The Impact of Generic Introduction on the Pharmaceutical and Healthcare

Industries

by

Charles Gelb

Submitted on

May 2, 2006

In Partial fulfillment

Of the Requirements

Of the Course

R&D and the Product Life Cycle

Introduction

It costs and estimated 800 million dollars to bring a new chemical entity to

market.1 It costs a fraction of that to introduce a generic after the patent of the “pioneer”

drug has expired. The result of this introduction is referred to as generic erosion and

causes enormous declines in the sales of brand-name drugs. Pharmaceutical companies

complain that generic drugs stifle profits so much that they can’t make enough returns to

cover the costs of research and development and are always trying for ways to extend

their patent and maintain exclusivity longer. However, from the a public policy

standpoint, generics drugs are has allowed for better access to life-saving pharmaceutical

drugs by significantly decreasing costs. Generics have a large impact on the

pharmaceutical and healthcare industry. This is evident implementation of legislation, the

ability to help managed care to control health care costs, the effect on brand-name drug

prices and profits and the methods that pharmaceutical companies have created to

decrease this impact.

What is a “generic” drug? A generic drug is a drug which is bioequivalent to a

brand name drug with respect to pharmacokinetic and pharmacodynamic properties, but

is normally sold for a lower price. Generic medicines must contain the same active

ingredient at the same strength as the "innovator" brand, be bioequivalent, and are

required to meet the same pharmacopoeial requirements for the preparation2. By

extension, therefore, generics are identical in dose, strength, route of administration,

safety, efficacy, and intended use. These generics are certified by the Food and Drug

Administration FDA to be perfect substitutes. It is the FDA’s job to ensure this. Let’s
examine some of the legislation that helped create this role and brought about the means

to successfully produce and market generic drugs.

The Legal History

In 1938 the Food, Drug, and Cosmetic Act was issued .The law brought cosmetics

and medical devices under control, and it required that drugs be labeled with adequate

directions for safe use. Moreover, it mandated pre-market approval of all new drugs, such

that a manufacturer would have to prove to FDA that a drug were safe before it could be

sold3. In 1962, the Kefauver-Harris Amendment was issued. This law was born as a

result of the “Thalidomide Babies.” The new law mandated efficacy as well as safety

before a drug could be marketed, required FDA to assess the efficacy of all drugs

introduced since 1938, instituted stricter agency control over drug trials (including a

requirement that patients involved must give their informed consent), transferred from the

Federal Trade Commission to the FDA regulation of prescription drug advertising,

established good manufacturing practices by the drug industry, and granted the FDA

greater powers to access company production and control records to verify those

practices.4 This law also effectively reduced the patent protection window of 17 years,

later increased to 20 years, from when the New Drug Application was accepted, because

it increased the time it took to get government approval.

In 1984 the most influential drug law regarding generics was passed, the Drug

Price Competition & Patent Term Restoration Act, commonly known as the Hatch-

Waxman Act. Up until this point, the ability of generics to compete was severely reduced

because they had to duplicate the costly and time-consuming approval process that

innovator drugs had to undergo. This limited the extent to which the generic could
compete on pricing, because it had to recoup significant expenditures on research and

development, even though the drug had already been proven to be safe and efficacious.

The Hatch-Waxman Act created the Abbreviated New Drug Application (ANDA). It

allowed approval of generic products through a shorter and less costly route than for

innovator drugs. Under the terms of the act, generic drugs are only were required to

show bioequivalence. To be considered bioequivalent, the bioavailability of two products

must not differ significantly when the two products are given in studies at the same

dosage under similar conditions.5 The act also allows the development of generic versions

even when the reference product is still protected by patents. In all other industries, this

activity constitutes patent infringement. In the pharmaceutical industry, it allows generic

companies to obtain bioequivalency data required for their drug applications.

Because of Hatch-Waxman, generic versions hit the market as soon as patent

protections on the brand-name product expire, in contrast to the case in many other

countries. Before Hatch-Waxman, only 35% of pioneer drugs had generic competition

after patents expired; now almost all innovator drugs face such competition.6 This has

resulted in enormous increase in the number of generic drugs in the market and in their

market share. This effect is clearly demonstrated in Figure 1. As the table shows generic

drugs once only held 19% of the market, and in 1996 accounted for around 45% of the

market.7 This number is still on the rise. According to IMS Health, generics made up 56

percent of all prescriptions filled in 2005, and although generics account for over half of

all prescriptions, they represent only 13% of the of the dollars spent8, demonstrating the

cost disparity between brand name drugs and generics.

