W. NICHOLSON PRICE II
M&M CANDIES are made with an efficiency and precision far surpassing the capabilities of many drug manufacturers (Helferich 2013; Hussain 2013). This is surprising—both are regulated by the U.S. Food and Drug Administration (FDA), and the drug industry’s operations have major implications for human health and for the health care system in general. But manufacturing in the drug industry generally is inefficient and expensive and shows little of the innovation that has characterized other manufacturing sectors over the past few decades (Price 2014a).
The lack of innovation in manufacturing might not be worrisome if it did not create major problems; unfortunately, it does. Drug recalls are rising, with more than 2,000 in 2011, many due to manufacturing quality problems and contamination (Shanley 2012). Drug shortages are also increasing, with hundreds of ongoing shortages, including common drugs and frontline cancer therapies; the majority of them are caused by manufacturing problems (Gatesman and Smith 2011; Kweder and Dill 2013). And more generally, expenditures on drugs make up over 15 percent of health care costs (Thomas 2013), and billions of dollars are wasted annually on excessive drug manufacturing costs. Reducing those costs would generate tens or hundreds of billions of dollars in annual consumer surplus, depending on how the savings were used.
The absence of innovation—and the attendant presence of inefficiency and waste—is especially surprising in the context of an industry that has long been viewed as a relatively successful target of innovation policy. Both regulatory and intellectual property factors are aimed at getting the industry to develop newer and better drugs, and despite some notable failures, the drug industry is generally seen as a success story for patents and innovation policy as a whole.
That success story, however, does not apply to pharmaceutical manufacturing. While strong intellectual property and regulatory incentives drive the costly development of new drugs, those incentives largely fail in the context of drug manufacturing. Instead, the combination of costly regulatory barriers to innovative change and ineffective intellectual-property incentives to develop new technology mean that pharmaceutical manufacturing is largely stagnant, with tremendous attendant costs.
Improving the situation requires policy change to lower regulatory hurdles or increase incentives for innovation—ideally, both. This chapter concludes by briefly discussing a few possible paths for positive change, including direct regulatory changes and ways that the regulatory apparatus can be used to change the incentives in the intellectual-property system without making wholesale changes to that system itself.
I. PHARMACEUTICAL MANUFACTURING TODAY
Manufacturing is either the first or second highest expense for drug firms. Nonetheless, it is surprisingly inefficient, lagging significantly behind the modernized manufacturing techniques of other industries; the industry was recently characterized as being “in the dark ages with respect to…efficiency” (Eglovitch 2012). If the industry could modernize its manufacturing practices, it could not only reduce the health care problems that arise from drug shortages and recalls but could also save tens of billions of dollars annually by modernizing manufacturing, with even larger social-welfare benefits.
Drug manufacturing is perceived as inexpensive because the most salient costs—marginal costs of blockbuster small-molecule drugs—are in fact typically very low (Outterson 2005). However, other drugs frequently have much higher marginal costs (Berndt et al. 1995), and the industry has high fixed costs, including capital costs and quality costs. Overall manufacturing costs, measured as “cost of goods sold” (COGS), averaged 26 percent of brand-name small-molecule drug manufacturer sales between 1994 and 2006 and 52 percent for generic manufacturers (Basu et al. 2008). Though the story for biologics is more complex, they typically face higher absolute manufacturing costs on both fixed and per-unit bases (Price 2014a). Throughout the drug industry, manufacturing is quite expensive. Surprisingly, given the potential for competitive advantage—and contributing to the initial expense—manufacturing is largely noninnovative and relies on outdated techniques and processes.
While other industries have developed and adopted modern manufacturing processes over the last few decades, the pharmaceutical industry has lagged far behind (Friedli et al. 2006). Modern manufacturing includes not only new technology but also processes like constant monitoring of production parameters, systematic waste reduction, continuous process improvement, and continuous quality management. These techniques have spread through many industries but not generally drug manufacturing (Friedli et al. 2010; Yu 2008).
As a result, pharmaceutical manufacturing suffers from poor operational performance, manifest in several ways (Herlant 2010). Process rigidity is frequent and problematic; instead of embracing flexibility and continuous improvement, drug companies view the initial regulatory commitments on manufacturing methods as approved processes, which should only be changed in exceptional circumstances (Friedli et al. 2010). Although regulatory barriers are certainly significant, as discussed later, they are not the only source of process rigidity, which also results from inadequate internal or external incentives for change. A linked problem is the frequent use of outdated equipment and production lines, including factories several decades old with limited upgrades (Woodcock and Wosinska 2013) that have been described as “in terrible shape” (Thomas 2012). Other problems with process management result in surprisingly loose control over processes, with much higher error rates than other industries to be caught in intermediate- or final-stage testing (Friedli et al. 2006). This emphasis on quality through testing creates major inefficiencies and slows the production of drugs tremendously.
