How Companies can Preserve Market Dominance after Patents Expire

Abstract

Patents provide market protection for companies that invent a process or product and therefore they influence financial success. When patents expire however the profit streams can run dry as rival companies introduce their own, often cheaper, versions. This paper describes how companies with patents can forestall the impact of such competition and extend the profitability of the product or process. It discusses the nature of patent protection and identifies three options that are open to companies looking to put a pre-expiration strategy into place: pre-emptively launching a generic product; layering innovations; and creating line extensions. The author illustrates these strategies with examples from three sectors that rely on innovation: the pharmaceutical, semiconductor and software industries.

Full text

How Companies can Preserve
Market Dominance after
Patents Expire
John A. Pearce II
Patents provide market protection for companies that invent a process or product and
therefore they influence financial success. When patents expire however the profit streams
can run dry as rival companies introduce their own, often cheaper, versions. This paper
describes how companies with patents can forestall the impact of such competition and
extend the profitability of the product or process. It discusses the nature of patent
protection and identifies three options that are open to companies looking to put a
pre-expiration strategy into place: pre-emptively launching a generic product; layering
innovations; and creating line extensions. The author illustrates these strategies with
examples from three sectors that rely on innovation: the pharmaceutical, semiconductor
and software industries.
Ó2005 Elsevier Ltd. All rights reserved.
Introduction
When patents expire
A patent is a strong protector. It permits a company to enjoy a period of limited competition and
profit from its monopoly of a particular product. It also prevents competitors from marketing exact
copies of a patented product. When a patent expires, however, lower-priced versions of the item can
be introduced by rivals. In the first year alone after the patent on a product expires, an average of
17.2 producers enter the market, according to research on 18 industries.
1
This increases to 25.1 after
two years. The principal consequences for the company that formerly held the patent are that its
product loses market share and profitability in a very brief period.
Fortunately, for any company that is about to see a patent expire, strategists have created options
to forestall the company’s loss of profits. This article will discuss three types of strategies that can
provide such a competitive advantage.
Long Range Planning 39 (2006) 71e87 www.lrpjournal.com
0024-6301/$ - see front matter Ó2005 Elsevier Ltd. All rights reserved.
doi:10.1016/j.lrp.2005.04.006

The first type of pre-expiration strategy is the ‘pre-emptive launch of a generic’. This is the release
of a generic eor mimicked eversion of the product before the patent expires. The second type of
pre-expiration strategy is ‘layering innovations’. This occurs when the original patent holder is
granted additional patents for improvements to the base product. In essence, the company makes
its own product obsolete by touting an upgraded version and therefore extends its monopolistic
profit stream.
The third type of pre-expiration strategy is line extension. This calls for the patent holder to add
markets for the patented idea by finding new ways to employ it. Drugs that can be patented for use
in the treatment of additional diseases, semiconductors that can be patented for use in new
applications and software that can be modified and patented to incorporate additional features are
all examples of line extensions.
To illustrate the value and broad potential of these three types of strategies, this article presents
each option accompanied by recent high-profile examples of its successful implementation. The
pharmaceutical, semiconductor and software industries were selected to provide the examples
because in these sectors patent protection is critical to profitability, renewal and continued growth,
and because the efforts of competitors in these industries to pre-empt generic substitution have
often been creative, aggressive and successful.
The nature of patent protection
Patents confer the right to exclude all but the patent holder from making, using, offering for sale
and selling an invention.
2
This right protects companies from direct competition on any new
process, machine, manufacture, composition of matter or innovation. To qualify for a patent, the
invention must meet the criteria of novelty and usefulness, and must not be obvious. In the US,
patents provide protection for 17 years from the date the application was filed. Other countries have
their own patent processes with protected periods varying from 10 to 20 years.
Patent infringement occurs when a competitor’s product violates the patent protection without
permission of the patent holder. When this happens, the patent holder may use the court system to
request an injunction that stops the competitor and allows it to claim damages. Patent infringement
is a major source of international conflict. While most nations have patent laws, their enforcement
varies widely despite international agreements to prevent the theft of intellectual property rights.
3
Research suggests that patent violations by Asian companies cost US pharmaceutical companies
more than $500m a year and computer software companies more than $6bn.
4
Global software
piracy is estimated at more than $15.2bn in lost revenues.
5
When the protection offered by a patent expires, the entry of low-priced
generic competition poses new challenges for the patent holder
When the protection offered by a patent expires, the entry of low-priced generic competition
poses new challenges for the patent holder. Generics are characteristically offered at significantly
lower prices because their manufacturers have not incurred the high costs of research and
development and marketing that are associated with the initial introduction of a product. Because
of their price advantage and comparable performance, generics quickly gain market share at the
expense of the original product. Consequently, when the patent on a product expires, the revenues
from that product rapidly deteriorate.
Pre-expiration strategies in the pharmaceutical industry
Competition from generics
Generic drugs are the bioequivalents to brand-name products. They must meet the same standards
for purity and strength as the branded products they imitate. Pharmaceutical companies that
72 How Companies can Preserve Market Dominance after Patents Expire

