Archives For doj

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.

I posted this originally on my own blog, but decided to cross-post here since Thom and I have been blogging on this topic.

“The U.S. stock market is having another solid year. You wouldn’t know it by looking at the shares of companies that manage money.”

That’s the lead from Charles Stein on Bloomberg’s Markets’ page today. Stein goes on to offer three possible explanations: 1) a weary bull market, 2) a move toward more active stock-picking by individual investors, and 3) increasing pressure on fees.

So what has any of that to do with the common ownership issue? A few things.

First, it shows that large institutional investors must not be very good at harvesting the benefits of the non-competitive behavior they encourage among the firms the invest in–if you believe they actually do that in the first place. In other words, if you believe common ownership is a problem because CEOs are enriching institutional investors by softening competition, you must admit they’re doing a pretty lousy job of capturing that value.

Second, and more importantly–as well as more relevant–the pressure on fees has led money managers to emphasis low-cost passive index funds. Indeed, among the firms doing well according to the article is BlackRock, “whose iShares exchange-traded fund business tracks indexes, won $20 billion.” In an aggressive move, Fidelity has introduced a total of four zero-fee index funds as a way to draw fee-conscious investors. These index tracking funds are exactly the type of inter-industry diversified funds that negate any incentive for competition softening in any one industry.

Finally, this also illustrates the cost to the investing public of the limits on common ownership proposed by the likes of Einer Elhague, Eric Posner, and Glen Weyl. Were these types of proposals in place, investment managers could not offer diversified index funds that include more than one firm’s stock from any industry with even a moderate level of market concentration. Given competitive forces are pushing investment companies to increase the offerings of such low-cost index funds, any regulatory proposal that precludes those possibilities is sure to harm the investing public.

Just one more piece of real evidence that common ownership is not only not a problem, but that the proposed “fixes” are.

At the heart of the common ownership issue in the current antitrust debate is an empirical measure, the Modified Herfindahl-Hirschmann Index, researchers have used to correlate patterns of common ownership with measures of firm behavior and performance. In an accompanying post, Thom Lambert provides a great summary of just what the MHHI, and more specifically the MHHIΔ, is and how it can be calculated. I’m going to free-ride off Thom’s effort, so if you’re not very familiar with the measure, I suggest you start here and here.

There are multiple problems with the common ownership story and with the empirical evidence proponents of stricter antitrust enforcement point to in order to justify their calls to action. Thom and I address a number of those problems in our recent paper on “The Case for Doing Nothing About Institutional Investors’ Common Ownership of Small Stakes in Competing Firms.” However, one problem we don’t take on in that paper is the nature of the MHHIΔ itself. More specifically, what is one to make of it and how should it be interpreted, especially from a policy perspective?

The Policy Benchmark

The benchmark for discussion is the original Herfindahl-Hirschmann Index (HHI), which has been part of antitrust for decades. The HHI is calculated by summing the squared value of each firm’s market share. Depending on whether you use percents or percentages, the value of the sum may be multiplied by 10,000. For instance, for two firms that split the market evenly, the HHI could be calculated either as:

HHI = 502 + 502 = 5.000, or
HHI = (.502 + .502)*10,000 = 5,000

It’s a pretty simple exercise to see that one of the useful properties of HHI is that it is naturally bounded between 0 and 10,000. In the case of a pure monopoly that commands the entire market, the value of HHI is 10,000 (1002). As the number of firms increases and market shares approach very small fractions, the value of HHI asymptotically approaches 0. For a market with 10 firms firms that evenly share the market, for instance, HHI is 1,000; for 100 identical firms, HHI is 100; for 1,000 identical firms, HHI is 1. As a result, we know that when HHI is close to 10,000, the industry is highly concentrated in one firm; and when the HHI is close to zero, there is no meaningful concentration at all. Indeed, the Department of Justice’s Horizontal Merger Guidelines make use of this property of the HHI:

Based on their experience, the Agencies generally classify markets into three types:

  • Unconcentrated Markets: HHI below 1500
  • Moderately Concentrated Markets: HHI between 1500 and 2500
  • Highly Concentrated Markets: HHI above 2500

The Agencies employ the following general standards for the relevant markets they have defined:

  • Small Change in Concentration: Mergers involving an increase in the HHI of less than 100 points are unlikely to have adverse competitive effects and ordinarily require no further analysis.
  • Unconcentrated Markets: Mergers resulting in unconcentrated markets are unlikely to have adverse competitive effects and ordinarily require no further analysis.
  • Moderately Concentrated Markets: Mergers resulting in moderately concentrated markets that involve an increase in the HHI of more than 100 points potentially raise significant competitive concerns and often warrant scrutiny.
  • Highly Concentrated Markets: Mergers resulting in highly concentrated markets that involve an increase in the HHI of between 100 points and 200 points potentially raise significant competitive concerns and often warrant scrutiny. Mergers resulting in highly concentrated markets that involve an increase in the HHI of more than 200 points will be presumed to be likely to enhance market power. The presumption may be rebutted by persuasive evidence showing that the merger is unlikely to enhance market power.

