John Carreyrou’s marvelous book Bad Blood chronicles the rise and fall of Theranos, the one-time Silicon Valley darling that was revealed to be a house of cards.[1] Theranos’s Svengali-like founder, Elizabeth Holmes, convinced scores of savvy business people (mainly older men) that her company was developing a machine that could detect all manner of maladies from a small quantity of a patient’s blood. Turns out it was a fraud.
I had a couple of recurring thoughts as I read Bad Blood. First, I kept thinking about how Holmes’s fraud might impair future medical innovation. Something like Theranos’s machine would eventually be developed, I figured, but Holmes’s fraud would likely set things back by making investors leery of blood-based, multi-disease diagnostics.
I also had a thought about the causes of Theranos’s spectacular failure. A key problem, it seemed, was that the company tried to do too many things at once: develop diagnostic technologies, design an elegant machine (Holmes was obsessed with Steve Jobs and insisted that Theranos’s machine resemble a sleek Apple device), market the product, obtain regulatory approval, scale the operation by getting Theranos machines in retail chains like Safeway and Walgreens, and secure third-party payment from insurers.
A thought that didn’t occur to me while reading Bad Blood was that a multi-disease blood diagnostic system would soon be developed but would be delayed, or possibly even precluded from getting to market, by an antitrust enforcement action based on things the developers did to avoid the very problems that doomed Theranos.
Sadly, that’s where we are with the Federal Trade Commission’s misguided challenge to the merger of Illumina and Grail.
Founded in 1998, San Diego-based Illumina is a leading provider of products used in genetic sequencing and genomic analysis. Illumina produces “next generation sequencing” (NGS) platforms that are used for a wide array of applications (genetic tests, etc.) developed by itself and other companies.
In 2015, Illumina founded Grail for the purpose of developing a blood test that could detect cancer in asymptomatic individuals—the “holy grail” of cancer diagnosis. Given the superior efficacy and lower cost of treatments for early- versus late-stage cancers, success by Grail could save millions of lives and billions of dollars.
Illumina created Grail as a separate entity in which it initially held a controlling interest (having provided the bulk of Grail’s $100 million Series A funding). Legally separating Grail in this fashion, rather than running it as an Illumina division, offered a number of benefits. It limited Illumina’s liability for Grail’s activities, enabling Grail to take greater risks. It mitigated the Theranos problem of managers’ being distracted by too many tasks: Grail managers could concentrate exclusively on developing a viable cancer-screening test, while Illumina’s management continued focusing on that company’s core business. It made it easier for Grail to attract talented managers, who would rather come in as corporate officers than as division heads. (Indeed, Grail landed Jeff Huber, a high-profile Google executive, as its initial CEO.) Structuring Grail as a majority-owned subsidiary also allowed Illumina to attract outside capital, with the prospect of raising more money in the future by selling new Grail stock to investors.
In 2017, Grail did exactly that, issuing new shares to investors in exchange for $1 billion. While this capital infusion enabled the company to move forward with its promising technologies, the creation of new shares meant that Illumina no longer held a controlling interest in the firm. Its ownership interest dipped below 20 percent and now stands at about 14.5 percent of Grail’s voting shares.
Setting up Grail so as to facilitate outside capital formation and attract top managers who could focus single-mindedly on product development has paid off. Grail has now developed a blood test that, when processed on Illumina’s NGS platform, can accurately detect a number of cancers in asymptomatic individuals. Grail predicts that this “liquid biopsy,” called Galleri, will eventually be able to detect up to 50 cancers before physical symptoms manifest. Grail is also developing other blood-based cancer tests, including one that confirms cancer diagnoses in patients suspected to have cancer and another designed to detect cancer recurrence in patients who have undergone treatment.
Grail now faces a host of new challenges. In addition to continuing to develop its tests, Grail needs to:
- Engage in widespread testing of its cancer-detection products on up to 50 different cancers;
- Process and present the information from its extensive testing in formats that will be acceptable to regulators;
- Navigate the pre-market regulatory approval process in different countries across the globe;
- Secure commitments from third-party payors (governments and private insurers) to provide coverage for its tests;
- Develop means of manufacturing its products at scale;
- Create and implement measures to ensure compliance with FDA’s Quality System Regulation (QSR), which governs virtually all aspects of medical device production (design, testing, production, process controls, quality assurance, labeling, packaging, handling, storage, distribution, installation, servicing, and shipping); and
- Market its tests to hospitals and health-care professionals.
