Joanna Shepherd is Professor of Law at Emory University School of Law.
Today, three of the largest proposed mergers — Bayer/Monsanto, Dow/Dupont, and ChemChina/Syngenta — face scrutiny in both the U.S. and Europe over concerns that the mergers will slow innovation in crop biotechnology and crop protection. The incorporation of innovation effects in the antitrust analysis of these agricultural/biotech mergers is quickly becoming more mainstream in both the U.S. and E.U. The concerns are premised on the idea that, by merging existing competitors into one firm, consolidation will reduce incentives to develop new products in the future. Since 2015, the Department of Justice has opposed proposed mergers between Applied Materials/Tokyo Electron, Comcast/Time Warner Cable, and Halliburton/Baker Hughes at least partly based on innovation concerns. Similarly, the European Commission has raised innovation concerns in its analyses of several mergers since 2015, including Biomet/Zimmer Holdings, GlaxoSmithKline/Novartis, and BASE/ Liberty Global.
Although most of these contested deals are not based exclusively on innovation markets, fear of harms to innovation often result in the required divestiture of innovation-related assets. For example, both the FTC and European Commission allowed the 2014 merger between Medtronic/Covidien only on the condition that Covidien divest its drug-coated balloon catheter business to protect innovation in that market. And just this week, Dupont agreed to divest a large part of its existing pesticide business, including its global R&D organization, to secure approval for the Dow/Dupont merger in the EU.
Certainly the incorporation of innovation effects in antitrust analysis could be relevant in specific mergers or acquisitions if the consolidating firms are the primary innovators in the area, the firms innovate internally, and there are limited sources of external innovation. However, in many industries, this model simply doesn’t apply. Take, for example, the pharmaceutical industry; as I explain in a recent Article, concerns about consolidation’s impact on drug innovation are largely based on an outdated understanding of the innovation ecosystem in the pharmaceutical industry.
Today, most drug innovation originates not in traditional pharmaceutical companies, but in biotech companies and smaller firms, where a culture of nimble decision-making and risk-taking facilitates discovery and innovation. In fact, about two-thirds of New Molecular Entities approved by the FDA originate in biotech and small pharmaceutical companies, and these companies account for almost 70 percent of the current global pipeline of drugs under development.
To complete the development process and commercialize their drugs, biotech companies regularly collaborate with large pharmaceutical companies that push drugs through the grueling late-stage clinical trials and regulatory hurdles of the FDA, organize their manufacturing and distribution capabilities to bring the drugs to market, and mobilize their vast sales force to quickly achieve peak sales. In this current ecosystem, biotech and pharmaceutical firms are each able to specialize in what they do best, bringing expertise and efficiencies to the innovation process.
This specialization has dramatically changed the share of internally-developed versus externally-developed drugs in the pharmaceutical industry. Whereas in the 1970s and early 1980s, almost all drug discovery and early stage development took place inside traditional pharmaceutical companies, today, the companies increasingly shift resources away from internal R&D expenditures and projects and towards external sources of innovation. Externally-sourced drugs now account for an incredible 74 percent of new drugs registered with the FDA for sale in the U.S. Internal R&D is no longer the primary source of drug innovation in large pharmaceutical companies.
As a result, antitrust analyses that focus on pharmaceutical mergers’ impacts on internal R&D and innovation largely miss the point. In the current innovation ecosystem, where little drug innovation originates internally, a merger’s impact on internal R&D expenditures or development projects is oftentimes immaterial to aggregate drug innovation. In many consolidated firms, increases in efficiency and streamlining of operations free up money and resources to source external innovation. To improve their future revenue streams and market share, consolidated firms can be expected to use at least some of the extra resources to acquire external innovation. This increase in demand for externally-sourced innovation increases the prices paid for external assets, which, in turn, incentivizes more early-stage innovation in small firms and biotech companies. Aggregate innovation increases in the process!
Thus, proper antitrust analyses must take into account the innovation ecosystem in the merging firms’ industries. In industries in which most innovation originates externally, as in the pharmaceutical industry, analyses should be less concerned with mergers’ impacts on internal innovation, and more focused on whether consolidation will increase demand for externally-sourced innovation and, ultimately, increase aggregate drug innovation.