Authorized Generic Strategy

The FTC's recent report on the strategic uses of "authorized generics" provides a lesson on the role of long-run versus short-run in policy analysis.

About two decades ago, pharmaceutical firms began releasing "authorized" generic (or AG) versions of their patented product a bit before the patent expired. This can be seen as a price discrimination that would have cannibalized sales of the branded product and so was only profitable when generic entry is imminent. In the early 1990’s the FTC investigated whether such a scheme allows the branded firm to garner so much of the profits from early generic entry that it would deter later generic entry by independent firms. That is, it was recognized that this would have a short-run effect of lowering generic prices but a possible long-run competitive effect leading to higher generic prices. The appropriate tradeoff is an empirical question. My direct involvement led to some empirical answers in publications coauthored with Dave Reiffen that examined the role of these profits on generic entry decisions and the role of this longer-run entry deterring incentive on the release of an authorized generic version of a branded product.

The newer wrinkle is that there appears to be evidence that branded firms have cut deals with generic producers to not release an authorized generic if the generic producer postpones entry. Normally, a branded firm would have to pay off all potential entrants which could be cost prohibitive. A feature of US pharmaceutical regulation, however, provides the first generic producer a period of generic “exclusivity” in some instances. The increase in profits to the branded product more than compensates for the “side payment” to a single generic firm. The report finds that, in the short-run, authorized generic entry does indeed reduce prices to consumers and that “About one-quarter (20 out of 76) of those patent settlements involved (1) an explicit agreement by the brand not to launch an AG to compete against the first filer, combined with (2) an agreement by the first-filer generic to defer its entry past the settlement date by, on average, 34.7 months.”

What are the longer term effects? My earlier work explicitly focused on how changes in expected profits affect the subsequent entry decisions of generic firms. But if the potential profits affect generic entry decisions, perhaps they also affect the entry decisions of the branded firm in the first place. These firms enter by developing new drugs. The return to R&D is the expected future profit from marketing any product that might result. There is evidence that drug companies appropriate only a fraction of the surplus generated by their products, or that drug development generates large positive spillovers. What we need to know is whether changes in their ability to appropriate the surplus alter the level of R&D investments and the pace of new product introductions. Admittedly, this is a tough question.