In the world of video games, the process by which players train themselves or their characters in order to overcome a difficult “boss battle” is called “leveling up.” I find that the phrase also serves as a useful metaphor in the context of corporate mergers. Here, “leveling up” can be thought of as acquiring another firm in order to enter or reinforce one’s presence in an adjacent market where a larger and more successful incumbent is already active.
In video-game terminology, that incumbent would be the “boss.” Acquiring firms choose to level up when they recognize that building internal capacity to compete with the “boss” is too slow, too expensive, or is simply infeasible. An acquisition thus becomes the only way “to beat the boss” (or, at least, to maximize the odds of doing so).
Alas, this behavior is often mischaracterized as a “killer acquisition” or “reverse killer acquisition.” What separates leveling up from killer acquisitions is that the former serve to turn the merged entity into a more powerful competitor, while the latter attempt to weaken competition. In the case of “reverse killer acquisitions,” the assumption is that the acquiring firm would have entered the adjacent market regardless absent the merger, leaving even more firms competing in that market.
In other words, the distinction ultimately boils down to a simple (though hard to answer) question: could both the acquiring and target firms have effectively competed with the “boss” without a merger?
Because they are ubiquitous in the tech sector, these mergers—sometimes also referred to as acquisitions of nascent competitors—have drawn tremendous attention from antitrust authorities and policymakers. All too often, policymakers fail to adequately consider the realistic counterfactual to a merger and mistake leveling up for a killer acquisition. The most recent high-profile example is Meta’s acquisition of the virtual-reality fitness app Within. But in what may be a hopeful sign of a turning of the tide, a federal court appears set to clear that deal over objections from the Federal Trade Commission (FTC).
Some Recent ‘Boss Battles’
The canonical example of leveling up in tech markets is likely Google’s acquisition of Android back in 2005. While Apple had not yet launched the iPhone, it was already clear by 2005 that mobile would become an important way to access the internet (including Google’s search services). Rumors were swirling that Apple, following its tremendously successful iPod, had started developing a phone, and Microsoft had been working on Windows Mobile for a long time.
In short, there was a serious risk that Google would be reliant on a single mobile gatekeeper (i.e., Apple) if it did not move quickly into mobile. Purchasing Android was seen as the best way to do so. (Indeed, averting an analogous sort of threat appears to be driving Meta’s move into virtual reality today.)
The natural next question is whether Google or Android could have succeeded in the mobile market absent the merger. My guess is that the answer is no. In 2005, Google did not produce any consumer hardware. Quickly and successfully making the leap would have been daunting. As for Android:
Google had significant advantages that helped it to make demands from carriers and OEMs that Android would not have been able to make. In other words, Google was uniquely situated to solve the collective action problem stemming from OEMs’ desire to modify Android according to their own idiosyncratic preferences. It used the appeal of its app bundle as leverage to get OEMs and carriers to commit to support Android devices for longer with OS updates. The popularity of its apps meant that OEMs and carriers would have great difficulty in going it alone without them, and so had to engage in some contractual arrangements with Google to sell Android phones that customers wanted. Google was better resourced than Android likely would have been and may have been able to hold out for better terms with a more recognizable and desirable brand name than a hypothetical Google-less Android. In short, though it is of course possible that Android could have succeeded despite the deal having been blocked, it is also plausible that Android became so successful only because of its combination with Google. (citations omitted)
In short, everything suggests that Google’s purchase of Android was a good example of leveling up. Note that much the same could be said about the company’s decision to purchase Fitbit in order to compete against Apple and its Apple Watch (which quickly dominated the market after its launch in 2015).
A more recent example of leveling up is Microsoft’s planned acquisition of Activision Blizzard. In this case, the merger appears to be about improving Microsoft’s competitive position in the platform market for game consoles, rather than in the adjacent market for games.
At the time of writing, Microsoft is staring down the barrel of a gun: Sony is on the cusp of becoming the runaway winner of yet another console generation. Microsoft’s executives appear to have concluded that this is partly due to a lack of exclusive titles on the Xbox platform. Hence, they are seeking to purchase Activision Blizzard, one of the most successful game studios, known among other things for its acclaimed Call of Duty series.
Again, the question is whether Microsoft could challenge Sony by improving its internal game-publishing branch (known as Xbox Game Studios) or whether it needs to acquire a whole new division. This is obviously a hard question to answer, but a cursory glance at the titles shipped by Microsoft’s publishing studio suggest that the issues it faces could not simply be resolved by throwing more money at its existing capacities. Indeed, Microsoft Game Studios seems to be plagued by organizational failings that might only be solved by creating more competition within the Microsoft company. As one gaming journalist summarized:
The current predicament of these titles goes beyond the amount of money invested or the buzzwords used to market them – it’s about Microsoft’s plan to effectively manage its studios. Encouraging independence isn’t an excuse for such a blatantly hands-off approach which allows titles to fester for years in development hell, with some fostering mistreatment to occur. On the surface, it’s just baffling how a company that’s been ranked as one of the top 10 most reputable companies eight times in 11 years (as per RepTrak) could have such problems with its gaming division.
The upshot is that Microsoft appears to have recognized that its own game-development branch is failing, and that acquiring a well-functioning rival is the only way to rapidly compete with Sony. There is thus a strong case to be made that competition authorities and courts should approach the merger with caution, as it has at least the potential to significantly increase competition in the game-console industry.
Finally, leveling up is sometimes a way for smaller firms to try and move faster than incumbents into a burgeoning and promising segment. The best example of this is arguably Meta’s effort to acquire Within, a developer of VR fitness apps. Rather than being an attempt to thwart competition from a competitor in the VR app market, the goal of the merger appears to be to compete with the likes of Google, Apple, and Sony at the platform level. As Mark Zuckerberg wrote back in 2015, when Meta’s VR/AR strategy was still in its infancy:
Our vision is that VR/AR will be the next major computing platform after mobile in about 10 years… The strategic goal is clearest. We are vulnerable on mobile to Google and Apple because they make major mobile platforms. We would like a stronger strategic position in the next wave of computing….
Over the next few years, we’re going to need to make major new investments in apps, platform services, development / graphics and AR. Some of these will be acquisitions and some can be built in house. If we try to build them all in house from scratch, then we risk that several will take too long or fail and put our overall strategy at serious risk. To derisk this, we should acquire some of these pieces from leading companies.
