Cost-conscious governments everywhere are bashing pricey patented drugs even as they boost cheap generics. In the past few weeks regulators in America and the EU have announced separate crackdowns on anti-competitive practices, including ‘pay-for-delay’ deals, whereby big drugmakers pay generics firms to delay the launch of competitors to drugs coming off-patent. From Japan to Germany, governments are liberalising drug markets, sweeping away barriers to generics.

This pressure from above comes just as the bottom is falling out. A record number of drug patents expire over the next few years, which should lead to stiff competition from generics and a collapse in prices. EvaluatePharma, an industry consultancy, estimates that about half of the US$383 billion (Euros 264.7 billion) worth of patented drugs to be sold in the world this year will lose patent protection within five years. In 2010 alone the industry will see nearly 15% of its revenue from patented drugs put at risk. Where competition from unbranded generics is fiercest, for instance, in the US, the price of a given drug falls by more than 85% within a year of patent expiry.

Big drug firms used to turn their noses up at the generics business, but the assault on their profits has forced them to think again. In many rich countries and most poor ones, they are managing to avoid calamitous drops in revenue by peddling ‘branded’ (but not patented) versions of their original drugs for higher prices than unbranded generic equivalents. Illogical though it may seem, such is the power of brand loyalty and inertia among doctors and patients that these branded generics often help the firm losing the patent retain half or more of the market, in value terms, even after generic competition is legally permitted.

Several pharmaceutical companies have gone further and bought generic-making rivals. That can speed up a move into branded generics. But most important, it helps drug giants gain better access to emerging markets – one of the few bright spots in an otherwise bleak outlook for the industry. Mr Jeff George, CEO of Sandoz, a large generics firm owned by Novartis, a Swiss drugmaker, is convinced that the lure of those growing markets is unleashing an “entirely new dynamic”. According to IMS Health, another consultancy, the seven biggest emerging markets will account for more than half of the industry’s total sales growth this year. By 2012, it reckons, nine of the top 20 markets will be emerging economies. Sandoz recently reported that its sales in the six biggest such markets were 14% higher in the first half than they were a year ago, while sales in Europe edged up by barely 3%.

Most big Western firms are already present in these countries, selling their patented products. But that is not enough, argues Dr Satish Reddy, Chief Operating Officer of Dr Reddy’s Laboratories, an Indian generics firm. The real action now is in branded generics, which command a premium in many emerging markets due in part to the fear that unknown products might be fake or of dubious quality. He argues that by joining with local generics firms, multinationals can get “cheap access to the middle class” in these markets. His arguments were well received by GlaxoSmithKline (GSK), a British drug giant, which struck a deal in June 2009 to have Dr Reddy’s make a portfolio of inexpensive drugs that GSK will sell as branded generics in the many countries in which it already has a sales force. Only the month before GSK had acquired 16% of Aspen, a South African maker of generics. GSK’s Mr Abbas Hussain says that this new strategy aims to “build new product portfolios of quality branded medicines, which we can combine with GSK’s existing extensive sales and marketing.”

Other drug giants have been making similar moves. Earlier this year sanofi-aventis, a French company, bought both Medley, Brazil’s biggest generics firm, and Zentiva, a big purveyor of generics in Eastern Europe. The most striking deals have involved Pfizer, a conservative giant not known for cosiness with upstart generics firms. In May 2009 it said it was entering licensing deals with Aurobindo and Claris LifeSciences, both Indian generics firms. Pfizer’s Mr David Simmons even says that “generics are not the enemy of innovative pharma any longer”. Rather, he insists, firms once derided as copycats and scofflaws should be seen as essential allies in entering new markets.

Will these alliances of convenience really last? The inevitable clash of cultures is a potential difficulty. Mr Sigurdur Olafsson, CEO of Actavis, an Icelandic generics firm, says that as a former Pfizer man he remains sceptical. “Generics firms need to be nimble and aggressive,” he observes. And litigious too, he reckons, “Will one of these hybrid firms really be willing to challenge the patents of a rival pharmaceutical firm?”

Sandoz’s Mr George insists there is no such cultural clash, only “a healthy debate of siblings” between his firm and its owner, Novartis. He points to his firm’s aggressive entry into the nascent market for ‘biosimilars’, which are the generic equivalents of biotechnology drugs, as proof that firms like his need not be toothless.

Mr Atul Sobti, boss of Ranbaxy, an Indian generics firm bought last year by Daiichi Sankyo, a Japanese pharmaceutical giant, offers a different reason for scepticism. His concern is not culture but rather the coming cash crunch. The generics business faces “phenomenally high cost pressures”, he explains, not least because “some government somewhere will always be ready to chop prices.”

Governments will surely continue to turn the screws on drug prices. Even so, argues Mr Charles-Andre Brouwers of the Boston Consulting Group, drug firms need not despair. In many parts of the world consumers pay for drugs at least partly out of their own pockets, rather than being subsidised by the state or having an insurer bear the cost. He reckons that their brand loyalty – or laziness – is something drug marketers can tap to keep a premium in their prices. As he puts it, “The secret about this industry is that patients taking a red pill don’t really like switching to a blue pill.”