Drug Innovation: When Patents Work

(and When They Don’t)

Reexamining Patent Protection

rachel sachs, is an associate professor at the Washington University School of Law and a faculty scholar at Washington University’s Institute for Public Health.

Illustrated by lincoln agnew

Published October 23, 2020


In recent years, drug makers have developed a host of dazzling products, including some based on cutting-edge gene therapy technology. Given the difficulties (scientific, financial and regulatory) of developing these new technologies and bringing them to market, pharmas argue that strong patent protection is essential if we expect innovation to continue at the current pace. Or maybe not. Fundamental shifts in the technology behind drug development suggest there are alternative ways for ensuring that successful innovators recoup their investments. And in light of the societal costs that are part and parcel of protecting intellectual property with patents, it’s worth asking whether this form of protection sometimes does more harm than good.

Here, I argue that, in the case of drug innovation, one size does not fit all. While patent protection is needed to incentivize the development of certain types of drugs, it is a relatively weak incentive for the development of others. In these latter cases, the rest of the innovation ecosystem we have built up around medical therapies is likely to get the job done while sparing consumers some of the patent system’s costs.

Why Patents Matter

In many fields of technology, there are ongoing debates about how much patents matter in encouraging innovation – or about whether patents, even if they do create the intended incentives, do considerable damage by delaying wide access to highly valued goods and services. But, until recently, there has been little debate about the role of patents in pharmaceuticals. Even the Federal Trade Commission, which over the decades has taken its charge to maintain competition very seriously, has referred to innovation in the pharmaceutical industry as “showcas[ing] the patent system’s benefits.”

The industry agrees: pharmaceutical executives rate patents as far more important to innovation than do representatives of any other tech-driven business. (Indeed, in the same surveys, software entrepreneurs report that patents create little to no incentive to innovate.)

The reasons for the longstanding primacy of patents in pharmaceuticals are traceable to the way most drugs are developed. Pharmaceuticals are among the most costly consumer products to bring to market, with companies often investing in excess of $1 billion before a new drug can launch. The process is extremely lengthy as well as expensive; after a potential therapeutic compound is identified, it typically takes more than a decade to be tested and to pass muster with the FDA.

Pharmaceuticals are among the most costly consumer products to bring to market, with companies often investing in excess of $1 billion before a new drug can launch.

Moreover, the process is also extraordinarily risky: Most candidate drugs fail at some point in the clinical trials process, meaning their sponsors must look elsewhere to recoup their investments on those products. Perhaps most problematic of all, once developed, most “small-molecule” drugs – classic drugs like aspirin produced through standard chemical synthesis techniques – are simple to imitate. It may take a nine-figure outlay and a decade to bring a new drug to market, but as little as two years and a few million dollars to develop a generic version.

The triple whammy – the exceptionally high fixed costs, the risk and length of time needed to get a new drug approved and the relative ease of imitation – explains why patents are seen as utterly necessary to keep drug innovation on track. Manufacturers can use their patents to prevent others from making, using and selling the technology for 20 years from the date of the patent’s filing. Importantly, because certain legal doctrines require innovators to apply for patents early in development, much of this time is eaten up by the FDA approval process.

As a result, companies, on average, have just 12 years of patent protection left once a drug has reached the market. Thus, while patents do create a time-limited monopoly during which the patent holder has full discretion to set their product’s price, the innovator must recover the investment along with sufficient profits to offset the cost of other development initiatives that didn’t pan out.

In exchange for this exclusive right, patent holders must disclose to the public sufficient information about how to make and use their invention. And at the end of the patent period, competitors are free to use this information to copy the technology and presumably make a profit selling the drug at a lower price.

But patent law’s stimulus to innovate almost inevitably comes with societal costs. The higher prices that patent holders can charge in an attempt to recoup their investments may mean the drug is unaffordable for at least some patients even if the manufacturing cost is trivial – an issue that is especially acute in the United States, where patients without health insurance must pay the price out of pocket.

Barriers to entry for generic manufacturers were quite high even after they no longer faced patent-based obstacles to production.

Lower-priced generic versions of these drugs may not appear for decades – and may be delayed beyond the expected date by patent holders’ arcane strategies for extending their legal monopolies. In the meantime, patent holders may have no qualms about raising their prices year after year, putting their products even further out of reach.

Our system for regulating prescription drugs is best understood as an attempt to balance these benefits and costs. The 1984 Hatch-Waxman Act – formally, the Drug Price Competition and Patent Term Restoration Act – sought a legislative compromise between innovators and generic makers. Innovators argued that they were losing too much of their patent protection in the years it took to run the FDA-approval gauntlet. On the other hand, barriers to entry for generic manufacturers were quite high even after they no longer faced patent-based obstacles to production, and policymakers were concerned that, as a result, prices remained high long after patents had expired.

Hatch-Waxman addressed both of these issues. The law gave patent holders the ability to restore some of the patent term they lost during FDA review. At the same time, the act lowered the barriers to entry for generic drug makers, enabling them to bring versions to market more quickly and cheaply – and, hopefully, lowering prices accordingly.