Fixing these inefficiencies would make a major contribution to welfare. Studies have estimated that the industry could save $15 to $90 billion annually worldwide by reducing manufacturing inefficiency (Suresh and Basu 2008). But the potential consumer welfare gains from these savings are much larger. If manufacturing expenses decreased by 20 percent and that decrease resulted in lower drug prices, as would be expected in a competitive market equilibrium, the expected annual consumer surplus gain in the United States alone would be $47.4 billion (Vernon, Hughen, and Trujillo 2007). If instead the savings resulted in increased research and development (Vernon 2005), the health gains could be worth as much as $574 billion annually.
In addition to lower costs, manufacturing innovation can improve drug quality and can decrease the number of drug recalls and shortages. Poorly controlled processes and outdated equipment contribute directly to quality problems, contamination, and drug recalls (Shanley 2012). The growing problem of drug shortages—estimated to cost $416 million a year in economic costs (Cherici et al. 2011; Kaakeh et al. 2011) and unknown human health costs (Born 2012)—is also highly linked to manufacturing problems. Forty-six percent of drug shortages in 2011 were caused by quality issues, “including bacterial or mold contamination, tablet disintegration, and the presence of foreign particles such as glass or metal in vials” (Kweder and Dill 2013). Delays or capacity issues caused another 19 percent. Manufacturing innovation, to the extent that it results in closer monitoring, greater control, and higher quality of drugs, could help decrease both recalls and shortages.
II. INNOVATION POLICY FAILURES
The significant problems in drug manufacturing and the major benefits from fixing them lead to the obvious question: Why is drug manufacturing in such poor shape? Two contrasts are illustrative. First, the drug industry as a whole certainly has the capacity to innovate; new drugs are constantly developed, despite the extremely high regulatory hurdles and costs of the drug development-and-approval process. Second, in other industries, manufacturing has been notably innovative in the last few decades, yielding major advances in efficiency and quality. Drug manufacturing is different because it suffers from two interlinked challenges: high regulatory barriers to innovation and low intellectual-property incentives for innovation, both of which will be discussed in detail following. In contrast, each of the comparison situations faces only one challenge: drug development has high regulatory hurdles but strong patent protection for new drugs, while other industries’ manufacturing faces lower regulatory barriers but little intellectual property protection.1 The combination of these two factors has resulted in the stagnation of manufacturing in the pharmaceutical industry.
A. Regulatory Barriers
Innovation in the pharmaceutical industry takes place against a backdrop of pervasive regulation designed to ensure that drugs are safe and effective. In the context of drug manufacturing, all manufacturing methods and changes to those methods must be approved by FDA (21 USC § 255(b)(1)(D)). Throughout this approval process, as has been discussed elsewhere in this volume, FDA imposes significant limits on innovation in three primary ways. First, institutional resistance to approving novel technologies restrains innovation during the New Drug Application (NDA) process, so that firms avoid innovative technologies in NDAs for fear of delays in receiving marketing approval. Second, de facto technical standards arise from current Good Manufacturing Processes (cGMP) regulations and associated guidances, to which firms frequently adhere overly closely in innovation-decreasing ways. Third, FDA imposes procedural hurdles to postapproval manufacturing changes, in the form of required filings of supplemental NDAs (sNDAs). Fourth and finally, FDA also imposes substantive hurdles to postapproval change, where manufacturing methods from early drug development are effectively locked in by regulation. These regulatory constraints are generally imposed without taking into account their effect on manufacturing innovation or efficiency.
The first and perhaps most pervasive hurdle to innovation comes before approval, where agency practice and market dynamics make firms reluctant to include new technologies in NDAs. FDA has historically been leery of approving new technologies, sometimes requiring years to accept them. For instance, FDA took several years to accept the shift from thin-layer chromatography to high-performance liquid chromatography, despite its superior performance and subsequent wide adoption in the industry (Hussain 2013). Firms have learned from this experience and understand that even though FDA may eventually be persuaded to accept a new technology, inclusion of such a technology within the context comes with the risk of significant delay.
