patent examination stage is initiated with

the filing of a patent application in the Patent

Office. The patent application, containing the

specifications and claims that the applicant

seeks to have patented, is examined by a patent

examiner who must determine whether each of

the claims defines an invention that is novel and

not obvious, and whether the patent application

has met other statutory requirements and the

regulatory and procedural requirements of the

Patent Office. In his examination, the examiner

conducts a search of relevant publications and

patents. He reports the findings of his examination to the patent applicant. The time between

the filing of the patent application and the first

report, or “action, ” from the examiner ranges

from 3 to 18 months.
54 ● Patent. Term Extension and the Pharmaceutical Industry

The examiner often finds a publication or patent that brings into question the patentability of

one or more claims. Thus, the first action by the

examiner may be a. rejection of the questionable

claims. The applicant is given 3 months (which

can be extended by an additional 3 months) to

respond to the action. The applicant may modify the claims to overcome the rejection or may

show that the rejection was unsound and should

be withdrawn.

Approximately 2 months after the applicant

responds, the examiner must act on the application and either allow the patent application or

issue what is called a final rejection of the questionable claims. The patent applicant then has 3

months to respond: he may delete or amend

claims to overcome the rejection; he may argue

that the rejection be withdrawn; or he may appeal directly to the Board of Appeals in the Patent Office. If the applicant responds without filing an appeal the examiner can entirely withdraw the rejection or notify the applicant that

the rejection, in its entirety or in modified form,

still stands. The applicant must thereafter appeal to the Board of Appeals or abandon the

patent application.

Because of the heavy workload on the Board

of Appeals, 2 years may pass between the filing

of an appeal and a resolution of the appeal. If

the applicant is unsuccessful at the Board of Appeals, he may then appeal either to the Court of

Customs and Patent Appeals or to the District

Court of the District of Columbia, in which case

the judicial appeal process applies. Another 12

to 18 months maybe consumed.

At any point in the examination period, the

patent application may be judged allowable.

The Patent Office then requires the payment of

a fee by the applicant. After this payment has

been made, the patent document is printed and

issued. A period of 5 to 12 months may elapse

between the allowance of the patent and its

issuance.

The period between the filing of a patent application and the patent issuance generally

ranges from 18 months to 3 or more years. The

average patent-pending period is currently a little more than 2 years. In the mid-1970’s, it was

about 18 months, and in the 1950’s, it was well

over 3 years.

During the patent examination stage, an applicant may file more than one application. For

example, after the initial patent application was

filed, the applicant may have discovered additional information regarding the invention and

may wish to supplement the original application. To do so, he must file a second patent application containing the information in the first

application (old matter) and the supplemental

information (new matter). This second application is termed a continuation-in-part application

and maintains the benefit of the filing date of the

first patent application with respect to the old

matter and the filing date of the second patent

application with respect to the new matter. The

identical patent application may also be refiled

(a continuation application), perhaps to obtain

a reconsideration by the examiner. If a patent

application claims more than one invention, the

Patent Office can require that applications be

filed for each of the inventions (divisional applications). The divisional applications need

only be filed before the first application is abandoned or is issued as a patent. There is no

statutory limit on the number of times that an

application may be refiled as continuing applications.

While sound reasons exist, in most instances,

for a patent applicant to file continuing or divisional applications, there is a potential for

abuse. So long as no competitor has entered the

market, the delays in the issuance of a patent

work to the advantage of the patent applicant

since the patent expiration is also delayed.

Interference Proceedings

Interference proceedings are time consuming.

Approximately 2.5 percent of all patent applications are involved in interferences, and the

figure for important inventions is higher. Interference proceedings can last 20 or more years

and most interference proceedings are not completed in less than 4 years. The subject of the interference proceedings might be two or more

patent applications or it might be a patent and

one or more patent applications.
Ch. 5—The Fundamenfals of the Patent System 55

The time consumed during the interference

proceeding will delay the issuance of a patent

from an involved patent application and thus

delay the expiration of the patent.

FOREIGN PATENTS

A U.S. patent provides the right to exclude

only in the United States and its territories. Patent rights must be sought in each country in

which a patent right is desired.

Although many differences exist between foreign patents and U.S. patents, only three aspects

will be discussed: the duration of the patent, the

types of inventions that can be patented, and the

compulsory licensing of patents.

Duration of the Patent

Virtually all foreign countries have patent

terms that begin on the patent application date.

The patent term in most industrialized foreign

countries is 20 years. The period in which a

patentee can exclude others from making, using,

or selling his invention is, however, considerably less than 20 years since a portion of the

patent term is spent in obtaining the patent.

Moreover, in countries in which the grant of a

patent can be opposed by the public (opposition

procedures), the patent term, may be further

eroded. After the patent is granted, however,

the patent owner may be able to recover damages for any patent infringement that occurred

while the patent application was pending if the

infringer knew or could have known of the patent application.

Extensions of patents in foreign countries

generally have not been permitted in recent

history except to compensate for the patent term

lost as a result of war. Some of the British Commonwealth countries do, however, permit extensions (usually up to 5 years) if the patent

owner has not been adequately remunerated for

his invention. Prior to 1978, Britain had a 16-

year patent term that could be extended in cases

of inadequate remuneration, but her patent law

now conforms with the laws in other European

countries: the patent term runs 20 years from

These proceedings have, on occasion, lasted

so long that pharmaceutical patents have been

issued ‘years after FDA premarket approval was

obtained.

the date of the patent

sions are permitted.

application and no extenPatentable Inventions

The types of inventions that can be patented

in foreign countries are in a state of flux. Many

countries do not permit chemical claims, and

some that allow chemical claims have specifically excluded such claims for pharmaceuticals. Of

the approximately 120 countries that have patent systems, nearly one half do not allow claims

to pharmaceuticals. Recently, many of the more

industrialized countries have begun to permit

chemical claims and to permit claims to pharmaceuticals, but the lesser developed countries

are not following suit. In some of the lesser

developed countries that do permit pharmaceutical patents, the local courts may not find the

patent enforceable because it relates to pharmaceuticals. Method-for-use claims for pharmaceuticals are permitted in less than 20 percent of

the foreign countries with patent systems. Some

countries (Egypt and India) provide shorter patent terms for pharmaceuticals than for other

chemicals.

