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The Legal Drug Cartel: Big Pharma's Big Loophole in Antitrust Law


Consumers are spending an extra $3.5 billion per year on brand name drugs, thanks to decades of (legal) price-fixing by manufacturers.

MINYANVILLE ORIGINAL We've previously discussed the idiosyncracies and unfortunate incentives of the telecommunications world, but we would never suggest that tech is the only sector vulnerable to corporate patent finagling.

Economist Steve D. Levitt and journalist Steven J. Dubner are best known as the duo behind the international bestseller Freakonomics, and its sequel, SuperFreakonomics. They also run a blog under the same popular social science brand, which earlier this week featured a piece on anti-competitive loopholes in drug patent regulation: "Why Do Patent Holders Sometimes Pay Patent Copiers?" The authors provide a clear, robust overview of the legal loopholes that encourage this counterintuitive practice. We're going to touch on the "why," before delving a bit deeper into both the past and future of these all-too-common cartels.

What's the Problem?

The short answer: Makers of generic drugs can freeze out competition on behalf of a brand name owner. Brand owners are more than happy to pay out a couple hundred million dollars to bribe the competition if it means extending their multi-billion-dollar monopoly on a popular drug for a few more months or years.

If you're thinking that doesn't add up, that it couldn't possibly be worthwhile for an original manufacturer to pay off every potential generic competitor, you'd be right. The beauty of the drug patent system is that it only takes one cooperative generic applicant to lock out all the rest.

The process begins when a generic maker files a request with the Food and Drug Administration to produce an off-brand version of a drug whoss patent has not yet expired. The most straightforward way to earn approval for a generic is to demonstrate that the drug clone will not enter the market before any relative patents have expired. If a would-be imitator wants to start selling its knockoff while the original patent is still in place, it can also attempt to prove that the new drug is different enough from the original to not infringe upon existing licenses. Such an application can, on its own, constitute patent infringement, however; as such, the prospective producer is obligated to notify the original patent holder.

The first firm to win FDA approval gains its own minor protections on the "new" drug, a 180-day period in which no other generic versions of the original may be sold. Nothing wrong with that on the surface -- the original patent holder enjoys several years or more of exclusivity to incentivize investment in the drug discovery process, so it stands to reason that whichever competitor expends the effort and the funds to open up the market should receive a little boost of its own. Once half a year has passed, all patent protections end, and the lucrative monopoly disappears as multitudes of imitators enter the market.

Oh, one other thing: The hold on other generic competition begins when the first applicant gets the FDA's go-ahead, but the 180-day clock doesn't start ticking until the copy actually makes it to the market.

Here's how to create a drug cartel in five easy steps:
  1. Wait for a rival manufacturer to apply to produce a generic version of your profitable brand name drug.
  2. Sue said rival for attempting to infringe upon your patent.
  3. Have a change of heart, and agree to an out-of-court settlement that awards the rival both the rights to market the proposed generic and a fat payout from your company coffers.
  4. Be pleasantly surprised as the rival to whom you just paid $400 million decides that it doesn't want to release its generic version after all.
  5. Enjoy the full duration of your patent, unchallenged by other generics.
If a nine-figure settlement seems high, consider this estimate from the FTC: Sales of a brand name drug will fall by around 90% in the first year following a generic competitor's entry into the market, while the generic itself only sells for around 15% of the brand name price. Unless the generic manages to capture vast swaths of new markets, revenues from the brand and the generic together amount to a fraction of what the brand would bring in by itself. This is Price Fixing 101 -- the nominal competitors are more than happy to each get some of a huge pie than all of a tiny cupcake.

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