Pay For Delay: Anticompetitive or Protector of Innovation?

Last Friday, the Supreme Court decided that it will review the pending FTC v. Watson Pharmaceuticals case that deals with the controversial "pay for delay" practice. The way it works is that brand name drug manufacturers pay a sum of money to generic manufacturers to delay the production of generic versions of brand name drugs. On its face, it certainly appears to be anticompetitive - a company is using its financial resources to keep others out of the market - not very different from forming a trust/monopoly. If it were that simple, however, this issue would have likely been resolved years ago.

The FTC's argument is as expected:

These drug makers have been able to sidestep competition by offering patent settlements that pay generic companies not to bring lower-cost alternatives to market.  [They] block all other generic drug competition for a growing number of branded drugs.  According to an FTC study... [they] cost  consumers and taxpayers $3.5 billion in higher drug costs every year.

The response of the pharmaceutical industry, however, is a bit more nuanced and presents an interesting dilemma - the official response is that the attempt to ban pay for delay settlements presumes that such payments are always anticompetitive, and as such ignores the "scope of the patent" rule, which makes an exception for payments that don't exceed the patents exclusionary potential. These should be important considerations for the court, but there are other, economic reasons for the frequency of pay for delay settlements.

An important consideration is that the effective life of pharmaceutical patents has markedly fallen over the past several decades. A drug patent is valid for 20 years in the U.S.; however, most companies have a much lower "effective" life for their patents because of the time spent in development and receiving regulatory approval. While in the 80s the effective patent life hit a high of around 14 years, by the mid-90s it fell to around 11 years - compared to products in industries with no regulatory approval which have an effective life of around 18.5 years. This means that pharmaceutical companies are pressed to at least break even on a new drug in a shorter span of time; while patent law allows companies to recoup up to 5 years of patent life lost during drug testing and FDA review, this is capped (arbitrarily) at a maximum of 14 years.

That effective patent life has fallen, leads to one of the reasons for the fall in patent life - the Hatch Waxman Act of 1984 that allowed generic drug manufacturers to file a claim against a patent prior to its expiration. Though the law greatly increased the number of generic drugs available to consumers (a huge financial benefit), it helped set the stage for protracted patent litigation between generic manufacturers and brand name innovators - with generics having little to lose (since they haven't started manufacturing) and brand name companies having a chunk of their business on the line. Pay for delay should be seen as a natural response to the economic conditions created by the law, the inherent uncertainties of litigation, and as a vehicle for less expensive settlement of patent disputes.

Another more nuanced point should be made - it is likely that the gains from pay for delay are priced into brand name drugs. That is, with a ban on pay for delay, the prices of brand name drugs would likely go up during the effective patent period. Thus, the FTC's claim that pay for delay practices cost consumers $3.5 billion annually should be taken with a grain of salt as they seem to focus on the increased cost of not having generic drugs on the market sooner, without looking at the potential change in costs of other brand name drugs as innovators increase prices to compensate for an even shorter (potential) effective patent life.

This shouldn't be seen as an outright defense of pay for delay - it certainly appears to be highly anticompetitive. However, rather than more lawsuits, legislative remedies may help to ameliorate the situation, especially if it improves incentives for innovation in the industry, which is the point of patents to being with.

For instance, if the cap on restoration time to patents were to be lifted (or extended) a good portion of the incentive for pay for delay would potentially disappear. On the regulatory side, if the FDA streamlined clinical trial requirements it would reduce total development costs and time, thus increasing effective patent life without lifting the cap.

What will the court decide? It's hard to say. Whatever the decision, it will likely affect not only drug companies, but consumers and incentives for future innovation.   Recognizing the trade-offs is the first step in developing a good solution.

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