The Pharmaceutical Industry - Northwestern University School of Law

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The Pharmaceutical Industry


Professor Scott Stern

Kellogg School of Management

Senior Fellow, Searle Center

Northwestern University


Northwestern Judicial Symposium

The Pharmaceutical Industry:

Economics, Regulation and Legal Issues

May, 2009




The Promise of Pharmaceutical Innovation


Despite the complex nature of HIV/AIDS and high transmission
potential, AIDS combination therapies developed in the early 1990s
dramatically reduce the AIDS death rate in the developed world


The rise of AIDS diagnoses and deaths
during the 1980s not only killed hundreds
of thousands of Americans but also
raised a broad array of fundamental
social, economic and legal issues


Privacy rights, discrimination,
employment law


Widespread skepticism about potential
treatment


Between the late 1980s and early 1990s,
emerging techniques in biotechnology,
biochemical discoveries, and clinical
trials give rise to a range of antiretroviral
treatments


notably protease inhibitors


that allow effective AIDS management
for those that can afford therapy

The Promise of Pharmaceutical Innovation


Despite the complex nature of HIV/AIDS and high transmission
potential, AIDS combination therapies developed in the early 1990s
dramatically reduce the AIDS death rate in the developed world


The rise of AIDS diagnoses and deaths
during the 1980s not only killed hundreds
of thousands of Americans but also
raised a broad array of fundamental
social, economic and legal issues


Privacy rights, discrimination,
employment law


Widespread skepticism about potential
treatment


Between the late 1980s and early 1990s,
emerging techniques in biotechnology,
biochemical discoveries, and clinical
trials give rise to a range of antiretroviral
treatments


notably protease inhibitors


that allow effective AIDS management
for those that can afford therapy

I tell you
,
it's funny because
the only time I think about
HIV is when I have to take
my medicine twice a day
.


Magic Johnson, 2004




But millions die each year die in developing countries,
concentrated in sub
-
Saharan Africa

Estimated number of adult and child deaths

due to AIDS globally, 1990

2007

Year

Millions

0

1.5

2.0

2.5

3.0

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

0.5

1.0

This bar indicates the range around the estimate







UN AIDS, 2008

5.3

Our Job Today


What is distinctive about the pharmaceutical industry?


History and Institutions


Economics



Where does pharmaceutical innovation come from?


The Emerging Life Sciences Innovation System


Innovative Productivity in Life Sciences Research



How do pharmaceutical and biotechnology products get into the
marketplace?


Creating and Capturing Value from Pharmaceutical Innovation


Regulation, Intellectual Property, and the Market for Ideas

Some Themes


The promise of the life sciences and biopharmaceutical
innovation offers the promise (but not a certainty) of dramatic
opportunities for improvement in our treatment of disease and
the human welfare.


How can we ensure that we realize the “life sciences” century?



Not simply a matter of exploiting “technological opportunity,”
the economic, social and health benefits from biopharmaceutical
innovation depends crucially on effective institutions and law


Shaping both the incentives to innovate and the ability to maximize the
social value arising from scientific discoveries and technological
innovation



But, in part because the underlying science and technology are
advancing so rapidly, many key challenges and controversies
reflect the need for institutions and the law to “catch up” with
the life sciences revolution

The Origins of the Biopharmaceutical Industry

The History of Pharmaceutical Preparation


The role of pharmaceutical
and medical preparation
appears across a wide range
of ancient civilizations


Chinese Divine Farmer's Herb
-
Root Classic as the source of
Chinese herbal medication


In ~ 1231, Holy Roman
Emporor Frederick II issues a
decree clarifying the role of
the pharmacist:


Separating the physician and
pharmacist


Official supervision of
pharmaceutical practice


Legal and professional duty of
careful preparation of mixtures

O true apothecary! Thy drugs
are quick. Thus with a kiss I
die


Juliet, Romeo and Juliet,


Act V, Scene III

The Emergence of Pharmaceutical Companies


The history of the “modern”
pharmaceutical industry reaches back
to the early 19
th

century and was
closely linked with the emergence of
the chemical industry over the course
of the 19
th

century


Discovery of aniline dyes


Development of the periodic table


Emergence of chemical engineering methods



Merck Sharpe &
Dohme


1668: Frederic Merck purchases a
pharmacy in Darmstadt, Germany


1827: develops and markets large
-
scale
production of pure alkaloids


1891: George Merck establishes American
Merck & Co, in New York


1917: German assets in US are
confiscated; Merck is established as a
separate US company