Just by way of reference, an HHI of 2500 could reflect four firms sharing the market equally (i.e., 25% each), or it could be one firm with roughly 49% of the market and 51 identical small firms sharing the rest evenly.

Injecting MHHIΔ Into the Mix

MHHI is intended to account for both the product market concentration among firms captured by the HHI, and the common ownership concentration across firms in the market measured by the MHHIΔ. In short, MHHI = HHI + MHHIΔ.

As Thom explains in great detail, MHHIΔ attempts to measure the combined effects of the relative influence of shareholders that own positions across competing firms on management’s strategic decision-making and the combined market shares of the commonly-owned firms. MHHIΔ is the measure used in the various empirical studies allegedly demonstrating a causal relationship between common ownership (higher MHHIΔs) and the supposed anti-competitive behavior of choice.

Some common ownership critics, such as Einer Elhague, have taken those results and suggested modifying antitrust rules to incorporate the MHHIΔ in the HHI guidelines above. For instance, Elhague writes (p 1303):

Accordingly, the federal agencies can and should challenge any stock acquisitions that have produced, or are likely to produce, anti-competitive horizontal shareholdings. Given their own guidelines and the empirical results summarized in Part I, they should investigate any horizontal stock acquisitions that have created, or would create, a ΔMHHI of over 200 in a market with an MHHI over 2500, in order to determine whether those horizontal stock acquisitions raised prices or are likely to do so.

Elhague, like many others, couch their discussion of MHHI and MHHIΔ in the context of HHI values as though the additive nature of MHHI means such a context make sense. And if the examples are carefully chosen, the numbers even seem to make sense. For instance, even in our paper (page 30), we give a few examples to illustrate some of the endogeneity problems with MHHIΔ:

For example, suppose again that five institutional investors hold equal stakes (say, 3%) of each airline servicing a market and that the airlines have no other significant shareholders.  If there are two airlines servicing the market and their market shares are equivalent, HHI will be 5000, MHHI∆ will be 5000, and MHHI (HHI + MHHI∆) will be 10000.  If a third airline enters and grows so that the three airlines have equal market shares, HHI will drop to 3333, MHHI∆ will rise to 6667, and MHHI will remain constant at 10000.  If a fourth airline enters and the airlines split the market evenly, HHI will fall to 2500, MHHI∆ will rise further to 7500, and MHHI will again total 10000.

But do MHHI and MHHI∆ really fit so neatly into the HHI framework? Sadly–and worringly–no, not at all.

The Policy Problem

There seems to be a significant problem with simply imposing MHHIΔ into the HHI framework. Unlike HHI, from which we can infer something about the market based on the nominal value of the measure, MHHIΔ has no established intuitive or theoretical grounding. In fact, MHHIΔ has no intuitively meaningful mathematical boundaries from which to draw inferences about “how big is big?”, a fundamental problem for antitrust policy.

This is especially true within the range of cross-shareholding values we’re talking about in the common ownership debate. To illustrate just how big a problem this is, consider a constrained optimization of MHHI based on parameters that are not at all unreasonable relative to hypothetical examples cited in the literature:

  • Four competing firms in the market, each of which is constrained to having at least 5% market share, and their collective sum must equal 1 (or 100%).
  • Five institutional investors each of which can own no more than 5% of the outstanding shares of any individual airline, with no restrictions across airlines.
  • The remaining outstanding shares are assumed to be diffusely owned (i.e., no other large shareholder in any firm).

With only these modest restrictions on market share and common ownership, what’s the maximum potential value of MHHI? A mere 26,864,516,491, with an MHHI∆ of 26,864,513,774 and HHI of 2,717.

That’s right, over 26.8 billion. To reach such an astronomical number, what are the parameter values? The four firms split the market with 33, 31.7, 18.3, and 17% shares, respectively. Investor 1 owns 2.6% of the largest firm (by market share) while Investors 2-5 each own between 4.5 and 5% of the largest firm. Investors 1 and 2 own 5% of the smallest firm, while Investors 3 and 4 own 3.9% and Investor 5 owns a minuscule (0.0006%) share. Investor 2 is the only investor with any holdings (a tiny 0.0000004% each) in the two middling firms. These are not unreasonable numbers by any means, but the MHHI∆ surely is–especially from a policy perspective.

So if MHHI∆ can range from near zero to as much as 28.6 billion within reasonable ranges of market share and shareholdings, what should we make of Elhague’s proposal that mergers be scrutinized for increasing MHHI∆ by 200 points if the MHHI is 2,500 or more? We argue that such an arbitrary policy model is not only unfounded empirically, but is completely void of substantive reason or relevance.

The DOJ’s Horizontal Merger Guidelines above indicate that antitrust agencies adopted the HHI benchmarks for review “[b]ased on their experience”.  In the 1982 and 1984 Guidelines, the agencies adopted HHI standards 1,000 and 1,800, compared to the current 1,500 and 2,500 levels, in determining whether the industry is concentrated and a merger deserves additional scrutiny. These changes reflect decades of case reviews relating market structure to likely competitive behavior and consumer harm.

