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2011 International Conference on Innovation, Management and Service

IPEDR vol.14(2011) © (2011) IACSIT Press, Singapore

Patterns of Innovation: A Case Study of US Pharmaceutical Industry

Saif Ullah Khan1 and Muhammad Tariq2


1
Institute of Management Studies, University of Peshawar
2
Sarhad University of Science and Information Technology – Peshawar

Abstract. Due to the unprecedented success of US economy in coming up with patent protected new
innovations it is intriguing to study the patterns of innovations in a given knowledge and capital intensive
industry such as pharmaceuticals. The pharmaceuticals industry is pivotal to longevity of life, lowering
hospital costs and mortality rate. Contrary to other sectors, pharmaceutical products take somewhere thirteen
to fifteen years to receive FDA approval. In the US strong patent protection mechanisms are present in
comparison to Japan and Italy, where only processes can be protected not products. It has been learnt that
strong appropriablity regime drives innovation by acting as an incentive for research and development
investments. However, on the flip side of the tight control only two out of ten launched drugs generates sales
that are equal to or exceed their research and development costs. Rise in the number of patents maybe due to
patent overlapping for “patent evergreening” purposes. Positive correlation has been found in the
specialization of US Pharmaceutical sector, the investment in the industry and the Revealed Comparative
Advantage (RTA>1). The highly regulated industry with longer product development cycles and greater
R&D investment has not only differentiated it from other industries in the US, but also has provided it with a
lead over pharmaceutical industries in other countries.
Keywords: Innovation, Pharmaceutical, US, Patterns

Background
Abraham Lincoln, who himself received a patent for a device used to lift boats over shoals in (1849),
once mentioned in a speech that patents, “added the fuel of interest to the fire of genius”. Providing a
stimuli for protecting innovations through intellectual property rights. The need for protecting inventions is
also included in the US constitution (Article I, Section 8, Clause 8, also called the Copyright Clause) where it
states, “Congress shall have power to promote the progress of science and useful arts, by securing for limited
times to authors and inventors the exclusive right to their respective writings and discoveries”.
According to World Intellectual Property Organization report (2008) in the year 2006, 425,966 patent
applications were put up in America and out of these 173,770 applicants were successful patents, that make
almost 24% of all the patents granted worldwide. Due to the unprecedented success of the United States in
coming up with patent protected innovations it would indeed be intriguing to study the pattern of innovations
in a US industry. For the purpose of the study the US Pharmaceutical industry has been selected due to its
innovative potential and its importance to the US economy. The importance of pharmaceutical industry to
US can be judged from its economic impact of creating 686,422 direct and 3.2 million indirect jobs in the
year 2006 alone (phRMa, 2006).

1. Introduction
In the domain of evolutionary economics the question “why and how innovation differs in industries”
has always remained an active topic of discussion. Pavitt (1984) and Malerba (1997) have discussed the issue
and have identified the dimensions that highlight the important factors contributing to differences in
industries. Therefore, different patterents of innovation are observed in various industries, in some
industries innovative activities may be concentrated in few large firms and in other industries, small
businesses seem to be actively involved in innovation. Overall innovation in an industry requires
technological oppurtunities and appropriability of innovation. Breshi et al, (2000) pointed out that

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technological opportunities denote the probability of creating innovation for a particular sum of money
investment in research. Similarly, the appropriability of innovations denotes opportunities to reap the
benefits of an innovation. In the same manner Malerba and Orsenigo (1990) describes that knowledge
created today is accumulated and used for creating new knowledge in future.
The pharmaceutical industry is complex and highly regulated industry in almost all developed
economies of the world. Governments control pricing and drug development. Similarly, there are restrictions
on marketing products without the involvement of learned middlemen such as doctors and pharmacists. This
unique controlled nature of the industry makes it an interesting specimen for study.

1.1. Patent Protection in Pharmaceuticals


According to World Intellectual Property Organization report published (2010) generally a patent has
two important functions. The foremost function is protection of the intellectual property by excluding other
people to use inventions granted in a specific region such as African Regional Intellectual Property
Organization and European Patent office (ARIFO & EPO) or internationally through Patent Cooperation
Treaty (PTC) which is administered by the World Intellectual Property Organization (WIPO). Second, a
patent helps other people to have access to information related to new technologies to help foster the process
of innovation and contribute to the economic growth.
According to Pharmaceutical Research and Manufacturers of America (2007), contrary to other sectors,
the pharmaceutical products takes somewhere in the neighborhood of 13 to 15 years to develop a new drug
and attain US Food and Drug Administration (FDA) approval. This means that a considerable duration of
patent is lost, reducing the effective patent life to 12 years approximately. The primary expenditure in the
pharmaceutical Research and Development (R&D) are high, therefore tight patent safety is needed to recover
initial costs from the newly developed drug. Recent research reveals that on average it needs 800 million
USD to develop a new medicine which is significanlty greater figure in comparison to other industries.