specialise in generic products enter the market only after their generic versions receive approval by
the Food and Drug Administration (FDA) and after patents on the brand-name product expires.
The first generic product approved receives 180 days of marketing exclusivity, during when no
other generic producers may enter the market. Production of generic pharmaceuticals appeals to
companies because they quickly capture a large share of established markets.
Delaying the introduction of a generic product by even a day can mean millions in profits for
a pharmaceutical company with a brand-name drug monopoly. The patents on 21 best-selling
drugs with annual US sales of $20bn will expire over the next five years. On average, the losses for
each of the originators of the drugs will be $2.6m per day. Overall, between 2003 and 2005, patents
will expire on 200 drugs that generate more than $30bn in annual sales. These blockbuster drugs
include the world’s best-selling ulcer medicine Prilosec and the allergy drug Claritin.
6
Growth in the generic share of the global pharmaceuticals market also increases the benefits of
entry. Between 1984 and 2002, the generic share of prescription units grew from 19 per cent to 47
per cent.
7
The global market for all drugs also is expanding at 8 per cent annually which further
encourages competitors to enter after patent expiration.
8
Given the tremendous sales and profit potential of being the first generics company to market,
these companies have turned to patent scrutiny as a main way to gain market access. If a generic
manufacturer can find an error, misrepresentation, omission or inconsistency in the patent, the
FDA may find the patent null and void and truncate the patent’s life. Furthermore, as attacks on
a chemical-composition patent rarely succeed, most generics attack the brand companies’ process
patents.
9
Searching for deficiencies in drug patents thus rivals the creation of branded drugs
bioequivalents as the generic industry’s primary approach to R&D.
Waxman-Hatch and pre-expiration
Until the mid-1980s, most drug companies retained their monopoly position long after their US
patents had expired. Except in the case of extremely popular drugs with great profit potential, the
cost to generic companies of duplicating the patent holder’s original research and development
efforts was considered too great to justify the financial returns.
However, when the Drug Price Competition and Patent Restoration Act, also known as
Waxman-Hatch Act, was passed in 1984, the regulatory barriers to generic drug companies were
greatly reduced. Specifically, generics companies need only to replicate already invented chemical
molecules and to pass a bioavailability test, which measures the level of the drug in the human body
over time but not its effects. As a result, the average cost of gaining a patent for a generics company
was reduced to approximately 1/18
th
as much as for the brand-name pharmaceutical companies
that spend 16 per cent of their total revenue on R&D.
10
Thus, with the greatly reduced entry
barriers, a proliferation of new, more active generics companies succeeded in capturing market
share from patent holders. Generic drugs represented 55 per cent of overall pharmaceutical sales in
2004, compared with 19 per cent in the year that preceded Waxman-Hatch.
Waxman-Hatch also provided for the creation of an expedited approval process for generic drugs
known as the ‘abbreviated new drug application’, or ANDA. The process allowed generic
manufacturers to bypass safety and efficacy testing if their drug had the same effect in the human
body as the brand-name drug, i.e., bioequivalence. Generics companies were further allowed to take
the test by using the exact same health and safety data that had been submitted with the brand-
name company’s original application for FDA approval.
With its ANDA application, a generic company can also announce its intention to go to market
with its drug before the brand company’s patent expires, by asserting that the patent is invalid or
that the generic version does not infringe on any existing patent, known as a Paragraph IV
Certification. According to a 2002 FTC study, Paragraph IV certifications appeared on just 2 per
cent of generic drug applications in the 1980s and 12 per cent in 1990-1997, but jumped to 20 per
cent from 1998 to 2000. There are currently more than 200 drug-patent challenges carrying
Paragraph IV assertions that are included almost routinely to claim the 180-day exclusivity over
Long Range Planning, vol 39 2006 73

other generic manufacturers. According to research by Wachovia Securities, Paragraph IV
challengers win in court about 80 per cent of the time.
Waxman-Hatch also addressed a major complaint of brand-name pharmaceutical companies.
‘Big pharma’ had objected to the fact that their patents had a reduced useful life due to the approval
process required by the FDA before the product can enter the market. The patent on a product is in
effect throughout the entire approval process, thereby reducing the time a product is exclusively
marketable. Instead of 17 years of sales, brand-name drugs have an average of 11.4 years on the
market under patent protection.
11
To respond to this complaint, Waxman-Hatch added a provision
that allowed for short extensions of patent protection when company sales are delayed by the FDA
approval process. This full period of monopolistic protection was justified by the government to
allow the patent holder to profitably recoup the $100m R&D investment that is incurred on average
by the innovating company in producing a new drug.
The patent on a product is in effect throughout the entire approval
process, thereby reducing the time a product is exclusively marketable
Imitation erodes innovator’s profits
Once a brand-name manufacturer loses patent protection for a profitable and popular product,
generic substitutes will almost certainly capture the majority of the market because they are
typically priced 25-70 per cent lower than their brand-name equivalents.
12
Thus, the ‘lost’ revenues
for the brand-name drug companies are substantial.
The experience of Bristol-Meyers Squibb typifies the dramatic impact that generic products can
have on competition after a patent expires. BMS’s medication Glucophage had sales of more than
$2bn in 2001 before its patent expired in January 2002. One month later, more than 85 per cent of
that drug’s market share had been taken by generic alternatives.
13
Pre-expiration strategy number 1: pre-emptive launch of a generic
To combat such ‘losses’ of revenue, a drug company may seek to optimise its profits by introducing
its own generic before its drug’s patent expires. This is often called an ‘authorised generic’. Using
this strategy, the branded pharmaceutical company gives permission to a preferred generic
company, or its own generic subsidiary, to sell and possibly to manufacture an ‘authorised’ version
of the drug. This authorised generic is then launched on the same day as the first generic
competitor, thereby effectively eliminating the 180 days of marketing exclusivity provided by
Waxman-Hatch to the first successful challenger of the patent. The strategy has a similar depressing
effect on the first provider of the drug as a post-patent generic. At best, the generic competitor sees
its proceeds halved when the original patent holder authorises a generic version. The plan of the
patent holder is to trade some short-term profit maximisation for net gain in the longer-term.
14
Brand-name pharmaceutical companies have a rational basis for such optimisation strategies that
can be shown schematically, as illustrated in Graph 1.
15
The area OABD represents the profit over
time that will be obtained by the brand-name company during the patent protection period. When
the patent expires, profits drop drastically. They are represented schematically to be a function that
reduces to zero (DCZ). However, if the company introduces a generic form of its drug before the
patent expires (time Y, point X), then the company’s profits over time will be represented as area
OAWXZ. Thus, if the patent-protected revenues of YWBD are estimated to be less than the generic
revenues of YXZ, the brand-name company will introduce a generic form of the drug before the
patent expires.
Notice the line XZ. Although it appears as a straight line, it is actually a downward step function.
The height and length of each step is determined principally by the price and duration of the pre-
patent expiration contracts that the brand-name pharmaceutical company can secure with its
74 How Companies can Preserve Market Dominance after Patents Expire

