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Antitrust In Life Sciences - Webinar #3: Do Pharmaceutical Mergers Harm Consumers?

Webinar part of the "Antitrust in Life Sciences" conference organized by Concurrences and Fordham University, with Max Miller (Iowa Attorney General’s Office), Patricia Danzon (The Wharton School), George Rozanski (Bates White), and Scott Hemphill (NYU Law).

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SYNTHESIS

Moderator Scott Hemphill opened the panel by introducing the fact that mergers in the prescription drug industry are unusual, especially because the individual who consumes the drug is typically not the one fully paying for it. He then posed the question of: how are the distinctive features of pharmaceuticals significant to understanding competition in the industry?

Patricia Danzon began the discussion by explaining how the nature of the pharmaceutical industry affects mergers. She noted that pharmaceutical markets are different in the sense that demand is very inelastic because patients are typically covered by insurance in all high-income countries. While payers in all other high-income countries respond to this price inelasticity with systems that limit drug prices as a condition of reimbursement, prices in the US are set freely by firms and have been rising roughly 8-9% for the last few years. To the extent that competition does occur on pharmaceutical prices, it is often in the form of rebating off the list prices. The drug benefit is managed by payers who employ pharmacy benefit managers (PBMs) that establish tiered formularies. Drug companies give discounts in return for preferred formulary positioning, which brings an increase in market share because the co-pays are lower on preferred tiers. In theory, PBMs should pass on rebates to consumers as lower insurance premiums, but limited evidence has suggested that not all rebates are passed through. Most new drugs are specialty drugs that are differentiated on a fourth tier, where the PBM puts a fairly high co-insurance percentage and there is no rebate or competitive pressure on price. Danzon then proceeded to lay out the two types of mergers in the pharmaceutical industry: (1) mergers between two big firms, each of which combines R&D, sales and marketing, and has significant retained earnings to finance their R&D, and (2) large firms merging with small firms, where the large firms bring financing and sales and marketing expertise and the small firm is trying to develop new drugs. She then moved on to discuss the generic sector, where the competition on price is driven by the pharmacies, which are the customers for generic firms. Pharmacies have a financial incentive to choose the cheapest generic because they are paid a maximum allowable cost (MAC) by PBMs and any difference between the MAC and their acquisition prices for generics accrues to the pharmacy as profit. Discounts are passed on to customers because payers reduce the MACs paid to pharmacies over time. Because generic firms have very strong incentives to compete for the business of these large pharmacy customers, generic firms seek economies of scale and scope, and cost savings in manufacturing and distribution. However, as we have seen in recent litigation, scale can also facilitate market sharing and collusion.

Hemphill then asked George Rozanski about the extent to which price competition in this intermediary-driven manner is unique to pharma or healthcare transactions. Rozanski responded by noting that US antitrust agencies and courts look first to the constraint on firms’ competitive strategies — including prices – imposed by the willingness of consumers to substitute. This determines market definition. In the case of generics, there are state laws in the US that encourage substitution of lower-cost generics by pharmacists, resulting in 80-90% of prescription being filled by generics today. In the case of drugs that are still on-patent, the payer – typically an employer — hires an insurance company and works with a PBM to establish a formulary that puts the drugs that are therapeutic substitutes in competition with one another. When there are close substitutes for drugs, drug manufacturers are willing to pay large rebates to obtain preferred positions on this formulary. The evidence is that a large and increasing portion of these rebates are passed through to the payer.

Moving to an enforcer’s perspective, Hemphill asked Max Miller about the extent to which the distinctive features of the pharmaceutical industry affect an enforcer’s sense of priorities. Miller responded saying that, because this market and its fundamental product are so distinctive, he believes that there is a problem when the pharmaceuticals are treated like any other product market. He raised the idea that the American market may be different from others due to a lack of enforcement in competition laws. Miller stated that while enforcers do a traditional economic antitrust analysis when approaching mergers, he believes that there needs to be a recognition on the enforcement side that this is a fundamentally different market. This may justify a more active government tole in ensuring that there are competitive restraints preventing pharmaceutical companies from being able to exercise the power to raise prices on consumers in a way that negatively impact American lives.

