In this article, we focus on so-called product hopping by branded pharmaceutical manufacturers. Product hopping is broadly characterized as a branded manufacturer introducing a minor change to an existing prescription drug product and substantially shifting sales to the reformulated product, with the effect of inhibiting emerging competition from a generic version of the original branded product. Because product hopping involves potentially beneficial (though incremental) improvements of an existing product, some argue that it should generally be viewed as per se lawful and see little role for antitrust intervention. On the other hand, because even a trivial reformulation can substantially inhibit generic competition on the older version of the product, others argue that product hopping can be anticompetitive and should be subject to antitrust scrutiny.
Crucial to understanding the debate is the recognition that pharmaceutical markets are characterized by a disjuncture between who is choosing prescription drug products and who is paying for them. In a typical industry, knowledgeable customers are able to compare the prices and qualities of competing products and are directly responsible for paying for their chosen products. In the pharmaceutical industry, in contrast, the actor who is most knowledgeable about the medical benefits of the drugs and who typically makes the drug choice (i.e., the doctor) is not the entity paying for the drug (i.e., the patient and/or the health insurer). This “price disconnect” can distort product purchase decisions and resource allocation.
Moreover, FDA regulations and state substitution laws substantially influence generic drug approval and generic drug substitution. Combined with the price disconnect, this regulatory environment can create opportunities for branded drug manufacturers to “game” the system, by raising the payoffs to incremental innovation and potentially encouraging inefficient innovation. Within the current regulatory framework, it is possible for minimally innovative products to gain substantial sales at the expense of much cheaper generic medicines and as a result to substantially reduce consumer welfare.
Whether and how this trade-off should be managed as a matter of regulatory and/or competition policy is an important question that has yet to be adequately resolved. Product hopping has received substantial scrutiny in recent years. The FDA has been evaluating the effects of regulatory “gaming” by branded drug manufacturers and has sought public comment on a variety of practices, including product hopping. The Federal Trade Commission has expressed the view that “minor, non-therapeutic changes to a branded pharmaceutical product that harm generic competition can constitute exclusionary conduct that violates U.S. antitrust laws.”
Several courts, including two Circuit courts, have evaluated the competitive effects of product hopping, with a wide variety of viewpoints being reflected in the courts’ opinions. Some courts advocate a rule of reason analysis, putting substantial weight on the unique characteristics and regulatory framework of the pharmaceutical industry. In some cases, this has led them to conclude that the incremental innovations were insufficient to balance the static harm to generic competition. Other courts have largely rejected product hopping as a viable theory of anticompetitive harm, putting less weight on this regulatory framework.
Antitrust scholars and practitioners have offered a similarly wide range of analyses of the competitive effects of product hopping. Some scholars view innovation as generally per se lawful and see little role for antitrust law. They argue that if any solution is necessary, it should be a regulatory fix to prevent gaming of the current system. Others argue for active intervention by the courts, pointing out that the potential exclusion of generic competition as a result of product hopping is the type of conduct the Sherman Act seeks to prevent.
This article aims to provide an overview of the relevant economic issues underlying this debate, summarize the existing academic literature, and provide additional views on policy options that could both protect incentives for branded drug innovation and preserve the substantial benefits from generic competition. In what follows, we first describe the unique industry dynamics of the pharmaceutical industry that must be considered when designing an appropriate policy. Against that backdrop, we then discuss the substantial benefits that both branded drug R&D and generic drug price competition generate for consumers. We explain how product hopping has the potential to substantially reduce consumer welfare and examine potential reasons why existing market participants, such as PBMs, have not been able to adequately address it. Finally, we evaluate potential regulatory and competition policy solutions.
