In pharmaceutical markets, more than anywhere else, “innovation is the name of the game.” Innovation rather than production drives the industry’s growth. Pharma markets are the pinnacle of “innovation markets” as defined by Richard Gilbert and as enshrined in the 1995 I.P. Guidelines. Because innovation requires sufficient scale, firms have often gained that scale through mergers.
The FTC’s strong enforcement record in pharma mergers suffers a paradox: While more than 50 consent decrees over the last 25 years required divestitures of products as a condition for merger approval, the political pressure for stricter antitrust enforcement continues ramping up. In the year 2020 for instance, notable pharma mergers included AstraZeneca acquiring Alexion for $39 billion, Gilead acquiring Immunomedics for $21 billion, BMS acquiring MyoKardia for $13.1 billion, and Johnson & Johnson acquiring Momenta for $6.5 billion. While popular perception of the pharmaceutical industry greatly improved with its effective response to the COVID-19 pandemic, these and other pharma mergers garnered political concerns.
The political pressure increased partly in response to an academic paper, “Killer Acquisitions,” by Colleen Cunningham, Florian Ederer, and Song Ma. The idea behind killer acquisition theory is that an incumbent buys an innovative nascent company developing a competing product and discontinues the competing product. The acquisition pre-empts future competition. The incumbent killed the potential rival and thereby distorted competition and stifled innovation. The antitrust implications are straightforward: Killer acquisitions go unnoticed by antitrust authorities and require a change of law and new theories of harm. In that regard, the present call for public input fits into the perceived need that the current antitrust framework cannot catch some detrimental mergers. Cunningham et al. assert that killer acquisitions represent only a small share of mergers: 5.3 to 7.4 percent of mergers.
But does the killer acquisition theory materialize in business reality? Do incumbents ever discontinue the acquired firm’s products for anticompetitive reasons? At least one study finds a similar share as Cunningham et al. and suggests that approximately 95 percent of pharma mergers are not “killer acquisitions.” And within the five percent that are allegedly problematic, any discontinuation of products requires balancing against counterfactuals absent the merger. Would discontinuation of the drug have occurred irrespective of the merger due to changing market circumstances or due to different corporate strategies? The authors of the killer acquisition theory assume that these five allegedly problematic percent are all anticompetitive acquisitions. In fact, this number could very well be less. Madl qualifies the very notion of killer acquisition stating that:
The mechanism of action used in the Cunningham, Ederer, and Ma study to identify cases of overlap is not mutation-specific, meaning that two drugs targeting the same enzyme and having the same net effect (e.g., inhibition) may not treat the same patients. Accordingly, purchasing the second drug could expand the acquirer’s market, rather than cannibalize sales.
In other words, Cunningham et al. overlook the possible positive effects on competition and innovation of these acquisitions. The notion of killer acquisitions overly emphasizes Kenneth Arrow’s concept replacement effect of innovation and overlooks the Schumpeterian aspect of innovation. In other words, the tenets of the notion of killer acquisitions rest upon the assumption that a dominant firm would acquire a rival to avoid the rival’s product “cannibalizing” the dominant firm’s profits. However, the acquiring firm may seek to create complementarities, thereby opening new markets. Schumpeter indeed wrote that entering new markets (through organic growth or mergers) “incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.”
Moreover, killer acquisitions suggest that the phenomenon of buying up nascent competitors is new and has not been addressed by antitrust agencies. The recent Illumina-Grail debacle proves the contrary: the desired acquisition of Grail by Illumina following its spinoff four years ago would generate considerable innovation and progress in the field of multi-cancer early detection tests. The merger aims at providing Grail with the regulatory and organizational capabilities necessary to commercialize its breakthrough inventions given Grail’s near zero revenue. Grail is a nascent company, but not a nascent competitor to Illumina as the theory of killer acquisitions would have it. Yet, because the competitive effects of such acquisitions arguably are positive, the FTC asked a federal judge to dismiss the lawsuit, because of the high probability the federal judge would approve this beneficial merger. Beyond the antitrust agency’s’ regrettable “gamesmanship,” one cannot reasonably conclude that the FTC is unable to block acquisitions of nascent companies. Current antitrust rules fully equip the FTC with such capability, although this ability may result in applying a misguided theory of killer acquisition to a pro-competitive enabler-acquisition.
