Competition through Innovation, Innovation through Competition

Kettler, H.

November 1998

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Pharmaceutical companies report that in their dynamic, research and technology intensive industry, competitiveness is synonymous with innovativeness. That is, companies must invest in product research and development (R&D) to stay ahead. To afford this type of strategy, companies seek adequate reimbursement for their time, risk, and investments.

Purchasers (governments, sickness funds, managed care organizations, insurance companies, patients) are concerned about getting value for their money and governments have the additional concern that their own country's industries compete effectively. In contrast to the industry's claims, a fear is intermittently voiced in policy debates that companies, in their pursuit of profits, are not investing in truly innovative medicines (Wastila et. al, 1989; Benzi, 1996). These industry critics 'contend that profit incentives motivate the multinational pharmaceutical industry to spend too much time, effort and money on 'me-too' research, as well as on research for line extensions of already marketed drugs' (Wastila et al., 1989, 106). These authors define a 'me-too' drug as a substance in the same chemical class and used for the same therapeutic indication as the innovator drug (first in class). The objective of this paper is to analyze the inference of these critics that the incremental improvements of so called 'me-toos' do not add economic and therapeutic value. 'Me-toos' are henceforth referred to as 'incremental innovations' to distinguish them from 'breakthrough innovations'.

According to such criticisms, the prevalence of a 'me-too' R&D strategy would have three serious negative implications:

1. health care purchasers are paying for drugs adding little value; 'me-toos' are poor value for money;

2. companies are distracted from the real social task of serious innovation; a 'me-too' strategy will ultimately threaten these companies' long term competitiveness;

3. justly earned rents to the first entrant in a market are dissipated by the entry of many copies; excessive competition from 'me-toos' might discourage desirable investment in breakthrough innovation.

To motivate companies to invest in higher quality R&D to produce innovative output, some European Parliament members have discussed the possibility of requiring products to meet an innovativeness standard. Repercussions for products failing to meet the standard might be, in the most extreme cases, the refusal of licensing approval by the European Medicines Evaluation Agency (EMEA), or the refusal of reimbursement or, more likely, a reimbursement only at a discount to the leading products in the class within the European Union (EU)3 (Benzi, 1996; Scientific and Technological Options Assessment for the European Parliament (STOA), 1993). It is hoped that such policies would discourage 'me-too' innovation, while encouraging breakthrough innovation.

Such policies might, however, fail to achieve the intended end, and reduce the level of breakthrough innovation achieved by the pharmaceutical industry, as well as hitting socially useful incremental innovation - what Wells (1988) referred to as 'innovative chemical extensions'. Pharmaceutical companies argue that the process by which they develop breakthroughs and incremental innovations is one and the same; you cannot tell with any certainty when you are developing a product who will be first to market or who will produce the best product. The discovery and development processes are long and plagued with uncertainties. As a crude illustration of this, assuming the global industry average development time profile of 10-12 years, Diagram 2.1 shows that R&D investments of $12.7 billion worldwide in 1987 corresponded to 46 products obtaining market approval in 1997 (source: CMR International) . Given an average failure rate of 80%, this suggests that almost 200 compounds failed to make it through the clinical trial process.

Companies who produce follower products do not necessarily start with a 'non-innovative' strategy. A threat of low reimbursements at the end of the process might therefore discourage, rather than encourage, investment which would have produced fundamental innovations.

There are political and economic arguments against limiting the number of products approved in any one class. From a national competitiveness standpoint, European governments would not want to prevent their own companies from entering a market where the class leader is from outside the EU.

There is also a strong case for incremental innovation. The full therapeutic value of a product is often not known until after it has been marketed to a large patient sample. The first product to market does not always turn out to be the best. Unexpected treatment or disease prevention benefits may emerge when use becomes widespread. This raises questions about the effectiveness of any external 'pre-market' evaluation of innovativeness to weed out 'useless' or 'low value' products.

Incremental innovations may be of considerable value to payers. Some chemically similar follower products may add extra attributes that advance existing therapies. That is, they are 'innovative chemical extensions'. Multiple products in a therapeutic class also promote price competition, potentially bringing down the cost of health care.

Policy makers might respond that in the case of imposing price discounts on follower drugs, they are simply formalizing pricing practices that frequently occur in the market anyway. There is evidence, discussed later in this paper, the producers of follower drugs do tend to introduce them at a price below the leading product. There is, however, a clear difference in the impact on incentives for companies, between a government ordained discount based on external assessments of product value and one that companies decided to offer in response to their perception of the market and the value of their product.

Rather than impose additional regulatory hurdles at the licensing or reimbursement stage, therefore, the innovative value of pharmaceutical industry's output could instead be promoted by enhancing demand side pressures (informed payers and incentivised prescribers can get value for money) and by ensuring high rewards for breakthrough innovations.

This debate raises important issues about the nature of pharmaceutical companies' R&D strategies and what motivates those investments, and about how and when to assess the value of pharmaceutical output. This report explores:

1. the pharmaceutical R&D process and the factors motivating investments in order to understand how companies may produce no or merely incremental innovations even while they strive for breakthrough innovations;

2. whether our understanding of the nature of an innovation can change across stages pre- and post-market launch;

3. the potential therapeutic and economic benefits which need to be set against the apparent redundancy of having multiple products m any one therapeutic class; and

4. whether ex-ante definitions of innovation can be made and are useful for public policy making.

Section 3 presents the range of different definitions and indicators used by various authors and agencies in their attempts to measure pharmaceutical innovation. It is evidently difficult to produce an objective measure. How innovation is defined and measured depends on what the analyst wants to show.

In Section 4 the pharmaceutical R&D process and the factors motivating investments in innovation are explored. Given the time and uncertainty involved in developing a new drug, successful innovation cannot be guaranteed but there are identifiable factors - some endogenous to firm strategy and some exogenous - that set the successful companies apart from the rest. Using information about the decision making process and the factors which encourage innovation, the possible impact of an 'innovation hurdle' on investment decisions is considered.

Sections 5 and 6 look at different aspects of pharmaceutical output. Section 5 presents examples from different therapeutic classes to illustrate the innovation continuum. Many new indications and uses for therapies are only revealed after marketing, as are the relative merits of drugs competing in the same therapeutic class. Evaluating drugs pre-market launch, would risk excluding potentially worthwhile innovations. In Section 6, economic and therapeutic benefits of having multiple products in any one therapeutic class are discussed and set against the possible disadvantages.

The conclusions drawn from this analysis are set out in Section 7.