The second hurdle to innovation comes from technological standards. Technological standards, when specific technologies are required, are recognized as problematic for innovation because they impose a cost, sometimes very high, on shifting technologies because the standard needs to change. The unusual aspect of technological standards in pharmaceutical manufacturing is that they are not actually mandated by FDA. FDA cGMP regulations are rigorous and wide-ranging but typically are goal-oriented performance standards rather than technological standards (21 CFR § 211). Instead, the industry has effectively created de facto technology mandates for itself by adhering tightly to technical examples found in cGMP guidance documents. In the largest example, the industry-wide practice of using three batches to validate a process apparently arose from FDA’s 1987 “Guideline on General Principles of Process Validation,” which stated that processes should be repeated “a sufficient number of times to assure reliable and meaningful results.” The guidance also mentioned a single example that required three repetitions; from this and a few other contemporary examples, the industry adopted a three-batch rule rather than the broad principle described in the guidance (FDA 2013a). Similarly, FDA noted that an approved-equipment addendum to a guidance was “misinterpreted as equipment required by FDA” (FDA 2013b). FDA has tried to limit this type of industry adherence, recently replacing the 1987 guideline (FDA 2011) and removing tables listing specific approved equipment, but the risk-averse industry continues setting its own de facto technical standards, which limit innovation.
The third hurdle is the set of procedural barriers to receive FDA approval of changes to manufacturing methods after the drug has been approved for the market. Drug sponsors must notify FDA of any changes to an approved application, which include manufacturing changes (21 CFR § 314.70(b)–(d)). Major changes, which include any change that “may affect the impurity profile and/or the physical, chemical, or biological properties of the drug substance,” require FDA preapproval (21 CFR § 314.70(b)). The procedure of getting changes approved is costly in terms of money to prepare and file the documents, time to prepare the submission and await a reply, and the risk both of nonapproval and of other questions about the drug being reopened by the agency. These procedural costs, even if small, can effectively block continuous improvement, which relies on small changes, and help create a change-averse culture, which also blocks larger changes (Friedli et al. 2006).
The fourth and final hurdle is a set of drug-specific substantive barriers to innovative change that arrive through a process of regulatory lock-in. Put briefly (Price 2014a; discussing in further detail), drugs are approved on the basis of clinical trials; accordingly, the specifications of the approved drug are based on the characteristics of the drug at the time it was used for clinical trials. Once specifications are set, the drug must continue to meet those specifications. However, manufacturers typically wait until late in development to optimize manufacturing; by that time, it may be too late to change many aspects of the drug, and associated manufacturing methods are locked in by the specifications (Friedli et al. 2006). This makes sense for drug parameters that are poorly understood but is just as true for parameters that are well understood and for which larger deviations from specifications would not be clinically relevant (Yu 2008).
B. Inadequate Intellectual-Property Incentives
Regulation significantly reduces innovation in pharmaceutical manufacturing. Regulatory hurdles alone, however, cannot fully explain manufacturing stagnation because firms are able to overcome the high hurdles for getting drugs initially approved. The lack of innovation in pharmaceutical manufacturing also arises from a lack of sufficient innovation incentives. Patents, which are dominant in drug discovery and development, are less valuable for drug manufacturing and consequently less important. Trade secrecy plays a greater role for manufacturing methods but has major drawbacks as an innovation incentive. Finally, regulatory exclusivity is important for drug development but does not exist for manufacturing methods.
Patents reward invention by letting inventors recoup high initial costs by creating a temporary monopoly and allowing correspondingly higher prices and are strikingly important in drug discovery and development, to the extent that most firms avoid developing drugs unless they can ensure strong patent protection (Roin 2008). Although patents are available throughout the development process, they are particularly prominent in protecting early investments (Kitch 1977). Postapproval, patents also protect drug innovations by preventing generic-drug entry until they expire, and that protection is often extended by “evergreening” tactics (Hemphill and Sampat 2012).
For drug manufacturing, by contrast, patents are worth much less than in other industries because they require costly disclosure but are difficult to enforce. Patents require that the patented invention be disclosed to the public. However, manufacturing processes are hard to observe and difficult to reverse engineer from the final product; this means that without disclosure, competitors must generally develop manufacturing process innovations independently. Thus, the disclosure of manufacturing process patents is particularly costly.
This costly disclosure is negatively complemented by the difficulty of enforcing manufacturing process patents. Process patents are easier to invent around than patents on drug products because a manufacturing process can sometimes be tweaked slightly to avoid a process patent in a way that drug products cannot. More fundamentally, knowing when a process patent is infringed is especially difficult because “no one outside the potential infringer knows how the product was made” (Lewis and Cody 2002). Identifying the use of a patented process is likely to be especially difficult for general patents, like ways to more closely monitor ongoing production. In addition, a significant subset of manufacturing patents, those focused on monitoring and gathering information, have become effectively impossible to enforce since the Federal Circuit held in the 2012 case Momenta v. Amphastar (2012:1348) that they fall within the “safe harbor” provision of the Hatch-Waxman Act (35 USC § 271(e)(1)) because they generate information used for regulatory submissions (Price 2014a). Overall, patents are frequently too costly and too hard to enforce for firms to rely on them to protect manufacturing innovations. As a consequence, firms turn instead to trade secrecy.
