Time Release: The Effect of Patent Expiration on U.S. Drug Prices, Marketing, and Utilization by the Public

Which policies are most likely to provide as many people as possible with the best medical treatments? Pharmaceutical companies invest in the risky and time-consuming process of discovering and synthesizing new and more effective drugs because the patents protecting them offer the chance of large profits by restricting competition for a period of time. Critics of patent protection and its rationales, who are especially vocal in the information-technology realm, minimize patents’ ability to add to the supply of novel, valuable products and instead focus on patents’ suppression of demand. These advocates of file-sharing and open-source computer programs argue that the prices patent owners command for the duration of a patent restrict the number of people who can use the product in question, and thus who benefit from it. This critique is perhaps even more germane to the medical arena, where the high prices charged for drugs on patent could, in principle, deny some people crucial, even life-saving treatment.

The companies that own the patents to such medicines use the monopoly profits they collect not only to finance research and development but to pay for the marketing of these medicines once they have been approved. Marketing expands the number of doctors and patients who use the drug by informing them of its availability and benefits.

In this paper, we examine the role of marketing in generating demand for drugs by observing changes in market structure when patents expire and cheaper generic competitors enter the market. If the critics are right, what we call "utilization"—the number of prescriptions dispensed for the universe of drugs sold in the United States—should increase as prices drop.

While it is true that utilization of a drug is strongly affected by price, utilization is also affected by the marketing efforts of patent owners. So while lower prices of generic drugs stimulate demand, reduced investments in marketing, in response to generics’ growing market share, may result in an offsetting decline in a drug’s utilization. The latter effect may extend beyond the drug in question to other drugs in its category.

Using data on virtually all prescription drugs sold in the United States during the period 2000-2004, our study examines the effect of patent expiration on prescription drug prices, marketing, and utilization. We examine how prices, marketing, and utilization change over a typical drug’s “life-cycle.” The year a drug is first sold in the United States is considered year zero. During the first twelve years of a typical drug’s life-cycle, it faces very little generic competition. Generic competitors tend to enter the market in years twelve to sixteen. In that period, both the prices of formerly patent-protected drugs and the marketing expenditures on their behalf fall by about sixty percent. However, we also find that the number of drugs dispensed doesn’t change. Evidently, the increase in utilization that results from lower prices is offset by the reduction in utilization that results from less marketing.

The pharmaceutical industry is the most research-intensive industry in the world. Indeed, drug development remains an expensive and uncertain undertaking in which failure is far more common than success. To encourage investment, exceptionally high risks to companies and investors must be accompanied by the promise of limited monopoly profits.

While branded drugs are significantly more expensive than generics, this study does not find any evidence that patent protection reduces utilization of drugs. This may be because of high prescription drug insurance coverage that shields U.S. consumers from a large fraction of prescription drug costs. (In 2007, out-of-pocket payments by consumers accounted for only about 20 percent of total U.S. drug expenditure.) Declines in drug prices resulting from competition from generics may produce significant savings to insurers or pharmaceutical benefit managers that are not necessarily passed on to consumers.

Improvements in public health depend not only on access to existing health-care technologies but on the existence of financial incentives to develop new medicines. Our results indicate that weakening patent protection would not increase Americans’ access to existing drugs. However, it would undoubtedly reduce the number of new drugs developed.

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