In short, many of the tech mergers that critics portray as killer acquisitions are just as likely to be attempts by firms to compete head-on with incumbents. This “leveling up” is precisely the sort of beneficial outcome that antitrust laws were designed to promote.
Building Products Is Hard
Critics are often quick to apply the “killer acquisition” label to any merger where a large platform is seeking to enter or reinforce its presence in an adjacent market. The preceding paragraphs demonstrate that it’s not that simple, as these mergers often enable firms to improve their competitive position in the adjacent market. For obvious reasons, antitrust authorities and policymakers should be careful not to thwart this competition.
The harder part is how to separate the wheat from the chaff. While I don’t have a definitive answer, an easy first step would be for authorities to more seriously consider the supply side of the equation.
Building a new product is incredibly hard, even for the most successful tech firms. Microsoft famously failed with its Zune music player and Windows Phone. The Google+ social network never gained any traction. Meta’s foray into the cryptocurrency industry was a sobering experience. Amazon’s Fire Phone bombed. Even Apple, which usually epitomizes Silicon Valley firms’ ability to enter new markets, has had its share of dramatic failures: Apple Maps, its Ping social network, and the first Home Pod, to name a few.
To put it differently, policymakers should not assume that internal growth is always a realistic alternative to a merger. Instead, they should carefully examine whether such a strategy is timely, cost-effective, and likely to succeed.
This is obviously a daunting task. Firms will struggle to dispositively show that they need to acquire the target firm in order to effectively compete against an incumbent. The question essentially hinges on the quality of the firm’s existing management, engineers, and capabilities. All of these are difficult—perhaps even impossible—to measure. At the very least, policymakers can improve the odds of reaching a correct decision by approaching these mergers with an open mind.
Unfortunately, this skeptical approach is something of a self-fulfilling prophecy: when authorities view mergers with suspicion, they are likely to be dismissive of the benefits discussed above. Mergers will be blocked and entry into adjacent markets will occur via internal growth.
Large tech companies’ many failed attempts to enter adjacent markets via internal growth suggest that such an outcome would ultimately harm the digital economy. Too many “boss battles” will needlessly be lost, depriving consumers of precious competition and destroying startup companies’ exit strategies.
In recent years, a growing chorus of voices has argued that existing merger rules fail to apprehend competitively significant mergers, either because they fall below existing merger-filing thresholds or because they affect innovation in ways that are purportedly ignored.
These fears are particularly acute in the pharmaceutical and tech industries, where several high-profile academic articles and reports claim to have identified important gaps in current merger-enforcement rules, particularly with respect to acquisitions involving nascent and potential competitors (here, here, and here, among many others).
Such fears have led activists, lawmakers, and enforcers to call for tougher rules, including the introduction of more stringent merger-filing thresholds and other substantive changes, such as the inversion of the burden of proof when authorities review mergers and acquisitions involving digital platforms.
However, as we discuss in a recent working paper—forthcoming in the Missouri Law Review and available on SSRN—these proposals tend to overlook the important tradeoffs that would ensue from attempts to decrease the number of false positives under existing merger rules and thresholds.
The paper draws from two key strands of economic literature that are routinely overlooked (or summarily dismissed) by critics of the status quo.
For a start, antitrust enforcement is not costless. In the case of merger enforcement, not only is it expensive for agencies to detect anticompetitive deals but, more importantly, overbearing rules may deter beneficial merger activity that creates value for consumers.
Second, critics tend to overlook the possibility that incumbents’ superior managerial or other capabilities (i.e., what made them successful in the first place) makes them the ideal acquisition partners for entrepreneurs and startup investors looking to sell.
The result is a body of economic literature that focuses almost entirely on hypothetical social costs, while ignoring the redeeming benefits of corporate acquisitions, as well as the social cost of enforcement.
One of the most significant allegations leveled against large tech firms is that their very presence in a market may hinder investments, entry, and innovation, creating what some have called a “kill zone.” The strongest expression in the economic literature of this idea of a kill zone stems from a working paper by Sai Krishna Kamepalli, Raghuram Rajan, and Luigi Zingales.
The paper makes two important claims, one theoretical and one empirical. From a theoretical standpoint, the authors argue that the prospect of an acquisition by a dominant platform deters consumers from joining rival platforms, and that this, in turn, hampers the growth of these rivals. The authors then test a similar hypothesis empirically. They find that acquisitions by a dominant platform—such as Google or Facebook—decrease investment levels and venture capital deals in markets that are “similar” to that of the target firm.
But both findings are problematic. For a start, Zingales and his co-authors’ theoretical model is premised on questionable assumptions about the way in which competition develops in the digital space. The first is that early adopters of new platforms—called “techies” in the authors’ parlance—face high switching costs because of their desire to learn these platforms in detail. As an initial matter, it would appear facially contradictory that “techies” both are the group with the highest switching costs and that they switch the most. The authors further assume that “techies” would incur lower adoption costs if they remained on the incumbent platform and waited for the rival platform to be acquired.
Unfortunately, while these key behavioral assumptions drive the results of the theoretical model, the paper presents no evidence to support their presence in real-world settings. In that sense, the authors commit the same error as previous theoretical work concerning externalities, which have tended to overestimate their frequency.
Second, the empirical analysis put forward in the paper is unreliable for policymaking purposes. The authors notably find that:
[N]ormalized VC investments in start-ups in the same space as the company acquired by Google and Facebook drop by over 40% and the number of deals falls by over 20% in the three years following an acquisition.
However, the results of this study are derived from the analysis of only nine transactions. The study also fails to clearly show that firms in the treatment and controls are qualitatively similar. In a nutshell, the study compares industry acquisitions exceeding $500 million to Facebook and Google’s acquisitions that exceed that amount. This does not tell us whether the mergers in both groups involved target companies with similar valuations or similar levels of maturity. This does not necessarily invalidate the results, but it does suggest that policymakers should be circumspect in interpreting those results.
Finally, the paper fails to demonstrate evidence that existing antitrust regimes fail to achieve an optimal error-cost balance. The central problem is that the paper has indeterminate welfare implications. For instance, as the authors note, the declines in investment in spaces adjacent to the incumbent platforms occurred during a time of rapidly rising venture capital investment, both in terms of the number of deals and dollars invested. It is entirely plausible that venture capital merely shifted to other sectors.
Put differently, on its own terms, the evidence merely suggests that acquisitions by Google and Facebook affected the direction of innovation, not its overall rate. And there is little to suggest that this shift was suboptimal, from a welfare standpoint.
