1. 1. Jordan Grant Econ477:RegulatoryEconomics Ratiopharm: Regulationfor Pro-competitive Licensing Agreements April 12, 2016
2. 2. Introduction This paper will provide an economic analysis of the Ratiopharm decision. Due to the lack of regulation on licensed patented products, there was significant discussion regarding the legal and economic grounds that the regulators are founded on. The purpose of this paper will be to carefully examine the decisions of the Patented Medicines Price Review Board and the courts up to this point. This analysis will be performed through an Economic lens, which will consider the effects on the pharmaceutical industry that regulation, in kind with the decisions of this case, may have. Licensing must not exclusively be considered as an extension of patent rights, Ratiopharm and other generic producers should be incentivized, not punished for issues that complement the competitive industries and help to increase the ability for consumers to have access to low price substitutes. Ratiopharm (now Teva Corporation) was a generic drug producer based in Germany that produces a variety of medicinal products. The product under question in this analysis is ratio- salbutamol HFA, which is the generic drug equivalent of Ventolin. Generic drugs are a pharmaceutical product, usually intended to be interchangeable with an innovator product that is manufactured without a licence from the innovator company and marketed after the expiry date of the patent or other exclusive rights1. Ratio-Salbutamol HFA is used to treat or prevent bronchospasm in patients with asthma, bronchitis, emphysema, and other lung diseases. This medicine is also used to prevent wheezing caused by exercise (exercise-induced 1 Generic drugs, WHO, WHO, 25 March 2016
3. 3. bronchospasm)2. Ratiopharm provides Ratio-Salbutamol HFA under an agreement with GlaxoSmithKline (GSK), the patent holder of Ventolin, which grants Ratiopharm the right to produce their equivalent of GSKs patented drug. Ratiopharm developed these arrangements to produce multiple other products provided in Canada and around the globe. However, after administering a price increase on the Ratio-salbutamol HFA product they were brought under the scrutiny of the Patented Medicines Price Review Board.3 The PMPRB is the regulatory body that monitors the pricing of patented medicines to ensure that pricing is not excessive. The PMPRB is responsible for ensuring fair prices in patented drugs. The regulatory board monitors activity in patented drugs, through a regulatory process that involves collecting information regarding prices and sales as well as a scientific review that helps to analyze the usefulness of a certain drug. Price changes must be approved by the PMPRB before being implemented.4 The provinces regulate the pricing of generic drugs in that they set the amount in which they are willing to pay for the provision of a drug.5 This framework should be designed to split up the objectives of pharmaceutical regulation, so that one body has the purpose of regulating to encourage innovator producers to invest into research and development and to recuperate the sunk expenditures on innovative research and the other regulates the activity of generic drug producers to ensure a competitive market. The case before us is an example of the failure of regulatory bodies to accomplish the goals they were designed to achieve. In 2008, the PMPRB requested pricing information from 2 Salbutamol, Drugs, Drugs, 25 March 2016 3 RatiopharmInc. (Now Teva Canada Limited) v. Attorney General of Canada,FC 502 (2014) 4 Regulatory Process, PMPRB, Government of Canada, 26 March 2016. 5 Aslam H. Anis, Quan Wen. 1998. Price Regulation of Pharmaceuticals in Canada. Journal of Health Economics. Volume 17 Pages 21-38
4. 4. Ratiopharm, for the products in which they determined that Ratiopharm was a patentee. While Ratiopharm was not the original patent holder and produced generic substitutes in which they had arranged licensing agreements, they were found to be a patentee as they were able to enjoy the rights of holding the patents for the drugs that they produced.6 In 2011, the PMPRB brought the case to be reviewed by the Hearing Panel, which decided in favour of the PMPRB that Ratiopharm was a patentee. As a result, Ratiopharm was ordered to deliver information to the board in regards to pricing and was fined $65,898,842.76.7 The case was then brought to the Federal Court in 2014, where they again considered the ruling on the basis of whether Ratiopharm was a Patentee. The Federal Court found that Ratiopharm was not a patentee, and directed the board to consider the case with the direction that Ratiopharm was not a patentee. In 2015, the Review Board appealed on the basis of stare decisis, referring to other decisions where similar rulings occurred. The Court of Appeals agreed in the favour of the Review Board that Ratiopharm did meet the definition of a patentee and was therefore under the jurisdiction of the PMPRB stating that the harm which the Act seeks to prevent arises by reason of the existence of the patent pertaining to the medicine being sold (ICN at para. 76), with the result that nothing turns on the fact that the person exercising the selling rights does not hold the patent itself.8 Now sought leave to appeal to Supreme Ct. 6 Subsection 79(1) of the The Patent Act states:Patentee,in respect of an invention pertaining to a medicine, means the person for the time being entitled to the benefit of the patent for that invention and includes, where any other person is entitled to exercise any rightsin relation to that patent;that other person in respect of those rights; 7 Decision: PMPRB-08-D3-ratiopharm, June 30, 2011, IN THE MATTER OF the Patent Act R.S.C. 1985, c. P-4, as amended, AND IN THE MATTER OF ratiopharm Inc. (ratiopharm), DECISION, PMPRB 8 Attorney General of Canada v. Sandoz Canada, and Attorney General of Canada v. RatiopharmInc. (Now Teva Canada Limited, FCA 249 (2015)