largest customers. A generic substitution strategy enables the patent holder to increase its overall
profits at the expense of generic companies and may even dissuade generic manufacturers from
entering the market.
Brand-name pharmaceutical companies also have the unique ability to market a generic version
of a patented brand-name drug before the patent expires. They approach customers with an offer to
supply a generic version of their own patented drug at a substantial price reduction for a contract
period that extends beyond the patent expiration date. Customers are attracted because such
contracts make irrelevant any concerns that they have about the availability or quality of a generic
substitute. Despite forfeiting short-term revenue from the loss of monopolistic profits, the brand-
name company is also pleased. It ‘locks in’ customers at a higher-than-generic price for a set period
following patent expiration when the likely alternative is to lose customers altogether. Brand-name
companies undertake this end-game strategy, known as pre-expiration generic manufacturing,
during the final years of their FDA monopoly protection.
Brand-name pharmaceutical companies have the unique ability to
market a generic version of a patented drug before the patent expires
For example, Upjohn succeeded in maintaining control of 90 per cent of the generic market for
its patented drug Xanax by introducing its own generic over-the-counter version one month before
the Xanax patent expired.
16
Upjohn was aware that it is a common practice among pharmacies to
stock the first generic substitute that becomes available and to stay with that generic even when
a second one is released. Effectively, Upjohn traded one month of sales at its high patent drug price
for years of generic drug sales at 90 per cent of its previous level, albeit at a substantially reduced
price. Syntex had success with a near-identical strategy by introducing its own generic version of its
patented drug Naproysn two months before the patent expired. In this case, however, the results for
the company were less spectacular because, after only a few months of competition, generic prices
dropped to only 10 per cent of those of Naproysn.
An authorised generic also makes sense from the perspective of the theory of complementary
assets. A patent holder and an independent generic manufacturer can share two benefits from an
exchange of capabilities: the preservation of the pharmaceutical company’s market power and the
avoidance of duplication costs, specifically those associated with manufacturing, marketing and
distributing a generic.
17
Branded companies generally regard their production facilities as far too
valuable in the manufacturing of high margin patented drugs to commit them to generics.
Decision rule: If the patent-protected revenues of YWBD are estimated to be less than
the generic revenues of YXZ, the brand-name company will introduce a generic form
of the dru
g
before the
p
atent ex
p
iration.
Graph 1. Assessing the Relative Merits of Generic Introduction Prior to Patent Expiration
Long Range Planning, vol 39 2006 75

Symbiotically, generics manufacturers, which commonly have excess production capacity awaiting
the release of drugs from patent protection, pin their survival on access to the markets that
the branded companies have controlled. By partnering to produce an authorised generic, the
complementary assets of branded and generics companies can be deployed for mutual benefit.
Research shows that the pre-expiration generic manufacturing strategy enjoys international
popularity.
18
The reason was expressed in a summary of the collective analysis: ‘Early introduction
of the generic product definitely benefits the patentee by raising its profits both before and after the
patent on the brand-name product expires ...’
19
Apparently concurring with this conclusion, several
pharmaceutical companies have elected to pursue strategies that include active participation in the
generics market. They include American Home Products that competes through its Lederle
Laboratories; Bayer through its 28 per cent share of Schein Pharmaceuticals; Novartis through its
Azupharma and Geneva Pharmaceuticals; and Schering-Plough through its Warrick Pharmaceuticals.
Pre-expiration strategy number 2: layering innovations
The second pre-expiration strategy of pharmaceutical manufacturers involves layering patents one
upon another by patenting innovations on a base product to maintain an exclusive market position.
The result is an enhanced product that enjoys a monopoly market guaranteed by additional grants
of patent exclusivity. In addition to patent protection, the FDA also grants periods of additional
marketing exclusivity in recognition of significant innovations to an already patented product,
including alterations in active ingredients, strength, dosage form, route of administration or
conditions of use. Other forms of patentable innovation involve alternative delivery methods for
a drug, such as offering a tablet, a time-release capsule, an injectable or an ointment as a substitute
for an original patented capsule. In any event, a significant innovation requires new clinical studies
to gain FDA approval.
FDA exclusivity periods range from six months to seven years, but all have the same effect in that
no generic drugs can be approved during the protected timespam. For example, in 1996, Astra
Zeneca obtained three years of exclusivity based on the patenting of a preservative added to the
drug Diprivan. This exclusivity was granted as the patent protection on Diprivan expired and
delayed the approval of a generic version submitted by Sicor.
20
Manufacturers of brand-name pharmaceuticals have one more special extension option available
to them. Since 1998, the Department of Health and Human Services has given makers of more than
two dozen brand-name drugs an extra six months of market exclusivity as an incentive for them to
conduct clinical trials to determine how well their medicines work in children. Pediatric clinical
trials typically cost the patent holder several million dollars, but can protect many millions of
dollars in additional sales, as is the case with the ulcer drug Prilosec which earns $11m a day under
extended patent protection for AstraZeneca, the patent holder.
Pre-expiration strategy number 3: line extensions
Another strategy for pharmaceutical companies is to promote revised versions of the original drugs
through line extensions. The goal is to switch current users to a new version of the drug before
generic introductions of the old versions can appear on the market. Eli Lilly reduced its losses from
the patent expiration on Prozac by getting FDA approval for Sarafem, which is a new name for
fluoxetine, the active chemical in Prozac. Sarafem is used in the treatment of a severe form of PMS.
Likewise, Merck’s prostate drug Proscar was approved by the FDA to help hair loss in men, under
the name Propecia. GlaxoSmithKline’s anti-depressant Wellbutrin was given the additional name,
Zyban, and marketed as a medication to help stop smoking.
One reason for the popularity of line extensions is that they enable the brand-name manufacturer
to create ‘customer pull’ for the product. Through aggressive advertising and free sampling to
prospective customers, pharmaceutical companies can prompt customers to ask their physicians to
request drugs by brand-name. For example, free samples were used to supplement ad campaigns
for Bristol-Myers Squibb’s Glucophage XR. Three months after the sampling was begun, nearly
35 per cent of the prescriptions written were for the line extension. Shortly thereafter, AstraZeneca
76 How Companies can Preserve Market Dominance after Patents Expire

