Virtual Patent Extension by Cannibalization

We propose a model to explain the recent practice of pharmaceutical firms of introducing generic substitutes for their own branded products before their patents expire. By this early introduction, a branded product's provider seeks to establish a Stackelberg leadership role in the forthcoming generic substitute market. Along with the early introduction of the generic substitute for its branded product, the firm optimally raises the price of its branded product above its prior monopoly level. However, despite its Stackelberg leadership position in the subsequent generic substitute market, the firm's branded product's price declines for a sufficiently large number of entrants into that market. Consumers, who are assumed to be composed of a brand‐loyal segment and a price‐sensitive segment, are better off both before and after the branded product's patent expires as a result of the branded products' suppliers early introduction of generic substitutes. The branded products' suppliers are also better off but the generics' suppliers are not as a result of this practice. However, total producer profits are higher than they would be if the branded products' suppliers were not involved in supplying their own generic substitute.