The Generic Drug Boom

[What counts is] competition from the new commodity, the new technology, the new source of supply, the new type of organization… competition which… strikes not at the margins of the profits and the outputs of the existing firms, but at their foundations and their very lives.

The words above were penned 70 years ago by an economist named Joseph Schumpeter in his book Capitalism, Socialism and Democracy. In that book, Schumpeter describes how transformational innovation disrupts the businesses of established market players in a capitalist economy.

Of course, our own legal framework serves to protect innovations made by existing companies. Enshrined in the US Constitution is the authority granted to Congress to “promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.”

Often called the “Copyright and Patent Clause,” the patent protections granted are time limited. The inventor enjoys a period of virtual monopoly, and then anyone else can use the technology described in the patent. If the inventor, however, fails to engage in new patent-protected innovation, the business is at risk of falling apart after the term comes to an end.

This is what’s happening in the pharmaceutical industry today — but on steroids. Big Pharma is in Big Trouble. Many of its most-popular and profitable medicines are nearing the end of their patent-protection periods. As blockbusters begin to face competition from generics, Big Pharma stands to lose billions of dollars in yearly revenue. At the same time, shrinking in-house pipelines mean that Big Pharma won’t have the new product sales to replace what it will lose to generics. The industry is turning to partnerships and acquisitions of small biotechnology companies to plug the innovation gap.

It will take a great many new products to make up for the ones being lost, however. Just this past November, for example, Pfizer’s cholesterol-fighting drug Lipitor fell off the dreaded “patent cliff.” As the world’s top-selling drug, and with annual sales north of $10 billion, Lipitor accounts for more than 10% of the world’s largest pharmaceutical’s revenues. To make matters worse, on the same day that Lipitor lost patent protection, Indian pharmaceutical company Ranbaxy Laboratories was cleared by the FDA to market a generic clone.

Lipitor, however, is just the beginning of Big Pharma’s woes. The second-biggest drug on the market, Bristol-Myers Squibb’s blood thinner, Plavix, is scheduled to go into generic status in 2012. More than a third of BMY’s sales are tied to Plavix.

Other multibillion-dollar sellers — such as Forest Laboratories’ antidepressant Lexapro, AstraZeneca’s anti-psychotic Seroquel and Merck’s asthma drug Singulair — also have a date with doom in 2012. All told, of the world’s top 20 drugs by sales, seven will go into generic status. By 2015, an estimated quarter-trillion dollars in sales of patent-protected drugs will be at risk of competition from chemically equivalent generic compounds.

All other factors being equal, generic competition reduces prices. For the millions of patients dependent on these drugs for their health, steep price drops make prescription drugs more affordable. This is a natural outcome stemming from an end to monopoly status.

Generic competition to these drugs will enjoy strong sales through government health care programs looking to cut costs. We are already seeing aggressive cost-cutting measures to reduce what these programs have to pay to provide beneficiaries with drug coverage.

Millions of Americans will begin receiving coverage under the provisions of the 2010 Affordable Care Act over the next few years. Add the millions of boomers entering retirement age, and the generic drug business will boom as well.


Patrick Cox,
for The Daily Reckoning

The Daily Reckoning