1.2. Pharmaceutical Patents as Drivers of Innovation


Mainsfield (1998) pointed out the fact that patents are primary drivers of innovation in pharmaceuticals.
In the United States and Europe strong patent protection mechanisms are prevalent in pharmaceuticals when
compared to Japan and Italy where only process can be protected but not products (Pammoli et al, 2000). As
a consequence, the latter countries have been reluctant to invest in new product research and development
initiatives . According to Levin et al. (1987) cited in Breshi et al. (2000) the appropriability of innovations
reflects the chances of protecting an innovation from imitators. Low appropriability depicts an economic
environment where externalities are common. Whereas, high appropriability on the other hand means that
there are prevalent ways of protecting an innovation. Breshi et al. (2000) further states that high
appropriability may drive innovation by acting as an incentive. As a result the R&D investments are
encouraged. It can be argued that in the United States there is a tight appropriablity regime as compared to
Europe where the claims are reduced and mostly process instead of product patents are granted (ibid). To
sum up the discussion we can infer that patents protects the inventor interests, in turn the holder of the patent
reveals the underlying knowledge of the invention, thus acting as an incentive for innovation activities
worldwide.

1.3. Challenges for Innovation in Pharmaceutical Industry


The pharmaceutical companies are confronted with numerous challenges ranging from how new drugs
are developed and commercialized as well as strict regulatory compliance is required. The process of new
drug development requires patience, expenditures and risk taking initiatives. According to
Pharmaceuticals Research and Manufacturers of America (2007) it takes more than a decade to launch a new
drug, costing about 1 billion USD, and for every (10,000) compounds which are undertaken by the R&D
only (1) of these is likely to receive Food & Drug Administration (FDA) approval. The research
further claims that only a scarce (3%) of the drugs that eventually are commercialized surpass the mean
average costs of research and development (R&D) used in their development.

1.4. New Drug Development Costs


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Accordiing to Dimaasi et al, (20003) new innnovations in the health seector have leead to somee noteworthyy
changes in improving general
g public health. The expenses in i the pharm
maceutical inddustry have grown
g fasterr
than other sectors.
s The chart
c below depicts the rising
r costs of
o making a new
n medicinne. In the yeaar (1975) thee
cost of deveeloping a neew drug was about 138 million
m USD that increassed to a conssiderable extent reachingg
318 millionn USD in (19987). Dimasii et al (2003)) pointed outt that duringg the 1990s thhe costs of developing
d a
new drug inncreased to 812 millionn USD in thee year (2000 0). Recently a new reseaarch was caarried out byy
DiMasi, andd Grabowskki, (2007) suggesting thaat the researcch and devellopment costs for develo oping a neww
drug was foound to be abbout 1.3 billioon USD in thhe year (20055).

Figuree 1: New Estim


mates of Drug
g Developmennt Costs

(Source: adopted fron DiM


Masi et al, 20003)

1.5. Reseearch and Developme


D ent in Pharm
maceuticalls (US)
Howeveer, the risinng costs of developing new drugs seems to have h little im
mpact on th he new drugg
developmennt process ass shown byy the Pharmaaceutical Ressearch and Manufacturer
M rs of America, indicatingg
18,00 mediccine in development stagges during (11999) and 2,,950 medicinnes in the yeear (2009). Similarly, thee
research shoows that the research & developmennt (R&D) exp penditures inn pharmaceuutical sector is i showing a
positive trennd with $47.6 billion in (2004), $51.8 billion in (2005), $566.1billion in (2006), $63..2 in (2007),,
$63.7 in (20008) and $655.3 billion in the year (20009) as depiccted by figuree 1.2. This means that a percentagee
of domesticc sales in thee US almost 19% went toowards reseaarch and deveelopment. Em mpirically, th
his indicatess
that only 2 out of 10 launched
l druugs generatee sales that are equal too or in excess of their research
r andd
developmennt costs.

