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In 1984, the Drug Price Competition and Patent Term Restoration Act (also known as the Hatch-Waxman Act) created an abbreviated approval process for generic prescription drugs and at the same time extended patent terms for innovator drugs. This Congressional Budget Office (CBO) study examines the extent to which competition from generic drugs has increased since the act. It also analyzes how that competition has affected the returns from developing a drug. The analysis was conducted at the request of the Chairman of the Senate Committee on the Budget.

Anna Cook of CBO's Natural Resources and Commerce Division wrote the study under the supervision of Jan Paul Acton and Elliot Schwartz. The analysis would not have been possible without data and information provided by the Food and Drug Administration (FDA), the Patent and Trademark Office (PTO), the Health Care Financing Administration, and Henry Grabowski of Duke University. A variety of industry experts provided information and insights, including Philip Chao and Donald Hare of the FDA, Karin Tyson of the PTO, Joel Hamilton of the General Accounting Office, David Reiffen of the Federal Trade Commission, Paul Wilson of IMS America, and Gary Persinger of the Pharmaceutical Research and Manufacturers of America (now of the National Pharmaceutical Council). Other outside reviewers included the following economics professors: Ernst Berndt and Scott Stern of MIT, Fiona Scott Morton of Stanford, David Salkever of Johns Hopkins, and F.M. Scherer of Harvard. Within CBO, John Peterson, Linda Bilheimer, Judith Wagner, Patrice Gordon, and Anne Cappabianca (now at Hoffman-La Roche) made extensive and valuable comments. Aaron Zeisler and Carl Muehlmann provided research assistance.

Christian Spoor edited the manuscript, and Melissa Burman proofread it. Angela McCollough typed the many drafts. Kathryn Quattrone prepared the study for publication, and Laurie Brown prepared the electronic version for CBO's World Wide Web site.

June E. O'Neill
Director
July 1998
 
 

SUMMARY

ONE - INTRODUCTION

• The Basis for Competition Among Drug Companies
• Changes Made by the Hatch-Waxman Act
• Data Used in This Analysis

TWO - THE EFFECT OF MANAGED CARE ON THE PHARMACEUTICAL MARKET

• The Rise of Managed Care
• How PBMs Help Hold Down Drug Expenditures
• How Managed Care Affects the Demand for Prescription Drugs
• Conclusions

THREE - PRICING AND COMPETITION IN THE PHARMACEUTICAL MARKET

• Competition Among Brand-Name Drugs
• Factors That Determine Discounts on Brand-Name Drugs
• Competition Between Brand-Name and Generic Drugs
• Competition Among Generic Drugs
• Conclusions

FOUR - THE EFFECTS OF THE HATCH-WAXMAN ACT ON THE RETURNS FROM INNOVATION

• Changes to the Length of Patents for Brand-Name Drugs
• Changes to the Approval Process for Generic Drugs
• Effects on the Returns from Marketing a Drug
• Effects of Proposed Changes to the Hatch-Waxman Act
• Conclusions

APPENDIXES

A - Data Used for the Empirical Estimates
B - Regression Results on Discounting
C - Assumptions Behind the Calculation of Returns from Marketing a New Drug
D - The Replacement Effect
 

TABLES
1.	Market Share and Average Retail Prescription Price, by Type of Drug, 1994
2.	Average Time from Clinical Testing to Final Approval for an Innovator Drug
3.	Percentage of New Drugs Acquired Rather Than Self-Originated by U.S.-Owned Drug Companies
4.	Average Price Differences for Various Types of Purchasers in the Pharmaceutical Market
5.	Price Comparison of Generic and Innovator Drugs, by Number of Manufacturers, 1994
6.	Generic Subsidiaries or Divisions of Brand-Name Manufacturers
7.	Changes in Patent Protection for U.S. Pharmaceuticals
8.	Average Length of Hatch-Waxman Extensions for Drugs Approved Between 1992 and 1995
9.	Limits on Hatch-Waxman Extensions for Drugs Approved Between 1992 and 1995
10.	Reasons That Some Drugs Approved Between 1992 and 1995 Did Not Receive a Hatch-Waxman Extension
A-1.	Data and Methods Behind CBO's Estimates
B-1.	Variables Used in the Regression Analysis of Discounting
B-2.	Regression Results on Price Dispersion in 1994
B-3.	The Effects of Generic and Brand-Name Competition on Price Dispersion
C-1.	Assumptions Used to Calculate the Change in Returns from Marketing a Drug
C-2.	Formulas for Calculating Generic Market Share
C-3.	How Sensitive Is the Calculation of Returns to Changes in the Base-Case Assumptions?
FIGURES
1.	How PBMs Fit Into the Payment System for Prescription Drugs
2.	Channels of Distribution for Prescription Drugs
3.	Change in the Profit Stream for a Typical Innovator Drug
4.	Choosing a Profit-Maximizing Price for a Drug
5.	Market Share of the Top Three Innovator Drugs in 66 Therapeutic Classes, 1994
6.	Growth in the Market Share of Generic Drugs Since 1984
7.	The Average Profit Stream for a Brand-Name Drug Before and After the Hatch-Waxman Act
BOXES
1.	Types of Prescription Drugs
2.	The Role of Changes in State Drug-Product Substitution Laws
3.	Defining Therapeutic Classes of Drugs
4.	Studies of How Generic Entry Affects Brand-Name Prices
C-1.	Calculating the Probability of Generic Entry
D-1.	Calculating the Impact of the Replacement Effect and Generic Competition on the Returns from Innovation

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