“Our City has become a cesspool,” according Portland police union president, Daryl Turner. He was describing efforts to address the city’s large and growing homelessness crisis.

Portland Mayor Ted Wheeler defended the city’s approach, noting that every major city, “all the way up and down the west coast, in the Midwest, on the East Coast, and frankly, in virtually every large city in the world” has a problem with homelessness. Nevertheless, according to the Seattle Times, Portland is ranked among the 10 worst major cities in the U.S. for homelessness. Wheeler acknowledged, “the problem is getting worse.”

This week, the city’s Budget Office released a “performance report” for some of the city’s bureaus. One of the more eyepopping statistics is the number of homeless camps the city has cleaned up over the years.

PortlandHomelessCampCleanups

Keep in mind, Multnomah County reports there are 4,177 homeless residents in the entire county. But the city reports clearing more than 3,100 camps in one year. Clearly, the number of homeless in the city is much larger than reflected in the annual homeless counts.

The report makes a special note that, “As the number of clean‐ups has increased and program operations have stabilized, the total cost per clean‐up has decreased substantially as well.” Sounds like economies of scale.

Turns out, Budget Office’s simple graphic gives enough information to estimate the economies of scale in homeless camp cleanups. Yes, it’s kinda crappy data. (Could it really be the case that in two years in a row, the city cleaned up exactly the same number of camps at exactly the same cost?) Anyway data is data.

First we plot the total annual costs for cleanups. Of course it’s an awesome fit (R-squared of 0.97), but that’s what happens when you have three observations and two independent variables.

PortlandHomelessTC

Now that we have an estimate of the total cost function, we can plot the marginal cost curve (blue) and average cost curve (orange).

PortlandHomelessMCAC1

That looks like a textbook example of economies of scale: decreasing average cost. It also looks like a textbook example of natural monopoly: marginal cost lower than average cost over the relevant range of output.

What strikes me as curious is how low is the implied marginal cost of a homeless camp cleanup, as shown in the table below.

FY Camps TC AC MC
2014-15 139 $171,109 $1,231 $3,178
2015-16 139 $171,109 $1,231 $3,178
2016-17 571 $578,994 $1,014 $774
2017-18 3,122 $1,576,610 $505 $142

It is somewhat shocking that the marginal cost of an additional camp cleanup is only $142. The hourly wages for the cleanup crew alone would be way more than $142. Something seems fishy with the numbers the city is reporting.

My guess: The city is shifting some of the cleanup costs to other agencies, such as Multnomah County and/or the Oregon Department of Transportation. I also suspect the city is not fully accounting for the costs of the cleanups. And, I am almost certain the city is significantly under reporting how many homeless are living on Portland streets.

This post was co-authored with Chelsea Boyd

The Food and Drug Administration has spoken, and its words have, once again, ruffled many feathers. Coinciding with the deadline for companies to lay out their plans to prevent youth access to e-cigarettes, the agency has announced new regulatory strategies that are sure to not only make it more difficult for young people to access e-cigarettes, but for adults who benefit from vaping to access them as well.

More surprising than the FDA’s paradoxical strategy of preventing teen smoking by banning not combustible cigarettes, but their distant cousins, e-cigarettes, is that the biggest support for establishing barriers to accessing e-cigarettes seems to come from the tobacco industry itself.

Going above and beyond the FDA’s proposals, both Altria and JUUL are self-restricting flavor sales, creating more — not fewer — barriers to purchasing their products. And both companies now publicly support a 21-to-purchase mandate. Unfortunately, these barriers extend beyond restricting underage access and will no doubt affect adult smokers seeking access to reduced-risk products.

To say there are no benefits to self-regulation by e-cigarette companies would be misguided. Perhaps the biggest benefit is to increase the credibility of these companies in an industry where it has historically been lacking. Proposals to decrease underage use of their product show that these companies are committed to improving the lives of smokers. Going above and beyond the FDA’s regulations also allows them to demonstrate that they take underage use seriously.

Yet regulation, whether imposed by the government or as part of a business plan, comes at a price. This is particularly true in the field of public health. In other health areas, the FDA is beginning to recognize that it needs to balance regulatory prudence with the risks of delaying innovation. For example, by decreasing red tape in medical product development, the FDA aims to help people access novel treatments for conditions that are notoriously difficult to treat. Unfortunately, this mindset has not expanded to smoking.

Good policy, whether imposed by government or voluntarily adopted by private actors, should not help one group while harming another. Perhaps the question that should be asked, then, is not whether these new FDA regulations and self-imposed restrictions will decrease underage use of e-cigarettes, but whether they decrease underage use enough to offset the harm caused by creating barriers to access for adult smokers.

The FDA’s new point-of-sale policy restricts sales of flavored products (not including tobacco flavors or menthol/mint flavors) to either specialty, age-restricted, in-person locations or to online retailers with heightened age-verification systems. JUUL, Reynolds and Altria have also included parts of this strategy in their proposed self-regulations, sometimes going even further by limiting sales of flavored products to their company websites.

To many people, these measures may not seem like a significant barrier to purchasing e-cigarettes, but in fact, online retail is a luxury that many cannot access. Heightened online age-verification processes are likely to require most of the following: a credit or debit card, a Social Security number, a government-issued ID, a cellphone to complete two-factor authorization, and a physical address that matches the user’s billing address. According to a 2017 Federal Deposit Insurance Corp. survey, one in four U.S. households are unbanked or underbanked, which is an indicator of not having a debit or credit card. That factor alone excludes a quarter of the population, including many adults, from purchasing online. It’s also important to note that the demographic characteristics of people who lack the items required to make online purchases are also the characteristics most associated with smoking.

Additionally, it’s likely that these new point-of-sale restrictions won’t have much of an effect at all on the target demographic — those who are underage. According to a 2017 Centers for Disease Control and Prevention study, of the 9 percent of high school students who currently use electronic nicotine delivery systems (ENDS), only 13 percent reported purchasing the device for themselves from a store. This suggests that 87 percent of underage users won’t be deterred by prohibitive measures to move sales to specialty stores or online. Moreover, Reynolds estimates that only 20 percent of its VUSE sales happen online, indicating that more than three-quarters of users — consisting mainly of adults — purchase products in brick-and-mortar retail locations.

Existing enforcement techniques, if properly applied at the point of sale, could have a bigger impact on youth access. Interestingly, a recent analysis by Baker White of FDA inspection reports suggests that the agency’s existing approaches to prevent youth access may be lacking — meaning that there is much room for improvement. Overall, selling to minors is extremely low-risk for stores. The likelihood of a store receiving a fine for violation of the minimum age of sale is once for every 36.7 years of operation, the financial risk is about 2 cents per day, and the risk of receiving a no sales order (the most severe consequence) is 1 for every 2,825 years of operation. Furthermore, for every $279 the FDA receives in fines, it spends over $11,800. With odds like those, it’s no wonder some stores are willing to sell to minors: Their risk is minimal.

