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HOW
INCREASED COMPETITION FROM GENERIC DRUGS HAS AFFECTED PRICES AND
RETURNS IN THE PHARMACEUTICAL INDUSTRY
July 1998
 By
substituting generic prescription drugs for brand-name ones, purchasers
at retail pharmacies saved $8 billion to $10 billion (at retail
prices) in 1994, the Congressional Budget Office (CBO) estimates.
Those savings were made possible in part by the Drug Price Competition
and Patent Term Restoration Act of 1984 (also known as the Hatch-Waxman
Act). That act created an abbreviated approval process for generic
drugs while extending patent terms for brand-name drugs. A new CBO
study, How Increased Competition from Generic Drugs Has Affected
Prices and Returns in the Pharmaceutical Industry, examines the
way in which competition in the pharmaceutical market has changed
because of the rise of the generic drug industry and the effects
of those changes on drug companies' returns from innovation.
Sales of generic drugs have increased dramatically since the Hatch-Waxman
Act. Before 1984, the probability that a generic manufacturer would
enter the market for a top-selling nonantibiotic drug no longer
under patent was only about 35 percent. And in cases in which generic
entry occurred, manufacturers of generic drugs held about 13 percent
of the market. Today, nearly all top-selling drugs have generic
versions available soon after their patents expire, and generic
manufacturers frequently take away more than half of a brand-name
drug's market. The Hatch-Waxman Act caused some of that rise in
generic competition, as did changes in state laws and efforts by
health care plans to promote the use of generic drugs.
That increased generic competition has cut into the returns that
pharmaceutical companies earn from developing brand-name drugs.
Considering only the rise in generic market share since 1984 and
the patent-term extensions provided by the Hatch-Waxman Act, CBO
calculates that the average expected returns from marketing a brand-name
drug have declined by $27 million (in 1990 dollars). That figure
represents about 12 percent of the total expected returns from marketing
a new drug, which previous studies have estimated at $210 million
to $230 million, on average. In this study, "returns from marketing
a new drug" refers to the present discounted value of the total
stream of future profits expected from an average brand-name drug,
after deducting the costs of manufacturing, advertising, distribution,
and other activities not related to research and development (R&D).
Although some drug-development projects may no longer be profitable
after accounting for the costs of R&D, the increase in generic
sales since 1984 has probably not reduced expected returns below
the average capitalized costs of developing a drug. And overall,
factors not measured in CBO's calculation appear to be favoring
investment in drug development, since the share of brand-name drug
revenues reinvested in R&D increased from 14.7 percent to 19.4
percent between 1983 and 1995.
Another finding of CBO's study is that different purchasers pay
different prices for prescription drugs. Specifically, for 100 top-selling
brand-name drugs, purchasers such as hospitals, health maintenance
organizations, federal health care facilities, and clinics pay less,
on average, than retail pharmacies. The reason is that drug manufacturers
offer a variety of discounts and rebates to various purchasers.
Such discounting may be an important means of facilitating price
competition in the pharmaceutical market. Previous studies have
found that the prices of brand-name drugs continue to rise faster
than inflation after generic entry. CBO's analysis found, however,
that certain purchasers receive larger discounts on brand-name drugs
after generic entry occurs. Discounts are also higher when a greater
number of similar brand-name drugs are available.
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