In short, as the authors themselves conclude: “[i]t would be premature to draw any policy conclusion on antitrust enforcement based solely on our model and our limited evidence.”
Mergers and Potential Competition
Scholars have also posited more direct effects from acquisitions of startups or nascent companies by incumbent technology market firms.
Acquisitions of potential or nascent competitors by a dominant firm raise inherent anticompetitive concerns. By eliminating the procompetitive impact of the entry, an acquisition can allow the dominant firm to continue to exercise monopoly power and earn monopoly profits. The dominant firm also can neutralize the potential innovation competition that the entrant would provide.
However, these antitrust theories of harm suffer from several important flaws. They rest upon several restrictive assumptions that are not certain to occur in real-world settings. Most are premised on the notion that, in a given market, monopoly profits generally exceed joint duopoly profits. This allegedly makes it profitable, and mutually advantageous, for an incumbent to protect its monopoly position by preemptively acquiring potential rivals.
Accordingly, under these theories, anticompetitive mergers are only possible when the acquired rival could effectively challenge the incumbent. But these are, of course, only potential challengers; there is no guarantee that any one of them could or would mount a viable competitive threat.
Less obviously, it must be the case that the rival can hope to share only duopoly profits, as opposed to completely overthrowing the incumbent or surpassing them with a significantly larger share of the market. Where competition is “for the market” itself, monopoly maintenance would fail to explain a rival’s decision to sell. Because there would be no asymmetry between the expected profits of the incumbent and the rival, monopoly maintenance alone would not give rise to mutually advantageous deals.
Second, potential competition does not always increase consumer welfare. Indeed, while the presence of potential competitors might increase price competition, it can also have supply-side effects that cut in the opposite direction.
For example, as Nobel laureate Joseph Stiglitz observed, a monopolist threatened by potential competition may invest in socially wasteful R&D efforts or entry-deterrence mechanisms, and it may operate at below-optimal scale in anticipation of future competitive entry.
There are also pragmatic objections. Analyzing a merger’s effect on potential competition would compel antitrust authorities and courts to make increasingly speculative assessments concerning the counterfactual setting of proposed acquisitions.
In simple terms, it is far easier to determine whether a merger between McDonald’s and Burger King would lead to increased hamburger prices in the short run than it is to determine whether a gaming platform like Steam or the Epic Games Store might someday compete with video-streaming or music-subscription platforms like Netflix or Spotify. It is not that the above models are necessarily wrong, but rather that applying them to practical cases would require antitrust enforcers to estimate mostly unknowable factors.
Finally, the real test for regulators is not just whether they can identify possibly anticompetitive mergers, but whether they can do so in a cost-effective manner. Whether it is desirable to implement a given legal test is not simply a function of its accuracy, the cost to administer it, and the respective costs of false positives and false negatives. It also critically depends on how prevalent the conduct is that adjudicators would be seeking to foreclose.
Consider two hypothetical settings. Imagine there are 10,000 tech mergers in a given year, of which either 1,000 or 2,500 are anticompetitive (the remainder are procompetitive or competitively neutral). Suppose that authorities can either attempt to identify anticompetitive mergers with 75% accuracy, or perform no test at all—i.e., letting all mergers go through unchallenged.
If there are 1,000 anticompetitive mergers, applying the test would result in 7,500 correct decisions and 2,500 incorrect ones (2,250 false positives and 250 false negatives). Doing nothing would lead to 9,000 correct decisions and 1,000 false negatives. If the number of anticompetitive deals were 2,500, applying the test would lead to the same number of incorrect decisions as not applying it (1,875 false positives and 625 false negatives, versus 2,500 false negatives). The advantage would tilt toward applying the test if anticompetitive mergers were even more widespread.
This hypothetical example holds a simple lesson for policymakers: the rarer the conduct that they are attempting to identify, the more accurate their identification method must be, and the more costly false negatives must be relative to false positives.
As discussed below, current empirical evidence does not suggest that anticompetitive mergers of this sort are particularly widespread, nor does it offer accurate heuristics to detect the ones that are. Finally, there is little sense that the cost of false negatives significantly outweighs that of false positives. In short, there is currently little evidence to suggest that tougher enforcement would benefit consumers.
Killer acquisitions are, effectively, a subset of the “potential competitor” mergers discussed in the previous section. As defined by Colleen Cunningham, Florian Ederer, and Song Ma, they are those deals where “an incumbent firm may acquire an innovative target and terminate the development of the target’s innovations to preempt future competition.”
Cunningham, Ederer, and Ma’s highly influential paper on killer acquisitions has been responsible for much of the recent renewed interest in the effect that mergers exert on innovation. The authors studied thousands of pharmaceutical mergers and concluded that between 5.3% and 7.4% of them were killer acquisitions. As they write:
[W]e empirically compare development probabilities of overlapping acquisitions, which are, in our theory, motivated by a mix of killer and development intentions, and non-overlapping acquisitions, which are motivated only by development intentions. We find an increase in acquisition probability and a decrease in post-acquisition development for overlapping acquisitions and interpret that as evidence for killer acquisitions. […]
[W]e find that projects acquired by an incumbent with an overlapping drug are 23.4% less likely to have continued development activity compared to drugs acquired by non-overlapping incumbents.
From a policy standpoint, the question is what weight antitrust authorities, courts, and legislators should give to these findings. Stated differently, does the paper provide sufficient evidence to warrant reform of existing merger-filing thresholds and review standards? There are several factors counseling that policymakers should proceed with caution.
To start, the study’s industry-specific methodology means that it may not be a useful guide to understand acquisitions in other industries, like the tech sector, for example.
Second, even if one assumes that the findings of Cunningham, et al., are correct and apply with equal force in the tech sector (as some official reports have), it remains unclear whether the 5.3–7.4% of mergers they describe warrant a departure from the status quo.
Antitrust enforcers operate under uncertainty. The critical policy question is thus whether this subset of anticompetitive deals can be identified ex-ante. If not, is there a heuristic that would enable enforcers to identify more of these anticompetitive deals without producing excessive false positives?
The authors focus on the effect that overlapping R&D pipelines have on project discontinuations. In the case of non-overlapping mergers, acquired projects continue 17.5% of the time, while this number is 13.4% when there are overlapping pipelines. The authors argue that this gap is evidence of killer acquisitions. But it misses the bigger picture: under the authors’ own numbers and definition of a “killer acquisition,” a vast majority of overlapping acquisitions are perfectly benign; prohibiting them would thus have important social costs.