Eliminating access to flavored products is the other arm of the FDA’s restrictions. Many people have suggested that flavors are designed to appeal to youth, yet fewer talk about the proportion of adults who use flavored e-cigarettes. In reality, flavors are an important factor for adults who switch from combustible cigarettes to e-cigarettes. A 2018 survey of 20,676 US adults who frequently use e-cigarettes showed that “since 2013, fruit-flavored e-liquids have replaced tobacco-flavored e-liquids as the most popular flavors with which participants had initiated e-cigarette use.” By relegating flavored products to specialty retailers and online sales, the FDA has forced adult smokers, who may switch from combustible cigarettes to e-cigarettes, to go out of their way to initiate use.

It remains to be seen if new regulations, either self- or FDA-imposed, will decrease underage use. However, we already know who is most at risk for negative outcomes from these new regulations: people who are geographically disadvantaged (for instance, people who live far away from adult-only retailers), people who might not have credit to go through an online retailer, and people who rely on new flavors as an incentive to stay away from combustible cigarettes. It’s not surprising or ironic that these are also the people who are most at risk for using combustible cigarettes in the first place.

Given the likelihood that the new way of doing business will have minimal positive effects on youth use but negative effects on adult access, we must question what the benefits of these policies are. Fortunately, we know the answer already: The FDA gets political capital and regulatory clout; industry gets credibility; governments get more excise tax revenue from cigarette sales. And smokers get left behind.

A recent NBER working paper by Gutiérrez & Philippon has attracted attention from observers who see oligopoly everywhere and activists who want governments to more actively “manage” competition. The analysis in the paper is fundamentally flawed and should not be relied upon by policymakers, regulators, or anyone else.

As noted in my earlier post, Gutiérrez & Philippon attempt to craft a causal linkage between differences in U.S. and EU antitrust enforcement and product market regulation to differences in market concentration and corporate profits. Their paper’s abstract leads with a bold assertion:

Until the 1990’s, US markets were more competitive than European markets. Today, European markets have lower concentration, lower excess profits, and lower regulatory barriers to entry.

This post focuses on Gutiérrez & Philippon’s claim that EU markets have lower “excess profits.” This is perhaps the most outrageous claim in the paper. If anyone bothers to read the full paper, they’ll see that claims that EU firms have lower excess profits is simply not supported by the paper itself. Aside from a passing mention of someone else’s work in a footnote, the only mention of “excess profits” is in the paper’s headline-grabbing abstract.

What’s even more outrageous is the authors don’t define (or even describe) what they mean by excess profits.

These two factors alone should be enough to toss aside the paper’s assertion about “excess” profits. But, there’s more.

Gutiérrez & Philippon define profit to be gross operating surplus and mixed income (known as “GOPS” in the OECD’s STAN Industrial Analysis dataset). GOPS is not the same thing as gross margin or gross profit as used in business and finance (for example GOPS subtracts wages, but gross margin does not). The EU defines GOPS as (emphasis added):

Operating surplus is the surplus (or deficit) on production activities before account has been taken of the interest, rents or charges paid or received for the use of assets. Mixed income is the remuneration for the work carried out by the owner (or by members of his family) of an unincorporated enterprise. This is referred to as ‘mixed income’ since it cannot be distinguished from the entrepreneurial profit of the owner.

Here’s Figure 1 from Gutiérrez & Philippon plotting GOPS as a share of gross output.

Fig1-GutierrezPhilippon

Look at the huge jump in gross operating surplus for U.S. firms!

Now, look at the scale of the y-axis. Not such a big jump after all.

Over 23 years, from 1992 to 2015, the gross operating surplus rate for U.S. firms grew by 2.5 percentage points. In the EU, the rate increased by about one percentage point.

Using the STAN dataset, I plotted the gross operating surplus rate for each EU country (blue dots) and the U.S. (red dots), along with a time trend. Three takeaways:

  1. There’s not much of a difference between the U.S. and the EU average—they both hover around a gross operating surplus rate of about 19.5 percent; and
  2. There’s a huge variation in gross operating surplus rate across EU countries.
  3. Yes, gross operating surplus is trending slightly upward in the U.S. and slightly downward for the EU average, but there doesn’t appear to be a huge difference in the slope of the trendlines. In fact the slopes of the trendlines are not statistically significantly different from zero and are not statistically significantly different from each other.

GOPSprod

The use of gross profits raises some serious questions. For example, the Stigler Center’s James Traina finds that, after accounting for selling, general, and administrative expenses (SG&A), mark-ups for publicly traded firms in the U.S. have not meaningfully increased since 1980.

The figure below plots net operating surplus (NOPS equals GOPS minus consumption of fixed capital)—which is not the same thing as net income for a business.

Same three takeaways:

  1. There’s not much of a difference between the U.S. and the EU average—they both hover around a net operating surplus rate of a little more than seven percent; and
  2. There’s a huge variation in net operating surplus rate across EU countries.
  3. The slope of the trendlines for net operating surplus in the U.S. and EU are not statistically significantly different from zero and are not statistically significantly different from each other.

NOPSprod

It’s very possible that U.S. firms are achieving higher and growing “excess” profits relative to EU firms. It’s also very possible they’re not. Despite the bold assertions of Gutiérrez & Philippon, the information presented in their paper provides no useful information one way or the other.

 

A recent NBER working paper by Gutiérrez & Philippon attempts to link differences in U.S. and EU antitrust enforcement and product market regulation to differences in market concentration and corporate profits. The paper’s abstract begins with a bold assertion:

Until the 1990’s, US markets were more competitive than European markets. Today, European markets have lower concentration, lower excess profits, and lower regulatory barriers to entry.

The authors are not clear what they mean by lower, however its seems they mean lower today relative to the 1990s.

This blog post focuses on the first claim: “Today, European markets have lower concentration …”

At the risk of being pedantic, Gutiérrez & Philippon’s measures of market concentration for which both U.S. and EU data are reported cover the period from 1999 to 2012. Thus, “the 1990s” refers to 1999, and “today” refers to 2012, or six years ago.

The table below is based on Figure 26 in Gutiérrez & Philippon. In 2012, there appears to be no significant difference in market concentration between the U.S. and the EU, using either the 8-firm concentration ratio or HHI. Based on this information, it cannot be concluded broadly that EU sectors have lower concentration than the U.S.

2012U.S.EU
CR826% (+5%)27% (-7%)
HHI640 (+150)600 (-190)

Gutiérrez & Philippon focus on the change in market concentration to draw their conclusions. However, the levels of market concentration measures are strikingly low. In all but one of the industries (telecommunications) in Figure 27 of their paper, the 8-firm concentration ratios for the U.S. and the EU are below 40 percent. Similarly, the HHI measures reported in the paper are at levels that most observers would presume to be competitive. In addition, in 7 of the 12 sectors surveyed, the U.S. 8-firm concentration ratio is lower than in the EU.