Compulsory Licensing

Most foreign countries (including most industrialized nations) have compulsory licensing

laws, which allow members of the public to demand that the patent be licensed for a reasonable royalty. The purposes behind compulsory

licensing may be twofold: to provide incentives

for putting inventions to practical use, and to

encourage industrial development in the country. In most foreign countries a compulsory

license can be demanded if the patentee is not

“working” the patented invention in the country

within a certain time after the issuance of the

patent. The term “working” varies in definition
.

56 Patent-Term Extension and the Pharmaceutical Industry

from country to country. In some countries, Several countries also require compulsory

marketing the patented invention in the country licensing if the patent owner is not meeting nais all that is required. In other countries, the tional demand for the product, and several

product must be manufactured in the country. countries require licensing if such licensing is in

In still other countries, an attempt to secure a the public interest.

licensee for the patent is sufficient.
Chapter 6

The Mechanics of

Patent-Term Extension
Chapter 6

The Mechanics of Patent-Term Extension

INTRODUCTION

Throughout this report, patent-term extension has been discussed as a concept, but the

specifics of its form have not been reviewed.

The effects of patent-term extension will, however, vary depending on the technical details of

the extension.

By extending the period in which a patentee

may exclude others from making, using, or selling his invention, patent-term extension provides potential rewards to the patentee. However, it also delays use of the innovative technology by others. Thus, to assess the effects of

patent-term extension on innovation, one must

compare the value of the extended protection

for the patentee with the reduced use of the

technology by others after the original patent

term expires. This comparison can only be made

in terms of the type of extension that is granted.

The effects will vary depending on whether

the entire patent right is extended or whether the

focus of the extension is narrowed to a portion

of the invention claimed in the patent. For example, a chemical patent may claim several new

chemicals, only one of which is marketed as a

drug. If the full patent right were provided during the extension, the patentee could exclude

others from making, using, or selling any of the

patented chemicals for any purpose. Under this

circumstance, those aspects of the patented

technology that were not subjected to the Food

and Drug Administration’s (FDA) premarketing

review would have patent protection for more

than 17 years. The rights protected during the

extension could be modified in a fashion that

would still provide meaningful incentives for

the patentee but yet allow others to use the

patented technology for some purposes during

the extension.

As seen in chapter 5, claims can be made for

chemicals, compositions of known chemicals,

processes, or methods-for-use but not all classes

of patents are considered to have equal value.

The relative value of each of the classes can be

further affected by modifications of the patent

rights during the extension. These modifications

and their implications on the classes of claims

are discussed in the following sections.

Modifications could be directed at the scope

of claims during the extension, the products,

processes, and uses against which the patent

could be enforced during the extension, and the .

remedies available to the patentee for infringement of the patent during the extension.

Two other aspects of patent-term extension

will significantly influence its effects: the duration of the extension, and the obligations of the

patentee during the extension.

LIMITATIONS IN SCOPE AND ENFORCEMENT

The most important factors affecting the balance between the degree of protection provided

to the patentee and the extent to which the patented technology can be used by others during

the extension are those relating to limitations in

scope and limitations in enforcement. Although

these factors are described separately, they are

interactive.

Scope: A patent claim defines the breadth of

the invention for which the patent rights are

sought. The claim may contain many possible

embodiments of the invention, and the full

scope of the claim would include all of the embodiments. A limitation in the scope of the

claim would result in the claim being narrowed

during the extension. For example, a chemical

59
60 Patent-Term Extension and the Pharmaceutical Industry

claim is directed to chemicals A, B, and C in its

full scope. If the scope were limited during the

extension to only chemical A, the making,

using, or selling of chemicals B and C for any

purpose would fall outside the narrowed scope

of the claim and would not be an infringement.

Enforceability: A patent is enforceable

against an infringement of the invention defined

by the claim. In the above example, during the

original term of the chemical patent, the patentee can enforce the patent against anyone in

the United States who makes, uses, or sells any

of chemicals A, B, or C, regardless of how the

chemical is made or used. During the extension,

the enforceability of the claim might be limited

by conditions not expressed in the claim. For example, the patentee might only be permitted to

enforce the patent against anyone who used or

sold the chemical for a particular purpose.

Thus, if the enforceability of the claim were

limited to chemicals A, B, and C, as used for

treating headaches, the claim would not be enforceable against someone who made or sold

any of the chemicals for gasoline additives.

Limitations in Scope

If the full scope of the claim could be enforced

during the extension, the effects of the extension

on the patentee’s rights and the availability of

the technology for use by others would be those

described in chapter 5. If, however, the scope

were limited during the extension, the effects

would vary depending on the way in which the

scope was limited and the type of claim involved.

The scope of claim could be limited in three

ways:

●

●

Method S.1—The extension might be provided only for those aspects of the patent

claims that involve the specific active

chemical approved by FDA.

Method S.2—The focus of the claim might

be narrowed during the extension by restricting the parameters (e.g., temperature

range, dosage amount, or type of chemical)

recited in the claim to the specific value existing in the FDA approved product, process, or method-for-use.

● Method S.3—The extension might be provided only for the specific chemical (in- the

case of chemical claims), composition (in

the case of composition claims), the specific

process (in the case of process claims), or

method-for-use (in the case of method-foruse claims) approved by FDA regardless of

whether a parameter for each product,

process, or method-for-use condition is

recited in the claims.

Examples of these methods are provided in

the discussion of the various types of claims.

These examples are provided to help explain

both the concepts involved in these methods and

the distinctions between them. As will be seen in

the following sections, meaningful patent protection could result if the full scope of the claim

is enforceable during the extension or if the

scope is restricted, according to method S.1, to

the active chemical approved by FDA. Methods

S.2 and S.3, however, provide little protection

for composition, process, and method-for-use

claims.

Chemical Claims: For chemical claims, there

is no difference in the amount of protection provided by any of these methods. Since the aspect

of the claimed invention involved in the specific

FDA approval is a chemical, all of the methods

would restrict the claim during the extensions to

the specific chemical contained in the FDA approved product.