Trade secrecy matters much more for innovation in drug manufacturing than patents do. Trade secrecy, grounded in state law, provides protection from misappropriation of information that is reasonably kept secret and derives value from its secrecy (Uniform Trade Secrets Act § 1(4)). Like patents, trade secrecy creates incentives for innovation by keeping others from copying the innovation and therefore allowing supracompetitive pricing. Trade secrecy can act at a range of strengths, from creating a competitive advantage when one firm can use a more efficient technique than another (Norbrook Labs. v. H.C. Manuf’g 2003:463) to excluding competitors from the market entirely if creating the product is impossible without the secret process, which is especially likely for biologics (Wyeth v Natural Biologics 2003:*1). But trade secrets play a bigger role than patents in protecting manufacturing processes for at least three reasons. First, while enforcing manufacturing process patents is difficult, as long as trade secrets can be kept secret, their effectiveness does not depend on monitoring other firms’ activities. Second, trade secrets, by definition, do not require disclosure of information to competitors, who might derive significant benefit from the information. Finally, trade secrets, unlike patents or statutory exclusivity, do not have a predetermined lifespan but can continue indefinitely.
Trade secrecy creates some incentives for innovation but also has major problems as innovation policy. First, the maintenance of secrecy means that trade-secret protection blocks cumulative innovation because neither other firms nor society in general can develop new knowledge based on the secret. Second, further innovation even within the firm is likely lessened because maintaining trade secrecy requires security measures that limit the dissemination of information to other potential innovators in the same firm. Third and finally, trade secrecy likely creates insufficient incentives for broadly applicable forms of innovation—which may be too hard to protect—or for forms of innovation that require wide licensing or network effects to function profitably. Unfortunately, the type of innovation most needed in drug manufacturing—innovations reflecting greater understanding and process knowledge—are particularly poorly suited to protection as trade secrets.
3. Regulatory Exclusivity
FDA also directly governs innovation incentives by offering a variety of forms of regulatory exclusivity to approved drugs. For five years after a new drug is approved, no generic version can be approved; biologics receive 12 years of exclusivity, and rewards are also available for conducting pediatric trials or developing drugs for rare conditions (so-called “orphan drugs”) (Eisenberg 2006). However, regulatory exclusivity is completely unavailable for manufacturing methods, and therefore does not serve as an incentive for innovation.
Overall, although the pharmaceutical industry is a major focus of innovation policy, the policy levers and rules, patents, and regulatory exclusivity, which work well for drug discovery and development work poorly for pharmaceutical manufacturing. Even the one form of incentive that has the most effect, trade secrecy, provides limited and flawed incentives.
III. PROPOSALS FOR CHANGE
The state of innovation in pharmaceutical manufacturing is poor, with major consequences, and that lack of innovation arises from a failure of innovation policy. Regulatory barriers to innovation are high, and incentives for firms to overcome those barriers are low. Potential solutions to this complex problem could act on both of those levers, lowering barriers—while maintaining safety—or raising incentives for innovation, or ideally both. This section briefly discusses possibilities for reform along those lines. One other set of reforms, not discussed here, focuses on increasing the information about drug quality available to the market, aiming to harness competitive forces (Woodcock and Wosinska 2013; Price 2014b).
A. Regulatory Changes
Regulatory changes to lower barriers to innovation could come in several forms (Price 2014a). FDA could offer increased regulatory flexibility as a reward for demonstrated manufacturing excellence and deeper understanding, by, for instance, allowing more significant changes to be made with only notice rather than preapproval, modeled on the Occupational Safety and Health Administration’s Voluntary Protection Programs.
Perhaps most promisingly, FDA could create an independent pathway to validate new technologies outside the context of the NDA process. A major reason new technologies do not enter drug manufacturing is the risk of delay in getting NDAs approved. If firms could demonstrate the efficacy and advantages of a new technology outside the context of an NDA, they might be significantly more willing to devote resources to developing that technology. Perhaps more importantly, other innovators—firms with special manufacturing excellence, such as fine chemical manufacturers or food manufacturers—could develop drug-applicable technologies, get them independently approved by FDA, and then market them to drug manufacturers.