The numbers in parentheses in the table above show the change in the measures of concentration since 1999. The changes suggests that U.S. markets have become more concentrated and EU markets have become less concentrated. But, how significant are the changes in concentration?

A simple regression of the relationship between CR8 and a time trend finds that in the EU, CR8 has decreased an average of 0.5 percentage point a year, while the U.S. CR8 increased by less than 0.4 percentage point a year from 1999 to 2012. Tucked in an appendix to Gutiérrez & Philippon, Figure 30 shows that CR8 in the U.S. had decreased by about 2.5 percentage points from 2012 to 2014.

A closer examination of Gutiérrez & Philippon’s 8-firm concentration ratio for the EU shows that much of the decline in EU market concentration occurred over the 1999-2002 period. After that, the change in CR8 for the EU is not statistically significantly different from zero.

A regression of the relationship between HHI and a time trend finds that in the EU, HHI has decreased an average of 12.5 points a year, while the U.S. HHI increased by less than 16.4 points a year from 1999 to 2012.

As with CR8, a closer examination of Gutiérrez & Philippon’s HHI for the EU shows that much of the decline in EU market concentration occurred over the 1999-2002 period. After that, the change in HHI for the EU is not statistically significantly different from zero.

Readers should be cautious in relying on Gutiérrez & Philippon’s data to conclude that the U.S. is “drifting” toward greater market concentration while the EU is “drifting” toward lower market concentration. Indeed, the limited data presented in the paper point toward a convergence in market concentration between the two regions.

 

 

An important but unheralded announcement was made on October 10, 2018: The European Committee for Standardization (CEN) and the European Committee for Electrotechnical Standardization (CENELEC) released a draft CEN CENELAC Workshop Agreement (CWA) on the licensing of Standard Essential Patents (SEPs) for 5G/Internet of Things (IoT) applications. The final agreement, due to be published in early 2019, is likely to have significant implications for the development and roll-out of both 5G and IoT applications.

CEN and CENELAC, which along with the European Telecommunications Standards Institute (ETSI) are the officially recognized standard setting bodies in Europe, are private international non profit organizations with a widespread network consisting of technical experts from industry, public administrations, associations, academia and societal organizations. This first Workshop brought together representatives of the 5G/Internet of Things (IoT) technology user and provider communities to discuss licensing best practices and recommendations for a code of conduct for licensing of SEPs. The aim was to produce a CWA that reflects and balances the needs of both communities.

The final consensus outcome of the Workshop will be published as a CEN-CENELEC Workshop Agreement (CWA). The draft, which is available for public comments, comprises principles and guidelines that prepare a foundation for future licensing of standard essential patents for fifth generation (5G) technologies. The draft also contains a section on Q&A to help aid new implementers and patent holders.

The IoT ecosystem is likely to have over 20 billion interconnected devices by 2020 and represent a market of $17 trillion (about the same as the current GDP of the U.S.). The data collected by one device, such as a smart thermostat that learns what time the consumer is likely to be at home, can be used to increase the performance of another connected device, such as a smart fridge. Cellular technologies are a core component of the IoT ecosystem, alongside applications, devices, software etc., as they provide connectivity within the IoT system. 5G technology, in particular, is expected to play a key role in complex IoT deployments, which will transcend the usage of cellular networks from smart phones to smart home appliances, autonomous vehicles, health care facilities etc. in what has been aptly described as the fourth industrial revolution.

Indeed, the role of 5G to IoT is so significant that the proposed $117 billion takeover bid for U.S. tech giant Qualcomm by Singapore-based Broadcom was blocked by President Trump, citing national security concerns. (A letter sent by the Committee on Foreign Investment in the US suggested that Broadcom might starve Qualcomm of investment, preventing it from competing effectively against foreign competitors–implicitly those in China.)

While commercial roll-out of 5G technology has not yet fully begun, several efforts are being made by innovator companies, standard setting bodies and governments to maximize the benefits from such deployment.

The draft CWA Guidelines (hereinafter “the guidelines”) are consistent with some of the recent jurisprudence on SEPs on various issues. While there is relatively less guidance specifically in relation to 5G SEPs, it provides clarifications on several aspects of SEP licensing which will be useful, particularly, the negotiating process and conduct of both parties.

The guidelines contain 6 principles followed by some questions pertaining to SEP licensing. The principles deal with:

  1. The obligation of SEP holders to license the SEPs on Fair, Reasonable and Non-Discriminatory (FRAND) terms;
  2. The obligation on both parties to conduct negotiations in good faith;
  3. The obligation of both parties to provide necessary information (subject to confidentiality) to facilitate timely conclusion of the licensing negotiation;
  4. Compensation that is “fair and reasonable” and achieves the right balance between incentives to contribute technology and the cost of accessing that technology;
  5. A non-discriminatory obligation on the SEP holder for similarly situated licensees even though they don’t need to be identical; and
  6. Recourse to a third party FRAND determination either by court or arbitration if the negotiations fail to conclude in a timely manner.

There are 22 questions and answers, as well, which define basic terms and touch on issues such as: what amounts as good faith conduct of negotiating parties, global portfolio licensing, FRAND royalty rates, patent pooling, dispute resolution, injunctions, and other issues relevant to FRAND licensing policy in general.

Below are some significant contributions that the draft report makes on issues such as the supply chain level at which licensing is best done, treatment of small and medium enterprises (SMEs), non disclosure agreements, good faith negotiations and alternative dispute resolution.

Typically in the IoT ecosystem, many technologies will be adopted of which several will be standardized. The guidelines offer help to product and service developers in this regard and suggest that one may need to obtain licenses from SEP owners for product or services incorporating communications technology like 3G UMTS, 4G LTE, Wi-Fi, NB-IoT, 31 Cat-M or video codecs such as H.264. The guidelines, however, clarify that with the deployment of IoT, licenses for several other standards may be needed and developers should be mindful of these complexities when starting out in order to avoid potential infringements.

Notably, the guidelines suggest that in order to simplify licensing, reduce costs for all parties and maintain a level playing field between licensees, SEP holders should license at one level. While this may vary between different industries, for communications technology, the licensing point is often at the end-user equipment level. There has been a fair bit of debate on this issue and the recent order by Judge Koh granting FTC’s partial summary motion deals with some of this.

In the judgment delivered on November 6, Judge Koh relied primarily on the 9th circuit decisions in Microsoft v Motorola (2012 and 2015)  to rule on the core issue of the scope of the FRAND commitments–specifically on the question of whether licensing extends to all levels or is confined to the end device level. The court interpreted the pro- competitive principles behind the non-discrimination requirement to mean that such commitments are “sweeping” and essentially that an SEP holder has to license to anyone willing to offer a FRAND rate globally. It also cited Ericsson v D-Link, where the Federal Circuit held that “compliant devices necessarily infringe certain claims in patents that cover technology incorporated into the standard and so practice of the standard is impossible without licenses to all incorporated SEP technology.”