We simply do not know enough yet empirically about the relation between MHHI∆ and benchmarks of competitive behavior and consumer welfare to make any intelligent policies based on that metric–even if the underlying argument had any substantive theoretical basis, which we doubt. This is just one more reason we believe the best response to the common ownership problem is to do nothing, at least until we have a theoretically, and empirically, sound basis on which to make intelligent and informed policy decisions and frameworks.

A few weeks ago I posted a preliminary assessment of the relative antitrust risk of a Comcast vs Disney purchase of 21st Century Fox assets. (Also available in pdf as an ICLE Issue brief, here). On the eve of Judge Leon’s decision in the AT&T/Time Warner merger case, it seems worthwhile to supplement that assessment by calling attention to Assistant Attorney General Makan Delrahim’s remarks at The Deal’s Corporate Governance Conference last week. Somehow these remarks seem to have passed with little notice, but, given their timing, they deserve quite a bit more attention.

In brief, Delrahim spent virtually the entirety of his short remarks making and remaking the fundamental point at the center of my own assessment of the antitrust risk of a possible Comcast/Fox deal: The DOJ’s challenge of the AT&T/Time Warner merger tells you nothing about the likelihood that the agency would challenge a Comcast/Fox merger.

To begin, in my earlier assessment I pointed out that most vertical mergers are approved by antitrust enforcers, and I quoted Bruce Hoffman, Director of the FTC’s Bureau of Competition, who noted that:

[V]ertical merger enforcement is still a small part of our merger workload….

* * *

Where horizontal mergers reduce competition on their face — though that reduction could be minimal or more than offset by benefits — vertical mergers do not…. [T]here are plenty of theories of anticompetitive harm from vertical mergers. But the problem is that those theories don’t generally predict harm from vertical mergers; they simply show that harm is possible under certain conditions.

I may not have made it very clear in that post, but, of course, most horizontal mergers are approved by enforcers, as well.

Well, now we have the head of the DOJ Antitrust Division making the same point:

I’d say 95 or 96 percent of mergers — horizontal or vertical — are cleared — routinely…. Most mergers — horizontal or vertical — are procompetitive, or have no adverse effect.

Delrahim reinforced the point in an interview with The Street in advance of his remarks. Asked by a reporter, “what are your concerns with vertical mergers?,” Delrahim quickly corrected the questioner: “Well, I don’t have any concerns with most vertical mergers….”

But Delrahim went even further, noting that nothing about the Division’s approach to vertical mergers has changed since the AT&T/Time Warner case was brought — despite the efforts of some reporters to push a different narrative:

I understand that some journalists and observers have recently expressed concern that the Antitrust Division no longer believes that vertical mergers can be efficient and beneficial to competition and consumers. Some point to our recent decision to challenge some aspects of the AT&T/Time Warner merger as a supposed bellwether for a new vertical approach. Rest assured: These concerns are misplaced…. We have long recognized that vertical integration can and does generate efficiencies that benefit consumers. Indeed, most vertical mergers are procompetitive or competitively neutral. The same is of course true in horizontal transactions. To the extent that any recent action points to a closer review of vertical mergers, it’s not new…. [But,] to reiterate, our approach to vertical mergers has not changed, and our recent enforcement efforts are consistent with the Division’s long-standing, bipartisan approach to analyzing such mergers. We’ll continue to recognize that vertical mergers, in general, can yield significant economic efficiencies and benefit to competition.

Delrahim concluded his remarks by criticizing those who assume that the agency’s future enforcement decisions can be inferred from past cases with different facts, stressing that the agency employs an evidence-based, case-by-case approach to merger review:

Lumping all vertical transactions under the same umbrella, by comparison, obscures the reality that we conduct a vigorous investigation, aided by over 50 PhD economists in these markets, to make sure that we as lawyers don’t steer too far without the benefits of their views in each of these instances.

Arguably this was a rebuke directed at those, like Disney and Fox’s board, who are quick to ascribe increased regulatory risk to a Comcast/Fox tie-up because the DOJ challenged the AT&T/Time Warner merger. Recall that, in its proxy statement, the Fox board explained that it rejected Comcast’s earlier bid in favor of Disney’s in part because of “the regulatory risks presented by the DOJ’s unanticipated opposition to the proposed vertical integration of the AT&T / Time Warner transaction.”

I’ll likely have more to add once the AT&T/Time Warner decision is out. But in the meantime (and with apologies to Mark Twain), the takeaway is clear: Reports of the death of vertical mergers have been greatly exaggerated.

I just posted a new ICLE white paper, co-authored with former ICLE Associate Director, Ben Sperry:

When Past Is Not Prologue: The Weakness of the Economic Evidence Against Health Insurance Mergers.

Yesterday the hearing in the DOJ’s challenge to stop the Aetna-Humana merger got underway, and last week phase 1 of the Cigna-Anthem merger trial came to a close.

The DOJ’s challenge in both cases is fundamentally rooted in a timeworn structural analysis: More consolidation in the market (where “the market” is a hotly-contested issue, of course) means less competition and higher premiums for consumers.