5. 5. As this legal battle ensues, there are some economic considerations that must be made. Regardless of whether Ratiopharm is or is not a patentee, Ratiopharm is a generic drug producer in a very unique position that needs to be considered before making a detrimental decision. Generic producers add a level of competition that is necessary to provide lifesaving drugs at low prices for consumers. This case indicates a regulatory mistake that could be used to achieve the short term goals of the Pricing Review Board, but could lead to significant detrimental effects in the long term. Regulation is necessary, in cases where it not only impacts firm behaviour but also encourages a desirable effect. This paper will analyze the case to investigate the effectiveness of the PMPRB in making their decision and what it possibly means for the pharmaceutical industry. Case Theory The pharmaceutical industry is supplied by two types of producers. Name brand producers; who develop new drugs and file patents which allow them exclusivity for 20 years on their new medicines.9 Generic drug producers; produce substitute drugs where patents have expired. The name brand producers spur innovation, through a process of Research and Development where they invest into research that could potentially produce a new medicinal product in which the firm will have the exclusive right to supply as long as they can hold a patent for it. These rent seeking activities are expensive. Frederic M. Scherer, an expert on patent regulation and professor of public policy at the Harvard Kennedy School Harvard, describes the process as new drug development resembles a risky lottery that throws out rich rewards to a few 9 Subsection 44 of The Patent Act states:Subject to section 46, where an application for a patent is filed under this Act on or after October 1, 1989, the term limited for the duration of the patent is twenty years from the filing date.
6. 6. big winners while the majority of entries lose money10(1993, p106). Its true, a lot of research can turn up unprofitable. Firms that are unable to develop a drug with a substantial ability to improve the health of the general public can find it difficult to either develop a drug or one that is of the effective quality to be provided. This can make it difficult for rare diseases to get the adequate level of investment. Generic drug producer do not have this issue. Since they are providing drugs that have already been discovered, there is a significantly smaller investment on their part to provide the drug. This is the major reason behind the differences in prices. Since a brand name firm has to invest capital for this risky lottery they have to expect to receive a higher return, that is, one above competitive levels, that covers their expected costs, in order to justify making that initial investment. As a generic firm only has to cover their quasi-rents their operation costs (without making risky investments in R&D), there is a huge differential in the pricing ability of the two types of producers. The brand name charges these high prices to cover the losses they made in past R&D expenditures and gets exclusive rights to the production of their new drug invention. At the same time, these are products that consumers cannot always opt out from use, so complete freedom for brand name firms is quite reckless. These medicinal products can sometimes have very inelastic demand, due to the fact that a drug product or treatment could mean the difference between life and death for some of the end consumers. This means that there will be a steep demand curve, and since brand-name firms are given the ability to act as monopolists during the duration of their patent, there has to be some way to ensure that a producer does not decide to crank up the prices exorbitantly beyond unreasonable levels. This is 10 F. M. Scherer. 1993. Pricing, Profits, and Technological Progress in the Pharmaceutical Industry. Journal of Economic Perspectives- Volume 7, Number 3 Pages 97-115 Retrieved on 22 March 2016
7. 7. why the PMPRB exists; regulation should be available, if needed, to ensure that price increases, in industries with limited constraints, cannot exercise market power, unrestricted by any outside pressure. Generic drug producers are one source of outside pressure on brand name firms in the form of competition. However, generics typically enter the market after a patent has expired, unless contracted otherwise. Up to that point, Brand name producers may price at monopoly conditions. However, brand names know that once their patent is expired, there will be low priced substitutes available. This may encourage them to invest in; attempts to extend patents, so as to increase the length of time in which they can obtain monopolistic rents, or methods of increasing brand recognition, which would allow the firm to reduce consumer substitution to lower priced substitutes. Support systems that ensure the brand names are not able to maintain monopoly rents by patent extension are extremely important. As well as building awareness of generic substitutes so that doctors will be more likely to prescribe the substitutes and thus substitution will be more likely to occur. The firm may create its own constraints, in general, consumers are best served with a policy that leaves firms, including dominant firms, free to charge prices above cost and earn positive, and possibly high, profits. This is especially the case in industries where innovation and investment plays a central role.11 Firms have to price their product in a manner that allows them to cover their costs, including the opportunity costs of their next best alternative. In the process of choosing the price they have to determine. What price level will maximize their profits, given that if they price too excessively, the consumers wont buy the good? If they produce too much 11 David S. Evans & A. Jorge. 2005. Excessive Prices: Using Economics to Define Administrable Legal Rules. Journal of Competition Law and Economics Volume 1, Issue 1 Pages 97122
