The FTC Loses in Ovation Pharmaceuticals

Josh Wright —  2 September 2010

There are some new developments in the Federal Trade Commission’s consummated merger case brought against Ovation.  Namely, the FTC has lost.  TOTM readers may recall that I spent some time criticizing the Federal Trade Commission’s complaint, back in 2008, in FTC v. Ovation in federal district court in Minnesota.  As I described the stylized facts back then:

There are two transactions here.  In the first, Ovation purchased the rights to Indocin from Merck.  In the second transaction, Ovation purchased the rights to NeoProfen from Abbott while NeoProfen was awaiting FDA approval.  NeoProfen was apparently the only potential substitute for Indocin with respect to treatment of PDA in premature babies.  The press release emphasizes the apparent and remarkable 1300% price hike that occurred after the second transaction.

The Complaint came along with some interesting separate statements that drew my attention, and criticism, including one from Commissioner Rosch suggesting the both transactions would violate Section 7, and suggesting the possibility of a Section 2 violation.  Recall Rosch’s articulation of the theory:

There is reason to believe that the sale of Indocin to Ovation had the effect of eliminating the reputational constraints on Merck that had existed prior to the sale. There is evidence that Ovation lacked Merck’s large product portfolio and thus arguably was not concerned, as Merck had been, that the sale of Indocin at a monopoly price would damage its reputation and sales of more profitable products. More specifically, there is evidence that after the transaction, Ovation began charging roughly 1300 percent more than the price at which Merck sold the same product. Put differently, there is reason to believe that Merck’s sale of Indocin to Ovation had the effect of enabling Ovation to exercise monopoly power in its pricing of Indocin, which Merck could not profitably do prior to the transaction. Moreover, there is also reason to believe that the transaction had the effect of substituting Ovation, a firm that had an incentive to protect its ability to engage in monopoly pricing, for Merck, which lacked the same incentive. It is arguable that Merck had no incentive to acquire NeoProfen, but Ovation had an incentive to do so in order to maintain its monopoly pricing in the PDA market. That, in my judgment, would be a violation of Section 7.

I was critical of this theory (as was TOTM guest blogger Mary Coleman in this post), and noting that while the Commission scored plenty of creativity points with the Complaint, it contained critical weaknesses in the underlying economic logic:

The idea is that Merck was a multi-product monopolist who was constrained in its pricing of Indocin because it was concerned at a reduction in demand for its other products because consumers would be upset if it priced this life-saving drug at “too high” a level.  Under the theory, Merck is setting a profit-maximizing price and figures out that Indocin’s profit-maximizing price would be higher because it is unconstrained by these reputational considerations.

As an initial matter, its seems like everybody here agrees that the the monopoly power associated with Indocin is lawfully acquired and it would not be a violation of the antitrust laws if Merck charged the monopoly price and appropriated the monopoly rate of return to their innovation.  Assuming it is correct that there decision to lower the price is to do with these reputational demand concerns, why does it become a violation if they assign something that they were entitled to do under the antitrust laws to a third party?

The implicit answer is that the antitrust laws condemn evasion of pricing constraints.  …

Well, if that’s all that the antitrust laws are about, this is easy.  Here are a few examples of conduct the FTC could go after that satisfy the “evading a constraint” theory.  Why not a monopolist whose pricing is constrained by current demand.  That is, the profit-maximizing monopoly price is $20 but the monopolist would REALLY like to charge $25.  It is only the fact that current demand is not high enough to support that price that prevents the monopolist from charging it.  So, our monopolist comes up with a plan (lets call it a scheme, it sounds worse) to evade the pricing constraint created by current demand by advertising its product to consumers and touting its virtues.  Or perhaps its going to invest in the quality of the product.  In either event, the purpose of the advertising is to shift the demand to the right and result in higher prices.  No matter that output increases, it doesn’t matter because the monopolist is evading a pricing constraint and presumably has violated Section 2.  Evading reputational constraints on demand for X is not analytically any different evasion of the constraints imposed on demand by consumer preferences.

And I wrote:

Simply describing Merck’s fear of raising its price as an economic constraint does not render Ovation consistent with the modern “economic approach” to antitrust anymore than my awkward and usually unsuccessful attempts to tell jokes during law school lectures converts my teaching style to a “comedic approach.”  In either event, the objection to the “evasion” of any constraint approach is not that it condemns behavior that could otherwise be achieved in other forms without antitrust scrutiny, but that it opens the door to enforcement actions applied to business conduct that is not likely to harm competition and might be welfare increasing.

My critique drew a response from former Commissioner Leary in Antitrust Magazine, defending Commissioner Rosch’s analysis and views on economics, which in turn drew a further reply from me here.  I stand by my view that the Ovation complaint suffered from serious economic flaws.

I raise all of this now because the Deal is reporting that the:

Federal Trade Commission suffered a significant loss in a case against a company that bought the only two treatments for a geneticdisorder in infants and then raised prices dramatically, according to sources who have seen the sealed opinion.  The decision of U.S. District Court Judge Joan Ericksen in Minnesota was issued Tuesday under seal to give the parties time to redact confidential business information. But the crux of the judge’s opinion was that the FTC had not proved that the drugs serve the same market, according to the sources, who asked not to be identified.

Evidence presented at trial showed most doctors used one drug or the other but rarely alternated between the two, suggesting that the choice was a doctor preference, not a medical necessity, the FTC told the court. One source said that the judge’s opinion suggested she “didn’t accept the FTC’s fundamental economic story.”

Its rude to say I told you so.  So I won’t.  And perhaps that would be premature.  In the same story, Cecile Kohrs Lindell also reports that an appeal might be in the works:

The case was referred to the FTC by Sen. Amy Klobuchar, D-Minn., who was besieged by doctors in Minnesota complaining of the scale of the price hikes.  The interest in the case is a key reason why the agency is likely to launch an appeal to the U.S. Court of Appeals for the 8th Circuit, according to Mike Sohn, a former FTC general counsel, now a lawyer at Davis Polk & Wardwell LLP. Sohn has not read the sealed opinion, but noted that the case is likely destined for an appeal for several reasons. “The agency alleged that this was a merger to monopoly of the only two branded drugs which were available to treat premature babies with a life-threatening heart condition and that prices rose dramatically as a result of the acquisition,” Sohn said. “Given those allegations, an adverse ruling either on market definition or competitive effects would have ramifications for other pharmaceutical industry mergers which follow.

The unsealed opinion should be made available soon. I will post it here with further commentary once I’ve had time to digest Judge Ericksen’s opinion.

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  1. FTC v. Ovation Update (and Opinion) « Truth on the Market - September 3, 2010

    […] Opinion is available here.  My earlier analyses of the FTC’s Ovation complaint are here and here. Judge Ericksen first summarizes the complaint: The FTC claims that Lundbeck violated Section 7 of […]