offered a one-week free trial of Nexium and Eli Lilly gave away a one-month trial of Prozac Weekly
with similar success.
Through aggressive advertising and free sampling, pharmaceutical
companies can prompt customers to request drugs by brand-name
In 2002, Forest Labs abandoned its antidepressant drug Celexa, even though it had two years of
patent protection remaining. Its 2,300 sales representatives were retrained to promote Lexapro,
which is nearly identical in chemical composition to Celexa. In its first six months on the market,
Lexapro grabbed 10 per cent of the $8bn antidepressant market. Lexapro is a ‘me-too’ drug, i.e.,
a slight modification on an existing drug that allows its maker to seek a new commercial patent to
replace sales lost when the initial patent expires.
21
This highly successful strategy of Forest Labs was
different from one that involves the layering of patents because the intent was not to extend the
lifecycle of the base product but rather to replace the original with a ‘new’ drug that would begin its
own lifecycle.
Schering-Plough used an identical strategy. In early 2002, it made enough tweaks to the chemical
composition of Claritin, the company’s $1.8bn prescription antihistamine drug for allergy relief, to
secure a patent for a new drug. Called Clarinex, the new product was introduced because Schering-
Plough’s patent on Claritin expired later in the year, which would have opened it to attack from
cheaper, generic rivals.
22
Drug makers do not need to prove that lookalike drugs are more effective
than their predecessors to gain a patent. The FDA simply compares the effectiveness and side effects
of a drug to a placebo, not to other drugs.
In 2001, AstraZeneca also found success with the strategy when it launched Nexium, a
reformulated version of its top-selling ulcer medication Prilosec, just bfore Prilosec’s patent
expired. The company even gave Nexium the same nickname that it had used to market Prilosec e
‘the purple pill’. Other major pharmaceutical companies that forgo generics competition to
concentrate on expanding their lines of patentable drugs include Bristol-Myers Squibb, Hoescht,
E.I. du Pont de Nemours, Merck and Warner-Lambert.
In an interesting twist on line extensions, holders of expiring patents can apply to the FDA for
approval to make new claims that help reposition a familiar drug. This tactic worked for Bristol-
Myers Squibb when it repositioned Excedrin as Excedrin Migraine and for J&J/McNeil when
Motrin was promoted as Motrin Migraine Pain. These additional benefits were acknowledged by
the FDA, despite the fact that the active ingredients in both products remained the same.
Pre-expiration strategies can breach legal limits
Brand-name and generics manufacturers occasionally breech legal limits in their creative efforts to
lengthen their product lifecycles ebrand-name companies when trying to extend their patent
protections and generics companies when trying to shorten the lives of those same patents so that
they can introduce their bioequivalents to market as soon as possible. In fact, situations have arisen
when previously untried variants of strategies are found by the FDA to exceed its rules. Elicit
partnerships, artificial entry barriers, procedural delays and data games are four strategies that have
occasionally landed their implementers in costly trouble.
Elicit partnerships. In December 2003, six months before the patent expiry on Bayer’s antibiotic
Cipro (ciprofloxacin hydrochloride), generic drugs manufacturer Barr Laboratories announced
that it would begin to distribute ciprofloxacin products under licence from Bayer. Ciprofloxacin is
principally used to treat urinary tract infections and competes in a market with $1.1bn in annual sales.
The licence was granted by Bayer as part of a settlement of a patent challenge that Barr initiated
against Bayer’s Cipro. Barr, a specialty pharmaceutical company that engages in the development,
manufacture and marketing of generic and proprietary pharmaceuticals, challenged the Bayer
patent. Under the terms of the agreement, Barr purchases ciprofloxacin products from Bayer, which
Long Range Planning, vol 39 2006 77

it markets under the Barr label. At the time, Bayer also announced its plan to seek pediatric
exclusivity for Cipro, which, if granted, would delay the introduction of generic versions for six
months into 2004. However, Barr and Bayer also negotiated an agreement to allow Barr to continue
distributing ciprofloxacin products during Bayer’s pediatric exclusivity period for Cipro.
In a second example, generic drug manufacturer Geneva Pharmaceuticals filed an ANDA with
the FDA and was awarded the standard 180-day exclusive right to market a generic capsule version
of Abbott Laboratories’ high blood pressure drug, known as Hytrin. Then, according to the FTC,
Geneva approached Abbott Laboratories and offered to refrain from introducing its version of
Hytrin if Abbott agreed to pay the generics company $4.5m per month. This amount was calculated
as being between what Geneva forecast its monthly profits to be from the generic sales and the
amount that Abbott expected to lose in sales to a generic. The two companies reached an agreement
that they attempted to conceal within other pending patent-infringement litigation. The FTC
charges were settled without either company admitting any wrongdoing. Undeterred, other
exploitative partnerships have formed, even though they are illegal in the view of the FTC. For
example, Schering-Plough, maker of the top-selling prescription potassium chloride supplement
K-Dur 20, paid American Home Products and Upsher-Smith Laboratories to delay generic
launches.
Artificial entry barriers. According to the FTC, generic-drug manufacturer Mylan Laboratories
conspired with three chemical suppliers to deprive Mylan competitors from obtaining the
ingredients necessary to manufacture generic versions of the anti-anxiety drugs clorazepate and
lorazepam. With its competitors unable to find supplies to produce the drugs that they had been
FDA approved to manufacture, Mylan was the only active generic producer. Mylan then raised the
wholesale price of clorazepate by 3300 per cent. Two months later, Mylan raised the wholesale price
of lorazepam by 2600 per cent. Before the cost increases were halted by the FTC, the arrangement
cost consumers more than $120m. In the largest monetary settlement in FTC history, Mylan denied
any wrongdoing but agreed to pay $147m in compensatory and legal damages.
Procedural delays. One delay tactic used by holders of expiring drug patents to keep generics at
bay involves the FDA’s ‘citizen petition’. This permits any interested person to petition the FDA to
issue, amend or revoke a regulation or order, or to take or refrain from taking any other form of
administrative action. It is intended to give any interested person, from health professionals to
patients, a voice on agency actions, including pointing out possible deficiencies in generic products.
When a citizen petition is filed, the FDA places a hold on approval of the generic while it
investigates the complaint. The problem is that brand-name drug companies are the source of many
of the petitions that are filed, the vast majority of which are ultimately rejected as baseless.
Nevertheless, citizen petition provide patent holders with another weapon to inhibit generic
competition.
A second procedural delay tactic was spawned by the administrative procedures of an ANDA.
After an ANDA has been submitted, the patent holder has 45 days to sue the generic manufacturer
for patent infringement. Filing a lawsuit stays the FDA’s approval of the ANDA until the date the
patents expire, a court rules that the patent is invalid or that it is not infringed, or 30 months from
the date of the Paragraph IV certification has passed, whichever occurs first.
As a tactic for counterattacking the generics companies once an ANDA was filed, the patent
holder sues within the requisite 45-day period triggering a 30-month stay, and then submits an
additional patent application on the drug with the FDA, based on a change formulation,
manufacturing process or drug use. The generic company then must modify its ANDA, the brand-
name company is notified again, a new suit is filed by the generics company and an additional
30-month stay begins. SmithKlineBeecham obtained five 30-month stays for Paxil, its depression
treatment, each related to a different new patent listed after the initial filing.
Data games. In 2003, generics manufacturer Ivax Corporation attacked Eli Lilly’s patent on
Zyprexa, its antipsychotic drug with $4bn a year in sales, which was not set to expire until 2011.
Ivax’s claim is that Lilly killed a laboratory dog in order to mislead patent examiners on the effects
of its drug.
23
78 How Companies can Preserve Market Dominance after Patents Expire

