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Patents and Prozac
Jan 30, 2007, 1:56p - Business

The core of current economic theory proposes that humans always act in their self-interest, maximizing their "utility function". They will do what brings them the most benefit, be it material, emotional, spiritual, or social in nature. Most capitalists focus almost exclusively on the material benefits, because they're much easier to quantify while the other 3 are more loosy-goosy. But just because something isn't measurable doesn't mean that it isn't meaningful or valuable.

Intellectual property (IP) laws exist because many believe that most people won't produce without material incentives. IP laws provide this incentive via the monopoly rights of patent and copyright. Word choice indicates our current cultural bias, as we often speak of "patent protection" as if it were a shield meant to protect the defenseless.

Let's assume that there are 2 types of creative acts: acts which occur due to material reward, and acts which occur even if there is no material reward. In a simple model, one could support IP laws because they incent the first type of creative act, and one could argue that the increase in creation leaves society better off as a whole. This is the conventional wisdom, but I don't believe that it's quite right.

Creation is a social phenomenon: all creation depends in some way on the creativity of others. I couldn't write this blog post if someone hadn't invented the blog, and they couldn't have invented the blog without the creation of the Internet, and the chain of dependence goes on forever.

By locking up creative works for many years, others are prevented from building on top of them. Imagine if someone had an enforceable patent on the invention of the blog: I may not be able to create this post without paying them for the right to, and chances are I wouldn't so this blog would never exist.

Current copyright law provides exclusive use for the lifetime of the creator plus many decades after their death. During this time, most copies cannot be made without getting the copyright holder's consent. Some copies can be made under the doctrine of fair use, which I won't go into here. Patents are for a shorter period of 20 years, during which no one can build the invention without the patent holder's permission.

I believe that if we don't lock up as much as we do for as long as we do behind the gates of IP, society would see greater creativity and inventiveness. Some people would create less because they may not have a material incentive, while others would create more because their creation wouldn't be as limited by IP laws. I believe the benefits from the second would outweight the costs from the first, but I haven't been able to prove this.

Last Saturday night, I got into a discussion about the usefulness of patents in drug development. My friend, who works in a neuroscience lab at Stanford, and his girlfriend, who's planning to become an IP lawyer, argued that the huge costs of drug development would not be undertaken if the companies couldn't rely on selling that drug without competition for the 17 years afforded by a patent. I wasn't so sure about that, and argued that there were many other industries, such as the soft drink industry, that innovated in spite of the fact that their inventions were not patented. Further, I argued that successful drugs, such as Tylenol, sell very well even as they compete with generics.

I don't believe that patents were necessary for drug development to continue at its current rate, and I believe that society, especially those who can't afford non-generic drugs, would benefit greatly from price competition.

When I got home, I decided to do some research on Prozac and New Coke to see if I could substantiate any of my claims. It turns out that New Coke cost only $4M to develop 1, while the average drug that reaches the market costs $900M to develop 2. This includes the cost of all the drugs that never make it to market. So you can't really compare development costs in the drug industry to the soft drink industry.

Next, I wanted to see if the revenue earned by Prozac after its patent expired could have offset the costs of development. After skimming Eli Lilly's financial statements, it turns out that they earned about $2.4B in revenue from Prozac from 2002-2005 3 (the patent expired on August 2, 2001 4). I wasn't able to track down the specific cost of Prozac development, but assuming it was the same as today's average drug, a return of $2.4B on an investment of $900M after 4 years isn't shabby. Of course, I'm simplifying things a lot here: I'm comparing revenue rather than profit; I'm not accounting for inflation; I'm not accounting for the negative press Prozac has been getting lately about causing suicide and increasing aggression; I'm not accounting for the the fact that Prozac has been riding 12 years of exclusivity in the marketplace; and I'm not accounting for the fact that Prozac is one of the most profitable drugs every made.

Even with all these caveats, I think the data shows that sales of Prozac could have earned a good profit even if it hadn't been patented. It wouldn't have been nearly as profitable, but a substantial incentive would have still existed to develop the drug.

Other facts that I dug up about Prozac in researching for this post:
- The patent was issued in 1986 5
- Prozac was approved by the FDA on Dec 29, 1987 and brought to market in 1988 6
- The patent expired on Aug 2, 2001 4
- Prozac generated $12.92B in revenue from 1996-2000 7
- Total revenue generated is unknown, but assuming rev of $1.5B/yr from 1988-1995, revenue from 1988-2000 would be $25B, or 28x return on investment (ROI)
- ~30% of Eli Lilly's revenue came from Prozac when it was under patent protection 7
- 3-6% of Eli Lilly's revenue came from Prozac when it was NOT under patent protection 3
- 2M people use Prozac daily, costing $2.63 per user per day. This is 20-40% more than the cost of generics 5
- The markup on Prozac 20mg is 224,000%, from 11 cents for active ingredient in 100 tablets to $247 retail price 8
- Here is the Prozac patent (fluoxetine hydrochloride), as well as 2 related patents: 4,018,895 and 4,626,549
- Condensed Eli Lilly revenue and profit table, including revenue from Prozac 7:

