Why the HIF rejected open licensing

In an exchange on the i+a listserve, I asked Professor Pogge if the decision to reject open licensing was in part because he was concerned about opposition from certain elements of the pharmaceutical industry. This was his response, shared here with permission:

Posted with permission
——- Forwarded Message ——–
From: Thomas Pogge To: James Love , iplusa

Cc: Aidan Hollis
Subject: [i+a] the Health Impact Fund
Date: Tue, 18 Nov 2008 15:10:11 -0500

In exploring reform ideas, Jamie, it seems to me reasonable to take prospects of implementation into account. The pharmaceutical industry has a lot of political influence. Other things equal, therefore, a reform proposal is improved when it is modified so that the pharmaceutical industry has less reason to oppose it.

In previous work, Aidan and I have both explored the possibility of requiring immediate open licensing as a condition of receiving health impact rewards. In long discussions we have come to the conclusion that allowing innovators to retain IP is actually the better way of specifying the Health Impact Fund. One reason is that the proposal is then less unacceptable to pharmaceutical companies and therefore more likely to be adopted. A second reason is that such companies would then be less reluctant to register a new medicine for HIF rewards (which, in our scheme, would result in the HIF paying for all registered medicines’ health impact at a lower rate). A third reason is that open licensing would typically be redundant: given the prospect of health impact rewards, the registered innovator would typically have incentives to sell the product below the price generic competition would result in. (The way we have it now, the registered innovator is required to sell below the price generic competition would result in: namely at the lowest feasible cost of manufacture and distribution. The innovator’s profits come entirely out of health impact rewards as diminished by the antecedent R&D outlays. Most innovators would in fact contract out manufacture of their medicines to generic producers who can manufacture at lower cost.) A fourth reason is that counterfeiting (drugs that don’t contain the listed ingredients) of new drugs is easier to control when the genuine item comes in only one variant. Fully appreciating these and other reasons requires bearing in mind the other features of the HIF proposal (see www.healthimpactfund.org for details). The second reason, for example, applies only because registration of products is voluntary. Proposing that registration be voluntary is again supported in part by the consideration you perhaps object to: that the proposal then has a better chance of implementation.

In conclusion, the HIF does not solve the whole problem (and we are supportive of other initiatives). The HIF may not even be part of the ideally best solution. But it would be, in the world as it is, a huge step forward by providing, at sub-generic prices, a stream of new high-impact medicines whose registrants would have strong incentives to work hard to ensure that these medicines are optimally used by patients everywhere who can benefit from them. This last point is important because price is only one of the factors now excluding poor people from access to advanced medicines.

Thomas Pogge

My response was as follows:

——– Forwarded Message ——–
From: james.love
To: Thomas Pogge
Cc: iplusa, Aidan Hollis
Subject: Re: [i+a] the Health Impact Fund
Date: Tue, 18 Nov 2008 17:58:10 -0500 (EST)

Dear Thomas,

I appreciate the note below, and particularly your candor in acknowledging
that making the proposal “less unacceptable” to the pharmaceutical
companies was one of your considerations in abandoning open licensing, as
well as your elaboration on the other reasons why you have rejected open
licensing.

. . .

At the risk of belabouring the points that I have made elsewhere, I think you are wrong about the fundamental unacceptability of open licensing. (If the rewards are large enough to attract candidates at all).

But I would explore this in a different way. If open licensing is a sticking point with big pharma, it is a sticking point for a reason. What do you think that reason is?

Jamie

Professor Aidan Hollis responded, as follows:

——- Forwarded Message ——–
From: Aidan Hollis
To: ‘James Love’
Cc: ‘Thomas Pogge’

Subject: re Open Licensing vs. Price Controls
Date: Wed, 19 Nov 2008 11:11:46 -0700

Jamie,

Once again thanks for your comments on the HIF. You asked why companies
might prefer price controls to open licensing in the context of the HIF.
There are several reasons.

