Transfer Pricing Associates

Facing crossroad – the patent cliff in pharmaceutical industry

post Tuesday June 4, 2013

by Yariv Ben-Dov, Bar-Zvi & Ben-Dov Law Offices

The pharmaceutical industry is undergoing a dramatic transformation, as several major forces drive the industry to a new era. Although many pharmaceutical companies remain dependent on mature markets, many of them are increasingly investing in emerging markets. The said trends include, in addition, newly focused growth engines, which are the aging population and the rising incidence of chronic diseases, technological advances and even the new healthcare reform  in the US that added approximately 30 million previously uninsured consumers. Yet, despite these trends, the industry's growth prospects are being tampered by upcoming challenges.

One of the said challenges is the upcoming "patent cliff" regarding pharmaceutical related patents of various large multinationals in the pharmaceutical industry. This term relates to the expiration of the protection granted to a registered patent. In the pharmaceutical industry, the patent cliff's magnitude is substantially larger, due the characteristics of its market (i.e., to the number pharmaceutical corporations, and market share of drugs which patents are due to expire within the following years).

Albeit, traditionally, the demand for pharmaceutical products is considered to be fixed, the pharmaceutical industry found itself un-immune to the recent recession, governments' pressure and new regulation aimed at decreasing prices and controlling the general expenditure on healthcare (e.g., as enacted in Spain, UK, Italy, Greece, Portugal, India, Brazil, etc.). Governments are working to incorporate price reduction on medications, which have become significantly more affordable as a result of the patent cliff, the expiration of patents which increases fierce price competition from generics and also results in declining R&D expenditure and productivity. As most of the top bestselling ethics companies have lost, and shall continue to lose their patent protection between 2009 and 2016, the pharmaceutical industry is facing with the sharpest revenue decline in history.

The direct meaning for the industry in general, and especially for the big pharmaceutical companies is that they all reach a crossroad in which the current pipelines are not able to compensate for the high R&D investments. As a result, they have to reshuffle all the cards and find new ways in order to keep up with the changing conditions. Companies need to find new ways in order to deal with the looming changes that harden the authorization and approval processes on one hand, and the competitors on the prowl during patent protection period, on the other hand.

As will be discussed below, the consequences of the patent cliff are beyond the predicted losses of the pharmaceutical industry. The generic industry, the contract research, manufacturing and sales organizations (respectively “CRO”, “CMO” and “CSO”) are also facing with significant changes and growth, as several processes are taking place simultaneously:
Companies are looking for cheaper alternatives to in-house R&D, such as outsourcing to CROs, establishing R&D and manufacturing centers in low-cost countries such as China, India; and lately, in Saudi Arabia. Moreover, as minimizing risk is substantial part of the companies’ cost-reduction strategies, the big pharmaceutical companies are looking into the in-licensing business model as a way to reduce costs. Pharmaceutical and biotech companies now increasingly turn to in-licensing agreements; for the pharmaceutical companies – obtaining new products in their pipelines; whereas for the biotech companies - retaining access to the needed resources for the final stage development, clinical trials, manufacturing and distribution, granted by the pharmaceutical companies. These days, it is clear that in-licensing appears to be the way of the future for most companies in this industry in replacing the traditional R&D model. Furthermore, with respect to the aforementioned, the in-licensing and the collaborations agreement frequently involve competitors, or at least potential competitors. This means that the ability of the big pharmaceutical companies to monitor the competition and entrance to the market of generic companies is increased.

In the last years, large pharmaceutical companies have responded to the patent cliff also by mega-merging. In those acquisitions, the multinationals organisations prefer late-phase leads rather than conducting in-house R&D. It seems that such acquisitions and in-licensing have been ubiquitous on pharmaceuticals' agendas. In addition, and due to the price consciousness, more brand firms are becoming involved with generic companies, either through acquiring generic companies or by setting up their own generic ventures. As pharmaceutical companies reorganize and consolidate their activities, and combine resources and knowledge, they cannot ignore the examination of those new paths through a transfer pricing perspective. Furthermore, once such companies consider the fact that the business models have change, and will continue to change in the next decade, the importance of transfer pricing becomes clear. Since those changes have both direct and indirect impact on the pharmaceutical companies’ supply chain and, which may result in tax implications, it is imperative that multinational organizations carefully measure their footsteps and focus on their long-term strategies.

What will be the transfer pricing consequences of focus shift from return on R&D investment to cost of goods sold? How are those going to be reflected in the operating margin? In the process of structuring in-licensed IPR - who is the IP owner? How should one valuate the consolidated IPR? What is the meaning of centralized IP in the perspective of the transfer pricing? What is the impact of the government's pressures in emerging markets on the intercompany price? Are the prices set by governments actually reflecting an arm’s length position?
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