Lilly’s patent request in 1992 had initially been rejected on the grounds that Zyprexa was
insufficiently unique from another of its drugs. To prove to the patent office that Zyprexa was
different, Lilly tested its two drugs in dogs. Lilly sought to collect evidence that Zyprexa could treat
schizophrenia without raising blood cholesterol levels as its earlier drug had done. Lilly’s research
results were favourable and it received the new patent.
However, in its patent challenge, Ivax claims that Lilly presented misleading information on its
study by eliminating one of the research animals. To study the difference in cholesterol levels, Lilly
compared two small groups of beagle dogs by giving one group Zyprexa and the other group the
old drug. Although the data reported to the patent examiner showed that the dogs on the old drug
had higher levels of cholesterol, Ivax found that Lilly had destroyed one particular dog in the new
drug group. Lilly says that the dog was killed because it developed an infection. Maybe so, replies
Ivax, but that dog also had the highest cholesterol levels in the study. Had she been allowed to live,
Ivax charges, her cholesterol data would have invalidated the Lilly claim that Zyprexa could treat
schizophrenia without raising blood cholesterol levels. In the filing documents, it came to light that
the original patent examiner had not been given these details of the study.
Lilly defended its patent on Zyprexa and its actions by arguing that the details concerning Dog
240712 were not relevant to its claims on the drug and that they represented only a fraction of the
evidence that was germane to the litigation. In late March 2005, the U.S. Food and Drug
Administration gave approval to Teva Pharmaceutical and Mylan Laboratories to sell generic
versions of Lilly’s bestselling drug Zyprexa should Eli Lilly lose the ongoing federal patent lawsuit.
However, on April 14, 2005, a U.S. District Court federal judge ruled in favor of Eli Lilly by
finding that the company’s patent on Zyprexa was valid. The complainants’ charges that Lilly’s
discovery of the drug’s molecular structure was obvious, that it was previously patented by Lilly and
that Lilly misled the patent office by omitting unfavorable test results when applying for the patent
were all dismissed.
Congressional attention. When the US Congress established the Waxman-Hatch Act of 1984,
it recognised that pharmaceutical companies and generics manufacturers would continue to ‘push
the envelope’ in efforts to gain advantage in patent law. Therefore, in 2003, the Medicare
Modernisation Act was passed to amend Waxman-Hatch by closing some loopholes and trying to
further prevent anticompetitive actions, especially stalling tactics based on legal manipulations.
The financial value of pre-expiration strategies
The value of a pre-expiration strategy depends on the size of the extended income stream from
keeping a drug at or near a patent-level price minus the cost of implementation. The projected costs
of a pre-expiration strategy vary with the nature of the strategy and the competitive contexts.
However, crude estimates are possible using the costly pharmaceutical industry as the example.
Cost estimates for the development of a drug vary substantially. For example, the pharmaceutical
industry’s estimate for 2001 of $800m cost per drug brought to market seems accurate when the
drug is based on a truly new molecular entity.
24
However, the public interest group Public Citizen is
also accurate when it finds that the costs are only $400m when a brand company develops a ‘me-too’
drug, such as the Type 2 (layering innovations) pre-expiration strategy discussed above.
25
Clearly, it is in the financial best interest of the patent holder to extend
a drug’s market dominance for as long as possible
Profits for the patent holder from the continued viability of a post-expiration drug at prices
usually reserved for monopoly positioned products are easier to estimate. Schering-Plough’s
Claritin made $3bn per year before its patent expired in 2001; Neurontin, an epilepsy drug made by
Pfizer, had $2.2bn in sales in 2003, its last year under patent; and Celebrex, Pfizer’s acute pain
medication, brought in $1.88bn in sales in 2003. The average of these three drugs was more than
Long Range Planning, vol 39 2006 79