These steps are all required to secure widespread use of Grail’s tests. And, importantly, such widespread use will actually improve the quality of the tests. Grail’s tests analyze the DNA in a patient’s blood to look for methylation patterns that are known to be associated with cancer. In essence, the tests work by comparing the methylation patterns in a test subject’s DNA against a database of genomic data collected from large clinical studies. With enough comparison data, the tests can indicate not only the presence of cancer but also where in the body the cancer signal is coming from. And because Grail’s tests use machine learning to hone their algorithms in response to new data collected from test usage, the greater the use of Grail’s tests, the more accurate, sensitive, and comprehensive they become.
To assist with the various tasks needed to achieve speedy and widespread use of its tests, Grail decided to reunite with Illumina. In September 2020, the companies entered a merger agreement under which Illumina would acquire the 85.5 percent of Grail voting shares it does not already own for cash and stock worth $7.1 billion and additional contingent payments of $1.2 billion to Grail’s non-Illumina shareholders.
Recombining with Illumina will allow Grail—which has appropriately focused heretofore solely on product development—to accomplish the tasks now required to get its tests to market. Illumina has substantial laboratory capacity that Grail can access to complete the testing needed to refine its products and establish their effectiveness. As the leading global producer of NGS platforms, Illumina has unparalleled experience in navigating the regulatory process for NGS-related products, producing and marketing those products at scale, and maintaining compliance with complex regulations like FDA’s QSR. With nearly 3,000 international employees located in 26 countries, it has obtained regulatory authorizations for NGS-based tests in more than 50 jurisdictions around the world. It also has long-standing relationships with third-party payors, health systems, and laboratory customers. Grail, by contrast, has never obtained FDA approval for any products, has never manufactured NGS-based tests at scale, has only a fledgling regulatory affairs team, and has far less extensive contacts with potential payors and customers. By remaining focused on its key objective (unlike Theranos), Grail has achieved product-development success. Recombining with Illumina will now enable it, expeditiously and efficiently, to deploy its products across the globe, generating user data that will help improve the products going forward.
In addition to these benefits, the combination of Illumina and Grail will eliminate a problem that occurs when producers of complementary products each operate in markets that are not fully competitive: double marginalization. When sellers of products that are used together each possess some market power due to a lack of competition, their uncoordinated pricing decisions may result in less surplus for each of them and for consumers of their products. Combining so that they can coordinate pricing will leave them and their customers better off.
Unlike a producer participating in a competitive market, a producer that faces little competition can enhance its profits by raising its price above its incremental cost.[2] But there are limits on its ability to do so. As the well-known monopoly pricing model shows, even a monopolist has a “profit-maximizing price” beyond which any incremental price increase would lose money.[3] Raising price above that level would hurt both consumers and the monopolist.
When consumers are deciding whether to purchase products that must be used together, they assess the final price of the overall bundle. This means that when two sellers of complementary products both have market power, there is an above-cost, profit-maximizing combined price for their products. If the complement sellers individually raise their prices so that the combined price exceeds that level, they will reduce their own aggregate welfare and that of their customers.
This unfortunate situation is likely to occur when market power-possessing complement producers are separate companies that cannot coordinate their pricing. In setting its individual price, each separate firm will attempt to capture as much surplus for itself as possible. This will cause the combined price to rise above the profit-maximizing level. If they could unite, the complement sellers would coordinate their prices so that the combined price was lower and the sellers’ aggregate profits higher.
Here, Grail and Illumina provide complementary products (cancer-detection tests and the NGS platforms on which they are processed), and each faces little competition. If they price separately, their aggregate prices are likely to exceed the profit-maximizing combined price for the cancer test and NGS platform access. If they combine into a single firm, that firm would maximize its profits by lowering prices so that the aggregate test/platform price is the profit-maximizing combined price. This would obviously benefit consumers.
In light of the social benefits the Grail/Illumina merger offers—speeding up and lowering the cost of getting Grail’s test approved and deployed at scale, enabling improvement of the test with more extensive user data, eliminating double marginalization—one might expect policymakers to cheer the companies’ recombination. The FTC, however, is trying to block it. In late March, the commission brought an action claiming that the merger would violate Section 7 of the Clayton Act by substantially reducing competition in a line of commerce.