YEAR: LLY REV | PROFIT | PROZ REV | PROZ as % of total rev
1996: 7.00B | | 2.38B | 34%
1997: 7.99B | | 2.56B | 32%
1998: 9.24B | | 2.77B | 30%
1999: 10.0B | 2.72B | 2.61B | 26%
2000: 10.9B | 3.08B | 2.60B | 24%
2001: 11.5B | 2.78B | 1.99B | 17% (year Prozac patent expired)
2002: 11.1B | 2.71B | 733M | 6.6%
2003: 12.6B | 2.56B | 645M | 5.1%
2004: 13.9B | 1.81B | ~500M | 3.6%
2005: 14.6B | 1.98B | ~500M | 3.4%
1 Pendergrast, Mark. For God, Country, and Coca-Cola: The Definitive History of the Great American Soft Drink and the Company That Makes It. Basic Books, 2000. Page 307.
2 "How much does it cost to develop a new therapeutic?" Biomedical Industry Advisory Group. 2005. PDF.
3 Eli Lilly annual reports 2002-2005.
4 Eli Lilly 2002 Annual Report (PDF). Page 16.
5 Smith Hopen Intellectual Property Law report. Report from Google cache.
6 Wikipedia's article on Prozac.
7 Eli Lilly annual reports 1996-2005.
8 Consumer Rape.

Read comments (3) - Comment

omar - Feb 13, 2007, 7:20p
in some ways coke is even worse! coke doesn't have a patent because i'm quite sure you can't patent food recipes. so instead, they have a carefully guarded secret. reverse engineering coke, from what i've read, doesn't really give you what you'd need to actually create coke.

on the other hand, because all the information about prozac is out in the public, even though you can't create prozac without paying eli lilly (at least, until recently) you could look at what they did to innovate, the recipe, etc.. and build on that work. certainly some of that is trade secret, but since so much information about the drug is out in the wild, people can at least use this information and derivative information and innovate, if not use the actual drug itself.

it's not perfect, sure, but on the other hand the potential for increased secrecy if you eliminate IP could grow. i think it's worth examining that angle in more detail.

vivek - Jul 11, 2007, 9:57a
But when you will take the R&D time period of 10-15 years into account it will all change.
Taking a modest cost of capital of 8% and comparing income with investment (not revenue), you will find that you will have negative return and it does not cover the money invested. Probably you will be better off buying CD's than investing in a risky business such as pharmaceutical drug development.

Just my 2 cents.

nikhil - Jul 11, 2007, 11:42a
Hey vivek. You bring up a good point, so let's do the math. For simplicity, let's make the following assumptions. These are just estimates that I find potentially reasonable. Changing these assumptions can have a *big* impact on the results, so again I wanted to emphasize that this is all mostly hypothetical.

Some Assumptions:
- Prozac cost $900M to develop, and for simplicity let's assume $100M was spent each year for 9 years (this assumption is based on today's avg drug development cost and period)
- Prozac would have earned $1.44B in profits in the first 4 years on the market (based on no patent protection and net profit margins of 60% on the $2.4B in revenue it earned when it lost it's patent protection - the net profit margin may be a bit high, given marketing and other costs)

Scenario #1 - Conventional investing:
- 8% return (with continuous compounding) on annual investments of $100M for 9 years and compounding for an additional 4 years = $1.89B = (((((((((100 * e^0.08 + 100) * e^0.08 + 100) * e^0.08 + 100) * e^0.08 + 100) * e^0.08 + 100) * e^0.08 + 100) * e^0.08 + 100) * e^0.08 + 100) * e^(0.08*5))

Scenario #2 - Prozac development and sale without patent protection:
- Return of $1.44B on investment of $900M

$1.89B is more than $1.44B, so you're right, investing at 8% would have yielded a greater return than developing Prozac, given our assumptions. But Prozac still has a decent return, though with a fair bit more risk. I guess my point is that developing Prozac would still yield a profit, and without patent protection it would likely help more people in the long-run (due to greater access, cheaper availability, and development of more derivatives), assuming of course that the incentives are great enough for it to be developed in the first place. A less-than-market return may not be enough of an incentive for some people. Then again, people earn less-than-market returns for a variety of reasons, including social benefit. For example, investing in a microfinance frequently yields only a 3% return, but some people still invest in it. Finally, increasing access by reducing prices may also increase overall revenue, as it may cause greater net consumption. Of course, it's hard to say for sure what would happen without actually trying it. Supply-demand curves are tricky things.

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