$19.6m in sales per month. Clearly, it is in the financial best interest of the patent holder to extend
a drug’s market dominance for as long as possible.
Pre-expiration strategies in the semiconductor industry
Patents are granted in the semiconductor industry on new technology materials, on the processes
used to develop them and on the associated products in which they are used. Patents provide the
holder with protection from imitation and thereby help the company secure a sustainable
competitive advantage, as discussed in the Exhibit (below). However, in most segments of the
semiconductor industry, innovation occurs at such a rapid rate that creating a new material, process
or product is no more expensive that imitating a competitor’s existing one, thereby rendering
a patent less valuable in the sense that its useful life is truncated by the successful R&D of
competitors. Research has confirmed the value of this logic.
26
One early study even concluded that
the pharmaceutical and semiconductor industries were near the opposite ends of a continuum on
which the value of patents might be measured.
27
Patents in the semiconductor industry provide the
basis for an important competitive advantage, albeit short-lived.
Pre-expiration strategy number 1: pre-emptive launch of a generic
The semiconductor industry puts an unusual twist on the idea of a generic. A semiconductor
manufacturer will occasionally commoditise its own patented product to ‘free’ its prime promotion
space for use in supporting and advancing a new and competing product.
For example, two months before the holiday season in 2003, Intel reduced the price of its
Pentium 4 desktop chips between 7 per cent and 35 per cent, paving the way for the Pentium 4
Extreme Edition, a newly-patented version of the Pentium 4 with 2MB of performance-enhancing
cache.
28
The company is pushing the Pentium 4 to replace the Pentium III in the market. This time,
as usual, Intel’s price reductions followed a step pattern and signal a new product introduction
strategy. When the company cuts prices, the highest-priced chip takes on the price of the second
most powerful chip, and so on down the steps of its complete product line. Reduced prices are
a signal that R&D on the product has been abandoned and that promotion of the product will be
Exhibit.
The criticality of patents in creating competitive advantage
Innovation creates new, company-specific resource combinations that the company can use
to generate competitive advantage.
44
This advantage is sustained through the ongoing
efforts of the company to revitalise existing or create additional new products, services and
processes that provide greater efficiency or effectiveness, thereby reducing costs or otherwise
improving performance.
45
A company’s competitive advantage depends on its ability to protect its innovations from
being imitated by competitors.
46
Thus, a sustainable competitive advantage depends on
creating products and processes that are difficult to replicate, commonly by obtaining
patents or copyrights that exclude competitive companies from making, using or selling the
innovation.
47
However, even patents and copyrights can provide weak forms of protection. The
shortcoming stems from the fact that the detailed information provided by the innovator on
patent and copyright applications is publicly available. This information allows competitors to
innovate around the government-engineered barriers and enter the market. Alternatively,
rivals can legally attack the substance of the application in the hope of having the patent or
copyright voided. When either of these efforts is successful, the competitive advantage
generated by an innovation may be sharply limited.
80 How Companies can Preserve Market Dominance after Patents Expire

substantially reduced. While such demoted products are not true generics, their place in the
company’s product hierarchy relegates them to near-generic status, since they are dramatically
more vulnerable to price competition and direct challenges from other manufacturers.
Intel’s price cuts also have an intended ripple effect on the rest of its industry. AMD, Intel’s main
competitor, is well known to match all Intel price cuts one day after they are announced, and
other competitors are forced to follow. Additionally, when Intel’s timing is good, as in this case, its
competitors are left without a new premier product to present to the market, thereby helping Intel
to secure an exclusive, if not monopolistic, competitive position.
Pre-expiration strategy number 2: layering innovations
Layering patents on core products is a proven strategy in the semiconductor industry. For example,
Xyron Semiconductor’s main product is its Core Optimiser technology, which greatly increases the
efficiency of microprocessors and system-on-chip designs.
29
Xyron received its core US patent in
1999 and was market-viable when it received its second patent on the core product in 2002. The
technology consists of a circuit that moves the task of data processing management from
a microprocessor directly on to the silicon itself, thus freeing capacity on the microprocessor for
data processing. Xyron both licenses its patented technology and offers its own proprietary
microprocessors for specific industry applications.
A second layering approach in the industry is accomplished by the acquiring of patents held by
other companies to enable the modification of an existing product or process before seeking a new
core patent. Nanotechnology start-up Nanosys is a good example.
30
The company is working on the
development and commercialisation of nanocomposite solar cell technology with the initial launch
of its products scheduled for release in 2006. To accomplish its goals, the company has accumulated
120 patents through internal development and licensing in the broad field of inorganic semi-
conductor nanomaterials. The company’s plan is to leverage processes from other industries and
apply them to their own.
Pre-expiration strategy number 3: semiconductor line extensions
Patenting a product or process innovation for a new application is a popular strategy in the
semiconductor industry and constitutes a line extension. For example, in 2002, Matsushita Electric
Industrial captured 50 per cent of the global DVD recorder market, 30 per cent of the global sales of
large-screen plasma-display TVs and became a global player in cellular camera phone handsets.
31
Matsushita’s competitive advantage is derived from patenting products and semiconductors and
other devices that go into them. Central to this strategy are line extensions. By paring compatible,
patented-product technology, Matsushita is able to produce attractive multi-tasking hybrids,
including internet-ready handsets and the Diga DVD recorder, which allows a viewer to watch the
beginning of a recorded programme even while the DVD is recording the end.
Pre-expiration strategies in the software industry
In the 1980s, patents on software were virtually unknown. But since the 1990s, patents on software
have been commonly awarded for innovative software technologies. The change has resulted from
the recognition of how critical patent protection is in enabling companies to recoup their in-
vestments in innovation:
Software patents represent a new horizon in the ongoing process of mapping the boundaries of
intellectual property.Like any other economic activity, software development must be viewed in
terms of costs, risks, incentives, rewards and property rights.
32
Patents are granted on new software technology, innovations to existing software products and to
software that does a job previously performed manually. Patent protection shields a company from
having competitors copy the algorithms that allow the program to function. Therefore, if a
competitor desires to enter a market with software that performs the same function as a patented
Long Range Planning, vol 39 2006 81