Focusing the discussion on brand-brand mergers, Hemphill asked Rozanski about the degree to which such mergers threaten the incentive to innovate? Rozanski responded saying that analyzing the effects on innovation of a merger presents certain challenges in the pharmaceutical industry as economic theory does not strongly support the presumption that more firms in the market and more competition leads to better outcomes. One reason for this is that because innovation is costly, firms that are racing their rivals in innovation may invest excessive amounts on R&D that may not be the optimal outcome for the economy. A second reason is that, with more competitors, firms may limit their investments because they may think that it may be harder to appropriate the benefits that their innovation will bring to consumers due to the possibility of rapid imitation by rivals. Rozanski added that there are practical challenges than must be met when trying to prove that a merger is likely to harm competition in innovation. These include establishing that there is competition at risk, and demonstrating that the competition eliminated by the merger is significant in the context of the totality of competition. Identifying all of the entities that are competing to innovate and quantifying all of their incentives to innovate can be difficult.

Miller added that he believes that when it comes to enforcement, enforcers dealing with mergers should always start from a stricter position of “no,” putting the burden on the merging parties to come up with a viable solution that does not substantially lessen competition. Danzon agreed with Miller’s position, but added that an important principle to consider is, if divestiture is a potential solution, the divested company must be a very significant player in the same general area so that there is both the incentive and marketing opportunity for it to be a real competitor

Hemphill then pivoted the discussion towards focusing on big-small mergers. He noted the rising concerns in the pharmaceutical industry, as well as outside the industry, of “killer acquisitions” or “stealth consolidation.” He noted that such acquisitions may be approved for two reasons: (1) the incumbent may have acquired the startup at a point where it was unclear whether the development effort would ever come to fruition or become a real competitor (2) the deal may have been too small to be noticed by a regulator. Hemphill then turned to Miller for his thoughts on the nascent competitor issue. Miller highlighted the fact that failure in antitrust law has real-world consequences with an example from Matt Stoller’s article in Pro Market, which dealt with a ventilator manufacturer’s acquisition of a nascent competitor that resulted in the cancellation of a government contract that would have ensured a federal ventilator supply. Rozanski then added, on the topic of “killer acquisitions,” that it is important to consider some of the procompetitive justifications for pharmaceutical mergers. For example, such mergers may combine complementary R&D assets, they may give innovators access to lower costs of capital, they may provide investors that have funded the development an exit strategy, and they may allow for access to needed expertise with the regulatory process to bring the product to market.

Questions and Answers

One participant asked the panelist for their views on the issue that there are mergers in the therapeutic industry that may not typically rise to the threshold required for an investigation, resulting in some firms having a lot of bargaining power when dealing with payers. Miller responded that he thinks that when it comes to a firm having power in one market, there is an increased chance that the firm can use that power to gain power in another market. While the US used to have pretty strong laws against tying, they have weakened over the last forty years, enabling the act of using ties in order to gain market share. Danzon added that she thinks this is a particular concern in the pharmaceutical market in terms of rebates. Large firms can bundle rebates and shift deals from various therapeutic classes to others to their advantage, whereas small firms do not have the same capacity. Rozanski further added that merging parties will often argue that a result of the transaction is the ability to negotiate between prices from suppliers. However, there remains the question of when the increased bargaining power crosses the line and represents an exercise of monopsony power, which raises another antitrust issue.

Another participant asked how potential competition is defined, and what indicators, such as patent portfolios, can be looked at? Rozanski answered saying in the case of pharmaceuticals, it is helpful that there is public information about development pipelines from the FDA. Even if there are levels of uncertainty, an analysis can still be done in terms of expected values to make an informed decision of whether to challenge a deal. Danzon added that the pharmaceutical industry is unique in that it has publicly available product databases that track products early on in development. These databases can be more reliable than patent portfolios, especially for small firms, as patents are costly to file.

Another participant asked: if it is clear that the solution in most cases is a divestiture of the innovative drug firm, should there be a statutory criteria that bans big-small mergers? Danzon responded that her suggestion would not be to stop big-small mergers because such mergers are a very important exist strategy for venture capitalists, which in turn encourages investment. Rather, she would resolve this issue by stopping large-midsize mergers. Rozanski then added his perspective, that he disagrees with the idea that there should be any new public policy aimed to ban mergers in an industry like the pharmaceutical industry, where there has been much innovation and R&D. Recent research has found that the cost and risk of new drug development has increased substantially, and that returns to investment in the development of new drugs are not excessive. While he believes that there should be active antitrust enforcement, mergers should be looked at on a case-by-case basis to assess their likely effects on both price and innovation.

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Intervenants

  • Iowa Attorney General’s Office
  • University of Pennsylvania - The Wharton School of Management (Philadelphia)
  • Bates White (Washington)
  • New York University