American
pharmaceutical companies established by 1888:


Merck (1818); Sharp & Dohme (1845); Squibb (1858); Eli Lilly (1876); Parke
-
Davis (1866);


Upjohn (1885); Abbott (1888

The Emerging Pharmaceutical Industry Value Chain

R&D

Clinical

Testing

Full Scale

Production

Marketing &

Sales

Patients/

MDs

By the late 19
th

century, a diverse array of companies
(led by the German and Swiss but also others) involved
in the development, testing, and marketing of
pharmaceuticals
but removed
from the direct choices of
physicians and patients


Importantly, the structure, scale, and organization of
each piece of this value chain co
-
evolves over time to
respond (and influence) the legal and institutional
environment

The Establishment of Formal Intellectual Property Rights

R&D

Clinical

Testing

Full Scale

Production

Marketing &

Sales

Patients/

MDs

1700s Some producers of medical preparations applied for, and
obtained, Royal Patents for their products


1840s Emergence of “patent medicines”


available without
prescription & heavy advertising.


1860s Development of periodic table offers a new paradigm for
structuring property rights for chemical structures (and for reverse
-
engineering)


1880s Key lawsuits over patentability of compounds, including Congo
Red infringement case.


1890s Contentious dispute and litigation in Germany over aspirin


was
it a novel molecule with a novel synthesis??



Innovation incentives are shaped by the interplay between
scientific knowledge and legal institutions

After the development of the periodic table, the development of well
-
defined
intellectual property rights for chemical and pharmaceutical inventions





Moser, 2007

The Emergence of a Regulatory Framework


While aspirin and other treatments had significant benefits (and were
tremendously successful), public concern over the production and
marketing of food and drug products


1852

American Pharmaceutical Association founded & adopts code of ethics


1862


Chemist Charles M. Wetherill heads the Bureau of Chemistry (FDA precursor)


1906


Pure Food
Food

and Drugs Act (Wiley Act) establishes rules for accurate disclosure

and non
-
adulteration and prompts movement towards regulating pharmaceuticals

on an ad
-
hoc basis


R&D

Clinical

Testing

Phase I

Clinical

Testing

Phase II

Clinical

Testing

Phase III

Full Scale

Production

Marketing &

Sales



“It is only from laboratories free
from any relations with
manufacturers that real
advances can be expected.”


Journal of the American Medical
Association, “Special Report of the


Work of the Council on Pharmacy


and Chemistry” (1915)



“How could old Max have gone
over to that damned pill
peddler?”

“Of all the people in the world! I
wouldn’t have believed it! Max
Gottlieb falling for those
crooks!”


reactions of Prof. Max Gottlieb to his
decision to join a private firm


Sinclair Lewis, Arrowsmith, (1925)

The Emergence of a Regulatory Framework


While aspirin and other treatments had significant benefits (and were
tremendously successful), public concern over the production and
marketing of food and drug products


1852

American Pharmaceutical Association founded & adopts code of ethics


1862


Chemist Charles M. Wetherill heads the Bureau of Chemistry (FDA precursor)


1906


Pure Food
Food

and Drugs Act (Wiley Act) establishes rules for accurate disclosure

and non
-
adulteration and prompts movement towards regulating pharmaceuticals

on an ad
-
hoc basis


1938

Federal Food Drug and Cosmetic Act dramatically expands regulation and



control over drug compounds, including mandating pre
-
marketing trials to

demonstrate safety, requirements to label safe and effective use, and

empowering FTC oversight over advertising


R&D

Clinical

Testing

Phase I

Clinical

Testing

Phase II

Clinical

Testing

Phase III

Full Scale

Production

Marketing &

Sales

Emergence of the Modern US Pharmaceutical Industry

Furman and MacGarvie, 2008

Geographic Distribution of Private
-
Sector

Pharmaceutical Research Laboratories, 1946



“Without the help…of an industrial
organization that took over a
major part of the
pharmacological evaluation of
the antibiotic [streptomycin] and
large
-
scale production, our
contribution would have never
attained its goal.”


-
Nobel Prize winner Selman Waksman,
in an address to the American College
of Chest Physicians in 1955


(quoted in Swann, 1988)

Miracle Cures!