1. __Inability to use low pricing to increase sales__
As I mentioned in my previous email to ip-health:

“An attractive feature of the HIF is that the firm obtaining a reward has an incentive to maximize measured health impact. That means that it may be able to earn a profit even from selling the product at or below variable cost, and requiring distributors to limit mark-ups. In general, it will be harder for the registrant to require generic licensees to sell at or below variable cost, and distributors will refuse to carry a product with limited mark-up if they can instead sell a generic version of the same product with a higher mark-up.”

Therefore, if the firm wishes to maximize its reward from health impact, price controls may be more attractive.

2. __Greater difficulty of monitoring sales __
In the case of open licensing, generics will in general be harder to monitor for the HIF, potentially leading to distortions in the rewards. If, for example, generic sales are unreported, the patentee may suffer reduced rewards. Clearly, it may also be costly for the patentee to monitor sales by generics.

3. __Greater risk of counterfeits__
Again, as I mentioned in my previous email:

“Having only a single supplier with a strong incentive to monitor sales volumes is likely to reduce the incentive and opportunity for counterfeit products to enter the supply chain.”

Here the interests of the company and the HIF coincide, since counterfeit products which do not contain the stated ingredients harm both society and the firm.

4. __Potential lost margin in low-elasticity markets__
There is also the possibility that the maximum price per unit may be above the variable cost, so that monopolist earns profits from this price-cost spread and from the rewards paid on the basis of health impact. Since the HIF would set a maximum price — and could, obviously, make an error in setting that maximum too high — it is possible that a firm could make extra profits in those circumstances, just as it might suffer a reduction in profits if the HIF set the price too low. However, given the structure of reward payments, we think that this problem is somewhat mitigated in that the firm still has an incentive to set its price *below* the maximum in locations with high price elasticity — i.e. for people without insurance — since the gains from the rewards, given the effect of increased volume on estimated health impact, could more than compensate the firm for any reduction in the price. In contrast, the firm would want to maintain price at the maximum in locations with widespread health insurance and low elasticity of demand.

5. __External patent considerations__
Companies may also prefer to maintain exclusive use of the IP when there are other reasons — outside the specific medicine being rewarded — for maintaining exclusivity. For example, suppose that a process required in the manufacture of medicine X is used also in medicine Y, but only X is registered with the HIF. The company may worry that generic companies which obtain a legitimate license for the process to be used in the manufacture of X may also use it for Y. A patentee facing this kind of concern might well decide to avoid the HIF if the HIF required licensing.

6. __Limitations on sub-licensing__
A drug company may have licensed a technology from a third party, which it uses in the formulation or manufacture of a medicine. It may not have the right to sub-license the technology to generics, or it may be more costly to obtain a license which includes the right to sub-license.

__Summary__

In other words, there are a number of reasons which may make price controls attractive to firms relative to open licensing, in the context of the HIF. These are legitimate reasons, in the sense that they are not just about exercising market power. If firms can reduce their costs, increase their sales volumes, and improve the quality of data regarding sales and usage of their medicines (to enable more accurate estimates of health impact for the purpose of determining rewards), firms will find registering their products with the HIF more attractive, relative to relying on the profits obtained from high prices. This, in turn, will enable wider access to important medicines.

Finally, let me highlight that the problem of generic competition not leading to low retail prices is not confined to developed countries. For example, p. 40 of the recent report on the Indian pharmaceutical sector by Divya Srivastava, sponsored by DFID, the problem of high retail mark-ups is noted:

“Only 3% of medicines in the Indian market do not have substitutes (ORG-IMS 2007). A McKinsey study projects that in 2015, the market will be worth $20 billion; 10% of the market will consist of patented drugs and 90% will be generic (McKinsey 2007). The high number of competitors may encourage price competition. In the current environment, however markups are not well regulated which results in high private sector retail prices. This implies that affordability will continue to be problem for low income individuals unless regulation is improved, and well designed insurance schemes are put in place.”

Firms rewarded under the HIF would have strong incentives to contract with retailers to limit their markups, and this would be much more difficult given sales by generics.

I hope that you find these answers helpful, and I ask that you forward this email to the i+a list, as I am not a member.

Best regards,
Aidan Hollis

Associate Professor
Department of Economics, University of Calgary 2500 University Dr NW
Calgary AB T2N 1N4 Canada