Figure 1. Growth in the Market Share of Generic Drugs Since 19847

Impact on Managed Care

Although Hatch-Waxman has helped to increase the supply of generic drugs on

the market, this increase in market share is due to other factors as well. Changes in

healthcare delivery and financing have affected the way that pharmaceutical drugs are

prescribed. The rise of managed care has brought about major changes in prescribing

frequencies, and in doing so has also affected the profitability of the pharmaceutical

companies within the industry. Health plans that are controlled by managed care

companies have rapidly become the plan of choice, as opposed to the traditional

fee-for-service plans, because the companies use collective bargaining techniques to

decrease the price of many health care treatments as well as pharmaceutical drugs.

Managed care companies themselves exist in a highly competitive market, were they are

competing on price of to gain members that subscribe to their plan. In order to keep

premiums down, health maintenance organizations (HMOs) and other managed care

organizations (MCOs) routinely push for generic substitution of pharmaceuticals. The

increase in the supply of generic drugs has made this possible for almost all drugs that
have come off patent. The impact of this is enormous because generics are typically 30-

80% cheaper than the pioneer drugs.7 The average price of a brand-name prescription

drug is $72, the average price of a generic version is about $17.9 Thus, the introduction

of generic drugs into a therapeutic class is a huge cost-saving tool that is utilized by

MCOs and is certainly promoted by the public administration.

This only examines the immediate savings occurred by generic substitution,

however the percentage of health cost associated with pharmaceuticals is only 11%10, if

we examine the indirect cost savings as well then the overall impact is even greater. In

many cost-saving analyses different types of therapies are compared to determine the

most cost-effective treatment. Sometimes, the price of the drug drives up the cost of

therapy so much that the alternative, surgery later on in life, appears to be the most cost-

effective treatment. This happens sometimes in the administration of statins for lipid

lowering, because the length of treatment is so long. The use of generics as a substitute

drastically reduces these costs and makes the pharmaceutical drug treatment more

economically attractive. The increase in the number of generics in the market will

increase the prevalence these types of preventive medical therapies, and so from a social

standpoint, will improve U.S. healthcare delivery. Therefore, as the number of generic

drugs increases in the market so will the ability of MCOs to control healthcare

expenditures and improve delivery.

Impact on Price and Sales

Under the federal Hatch-Waxman Act of 1984, the first company to market a

generic version of a brand-name drug is typically granted 180 days of exclusive sales,

this brings huge amounts of revenue to the generic company that is granted this
exclusivity. These first 180 days give the generic an effective monopoly on the market.

Depending on the drug the overall effect of the generic varies. For some pharmaceutical

drugs they can lose 50-70% of their market in just those first 3 months11. For some drugs

the effect is less profound. Figure 2 illustrates how brands can experience different

effects on market share after patent expiration.

Figure 2 Comparison of Effect on Market Share after Patent Expiration11

Figure 2 also reveals that the attributes of the drug, the number of competitors, its

total sales and its role in the disease therapy most likely played a role in the variability of

the level of generic erosion. Considering only the sales through pharmacies - ignoring

hospitals, mail-order pharmacies and clinics - the Congressional Budget Office (CBO)

estimated that by substituting generic for brand-name drugs, purchasers saved roughly $8

billion to $10 billion in 19947. The pricing of generic drugs is not only a reflection of the

reduced cost to develop the drug, it is also a technique employed by the generic drug

manufacturers to rapidly increase market share. Studies have shown that as the number

of generic manufacturers increase, the price of the generic drug decreases even further.

The drug is priced initially at around 60% of the “innovator” drug and eventually falls to

around 40% of the price. This is shown in Table 1.

Table 1. Price Comparison of Generic and Innovator Drugs, by Number of

 Manufacturers, 19947

The data in Table 1 also reveals that the price elasticity of the generic is

significantly greater than the branded drug. A negative relationship between the number

of generics and the price of the generics is observed. The data indicates that the number

of generics has no influence on the price of the “innovator” drug.

According to the international consulting firm Bain & Co., over the next two

years patents are set to expire on 75 brand-name drugs launched during the 1990s drug

innovation boom. The sales boost from this should help the overall generic market grow

10 to 12 percent each year for the next five years, says Tim van Biesen, a New York-

based partner in Bain's global health practice.8 With this much money on the line, you

can bet that pharmaceutical companies will be doing everything they can to temper the

effect of felt from generic erosion.

Pharmaceutical Company Tactics

 In an effort to retain sales of their branded drugs, pharmaceutical companies

will try numerous ways to delay the entry of generics into the market. One method is by

legislative restraint. The Hatch-Waxman Act allows the pharmaceutical company to file a

patent infringement suit within 45 of a generic drug company’s ANDA submission. If an

infringement suit is filed within the 45-day period, FDA approval to market the generic

version is automatically postponed for 30 months. The 30 months is supposed to be used

so the courts can determine the outcome of the suit. Even if the suit is invalid and the suit

is lost, the revenue obtained over the period of exclusivity far outweighs the legal costs.