1920s


Insulin



1930s


Penicillin



1940s


Streptomycin



1950s


Alpha Blockers, Anti
-
Depressants


Interestingly, the vast majority of “miracle cures” were the result

of significant serenipidity in which the
reason
why a particular drug

Worked was often discovered only longer after the drug had been

Introduced into the market.

The Modern Regulatory Framework


The thalidomide tragedy, more
dramatically than prior pharmaceutical
failures, highlighted both the potential
importance of the approval process
(thalidomide was not approved in the
US) and the unregulated nature of the
pre
-
approval clinical trials process



The 1962 Kefauver
-
Harris amendments
ushered in significant pre
-
marketing
clinical trials, including a requirement
for demonstrating efficacy and safety,
and requiring monitoring and reporting
of adverse events

American
pharmaceutical companies established by 1888:


Merck (1818); Sharp & Dohme (1845); Squibb (1858); Eli Lilly (1876); Parke
-
Davis (1866);


Upjohn (1885); Abbott (1888

Ushering in an extremely costly and time
-
consuming drug approval process

0

2

4

6

8

10

12

Assay
development

Hit to lead

Lead optimization


R
&
D

HTS screening

Target ID

Years

Preclinical

Phase I

Phase IIA

Phase IIB

Phase III



C
L
I
N
I
C
A
L

Registration

37

28

25

19

9

5

3

2

1.5

1.1

1

Cost*

0.4

1.2

9.0

0.5

~0

5.3

9.3

12.5

32.1

98.0

11.8

0.5

1.5

<0.25

1.25

1

Time**

0.25

0.25

1

1.5

2

1.5

37

POS***

75%

75%

45%

90%

100%

60%

67%

60%

75%

75%

88%


* $, millions


** Years


*** Probability of success

2.7%

Industry averages

5

The Life Sciences Revolution

Biochemistry

-


-

how are molecules
transformed within
biological systems

Genetics

-


-

studying genes and their
mode of action

Molecular Biology emerges


1941 Beadle shows that genes control enzyme synthesis


1944 Avery determines that a cell's genetic information was
carried in the nucleic acid DNA while investigating bacteria


1953 Watson & Crick
find structure of DNA


Phosphate backbone


bases attached
-
adenine,
thymine, guanine, cytosine


Pairing AT, CG


Microbiology was largely isolated from

the pharmaceutical industry through the

early 1970s

The Origins of Biotechology


A Growing Pool of Public and Private Funds for Basic Research in
Molecular Biology & Related Fields


The War on Cancer


The Emergence of Venture Capital



Key Scientific and Technical Breakthroughs


Boyer and Cohen’s Development of Gene Splicing


Gel Electrophoresis



A Changing Institutional Environment


Bayh
-
Dole, encouraging university technology commercialization


Diamond v Chakrabarty, allowing IPR over living organisms


Clarifying the Prudent Man Rule, encouraging venture capital


The Development of Synthetic Insulin


3 teams, 2 located in San Francisco (UC
-
SF and
Genentech) and one in Cambridge (Gilbert @
Harvard),
compete
to develop the first biotech product


Focused on human insulin, the university teams
pursue the extraction & expression of human DNA,
while start
-
up Genentech pursues a
chemical
synthesis approach


Genentech’s approach is
cheaper
, more direct and
overcomes significant regulatory hurdles


Genentech sets up a laboratory in South San
Francisco, driving distance from the postdocs and
academics who are “moonlighting” or hired away. In
contrast, Harvard team is faced with the Cambridge
biotechnology ban and Federal regulations over use of
human DNA material. Gilbert founds Biogen, and
arranges to perform key experiments in UK, which
ultimately fail.


