Patent cliff
Sector Deep DivesThe abrupt collapse in a drug's revenue when its patent expires and generic competition enters.
Pharmaceutical revenue does not decay gently at patent expiry. Once generics enter, a drug can lose the large majority of its sales within a year or two, because substitution is often automatic at the pharmacy and price falls by most of its original level.
This makes pharmaceutical forecasting unlike almost any other sector. You cannot extrapolate a trend across an expiry, and a DCF that fails to model the cliff explicitly will overstate value enormously.
It is also the strategic driver of the whole industry. The need to replace expiring revenue is why large pharmaceutical companies are persistent acquirers of biotech, and why business development activity accelerates as a major expiry approaches.
The shape of the cliff varies by product type. Small molecules face the steepest fall; biologics face biosimilars, where manufacturing complexity and physician caution make substitution slower and erosion far more gradual.
Worked example
A drug earns 3,000 a year and loses exclusivity in 2027.
A trend based forecast carries 3,000 forward and is wrong by an order of magnitude. Realistically, small molecule erosion runs to something like 80% to 90% within two years, so 2029 revenue is a few hundred rather than 3,000.
For a biologic facing biosimilars the same cliff is far shallower and slower, because substitution is not automatic. Getting that distinction right changes the valuation more than any discount rate debate.