Compulsory licenses in the pharmaceutical industry: pricing and R&D strategies

A pharma manufacturer enters a developing country with a new drug after investing some R&D in the first period. The firm can be subjected to a compulsory license mechanism that allows a generic manufacturer to produce an imitated version of the patented product in exchange of a fixed royalty. When the patent expires, a traditional price competition ensues between the patent-holder and the generic manufacturer. We compare two deterministic scenarios wherein the patent-holder has full information regarding the compulsory license. We identify the conditions under which the license is socially and economically beneficial. Our analyses suggest that the patent-holder is seldom economically better-off. We next model a stochastic compulsory license decision rule whereby the patent-holder is exposed to a certain probability that the compulsory license is issued. We show that uncertainty renders the patent-holder more willing to operate in that market.