During the extension any other chemical

claimed in the patent could be freely made,

used, or sold by others. For example, even a

minor modification of the chemical would create a different chemical and take it outside the

scope of the extended patent. During the extended period, therefore, the patentee could face

direct competition from chemicals covered by

his claims during the original patent term. However, the competitor would have to undergo the

expense of conducting safety and efficacy tests

for FDA approval of the modified chemical.

Moreover, the modified chemical would not be

chemically and therapeutically equivalent to the

existing drug and could not be generically

substitututed for the patented drug. The developer of the modified product would, therefore, have to establish a market for the drug.
Ch. 6— The Mechanics of Patent-Term Extension ● 61

Because of the nonpatent barriers that supplement the patent protection, these methods provide the patentee with moderate protection.

Although it is possible that the modified

chemical might have enhanced therapeutic

value, the therapeutic value in most cases would

be similar to that of the patented drug. Thus,

considerable effort would be spent by competitors to secure FDA approval but few social

benefits would accrue. The innovator could attempt to broaden the scope by securing FDA approval (and patent-term extensions) for other

chemicals within the original scope of the claim,

but, such efforts, while blocking competition,

would be costly and would provide few benefits

to society.

Composition Claims: For composition

claims, the three different methods would have

different effects on the amount of protection

provided to the patentee and the availability of

the technology for use by others.

Assume that a composition claim recites: “A

therapeutic composition for treating headaches

in humans comprising a unit dosage amount of

chemical A or B in an inert carrier” and that the

product approved by FDA consists of 0.4 milligrams of chemical A and 3 grams of sodium

stearate as a binder.

If method S.1 were used to limit the scope to

chemicals approved by FDA, the claim would

apply to compositions containing chemical A

and any carrier. Thus, the scope of the claim

would be limited more by chemical than by

composition, and the claim would cover many

compositions for which FDA approval was not

sought. The scope of the claim would still be

broad and the value of the claim to the patentee

would be similar to the value of a chemical

claim.

If method S.2 were used, to restrict the scope

to the specific values for the recited parameters

present in the FDA approved composition, the

claim would be limited to compositions containing chemical A and sodium stearate. The claim

would still cover many compositions for which

FDA approval was not sought. The value of the

claim would be limited to the patentee since

many possible inert carriers exist; by selecting a

different, but equivalent carrier, the claim could

be avoided. The modifications to avoid infringement would, however, necessitate FDA

approval.

If method S.3 were used and claims were

restricted to the precise embodiment approved

by FDA, the claim would, in our example, be

limited to compositions containing 0.4 milligrams of chemical A and 3 grams of sodium

stearate. Because the claim covers only one

composition it could be easily circumvented.

Process Claims: FDA, in approving a drug,

also approves the processes by which it is made.

The aspects of the claimed invention involved in

the specific FDA approval are, therefore, the

process conditions.

For example, the process claim recites: “A

process for making chemical A or A1 by admixing chemical X or Xl and chemical Y and

heating the mixture to between500 and800 C in

the presence of a dehydrating catalyst. ” The

process used to make chemical A, which was

approved by FDA, involves very specific conditions including amounts of reactants and purification procedures.

If extensions were based on method S.1 and

the scope of claims were limited to chemicals approved by FDA, in our example the claim would

be limited to a process for making chemical A

using the specified reactants, a reaction temperature between 500 and 80° C, and any dehydrating catalyst. The process could be used by

anyone to make chemical Al

. Many processes

for making chemical A other than the one specifically involved in the FDA approval would be

covered by the claim.

If method S.2 were used and the scope of

claims during the extension were narrowed to

the specific values of parameters in the FDA approved invention, the claim would be limited to

processes for making chemical A using the

specified reactants, a specific temperature, and a

specific catalyst. If method S.3 were used, the

claim would be limited to the precise process involved in the FDA approval including process

limitations not specifically recited in the claim,

e.g., the amounts of the reactants and the procedure for purifying chemical A.
62 ● Patent-Term Extension and the Pharmaceutical Industry

Under methods S.2 and S.3, the patent could

be easily avoided by minor and insignificant

process modifications and the patentee would

have disclosed specific process information to

the public so that the scope of the claim would

be known. Methods S.2 and S.3 would not provide meaningful patent protection.

Method-for-Use Claims: The method used for

extending patent terms can have a significant effect on the value of method-for-use claims.

Assume that a method-for-use claim recites:

“A method for relieving pain in a human comprising internally administering a therapeutically effective amount of chemical A or B“ and

that the FDA approval is for orally administering 10 to 20 milligrams of chemical A three

times a day to relieve the pain of headaches in

adults.

Under method S1, the claim would be limited

to any internal administration of chemical A to

relieve pain. The patentee could exercise his

rights against another who used or sold chemical A for the treatment of any pain, e.g., arthritis, even though the FDA approval was only for

the treatment of headaches.

Under method S.2, the claim would be limited

to any oral administration of 10 to 20 milligrams of chemical A to relieve the pain of headaches. Under method S.3, the claim would be

limited to the specific use of orally administering 10 to 20 milligrams of chemical A three

times a day to relieve the pain of headaches in

adults.

Under methods S.2 and S.3, others could use

chemical A for relieving the pain of arthritis.

Both of these methods present problems of enforcement since doctors could prescribe and

consumers use chemical A (produced by another

as an arthritis pain reliever) for treating headaches; the only remedy available to the patentee

would be to sue each of the infringers individually.

Limitations in Enforcement

If no limitations were placed on enforcement,

the patent could be enforced against any product, process, or use that falls within the scope of

the claim regardless of the purposes for which it

would be used. Thus the public would have no

right to use any of the patented technology during the extension. There are, however, methods

for limiting enforcement of actions during the

extensions:

•

●

Method El: During the extension the patent could be enforced only against a pharmaceutical product, process, or use that requires FDA premarketing approval.

Method E.2: During the extension the patent could be enforced only against one who

uses the claimed invention for the same

therapy that was specified in the patentee’s

drug application and for the therapy

(termed “specific therapy approved”) for

which FDA approval was granted.