Following the traditional structural playbook, the DOJ argues that the Aetna-Humana merger (to pick one) would result in presumptively anticompetitive levels of concentration, and that neither new entry not divestiture would suffice to introduce sufficient competition. It does not (in its pretrial brief, at least) consider other market dynamics (including especially the complex and evolving regulatory environment) that would constrain the firm’s ability to charge supracompetitive prices.

Aetna & Humana, for their part, contend that things are a bit more complicated than the government suggests, that the government defines the relevant market incorrectly, and that

the evidence will show that there is no correlation between the number of [Medicare Advantage organizations] in a county (or their shares) and Medicare Advantage pricing—a fundamental fact that the Government’s theories of harm cannot overcome.

The trial will, of course, feature expert economic evidence from both sides. But until we see that evidence, or read the inevitable papers derived from it, we are stuck evaluating the basic outlines of the economic arguments based on the existing literature.

A host of antitrust commentators, politicians, and other interested parties have determined that the literature condemns the mergers, based largely on a small set of papers purporting to demonstrate that an increase of premiums, without corresponding benefit, inexorably follows health insurance “consolidation.” In fact, virtually all of these critics base their claims on a 2012 case study of a 1999 merger (between Aetna and Prudential) by economists Leemore Dafny, Mark Duggan, and Subramaniam Ramanarayanan, Paying a Premium on Your Premium? Consolidation in the U.S. Health Insurance Industry, as well as associated testimony by Prof. Dafny, along with a small number of other papers by her (and a couple others).

Our paper challenges these claims. As we summarize:

This white paper counsels extreme caution in the use of past statistical studies of the purported effects of health insurance company mergers to infer that today’s proposed mergers—between Aetna/Humana and Anthem/Cigna—will likely have similar effects. Focusing on one influential study—Paying a Premium on Your Premium…—as a jumping off point, we highlight some of the many reasons that past is not prologue.

In short: extrapolated, long-term, cumulative, average effects drawn from 17-year-old data may grab headlines, but they really don’t tell us much of anything about the likely effects of a particular merger today, or about the effects of increased concentration in any particular product or geographic market.

While our analysis doesn’t necessarily undermine the paper’s limited, historical conclusions, it does counsel extreme caution for inferring the study’s applicability to today’s proposed mergers.

By way of reference, Dafny, et al. found average premium price increases from the 1999 Aetna/Prudential merger of only 0.25 percent per year for two years following the merger in the geographic markets they studied. “Health Insurance Mergers May Lead to 0.25 Percent Price Increases!” isn’t quite as compelling a claim as what critics have been saying, but it’s arguably more accurate (and more relevant) than the 7 percent price increase purportedly based on the paper that merger critics like to throw around.

Moreover, different markets and a changed regulatory environment alone aren’t the only things suggesting that past is not prologue. When we delve into the paper more closely we find even more significant limitations on the paper’s support for the claims made in its name, and its relevance to the current proposed mergers.

The full paper is available here.

As Truth on the Market readers prepare to enjoy their Thanksgiving dinners, let me offer some (hopefully palatable) “food for thought” on a competition policy for the new Trump Administration.  In referring to competition policy, I refer not just to lawsuits directed against private anticompetitive conduct, but more broadly to efforts aimed at curbing government regulatory barriers that undermine the competitive process.

Public regulatory barriers are a huge problem.  Their costs have been highlighted by prestigious international research bodies such as the OECD and World Bank, and considered by the International Competition Network’s Advocacy Working Group.  Government-imposed restrictions on competition benefit powerful incumbents and stymie entry by innovative new competitors.  (One manifestation of this that is particularly harmful for American workers and denies job opportunities to millions of lower-income Americans is occupational licensing, whose increasing burdens are delineated in a substantial body of research – see, for example, a 2015 Obama Administration White House Report and a 2016 Heritage Foundation Commentary that explore the topic.)  Federal Trade Commission (FTC) and Justice Department (DOJ) antitrust officials should consider emphasizing “state action” lawsuits aimed at displacing entry barriers and other unwarranted competitive burdens imposed by self-interested state regulatory boards.  When the legal prerequisites for such enforcement actions are not met, the FTC and the DOJ should ramp up their “competition advocacy” efforts, with the aim of convincing state regulators to avoid adopting new restraints on competition – and, where feasible, eliminating or curbing existing restraints.

The FTC and DOJ also should be authorized by the White House to pursue advocacy initiatives whose goal is to dismantle or lessen the burden of excessive federal regulations (such advocacy played a role in furthering federal regulatory reform during the Ford and Carter Administrations).  To bolster those initiatives, the Trump Administration should consider establishing a high-level federal task force on procompetitive regulatory reform, in the spirit of previous reform initiatives.  The task force would report to the president and include senior level representatives from all federal agencies with regulatory responsibilities.  The task force could examine all major regulatory and statutory schemes overseen by Executive Branch and independent agencies, and develop a list of specific reforms designed to reduce federal regulatory impediments to robust competition.  Those reforms could be implemented through specific regulatory changes or legislative proposals, as the case might require.  The task force would have ample material to work with – for example, anticompetitive cartel-like output restrictions, such as those allowed under federal agricultural orders, are especially pernicious.  In addition to specific cartel-like programs, scores of regulatory regimes administered by individual federal agencies impose huge costs and merit particular attention, as documented in the Heritage Foundation’s annual “Red Tape Rising” reports that document the growing burden of federal regulation (see, for example, the 2016 edition of Red Tape Rising).