product, the entrant must design an original program. However, patents are very limited in scope
and a small variation may enable a copycat to avoid infringement.
Even when patent protection is effective, the dramatic rate of innovation in high revenue software
segments often results in patents that protect products past their obsolescence. When needed,
however, the three pre-expiration strategies that benefited pharmaceuticals patent holders can also
be utilised to forestall software imitators. Imitators that follow the lead of innovator companies have
the inherent advantage of being able to replicate rather than create products, thereby avoiding high
R&D costs.
33
For example, Paperback created a copycat program to perform the same functions as
Lotus 1-2-3, but which sold at a much lower price.
34
Similarly, Linux became the world’s fastest
growing operating system by basing itself very closely on its competitor Unix.
35
Low R&D costs
allowed Linux to be priced far below Unix and thereby generate a 39 per cent market share.
36
Pre-expiration strategy number 1: pre-emptive launch of software as a standard
Occasionally, software companies make available basic editions for free. Their actions are the
software industry’s version of a pre-emptive launch of a generic. As certain functions are disabled in
the trial version, users are encouraged to purchase upgrades. For example, Microsoft offers a free
version of EasyRecovery, version 6.0. This software protects files from being deleted and helps
repair damaged files. Once users are comfortable with this software they are likely to buy the
upgrade as switching to another standard program would require additional learning time and
effort. The release of free products also inhibits competitive entry.
Inzomia makes graphics software that manages digital photos, allowing easy conversion to
HTML and simplifying the creation of websites. The company provides free versions of the
standard software; then sells upgraded versions. Thus Inzonmia forgoes profits on its basic product
to generate sales of its upgrades and to inhibit competitive entry.
Quicken, a bookkeeping program, utilises the pre-emptive launch strategy to increase sales of
a compatible software product for preparing tax returns, Turbo Tax. A version of Quicken is offered
to consumers for free. When consumers use the product to manage their finances, they are offered
an opportunity to purchase Turbo Tax, a program that works with Quicken to calculate taxes for
that year. This strategy has helped Turbo Tax to become a highly profitable product of Quicken’s
parent company, Intuit.
A successful variation on a pre-expiration launch strategy occurred when the key encryption
patent of RSA Security was about to lapse.
37
RSA’s software is used to scramble digital text to make
it safe for internet transmission. It is included in Microsoft and Netscape browsers to enable the
sending of sensitive information, such credit-card numbers, over the internet.
Although RSA Security’s competitors had been barred from copying the software for sales in the
US, they had been achieving sales overseas where the patent protection was not honoured. These
competitors had advertised in the US that upon the expiration of the patent, their versions would
be shown to be superior. In response, RSA Security took the pre-emptive move of releasing the code
to its expiring software two weeks early. The company took the gamble to reassure users and
investors that its own new software, based on newly-patented codes, would be far superior to any
other option available and that its sales growth would be sustained.
Pre-expiration strategy number 2: layering innovations
Layering patents on innovations not only extends a product’s exclusivity, it also serves as a source of
licensing revenue. The complexity of technology causes many companies to need to have patented
technology incorporated in their products. If these innovations are patented, competitors desiring
to use that innovation in their own products must get permission from the patent holder. These
competitors would then license the use of the technology, paying the patent holder for the right to
use the product. The need to license independent technologies gives patent holders a great deal of
control over which competitors enter the market.
Firms utilise a series of patents for improvements on software as a means to limit competition.
For example, in 2002, SupportSoft received a sixth patent on its support automation software. The
82 How Companies can Preserve Market Dominance after Patents Expire

innovation patent expands on their previously patented self-healing technology for computing
systems.
38
SupportSoft has additional patents pending on improvements to the product to help
maintain its market position by limiting the number of competitors with comparable upgrades.
Check Point Software also uses a patent layering strategy. Its most recent patent on its market-
leading internet security software allows it to adapt to the demands of higher bandwidth internet
connections.
39
The need to license independent technologies gives patent holders
a great deal of control over which competitors enter the market
Pre-expiration strategy number 3: software line extensions
Patenting an updated version of patented software is a popular strategy in the industry and
constitutes a line extension. Sometimes, new versions represent the next generation of a product, as
with Microsoft’s Windows 95, 98, 2000 and XP. More often, such strategies involve annual updates
to a software program that reflect changes in legal requirements and make prior versions obsolete.
For example, each year a new edition of Turbo Tax, which uploads information from Quicken,
is released to calculate that year’s taxes. While competitors’ programs are available, customers
switching to a different tax program would face both the purchase price and having to devote
additional time in learning and data conversion.
Recognising the potential of pre-expiration strategies
Table 1 illustrates the use of the three strategies to forestall the effects of patent expiration in
the pharmaceutical, semiconductor and software industries. However, the table provides only
examples, not archetypes, as each strategy is applicable to any industry where products are
protected by patents. Thus, the need is for strategists who can adapt these strategies to the unique
requirements of their industries, thereby forestalling the impact of competition, extending the
profitability of a product and increasing the rewards for innovation.
Certain contexts have proven appropriate for each of the three pre-emptive strategies. The pre-
emptive launch of a generic product by the patent holder is particularly promising when the
company can contractually commit major purchasers of the product for multi-year periods.
Locking in important purchasers helps to guarantee a sizable income stream for the patent holder,
keeps its production costs low and dissuades generic companies from entering the market because it
makes economies of scale more difficult to achieve.
Layering innovations usually presents a patent holder with a scaled-down version of its original
R&D decision, namely, should the company invest in a new undertaking given the market potential
that a new or distinguishably improved product provides. The layering decision usually involves
lower risks of product failure and market rejection. However, it also usually forecasts lower
expected financial returns than the initial product investment decision because consumer and
competitor options have changed in their favour during the interim period. Therefore, a patent
holder would usually want to undertake R&D to upgrade the product under patent protection only
when the decision is likely to produce returns sufficient to compensate the company for additional
invested capital above the returns on the original investment.
Creating line extensions is advisable when market niches have been identified that would
welcome a tailored version of the product. As such extension must usually be financially self-
sufficient, a patent holder would want to attend to the needs of a market splinter only when the
number of customers was sufficient in size or financial wherewithal to support the additional costs
incurred by the company in developing and marketing a specialised version of the product.
Long Range Planning, vol 39 2006 83

