Product hopping is essential to prevent freerides and make money for future R&D

II. The Legal and Industry Framework that Incentivizes Product Hopping In this section, I describe the incentives for product hopping created by patent law and state substitution laws. Patent law enables companies to make large investments in cutting-edge products without the fear that their work will be immediately copied by others who, having made no research and development (R&D) investment, could afford to sell the same product for much less. Patents are vital to our innovation economy, as they allow businesses to engage in developments that would be unsustainable otherwise. Many people assume that, without patents, certain products would be far less expensive. The truth is that, without patents, those products would never exist in the first place. In the pharmaceutical industry, the ability to charge higher prices during the patent period is critical because it allows a company to recoup the enormous costs of bringing a drug to market and provides a powerful profit incentive to develop next-generation medicines. During the limited period in which a novel therapeutic drug is both approved for sale and has patent protection, a manufacturer must recuperate the expenses of R&D, securing patent protection, and navigating the arduous FDA approval process—in addition to similar costs for the unsuccessful majority of drug candidates. The average brand drug takes over 10 years and $2.6 billion to achieve FDA approval. Moreover, only 10 to 15 percent of drugs that begin clinical trials are eventually approved by the FDA.2 For most brand manufacturers, this means that they will never recoup their R&D costs; in fact, 80 percent of marketed brand drugs never earn enough sales to cover these costs.3 However, after a developer has already blazed a trail to FDA approval for the brand drug, generic versions are entitled to a much simpler process. The 1984 Hatch-Waxman Act4 created the abbreviated new drug application (ANDA), a process of granting approval for generic drugs when they can show bioequivalence with the original.5 Generics can rely on the brand name’s previously submitted safety and efficacy data, skipping the most expensive step—the clinical trials.6 With ANDAs, generics can bring a drug to market for $1 to $2 million, a far cry from the $2.6 billion needed for a brand drug’s costs of research, development, and FDA approval.7 State substitution laws make it even harder for a brand to recover costs outside of the patent period because the laws result in brand companies losing 80 to 90 percent of their sales to generic versions. These laws allow and sometimes require pharmacists to substitute a generic drug when a patient brings a prescription for the brand name. As a result, state substitution laws enable generics to free ride off their brand-name counterparts, not only with respect to R&D and FDA approval, but for marketing as well. Brand-name manufacturers engage in extensive marketing efforts, often spending hundreds of millions of dollars to promote their drugs to physicians 8 and the general public.9 When generic drugs are automatically substituted for brand drugs under state substitution laws, the generic companies reap the benefits of years of the brand companies’ marketing efforts without bearing any costs. Generic companies typically spend very little on advertising. Instead, they can free ride on the reputation established by the marketing efforts of the brand companies and let automatic substitution laws generate their sales for them. Brand companies, understanding that automatic substitution laws grant generics a regulatory windfall, often have no incentive to develop new indications for existing drugs or to continue marketing their drugs after the patent period expires and generics enter the market. To do so would essentially be handing over 80 to 90 percent of their sales directly to generic competitors. And a perverse consequence of these laws is that the more effective the brands are at promoting their drugs to prescribers, the more money generics make when pharmacists substitute the generic for the brand. This legal framework incentivizes brand companies to focus their marketing efforts on newer versions of their drugs, which have more patent life remaining. To obtain a patent on the new version, the new drug must be different and innovative; for example, new versions may be extended release drugs that improve patient compliance and reduce the likelihood of adverse events, scored versions of tablets that allow for increased dosing flexibility, or variations in dosage strengths that allow the drug to be used to treat new indications. The brand companies hope to retain their customers by attracting them away from drugs that are about to go off patent. Thus, incentives under patent law—incentives to innovate in order to obtain the exclusionary patent period—motivate brand companies to create new drugs instead of handing over the majority of their sales to the generic companies. As the FTC has explained, these new drugs can, in turn, benefit consumers: “The threat posed to existing brand drugs by generic competition can incentivize the brand company facing a dramatic loss of sales to develop new and innovative drugs that benefit consumers.”10