Third, there are several problems with describing this kind of behavior as harmful. Indeed, Cunningham, et al., acknowledge that this kind of behavior could increase innovation by boosting the returns to innovation.
And even if one ignores incentives to innovate, product discontinuations can improve consumer welfare. This question ultimately boils down to identifying the counterfactual to a merger. As John Yun writes:
For instance, an acquisition that results in a discontinued product is not per se evidence of either consumer harm or benefit. The answer involves comparing the counterfactual world without the acquisition with the world with the acquisition. The comparison includes potential efficiencies that were gained from the acquisition, including integration of intellectual property, the reduction of transaction costs, economies of scope, and better allocation of skilled labor.
One of the reasons R&D project discontinuation may be beneficial is simply cost savings. R&D is expensive. Pharmaceutical firms spend up to 27.8% of their annual revenue on R&D. Developing a new drug has an estimated median cost of $985.3 million. Cost-cutting—notably as it concerns R&D—is thus a critical part of pharmaceutical (as well as tech) companies’ businesses. As a report by McKinsey concludes:
The recent boom in M&A in the pharma industry is partly the result of attempts to address short-term productivity challenges. An acquiring or merging company typically designs organization-wide integration programs to capture synergies, especially in costs. Such programs usually take up to three years to complete and deliver results.
Maximizing the efficiency of production labor and equipment is one important way top-quartile drugmakers break out of the pack. Their rates of operational-equipment effectiveness are more than twice those of bottom-quartile companies (Exhibit 1), and when we looked closely we found that processes account for two-thirds of the difference.
In short, pharmaceutical companies do not just compete along innovation-related parameters, though these are obviously important, but also on more traditional grounds such as cost-rationalization. Accordingly, as the above reports suggest, pharmaceutical mergers are often about applying an incumbent’s superior managerial efficiency to the acquired firm’s assets through operation of the market for corporate control.
This cost-cutting (and superior project selection) ultimately enables companies to offer lower prices, thereby benefiting consumers and increasing their incentives to invest in R&D in the first place by making successfully developed drugs more profitable.
In that sense, Henry Manne’s seminal work relating to mergers and the market for corporate control sheds at least as much light on pharmaceutical (and tech) mergers as the killer acquisitions literature. And yet, it is hardly ever mentioned in modern economic literature on this topic.
While Colleen Cunningham and her co-authors do not entirely ignore these considerations, as we discuss in our paper, their arguments for dismissing them are far from watertight.
A natural extension of the killer acquisitions work is to question whether mergers of this sort also take place in the tech industry. Interest in this question is notably driven by the central role that digital markets currently occupy in competition-policy discussion, but also by the significant number of startup acquisitions that take place in the tech industry. However, existing studies provide scant evidence that killer acquisitions are a common occurrence in these markets.
This is not surprising. Unlike in the pharmaceutical industry—where drugs need to go through a lengthy and visible regulatory pipeline before they can be sold—incumbents in digital industries will likely struggle to identify their closest rivals and prevent firms from rapidly pivoting to seize new commercial opportunities. As a result, the basic conditions for killer acquisitions to take place (i.e., firms knowing they are in a position to share monopoly profits) are less likely to be present; it also would be harder to design research methods to detect these mergers.
The empirical literature on killer acquisitions in the tech sector is still in its infancy. But, as things stand, no study directly examines whether killer acquisitions actually take place in digital industries (i.e., whether post-merger project discontinuations are more common in overlapping than non-overlapping tech mergers). This is notably the case for studies by Axel Gautier & Joe Lamesch, and Elena Argentesi and her co-authors. Instead, these studies merely show that product discontinuations are common after an acquisition by a big tech company.
To summarize, while studies of this sort might suggest that the clearance of certain mergers might not have been optimal, it is hardly a sufficient basis on which to argue that enforcement should be tightened.
The reason for this is simple. The fact that some anticompetitive mergers may have escaped scrutiny and/or condemnation is never a sufficient basis to tighten rules. For that, it is also necessary to factor in the administrative costs of increased enforcement, as well as potential false convictions to which it might give rise. As things stand, economic research on killer acquisitions in the tech sector does not warrant tougher antitrust enforcement, though it does show the need for further empirical research on the topic.
Many proposed merger-enforcement reforms risk throwing the baby out with the bathwater. Mergers are largely beneficial to society (here, here and here); anticompetitive ones are rare; and there is little way, at the margin, to tell good from bad. To put it mildly, there is a precious baby that needs to be preserved and relatively little bathwater to throw out.
Take the fulcrum of policy debates that is the pharmaceutical industry. It is not hard to point to pharmaceutical mergers (or long-term agreements) that have revolutionized patient outcomes. Most recently, Pfizer and BioNTech’s efforts to successfully market an mRNA vaccine against COVID-19 offers a case in point.
The deal struck by both firms could naïvely be construed as bearing hallmarks of a killer acquisition or an anticompetitive agreement (long-term agreements can easily fall into either of these categories). Pfizer was a powerful incumbent in the vaccine industry; BioNTech threatened to disrupt the industry with new technology; and the deal likely caused Pfizer to forgo some independent R&D efforts. And yet, it also led to the first approved COVID-19 vaccine and groundbreaking advances in vaccine technology.
Of course, the counterfactual is unclear, and the market might be more competitive absent the deal, just as there might be only one approved mRNA vaccine today instead of two—we simply do not know. More importantly, this counterfactual was even less knowable at the time of the deal. And much the same could be said about countless other pharmaceutical mergers.
The key policy question is how authorities should handle this uncertainty. Critics of the status quo argue that current rules and thresholds leave certain anticompetitive deals unchallenged. But these calls for tougher enforcement fail to satisfy the requirements of the error-cost framework. Critics have so far failed to show that, on balance, mergers harm social welfare—even overlapping ones or mergers between potential competitors—just as they are yet to suggest alternative institutional arrangements that would improve social welfare.
In other words, they mistakenly analyze purported false negatives of merger-enforcement regimes in isolation. In doing so, they ignore how measures that aim to reduce such judicial errors may lead to other errors, as well as higher enforcement costs. In short, they paint a world where policy decisions involve facile tradeoffs, and this undermines their policy recommendations.