When Patents Fail

However, patents are not always available as an incentive for companies to develop new drugs. In some cases, the structure of the law makes it difficult to obtain patents in a relevant context; in others, patents simply do a poor job of encouraging investment even when they can be obtained. Yet we still see innovation in these arenas, suggesting there may be insights to glean about the best design for intellectual property protection – and, specifically, whether patents might be supplemented or replaced by incentives that create less societal costs.

One area in which patents may be less important to innovators is in the growing field of microbiome research. Dysfunction of the microbiome, the ecosystem of microbes that lives within our bodies, has been linked to a wide range of maladies, including autoimmune diseases, mental health conditions and gastrointestinal illness. Scientists are investigating the ways in which the microbiome can be harnessed to fight or prevent disease as an alternative to more conventional drug therapies that impose harmful side effects.

This subject is no longer at the fringe of medicine. Policymakers have begun to recognize the potential of the microbiome, with the launching of a National Microbiome Initiative by President Obama in 2016 to help support research and development in this area.

Yet the very ways in which microbiomebased therapeutics offer novel approaches to treatment also make it more difficult to obtain strong patent protection for them. The problem is one of patent doctrine. Pharmaceutical companies that create traditional small-molecule drugs are able to obtain “primary” patents covering the chemical compound itself. These patents give them a clear-cut way to prevent would-be competitors from making and selling that compound, even if rivals have discovered, say, a novel method of manufacturing it.

In the microbiome context, the analogous patent would cover a combination of bacteria that is administered to a patient to treat an illness. But it is extremely difficult to obtain such patents. Applications are likely to be blocked by a 1948 Supreme Court decision that considered this question in the context of agronomy: whether a combination of strains of bacteria was patent-eligible. The Supreme Court concluded that it was not.

Even though the combination itself was both novel and useful, the Court reasoned that “patents cannot issue for the discovery of the phenomena of nature. The qualities of these bacteria, like the heat of the sun, electricity or the qualities of metals, are part of the storehouse of knowledge of all men. They are manifestations of laws of nature, free to all men and reserved exclusively to none.”

Innovators can be granted lengthy periods of administered exclusivity, which function similarly to patents in blocking generic competitors.

Despite the technological change that has occurred since the 1948 decision, don’t assume the precedent is likely to be discarded: the Supreme Court has recently cited it approvingly, reaffirming its principles.

That does not mean that innovators in this space are definitively locked out of patent protection. They may obtain patents that look much more like standard “secondary” patents – patents that cover a particular formulation of bacteria, or that cover a method of treating a patient using those bacteria. But secondary patents are weaker than primary patents, and potential competitors may be able to design around them.

In view of this diminished patent protection, we might expect that there would be little or no private investment in microbiomebased technologies. Happily, though, this is not the case. Venture capital firms, large pharmaceutical companies and small startups are all pouring money and talent into development. To be sure, they might invest even more if there were stronger patent protection. But the conventional wisdom that innovation stands or falls on a foundation of patent protection is not supported in this area.

What explains the disparity between the conventional story and the brighter reality? It may be due in part to the regulatory ecosystem we have built around prescription drugs. Innovators in this space do not need to rely solely on patents to protect their investments. They can also be granted lengthy periods of FDA-administered exclusivity, which function similarly to patents in blocking generic competitors from easily invading the market.

There’s another non-patent barrier, too. With so-called “biologic drugs” made in living cells, like many potential microbiome technologies, the complexity of copying (in contrast to copying small-molecule drugs) may enable their manufacturers to use trade secrecy to block potential competitors. Although these innovation incentives are not perfect substitutes for patents, they can certainly make a difference.

Much of the critical information identified and developed by the Flu Network is just that: basic information that cannot be as easily protected through patent law because it is highly nonexcludable.

Patents might well cover new methods of making vaccines or diagnostic reagents. But given the quality of existing methods and products, there may be little market pressure to develop novel strategies. Or so it appears: Flu Network participants have only rarely obtained patents covering their research and development activities.

Instead, Flu Network scientists work in close cooperation to perform crucial public health services. This model of information production is typically referred to in the scholarly literature as “open science.” Rather than seeking proprietary rights over discoveries and innovations, these scientists choose to share freely the new information they have developed.

Scientists operating under communitarian norms of information-sharing are motivated not by the direct financial remuneration enabled by exclusivity, but by other considerations. These may include scientific curiosity and reputational credit. In the specific context of the Flu Network, there’s little doubt that scientists are also motivated by altruism – by commitments to public health.

To be sure, scientists operating in the biomedical space do need financial support for their work. Flu surveillance and vaccine research is capital-intensive, just like other areas of biomedical research. But there is a strong public health need not only to ensure that this research is completed, but also that the results of such research (in the form of the seasonal flu vaccine) are made widely available for consumption at low or no cost. As a result, these flu research projects are generally recognized as what economists call “public goods” whose benefits are widely shared, and thus are typically (and rightly) supported by governmental funding.

Note, too, that a disproportionate share of the fully allocated cost of a vaccine is embodied in the R&D rather than the manufacture. The availability of development funding thus sharply lowers the cost of delivering it to patients, meaning that companies have less need to rely on the availability of patents.

