Three things are indisputably true about the pharmaceutical industry:
Over the past decade, there has been significant cross-border consolidation involving major pharmaceutical companies and promising biotech firms.
Whatever operating efficiencies that consolidation may have generated, none of it was passed on to consumers in the form of lower prices.
During the same period, there has been a steady decline in the number of important new drugs flowing from company research labs.
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All of which ought to raise serious questions about why the government's antitrust regulators should approve the latest industry mega-merger in which No. 2 Pfizer proposes to buy No. 11 Wyeth in a deal valued at $68 billion.
The impetus for this merger couldn't have been clearer: In 2011, the patent will expire on Pfizer's blockbuster cholesterol-lowering drug, Lipitor, which now accounts for a quarter of the company's revenue, and there is little in Pfizer's development pipeline to replace it.
Unable to stop the slide in its stock price by creating new drugs, Pfizer has concluded that the next best way to keep shareholders happy is through financial engineering. The company will borrow $22 billion at steep interest rates and pay a 29 percent premium to pick up Wyeth, which has been more successful moving from chemical compounds into biotech products and has a few high-potential products in development.
As they always do, the companies argue that the deal should sail through antitrust review. Using traditional antitrust analysis, that's exactly what would happen. The two companies have few, if any, overlapping products and the combination is expected to generate $4 billion in savings over the next three years. Even after the merger, there will be at least 10 large global players in the industry.
But pharmaceuticals is an industry that doesn't lend itself to traditional market analysis. Because the bulk of profits in the industry come from temporary monopolies – government-granted patents – the current marketplace is not where the important competition takes place. Rather, the real rivalry takes place “upstream,” as companies compete to innovate, either by developing medicines in their labs or by buying up promising patents and biotech start-ups. And in that “market for innovation,” it is hard to see how further consolidation would be good for consumers.
It is important to remember that, like many industries, the pharmaceutical industry divides itself into submarkets – cancer drugs, heart drugs, painkillers, vaccines – and that because not all companies compete in all markets, there are only a few players in each. Eliminating one of the global players, therefore, risks reducing to a handful the number of players in each submarket.
It is also important to remember that this is an industry that deserves to be treated with deep suspicion by antitrust regulators because of its congenital distaste for competition.
It is an industry that spends lavishly on lawyers and lobbyists to protect and extend its patents and throw up endless challenges to approvals of competitive drugs.
It is an industry in which companies rarely compete on the basis of price, both because its patents give it near-monopoly pricing power and because the people who decide which drug to use (doctors) are not the ones who pay the bills (insurers and consumers).
It is an industry in which companies facing expiration of lucrative patents routinely pay millions of dollars to potential rivals to delay the introduction of lower-priced generic drugs under the guise of “joint ventures” – payments that the Federal Trade Commission has described as kickbacks designed to lessen competition.
And it is an industry that, when all else fails, would always rather buy a rival than compete against it.
Consider Ovation Pharmaceuticals of Deerfield, Ill. Back in August 2005, Ovation bought from Merck a drug called Indocin IV, which at the time was the only approved product to treat a life-threatening heart condition in premature infants.
Unfortunately for Ovation, Abbott Laboratories was in the process of winning approval from the Food and Drug Administration of a product that would compete with Indocin. So in January 2006, Ovation purchased the rights for the second drug, NeoProfen. According to a complaint filed in December by the FTC, Ovation then raised the price of Indocin by nearly 1,300 percent, from $36 per vial to nearly $500. When NeoProfen eventually hit the market, it was priced at roughly the same level.
Ovation is not some rogue drug company. Its slimy behavior reflects the way the industry thinks, the way it behaves and the way it prefers to “compete.” Which is why it is crucial for the government to bring closer scrutiny to industry mega-mergers.
There is nothing in the various pronouncements this week by Pfizer executives, or in the projections of industry analysts, to credibly suggest that the combined company will suddenly become more innovative, or that it will resist the temptation to cut back on the $10 billion now spent on research and development. Nor is there anything in the company statements, or the history of recent drug company mergers, to suggest the $4 billion in operating savings will translate into lower drug prices.
Indeed, even shareholders should be worried. Pfizer's overpriced purchases of Warner Lambert in 2000 and Pharmacia in 2003 have done little to boost either its stock price or its pace of innovation. And a recent study of industry mergers by Harvard Business School professor Gary Pisano suggests that most drug industry mega-mergers have destroyed shareholder value, not enhanced it.
What we do know, however, is that because of the herd-like behavior of corporate titans and industry analysts, and the prodding of Wall Street's fee-grubbing investment bankers, the Pfizer-Wyeth deal will almost surely be followed by other mega-mergers. And we know that, in an industry with high barriers to new entrants, each of these mergers will result in one fewer company competing, or potentially competing, to develop new drugs.
The Pfizer-Wyeth deal offers a wonderful opportunity for a new administration in Washington to signal the end of the era of anything-goes mergers, and to apply the antitrust laws in creative new ways to innovative high-tech industries that are the key to America's economic future.