Given these significant limitations, this body of academic research should be met with an appropriate degree of caution. For all the criticism it has faced, the current merger-review system is mostly a resounding success. It is administrable, predictable, and timely. Yet it also eliminates a vast majority of judicial errors: even its critics concede that false negatives make up only a tiny fraction of decisions. Policymakers must decide whether the benefits from catching the very few arguably anticompetitive mergers that currently escape prosecution outweigh the significant costs that are required to achieve this goal. There is currently little evidence to suggest that this is, indeed, the case.
This post is authored by Nicolas Petit himself, the Joint Chair in Competition Law at the Department of Law at European University Institute in Fiesole, Italy, and at EUI’s Robert Schuman Centre for Advanced Studies. He is also invited professor at the College of Europe in Bruges.]
A lot of water has gone under the bridge since my book was published last year. To close this symposium, I thought I would discuss the new phase of antirust statutorification taking place before our eyes. In the United States, Congress is working on five antitrust bills that propose to subject platforms to stringent obligations, including a ban on mergers and acquisitions, required data portability and interoperability, and line-of-business restrictions. In the European Union (EU), lawmakers are examining the proposed Digital Markets Act (“DMA”) that sets out a complicated regulatory system for digital “gatekeepers,” with per se behavioral limitations of their freedom over contractual terms, technological design, monetization, and ecosystem leadership.
Proponents of legislative reform on both sides of the Atlantic appear to share the common view that ongoing antitrust adjudication efforts are both instrumental and irrelevant. They are instrumental because government (or plaintiff) losses build the evidence needed to support the view that antitrust doctrine is exceedingly conservative, and that legal reform is needed. Two weeks ago, antitrust reform activists ran to Twitter to point out that the U.S. District Court dismissal of the Federal Trade Commission’s (FTC) complaint against Facebook was one more piece of evidence supporting the view that the antitrust pendulum needed to swing. They are instrumental because, again, government (or plaintiffs) wins will support scaling antitrust enforcement in the marginal case by adoption of governmental regulation. In the EU, antitrust cases follow each other almost like night the day, lending credence to the view that regulation will bring much needed coordination and economies of scale.
But both instrumentalities are, at the end of the line, irrelevant, because they lead to the same conclusion: legislative reform is long overdue. With this in mind, the logic of lawmakers is that they need not await the courts, and they can advance with haste and confidence toward the promulgation of new antitrust statutes.
The antitrust reform process that is unfolding is a cause for questioning. The issue is not legal reform in itself. There is no suggestion here that statutory reform is necessarily inferior, and no correlative reification of the judge-made-law method. Legislative intervention can occur for good reason, like when it breaks judicial inertia caused by ideological logjam.
The issue is rather one of precipitation. There is a lot of learning in the cases. The point, simply put, is that a supplementary court-legislative dialogue would yield additional information—or what Guido Calabresi has called “starting points” for regulation—that premature legislative intervention is sweeping under the rug. This issue is important because specification errors (see Doug Melamed’s symposium piece on this) in statutory legislation are not uncommon. Feedback from court cases create a factual record that will often be missing when lawmakers act too precipitously.
Moreover, a court-legislative iteration is useful when the issues in discussion are cross-cutting. The digital economy brings an abundance of them. As tech analysist Ben Evans has observed, data-sharing obligations raise tradeoffs between contestability and privacy. Chapter VI of my book shows that breakups of social networks or search engines might promote rivalry and, at the same time, increase the leverage of advertisers to extract more user data and conduct more targeted advertising. In such cases, Calabresi said, judges who know the legal topography are well-placed to elicit the preferences of society. He added that they are better placed than government agencies’ officials or delegated experts, who often attend to the immediate problem without the big picture in mind (all the more when officials are denied opportunities to engage with civil society and the press, as per the policy announced by the new FTC leadership).
Of course, there are three objections to this. The first consists of arguing that statutes are needed now because courts are too slow to deal with problems. The argument is not dissimilar to Frank Easterbrook’s concerns about irreversible harms to the economy, though with a tweak. Where Easterbook’s concern was one of ossification of Type I errors due to stare decisis, the concern here is one of entrenchment of durable monopoly power in the digital sector due to Type II errors. The concern, however, fails the test of evidence. The available data in both the United States and Europe shows unprecedented vitality in the digital sector. Venture capital funding cruises at historical heights, fueling new firm entry, business creation, and economic dynamism in the U.S. and EU digital sectors, topping all other industries. Unless we require higher levels of entry from digital markets than from other industries—or discount the social value of entry in the digital sector—this should give us reason to push pause on lawmaking efforts.
The second objection is that following an incremental process of updating the law through the courts creates intolerable uncertainty. But this objection, too, is unconvincing, at best. One may ask which of an abrupt legislative change of the law after decades of legal stability or of an experimental process of judicial renovation brings more uncertainty.
Besides, ad hoc statutes, such as the ones in discussion, are likely to pose quickly and dramatically the problem of their own legal obsolescence. Detailed and technical statutes specify rights, requirements, and procedures that often do not stand the test of time. For example, the DMA likely captures Windows as a core platform service subject to gatekeeping. But is the market power of Microsoft over Windows still relevant today, and isn’t it constrained in effect by existing antitrust rules? In antitrust, vagueness in critical statutory terms allows room for change. The best way to give meaning to buzzwords like “smart” or “future-proof” regulation consists of building in first principles, not in creating discretionary opportunities for permanent adaptation of the law. In reality, it is hard to see how the methods of future-proof regulation currently discussed in the EU creates less uncertainty than a court process.
The third objection is that we do not need more information, because we now benefit from economic knowledge showing that existing antitrust laws are too permissive of anticompetitive business conduct. But is the economic literature actually supportive of stricter rules against defendants than the rule-of-reason framework that applies in many unilateral conduct cases and in merger law? The answer is surely no. The theoretical economic literature has travelled a lot in the past 50 years. Of particular interest are works on network externalities, switching costs, and multi-sided markets. But the progress achieved in the economic understanding of markets is more descriptive than normative.
Take the celebrated multi-sided market theory. The main contribution of the theory is its advice to decision-makers to take the periscope out, so as to consider all possible welfare tradeoffs, not to be more or less defendant friendly. Payment cards provide a good example. Economic research suggests that any antitrust or regulatory intervention on prices affect tradeoffs between, and payoffs to, cardholders and merchants, cardholders and cash users, cardholders and banks, and banks and card systems. Equally numerous tradeoffs arise in many sectors of the digital economy, like ridesharing, targeted advertisement, or social networks. Multi-sided market theory renders these tradeoffs visible. But it does not come with a clear recipe for how to solve them. For that, one needs to follow first principles. A system of measurement that is flexible and welfare-based helps, as Kelly Fayne observed in her critical symposium piece on the book.