I. Unique Pharmaceutical Industry Dynamics
In general, new product introductions benefit consumers. In a typical industry, the extent to which the new products lead to increased consumer welfare can be observed from the decisions in the marketplace. When a company introduces a new product, well-informed consumers weigh the price and features of the new product against the price and features of the old product, and directly and freely make the choice most appropriate for them. Thus, if the new product is successful, one can infer that it was a product that the market demanded, and its introduction generated benefits for consumers. If it is not successful, then one can infer that its introduction failed to generate meaningful benefits to consumers.
The pharmaceutical industry, however, is not typical. Drugs are prescribed and distributed through a complex and highly regulated health care system. Many drugs require a prescription from a doctor before the patient can purchase the product. This creates the price disconnect problem mentioned earlier. The market participant that makes the product choice (i.e., the doctor) is not the entity paying for the drug (i.e., the patient/payor) and the calculus of the doctor may be substantially different than the calculus of the patient/payor. Doctors are tasked with providing the best care possible for their patients, and the therapeutic benefits of a drug (and, for example, the side effects of generating those benefits) typically drive a doctor’s product choice. The doctor may not adequately consider the price that the patient/ payor will pay. Indeed, given the complexities of the current health insurance system, prices are often not transparent. There are hundreds or thousands of different drug formularies across insurance products affecting the net prices that insurers and patients pay. As a result, even doctors attempting to be wellinformed often will not have good pricing information. Thus, the typical price/quality trade-off faced by consumers in other industries that drives competition does not work the same way here.
Moreover, the current regulatory framework substantially influences generic drug approval and generic drug substitution. Prior to 1984 both branded and generic drugs needed to go through an expensive and lengthy approval process with the FDA before being brought to market. Congress passed the Hatch-Waxman Act in 1984, which revised the approval process for generic drugs to stimulate competition from lower-priced generic drugs while preserving innovation incentives for branded manufacturers. The Hatch-Waxman Act allows generic manufacturers to submit an Abbreviated New Drug Application (ANDA) when seeking approval for a generic product without the need to conduct their own clinical trials to independently demonstrate safety and efficacy.
To obtain approval for an ANDA, the generic manufacturer must show that its product is pharmaceutically equivalent and bioequivalent to the referenced branded product. To demonstrate pharmaceutical equivalence, the generic product must be shown to have the same active ingredient, dosage form, strength, and route of administration as the branded product. The generic version must also be bioequivalent to the branded product, meaning that the active ingredients are absorbed by the body at approximately the same rate.
If these requirements are met, the FDA denotes the generic drug as “ABrated” to the branded drug. An AB-rating signals to consumers, physicians, and pharmacists that the FDA has concluded that the generic drug is therapeutically equivalent and can be used interchangeably with the corresponding branded drug.
In addition to federal legislation, states have also played an important role in facilitating generic competition. All 50 states in the United States have passed generic substitution laws, which permit, and in some cases require, pharmacists to substitute branded drugs with their AB-rated generic versions at the pharmacy without the prescribing doctor changing the prescription. As a result of the FDA’s AB rating for generic drugs and these state laws, substitution from branded drugs to their generic versions is, as discussed below, typically widespread and swift following generic entry, with a large majority of prescriptions switched to the generic products.
This regulatory framework has strongly encouraged the growth of a generic manufacturing industry where, rather than developing products that can be distinguished based on product features or brand, generic manufacturers develop products that are intentionally and effectively identical to the branded product and to the products of other generic manufacturers.
This business model focuses on keeping costs down and competing aggressively on price. The cost of bringing a generic drug to market, while still substantial, is much lower now than it was prior to the passage of the HatchWaxman Act (when generic drug makers needed to go through the same clinical trials as the branded companies to prove drug efficacy and safety). Generic manufacturers’ costs are also relatively low because generics do not expend substantial resources on marketing and promotion. Instead, generic manufacturers primarily rely on the mechanism of AB-rated automatic substitution permitted or mandated by the state generic substitution laws to achieve swift conversion from brand to generic. By the design of the regulatory framework, this is an efficient and effective means for generic manufacturers to distribute their drugs and bring these savings to consumers.
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