These methods are illustrated in relation to

the following example: the patentee has a chemical claim on chemical A and obtains FDA approval for treating headaches with chemical A.

Under method El, the patent could be enforced against anyone making, using, or selling

chemical A as a drug, (e.g., sale of the drug for

treating high blood pressure would be prohibited) but not against anyone making, using, or

selling chemical A for a nondrug use, even

though the nondrug use might be regulated.

Thus, one could sell the chemical as an herbicide. Method E.1 therefore enables the public to

use the patented technology during the extension for other than drug uses. Such use would

not result in competition for the innovator’s

drug.

Under method E.2, the patent could only be

enforced against anyone making, using, or selling chemical A for treating headaches. Method

E.2 could significantly affect the patentee’s incentives but could provide the public with a

greater right to use the patented technology during the extension,

From the standpoint of the patentee, method

E.2 presents a disadvantage since the patent

would be enforceable only when the drug is used

for the specific therapy approved. A competitor

could obtain FDA approval and manufacture

and sell the identical drug for a different therapy; yet the doctor could prescribe or the con-
. .

Ch. 6—The Mechanics of Patent-Term Extension ● 63

sumer could use the competitor’s drug for the

specific therapy approved. As with method-foruse patents discussed in chapter 5, the patentee

may not have an effective mechanism to enforce

his patent. His only remedy would be to sue

each of the prescribers or users for patent infringement.

From the standpoint of promoting pharmaceutical innovation, method E.2 (limiting enforcement to the specific therapy approved)

could be beneficial for developing new therapies

for existing drugs. A competitor would have an

incentive to develop another pharmaceutical use

for the drug so that he could market it. The patentee would also have an incentive to develop

other pharmaceutical uses so that those uses

would be covered during the extension. While

some uses developed may provide significant

improvements in health care, others may not.

Interaction Between Limitations of

Scope and Limitations of Enforcement

By combining scope limitations with enforcement limitations, one can achieve a desirable

balance between meaningful patent protection

for the patentee and public use of the patented

technology during the extension. Three combinations of the methods discussed appear to be

most attractive from the standpoint of balancing these sometimes conflicting objectives. Each

combination strikes a different balance.

Combination A:

● Limitation in scope: Method S. I—Claims

restricted to the chemical approved by

FDA.

● Limitation in enforcement: Method E.l —

Enforcement only against FDA approved

product, process, or method-for-use.

In combination A the scope of the claim

would be limited to the chemical approved by

FDA, and the patent could be enforced only

against products, processes, or methods-for-use

which were subject to FDA approval. Of the

three combinations, this one would provide the

most protection to the patentee.

Combination A would have the following

effects:

●

●

●

●

the patented technology could be used for

all but pharmaceutical purposes;

others could produce minor variations of

the chemical and use the technology for

drugs;

others could not develop the approved

chemical for new FDA uses; and

the patentee could enforce the patent

against anyone who marketed an identical

drug regardless of the drug therapy for

which it was prescribed or used.

Combination B:

Ž No Imitation in scope.

● Limitation in enforcement: Method E.2—

Enforcement limited to specific therapy approved.

With combination B, the claim would be interpreted to its full scope; however, the patent

could only be enforced against anyone who

made, sold, or used the patented product, process, or method-for-use for the specific therapy

approved. This combination differs from combination A in that the claim would be broader

with respect to the active chemicals covered, but

the patented technology could be used for other

drug therapies.

Combination B would have the following

effects:

● the patented technology could be developed for all uses other than the specific

therapy approved by FDA; and

● enforcement would not be practicable

against an identical drug developed for a

different therapy but prescribed or used for

the patentee’s therapy.

Combination C:

● Limitation in scope: Method S.1—Claims

restricted to chemical approved by FDA.

● Limitation in enforcement: Method E.2—

Enforcement limited to specific therapy approved.

Under combination C, the scope of the claim

would be linked to the chemical or chemical and

use approved by FDA, and the patent could

only be enforced against the sale or use of the

patented product, process, or method-for-use
64 Patent-Term Extenstion and the Pharmaceutical Industry

for the specific therapy approved. Of the three ●

combinations, this combination would provide

the least protection to the patentee.

Combination C would have the following

●

effects:

others could make, use, and sell minor

variations of the chemical for uses identical

to the specific therapy approved;

LIMITATIONS IN REMEDIES

In the original patent term a patentee can

secure an injunction against an infringer and obtain damages for the infringement. Proposals

have been made to limit the remedies available

to the patentee during the extension period. The

most restrictive proposal would not permit the

patentee to exclude others from making, using,

or selling the patented drug but would require

him to license the invention for a reasonable fee

(compulsory licensing).

If the objective of extending the patent term is

to increase the potential for returns to the innovating firm, compulsory licensing would

probably not accomplish that objective. The

benefits of a reasonable royalty are likely to be

less than the benefits received by the patentee

through the sales of products. Moreover, the

determination of a reasonable royalty can be

difficult, expensive, and time-consuming. Burdens would be placed on both the administrators of the law and on the firms contesting

others could develop the patented technology for all uses other than the specific therapy approved; and

enforcement would not be practicable

against an identical drug developed for a

different therapy but prescribed or used for

the patentee’s therapy.

the royalty. Most significantly, compulsory

licensing would create an uncertainty which

would not be resolved until a request for a

license was made and granted. For these reasons, compulsory licensing could detract from

any incentive for pharmaceutical innovation

provided by patent-term extension.

There are, however, intermediate grounds.

For example, compulsory licensing could be required only if the firm were not satisfying the

needs of the public or if the licensing were essential for national security (e.g., to assure more

than one source of supply in the event of a catastrophe). Such intermediate grounds presently

exist to protect national interests. Title 28, section 1498 of the U.S. Code, provides that the

United States can use or manufacture, or have

used and have manufactured for it, a patented

invention without the patentee’s permission.

The patentee however, is entitled to reasonable

compensation for such use and manufacture.