Humulin is commercialized through licensing with Eli
Lilly, while Biogen ultimately partners with the Danish
company Novo Nordisk

Some Key Issues in the Insulin Case


The Development of Human Insulin was simultaneously:


A fundamental scientific discovery (expression of human hormone in bacteria)


A key step in commercializing a new technology (a better treatment for diabetes)



The commercialization arose in close geographic proximity to the
science, due to the location of both key scientists (“stars”) as
well as an available pool of life science researchers (“postdocs”),
and other resources



While the innovation was
close

to the science, the production
and distribution were not. Commercialization occurred by and
large through partnership with more established pharmaceutical
firms and in locations distant from the underlying science



Both the timing and pattern of innovation for insulin was shaped
by the interplay between scientific norms and commercial
motives, and by differences in the regulation of biotechnology
research in different locations





Many different perspectives have been taken about how to organize
and commercialize biotechnology innovation

1975
1980
1985
1990
1995
2000
Amgen

Founded

IDEC

Incyte

Tools Companies Emerge

Hybrids

EPO

Genentech

Founded

HGH

Insulin

Rituxan

Product Companies

Gene

Database

Affymetrix

DNA

Chips

Celera

Sequencing+

MLNM





HGS

Platforms to
Products

The Rise of Generics and a more responsive FDA


R&D

Clinical

Testing

Phase I

Clinical

Testing

Phase II

Clinical

Testing

Phase III

Full Scale

Production

Marketing &

Sales


Kefauver
-
Harris Amendment of 1962

(post
-
thalidomide):The amendment requires drug
manufacturers to show the effectiveness of their products as well as their safety, to report
adverse events to the FDA, and to ensure that their advertisements to physicians
disclose the risks as well as the benefits of their products.



Hatch
-
Waxman Act (1984)
reduced barriers to generic entry after patent expiration (in
exchange for a longer exclusivity term), giving rise to a robust generics sector


Prescription Drug User Fee Act (PDUFA)

of 1992 (reauthorized in 1997 and 2002): Allows
the FDA to accept user fees from drug and biologic companies in return for committing to
review new drug and biologic products within certain time frames.



Food and Drug Modernization Act (FDAMA)
of 1997: FDAMA established fast
-
track
approval for certain new drugs and accelerated approval for innovative devices by
exempting certain devices from premarket notification requirements.



Over time, generics have claimed the
majority

of the
market, in terms of prescriptions (i.e., quantities)

The rise of user fees seems to have a temporary effect in raising
approval rates with a return to historical norms

0
10
20
30
40
50
60
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
NMEs
biotherapeutics
Number of “New Molecular
Entities” approved per year
in the US

Source: FDA, Tufts CSDD

A century of Blockbuster Innovation


1920s


Insulin



1930s


Penicillin



1940s


Streptomycin



1950s


Alpha Blockers, Anti
-
Depressants



1960s


Birth Control, Minor Tranquilizers




1970s


Antihypertensives
, Chemotherapy



1980s


Anti
-
cholesterol, AZT, Prozac



1990s


AIDS Combination Therapies, Viagra

The Historical & Institutional Origins of the Pharmaceutical Industry


Co
-
Evolution over time between the scientific knoweldge base,
the legal and institutional framework, and industry structure



Many of the hot
-
button issues today


from patent validity for
incremental innovations to concerns over pharmaceutical firms’
duty to disclose adverse reactions and scientific findings


recall
earlier debates, controversies and policy shifts



Over time, an inexorable (if uneven) shift towards a scientific
basis for drug discovery and development, harnessing the tools
and discoveries of the life sciences innovation system



Despite this promise, persistent concerns over R&D productivity
and the ability to translate the potential of underlying research
into meaningful clinical outcomes for patients and society



The Economics of the Biopharmaceutical Industry

The Key Economic Drivers of Biopharmaceuticals


Extremely high sunk costs of innovation


Grounded in Science


Expenditures take place over time, with multiple milestones=


Low marginal cost of production


For “small” molecules, main cost is distribution and (non
-
fixed) mktg


Biologics are associated with higher relative costs


Strong (but time
-
limited) product monopoly for a given drug


Composition of matter patents are widely considered to be perhaps the
“strongest” type of intellectual property by practitioners and managers


FDA exclusivity rules offer explicit product market protection


Competition during exclusivity period from alternate therapies


High willingness
-
to
-
pay for clinical breakthroughs for well
-
defined
conditions


Significant variation in overall market size (orphans versus mainstream)


Separation of drug choice (physician) from drug payment (patient/insurer)


Increasing prevalence over time in insurance coverage for pharmaceuticals
and more explicit negotiations with prescribers and payers