The guidelines speak about the importance of non-disclosure agreements (NDAs) in such licensing agreements given that some of the information exchanged between parties during negotiation, such as claim charts etc., may be sensitive and confidential. Therefore, an undue delay in agreeing to an NDA, without well-founded reasons, might be taken as evidence of a lack of good faith in negotiations rendering such a licensee as unwilling.

They also provide quite a boost for small and medium enterprises (SMEs) in licensing negotiations by addressing the duty of SEP owners to be mindful of SMEs that may be less experienced and therefore lack information from which to draw assurance that proposed terms are FRAND. The guidelines provide that SEP owners should provide whatever information they can under NDA to help the negotiation process. Equally, the same obligation applies on a licensee who is more experienced in dealing with a SEP owner who is an SME.

There is some clarity on time frames for negotiations and the guidelines provide a maximum time that parties should take to respond to offers and counter offers, which could extend up to several months in complex cases involving hundreds of patents. The guidelines also prescribe conduct of potential licensees on receiving an offer and how to make counter-offers in a timely manner.

Furthermore, the guidelines lay down the various ways in which royalty rates may be structured and clarify that there is no one fixed way in which this may be done. Similarly, they offer myriad ways in which potential licensees may be able to determine for themselves if the rates offered to them are fair and reasonable, such as third party patent landscape reports, public announcements, expert advice etc.

Finally, in the case that a negotiation reaches an impasse, the guidelines endorse an alternative dispute mechanism such as mediation or arbitration for the parties to resolve the issue. Bodies such as International Chamber of Commerce and World Intellectual Property Organization may provide useful platforms in this regard.

Almost 20 years have passed since technology pioneer Kevin Ashton first coined the phrase Internet of Things. While companies are gearing up to participate in the market of IoT, regulation and policy in the IoT world seems far from a predictable framework to follow. There are a lot of guesses about how rules and standards are likely to shape up, with little or no guidance for companies on how to prepare themselves for what faces them very soon. Therefore concrete efforts such as these are rather welcome. The draft guidelines do attempt to offer some much needed clarity and are now open for public comments due by December 13. It will be good to see what the final CWA report on licensing of SEPs for 5G and IoT looks like.

 

Last week, the UK Court of Appeal upheld the findings of the High Court in an important case regarding standard essential patents (SEPs). Of particular significance, the Court of Appeal upheld the finding that the defendant, an implementer of SEPs, could have the sale of its products enjoined in the UK unless it enters into a global licensing deal on terms deemed by the court to be fair, reasonable and non-discriminatory (FRAND). The case is noteworthy not least because the threat of an injunction of this sort has become increasingly rare in other jurisdictions, arguably resulting in an imbalance in bargaining power between patent holders and implementers.

The case concerned patents held by Unwired Planet (most of which had been purchased from Ericsson) that it had declared to be essential to the operation of various telecommunications standards. Chinese telecom giant Huawei had incorporated these patented technologies in its products but disputed the legitimacy of Unwired Planet’s (UP) patents and refused to license them on the terms that were offered.

By way of a background to the case, in March 2014, UP resorted to suing Huawei, Samsung and Google and claiming an injunction when it found it hard to secure licenses. After the commencement of proceedings, UP made licence offers to the defendants. It made offers in April and July 2014 respectively and during the proceedings, including a worldwide SEP portfolio licence, a UK SEP portfolio licence and per-patent licences for any of the SEPs in suit. The defendants argued that the offers were not FRAND. Huawei and Samsung also contended that the offers were in breach of European competition law. UP  settled with Google. Three technical trials of the patents began and UP was able to show that at least two of the patents sued upon were valid and essential and had been infringed. Subsequently, Samsung secured a settlement (at a rate below the market rate) and the FRAND trial went ahead with just Huawei.

Judge Birss delivered the High Court order on April 5, 2017. He held that UP’s patents were valid and infringed and it did not abuse its dominant position by requesting an injunction. He ordered a FRAND injunction that was stayed pending appeal against the two patents that had been infringed. The injunction was subject to a number of conditions which are applied because the case was dealing with patents subject to a FRAND undertaking. It will cease to have effect if Huawei enters into the FRAND license determined by the Court. He also observed that the parties can return for further determination when such license expires. Furthermore, it was held that there was one set of FRAND terms and that the scope of this FRAND was world wide.

The UK Court of Appeal (the bench consisting of Lord Justice Kitchin, Lord Justice Floyd, Lady Justice Asplin) in handing down a 291 paragraph, 66 page judgment dealing with Huawei’s appeal, upheld Birss’ findings. The centrality of Huawei’s appeal focused on the global nature of the FRAND license and the non-discrimination undertaking of UP’s FRAND commitments. Some significant findings of the Court of Appeal are briefly provided below.

The Court of Appeal in upholding Birss’ decision noted that it was unfair to say that UP is using the threat of an injunction to leverage Huawei into taking a global license, and that Huawei had the option to take the global license or submit to an injunction in the UK. Drawing attention to the potential complexities in a FRAND negotiation, the Court observed:

..The owner of a SEP may still use the threat of an injunction to try to secure the payment of excessive licence fees and so engage in hold-up activities. Conversely, the infringer may refuse to engage constructively or behave unreasonably in the negotiation process and so avoid paying the licence fees to which the SEP owner is properly entitled, a process known as “hold-out”.

Furthermore, Huawei argues that imposition of a global license on terms set by a national court based on a national finding of infringement is wrong in principle. It also states that there is currently an ongoing patent litigation in both Germany and China and that there are some countries where UP holds “no relevant” patents at all.

In response to these contentions, the Court of Appeal has held that it may be highly impractical for a SEP owner to seek to negotiate a license of its patent rights in each country and rejected the submission made by Huawei that the approach adopted by Birss in these proceedings is out of line with the territorial nature of patent litigations. It clarified that Birss did not adjudicate on issues of infringement or validity concerning foreign SEPs and did not usurp the rights of foreign courts. It further observed that such an approach of Birss  is consistent with the Council and the European Economic and Social Committee dated 29 November 2017 (COM (2017) 712 final) (“the November 2017 EU Communication”) which notes in section 2.4:

For products with a global circulation, SEP licences granted on a worldwide basis may contribute to a more efficient approach and therefore can be compatible with FRAND.

The Court of Appeal however disagreed with Birss on the issue that there was only one set of FRAND terms. This view of the bench certainly comes as a relief since it seems to appropriately reflect the practical realities of a FRAND negotiation. The Court held:

Patent licences are complex and, having regard to the commercial priorities of the participating undertakings and the experience and preferences of the individuals involved, may be structured in different ways in terms of, for example, the particular contracting parties, the rights to be included in the licence, the geographical scope of the licence, the products to be licensed, royalty rates and how they are to be assessed, and payment terms. Further, concepts such as fairness and reasonableness do not sit easily with such a rigid approach.