8. 8. output, how will this affect price? What is the right capacity level of the firm such that the firm can produce the optimal amount of the product that fulfills their target? In many ways, the firm's actions have to be self-regulated by good management and the adherence of rational economic thinking to achieve the desired outcome. Regulation is another source that provides constraints, but it has to be done right. Regulation must balance the scale that is; industry profits that encourage innovation, and maintaining a sufficient level of consumer welfare through reasonable prices. Rules that restrict the freedom of firms to prevent them from exercising excess market power and punishment for breaking the rules when they do. However any system that desires to be effective must be careful. Any policy that seeks to detect and prohibit excessive prices in practice is likely to yield incorrect predictions.12 A system that attempts to do this will either be too expensive to limit errors to zero or lead to an error of regulating those who should not be and missing those who should. The case of Ratiopharm is a good example of the latter. Punishment can be very necessary in cases of abuse. Without an effective punishment mechanism, cases like Martin Shkreli of Turing pharmaceuticals price increase of Daraprim13, would be in abundance. However, while the Turing Pharmaceutical case is one that lacks an economic justification for the procedure, regulators must be very careful not to implement a one-size-fits-all strategy for price increases, especially when there are cases where costs could have been raised in which case the firm would be forced to raise price. Assuming that all firms that raise price are attempting to 12 See Excessive Prices: Using Economics to Define Administrable Legal Rules. 13 Frankin Liu. 2015. The Daraprim and the Pharmaceutical Pricing Paradox: A Broken System? Boston College Intellectual Property &Technology Forum. Pages 1-19
9. 9. exploit consumers will have the negative effect that will increase the chance of errors, potentially leading to innocent but guilty verdicts. Economic Analysis Ratiopharm had implemented a price increase on one of the drugs they were currently licensing under an agreement with GSK the licensor. In 2002, the price of Ratio-Salbutamol was increased by 67% from $4.61 to $7.73 per Metered Dose Inhalers (MDI). An MDI consists of 100 micrograms. Ratiopharm also had a substantial market share of 75%. Ventolin was priced at $12.27 per MDI since 1972. Prices for similar products were stable or generally declined. Ratio- salbutamol was the first case of a price increase for comparable drugs. In October 2009, the agreements that GSK held with Ratiopharm expired, and GSK reduced its price to $6.50. The following month, Ratiopharm dropped their price to $6.50 and sold off their remaining inventory of Ratio-Salbutamol HFA, till January 2010.14 During the life of the licensing agreement Ratiopharm never implemented a price increase that was not competitive. Consumers may have incurred a higher cost due to the price increase in 2004, but consumers were still better off from having access to a lower price alternative than the original patentee, GSK. The price increase was substantial but beyond the powers of the PMPRB. If, the true purpose of the PMPRB is to be a regulatory body that ensures that consumers are not exploited by higher prices by patentees, then it should be ensured that their actions lead to improved consumer welfare. A thorough look at the economic effects, as well as the legal impact that a decision will have, especially in this world of stare decisis, is essential. The price increase was substantial, but not in excess of the next best option. The new higher price was always 14 See Decision
10. 10. below the price of the licensing firm during the period in which the agreement was in place. Therefore, regulation needs to be considered only if it can be shown that this action was an exercise of market power, where substitution is not likely between products. However, this is not the case. With the division of regulatory powers, the regulatory bodies should clearly understand and reside within the realm of their responsibilities. The PMPRB, should be focused on patented medicines, more specifically, drugs in which a brand name producer invested a significant amount of capital into Research and Development, to develop a patented medicine. Regulation should be very specific to these firms as they have a very different cost structure to the generics, and they receive exclusive rights due to the Intellectual Property aspect of the drugs they produce. The firms who accrue patents have substantial market power and if they are not controlled, they may take advantage of the inelastic demand of their product and raise prices beyond reasonable levels. If a brand name firm is pricing beyond what is reasonable they should be scrutinized by the regulatory board designated to regulate producers who abuse their exclusivity rights. The provinces, as stated in legislature, are responsible for the regulation of generic producers, and therefore should monitor and control the pricing of these firms. In that way the regulations can be focused on competition and helping to promote generic drugs as an effective substitute. Regulations should be no different for licensee companies that contribute to the competitive process than they are for generic producers who start producing after the expiry of the patent. It is beneficial for the Licensing firm as they can increase their profits from the payment that the licensee pays to the original patent holder. The generic producer benefits because they can increase the amount of drugs they produce and increase their profits by being
