Tuesday, January 19, 2010

Are Pay-for-Delay Drug Deals Anticompetitive?

In January, the Federal Trade Commission published a new study claiming that so-called pay-for-delay drug deals are costing consumers $3.5 billion per year.

Pay-for-delay drug deals are, in large part, an unintended consequence of the Hatch-Waxman Act of 1984, which was intended to allow earlier market entry for generic drugs. Under certain conditions, Hatch-Waxman allows generic drug makers to begin selling their products before the patent on the brand-name drug expires. However, producers of generics who attempt to use this early-entry mechanism are sometimes sued by the brand-name producer. Often, the suits never come to trial. Instead, a pay-for-delay deal is reached in which the maker of the brand-name drug pays a large sum to the generic manufacturer, in return for which the latter agrees to stay out of the market. The FTC calculates that the average delay achieved by such deals is 17 months.

Pay-for-delay deals are profitable for both companies if the payment is smaller than the profit that would potentially be lost by the brand-name manufacturer, but greater than the potential profit earned by the generic producer. Both elementary economic theory and empirical evidence suggest that this condition will often be satisfied. It is equally clear that consumers are the losers when such deals are reached.

The legal status of pay-for-delay deals is murky. In the early years after passage of Hatch-Waxman, they were considered anticompetitive per se, and very few such deals were made. Then, beginning in 2005, federal appeals courts determined that the deals were legal, after all. The number of such deals increased rapidly.

Now there is a push to end pay-for-delay deals once and for all. They are under attack both by the Federal Trade Commission and the Antitrust Division of the Justice Department. In addition, the House version of the omnibus health care bill currently under consideration by Congress would outlaw pay-for-delay. The Senate version does not include this language. (The final fate of the legislation is not yet known as this is written.)

To download a free set of PowerPoint slides that explain the pay-for-delay controversy, follow this link. The slides include a simple graphical model that can be used as a classroom example in your principles of microeconomics course. If you find the slides useful, please post a comment, or send me an e-mail.

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