One of the books I am currently reading, when I am not frantically busy consulting on social media, new product development, competitive intelligence, strategic landscape opportunity assessments, disease overviews or even KOL market research studies, is “Negotiation Genius" by Deepak Malhotra and Max Bazerman of Harvard Business School.

They draw attention to the concept of “parasitic value creation” in the pharmaceutical industry and how this occurs when a pharmaceutical company pays a generics company to stay out of the market.  Despite the fact that the Federal Trade Commission (FTC) considers such deals illegal, there are numerous examples of this occurring.

How does it work?

Malhotra and Bazerman describe the scenario of a Pharma company with a drug earning $400M profit per year, where the introduction of a generic competitor will lower profit to $180M for the pharma company and generate $100M of profit for the generics company i.e. a combined profitability of $280M.  If the Pharma company pays the Generic company $125M to stay out of the market, both parties appear to win: the generics company receives more profit than it would have with competition and the Pharma company obtains profits of $400M less $125M i.e. $275M which is more than the $180M it would have received in competition with the generic.

It appears to be the perfect business solution on paper i.e. by working together the companies have maintained a $400M market rather than reduced it to a $280M one.  Anyone familiar with the prisoner’s dilemma in negotiating strategy will know that co-operation has the maximum payoff in game theory.

However, Malhotra and Bazerman ask the question where does the $120M in value that was “created” by co-operation come from ? The answer is that it is generated from the consumers who must now continue to pay more for the drug than they would if a generic was available.  They argue that there has been no value creation only a transfer of value from consumers to producers, therefore it is “parasitic value creation.”

The above might just be interesting negotiation theory were it not for the fact there are numerous apparent deals between generics companies and pharmaceutical companies where payments are made to delay the introduction of generics.  The FTC considers “pay for delay” agreements to be an unreasonable restraint of trade that attempts to monopolize the market, and has brought antitrust law suits against companies, with mixed success.

The idea of formally banning “pay to delay” agreements has been discussed as part of the current health care reform.  The FTC estimates that stopping this would save consumers $3.5B per year. 

Of the $35 billion in savings over ten years, $12 billion would be savings to the Federal government, not an insignificant amount.

It is hard to consider pharmaceutical companies as being “ethical” when parasitic value creation through “pay to delay” occurs, yet like baseball players with steroids, there is always going to be pressure to “cheat” if others are doing it and apparently getting away with it.  It will be interesting to watch the ongoing health care reform debate to see if "pay to delay" is addressed as part of it.

Do you believe these deals are fair game and ethical, or not?

 Generics: “Pay for Delay” is parasitic value creation