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.