Similarly, on the non- discrimination prong of FRAND, the Court of Appeal agreed with Birss that it was not “hard-edged” and the test is whether such difference in rates distorts competition between the licensees. It also noted that the “hard-edged” interpretation would be “akin to the re-insertion of a “most favoured licensee” clause in the FRAND undertaking” which does not seem to be what the standards body, European Telecommunications Standards Institute (ETSI) had in mind when it formulated its policies. The Court also held :

We consider that a non-discrimination rule has the potential to harm the technological development of standards if it has the effect of compelling the SEP owner to accept a level of compensation for the use of its invention which does not reflect the value of the licensed technology.

Finally, the Court of Appeal held that UP did not abuse its dominant position just because it failed to strictly comply with the safe harbor framework laid down by Court of Justice of the European Union in Huawei v. ZTE. The only requirement that must be satisfied before proceedings are commenced by the SEP holder is that the SEP holder give sufficient notice to or consult with the implementer.

The Court of Appeal’s decision offers some significant guidance to the emerging policy debate on FRAND. As mentioned at the beginning of this post, the decision is significant particularly for the reason that UP is one of a total of two cases in the last two years, where an injunctive relief has been granted in instances involving standard essential patents. Such reliefs have been rarely granted in years in the first place. The second such instance of a grant of injunction pertains to Huawei v. Samsung where the Shenzhen Court in China held earlier this year that Huawei met the FRAND obligation while Samsung did not (negotiations were dragged on for 6 years). An injunction was granted against Samsung for infringing two of Huawei’s Chinese patents which are counterparts of two U.S. asserted patents (however Judge Orrick of the U.S. District Court for the Northern District of California enjoined Huawei from enforcing the injunction).

Current jurisprudence on injunctive relief with respect to FRAND encumbered SEPs is that there is no per se ban on these reliefs. However, courts have been very reluctant to actually grant them. While injunctions are statutory remedies, and granted automatically in most cases when a patent is found to be infringed, administrative agencies and courts have held a position that shows that FRAND commitments certainly limit this premise.

Following the eBay decision in the U.S., defendants in infringement claims involving SEPs have argued that permanent injunctions should not be available for FRAND-encumbered SEPs and were upheld in cases such as Apple v. Motorola in 2014 (where Judge Randall Radar also makes a sound case for evidence of a hold out by Apple in his dissenting order). However, in an institutional bargaining framework of FRAND, which is based on a mutuality of considerations, such a recourse is misplaced and likely to inevitably disturb this balance. The current narrative on FRAND that dominates policymaking and jurisprudence is incomplete in its unilateral focus of avoiding the possible problem of a patent hold up in the absence of concrete evidence indicating its probability. In Ericsson v D-Links Judge Davis of the US Court of Appeals for the Federal Circuit underscored this point when he observed that “if an accused infringer wants an instruction on patent hold-up and royalty stacking [to be given to the jury], it must provide evidence on the record of patent hold-up and royalty stacking.”

Remedies emanating from a one sided perspective tilt the bargaining dynamic in favour of implementers and if the worst penalty a SEP infringer has to pay is the FRAND royalty it would have otherwise paid beforehand, then a hold out or a reverse hold up by implementers becomes a very profitable strategy. Remedies for patent infringement cannot be ignored because they are also core to the framework for licensing negotiations and ensuring compliance by licensees. A disproportionate reliance on liability rules over property rights is likely to exacerbate the countervailing problem of hold out and detrimentally impact incentives to innovate, ultimately undermining the welfare goals that such enforcement seeks to achieve.

The Court of Appeal has therefore given valuable guidance in its decision when it noted:

Just as implementers need protection, so too do the SEP owners. They are entitled to an appropriate reward for carrying out their research and development activities and for engaging with the standardization process, and they must be able to prevent technology users from free-riding on their innovations. It is therefore important that implementers engage constructively in any FRAND negotiation and, where necessary, agree to submit to the outcome of an appropriate FRAND determination.

Hopefully this order brings with it some balance in FRAND negotiations as well as a shift in the perspective of courts in how they adjudicate on these litigations. It underscores an oft forgotten principle that is core to the FRAND framework- that FRAND is a two-way street, as was observed in the celebrated case of Huawei v. ZTE in 2015.

REGISTER HERE for the much-anticipated 2018 ICLE/Leeds competition law conference, this Friday and Saturday in Washington, DC.

NB: We’ve been approved for 8 credit hours of VA MCLE

The conference agenda is below. We hope to see you there!

ICLE/Leeds 2018 Competition Law Conference: Have We Exceeded the Limits of Antirust?
Agenda Day 1
Agenda Day 2

Over the past few weeks, Truth on the Market has had several posts related to harm reduction policies, with a focus on tobacco, e-cigarettes, and other vapor products:

Harm reduction policies are used to manage a wide range of behaviors including recreational drug use and sexual activity. Needle-exchange programs reduce the spread of infectious diseases among users of heroin and other injected drugs. Opioid replacement therapy substitutes illegal opioids, such as heroin, with a longer acting but less euphoric opioid. Safer sex education and condom distribution in schools are designed to reduce teenage pregnancy and reduce the spread of sexually transmitted infections. None of these harm reduction policies stop the risky behavior, nor do the policies eliminate the potential for harm. Nevertheless, the policies intend to reduce the expected harm.

Carrie Wade, Director of Harm Reduction Policy and Senior Fellow at the R Street Institute, draws a parallel between opiate harm reduction strategies and potential policies related to tobacco harm reduction. She notes that with successful one-year quit rates hovering around 10 percent, harm reduction strategies offer ways to transition more smokers off the most dangerous nicotine delivery device: the combustible cigarette.

Most of the harm from smoking is caused by the inhalation of toxicants released through the combustion of tobacco. Use of non-combustible nicotine delivery systems, such as e-cigarettes and smokeless tobacco generally are considered to be significantly less harmful than smoking cigarettes. UK government agency Public Health England has concluded that e-cigarettes are around 95 percent less harmful than combustible cigarettes.

In the New England Journal of Medicine, Fairchild, et al. (2018) identify a continuum of potential policies regarding the regulation of vapor products, such as e-cigarettes, show in the figure below.  They note that the most restrictive policies would effectively eliminate e-cigarettes as a viable alternative to smoking, while the most permissive may promote e-cigarette usage and potentially encourage young people—who would not do so otherwise—to take-up e-cigarettes. In between these extremes are policies that may discourage young people from initiating use of e-cigarettes, while encouraging current smokers to switch to less harmful vapor products.

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International Center for Law & Economics chief economist, Eric Fruits, notes in his blog post that more than 20 countries have introduced taxation on e-cigarettes and other vapor products. In the United States, several states and local jurisdictions have enacted e-cigarette taxes. His post is based on a recently released ICLE white paper entitled Vapor products, harm reduction, and taxation: Principles, evidence and a research agenda.

