As the pharmaceutical industry shifts more and more away from the production of chemical drugs to biological therapies, these new therapeutics pose a range of regulatory concerns that were absent their chemical counterparts. Generics of these biologics or "biosimilars" are generally not identical to their main-brand counterparts, and therefore require a separate approval process to ensure that they have a similar potency and effect.
These regulatory hurdles as well as the increased cost to develop and manufacture biologics present a barrier of entry for biosimilar competitors that is protective of innovator pharmaceutical companies that invest in the development of biologics. These forces are responsible in part for the large scale movement of the industry to biologics, and as of 2013, six of the top ten best selling drugs worldwide were biomolecules, including all of the top 3. The patent for the best selling drug and biologic Humira from AbbVie (NYSE:ABBV), as well as No. 3 Rituxan from Roche and Biogen, and No. 6 Lantus from Sanofi (NYSE:SNY) are all expected to expire in the next two years.
New FDA regulations
Until recently, the US lacked any sort of comprehensive mechanism by which biosimilars could reach approval. The FDA is seeking to change that and has introduced a series of draft guidelines for evaluating the effectiveness of biosimilars. The document is similar to protocols approved in the EU in 2006 and describes the method for determining if generic versions of these drugs mimic their patented counterparts. If a biosimilar has the same pharmacodynamics and pharmacokinetics as the original, it can skip the lengthy approval process of novel drugs.
How are drug makers adapting?
Opening of the US market to generic biologics will dramatically impact the earnings predictions for companies with upcoming patent expirations, because the US remains the most profitable pharmaceutical market in the world. Moreover, because the approval process for biosimilars has been in place outside of the US, there are numerous biosimilars already in development waiting for the upcoming patent cliffs.
But many of the biggest developers of biologics are not to be left out of this party. Biogen and Amgen (NASDAQ:AMGN) have announced plans to begin their own biosimilar production. Part of the reason for the interest from big pharma is the higher profit potential of biosimilars, which retail for 60% to 80% of the price of patented drugs, unlike 10% to 20% for small molecules. This has generated a highly competitive marketplace in the EU with a wide range of smaller pharmaceutical companies hoping to get a small slice of a very big pie. It is highly unlikely that big pharma entering the biosimilar game will be able to protect a large fraction of their pre-patent cliff profits, even with their increased marketing capacity and development resources.
Bottom line: More competition, less research
AbbVie and Sanofi stand to lose a wide swath of their profit margin if Humira and Lantus lose share due to competition from biosimilars. However, in typical fashion, both are trying to lock in longer term patent protection at the last minute with new clinical trials. On the other hand, Amgen could generate significant profits from its new biosimilar business, because its own best-selling biologic patent for Embrel is locked in until 2020, and it already has the expertise that comes with being one of the biggest biologics manufacturers in the world.
Pharmaceutical companies will do everything in their power to protect these assets, and that's not going to be as easy with these new regulations. At least one patent expert may have found a loophole that will allow companies to protect their drug portfolios by patenting the tests necessary to evaluate the efficacy of competing biosimilars. But I expect that companies who take this route will be forced to license the testing technology. The protective nature of biologic development promised long term profit margins that have bolstered the outlook for the bottom line and future development. However, the benefits of biologics are not solely attached to their barriers to competition, and they open up a wide number of development leads, so research of biologics will likely continue to increase as a proportion of total research spending. However, they are not the solution to the steadily increasing development costs they were once heralded as. The blockbuster biologics discussed here have certainly validated their risk-reward ratio, but without the promise of a long term income stream for those middle-ground therapeutics, I think we will see fewer risks taken.
Nathaniel Calloway has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.