STRONGBRANDS    Professor Tim Calkins, Kellogg School of Management

One of the few things that most politicians in this country seem to agree on is that generic drugs are terrific and we should have more of them. FDA Commissioner Scott Gottlieb released a statement this week: “A robust pathway for generic competition is critical to expanding drug access and promoting public health.” Senator Elizabeth Warren is so committed to the idea that she is proposing that the U.S. government should start manufacturing generics.

The Appeal of Generics

It is easy to see why people like generic pharmaceuticals: they are cheap. When the patent on a typical drug expires, competitors rush to the market with identical products and prices, not surprisingly, fall. Pfizer’s atorvastatin (Lipitor), for example, lost patent protection in 2011 and is now available for only a few cents per pill.

Generic drugs make up 89% of total prescriptions in the U.S. but account for only 26% of pharmaceutical spending.

One way to reduce healthcare costs, it seems, is to simply expand generics.

The Problems

Unfortunately, generics drugs are not the easy solution that they seem to be. Even if you set aside the question of innovation and incentives, the world of generic drugs is troubled.

The core problem with generic drugs is that they generate little profit. In the U.S. market, pharmacies are allowed to quickly move from one generic manufacturer to the next. If a company making generic methylphenidate (Ritalin) raises the price a bit, pharmacies can switch to a different manufacturer and not inform the patient. The drug looks exactly the same, with the same packaging. This dynamic drives down prices and reduces profitability.

The problem is that when you reduce profitability you create all sorts of other problems. One issue is that companies don’t invest in capacity. A firm making a product with little profit won’t build new production facilities; it would not make financial sense. According to the FDA, the issue of drug shortages is getting worse. This is one of the reasons why Elizabeth Warren and others want the government to start manufacturing generics: companies trying to make a profit have no incentive.

Another issue is that firms don’t invest in patient support programs. Many drugs are complicated to take, often with challenging side-effects. Most pharma companies have robust patient support programs; if someone has a question about a particular drug, they can easily get in touch with a nurse or counselor. Some firms have apps and on-line monitoring systems, and personal connections with each patient. Generic manufacturers do not have these sorts of programs for the simple reason that there is no financial return. Why invest in a patient support program for a product with no profits?

Generic drug manufactures also don’t invest in marketing efforts, to patients or physicians. You don’t see ads for Prozac or Lipitor because there is no justification. There are no drug reps promoting simvastatin (Zocor) or alendronate (Fosamax). The result is that patients don’t request generic drugs, and physicians don’t always think of them.

Perhaps the most disturbing impact of generic drugs is that there are few clinical trials. A company isn’t going to invest in a $50 or $100 million clinical trial for a drug that has lost patent protection since there would be no possible way to recoup the investment. This is an enormous missed opportunity. Could Zoloft, Boniva, or Cymbalta have other uses? Perhaps. But we will never know.

A New Approach

The U.S. needs a new approach to generic pharmaceuticals. The high cost of new molecules gets considerable attention. Perhaps a more interesting question, however, is how best to manage older products and ensure that companies have an incentive to invest in them. Allowing companies to differentiate these products and build brands – as over-the-counter drugs like Tylenol do today – is one idea to consider.

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