11. 11. able to provide a new drug, and the consumer/the payer, benefits from having access to lower priced substitutes. Regulations should not be absent for these licensee firms, but there is no economic benefit from regulating the licensing firm as a firm who has market power, when they are a procompetitive force. Now, that is not to say that licensing is always the perfect solution. In some cases, licensees may become the sole provider of a drug and in such a situation, it may be best to allow the PMPRB to regulate when a licensee fits the criteria of an exclusive producer. Licensing does not necessarily create competition, some licenses are just a way of transferring the right to exploit the market, but it can potentially add a competitive pressure to monopoly power. Therefore the answer is not very simple as to whether or not the PMPRB should consider licenses. The issue has to be more about whether the license enhances competition or lowers the price to consumers. If the license enhances competition, then the PMPRB needs to be extremely cautious so as to not enforce a decision that is not in the best interests of stakeholders. However, this just indicates the complexity of licensing agreements and the need for more legislation that guides the regulatory boards from making decisions that are not efficiency enhancing. For the purpose of this discussion, assume that licensees refer to companies that are entering markets in which they must compete with the brand name producer. Cases of licensing agreements being used to enhance market power, are important, but not in relation to the case and the issue that this paper addresses. As a licensee, Ratiopharm adds another level to the market in which competition can be created that helps to control the market. Since the patent holder has exclusive rights to their product during the life of the patent, if anything can be done to generate more producers in the upstream, it should be considered methods that can successfully promote it and help to build
12. 12. competition. The regulation, which the PMPRB is charged with emplacing is not to be aimed at punishing licensees, unless they act as patent holders. In fact, the courts specifically stated that generic companies either help create or join a competitive marketplace, which helps keep the costs of patented medicines down. Reviewing the prices charged by generic companies who hold no patents and no monopolies, on its face, appears to be beyond the Boards mandate 15(2014, para 21). In this case, Ratiopharm did not believe that they were a patentee, the market in which they operated had a present brand name firm who was charging a higher price, and Ratiopharm acted under the provisions of the provincial laws that govern the actions of generic firms. Since there were no guidelines that discussed the licensing issue, the PMPRB saw this case as an issue that fell within the jurisdiction, however, this case indicates that specific legislature needs to be developed to protect firms who get into licensing agreements from potential errors in the regulatory system. It is clear that there are benefits created from supporting licensing agreements. Therefore, specific regulation highlighting the benefits of these firms and properly directing the actions of regulators will lead to improved decisions. Licensing is a procompetitive force that will help to provide lower pricing during the length of the period of the patent. Without licensing, patent holders are able to price as monopolists for the duration of their patent and consumers are faced with higher prices. As such the regulations must be set such that a firm is attracted by the idea of being a licensee and providing a lower priced substitute. This fits more closely with the Paramount responsibility of Provincial Regulation, while the PMPRB should remain in control over issues that arise in relation to the power granted through patent. 15 RatiopharmInc. v. Attorney General of Canada,FC 502 (2014)
13. 13. Penalizing these firms is not only contradictory to the true intentions of the regulatory bodies, but it also encourages firms who do take on licensing agreements to charge excessive initial prices, rather than competitive prices, as initial prices are not generally considered to be excessive. Rather than creating an effective competitive market, firms that should be providing at low competitive levels will just price their goods at excessively high levels at introduction to avoid the avoid the regulatory hurdles. Other firms may decide not to get involved in the process, which reduces the availability of lower priced substitutes. If the overall goal of regulation is to ensure that low prices, then the effect of any regulation, or decision should be made with the goal of incentivizing lower prices. Therefore, there are two ways to regulate the firms who participate in licensing; Licensee as patentee or a licensee not as a patentee. Here is a brief economic argument as to where the effects of either direction may go. Licensee as patentee; continued regulation by the PMPRB. The PMPRB would enforce rules on licensees as patentees. Firms who were looking to license product would anticipate this and price at the patent holder levels. Licensing firms would anticipate this and contract higher licensing fees. Higher licensing fees could detract some potential licensees. However, some, would still take on the agreements. The price may be a depressed monopoly price. Bertrand competition does not occur as all firms price at the same monopoly price and there is no incentive to lower price as it is not likely to induce substitution (substitution is already limited from brand name drugs to generics, although the prices of generics are substantially lower). Overall, lower prices compared to no licensing world. The difference between this example and the case, is that the firm made its ex-ante decisions as a generic firm. Lack of clarity on licensing was the major issue.