With respect to traditional antitrust enforcement, the Trump Administration should emphasize sound, empirically-based economic analysis in merger and non-merger enforcement.  They should also adopt a “decision-theoretic” approach to enforcement, to the greatest extent feasible.  Specifically, in developing their enforcement priorities, in considering case selection criteria, and in assessing possible new (or amended) antitrust guidelines, DOJ and FTC antitrust enforcers should recall that antitrust is, like all administrative systems, inevitably subject to error costs.  Accordingly, Trump Administration enforcers should be mindful of the outstanding insights provide by Judge (and Professor) Frank Easterbrook on the harm from false positives in enforcement (which are more easily corrected by market forces than false negatives), and by Justice (and Professor) Stephen Breyer on the value of bright line rules and safe harbors, supported by sound economic analysis.  As to specifics, the DOJ and FTC should issue clear statements of policy on the great respect that should be accorded the exercise of intellectual property rights, to correct Obama antitrust enforcers’ poor record on intellectual property protection (see, for example, here).  The DOJ and the FTC should also accord greater respect to the efficiencies associated with unilateral conduct by firms possessing market power, and should consider reissuing an updated and revised version of the 2008 DOJ Report on Single Firm Conduct).

With regard to international competition policy, procedural issues should be accorded high priority.  Full and fair consideration by enforcers of all relevant evidence (especially economic evidence) and the views of all concerned parties ensures that sound analysis is brought to bear in enforcement proceedings and, thus, that errors in antitrust enforcement are minimized.  Regrettably, a lack of due process in foreign antitrust enforcement has become a matter of growing concern to the United States, as foreign competition agencies proliferate and increasingly bring actions against American companies.  Thus, the Trump Administration should make due process problems in antitrust a major enforcement priority.  White House-level support (ensuring the backing of other key Executive Branch departments engaged in foreign economic policy) for this priority may be essential, in order to strengthen the U.S. Government’s hand in negotiations and consultations with foreign governments on process-related concerns.

Finally, other international competition policy matters also merit close scrutiny by the new Administration.  These include such issues as the inappropriate imposition of extraterritorial remedies on American companies by foreign competition agencies; the harmful impact of anticompetitive foreign regulations on American businesses; and inappropriate attacks on the legitimate exercise of intellectual property by American firms (in particular, American patent holders).  As in the case of process-related concerns, White House attention and broad U.S. Government involvement in dealing with these problems may be essential.

That’s all for now, folks.  May you all enjoy your turkey and have a blessed Thanksgiving with friends and family.

Public comments on the proposed revision to the joint U.S. Federal Trade Commission (FTC) – U.S. Department of Justice (DOJ) Antitrust-IP Licensing Guidelines have, not surprisingly, focused primarily on fine points of antitrust analysis carried out by those two federal agencies (see, for example, the thoughtful recommendations by the Global Antitrust Institute, here).  In a September 23 submission to the FTC and the DOJ, however, U.S. International Trade Commissioner F. Scott Kieff focused on a broader theme – that patent-antitrust assessments should keep in mind the indirect effects on commercialization that stem from IP (and, in particular, patents).  Kieff argues that antitrust enforcers have employed a public law “rules-based” approach that balances the “incentive to innovate” created when patents prevent copying against the goals of competition.  In contrast, Kieff characterizes the commercialization approach as rooted in the property rights nature of patents and the use of private contracting to bring together complementary assets and facilitate coordination.  As Kieff explains (in italics, footnote citations deleted):

A commercialization approach to IP views IP more in the tradition of private law, rather than public law. It does so by placing greater emphasis on viewing IP as property rights, which in turn is accomplished by greater reliance on interactions among private parties over or around those property rights, including via contracts. Centered on the relationships among private parties, this approach to IP emphasizes a different target and a different mechanism by which IP can operate. Rather than target particular individuals who are likely to respond to IP as incentives to create or invent in particular, this approach targets a broad, diverse set of market actors in general; and it does so indirectly. This broad set of indirectly targeted actors encompasses the creator or inventor of the underlying IP asset as well as all those complementary users of a creation or an invention who can help bring it to market, such as investors (including venture capitalists), entrepreneurs, managers, marketers, developers, laborers, and owners of other key assets, tangible and intangible, including other creations or inventions. Another key difference in this approach to IP lies in the mechanism by which these private actors interact over and around IP assets. This approach sees IP rights as tools for facilitating coordination among these diverse private actors, in furtherance of their own private interests in commercializing the creation or invention.

This commercialization approach sees property rights in IP serving a role akin to beacons in the dark, drawing to themselves all of those potential complementary users of the IP-protected-asset to interact with the IP owner and each other. This helps them each explore through the bargaining process the possibility of striking contracts with each other.

