Monday mornings lend themselves to idle speculation. Keep that in mind as you read what follows, as I'm not necessarily predicting that any of this is going to happen, but rather speculating on what could happen.

But ever since Merck (NYSE:MRK) announced that it was going to take aggressive pricing action on its Zocor cholesterol drug, and thereby imperil the profits of Teva Pharmaceutical's (NASDAQ:TEVA) 180-day exclusivity period, I've began to wonder about the space. I should also point out that some of these thoughts were developed in an email exchange with a reader who'd prefer to be nameless (or at least not mentioned here).

The problem
Big Pharma (that is, companies like Pfizer (NYSE:PFE), Merck, EliLilly (NYSE:LLY), and so forth) have all been beset to varying degrees by competition from generic drugmakers like Teva, Mylan, and others. That's not particularly new in and of itself -- generics have been around for a long time.

What has changed over the years, though, is the extent to which generics firms will aggressively pursue potential opportunities. U.S. law gives them an incentive to challenge Big Pharma patents that they believe are incorrect, invalid, or otherwise unenforceable -- the incentive being that the first to challenge is awarded an 180-day period of marketing exclusivity. Since competition in the generics space ultimately devolves into who can produce and distribute their drugs most cheaply, that window of exclusivity (in which the price of the drug is usually cheaper than the branded version, but not so cheap as when the 180-day window expires) is a key component of profitability.

As you might imagine, this provides a tremendous incentive for generics firms to muster their legal teams and go after high-profile drugs. What's more, many generics advocates will tell you that Big Pharma goes to sometimes ridiculous extremes in an attempt to extend patent protection and squeeze every drop of profits from a drug. On the flip side, Big Pharma will tell you that that's the only way they can continue to sink billions of dollars of R&D into fields like cancer, Alzheimer's, and autoimmune disease, where the likelihood of success is very small.

Big Pharma attacks
One way in which Big Pharma has sought to fight back is through so-called authorized generic agreements. These basically give the generics company the right to sell a given drug under a license agreement. Big Pharma doesn't make as much money as they would if they won the patent challenge outright, but they certainly get more money than if they had to face the sudden revocation of a patent and the loss of high-value sales on major drugs. In other words, it lets Big Pharma manage their portfolio and their profits a little more effectively.

Trouble is, though, that there are some anti-trust concerns about this practice. What's more, it's clearly aimed at devaluing that 180-day exclusivity window and thus discouraging generic companies from challenging patents. It also leaves some generics in a tough spot -- do you invest millions of dollars in a legal battle that you might lose, or do you accept a more certain (but less lucrative) alternative in the form of an authorized generic agreement?

Big Pharma attacks again
Authorized generics are controversial, but perhaps not nearly as controversial as what Merck is doing with its Zocor drug. As I wrote last week, Merck has reached special agreements with health benefits companies like UnitedHealth (NYSE:UNH) and WellPoint (NYSE:WLP) to offer sweetheart discounts on Zocor. The details differ from deal to deal, but the gist is that Merck will be selling Zocor at a price below what Teva was intending for its 180-day window.

That's a major shot across the bow. What if all Big Pharma decides to do likewise?

Let's say that a drug company can sell Supercalifragilisticor for $5 a pill while it's under patent, but it only costs about $1 to make and distribute. A generics company that challenges the patent might be able to charge $3 or $4 a pill in that 180-day window (the discounts vary with the popularity of the drug in question) before seeing other generics jump in and charge something like $1.10. Obviously a half-year of the higher price makes a big difference if it's a massively popular drug like Lilly's Prozac.

If you don't get that 180-day window of profits, you can't afford the multi-million dollar legal bills that it takes to overturn a patent, and you're instead forced to accept that $1.10 price that everyone else gets and you have to wait longer for it. That's a tough spot for a generics company that wants to grow its business and its earnings, and reward shareholders.

The future . maybe
Novartis (NYSE:NVS) might just be the face and future of the generics industry to come. As you may recall, they made some major purchases last year to become a big player in the generics space. And if Big Pharma succeeds in pressuring generic companies, that just might be more common.

See, it takes money to develop generics. Sure, not nearly as much money as to develop (and test) a new branded drug, but money all the same. What's more, investors are attracted to growth, and it might be tough for a lot of generics companies to post real growth if Big Pharma decides to aggressively price their drugs during those 180-day windows.

Using that prior example, it's probably not worth spending the money to challenge a patent on a $5/pill drug if you know that the owner of that drug is going to slash its prices in the aftermath. And it may be hard to justify investing in new capacity and R&D if you're only going to get the run-of-the-mill generics price. But if you're another Big Pharma company, you probably already have the spare manufacturing capacity and know-how, so you might be willing to offer a generic and reap a little extra money (think of it as almost being like earning rent from spare machinery).

What may end up happening is a wave of consolidation where leveraging a huge production base can pay off (economies of scale, that is). It could also mean that large generics firms that have the wherewithal might also begin focusing more on branded drugs -- using the higher profits of a branded drug franchise to subsidize a profitable (but not as profitable) generics business. In other words, it might become like the steel or chemical industries, where it's very hard for small players to compete in the most commodity-like niches.

Can this happen?
In short, I have no idea. The fact of the matter is that our Congress has a powerful incentive to prop up the generics industry (given the huge expenditures on healthcare). On the other hand, so long as Big Pharma doesn't collude or price drugs below their cost of production, I'm not sure what lawmakers can do about it. I mean, if Merck wants to drop its price for Zocor, that's pretty much their right in a free market.

One way or another, this whole story is likely to get more and more interesting. Perhaps the solution lies in a modified version of authorized generics, where Big Pharma allows generics companies a window of higher profits in exchange for less aggression on the patent front.

Or maybe the solution simply lies in scale -- getting big enough that you can compete profitably no matter what the price. In the meantime, investors should keep an eye on stocks like Teva, Barr Labs, and Mylan; I can't imagine that Congress will let the generics industry fail, and big players like these should be the ones to ultimately come out on top.

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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares). The Fool has an ironclad disclosure policy.