Under a harm reduction principle, Fruits argues that e-cigarettes and other vapor products should face no taxes or low taxes relative to conventional cigarettes, to guide consumers toward a safer alternative to smoking.

In contrast to harm reduction principles,  the precautionary principle as well as principles of tax equity point toward the taxation of vapor products at rates similar to conventional cigarettes.

On the one hand, some policymakers claim that the objective of taxing nicotine products is to reduce nicotine consumption. On the other hand, Dan Mitchell, co-founder of the Center for Freedom and Prosperity, points out that some politicians are concerned that they will lose tax revenue if a substantial number of smokers switch to options such as vaping.

Often missed in the policy discussion is the effect of fiscal policies on innovation and the development and commercialization of harm-reducing products. Also, often missed are the consequences for current consumers of nicotine products, including smokers seeking to quit using harmful conventional cigarettes.

Policy decisions regarding taxation of vapor products should take into account both long-term fiscal effects and broader economic and welfare effects. These effects might (or might not) suggest very different tax policies to those that have been enacted or are under consideration. These considerations, however, are frustrated by unreliable and wildly divergent empirical estimates of consumer demand in the face of changing prices and/or rising taxes.

Along the lines of uncertain—if not surprising—impacts Fritz Laux, professor of economics at Northeastern State University, provides an explanation of why smoke-free air laws have not been found to adversely affect revenues or employment in the restaurant and hospitality industries.

He argues that social norms regarding smoking in restaurants have changed to the point that many smokers themselves support bans on smoking in restaurants. In this way, he hypothesizes, smoke-free air laws do not impose a significant constraint on consumer behavior or business activity. We might likewise infer, by extension, that policies which do not prohibit vaping in public spaces (leaving such decisions to the discretion of business owners and managers) could encourage switching by people who otherwise would have to exit buildings in order to vape or smoke—without adversely affecting businesses.

Principles of harm reduction recognize that every policy proposal has uncertain outcomes as well as potential spillovers and unforeseen consequences. With such high risks and costs associated with cigarette and other combustible use, taxes and regulations must be developed in an environment of uncertainty and with an eye toward a net reduction in harm, rather than an unattainable goal of zero harm or in an overt pursuit of tax revenues.

 

The dust has barely settled on the European Commission’s record-breaking €4.3 Billion Google Android fine, but already the European Commission is gearing up for its next high-profile case. Last month, Margrethe Vestager dropped a competition bombshell: the European watchdog is looking into the behavior of Amazon. Should the Commission decide to move further with the investigation, Amazon will likely join other US tech firms such as Microsoft, Intel, Qualcomm and, of course, Google, who have all been on the receiving end of European competition enforcement.

The Commission’s move – though informal at this stage – is not surprising. Over the last couples of years, Amazon has become one of the world’s largest and most controversial companies. The animosity against it is exemplified in a paper by Lina Khan, which uses the example of Amazon to highlight the numerous ills that allegedly plague modern antitrust law. The paper is widely regarded as the starting point of the so-called “hipster antitrust” movement.

But is there anything particularly noxious about Amazon’s behavior, or is it just the latest victim of a European crusade against American tech companies?

Where things stand so far

As is often the case in such matters, publicly available information regarding the Commission’s “probe” (the European watchdog is yet to open a formal investigation) is particularly thin. What we know so far comes from a number of declarations made by Margrethe Vestager (here and here) and a leaked questionnaire that was sent to Amazon’s rivals. Going on this limited information, it appears that the Commission is preoccupied about the manner in which Amazon uses the data that it gathers from its online merchants. In Vestager’s own words:

The question here is about the data, because if you as Amazon get the data from the smaller merchants that you host […] do you then also use this data to do your own calculations? What is the new big thing, what is it that people want, what kind of offers do they like to receive, what makes them buy things.

These concerns relate to the fact that Amazon acts as both a retailer in its own right and a platform for other retailers, which allegedly constitutes a “conflict of interest”. As a retailer, Amazon sells a wide range of goods directly to consumers. Meanwhile, its marketplace platform enables third party merchants to offer their goods in exchange for referral fees when items are sold (these fees typically range from 8% to 15%, depending on the type of good). Merchants can either execute theses orders themselves or opt for fulfilment by Amazon, in which case it handles storage and shipping. In addition to its role as a platform operator,  As of 2017, more than 50% of units sold on the Amazon marketplace where fulfilled by third-party sellers, although Amazon derived three times more revenue from its own sales than from those of third parties (note that Amazon Web Services is still by far its largest source of profits).

Mirroring concerns raised by Khan, the Commission worries that Amazon uses the data it gathers from third party retailers on its platform to outcompete them. More specifically, the concern is that Amazon might use this data to identify and enter the most profitable segments of its online platform, excluding other retailers in the process (or deterring them from joining the platform in the first place). Although there is some empirical evidence to support such claims, it is far from clear that this is in any way harmful to competition or consumers. Indeed, the authors of the paper that found evidence in support of the claims note:

Amazon is less likely to enter product spaces that require greater seller efforts to grow, suggesting that complementors’ platform‐specific investments influence platform owners’ entry decisions. While Amazon’s entry discourages affected third‐party sellers from subsequently pursuing growth on the platform, it increases product demand and reduces shipping costs for consumers.

Thou shalt not punish efficient behavior

The question is whether Amazon using data on rivals’ sales to outcompete them should raise competition concerns? After all, this is a standard practice in the brick-and-mortar industry, where most large retailers use house brands to go after successful, high-margin third-party brands. Some, such as Costco, even eliminate some third-party products from their shelves once they have a successful own-brand product. Granted, as Khan observes, Amazon may be doing this more effectively because it has access to vastly superior data. But does that somehow make Amazon’s practice harmful to social social welfare? Absent further evidence, I believe not.

The basic problem is the following. Assume that Amazon does indeed have a monopoly in the market for online retail platforms (or, in other words, that the Amazon marketplace is a bottleneck for online retailers). Why would it move into direct retail competition against its third party sellers if it is less efficient than them? Amazon would either have to sell at a loss or hope that consumers saw something in its products that warrants a higher price. A more profitable alternative would be to stay put and increase its fees. It could thereby capture all the profits of its independent retailers. Not that Amazon would necessarily want to do so, as this could potentially deter other retailers from joining its platform. The upshot is that Amazon has little incentive to exclude more efficient retailers.

Astute readers, will have observed that this is simply a restatement of the Chicago school’s Single Monopoly Theory, which broadly holds that, absent efficiencies, a monopolist in one line of commerce cannot increase its profits by entering the competitive market for a complementary good. Although the theory has drawn some criticism, it remains a crucial starting point with which enforcers must contend before they conclude that a monopolist’s behavior is anticompetitive.