THE DURATION OF THE EXTENSION

Several proposals have been made for estab- ● the duration could be the period between

lishing the duration of the extension. the date on which the innovator was pre-

● the duration could be a period which pared to commercialize the invention and

the date on which marketing approval was enables the innovator to obtain adequate

remuneration for the invention, and would obtained (proposal D.3); or

be decided on a case-by-case basis (pro- ● the duration could be a period correspondposal D.l); ing to at least a part of the time consumed

• the duration could be a predetermined and in the regulatory review process (proposal

uniform period (proposal D.2); D.4).
Ch. 6—The Mechanics of Patent-Term Extension ● 65

Each of these proposals could be modified in

such a way that the extension would be terminated if the drug were not being sold by the

innovator firm or if the patented technology

(e.g., in the instance of a patented process) were

no longer being used for the drug.

Proposal D.1: Adequate remuneration.

This method would pose significant administrative problems but because very few new

drugs are marketed (between 40 and 100 new

drug applications (NDAs) are approved per

year), the problems would be small in number.

More significantly, the determination of adequate remuneration would be subject to controversy. The extension is most meaningful to

the research-intensive companies as it applies to

drugs that have been most profitable during the

original patent term. Unless the extension included these drugs, the economic benefits from

pharmaceutical innovation provided by patentterm extension would be significantly reduced.

Because this method would not provide the

public with notice that the patent was being extended until the expiration date of the original

patent term was approaching, potential competitors might not initiate steps for manufacturing and marketing the drug until they knew that

no extension would be granted. Thus, if the administrative proceedings were lengthy, a de

facto extension might result.

Proposal D.2: Predetermined and uniform

period.

Extending the patent term for a predetermined period, e.g., 7 years, might result in inequities, with some drugs being protected for

more than 17 years. There would be no direct

correlation between the regulatory approval

time and the patent life. This method, however,

would be easy to administer.

Proposal D.3: Marketing delay compensation.

Determining the delay between the time when

a firm was ready to market a product and the

time the product was approved by FDA would

be difficult and the determination would be subject to dispute. Making these determinations

would be an administrative burden. Moreover,

firms would be encouraged to prematurely proceed with manufacturing plans in order to increase the extension which could be obtained. If

the firm timed its manufacturing plans according to the progress of the drug through

FDA, the measured delay might be unduly brief.

Proposal D.4: Time consumed in the

regulatory review process.

This proposal, which makes the duration of

the extension dependent on the time consumed

by the regulatory proceedings, overcomes some

of the difficulties and inequities of the other

three proposals. Because the dates that premarketing approval procedures begin and end are

known, this method would not impose a great

administrative burden.

Basing the period of extension on the regulatory review period could compensate the patentee for time he would have spent developing

and testing the drug even if FDA did not exist.

The likelihood of this occurring would depend

on when the period eligible for compensation

begins. If the objective of patent-term extension

is to encourage pharmaceutical innovation, the

issue of whether the patentee receives excess

compensation may not be of prime importance.

If proposal D.4 were adopted, the innovators

might delay the testing needed to secure premarketing approval. But, such dilatory tactics

would also delay the marketing and would

therefore be disadvantageous to innovators. If,

however, the new drug would compete with an

existing drug of the innovator firm, dilatory tactics might be used. But such tactics are discouraged by the courts. If a patentee has purposefully delayed steps needed for FDA approval,

the court may refuse to enforce the patent, but

proving purposeful delay can be quite expensive

and time-consuming.

The effects of this proposal would depend on

when the period eligible for compensation

begins. In general, the earlier in the regulatory

process that the clock starts ticking for determining the duration of the extension, the longer

and more economically meaningful the patentterm extension will be. There are a number of

dates at which the clock could start.
66 ● patent-Term Extension and the Pharmaceutical Industry

The period could begin on the date that the

NDA was filed with FDA. The period between

NDA filing and final approval is frequently

about 2 to 3 years, This amount of time might

be insufficient to provide significant additional

incentives for pharmaceutical innovation, A

predetermined period of time could, however,

be added to the extension. In some instances,

adding a predetermined time would more than

compensate for time lost in the regulatory

review process.

The period eligible for compensation might

instead begin on the date that the first clinical

trials in the United States were initiated. The

time between the initiation of clinical trials and

the approval of the NDA for new chemical entities is frequently 5 to 8 years. Beginning the

clock at the first clinical trials could result in

significantly extended patent terms.

Alternatively, the period eligible for compensation could begin on the date on which the investigational new drug (IND) application is filed

with FDA. The filing date of an IND is easy to

determine and the filing of an IND is a precondition to the initiation of clinical trials in the

United States. The IND could be filed long

before clinical trials began.

Another proposal would begin the eligibility

period when substantial preclinical animal tests

(e.g., tests of longer than 6 months) were

OTHER CONSIDERATIONS

There are several other aspects of patent-term

extension that must be addressed. Should extensions be granted to marketed drugs that are

ordered off the market for further testing?

Should patent extensions be granted in cases involving alternative uses of drugs, since alternative uses also must be approved by FDA?

With respect to the first question, extending a

patent to compensate for the period when the

product is ordered off the market could pose difficulties. If an extension were granted only when

a Federal regulatory agency ordered a withdrawal, the innovator firm might be reluctant to

voluntarily withdraw the product until such an

started. These tests are frequently initiated prior

to the filing of an IND.

Maximum Extension Period

A maximum period of extension has been

proposed to eliminate extensions of long duration and to discourage innovator firms from

delaying the premarketing approval process to

obtain later expiration dates on extensions.

The effects of the extension will depend on the

length of the extension. If the maximum period

is too short, the potential for incentives for

pharmaceutical innovation may be too small to

be meaningful. If the maximum period is too

long, the social costs of innovation may outweigh its benefits.

The maximum extension could simply be a

specific number of years with no qualifications.

Proposals have been made, however, that

would prevent the extension from going beyond

a fixed time from the filing of the first patent

application.

This constraint could act as a disincentive for

delaying proceedings in the Patent Office. If the

date of the filing of the first patent application

were selected as the starting point, the patentee

would receive no benefit from filing continuation or divisional applications to delay the issuance of the patent application.

order was issued. In any event, drugs are withdrawn from the market infrequently.