Another example might be worth considering. The theory of increasing returns suggests that markets subject to network effects tend to converge around the selection of a single technology standard, and it is not a given that the selected technology is the best one. One policy implication is that social planners might be justified in keeping a second option on the table. As I discuss in Chapter V of my book, the theory may support an M&A ban against platforms in tipped markets, on the conjecture that the assets of fringe firms might be efficiently repositioned to offer product differentiation to consumers. But the theory of increasing returns does not say under what conditions we can know that the selected technology is suboptimal. Moreover, if the selected technology is the optimal one, or if the suboptimal technology quickly obsolesces, are policy efforts at all needed?
Last, as Bo Heiden’s thought provoking symposium piece argues, it is not a given that antitrust enforcement of rivalry in markets is the best way to maintain an alternative technology alive, let alone to supply the innovation needed to deliver economic prosperity. Government procurement, science and technology policy, and intellectual-property policy might be equally effective (note that the fathers of the theory, like Brian Arthur or Paul David, have been very silent on antitrust reform).
There are, of course, exceptions to the limited normative content of modern economic theory. In some areas, economic theory is more predictive of consumer harms, like in relation to algorithmic collusion, interlocking directorates, or “killer” acquisitions. But the applications are discrete and industry-specific. All are insufficient to declare that the antitrust apparatus is dated and that it requires a full overhaul. When modern economic research turns normative, it is often way more subtle in its implications than some wild policy claims derived from it. For example, the emerging studies that claim to identify broad patterns of rising market power in the economy in no way lead to an implication that there are no pro-competitive mergers.
Similarly, the empirical picture of digital markets is incomplete. The past few years have seen a proliferation of qualitative research reports on industry structure in the digital sectors. Most suggest that industry concentration has risen, particularly in the digital sector. As with any research exercise, these reports’ findings deserve to be subject to critical examination before they can be deemed supportive of a claim of “sufficient experience.” Moreover, there is no reason to subject these reports to a lower standard of accountability on grounds that they have often been drafted by experts upon demand from antitrust agencies. After all, we academics are ethically obliged to be at least equally exacting with policy-based research as we are with science-based research.
Now, with healthy skepticism at the back of one’s mind, one can see immediately that the findings of expert reports to date have tended to downplay behavioral observations that counterbalance findings of monopoly power—such as intense business anxiety, technological innovation, and demand-expansion investments in digital markets. This was, I believe, the main takeaway from Chapter IV of my book. And less than six months ago, The Economist ran its leading story on the new marketplace reality of “Tech’s Big Dust-Up.”
Similarly, the expert reports did not really question the real possibility of competition for the purchase of regulation. As in the classic George Stigler paper, where the railroad industry fought motor-trucking competition with state regulation, the businesses that stand to lose most from the digital transformation might be rationally jockeying to convince lawmakers that not all business models are equal, and to steer regulation toward specific business models. Again, though we do not know how to consider this issue, there are signs that a coalition of large news corporations and the publishing oligopoly are behind many antitrust initiatives against digital firms.
Now, as is now clear from these few lines, my cautionary note against antitrust statutorification might be more relevant to the U.S. market. In the EU, sunk investments have been made, expectations have been created, and regulation has now become inevitable. The United States, however, has a chance to get this right. Court cases are the way to go. And unlike what the popular coverage suggests, the recent District Court dismissal of the FTC case far from ruled out the applicability of U.S. antitrust laws to Facebook’s alleged killer acquisitions. On the contrary, the ruling actually contains an invitation to rework a rushed complaint. Perhaps, as Shane Greenstein observed in his retrospective analysis of the U.S. Microsoft case, we would all benefit if we studied more carefully the learning that lies in the cases, rather than haste to produce instant antitrust analysis on Twitter that fits within 280 characters.
 But some threshold conditions like agreement or dominance might also become dated.
[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.
This post is authored by Geoffrey A. Manne, (President, ICLE; Distinguished Fellow, Northwestern University Center on Law, Business, and Economics); and Dirk Auer, (Senior Fellow of Law & Economics, ICLE)]
Back in 2012, Covidien, a large health care products company and medical device manufacturer, purchased Newport Medical Instruments, a small ventilator developer and manufacturer. (Covidien itself was subsequently purchased by Medtronic in 2015).
Eight years later, in the midst of the coronavirus pandemic, the New York Times has just published an article revisiting the Covidien/Newport transaction, and questioning whether it might have contributed to the current shortage of ventilators.
The article speculates that Covidien’s purchase of Newport, and the subsequent discontinuation of Newport’s “Aura” ventilator — which was then being developed by Newport under a government contract — delayed US government efforts to procure mechanical ventilators until the second half of 2020 — too late to treat the first wave of COVID-19 patients:
And then things suddenly veered off course. A multibillion-dollar maker of medical devices bought the small California company that had been hired to design the new machines. The project ultimately produced zero ventilators.
That failure delayed the development of an affordable ventilator by at least half a decade, depriving hospitals, states and the federal government of the ability to stock up.
* * *
Today, with the coronavirus ravaging America’s health care system, the nation’s emergency-response stockpile is still waiting on its first shipment.
The article has generated considerable interest not so much for what it suggests about government procurement policies or for its relevance to the ventilator shortages associated with the current pandemic, but rather for its purported relevance to ongoing antitrust debates and the arguments put forward by “antitrust populists” and others that merger enforcement in the US is dramatically insufficient.
Only a single sentence in the article itself points to a possible antitrust story — and it does nothing more than report unsubstantiated speculation from unnamed “government officials” and rival companies:
Government officials and executives at rival ventilator companies said they suspected that Covidien had acquired Newport to prevent it from building a cheaper product that would undermine Covidien’s profits from its existing ventilator business.
Nevertheless, and right on cue, various antitrust scholars quickly framed the deal as a so-called “killer acquisition” (see also here and here):
Unsurprisingly, politicians were also quick to jump on the bandwagon. David Cicilline, the powerful chairman of the House Antitrust Subcommittee, opined that:
The public reporting on this acquisition raises important questions about the review of this deal. We should absolutely be looking back to figure out what happened.