So why does Amazon move into retail segments that are already occupied by its rivals? The most likely explanation is simply that it can source and sell these goods more efficiently than them, and that these efficiencies cannot be achieved through contracts with the said rivals. Once we accept the possibility that Amazon is simply more efficient, the picture changes dramatically. The sooner it overthrows less efficient rivals the better. Doing so creates valuable surplus that can flow to either itself or its consumers. This is true regardless of whether Amazon has a marketplace monopoly or not. Even if it does have a monopoly (which is doubtful given competition from the likes of Zalando, AliExpress, Google Search and eBay), at least some of these efficiencies will likely be passed on to consumers. Such a scenario is also perfectly compatible with increased profits for Amazon. The real test is whether output increases when Amazon enters segments that were previously occupied by rivals.

Of course, the usual critiques voiced against the “Single Monopoly Profit” theory apply here. It is plausible that, by excluding its retail rivals, Amazon is simply seeking to protect its alleged platform monopoly. However, the anecdotal evidence that has been raised thus far does not support this conclusion.

But what about innovation?

Possibly sensing the weakness of the “inefficiency” line of arguments against Amazon, critics will likely put put forward a second theory of harm. The claim is that by capturing the rents of potentially innovative retailers, Amazon may hamper their incentives to innovate and will therefore harm consumer choice. Margrethe Vestager intimated this much in a Bloomberg interview. Though this framing might seem tempting at first, it falters under close inspection.

The effects of Amazon’s behavior could first be framed in terms of appropriability — that is: the extent to which an innovator captures the social benefits of its innovation. The higher its share of those benefits, the larger its incentives to innovate. By forcing out its retail rivals, it is plausible that Amazon is reducing the returns which they earn on their potential innovations.

Another potential framing is that of holdup theory. Applied to this case, one could argue that rival retailers made sunk investments (potentially innovation-related) to join the Amazon platform, and that Amazon is behaving opportunistically by capturing their surplus. With hindsight, merchants might thus have opted to stay out of the Amazon marketplace.

Unfortunately for Amazon’s critics, there are numerous objections to these two framings. For a start, the business implication of both the appropriability and holdup theories is that firms can and should take sensible steps to protect their investments. The recent empirical paper mentioned above stresses that these actions are critical for the sake of Amazon’s retailers.

Potential solutions abound. Retailers could in principle enter into long-term exclusivity agreements with their suppliers (which would keep Amazon out of the market if there are no alternative suppliers). Alternatively, they could sign non-compete clauses with Amazon, exchange assets, or even outright merge. In fact, there is at least some evidence of this last possibility occurring, as Amazon has acquired some of its online retailers. The fact that some retailers have not opted for these safety measures (or other methods of appropriability) suggests that they either don’t perceive a threat or are unwilling to make the necessary investments. It might also be due to bad business judgement on their part).

Which brings us to the big question. Should competition law step into the breach in those cases where firms have refused to take even basic steps to protect their investments? The answer is probably no.

For a start, condoning this poor judgement encourages firms to rely on competition enforcement rather than private solutions  to solve appropriability and holdup issues. This is best understood with reference to moral hazard. By insuring firms against the capture of their profits, competition authorities disincentivize all forms of risk-mitigation on the part of those firms. This will ultimately raise enforcement costs (as firms become increasingly reliant on the antitrust system for protection).

It is also informationally much more burdensome, as authorities will systematically have to rule on the appropriate share of profits between parties to a case.

Finally, overprotecting these investments would go against the philosophy of the European Court of Justice’s Huawei ruling.  Albeit in the specific context of injunctions relating to SEPs, the Court conditioned competition liability on firms showing that they have taken a series of reasonable steps to sort out their disputes privately.

Concluding remarks

This is not to say that competition intervention should categorically be proscribed. But rather that the capture of a retailer’s investments by Amazon is an insufficient condition for enforcement actions. Instead, the Commission should question whether Amazon’s actions are truly detrimental to consumer welfare and output. Absent strong evidence that an excluded retailer offered superior products, or that Amazon’s move was merely a strategic play to prevent entry, competition authorities should let the chips fall where they may.

As things stand, there is simply no evidence to indicate that anything out of the ordinary is occurring on the Amazon marketplace. By shining the spotlight on Amazon, the Commission is putting itself under tremendous political pressure to move forward with a formal investigation (all the more so, given the looming European Parliament elections). This is regrettable, as there are surely more pressing matters for the European regulator to deal with. The Commission would thus do well to recall the words of Shakespeare in the Merchant of Venice: “All that glisters is not gold”. Applied in competition circles this translates to “all that is big is not inefficient”.

Last week, the DOJ cleared the merger of CVS Health and Aetna (conditional on Aetna’s divesting its Medicare Part D business), a merger that, as I previously noted at a House Judiciary hearing, “presents a creative effort by two of the most well-informed and successful industry participants to try something new to reform a troubled system.” (My full testimony is available here).

Of course it’s always possible that the experiment will fail — that the merger won’t “revolutioniz[e] the consumer health care experience” in the way that CVS and Aetna are hoping. But it’s a low (antitrust) risk effort to address some of the challenges confronting the healthcare industry — and apparently the DOJ agrees.

I discuss the weakness of the antitrust arguments against the merger at length in my testimony. What I particularly want to draw attention to here is how this merger — like many vertical mergers — represents business model innovation by incumbents.

The CVS/Aetna merger is just one part of a growing private-sector movement in the healthcare industry to adopt new (mostly) vertical arrangements that seek to move beyond some of the structural inefficiencies that have plagued healthcare in the United States since World War II. Indeed, ambitious and interesting as it is, the merger arises amidst a veritable wave of innovative, vertical healthcare mergers and other efforts to integrate the healthcare services supply chain in novel ways.

These sorts of efforts (and the current DOJ’s apparent support for them) should be applauded and encouraged. I need not rehash the economic literature on vertical restraints here (see, e.g., Lafontaine & Slade, etc.). But especially where government interventions have already impaired the efficient workings of a market (as they surely have, in spades, in healthcare), it is important not to compound the error by trying to micromanage private efforts to restructure around those constraints.   

Current trends in private-sector-driven healthcare reform

In the past, the most significant healthcare industry mergers have largely been horizontal (i.e., between two insurance providers, or two hospitals) or “traditional” business model mergers for the industry (i.e., vertical mergers aimed at building out managed care organizations). This pattern suggests a sort of fealty to the status quo, with insurers interested primarily in expanding their insurance business or providers interested in expanding their capacity to provide medical services.

Today’s health industry mergers and ventures seem more frequently to be different in character, and they portend an industry-wide experiment in the provision of vertically integrated healthcare that we should enthusiastically welcome.

Drug pricing and distribution innovations

To begin with, the CVS/Aetna deal, along with the also recently approved Cigna-Express Scripts deal, solidifies the vertical integration of pharmacy benefit managers (PBMs) with insurers.