With respect to the second question, drugs

frequently possess efficacy in more than one

therapeutic area. The ability to extend the enforceability of the patent to other therapeutic

uses that the patentee has developed might promote innovation. If the enforceability of the patent were limited during the extension to the specific therapy approved, the additional extension

would not have any effect on the length of the

extension for the first use. If the enforceability

were not so limited, providing an extension for

another therapy would also extend the patent
Ch. 6—The Mechanics of Patent-Term Extension ● 67

for the first therapy, and the patentee could

therefore increase the effective patent term for

the first therapeutic use.

The Number of Patents Extended

per Drug

It is possible that more than one patent may

provide protection to a drug. The issue dates of

the patents may differ, thereby allowing the patent protection provided by a later-issued patent

to extend beyond the expiration of the first patent. Patent-term extension could be restricted to

only one patent per drug or could apply to each

patent covering the drug. Depending on the

method used for determining the length of the

extension, permitting more than one patent to

be extended could result in extensions that expired at different times. If the method for determining the extension corresponded to the effective patent term lost due to premarketing review, no patent could have its term extended

beyond 17 years.

The Obligations Incurred by

the Patentee

In the normal operation of the patent system,

a patent is granted and, in return, the public

receives a disclosure of the invention and a

description of its best mode. The patentee incurs

no further obligations (other than maintenance

fees) during the patent term.

Proposals have been made to impose additional obligations on the patentee in return for

the extended patent period:

1.

2.

3.

4.

5.

after the extension the patentee could be

required to provide potential competitors

with available data (results from clinical

and toxicity testing) needed for securing

FDA approval for generically equivalent

drugs;

after the extension the patentee could be

required to relinquish all rights to the

trade name;

after the extension the patentee could be

required to allow others to use the size,

color, and shape of the drug that is coming off patent;

during the extension maximum prices for

the drug could be mandated; and

patentees could be required to use a portion of the revenues derived during the extension for research and development.
Appendix
Appendix

Patent-Term Extension

for Other Industries

The Medical Devices Industry

The medical devices industry manufactures products that are used in the diagnosis, treatment, or

prevention of diseases or conditions. The benefits of

these products reside in their ability to affect the

structure or function of the human body through

means other than chemical action. 1 The definition includes simple products, such as surgical instruments

and orthopedic shoes, and vastly complex products,

like cardiac pacemakers and diagnostic equipment.

The Food and Drug Administration (FDA) regulates

this industry, and only in certain instances is premarket approval required.

The medical devices industry emerged after World

War II as a result of technological developments. In

the last two decades, the industry has experienced

substantial growth in sales: between 1974 and 1980

sales increased by more than 100 percent, with 1980

sales estimated at about $11.5 billion. z The industry

is comprised of several thousand firms, many of

whom are quite small.3 Several relatively large firms

in the industry appear to play a dominant role in the

market. ’ According to one source, the larger firms

constitute the stable portion of the industry; but the

turnover rate for smaller firms is high. This difference does not derive from differences in the types

of devices produced. Since a company need not have

a large minimum plant size to produce medical devices, it appears that medical devices in general are

not characterized by great economies of scale. 5 Thus,

entry is not dependent on large amounts of capital.

Sales in the industry are made through a large independent distributor network. Recently, there has

been a shift in the character of this network from

small local/regional dealers to major national suppliers. ’ Under these circumstances, larger manufacI tie~]th Industry, Nlanutacturers A\s(~clatlon, Summary Report, ‘

(\\’a\hlngtcJn, El C H1\lA, Octt>ber l’?78~, p. 8 .

‘1’redlcasts Inc Value (~t Shipment, ( SIC COCk’ 2831 3841-43, 36Q3~

IQ80

‘Health ]ndustry ~lanutacturer~ Ass[lclatl(~n Summary Rep{lrtf ‘ rept~rted ,~ver 1,000 members In 1978 w]th 72 percent having sa]es less than

!510 mllllt~n Thus 280 c~~mpanle~ had $73 bllll(~n ot the 1~78 $8 ~illl(~n ~ale~

t lgure

\lanut~c turers (~t hlecllcal Devices I(lln the Ch(u-u~e~ ~~f llet-wlat~~r>r

Crltlcs TIIC N’utI~~Na/ /LII/rIInl ( Sept 20, lQ80~ p 15bb, rep[~rted more tha n

5,000 manufacturers In IQ80

“Oltlce (It Planning and Evaluatl(ln, Ec(~n[lmlcs Statt Study 53, Fmd and

Drug Admlnl\trati(~n ( \\’a\hln~t(~n, D C FDA, 1Q801

‘Iblci

‘S[{[ Intcrnatlonal Structure (,I the U S NledIcal Suppl I+ Equipmen t

and [k,v 1Icc\Indu\t ry ( Stant(lrci, C’allt. SRI In tuna tl(lna 1 Print Ing, 1 Q79 ~

turers have a distinct advantage because they are

capable of delivering the quantity a national distributor would require. Insofar as the larger medicaldevice manufacturer may tend to be a multiproduct

concern, its reputation in one line will influence a

distributor’s decision to carry another of its product

lines. Thus, the development of a national distribution network may act as an entry barrier for the

smaller medical device company.

For several reasons, the patent system is not as important in this industry as it is in the pharmaceutical

industry. First, there are generally many more substitutes available for any one medical device than there

are substitutes for drugs. Second, there is a very high

turnover in technological achievements in the industry and products are often outmoded before their

patents expire. Third, devices are generally simpler

to invent around than drugs and the patent, therefore, may provide little protection from imitators.

Fourth, premium prices commanded by patented

medical devices may not be as great as premium

prices in the pharmaceutical industry because some

downward price pressure is exerted through an informed and price-conscious market (hospitals,

laboratories, and independent distributors, etc. ).

Thus, while the patent may be viewed by the industry as one of several avenues for the minimization

of risk, it is typically not the overriding incentive for

innovative activity.