More generally, antitrust enforcers and commentators have historically considered the acquisition of potential competitors. Indeed, in their study of pharma mergers, Balto and Mongoven consider that “an acquired firm’s disappearance can have a negative impact on competition, regardless of whether or not it was producing in the market. Potential competitors also wield market power.” Antitrust agencies have traditionally considered potential competitors—referred to as “nascent competitors” in the killer acquisition’s rhetoric—as part of the merger review. For instance, in Zeneca where Zeneca could acquire Astra, the consent order required Zeneca to transfer and surrender all of its rights and assets relating to levobupivacaine to the firm Chiroscience within 10 business days. Zeneca was not an actual competitor to the long-acting local anesthetics, but it was a potential competitor by virtue of its agreement with Chiroscience. The FTC thus required a spinoff to address the competition concerns raised by such potential competition.
Another case is Hoechst. The German pharmaceutical company acquired MMD in 1995, thereby creating the third-largest pharmaceutical company. Dominant in four product markets (i.e., hypertension, angina, arteriosclerosis, and tuberculosis), the merged entity needed to divest either the current line of business or the potential new product to a buyer who could market the drugs. More specifically, Hoechst owned the patent for the only drug that at the time was approved by FDA for intermittent claudication, but MMD had one of the few drugs in development that could compete with Hoechst’s drug. The consent order protected potential competition by requiring Hoechst to divest its drug for intermittent claudication. The settlement also required Hoechst to maintain its research and development (R&D) efforts.
Against that backdrop, should the FTC introduce novel theories of harm for reviewing pharma mergers specifically? There is no need to introduce novel theories of harm, especially if the concern is allegedly excessive drug prices. Concerning higher drug prices, antitrust authorities have seminally stated that increases in drug prices are not illegal under U.S. antitrust laws. Indeed, as recently as 2018, the FTC and the DOJ wrote for the Organisation for Economic Co-Operation and Development that “excessive pricing in pharmaceuticals by itself is not an antitrust violation under U.S. antitrust law, although soaring prices may be indicative of anticompetitive conduct.”
Although excessive prices may support the finding of anticompetitive conduct, increasing prices per se may actually reflect innovation in the sense of the ability to develop a unique patented drug before any other competitors. U.S. antitrust agencies identify drug shortages, regulatory factors, and unilateral conducts other than antitrust violations as potential explanations for increased drug prices absent anticompetitive conduct. Moreover, there is strong scholarly research showing that increased drug company revenues spur more funding on research and development.
Novel theories of harm appear to constitute a way for the FTC to block mergers otherwise lawful under current antitrust laws because they are pro-competitive and pro-innovative (as illustrated in the recent case of Illumina-Grail). Indeed, under current laws, anticompetitive mergers can not only be investigated but most importantly blocked whenever they are anticompetitive. In other words, it appears regrettable that the FTC wants to break its adequate compass for the sake of reaching the detrimental ends it seeks to achieve. Namely, blocking lawful and pro-competitive acquisitions in the pharma industry. To paraphrase the Supreme Court, the FTC’s desire to alter its merger review (and only regarding pharmaceutical companies) is a regrettable attempt to make the government “always wins” in challenging mergers. Such inconsistent policy is both detrimental—for consumer benefits and innovation purposes—and regrettable—for representing a discriminatory stance against pharma mergers without legal consistency.
Novel theories of harm can be appealing and coherent only if the diagnosis of pharma markets underpinning those proposals is correct. Unfortunately, such diagnosis is not. We demonstrate how a misguided diagnosis may lead to costly novel theories of harm.