Investors should remember the patent cliff

WHAT IT MEANS AND WHY ITS IMPORTANT Some investors quoted in published reports foresee huge gains for such retail pharmacy chains as CVS and Walgreens, as blockbuster drugs like Pfizer’s Lipitor (atorvastatin) and Sanofi-Aventis’ and Bristol-Myers Squibb’s Plavix (clopidogrel bisulfate) come off patent and face generic competition, but they would do well to remember an important factor: the patent cliff.

(THE NEWS: Report: Drug stores may benefit from patent expiries. For the full story, click here)

The first generic company to introduce a version of a branded drug gets six months of market exclusivity, competing directly with the branded drug company. After those six months, however, the molecule will become a free-for-all, and as many as 20 or 30 other generic companies may swoop in to make their own versions. This commoditizes the drug and creates huge discounts, sometimes to such a degree that the original branded manufacturer stops making it altogether.

For pharmacy retailers, the loss of patent protection for a slew of blockbuster drugs over the next decade is a double-edged sword. It’s true that the generic versions of those products will likely spawn significantly higher profit margins, but topline sales in the pharmacy department could take a big hit as high-ticket branded drugs are replaced by much cheaper alternatives. What’s more, the profit margin spigot will face pressure in future years as the supply of patent expiries slows down.

Some industry wags are predicting that the age of the traditional blockbuster drug is already a thing of the past, as pharma companies increasingly target ever-more-specific disease states with ever-more-sophisticated approaches to molecular development -- and avoid the huge risks and costs inherent in developing major drugs via traditional methods to treat a broad spectrum of conditions. So what will replace those blockbuster revenue streams?

The likeliest source of potential growth in new-drug pharmaceutical sales, of course, will be specialty and bio-engineered medicines --provided drug retailers can shift their practice models to accommodate the complex treatment regimens, doctor-pharmacist-patient communication protocols and patient oversight procedures that specialized pharmaceutical care requires. It hardly needs to be pointed out that they’ll also have to adapt their business models to handle just-in-time deliveries of drug products that sometimes carry staggering inventory costs.

Retail pharmacies have a number of avenues by which to pursue this growing field. This could include setting up their own specialty pharmacy divisions, as CVS Caremark has, or forming partnerships with existing specialty pharmacy companies, as grocery and retail pharmacy chain Hy-Vee did with Amber Pharmacy.

In the future, however, it may not be a question of whether a drug chain or independent must adopt a strategy for competing in the specialty pharmaceutical arena, but when. Randell J. “RJ” Correia, who is VP mail service and specialty pharmacy operations for Prescription Solutions, a division of insurance giant UnitedHealth Group, foresees a continuing explosion in specialized therapeutic treatments. “Specialty pharmacy already accounts for about 20% of the drug spend for many plans, and it will probably go to over 40% by 2030,” he said early this year.

Whatever happens on the specialty front, generics will remain a huge part of the U.S. drug market. According to IMS Health, they account for 69% of prescription drugs dispensed -- but the 20% rise in profits that some investors have predicted won’t last indefinitely.