Why Does the Patent Cliff Exist?

The executives and scientists of big pharma companies are extremely intelligent people. How then, could nearly all of the world's largest pharmaceutical companies have journeyed over the patent cliff? There were enormous sums of money at stake. In fact, a recent study (link opens PDF) by IMS Health estimates that loss of exclusivity will result in $120 billion in lost sales for brand-name drugs from 2011 to 2015. It is not like the problem snuck up on anyone: Approved patents come with firm expiration dates for exclusivity more than 10 years in advance. Have all of the "easy" drugs been discovered? Are R&D departments at drug companies broken? What is being done now to combat the patent cliff? There is a lot to cover, so let's get started.

The curse of '96
Why is the patent cliff referred to as a super-slow motion train wreck playing out before our eyes? Varying dosages can be granted independent patents, so one drug will have multiple expiration dates. For example, Pfizer's (NYSE: PFE  ) Lipitor won't become obsolete overnight because it will retain protection on larger-dose applications. Nonetheless, gradual loss of patent protection allows generics to gain market share and build a loyal customer base -- a scary thought for brand-name drugs. Here is a list of blockbusters that lost major protection in 2011:

Company

Drug, treatment

First issued patent

2010 World Sales

Pfizer

Lipitor, high cholesterol

Dec. 17, 1996

$10.7 billion

Bristol Myers Squibb (NYSE: BMY  ) / Sanofi (NYSE: SNY  )

Plavix, blood clots

Nov. 17, 1997

$6.67 billion

Eli Lilly 

Zyprexa, antipsychotic

Sept. 30, 1996

$5.03 billion

Johnson & Johnson (NYSE: JNJ  )

Levaquin, infections

Dec. 20, 1996

$1.36 billion

Sources: FDA Orange Book, company 10-Ks.  

How steep is the cliff? Plavix posted Q3 2012 sales of $64 million, a whopping loss of 96% over the previous quarter. The drug lost exclusivity in May 2012. Lipitor sold $749 million worth of cholesterol-fighting power in the same quarter, a decline of about 71%.  

The fact that 1996 shows up a lot is no coincidence. The pharmaceutical industry enjoyed record years in 1996 and 1997 with a total of 100 drugs gaining FDA approval. This large influx of drugs helped carry share prices of the largest companies higher over the two decades -- only GlaxoSmithKline and Sanofi saw returns (not including dividends) of less than 700% since 1995 -- but it is also largely responsible for the chronic loss of exclusivity sweeping the industry today.   

Big pharma knew as early as 1996 that patents were going to start expiring today. Why didn't they increase the pace of R&D to find new blockbusters to replace older ones? Well, they did.

This elevator going down: R&D productivity
Have all of the "easy" drugs been discovered? Or are big pharmas' R&D arms becoming more inefficient? Perhaps a combination of the two?

Consider that the same amount of new drugs were approved in 2002 as in 1981 and 1993, but R&D budgets were 393% and 85% higher, respectively. Another report (link opens PDF) released last year by IMS Health makes it awfully difficult to believe companies are spending their money in the most responsible manner. After analyzing clinical trials conducted worldwide from 2000 to 2011, IMS claims that the industry is wasting more than $1 billion on clumsy trial designs, which are completely avoidable.  

Stop swinging for the fences
How is big pharma responding to the cliff? Not very well. Increased acquisitions may be necessary, for it is much too late to push a new blockbuster drug through the gauntlet of FDA trials. In a study (link opens PDF) conducted for the Federal Trade Commission in 2003, Christopher Adams and Van Brantner looked at 398 drugs launched worldwide between 1989 and 2003. The pair found that the larger the target market was, the longer a drug would take to develop.

A drug approved for Parkinson's disease took an average of 10.8 years of development, while those treating arthritis and asthma took an average of 9.6 years and 8.2 years, respectively. In general, a drug targeting a market worth $500 million required two fewer years than a potential blockbuster targeting markets greater than $10 billion.  

Some pipelines are faring better than others. Among the worst is that of AstraZeneca (NYSE: AZN  ) , which has overhauled its management team. The company also lost protection for Seroquel in 2011 and will begin losing protection on Nexium in 2014 (Seroquel was granted its first patent in, you guessed it, 1997). Desperate to combat a lack of R&D results, the company appointed three R&D managers to its executive leadership team. Louisa Peacock of London's The Telegraph recently summed up the challenges facing the new CEO: 

A toxic cocktail of scientific setbacks, a decline in discoveries of new drugs, mixed with the so-called "patent cliff" gives (the new CEO) an unenviable task. He needs to restore the company to growth.

By contrast, GlaxoSmithKline, another U.K.-based pharma, and Johnson & Johnson have perhaps the most diverse product lines in big pharma -- ranging from therapeutic drugs to toothpaste to baby powder. At the end of the day, offsetting $79 billion in sales lost to generics between now and 2016 will be nearly impossible. Big pharma will be running just to stay in place if it doesn't find a new gold mine.  

The next frontier is...
R&D at big pharma may be broken, but don't count out the group's tremendous track record of innovation. Companies throughout the industry are targeting biologic compounds through acquisitions and internal development. This represents a historic shift in pharmaceutical development. Molecules, or synthetic drugs, are vetted through trials and potential applications after they have been chemically synthesized -- drug then application. Biologics are sought out only after studying the intracellular causes of a disease or ailment -- application then drug. These miracle proteins and antibodies could be exactly what big pharma needs to reverse falling R&D productivity. 

If the patent cliff poses too much risk to your portfolio, you may want to consider the potential blockbuster market for obesity drugs. It has its own risks, but it could offer investors superior growth over flat-lining big pharma. If you're looking for more information on the top two obesity drug players, grab copies of our premium research reports on Arena Pharmaceuticals and VIVUS today. Our senior biotech analyst, Brian Orelli, Ph.D., breaks down each company's strengths and weaknesses, and explains the critical issues you need to know about. News in this space moves fast, so both reports come with a full year of updates. Click now for exclusive information on Arena and VIVUS.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 06, 2013, at 5:56 PM, ynotc wrote:

    It is no longer in the best interest of the government to approve new expensive drugs even if they are life saving.

    With the advent of government controlled healthcare there is no longer disinterested 3rd party oversight from the FDA.

    The governments interest is now to keep the costs down.

  • Report this Comment On February 06, 2013, at 5:57 PM, TMFBlacknGold wrote:

    Generics will keep costs down all on their own. For every dollar in lost sales for a brand name drug the consumer saves money.

  • Report this Comment On March 07, 2013, at 4:56 AM, thidmark wrote:

    I blame global warming

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