Other possibilities include devolving regulatory authority to the states or privatizing it entirely, mandating innovation through FDA’s extant but slow-moving Quality-by-Design program, or shifting requirements for deeper manufacturing understanding earlier in the drug development process to reduce the problematic effects of substantive lock-in. FDA is taking some steps to mandate quality more directly through the establishment of a unified Office of Pharmaceutical Quality. Congress acted in 2013 by passing the Drug Quality and Security Act, though this focuses primarily on compounding pharmacies and increasing the traceability of the drug supply chain and not on driving quality or innovation specifically. Each approach has potential benefits, and together they might drive sufficient innovation. It seems more likely, however, given the continuing necessity of strong regulatory oversight, that additional incentives would be required.
B. Changing Intellectual Property Through Regulation
The intellectual-property system could provide significant incentives for manufacturing process innovation but does not currently do so for the reasons described above. Rather than changing the entire system—which would have major effects on other industries—regulatory structures could change the way intellectual-property incentives function to drive drug manufacturing innovation. Alternately, FDA could operate a system of regulatory exclusivity for manufacturing innovation in parallel to the intellectual-property system.
The first scenario seeks to change the major misalignment of innovation incentives in pharmaceutical manufacturing caused by the dominance of trade secrecy over difficult-to-enforce patents. FDA could profoundly alter this dynamic by requiring that manufacturing method regulatory submissions be public disclosures. Firms could much more easily police their manufacturing patents if they could observe their competitors’ processes, and such patents would consequently be more valuable and would provide greater incentives for innovation. Other potential benefits include innovation to increase efficiency and quality, as well as increased cumulative innovation and greater overall transparency, which would ease oversight.
The change from secrecy to disclosure and transparency would be challenging to implement retrospectively, raising constitutional Takings Clause concerns and practical concerns based on prior use rights found in the America Invents Act. However, implementing a disclosure regime prospectively would be more straightforward, and, in fact, the Biologics Price Competition and Innovation Act of 2009 (BPCIA) already contains a very limited version of this idea for biologics: under the law, biosimilar applicants are required to disclose their entire application package—including manufacturing details—to the reference biologic sponsor so that the sponsor can determine which, if any, of its patents are infringed (42 USC § 262(l)). A broader regime of that nature—and one that covered not only biosimilars but all drug manufacturers—could have major systemic benefits.
The second scenario involves FDA taking a more active role in rewarding manufacturing innovation by imposing regulatory exclusivity for such innovation. FDA already does this for drug-discovery-related investments like winning drug approval, developing an orphan drug, or conducting pediatric studies. A similar approach could apply to innovative manufacturing methods, and since FDA approval is already required to implement a manufacturing method, FDA could expand this gatekeeping role to reward innovation.
Implementation concerns are significant. Principally, FDA currently lacks the institutional experience to manage the line-drawing, overlapping-innovation, and novelty concerns that are familiar in patent law but relatively absent in FDA’s current regulatory exclusivity decisions. However, FDA does already manage innovation incentives to some extent (Eisenberg 2006) and complements that experience with deep scientific expertise. In a way largely unavailable to the patent system, FDA could potentially tune rewards much more closely to innovation value, focusing innovation on the most important areas of drug manufacturing.
IV. CONCLUSION
Academic and policy studies of pharmaceutical innovation policy have, until now, missed a crucial piece of the industry puzzle: the costs and complexities of pharmaceutical manufacturing. This gap has had major practical consequences: the current combination of regulatory barriers to manufacturing innovation and poorly aligned intellectual property incentives results in immense economic and human costs.
The problem, however, is not insoluble. Discovery and development of new drugs is a paradigm area where regulation is designed to encourage innovation, and manufacturing those drugs is another target for such design, whether focused directly on regulatory hurdles or on changing intellectual-property incentives. Furthermore, such regulatory levers are not limited to the pharmaceutical industry and may be especially appropriate for substantively related industries with tight regulation, like medical devices or biomedical diagnostics. Whatever the particular solutions, actively shaping the interaction of regulatory forms and intellectual property has far-reaching implications for innovation policy.
NOTES
This chapter is based in large part on a previously published, longer treatment of these issues (Price 2014a).
1. The optimal balance between hurdles and incentives is not obvious. The classical justification for intellectual property assumes a low-regulation baseline and justifies intellectual property as necessary to incentivize the creation of public knowledge goods, the value of which is difficult for firms to capture—a low-regulation, high-IP situation. Drug development is high regulation, high IP, and nondrug manufacturing is typically low regulation, low IP; both demonstrate significant innovation. Drug manufacturing, a high-regulation, low-IP situation, shows very little innovation. Whether the classical situation is preferable to that of nondrug manufacturing or drug development is questionable, and the existence of patent thickets may suggest that the intermediate situations might be preferable.
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