These “hot takes” raise a crucial issue. The New York Times story opened the door to a welter of hasty conclusions offered to support the ongoing narrative that antitrust enforcement has failed us — in this case quite literally at the cost of human lives. But are any of these claims actually supportable?
Unfortunately, the competitive realities of the mechanical ventilator industry, as well as a more clear-eyed view of what was likely going on with the failed government contract at the heart of the story, simply do not support the “killer acquisition” story.
What is a “killer acquisition”…?
Let’s take a step back. Because monopoly profits are, by definition, higher than joint duopoly profits (all else equal), economists have long argued that incumbents may find it profitable to acquire smaller rivals in order to reduce competition and increase their profits. More specifically, incumbents may be tempted to acquire would-be entrants in order to prevent them from introducing innovations that might hurt the incumbent’s profits.
For this theory to have any purchase, however, a number of conditions must hold. Most importantly, as Colleen Cunningham, Florian Ederer, and Song Ma put it in an influential paper:
“killer acquisitions” can only occur when the entrepreneur’s project overlaps with the acquirer’s existing product…. [W]ithout any product market overlap, the acquirer never has a strictly positive incentive to acquire the entrepreneur… because, without overlap, acquiring the project does not give the acquirer any gains resulting from reduced competition, and the two bargaining entities have exactly the same value for the project.
Moreover, the authors add that:
Successfully developing a new product draws consumer demand and profits away equally from all existing products. An acquiring incumbent is hurt more by such cannibalization when he is a monopolist (i.e., the new product draws demand away only from his own existing product) than when he already faces many other existing competitors (i.e., cannibalization losses are spread over many firms). As a result, as the number of existing competitors increases, the replacement effect decreases and the acquirer’s development decisions become more similar to those of the entrepreneur.
Finally, the “killer acquisition” terminology is appropriate only when the incumbent chooses to discontinue its rival’s R&D project:
If incumbents face significant existing competition, acquired projects are not significantly more frequently discontinued than independent projects. Thus, more competition deters incumbents from acquiring and terminating the projects of potential future competitors, which leads to more competition in the future.
…And what isn’t a killer acquisition?
What is left out of this account of killer acquisitions is the age-old possibility that an acquirer purchases a rival precisely because it has superior know-how or a superior governance structure that enables it to realize greater return and more productivity than its target. In the case of a so-called killer acquisition, this means shutting down a negative ROI project and redeploying resources to other projects or other uses — including those that may not have any direct relation to the discontinued project.
Such “synergistic” mergers are also — like allegedly “killer” mergers — likely to involve acquirers and targets in the same industry and with technological overlap between their R&D projects; it is in precisely these situations that the acquirer is likely to have better knowledge than the target’s shareholders that the target is undervalued because of poor governance rather than exogenous, environmental factors.
In other words, whether an acquisition is harmful or not — as the epithet “killer” implies it is — depends on whether it is about reducing competition from a rival, on the one hand, or about increasing the acquirer’s competitiveness by putting resources to more productive use, on the other.
As argued below, it is highly unlikely that Covidien’s acquisition of Newport could be classified as a “killer acquisition.” There is thus nothing to suggest that the merger materially impaired competition in the mechanical ventilator market, or that it measurably affected the US’s efforts to fight COVID-19.
The market realities of the ventilator market and its implications for the “killer acquisition” story
1. The mechanical ventilator market is highly competitive
As explained above, “killer acquisitions” are less likely to occur in competitive markets. Yet the mechanical ventilator industry is extremely competitive.
Medical ventilators market competition is intense.
The conclusion that the mechanical ventilator industry is highly competitive is further supported by the fact that the five largest producers combined reportedly hold only 50% of the market. In other words, available evidence suggests that none of these firms has anything close to a monopoly position.
Similarly, following preliminary investigations, neither the FTC nor the European Commission saw the need for an in-depth look at the ventilator market when they reviewed Medtronic’s subsequent acquisition of Covidien (which closed in 2015). Although Medtronic did not produce any mechanical ventilators before the acquisition, authorities (particularly the European Commission) could nevertheless have analyzed that market if Covidien’s presumptive market share was particularly high. The fact that they declined to do so tends to suggest that the ventilator market was relatively unconcentrated.
2. The value of the merger was too small
A second strong reason to believe that Covidien’s purchase of Newport wasn’t a killer acquisition is the acquisition’s value of $103 million.
Indeed, if it was clear that Newport was about to revolutionize the ventilator market, then Covidien would likely have been made to pay significantly more than $103 million to acquire it.
As noted above, the crux of the “killer acquisition” theory is that incumbents can induce welfare-reducing acquisitions by offering to acquire their rivals for significantly more than the present value of their rivals’ expected profits. Because an incumbent undertaking a “killer” takeover expects to earn monopoly profits as a result of the transaction, it can offer a substantial premium and still profit from its investment. It is this basic asymmetry that drives the theory.
[Where] a court may lack the expertise to [assess the commercial significance of acquired technology]…, the transaction value… may provide a reasonable proxy. Intuitively, if the startup is a relatively small company with relatively few sales to its name, then a very high acquisition price may reasonably suggest that the startup technology has significant promise.
The strategy only works, however, if the target firm’s shareholders agree that share value properly reflects only “normal” expected profits, and not that the target is poised to revolutionize its market with a uniquely low-cost or high-quality product. Relatively low acquisition prices relative to market size, therefore, tend to reflect low (or normal) expected profits, and a low perceived likelihood of radical innovations occurring.
We can apply this reasoning to Covidien’s acquisition of Newport:
Precise and publicly available figures concerning the mechanical ventilator market are hard to come by. Nevertheless, one estimate finds that the global ventilator market was worth $2.715 billion in 2012. Another report suggests that the global market was worth $4.30 billion in 2018; still another that it was worth $4.58 billion in 2019.
As noted above, Covidien reported to the SEC that it paid $103 million to purchase Newport (a firm that produced only ventilators and apparently had no plans to branch out).
For context, at the time of the acquisition Covidien had annual sales of $11.8 billion overall, and $743 million in sales of its existing “Airways and Ventilation Products.”
If the ventilator market was indeed worth billions of dollars per year, then the comparatively small $108 million paid by Covidien — small even relative to Covidien’s own share of the market — suggests that, at the time of the acquisition, it was unlikely that Newport was poised to revolutionize the market for mechanical ventilators (for instance, by successfully bringing its Aura ventilator to market).
