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Intellectual Property Dispute Raises Ethical Questions Argues Eli Lilly CEO Sidney Taurel

October 16, 2002

STANFORD GRADUATE SCHOOL OF BUSINESS—Few people in the business community would disagree with the argument that profits, intellectual property rights, and innovation are closely tied. But Sidney Taurel, CEO of pharmaceutical giant Eli Lilly, goes further. Much further. He argues that defending intellectual property rights is an ethical duty, nearly on a par with defending the Bill of Rights.

"Now, in my view of what the ethics of business really entail, I would argue that all of us who work and prosper under this system have an obligation to support and uphold its driving principles," Taurel said during his View From the Top lecture at Stanford Graduate School of Business in mid-October. "Thus, it is no more ethical for one company to try to appropriate or undermine the intellectual property of another than it is for one citizen in a democracy to suppress the free speech of another. And yet, that is exactly what is happening today."

And from Taurel's point of view, it's happening to him.

Lilly and other major drug makers are fighting hard to defeat federal legislation that would ease the market availability of cheaper, generic drugs. Moreover, Lilly suffered a crushing defeat at the hands of a generic drug maker two years ago when it successfully sued to end Lilly's patent on Prozac, its marquee anti-depressant.

The stakes for Lilly and the rest of the pharmaceutical industry are very high: Congressional proponents of the legislation claim that it could save consumers as much as $60 billion over 10 years—with much of those savings coming at the expense of the industry. The legal protection offered pharmaceutical companies via existing patent law artificially inflates drug prices, they argue.

Taurel, of course, rejects that contention. But he does more than argue for preservation of the status quo. He argues that the pharmaceutical industry already has been victimized by forces antithetical to capitalism. And although he stops short of saying it, Taurel's implication is clear: The industry deserves more—not less—protection of its intellectual property.

The Engine of Capitalism
Taurel, quoting a review in The Economist of William Baumol's The Free-Market Innovation Machine, likens the capitalist system to a machine whose primary product is economic growth and asks: "What are the machine's components? The rule of law, of course, especially the protection of property, including intellectual property, and the enforceability of contracts. This motivates innovators by assuring that they can gain some reward for their efforts."

Moreover, says Taurel, "the patent system represents a sort of balancing mechanism between property rights and another central concept in capitalism—the idea of a free market.

The innovator is given the incentive of exclusive use, as Baumol says, but only for a limited period of time. When that term expires, the innovation passes into the public domain and all competitors are free to copy it. This ensures that the economy remains dynamic."

Sounds ideal, doesn't it? But the appearance, Taurel says, is deceptive. At a deeper level, the US system is out of balance.

"A new drug has to be the most valuable and most desirable kind of intellectual property in the world. It's hugely expensive and highly risky to create… and therefore very costly.

"So it's perhaps understandable that governments can't seem to resist trying to tinker with the machinery of capitalism—trying to shift the balance so as to harvest this precious innovation sooner… or at lower cost. The Europeans—and many other nations—tinker with the market mechanisms by imposing price controls. The U.S. approach has been to tinker with intellectual property protection—trying to commoditize it faster.

"Consequently, the pharmaceutical industry in the U.S. is in a very different position with respect to intellectual property rights than any other industry in the country. One hundred years from now, the formula for Coca-Cola could still be a secret. But for the pharmaceutical industry, we can only keep competitors from acquiring and using our most valuable trade secrets—our clinical trial data—for five years."

The legal deck, Taurel argues, is already stacked against the innovative pharmaceutical player.

"In any other industry, it's illegal for me to copy your product in order to prepare to market my version when yours goes off patent. It's patent infringement. But in the pharmaceutical industry, it's entirely legal," he says.

Nevertheless, Lilly and its investors are hardly poor—last year it earned $2.58 a share (or $3.5 billion before taxes) on revenues of $11.5 billion. And Lilly continues to invest heavily in research and development. The company spends about 20 percent of gross sales on R&D, including the salaries of 7,500 of its 40,000-plus employees.

The Patent Game
Under existing law (the federal Hatch-Waxman Act), drugs are patent-protected for 20 years, a period that can be extended for 30 months if the owner files a new patent on the product. Generic drug makers and some consumer advocates charge that brand-name drug makers file frivolous patent applications, in hopes of squeezing additional profits from lucrative products.

The stated goal of federal legislation is the closing of those loopholes. Taurel concedes that there have been a few cases of abuse, "but they've received publicity vastly out of proportion to their frequency. Out of some 8,000 generic drugs approved since 1984, only 8—one tenth of one percent—have been delayed due to legal action by the patent holders," he says.

In any case, Taurel argues, "the new legislation would go far, far beyond merely closing loopholes. The real motive of the proponents is a desperate attempt to get some kind of leverage over health care spending. They believe a more rapid transfer of intellectual property from drug innovators to drug imitators is the best way to achieve that."

Patent limitation, Taurel warns, ultimately could harm patients "by hijacking the incentive for medical innovation."

Beyond the Courtroom
Beyond patent law, the industry will face intellectually challenging issues as technology advances.

Genomics, the applied study of nucleotide sequences, promises the development of so-called boutique drugs that would target a very small segment of the population. Rather than producing, say, a drug that fights diabetes in all individuals, researchers might develop a drug that fights a specific type of diabetes in certain people. That possibility raises an interesting problem: Drug companies typically develop drugs for large markets; can they earn a reasonable return developing a drug for a niche population?

"It's not black and white," answers Taurel. A fully developed model to manage the economics of that situation doesn't exist yet, but he believes that niche drugs will be significantly cheaper to develop since testing of a limited target population will be simpler. If so, there will be an economic incentive for Lilly and other companies to bring boutique products to market.

Taurel closed his talk by explaining why he raised questions of ethics and intellectual property rights at Stanford:

"I want to believe the general claim I'm making is worth academic scrutiny. A common response to the current wave of corporate scandals has been the creation of new courses in business ethics. Well, if we're going to have new courses, let us have a few new problems to chew on.

"But my real purpose is more concrete.

"I've put this case to you because, in the not-too-distant future, you will be where I am now. You will lead the great companies of America. And moreover, if you are true to your training and your tradition, you will be the innovators.

"This is Stanford, after all. This is the wellspring. So if I cannot persuade you to defend the rights of innovators, whom can I persuade?"

by Bill Snyder