Figure 2: R&D
R Spendingg Trends in Ph
harmaceuticalls Sector in US
S

13
(Source: adopted from
m phRMA 20110 Key Facts)

1.6. Rolee of Patentss in Pharm


maceutical Sector
S
There iss no doubt that
t innovatioons in the fiield of mediccine have coontributed to preservation n of life andd
therefore it needs moree attention as a it contribuutes towardss longevity of o human liffe. Accordin ng to Globall
Intellectual Property Center,
C (20110) from thhe 300 top-notch druggs as identiified by World W Healthh
Organizatioon which saave preciouus human lives come from the research r and knowledg ge intensivee
pharmaceuttical sector. It
I is interestinng to note thhat during (20000-2004), thhe average wworker in phaarmaceuticall
industry earrned (44%) more
m than workers
w in noon-intellectuaal property inntensive induustries. Duriing the samee
period of tim
me in the maanufacturing industry thee employmen nt rate went down
d by (16%
%) in Ameriica, whereas,,
the pharmacceutical sectoor increased their employyment rate by y almost 8 %.
%
Accordiing to Kesseelheim (20077) in the pharrmaceutical sector
s there is a trend am
mong patent holders is too
stretch theirr market exclusivity furrther. A diffferent strateg
gy such as “patent
“ everggreening,” iss used. Thiss
strategy enccompasses thhe patenting of non critiical product features succh as their mmethod of forrmulation orr
administratiion.
o the innovaations whichh brought ennduring economic effectss
There iss no denyingg the fact thaat majority of
were develooped in counntries possesssing strong patents
p and otther intellecttual propertyy protection mechanisms.
m .
In the absennces of stronng protection the process of creativity
y and innovattion is seriouusly halted. According
A too
Shapiro and Hassestt (2005) econnomies with weak intelllectual propperty protecttion attract less foreignn
investment which can be b detriminall to the econnomic develo opment of a country. Sim milarly, it caan be arguedd
that countriies with stroong IP proteection are more
m inclined
d to spend on o research and develop pment whenn
compared to t nations where
w there is
i weak intellectual prop perty protecttion. Strong patent and IP laws aree
helpful p
protecting coonsumers froom fake druggs such as in n USA wherre there are heavy penallties. On thee
other hand illegitimate
i p
practices are more commmon in countrries where thhe regulatoryy regimes aree either weakk
or were nonn- existent beefore the year 2005.

2. Analyysis
For the purpose of task II of thhe paper ISICC 24 (Chemiicals and cheemical produucts) has beeen chosen ass
approximatiion of pharmmaceutical inndustry. In coonformance with task I ofo the paper the authors have chosenn
to analyze and
a comparee the pattern of innovations in the phaarmaceuticall industry in the US. It is importantt
to note that market econnomy was asssumed as tottal economy y. In the first place the deevelopment of
o number off
t US pharrmaceutical industry hass been analy
patents in the yzed with thhe help of ddata provided d on Jibsnett
(Provided by
b Jonkopingg Internationaal Business School,
S Swedden).
Figure 2.1: The Num
mber of Patentts between 1980-1999

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(Sourcce: The authors own creatioon for this pap
per)

me range for analyzing thhe number off patents perr year was chhosen from 11980 to 1999
The tim 9. The graphh
indicates a positive
p trennd in the num
mber of patennts for the US
U pharmaceeuticals startiing from 590 05 patents inn
the year 19980 with a gradual increase year by year until 1995 where it i suddenly sstarted to acccelerate andd
experiencedd a sharp risee in the nummber of patennts reaching 14752. Thiss is in confoormance with h Mainsfieldd
(1998) whoo suggests thhat in the Unnited States there
t ong protectioon mechanism
are stro ms (tight app
propriabilityy
regime) avaailable whereeby both prooduct and proocess orienteed patents caan be patenteed. On the other
o hand, itt
can be arguued that the sudden risse during thee mid nineties might be due to overrlapping pattents grantedd
which can result
r in prevventing effecctive cooperaative usages of such pateents. This gooes in conforrmance withh
Kesselheimm (2007) whoo argues thaat in the phharmaceuticall sector the patent holdders stretch their t markett
exclusivity further by sttrategies suchh as “patent evergreeningg,”. This resuults in greateer number off patents andd
it might be the case thaat during miid 1990s thiss was the caase. Ever sinnce, (1995) aas the graph depicts, thee
industry is showing a deteriorating
d g trend but still the num mber of pateents have remained abov ve the meann
average of patents
p grantted between (1980) and (1999).
(
Figure 2.2
2 depicts the t relationshhip between the R&D in nvestments and
a the numbber of patentts developedd
between (19980 & 1999)). There seem ms to be a positive
p correlation betw
ween the inveestment in R&D R and thee
number of patents
p creatted per year. This trend goes
g in confformance witth Breshi et aal. (2000) who
w state thatt
high approppriablity driives innovattion by actinng as an in ncentive; as a result thee R&D inveestments aree
encouraged. Therefore it i can be arggued that in the
t United Sttates there iss a tight apprropriablity reegime wheree
patents are strictly
s proteected.

