Competition, Capacity & Evergreening
Time, Date, Venue
13th April 2011 12.00-13.30
University College London
1st floor Exec-ed
room, Engineering Front Building
("Malet place" in Google maps)
Abstract
Firms
in innovation-intensive industries such as the pharmaceutical industry have to
deal with patent expiration and consequent loss of monopoly position for key
blockbuster products. One strategy to beat ``patent death'' is to introduce a
vertical line extension / upgrade with a new patent, a strategy referred to as
``Evergreening''. However, the process of evergreening is fraught with
uncertainty since this new patent is subject to tight guidelines and may also
fail other approval processes (such as FDA approval in the case of
pharmaceutical products). Thus, an incumbent firm has to make an upfront
production capacity commitment without clarity on whether the upgrade will
reach the market. This uncertainty also affects the capacity commitment of a
generic entrant who introduces a clone of the incumbent's existing product
ex-post patent expiration but whose market demand depends on the success or
failure of the incumbent's upgrade. We analyze a two stage competitive game
between the incumbent and the generic manufacturer where the firms commit to
capacities before uncertainty resolution and then set prices. We find that the
minimum upgrade success probability required for an incumbent to undertake
evergreening is higher when generic competition is anticipated as opposed to a
monopolistic setting. However, upgrade success probability is typically a
decreasing function of the level of product improvement in the upgrade. We
characterize equilibrium outcomes in the context of this risk-return trade-off
faced by the incumbent. We find that the incumbent's equilibrium capacity under
competition is higher than that under monopoly for an intermediate level of
retrofit cost. The entrant's equilibrium capacity is a non-monotonic function
of the incumbent's level of product improvement. The use of evergreening always
increases equilibrium market coverage and social surplus. Further, both market
coverage and social surplus decrease as functions of product improvement in the
upgrade. This implies that a social planner interested in maximizing market
coverage or social surplus should be cautious about imposing a restriction on
incremental evergreening. Essentially, our results convey the impact of an
operational variable (capacity) on policies related to patenting and
innovation.
This is joint work with Sumit Kunnumkal & Milind Sohoni (ISB)
Biography
Ram Bala is an Assistant Professor of Operations at the Indian School of Business. He received his PhD in Management from the UCLA Anderson School of Management and Bachelors in Technology from the Indian Institute of Technology, Bombay. Professor Bala is a recipient of UCLA Graduate Division Fellowship and the Lippman Fellowship.
His research interests lie in the pricing of software and other durable goods in competitive markets, market implications of product and process change and operational analysis of the marketing function in the pharmaceutical industry.