The Flu Network also relies on unrelated legal tools – particularly contract law – to assure cooperation among its members. Material transfer agreements govern the sharing of virus strains both within the Flu Network and outside it. These contractual agreements specify the rights of and duties owed by the various parties, and function to bolster adherence to the norms that are features of the open science model. But the contracts also help to fill the gap left by a lack of standard intellectual property protection: manufacturers who wish to make and sell vaccines benefiting from Flu Network research must commit to benefit-sharing requirements in exchange

Admittedly, the examples of microbiome therapies and flu vaccines don’t prove that in the majority of instances patent protection has marginal value in new areas of biomedical research.

But they do suggest the potential for partial substitutes, including public funding of research, FDA-administered exclusivity periods and care in guarding trade secrets. And where these alternatives are practical, they may well stimulate innovation without the social downsides of our patent system.

Innovative Policy Options for Reform

Even when patents do incentivize the development of new pharmaceuticals, they do so at a heavy social cost because patent holders are free to charge prices far above incremental production costs. Even with insurers, public and private, providing coverage of medications for many patients, nearly one in four Americans still reports difficulty paying for their prescription medications.

Even when patents do incentivize the development of new pharmaceuticals, they do so at a heavy social cost because patent holders are free to charge prices far above marginal cost.

This is not a new problem. But it has become more acute in recent years both be-cause a good portion of the novel, innovative drugs are expensive to develop and because drug-company executives under pressure to report ever-growing profits have become more inclined to charge whatever the market will bear.

How, then, to make drugs affordable with-out losing the innovation benefits of patents? One option proposed by both scholars and 20 The Milken Institute Review policymakers is to reduce the ability of pharmaceutical companies to obtain the aforementioned secondary patents covering their products.

There has been a great deal of criticism of drug makers who extend their patent terms by obtaining secondary patents through what’s called “evergreening” – say, by patenting an extended-release form of a drug or a method for administering a new dosage.

Evergreening permits pharmaceutical companies to keep prices high for years, even decades, after the expiration of their primary product patent. In theory, one might argue that the potential for extending patents is baked into the incentive structure for stimulating innovation – and thus, without it, less innovation would take place. But it is really hard to believe that pharmaceutical firms’ investment decisions are strongly affected by events that may or may not happen 20 years later. Federal policymakers have proposed a range of bills that would make it more difficult for pharmaceutical companies to engage in evergreening, though none has become law yet.

A related set of reform strategies would strengthen the role of regulatory exclusivities granted by the FDA, while simultaneously constraining patent extensions.

After FDA approval, regulatory exclusivities and patents function similarly, enabling innovators to block generic competitors from the market. But they do have differences that might make it desirable to trade one incentive for the other.

In particular, regulatory exclusivities are more predictable than patents, which may have their validity challenged by potential competitors (and thus may end earlier than expected, if the challenge is successful). But regulatory exclusivities can also be narrowly formulated, covering only the product in question. Patents, by contrast, may cover not only the particular drug being sold but also limit the scope of competitors’ rights to sell distinct molecules in other forms for other purposes.

It thus might make sense to limit companies’ abilities to use the secondary patent strategy while making it easier to obtain regulatory exclusivities, as has been suggested in the biologics context. This combination would help solidify innovation incentives, while also limiting pharmaceutical companies’ methods for stifling competition.

There is no intrinsic reason why the use of intellectualproperty- based innovation incentives must be matched with exclusive means for allocating the resulting drugs.

A third possible solution would more broadly seek to delink the innovation incentive provided by patents from the allocation mechanism (of high monopoly prices) that patents use. Essentially, there is no intrinsic reason why the use of intellectual-propertybased innovation incentives must be matched with exclusive means for allocating the resulting drugs. For example, patents could be used to encourage companies to develop new technologies with the understanding that the government would purchase the proven drug in sufficient quantity at a sufficiently high price to yield a generous rate of return for the developer. The government could then make the drug available to all patients at much lower prices.

In practice, certain forms of health insurance already serve this function. Medicaid provides reimbursement for essentially all FDA-approved drugs, but Medicaid beneficiaries are charged nominal amounts for access. This approach retains the benefits of patent law as an incentive but redresses both the inefficiency of pricing drugs above marginal production cost and the inequity of pricing some patients out of the market.

Note, moreover, that the system could continue the practice of giving the patent holder most of the leverage over the price charged to the government buyer. But it need not work that way. In fact, it doesn’t work that way in many universal health care systems elsewhere in the world, where governments attempt to negotiate prices that are high enough to allow sufficient profit to encourage further innovation but still well below the profit-maximizing monopoly price in the United States.

• • •

The institutional framework of the American health care system – everything from its deep reliance on employer-based insurance to the incomplete power over the prices of medical goods and services exerted by large federal insurers – has evolved piecemeal over decades. Almost everyone agrees it could deliver better service at lower cost.

Like so many other aspects of the health care system, the pharmaceutical sector is a moving target – one that yields stunning successes, but is facing real structural problems. These are solvable. But it will take good economics, good science and strong political will to keep this great American innovation machine on track.

main topic: Medical Research
related topics: Intellectual Property