Figure 2.22 Research annd Developmeent (R&D) Stoock and Numb


ber of Patents Relationship bbetween 1980
0 and 1999

15
(Source: autthors own creation for this Paper)
P

Additioonally, this trend


t can also
a be justiified by a recent
r reporrt of Pharm
maceutical Research andd
Manufacturrers of Amerrica which claims
c that almost
a (19%%) of the dommestic pharm
maceutical sales goes too
Research annd Developm ment (R&D). Simply put we canarguee that input R&D R compaared with thee output ratioo
(patents) iss favorable and
a that cann arguably be
b the reaso on for consttant growth in terms ofo increasingg
investmentss in the R&DD in the US pharmaceutic
p cals sector.

2.1. Euroopean Pateent office (E


EPO) paten
nts and PCT
Patents can be filedd in differennt regional (ARIFO
( & EPO)
E and Innternational (PCT) basiss. To gain a
comparativee view pateents registereed under EP PO have beeen plotted again those registered under PCT..
Interestinglyy, the numbeer of patents in the Europpean Patent Office
O (EPO
O) is considerrably more th
han the oness
filed at the Patent
P Cooperation Treatty (PCT) meember nation ns. Perhaps thhe reason of lower number of patentss
at (PCT) is higher costts and long procedures
p w
which makess it possible to seek prootection for an
a inventionn
simultaneouusly in severaal countries by
b filing a siingle internattional application (WIPOO, 2009).

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F
Figure 2.3. A comparisonn between pattents registered in EPO annd PCT from
m 1987 to 200
03

(Source:: authors own creation for thhis paper)

2.2. Reveealed Comparative Advantage


A (
(RTA)
The revvealed comparative advaantage (RTA) is an index x used internnational econnomics for assessing
a thee
relative advvantage of a certain
c nationn in a sector. In the first place the tottal number of global pateents (P) weree
calculated using
u the data
d set giveen on jibsnet by taking g (ISIC 24)) as an appproximation for the US S
Pharmaceuttical industryy. In the secoond step (Pi)) which is to otal patents globally
g in thhe industry chosen
c weree
calculated using
u excel spread sheeet. In the thhird step (Pcc) which meeans total paatents in thee US for alll
industries was
w carried out. In the fouurth step (Picc) which is total
t patents in the pharmmaceutical ind dustry in thee
US were calculated.

Figgure 2.4. RTA


A for US Phaarmaceuticall Industry sinnce 1987 to 22002

(Source: authhors own creaation for this Paper)


P
Afterwaards using thhe simple eqquation reveealed comparrative advanntage was caalculated and
d the resultss
were plottedd on the grapph as shown above.

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The graph indicates that US has a Revealed Technological Advantage in Pharmaceuticals as the results
are above 100 on a consistent basis from 1987 onwards. That implies US specialization in pharmaceutical
sector and the likelihood of fostering new innovation is higher. This notion is supported by Shapiro and
Hassett (2005), who argue that nations with weak intellectual property protection attract less foreign
investment and countries with strong IP protection are more inclined to spend on Research and Development
(R&D) when compared to nations where there is Strong patent and IP laws are helpful protecting consumers
from fake drugs such as in US.

3. Conclusions
The pharmaceutical Indusrty is very R&D intensive in nature as it involves creating new knowledge, and
therefore the viability of pharmaceutical sector depends upon protection of intellectual property rights, as
they provide cusion to the inovating firm to recover the initial costs. Patents are useful for the development
of new medicines, sometimes patents can add extra expenses and serve as barriers to for new research. This
paper indicates that pharmaceutical industry can be characterised as having extended new product
development cycles (10-15 years), coupled with higher degree of regulations and requires great initial R&D
investments, patience and risk in developing a new drug. There has been a constant increase of ~5% in
investment in US Pharmaceutical Industry since mid 1980s on annual basis with a corresponding increase in
Pantent. Additionally, Government intervention in terms of pricing, regulation and promotion mechanisms
are relatively strict and demands stringent compliance in the United States. These characteristics serve to
differentiate pharmaceutical industry in the US from other sectors which are mostly unregulated, with lower
R&D investments and shorter product development cycles. Due to high protection and technological
opportunities United States has taken the lead from other countries in the domain of international
competition in Pharmaceuticals industry leading to a RTA greater than (1) on a consistent basis.

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