The growth in sales and in the number of firms in

the industry seems to indicate a reasonable degree of

competition and therefore an environment conducive

to innovation. However, insufficient information exists for a reliable evaluation of the industry’s competitiveness. First, we have not studied how concentrated any particular device area may be within the

industry (e. g., we do not know if one firm or a thousand produces X-ray equipment). Second, regulation

of the industry began recently (1976) and its effects

may not yet be evident.

FDA began its present scope of regulation of

medical devices in 1976 with the passage of the medical device amendments to the Food, Drug, and Cosmetic Act. Prior to 1976, some devices such as soft

contact lenses, IUDS, hemostats and others, fell

under the purview of FDA because the agency had

these devices classified as “drugs. ” As well, prior to

71
72 ● Patent-Term Extension and the Pharmaceutical Industry

1976, FDA had postmarked surveillance regulatory

powers for devices. That is, FDA could remove a

device from the market if it was not safe and had

power to ensure that the product’s label was not

misleading. Thus, while regulation of the industry is

not as recent a phenomenon as it might appear, the

scope of the regulation has widened considerably

since 1976. Currently, the thousands of medical device products are divided among three groups. Class

I devices are noncritical items such as bedpans and

are subject to generally the same standards of regulation as all devices were prior to 1976, that is postmarked surveillance techniques. Class II devices include

items thought to require something more than Class I

regulation to ensure safety but not as much control as

a premarket approval. Regulation of Class II devices

takes the form of setting performance standards.

Class III devices (those previously classified as

“drugs” as well as others whose use can be similarly

dangerous) require premarket approval. The process

for obtaining Class III premarket approval is quite

similar to that required for drug approval.

Devices can short-cut the regulatory procedures by

being judged “substantially equivalent” to pre-1976

devices. In the 4 years since the medical devices

amendment was enacted, about 98 percent of premarket notifications were declared “substantially

equivalent.“ 7 Notifications are required 90 days prior

to the marketing of a device to ensure that it will not

be a member of Class III and require extensive

testing.

The full effect of these regulations on the competition and innovation in the industry has not yet been

felt. The uncertain}’ about future regulations may

change the weight of the patent as a factor in the

innovative process. However, some general tendencies can be noted. The performance standards for

Class II devices may dampen innovative activity, as

the standards need only be met, not exceeded, to obtain approval.

In addition, FDA has been exploring the concept of

voluntary standards for Class II devices. Larger

device companies, by virtue of their larger voices,

would appear to be able to have their products’

standards emerge quickly and effectively as the accepted measure of voluntary standards, To the extent

that smaller companies’ voluntary standards are different from those of large companies, competition

and innovation may become more difficult for

smaller device manufacturers.

FDA regulations concerning “substantially equivalent” devices may hold the potential for dampening

““New Device Introductions on the Rise, ” in Det~lces ad Diag)~ostics Letter vol. 1, Aug. 12, 1Q80.

competition simply by encouraging manufacturers to

produce devices that are based on minor changes in

old products. However, such products may not be

able to obtain patents. If manufacturers claim substantial equivalency at FDA, they may injure their

chances to get a patent approved, i.e., an old device

may be considered prior art for patent purposes. On

the other hand, the issuance of a patent may be considered proof that a device is not substantially

equivalent because patents are supposed to be

granted for new and unobvious inventions. Thus, the

patent may become much less important than it currently is for devices similar to existing products. By

the same token, patents may become more important

to first entrants with wholly new products.

Two other trends that may affect the industry’s

competitiveness should be noted. First, while medical

devices are more price sensitive than pharmaceuticals, this industry is becoming more subject to price

insulation from third-party reimbursement. a Compared to most industries, the medical device industry

is considered price insensitive, however, hospital cost

containment programs often look toward medical

devices for areas of savings. Future competition may

increasingly be based on other considerations in addition to price and, to the extent that this leads to

higher profits, entry may be encouraged. It has been

reported that the larger device manufacturers have

generally been generating far more cash than they are

able to reinvest profitably and thus can be expected

gradually to lose their current market shares unless

reinvestment alternatives emerge.9

In summary, the medical devices industry is likely

to continue to be reasonably competitive and innovative in many product lines and patent-term extensions may, therefore, be unnecessary. However,

for Class I and II devices, the level of innovation may

depend on the balance struck between the attractiveness of obtaining a patent and the desirability of

receiving rapid approval for “substantially equivalent devices. ” In this regard, patent-term extensions

could have a limited, but perhaps important, positive

effect by shifting the balance toward innovation.

Finally, regulation of this industry is in the early

stages. As more devices become available for uses

with potentially hazardous side effects, more aggressive regulatory measures may be seen in the

future; that is, technological sophistication may lead

to a larger portion of devices being classified as Class

III (those requiring premarket approval).

———.——

“Arthur Young & Co., “A Profile IJl the Medical Technology Industry

and Governmental Policies, ” draft final report (Washington, D. C.: Arthur

Young & Co. Printing, Mar. 31, 1981), pp. IX-7.

“Mitch and Martinelli, “An Analysis of Business Performance in the

Health Care Industries, ” Business EcoHomIcs, March 1980.
Appendix—Patent-Term Extension for Other Industries 73

The Pesticide Industry

Because the pesticide industry and the pharmaceutical industry are subject to similar regulations,

the effects of patent-term extension will be simiIar for

the two industries.

Companies selling the most pesticides are often

very large and diversified; pesticide sales frequently

account for 20 percent or less of company sales.10

The pesticide industry manufactures herbicides, insecticides, and fungicides, all of which are subject to

premarket regulatory approval by the Environmental

Protection Agency (EPA). The products are regulated under the Federal Insecticide Fungicide and

Rodenticide Act which was amended in 1972 and

now requires a demonstration of human safety. As in

the pharmaceutical industry, the more stringent requirements have increased the costs and times associated with research and development. The regulatory

process in 1975 required about 7 years to complete in

contrast with a little less than 3 years in 1960.