Several payoffs can flow from using this commercialization approach. Focusing on such a beacon-and-bargain effect can relieve the governmental side of the IP system of the need to amass the detailed information required to reasonably tailor a direct targeted incentive, such as each actor’s relative interests and contributions, needs, skills, or the like. Not only is amassing all of that information hard for the government to do, but large, established market actors may be better able than smaller market entrants to wield the political influence needed to get the government to act, increasing risk of concerns about political economy, public choice, and fairness. Instead, when governmental bodies closely adhere to a commercialization approach, each private party can bring its own expertise and other assets to the negotiating table while knowing—without necessarily having to reveal to other parties or the government—enough about its own level of interest and capability when it decides whether to strike a deal or not.            

Such successful coordination may help bring new business models, products, and services to market, thereby decreasing anticompetitive concentration of market power. It also can allow IP owners and their contracting parties to appropriate the returns to any of the rival inputs they invested towards developing and commercializing creations or inventions—labor, lab space, capital, and the like. At the same time, the government can avoid having to then go back to evaluate and trace the actual relative contributions that each participant brought to a creation’s or an invention’s successful commercialization—including, again, the cost of obtaining and using that information and the associated risks of political influence—by enforcing the terms of the contracts these parties strike with each other to allocate any value resulting from the creation’s or invention’s commercialization. In addition, significant economic theory and empirical evidence suggests this can all happen while the quality-adjusted prices paid by many end users actually decline and public access is high. In keeping with this commercialization approach, patents can be important antimonopoly devices, helping a smaller “David” come to market and compete against a larger “Goliath.”

A commercialization approach thereby mitigates many of the challenges raised by the tension that is a focus of the other intellectual approaches to IP, as well as by the responses these other approaches have offered to that tension, including some – but not all – types of AT regulation and enforcement. Many of the alternatives to IP that are often suggested by other approaches to IP, such as rewards, tax credits, or detailed rate regulation of royalties by AT enforcers can face significant challenges in facilitating the private sector coordination benefits envisioned by the commercialization approach to IP. While such approaches often are motivated by concerns about rising prices paid by consumers and direct benefits paid to creators and inventors, they may not account for the important cases in which IP rights are associated with declines in quality-adjusted prices paid by consumers and other forms of commercial benefits accrued to the entire IP production team as well as to consumers and third parties, which are emphasized in a commercialization approach. In addition, a commercialization approach can embrace many of the practical checks on the market power of an IP right that are often suggested by other approaches to IP, such as AT review, government takings, and compulsory licensing. At the same time this approach can show the importance of maintaining self-limiting principles within each such check to maintain commercialization benefits and mitigate concerns about dynamic efficiency, public choice, fairness, and the like.

To be sure, a focus on commercialization does not ignore creators or inventors or creations or inventions themselves. For example, a system successful in commercializing inventions can have the collateral benefit of providing positive incentives to those who do invent through the possibility of sharing in the many rewards associated with successful commercialization. Nor does a focus on commercialization guarantee that IP rights cause more help than harm. Significant theoretical and empirical questions remain open about benefits and costs of each approach to IP. And significant room to operate can remain for AT enforcers pursuing their important public mission, including at the IP-AT interface.

Commissioner Kieff’s evaluation is in harmony with other recent scholarly work, including Professor Dan Spulber’s explanation that the actual nature of long-term private contracting arrangements among patent licensors and licensees avoids alleged competitive “imperfections,” such as harmful “patent hold-ups,” “patent thickets,” and “royalty stacking” (see my discussion here).  More generally, Commissioner Kieff’s latest pronouncement is part of a broader and growing theoretical and empirical literature that demonstrates close associations between strong patent systems and economic growth and innovation (see, for example, here).

There is a major lesson here for U.S. (and foreign) antitrust enforcement agencies.  As I have previously pointed out (see, for example, here), in recent years, antitrust enforcers here and abroad have taken positions that tend to weaken patent rights.  Those positions typically are justified by the existence of “patent policy deficiencies” such as those that Professor Spulber’s paper debunks, as well as an alleged epidemic of low quality “probabilistic patents” (see, for example, here) – justifications that ignore the substantial economic benefits patents confer on society through contracting and commercialization.  It is high time for antitrust to accommodate the insights drawn from this new learning.  Specifically, government enforcers should change their approach and begin incorporating private law/contracting/commercialization considerations into patent-antitrust analysis, in order to advance the core goals of antitrust – the promotion of consumer welfare and efficiency.  Better yet, if the FTC and DOJ truly want to maximize the net welfare benefits of antitrust, they should undertake a more general “policy reboot” and adopt a “decision-theoretic” error cost approach to enforcement policy, rooted in cost-benefit analysis (see here) and consistent with the general thrust of Roberts Court antitrust jurisprudence (see here).

The Global Antitrust Institute (GAI) at George Mason University’s Antonin Scalia Law School released today a set of comments on the joint U.S. Department of Justice (DOJ) – Federal Trade Commission (FTC) August 12 Proposed Update to their 1995 Antitrust Guidelines for the Licensing of Intellectual Property (Proposed Update).  As has been the case with previous GAI filings (see here, for example), today’s GAI Comments are thoughtful and on the mark.

