The Neglected Concern of Firm Size in Pharmaceutical Mergers

Abstract

Pharmaceutical markets are complex. Multiple agents, including doctors, insurers, and pharmacies, play critical roles that affect competition between manufacturers and patient choice between drugs. This complexity, however, is neglected in standard antitrust analysis. In evaluating proposed mergers, the antitrust agencies have focused almost exclusively on whether the merging firms have potentially competing products in specific drug markets in the firms’ portfolios. If they do, the remedy sought in nearly every case is divesture of the overlapping products. A recent comprehensive report by the American Antitrust Institute (AAI) found that between 1994 and 2020, the Federal Trade Commission (FTC) “challenged 67 drug mergers worth over $900 billion, moved to block only one, and settled virtually all of the remainder subject to divestitures.” As AAI explained, the result of this narrow focus on drug-specific markets has been “the swapping of assets within a relatively small group of large and increasingly powerful firms.”

This Essay examines the inadequacies of the traditional merger analysis by evaluating the firm-wide effects of mergers, particularly those involving large firms. By focusing on individual product markets in isolation, the agencies ignore the advantages of overall firm size and the potential for spillover effects across product markets. Size, reflected in a firm’s number of products and sales value, conveys significant advantages in negotiations, marketing, and financing that a large firm can exploit to impede entry and thwart competition in multiple drug markets. Mergers and acquisitions (hereinafter “mergers”) involving large firms exacerbate these size advantages. But they are ignored in the standard antitrust analysis that focuses narrowly on increased concentration in individual drug markets to determine whether – as the Clayton Act provides – the merger threatens to “substantially lessen competition.” After examining all 67 pharmaceutical mergers the FTC challenged between 1994 and 2020, AAI concluded that the largest companies “have grown through hundreds of mergers and acquisitions.”

In this Essay, we first document the stability of leading firms in the pharmaceutical industry and contend that mergers, not innovation, have enabled these firms to maintain their industry dominance. We then identify three characteristics of prescription drug markets that lead to advantages related to overall firm size. First, insurance and reimbursement create size advantages in negotiations for formulary placement and pricing. Second, size conveys benefits in detailing, marketing, and sales to physicians. Third, size-related advantages in retained earnings provide a relatively low-cost source of financing for acquisitions. In all three contexts, any real efficiency savings are unlikely to be passed on to consumers through lower prices because insurance undermines competition on the final price.

We conclude by outlining a framework for applying these considerations to the antitrust analysis of pharmaceutical mergers. When two large firms merge, the already significant advantages each firm has are compounded in a manner likely to harm competition across many drug markets in the firm’s portfolio (not just markets with overlapping products). This tends to entrench the enlarged firm’s dominance and effectively block smaller rivals from competing. As a result of these size-related advantages, we suggest a presumption that a merger between two large firms substantially lessens competition.

Mergers involving mid-size firms are less likely to harm competition, with the extent of harm depending on the size of the merged entity and whether dominant products are involved. As a result, in addition to the standard concerns about overlapping products in particular markets, we recommend heightened scrutiny of mergers involving mid-size firms, especially where one of the merging firms has a dominant product. We recommend the continuation of the current approach for mergers involving small firms. Such a framework is more consistent with industry realities than the approach applied today and ensures that antitrust enforcement can play a vital role in the pharmaceutical industry.

Keywords: pharmaceutical industry, mergers, acquisitions, antitrust, divestitures

JEL Classification: I18, K21, L40, L41, L43, L65, O34, O38