14. 14. Licensee not as a patentee; would entail regulation by the provinces. Prices of the licensee would be kept at lower levels due to existing generic regulation. Licensing fees would be as is, since firms prior to this decision, had already considered licensee firms as generics; two different prices, a high price and a low price. One price set by a monopolist and another price set by a price sensitive generic producer. Consumers benefit from the availability of the significantly lower priced substitute (Ratiopharm being an example, provided $4.54 per MDI in savings which is 37% in savings). In these two situations, there can be benefits from licensing. However, in one case there is substantial empirical evidence to show that it was beneficial to the payer as that has been the status quo. In the other case, we can only hypothesize what the outcome will be. The licensee as a generic, is a less risky route, which provides the lowest pricing. It is unlikely that licensees as patentees will be beneficial to any party other than patent holders. Perhaps another solution would be to expand the definition of patentee from Subsection 79(1) of the patent act to read as follows: Patentee, in respect of an invention pertaining to a medicine, means the person(organization) for the time being entitled to the benefit of the patent for that invention and includes, where any other person(organization) is entitled to exercise any rights in relation to that patent, whereas the lack of outside pressures prevents restraint, competitive or otherwise, that would limit the ability of a person(organization) to abuse these rights, and the presence of the outside pressure is not attributable to the person(organization) who holds the patent; that other person(organization) in respect of those rights;
15. 15. Such that only the beneficiaries of a patent, who may also obtain market power through some exchange of rights, will be under the provision of the PMPRB, while competition enhancing licensing agreements, remain outside of their control. Conclusion Licensing must not be considered exclusively an extension of patent rights, Ratiopharm and other generic producers should be incentivized, not punished for issues that complement the competitive industries and help to increase the ability for consumers to have access to low price substitutes. Ratiopharm did purchase the rights to provide the bioequivalent of Ventolin, however their prices remained significantly below the licensors price. Licensing provides an additional source of supply, which is of a lower cost to consumers and the government payers, than the drugs produced by the patent holder. There are tangible cost savings that can exist due to licensing. Therefore, this decision by the PMPRB was a huge mistake. No economic value was created. The decision that the PMPRB is still fighting to be affirmed, is one that will reduce the availability of low price substitutes, either by reducing the amount of licensees or by causing licensee firms to charge at brand name levels. If licensees are to be treated as patentees, then this will be the outcome. If licensees are to be treated as generics and regulated as such, then we will have high prices charged by the brand name provider (which is unavoidable) and then low prices charged by the licensees. In one case, we promote competition and encourage lower prices, in another we help to strengthen patent law and allow original IP holders to benefit from licensing out at higher prices and generic drug firms to benefit from brand name prices.
16. 16. References 1) Generic drugs, WHO, WHO, Retrieved on 25 March 2016 2) Salbutamol, Drugs, Drugs, Retrieved on 25 March 2016 3) Ratiopharm Inc. (Now Teva Canada Limited) v. Attorney General of Canada, FC 502 (2014) 4) Regulatory Process, PMPRB, Government of Canada, Retrieved on 26 March 2016. 5) Aslam H. Anis, Quan Wen. 1998. Price Regulation of Pharmaceuticals in Canada. Journal of Health Economics. Volume 17 Pages 21-38 6) Patent Act, (R.S.C., 1985, c. P-4), Retrieved from the http://laws- lois.justice.gc.ca/eng/acts/P-4/page-11.html#docCont 7) Decision: PMPRB-08-D3-ratiopharm, June 30, 2011, IN THE MATTER OF the Patent Act R.S.C. 1985, c. P-4, as amended, AND IN THE MATTER OF ratiopharm Inc. (ratiopharm), DECISION, PMPRB
17. 17. 8) Attorney General of Canada v. Sandoz Canada, and Attorney General of Canada v. Ratiopharm Inc. (Now Teva Canada Limited, FCA 249 (2015) 9) David S. Evans & A. Jorge. 2005. Excessive Prices: Using Economics to Define Administrable Legal Rules. Journal of Competition Law and Economics Volume 1, Issue 1 Pages 97122 10) Frankin Liu. 2015. The Daraprim and the Pharmaceutical Pricing Paradox: A Broken System?. Boston College Intellectual Property &Technology Forum Pages 1-19 11) Ratiopharm Inc. v. Attorney General of Canada, FC 502 (2014)