The FTC’s theory is that recombining Illumina and Grail will impair competition in the market for “multi-cancer early detection” (MCED) tests. The commission asserts that the combined company would have both the opportunity and the motivation to injure rival producers of MCED tests.
The opportunity to do so would stem from the fact that MCED tests must be processed on NGS platforms, which are produced exclusively by Illumina. Illumina could charge Grail’s rivals or their customers higher prices for access to its NGS platforms (or perhaps deny access altogether) and could withhold the technical assistance rivals would need to secure both regulatory approval of their tests and coverage by third-party payors.
But why would Illumina take this tack, given that it would be giving up profits on transactions with producers and users of other MCED tests? The commission asserts that the losses a combined Illumina/Grail would suffer in the NGS platform market would be more than offset by gains stemming from reduced competition in the MCED test market. Thus, the combined company would have a motive, as well as an opportunity, to cause anticompetitive harm.
There are multiple problems with the FTC’s theory. As an initial matter, the market the commission claims will be impaired doesn’t exist. There is no MCED test market for the simple reason that there are no commercializable MCED tests. If allowed to proceed, the Illumina/Grail merger may create such a market by facilitating the approval and deployment of the first MCED test. At present, however, there is no such market, and the chances of one ever emerging will be diminished if the FTC succeeds in blocking the recombination of Illumina and Grail.
Because there is no existing market for MCED tests, the FTC’s claim that a combined Illumina/Grail would have a motivation to injure MCED rivals—potential consumers of Illumina’s NGS platforms—is rank speculation. The commission has no idea what profits Illumina would earn from NGS platform sales related to MCED tests, what profits Grail would earn on its own MCED tests, and how the total profits of the combined company would be affected by impairing opportunities for rival MCED test producers.
In the only relevant market that does exist—the cancer-detection market—there can be no question about the competitive effect of an Illumina/Grail merger: It would enhance competition by speeding the creation of a far superior offering that promises to save lives and substantially reduce health-care costs.
There is yet another problem with the FTC’s theory of anticompetitive harm. The commission’s concern that a recombined Illumina/Grail would foreclose Grail’s rivals from essential NGS platforms and needed technical assistance is obviated by Illumina’s commitments. Specifically, Illumina has irrevocably offered current and prospective oncology customers 12-year contract terms that would guarantee them the same access to Illumina’s sequencing products that they now enjoy, with no price increase. Indeed, the offered terms obligate Illumina not only to refrain from raising prices but also to lower them by at least 43% by 2025 and to provide regulatory and technical assistance requested by Grail’s potential rivals. Illumina’s continued compliance with its firm offer will be subject to regular audits by an independent auditor.
In the end, then, the FTC’s challenge to the Illumina/Grail merger is unjustified. The initial separation of Grail from Illumina encouraged the managerial focus and capital accumulation needed for successful test development. Recombining the two firms will now expedite and lower the costs of the regulatory approval and commercialization processes, permitting Grail’s tests to be widely used, which will enhance their quality. Bringing Grail’s tests and Illumina’s NGS platforms within a single company will also benefit consumers by eliminating double marginalization. Any foreclosure concerns are entirely speculative and are obviated by Illumina’s contractual commitments.
In light of all these considerations, one wonders why the FTC challenged this merger (and on a 4-0 vote) in the first place. Perhaps it was the populist forces from left and right that are pressuring the commission to generally be more aggressive in policing mergers. Some members of the commission may also worry, legitimately, that if they don’t act aggressively on a vertical merger, Congress will amend the antitrust laws in a deleterious fashion. But the commission has picked a poor target. This particular merger promises tremendous benefit and threatens little harm. The FTC should drop its challenge and encourage its European counterparts to do the same.
[1] If you don’t have time for Carreyrou’s book (and you should make time if you can), HBO’s Theranos documentary is pretty solid.
[2] This ability is market power. In a perfectly competitive market, any firm that charges an above-cost price will lose sales to rivals, who will vie for business by lowering their prices down to the level of their cost.
[3] Under the model, this is the price that emerges at the output level where the producer’s marginal revenue equals its marginal cost.