For those of you who are pressed for time, the latest GAI comments make these major recommendations (summary in italics):

Standard Essential Patents (SEPs):  The GAI Comments commended the DOJ and the FTC for preserving the principle that the antitrust framework is sufficient to address potential competition issues involving all IPRs—including both SEPs and non-SEPs.  In doing so, the DOJ and the FTC correctly rejected the invitation to adopt a special brand of antitrust analysis for SEPs in which effects-based analysis was replaced with unique presumptions and burdens of proof. 

o   The GAI Comments noted that, as FTC Chairman Edith Ramirez has explained, “the same key enforcement principles [found in the 1995 IP Guidelines] also guide our analysis when standard essential patents are involved.”

o   This is true because SEP holders, like other IP holders, do not necessarily possess market power in the antitrust sense, and conduct by SEP holders, including breach of a voluntary assurance to license its SEP on fair, reasonable, and nondiscriminatory (FRAND) terms, does not necessarily result in harm to the competitive process or to consumers. 

o   Again, as Chairwoman Ramirez has stated, “it is important to recognize that a contractual dispute over royalty terms, whether the rate or the base used, does not in itself raise antitrust concerns.”

Refusals to License:  The GAI Comments expressed concern that the statements regarding refusals to license in Sections 2.1 and 3 of the Proposed Update seem to depart from the general enforcement approach set forth in the 2007 DOJ-FTC IP Report in which those two agencies stated that “[a]ntitrust liability for mere unilateral, unconditional refusals to license patents will not play a meaningful part in the interface between patent rights and antitrust protections.”  The GAI recommended that the DOJ and the FTC incorporate this approach into the final version of their updated IP Guidelines.

“Unreasonable Conduct”:  The GAI Comments recommended that Section 2.2 of the Proposed Update be revised to replace the phrase “unreasonable conduct” with a clear statement that the agencies will only condemn licensing restraints when anticompetitive effects outweigh procompetitive benefits.

R&D Markets:  The GAI Comments urged the DOJ and the FTC to reconsider the inclusion (or, at the very least, substantially limit the use) of research and development (R&D) markets because: (1) the process of innovation is often highly speculative and decentralized, making it impossible to identify all market participants to be; (2) the optimal relationship between R&D and innovation is unknown; (3) the market structure most conducive to innovation is unknown; (4) the capacity to innovate is hard to monopolize given that the components of modern R&D—research scientists, engineers, software developers, laboratories, computer centers, etc.—are continuously available on the market; and (5) anticompetitive conduct can be challenged under the actual potential competition theory or at a later time.

While the GAI Comments are entirely on point, even if their recommendations are all adopted, much more needs to be done.  The Proposed Update, while relatively sound, should be viewed in the larger context of the Obama Administration’s unfortunate use of antitrust policy to weaken patent rights (see my article here, for example).  In addition to strengthening the revised Guidelines, as suggested by the GAI, the DOJ and the FTC should work with other component agencies of the next Administration – including the Patent Office and the White House – to signal enhanced respect for IP rights in general.  In short, a general turnaround in IP policy is called for, in order to spur American innovation, which has been all too lacking in recent years.

For several decades, U.S. federal antitrust enforcers, on a bipartisan basis, have publicly supported the proposition that antitrust law seeks to advance consumer welfare by promoting economic efficiency and vigorous competition on the merits.  This reflects an economic interpretation of the antitrust laws adopted by the Supreme Court beginning in the late 1970s, inspired by the scholarship of Robert Bork and other law and economics experts.  As leading antitrust scholars Judge (and Professor) Douglas Ginsburg and Professor Joshua Wright have explained (footnotes omitted), the “economic approach” to antitrust has benefited the American economy and consumers:

The promotion of economic welfare as the lodestar of antitrust laws—to the exclusion of social, political, and protectionist goals—transformed the state of the law and restored intellectual coherence to a body of law Robert Bork had famously described as paradoxical. Indeed, there is now widespread agreement that this evolution toward welfare and away from noneconomic considerations has benefitted consumers and the economy more broadly. Welfare-based standards have led to greater predictability in judicial and agency decision making. They also rule out theories of liability (e.g., a transaction will tend to reduce the number of small businesses in a market) and defenses (e.g., the restraint upon trade is necessary to save consumers from the consequences of competition) that would significantly harm consumers.