The Economics of a Blockbuster Drug

Annual drug sales for “blockbusters” can exceed $1B per year

Gross margins are 40
-
90%

Companies granted exclusivity during remaining patent life of drug

Peak year
sales

Sales, $M

Time

~12


15 years

1,000

Drug
launch

End of patent life,
start of generic
competition

0

Sales

Earnings

Pharma Value Chain

Pharmaceuticals (FIPCO) Blockbusters


Aventis
22.06%
1 9.72%
1 4.08%
1 0.03%
7.1 3%
4.65%
3.86%
3.63%
3.60%
2.95%
2.86%
2.59%
2.01 %
0.83%
Pfizer
27.81%
18.58%
11.83%
7.64%
7.43%
7.37%
5.61%
4.39%
3.86%
3.06%
2.41%
AstraZeneca
44.20%
8.33%
5.18%
4.98%
4.07%
4.07%
3.58%
3.39%
3.33%
3.06%
2.99%
2.07%
1.68%
1.67%
1.56%
1.20%
1.10%
1.07%
0.88%
0.82%
0.65%
0.12%
Schering-Plough Corporation
45.12%
20.38%
6.22%
4.35%
2.95%
2.88%
2.62%
2.58%
2.56%
2.07%
1.92%
1.90%
1.81%
1.80%
0.85%
Lipitor

Claritin

Losec/Prilosec

Allegra

Intron

Lovenox

Source: Changing Face of Developing Blockbuster
Drugs, 2002. Pittiglio Rabin Todd & McGrath

Taking advantage of rising health care costs over time…

Drug Spending ($B)

And investing ever more to get each major drug to the market….

Pharmaceutical firms have been effective at capturing an increasing share of health
care expenditures…

Adapted from Burrill, 2008

And taking advantage of an increasingly global market….

Adapted from Burrill, 2008

Rapid growth in both the US and particularly abroad…

Audited Market 2007


Sales

% Growth
(const US$)

US$bn

%Mkt Shr

2007

CAGR 6
-
Feb

Worldwide

$663.50

100%

6.1

7.8

North America

304.5

45.9

4.2

8.7

Europe

206.2

31.1

6.7

6.6

Asia

62.2

9.4

13.1

11.3

Japan

58.5

8.8

4.2

2.8

Latin America

32

4.8

12

13.4

10 Key Markets

529.5

79.8

5.1

7.4

All information is current as of Feb 26, 2008.

*Excludes unaudited markets, and Russia, Ukraine and Belarus audited data. Sales cover direct and indirect pharmaceutical cha
nne
l
purchases in U.S. dollars from pharmaceutical wholesalers and manufacturers. The figures above include prescription and certa
in
over
-
the
-
counter data and represent manufacturer prices. Totals may not add due to rounding.

Source: IMS Health

Adapted from Burrill, 2008

From the perspective of innovator firms, significant
losses of exclusivity

Expiry*

Drug Name

Company

Estimated US sales peak in billions

2008

Risperdal

Fosamax

Johnson & Johnson

Merck

$2.5


2.0

2009

Prevacid

Topamax

Abbot/Takeda

Johnson & Johnson

3.2

2.1

2010

Lipitor

Effexor/XR

Pfizer

Wyeth

8.7

2.7

2011

Plavix

Actos

Zyprexa

Bristol Myers/Sanofil

Lilly/Takeda/Waston

Lilly

5.0

4.4

2.6

2012

Seroquel

Singulair/AR

AstraZeneca

Merck

4.1

3.4

With Significant Revenue Losses to Current Incumbents…

$0
$5
$10
$15
$20
$25
$30
2007 (est.)
2008
2009
2010
2011
2012
Source: Sanford C. Bernstein & Co.

Adapted from Burrill, 2008


Is there a pharmaceutical productivity crisis?

0
10
20
30
40
50
60
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
NMEs
biotherapeutics
Number of “New Molecular
Entities” approved per year
in the US

Source: FDA, Tufts CSDD

After a twenty year run of excess returns, significant skepticism in
financial markets about the ability of the pharmaceutical industry to
continue creating and capturing value as effectively as in the past….

Going Forward…


What is distinctive about the pharmaceutical industry?


History and Institutions


Economics



Where does pharmaceutical innovation come from?


The Emerging Life Sciences Innovation System


Innovative Productivity in Life Sciences Research



How do pharmaceutical and biotechnology products get into the
marketplace?


Creating and Capturing Value from Pharmaceutical Innovation


Regulation, Intellectual Property, and the Market for Ideas