But a number of other recent arrangements and business models center around relationships among drug manufacturers, pharmacies, and PBMs, and these tend to minimize the role of insurers. While not a “vertical” arrangement, per se, Walmart’s generic drug program, for example, offers $4 prescriptions to customers regardless of insurance (the typical generic drug copay for patients covered by employer-provided health insurance is $11), and Walmart does not seek or receive reimbursement from health plans for these drugs. It’s been offering this program since 2006, but in 2016 it entered into a joint buying arrangement with McKesson, a pharmaceutical wholesaler (itself vertically integrated with Rexall pharmacies), to negotiate lower prices. The idea, presumably, is that Walmart will entice consumers to its stores with the lure of low-priced generic prescriptions in the hope that they will buy other items while they’re there. That prospect presumably makes it worthwhile to route around insurers and PBMs, and their reimbursements.

Meanwhile, both Express Scripts and CVS Health (two of the country’s largest PBMs) have made moves toward direct-to-consumer sales themselves, establishing pricing for a small number of drugs independently of health plans and often in partnership with drug makers directly.   

Also apparently focused on disrupting traditional drug distribution arrangements, Amazon has recently purchased online pharmacy PillPack (out from under Walmart, as it happens), and with it received pharmacy licenses in 49 states. The move introduces a significant new integrated distributor/retailer, and puts competitive pressure on other retailers and distributors and potentially insurers and PBMs, as well.

Whatever its role in driving the CVS/Aetna merger (and I believe it is smaller than many reports like to suggest), Amazon’s moves in this area demonstrate the fluid nature of the market, and the opportunities for a wide range of firms to create efficiencies in the market and to lower prices.

At the same time, the differences between Amazon and CVS/Aetna highlight the scope of product and service differentiation that should contribute to the ongoing competitiveness of these markets following mergers like this one.

While Amazon inarguably excels at logistics and the routinizing of “back office” functions, it seems unlikely for the foreseeable future to be able to offer (or to be interested in offering) a patient interface that can rival the service offerings of a brick-and-mortar CVS pharmacy combined with an outpatient clinic and its staff and bolstered by the capabilities of an insurer like Aetna. To be sure, online sales and fulfillment may put price pressure on important, largely mechanical functions, but, like much technology, it is first and foremost a complement to services offered by humans, rather than a substitute. (In this regard it is worth noting that McKesson has long been offering Amazon-like logistics support for both online and brick-and-mortar pharmacies. “‘To some extent, we were Amazon before it was cool to be Amazon,’ McKesson CEO John Hammergren said” on a recent earnings call).

Treatment innovations

Other efforts focus on integrating insurance and treatment functions or on bringing together other, disparate pieces of the healthcare industry in interesting ways — all seemingly aimed at finding innovative, private solutions to solve some of the costly complexities that plague the healthcare market.

Walmart, for example, announced a deal with Quest Diagnostics last year to experiment with offering diagnostic testing services and potentially other basic healthcare services inside of some Walmart stores. While such an arrangement may simply be a means of making doctor-prescribed diagnostic tests more convenient, it may also suggest an effort to expand the availability of direct-to-consumer (patient-initiated) testing (currently offered by Quest in Missouri and Colorado) in states that allow it. A partnership with Walmart to market and oversee such services has the potential to dramatically expand their use.

Capping off (for now) a buying frenzy in recent years that included the purchase of PBM, CatamaranRx, UnitedHealth is seeking approval from the FTC for the proposed merger of its Optum unit with the DaVita Medical Group — a move that would significantly expand UnitedHealth’s ability to offer medical services (including urgent care, outpatient surgeries, and health clinic services), give it a significant group of doctors’ clinics throughout the U.S., and turn UnitedHealth into the largest employer of doctors in the country. But of course this isn’t a traditional managed care merger — it represents a significant bet on the decentralized, ambulatory care model that has been slowly replacing significant parts of the traditional, hospital-centric care model for some time now.

And, perhaps most interestingly, some recent moves are bringing together drug manufacturers and diagnostic and care providers in innovative ways. Swiss pharmaceutical company, Roche, announced recently that “it would buy the rest of U.S. cancer data company Flatiron Health for $1.9 billion to speed development of cancer medicines and support its efforts to price them based on how well they work.” Not only is the deal intended to improve Roche’s drug development process by integrating patient data, it is also aimed at accommodating efforts to shift the pricing of drugs, like the pricing of medical services generally, toward an outcome-based model.

Similarly interesting, and in a related vein, early this year a group of hospital systems including Intermountain Health, Ascension, and Trinity Health announced plans to begin manufacturing generic prescription drugs. This development further reflects the perceived benefits of vertical integration in healthcare markets, and the move toward creative solutions to the unique complexity of coordinating the many interrelated layers of healthcare provision. In this case,

[t]he nascent venture proposes a private solution to ensure contestability in the generic drug market and consequently overcome the failures of contracting [in the supply and distribution of generics]…. The nascent venture, however it solves these challenges and resolves other choices, will have important implications for the prices and availability of generic drugs in the US.

More enforcement decisions like CVS/Aetna and Bayer/Monsanto; fewer like AT&T/Time Warner

In the face of all this disruption, it’s difficult to credit anticompetitive fears like those expressed by the AMA in opposing the CVS-Aetna merger and a recent CEA report on pharmaceutical pricing, both of which are premised on the assumption that drug distribution is unavoidably dominated by a few PBMs in a well-defined, highly concentrated market. Creative arrangements like the CVS-Aetna merger and the initiatives described above (among a host of others) indicate an ease of entry, the fluidity of traditional markets, and a degree of business model innovation that suggest a great deal more competitiveness than static PBM market numbers would suggest.

This kind of incumbent innovation through vertical restructuring is an increasingly important theme in antitrust, and efforts to tar such transactions with purported evidence of static market dominance is simply misguided.

While the current DOJ’s misguided (and, remarkably, continuing) attempt to stop the AT&T/Time Warner merger is an aberrant step in the wrong direction, the leadership at the Antitrust Division generally seems to get it. Indeed, in spite of strident calls for stepped-up enforcement in the always-controversial ag-biotech industry, the DOJ recently approved three vertical ag-biotech mergers in fairly rapid succession.

As I noted in a discussion of those ag-biotech mergers, but equally applicable here, regulatory humility should continue to carry the day when it comes to structural innovation by incumbent firms:

But it is also important to remember that innovation comes from within incumbent firms, as well, and, often, that the overall level of innovation in an industry may be increased by the presence of large firms with economies of scope and scale.

In sum, and to paraphrase Olympia Dukakis’ character in Moonstruck: “what [we] don’t know about [the relationship between innovation and market structure] is a lot.”

What we do know, however, is that superficial, concentration-based approaches to antitrust analysis will likely overweight presumed foreclosure effects and underweight innovation effects.

We shouldn’t fetishize entry, or access, or head-to-head competition over innovation, especially where consumer welfare may be significantly improved by a reduction in the former in order to get more of the latter.