The measures of innovation available in the pesticide industry indicate that innovation has, thus far,

been virtually unaffected by the increased costs and

times required for regulatory approval. Table A-1

below illustrates a steady rate of new pesticide chemicals being registered per year in the United States between 1967 and 1979. It should be noted that fluctuations in pesticide registration are primarily a function

of legal and administrative measures at the EPA and

‘“The Ct)nservat][)n F[~undation, “[’r(duct Regulation and chemical Innt~vatlon.” March 1980, p II-8

Table A-1.— New Pesticide Chemicals Registered

in the United States, 1967-79

Year Total numbera

1967 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

1968 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

1969 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

1970 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

1971 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

1972 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

1973 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

1974 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

1975 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34

1976 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

1977 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

1978 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

1979 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

aHerblcldes, msectlcldes, fungicides, and others

SOURCES Organlzatlon for Economic Cooperation and Development, “Regulation and Innovation In the Chemical industry—A Preliminary

Assessment of the Impact of Recent Chemicals Leglslatlon, ” p 28;

and The Conservation Foundation, Product/on Ffegu/af/on arrd

Chemical /nrrovaf/on, March 1980, p III-14

are not necessarily a sound measure of innovation in

the industry.

Figure A-1 illustrates the growth in research and

development (R&D) expenditures in both constant

(1967) and current dollars. As can be seen, real

growth in R&D expenditures has occurred, with particularly evident spurts taking place after 1975, when

one would have expected the effects of the 1972

amendments to be felt.

In table A-2 below, we see similar constant growth

in sales (at least for 1970-76).

No measure of the qualitative value of pesticides

was available to this study. One can reasonably

assume that regulatory requirements for efficacy did

not produce a decline in the value of pesticides

marketed since 1972.

The research companies appear to be continuing to

increase R&D expenditures at the present time, regardless of the trends in patent life. Uncertainty exists

as to whether R&D expenditures would increase

more rapidly with patent-term extension or whether,

without the extension, R&D expenditures would continue to increase if effective patent lives decline.

One important characteristic of the pesticide industry that is dissimilar from the pharmaceutical industry is the role of the Federal Government in

pesticide research and development. The Conservation Foundation reports that the Department of AgriFigure A-1 .—Pesticide R&D Expenditures, Domestic

Manufacturers Reporting to NACA, 1967-78

100 ‘

— Current dollars

250 —

— - Constant 1967 dollars

Year

SOURCE: National Agricultural Chemicals Association, Industry Profile

Surveys.
74 . Patent-Term Extension and the Pharmaceutical Industry

Table A-2.--U.S. Pesticide Sales in

1970 Constant Dollars

Total sales

Year (millions of dollars)

1970. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 70

1971 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81

1972. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91

1973. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91

1974. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93

1975. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107

1976. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118

SOURCE Organlzatlon for Economi cCooperatton and Development, “RegulatlonandlnnovatlonintheChemlcal Industry—A Preliminary Assessmentofthelmpact cfthe Present Chemical Legislation,’’p.29,

culture and the State experiment stations spent

$332.6 million on research and implementation of

pest control and pest management programs in

1978. 11Several other Government agencies contribute to pest control research as well. While Government agencies also contribute to pharmaceutical

research, the proportion of those funds as a percentage of the total is smaller. In cases where the funds

support industry research which, in turn, produces

an industry-owned patent, patent-term extension

may entail double rewards.

Some of the similarities between the pesticide and

pharmaceutical industries are also worth highlighting

here in order to provide additional understanding of

the possible effects of patent-term extension. First,

while some 80 companies actually produce pesticides, another 5,300 are pesticide formulators, or

companies involved in the combining and packaging

of pesticide products for specific uses. As with the

production-intensive pharmaceutical firms, the patented innovations made by formulators will not benefit from extensions of the patent term.

Finally, the pesticide industry has an analogous

situation to the “orphan drug” research problem in

the pharmaceutical industry. Minor crops do not present enough potential market for a pesticide company to invest in research for that crop. Here patentterm extensions also cannot be expected to induce

firms to increase expenditures for minor cro p

research.

The Chemical Industry

The title of this industry is somewhat misleading;

although pharmaceuticals and pesticides are chemicals, they are not meant to be included in this discus-

“Ibid., p 11-10.

sion. The chemicals considered here are basic industrial chemicals that are used to make other chemicals

or products. Also included are dyes, pigments,

paints, plastics, synthetic rubber, and synthetic

fibers. The vast majority of the industry’s sales are of

intermediate goods; that is, they are used to make

other products which are then used by consumers.

Chemical products, other than pharmaceuticals,

pesticides, food additives, and cosmetics are regulated under the 1976 Toxic Substances Control Act

(TSCA), which is administered by EPA. TSCA, in

contrast to the laws regulating pharmaceuticals and

pesticides, does not require Government approval

before a product can be marketed. It requires only

that the manufacturer submit a notice to EPA 90 days

before he intends to begin manufacture. The notice

must contain information about the use of the chemical, the anticipated volume of production, and the

expected exposure of workers and others to the

chemical, but EPA cannot require manufacturers to

submit specific tests with the notice. If the notice does

not contain enough information for EPA to evaluate

the risks which may be posed by a chemical and if

there is reason to believe that the chemical may pose

a risk, the agency can delay manufacture of the

chemical until adequate information is submitted. If

the agency finds that a chemical for which a notice

has been submitted will pose an unreasonable risk, it

can impose any of a wide variety of restrictions, including a prohibition on manufacturing the chemical.

Because EPA is given only 90 days to review a

chemical notice (the 90-day period can be extended

up to 180 days), patent-term extension will not be applicable to the great majority of chemical products.

Some new chemicals will fall into categories of chemicals which are required to be tested under section 4

of the Act, and for such chemicals a patent extension

for the period it takes to conduct the required tests is

meaningful. Manufacture of a chemical can also be

delayed if the manufacturer submits inadequate information (TSCA sec. 5(e)) or if EPA finds that the

chemical will pose an unreasonable risk to health and

the environment (TSCA sec. 5(f)). Patent-term extension for chemicals delayed under section 5(e) or 5(f)

might reduce the incentives for firms to conduct adequate testing or provide adequate information, since

there would be no patent penalty for not doing so.

Patent-term extension could be abused by premature

filing of a notification without previously conducting

adequate testing or withholding pertinent information.