Prize system doesn’t work because lack of clear criteria. That uncertainty means innovators and VCs don’t trust the CP

Henry G. Grabowski, Joseph A. DiMasi, Genia Long, “The Roles Of Patents And Research And Development Incentives In Biopharmaceutical Innovation,” Health Affairs, February 2015

Alternatives To The Patent-Based System

Some critics of the patent-based system have advocated replacing it with prize systems, government contracting, or other options that they argue could better balance the dual objectives of price competition and innovation incentives.39 For instance, legislation—the Medical Innovation Prize Act—was introduced in Congress in 2005 that would substitute a prize approach for patents.

As proposed alternatives to the patent system, government spending could be substituted for private R&D spending, directly through government contracts or through a prize system for specified drug innovations.40 Through either method, government expenditures would be funded by additional federal taxes. These would be theoretically offset, at least in part, by lower prices from the immediate “genericization” of all drugs covered by these programs at launch. Proponents of the prize system approach contend that pharmaceutical prices remain significantly above the marginal costs of production (which exclude the high fixed costs of R&D and other up-front investments) and that, as a result, health care costs are higher than they would be in the absence of patents and regulatory exclusivity (at least temporarily, and for drugs that would be developed and launched under such a regime). This means that some patients in need of certain medicines are unable to afford them.

These proposals present both theoretical and practical problems, depending on their design and on whether they would be mandatory alternatives or voluntary supplements to the existing intellectual property system. As mandatory alternatives, they would introduce more immediate generic price competition but also risks of reduced innovation incentives, R&D delays, and therefore fewer new therapies’ being developed and coming to market. As supplements, depending on their design, they might address important unmet needs and gaps.38 A detailed analysis of alternatives is beyond the scope of this article. However, some of the key issues are summarized briefly below.

Government-Contracted Drug Development

As a widespread replacement for private sector later-stage R&D investment, direct government purchase through grants and contracts generally would require a degree of centralized information and decision making that critics say would introduce uncertainties and delays into biotechnology’s scientific and business environment. Program administrators would face challenges in “picking winners” among constantly changing scientific opportunities and competing organizations. In comparison, NIH grants have focused on basic research and technology transfer, instead of on late-stage drug development, and the grants amount to a fraction of private-sector investment.12 In some cases, however, no effective market exists, and government contracting might provide a necessary complementary incentive to patents. For example, in response to bioterrorism threats, the government has developed funding programs and other initiatives to encourage research and development in the absence of a developed market (Exhibit 2).41 The importance of consistent and adequate investment in underdeveloped therapies and the public health linkage between developed and less-developed regions is highlighted by recent developments in the spread of Ebola.

Prize Systems

Prizes have the advantage of rewarding outputs instead of funding inputs (they only pay for success), and in some instances they may attract a wider set of options and market participants, compared to current market incumbents. However, there would be several challenges if they were mandatory replacements for patents.

First, prizes generally require clear, prespecified performance criteria, which might not always be possible to define. Second, given that the biopharmaceutical R&D process is particularly long and costly, prizes could be subject to “hold-up” problems. As a result, innovators might fear that, having made substantial nonrecoverable investments over many years, they could see their prizes reduced by legislatures or government agencies because of budget constraints or cost reduction efforts. Early-stage venture-supported research and development would be particularly vulnerable. Third, biomedical progress often occurs incrementally, as successive “best-in-class” drugs are introduced. It is also clinically desirable that a variety of agents be available, given sometimes idiosyncratic patient response. Unless an ongoing series of prizes were offered to simulate the effects of such dynamic competition, the benefits of therapeutic on-patent competition would be lost in a “winner-take-all” competition.