Sometimes companies can obtain additional 30-month stays by submitting additional

patents within 45 days of an ANDA submission and then filing additional suits. This can

maintain the high profit streams for an extended period of time. When Paxil went off

patent, SmithKline Beecham (now GlaxoSmithKline) was granted 5 stays due to suits

they filed. The length of stays totaled 65 months and the net sales in year the second stay

was issued was over $1 billion.12

Another method that has begun to change to face of the pharmaceutical industry

is the advent “authorized generics.” When generic infiltration is imminent drug

companies will produce low-cost copies of their own brand-name medications. This way

they will be the first to file the ANDA and will be granted the 180-day exclusivity. This

decreases the amount of sales lost to generics and also puts downward pressure on the

other generics to decrease their entry prices. This technique can be very lucrative if

properly implemented. Schering-Plough’s Claritin when OTC in December of 2002.

Sales of Clarinex, its “authorized generic,” were 163.3 million across food, drug, and

mass outlets (excluding Wal-Mart) for the 52 weeks ending November 2.13
 In addition to producing an “authorized generic,” a company can also try to re-

brand a different product that still has patent protection. AstraZeneca sells both Prilosec

OTC and Nexium. Nexium is the single isomer form of Prilosec, but because Prilosec is

the racemic mixture, the drugs are not identical and so Nexium still has patent protection.

Initially, Prilosec was advertised as “the purple pill,” but as the patent expiration neared,

AstraZeneca began to roll out advertising that began to call Nexium “the purple pill.”

Apparently the marketing campaign worked, because AstraZeneca was able to retain 90%

of its after the first six months of following Prilosec’s patent expiration, which is

extremely difficult, as described earlier. Global sales of Nexium were $1.47 billion (up

81%) while the sales of Prilosec fell 38% to 1.43 billion through the first half of 2003.

Together the drugs generated $2.9 billion, compared to $3.11 billion during the same

period a year earlier.14

Conclusion

The impact that generic drugs has on the pharmaceutical and healthcare industry

is significant. Generic introduction has caused the formation of legislation that governs

the way this country ensures drug safety and efficacy. It has helped to improve the

delivery of healthcare and helped reduce total system costs. Generic erosion accounts for

huge decrease in the profits of pharmaceutical companies, and in doing so has shaped the

future of the pharmaceutical industry by forcing pharmaceutical companies to create new

ways to sustain high profits. It is evident that the generic drug market will only continue

to expand. Whether that is a good or a bad thing depends on if you are doing the selling

or buying of brand-name drugs.

References

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Vivo the Business & Medicine Report 2003, 21(10):1-10.

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(Accessed April 27 2006)

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the FDA- The 1938 Food, Drug, and Cosmetic Act. U.S. Food and Drug
administration (Accessed May 1 2006)

4. U.S. FDA. (http://www.fda.gov/oc/history/historyoffda/section3.html). History of

the FDA - Drugs and Foods Under the 1938 Act and Its Amendments. U.S. Food
and Drug administration (Accessed May 1 2006)

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Glossary. U.S. Food and Drug administration (Accessed May 1 2006)

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loopholes in U.S. law that delay entry of generics into the market. Chem & Eng
News (2002) 80:30 p53-59

7. The Congress of the United States, Congressional Budget Office. How increased
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pharmaceutical industry. Congressional Budget Office (July 1998)

8. Pugh, T. Generics will benefit as 75 drugs lose their patent protections. San Jose
Mercury News (April 27, 2006)

9. U.S. FDA. ( http://www.fda.gov/oc/initiatives/generics/whitepaper.html). New

FDA Initiative on "Improving Access to Generic Drugs" FDA White Paper (June
12, 2003)

10. Branning, G. Lecture Notes: The Healthcare Industry and Pharmaceutical

Companies. Rutgers University (Fall 2005)

11. Tuttle E, Parece A, and Hector A. Your Patent Is About to Expire: What Now?
Pharmaceutical Executive (November 2004)

12. Eurek, SE. Hatch-Waxman reform and accelerated market entry of generic drugs:
Is faster necessarily better? Duke University School of Law (2003)

13. Johnsen, M. After successful Rx-to-OTC switches, Claritin, Prilosec aim to

sustain sales – OTC. Drug Store News, Jan 19, 2004.
14. FDC Reports. AstraZeneca retains 90% of GI business despite Prilosec generics.
“The Pink Sheet” (2003) 65:31 p. 11