These brief examples of contexts where the three pre-expiration strategies hold special promise
proffer but a first step in the development of broadly applicable adoption guidelines. They dem-
onstrate that companies in other patent-sensitive industries can productively benchmark successful
pre-expiration strategies. While companies differ in their strategic requirements, where patent
protection is central to long-term corporate viability, these pre-expiration options deserve
consideration.
Pre-expiration options as midrange strategies
The role of pre-expiration strategies has implications for addressing the fundamental need in
strategic management to rethink the value of analytical models. Typologies of business strategies try
to encompass all possibilities and are, by definition, nonspecific with regard to the behaviour of any
particular company. Porter classifies all companies as pursuers of low cost, differentiation or focus
strategies or some combination of the three.
40
Pearce categorises 15 discrete strategies as growth,
disinvestment, collaborative or consortia and argues that all business alternatives are selections or
combinations of these options.
41
Treacy and Wiersema believe that all strategies are versions of
customer intimacy, operational excellence or product leadership.
42
However, none of these schemes
provides much more than a generic, almost philosophical, understanding of the large-scale, future-
orientated plans for interacting with the competitive environment that the company undertakes to
achieve its objectives. As the findings of this study demonstrate, finer-grained midrange strategies e
for example, those based on pre-expiration options ebetter define the strategic intentions of
a company.
How does the study of midrange strategies, such as pre-expiration options, differ from the typical
research in strategic management? The answer is that prolonged profitability is not determined by
a company’s strategic intent or its initial realised strategy. Instead, extended profitability results
from refining strategy. By massaging, modifying and bolstering its initial strategy, a company is able
to profit beyond the premiums it earned for originality. This is exactly the function of pre-
expiration strategies, which operate in the midrange between a company’s grand strategy and its
functional tactics.
Exacerbating the problems of the traditional fixation of researchers with course-grained strategies
is the fact that the bulk of their attention is placed on the formulation and initial implementation of
a company strategy. For example, with their interest drawn to the study of technology-driven
Table 1. Pre-Expiration Strategies in the Pharmaceutical, Semiconductor and Software Industries
Strategy/Application Pharmaceutical Industry Semiconductor Industry Software Industry
Pre-emptive Launch
of Generic
Launching a generic
formulation before patent
expiration to lengthen
the period of attractive
profitability
Accelerating mass-production
of microprocessors at lower
margins to take market
share, forcing competitors
to respond
Releasing products
with expiring patents
at cost or below to gain
market share, then
charging for upgrades
Layering Innovations Extending exclusivity
by adding FDA-protected
periods
Purchasing niche
technologies or players
for patent rights to block
competitors’ advancements
Patenting innovations
to the existing product
to add to the barriers
of competition
Line Extensions Altering a chemical
composition to create
patentable version of a
product with an expiring
patent
Creating and patenting
technology enhancements
that are compatible with
future released products
Patenting an updated
version of patented
software, i.e. annual
updates to reflect changes
in legal requirements.
84 How Companies can Preserve Market Dominance after Patents Expire

industries that prioritise innovation and feed hypercompetition, researchers have ignored the
maintenance and enhancement of existent business strategies. Other researchers, fascinated by
industries facing the pandemic of low-cost rivalry, seem content to report on companies’ attempts
to reduce expenses, rather than contribute to the discussion of strategies that competitors could
activate to counterattack with variety, quality and uniqueness.
Again, midrange strategies are the topics that need to be more fully explored.
43
It does not
sufficiently benefit a company to say that a competitor’s low-cost strategy can be neutralised by
a customer intimacy strategy. Executives want to know the considerations and components of
a strategy that can produce the desired results. Such insights are within the domain of midrange
strategies. For example, the discussion in this article of pre-emptive launches in the software
industry may lead executives to reconsider the merits of releasing code to customers as a means to
engender their confidence and implicit partnership in developing new applications.
Finally, in a different vein, the research that underpins this article has special implications for
entrepreneurs. In markets characterised by dominant players with low-cost strategies, the survival
of new and smaller companies often depends on their ability to prosper in micro-segments. The
most profitable of these segments commonly exist because of patent protection. While patents are
less critical in hypercompetitive markets where a constant stream of innovations makes 20 years of
exclusivity on a single product or process inconsequential, patents are more critical in lightly
contested markets that large companies have chosen to disregard. Alternatively, entrepreneurial
companies can benefit by exploiting opportunities that arise because of errors in the patent filings
of brand companies or upon the expiration of a patent’s enforcement period. This article specifies
pre-expiration strategies that are available to competitors which maximise their chances of gaining
or sustaining competitive advantage.
Conclusion
This article was written for executives in industries where patent protection is an element of
profitability. Pre-emptively launching a generic product, layering innovations and creating line
extensions were shown to be high-potential options because of their value in forestalling expiration
and thereby extending the rewards for innovation. They were also found to be exemplary of
midrange strategies, which are needed by companies to clarify their competitive postures.
Acknowledgements
The author wishes to express his appreciation to two anonymous reviewers, and especially to the
editor, for their contributions to the refinement of this article.
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Biography
John A. Pearce II holds the Endowed Chair in Strategic Management and Entrepreneurship of the College of
Commerce & Finance at Villanova University, where he also serves as Director of the Entrepreneurship Research
Center. Among his 32 books are Strategic Management: Strategy Formulation, Implementation and Control, 9th
edition, with Richard B. Robinson (Richard D. Irwin, 2005) and Strategy: A View from the Top, with Cornelis
A. DeKluyver (Prentice Hall, 2006). A frequent leader of executive development programmes, an active consultant
and expert witness, his focus is on strategy formulation and implementation. Recent publications have appeared in
Business Horizons,Journal of Business Venturing,Journal of Management Studies,Organizational Dynamics and Sloan
Management Review. Email: John.Pearce@Villanova.edu
Long Range Planning, vol 39 2006 87