It is therefore most regrettable that the Attorney General of the United States, who oversees U.S. Executive Branch antitrust enforcement (which is carried out by the U.S. Justice Department’s Antitrust Division), recently delivered a speech on federal antitrust enforcement that is, at the very least, in severe tension with the (up to now) bipartisan federal antitrust enforcement consensus regarding the efficiency-centered goal of antitrust.  In an April 6 keynote luncheon address to the Spring Meeting of the American Bar Association’s (ABA) Antitrust Section, Attorney General Loretta E. Lynch focused instead on the themes of “fairness” and “economic justice” in discussing American antitrust enforcement:

[The ABA Antitrust Section] ha[s] always stood at the forefront of the Bar’s [laudable] efforts to guarantee fair competition; to encourage transparent business practices; and, above all, to secure economic justice. . . .  [O]ur choices have always been steeped in fundamental fairness.  The Sherman [Antitrust] Act was also a landmark in the history of the Department of Justice, adding the maintenance of a level economic playing field to our fundamental mission of upholding the law and seeking justice.  And the principle that it embodied – that the people of this country deserve the freedom to navigate their own path and chart their own future – still stands at the core of our work.  Today, the Department of Justice is as committed to fair, open and competitive markets as it has ever been. . . .  All of us in this room have a responsibility to stand up for people where they cannot stand up for themselves.  We have a duty to defend the institutions that make this country strong . . . [including] markets that allow for competition that is fair, . . . [and] a nation where every person has a meaningful chance to succeed and to thrive. . . .  [A]ll of you are making a significant and lasting contribution to a stronger and more just society. 

“Fairness” and “economic justice” may be laudable (albeit ill-defined) social goals in the abstract, but antitrust is ill-suited to advance them.  Indeed, history demonstrates that invocation of those goals was associated with welfare-inimical American antitrust enforcement policies that ill-served the American public.  Prior to the 1970s, “fairness,” “justice,” and related concepts (such as “a level playing field”) were often cited by the courts and public enforcers to justify antitrust interventions aimed at protecting entrenched small businesses from more efficient competitors, and at precluding the aggressive exploitation of efficiencies by large innovative companies.  This often resulted in higher prices to consumers, sluggish economic productivity, and slower innovation and economic growth, to the detriment of the overall American economy.

Admittedly, modern U.S. federal antitrust case law holdings and enforcement tools emphasize economic efficiency, rather than “fairness” and “justice,” so one might be tempted to dismiss the Attorney General’s remarks as unfortunate but of no real consequence.  (In fairness, the Attorney General did pay lip service to the importance of competition and to recent enforcement victories by the Antitrust Division, although inexplicably she had nothing to say about cartel prosecutions – the one area of antitrust that is most clearly welfare-enhancing.)  Unfortunately, however, many foreign antitrust enforcement officials and practitioners attended her speech, which by now has been disseminated throughout the global antitrust enforcement community.  Significantly, a number of major foreign jurisdictions have recently employed antitrust concepts of “unfair competition” and “superior bargaining position” to attack efficient, economic welfare-enhancing business arrangements, such as patent licensing restrictions, by major companies (including U.S. multinationals).  When American competition experts urge foreign antitrust officials to eschew such tactics in favor of efficiency-based antitrust rules, it would not be surprising to see those officials invoke Attorney General Lynch’s unfortunate paean to “fairness” in defense of their approach.  (For this reason, U.S. Federal Trade Commissioner Maureen Ohlhausen has stressed that American officials should be careful in their public antitrust pronouncements, a warning that obviously went unheeded by the Attorney General’s April 6 speechwriter.)

One may only hope that going forward, Attorney General Lynch, and the U.S. antitrust enforcers who report to her, will keep these concerns in mind and publicly reaffirm their dedication to the accepted mainstream consensus view that American antitrust policy is based on efficiency and consumer welfare considerations, not on bygone populist nostrums of “fairness.”  In so doing, U.S. officials should emphasize that efficiency-based antitrust strengthens innovation, advances consumer welfare, and fosters strong economies, considerations that ideally should prove attractive to public officials from all jurisdictions.

By William Kolasky

Jon Jacobson in his initial posting claims that it would be “hard to find an easier case” than Apple e-Books, and David Balto and Chris Sagers seem to agree. I suppose that would be true if, as Richard Epstein claims, “the general view is that horizontal arrangements are per se unlawful.”

That, however, is not the law, and has not been since William Howard Taft’s 1898 opinion in Addyston Pipe. In his opinion, borrowing from an earlier dissenting opinion by Justice Edward Douglas White in Trans-Missouri Freight Ass’n, Taft surveyed the common law of restraints of trade. He showed that it was already well established in 1898 that even horizontal restraints of trade were not necessarily unlawful if they were ancillary to some legitimate business transaction or arrangement.

Building on that opinion, the Supreme Court, in what is now a long series of decisions beginning with BMI and continuing through Actavis, has made it perfectly clear that even a horizontal restraint cannot be condemned as per se unlawful unless it is a “naked” restraint that, on its face, could not serve any “plausible” procompetitive business purpose. That there are many horizontal arrangements that are not per se unlawful is shown by the DOJ’s own Competitor Collaboration Guidelines, which provide many examples, including joint sales agents.

As I suggested in my initial posting, Apple may have dug its own grave by devoting so much effort to denying the obvious—namely, that it had helped facilitate a horizontal agreement among the publishers, just as the lower courts found. Apple might have had more success had it instead spent more time explaining why it needed a horizontal agreement among the publishers as to the terms on which they would designate Apple as their common sales agent in order for it to successfully enter the e-book market, and why those terms did not amount to a naked horizontal price fixing agreement. Had it done so, Apple likely could have made a stronger case for why a rule of reason review was necessary than it did by trying to fit a square peg into a round hole by insisting that its agreements were purely vertical.