The New York Times article claimed that Newport’s ventilators would be sold (at least to the US government) for $3,000 — a substantial discount from the reportedly then-going rate of $10,000. If selling ventilators at this price seemed credible at the time, then Covidien — as well as Newport’s shareholders — knew that Newport was about to achieve tremendous cost savings, enabling it to offer ventilators not only to the the US government, but to purchasers around the world, at an irresistibly attractive — and profitable — price.
Ventilators at the time typically went for about $10,000 each, and getting the price down to $3,000 would be tough. But Newport’s executives bet they would be able to make up for any losses by selling the ventilators around the world.
“It would be very prestigious to be recognized as a supplier to the federal government,” said Richard Crawford, who was Newport’s head of research and development at the time. “We thought the international market would be strong, and there is where Newport would have a good profit on the product.”
If achievable, Newport thus stood to earn a substantial share of the profits in a multi-billion dollar industry.
Of course, it is necessary to apply a probability to these numbers: Newport’s ventilator was not yet on the market, and had not yet received FDA approval. Nevertheless, if the Times’ numbers seemed credible at the time, then Covidien would surely have had to offer significantly more than $108 million in order to induce Newport’s shareholders to part with their shares.
Given the low valuation, however, as well as the fact that Newport produced other ventilators — and continues to do so to this day, there is no escaping the fact that everyone involved seemed to view Newport’s Aura ventilator as nothing more than a moonshot with, at best, a low likelihood of success.
Curically, this same reasoning explains why it shouldn’t surprise anyone that the project was ultimately discontinued; recourse to a “killer acquisition” theory is hardly necessary.
3. Lessons from Covidien’s ventilator product decisions
The killer acquisition claims are further weakened by at least four other important pieces of information:
Covidien initially continued to develop Newport’s Aura ventilator, and continued to develop and sell Newport’s other ventilators.
There was little overlap between Covidien and Newport’s ventilators — or, at the very least, they were highly differentiated
Covidien appears to have discontinued production of its own portable ventilator in 2014
The Newport purchase was part of a billion dollar series of acquisitions seemingly aimed at expanding Covidien’s in-hospital (i.e., not-portable) device portfolio
Covidien continued to develop and sell Newport’s ventilators
For a start, while the Aura line was indeed discontinued by Covidien, the timeline is important. The acquisition of Newport by Covidien was announced in March 2012, approved by the FTC in April of the same year, and the deal was closed on May 1, 2012.
However, as the FDA’s 510(k) database makes clear, Newport submitted documents for FDA clearance of the Aura ventilator months after its acquisition by Covidien (June 29, 2012, to be precise). And the Aura received FDA 510(k) clearance on November 9, 2012 — many months after the merger.
It would have made little sense for Covidien to invest significant sums in order to obtain FDA clearance for a project that it planned to discontinue (the FDA routinely requires parties to actively cooperate with it, even after 510(k) applications are submitted).
Moreover, if Covidien really did plan to discreetly kill off the Aura ventilator, bungling the FDA clearance procedure would have been the perfect cover under which to do so. Yet that is not what it did.
Covidien continued to develop and sell Newport’s other ventilators
Second, and just as importantly, Covidien (and subsequently Medtronic) continued to sell Newport’s other ventilators. The Newport e360 and HT70 are still sold today. Covidien also continued to improve these products: it appears to have introduced an improved version of the Newport HT70 Plus ventilator in 2013.
If eliminating its competitor’s superior ventilators was the only goal of the merger, then why didn’t Covidien also eliminate these two products from its lineup, rather than continue to improve and sell them?
At least part of the answer, as will be seen below, is that there was almost no overlap between Covidien and Newport’s product lines.
There was little overlap between Covidien’s and Newport’s ventilators
Third — and perhaps the biggest flaw in the killer acquisition story — is that there appears to have been very little overlap between Covidien and Newport’s ventilators.
This decreases the likelihood that the merger was a killer acquisition. When two products are highly differentiated (or not substitutes at all), sales of the first are less likely to cannibalize sales of the other. As Florian Ederer and his co-authors put it:
Importantly, without any product market overlap, the acquirer never has a strictly positive incentive to acquire the entrepreneur, neither to “Acquire to Kill” nor to “Acquire to Continue.” This is because without overlap, acquiring the project does not give the acquirer any gains resulting from reduced competition, and the two bargaining entities have exactly the same value for the project.
A quick search of the FDA’s 510(k) database reveals that Covidien has three approved lines of ventilators: the Puritan Bennett 980, 840, and 540 (apparently essentially the same as the PB560, the plans to which Medtronic recently made freely available in order to facilitate production during the current crisis). The same database shows that these ventilators differ markedly from Newport’s ventilators (particularly the Aura).
In particular, Covidien manufactured primarily traditional, invasive ICU ventilators (except for the PB540, which is potentially a substitute for the Newport HT70), while Newport made much-more-portable ventilators, suitable for home use (notably the Aura, HT50 and HT70 lines).
Under normal circumstances, critical care and portable ventilators are not substitutes. As the WHO website explains, portable ventilators are:
[D]esigned to provide support to patients who do not require complex critical care ventilators.
A quick glance at Medtronic’s website neatly illustrates the stark differences between these two types of devices:
This is not to say that these devices do not have similar functionalities, or that they cannot become substitutes in the midst of a coronavirus pandemic. However, in normal times (as was the case when Covidien acquired Newport), hospitals likely did not view these devices as substitutes.
The conclusion that Covidien and Newport’s ventilator were not substitutes finds further support in documents and statements released at the time of the merger. For instance, Covidien’s CEO explained that:
This acquisition is consistent with Covidien’s strategy to expand into adjacencies and invest in product categories where it can develop a global competitive advantage.
Newport’s products and technology complement our current portfolio of respiratory solutions and will broaden our ventilation platform for patients around the world, particularly in emerging markets.
In short, the fact that almost all of Covidien and Newport’s products were not substitutes further undermines the killer acquisition story. It also tends to vindicate the FTC’s decision to rapidly terminate its investigation of the merger.
Covidien appears to have discontinued production of its own portable ventilator in 2014
Perhaps most tellingly: It appears that Covidien discontinued production of its own competing, portable ventilator, the Puritan Bennett 560, in 2014.
The product is reported on the company’s 2011, 2012 and 2013 annual reports:
Airway and Ventilation Products — airway, ventilator, breathing systems and inhalation therapy products. Key products include: the Puritan Bennett™ 840 line of ventilators; the Puritan Bennett™ 520 and 560 portable ventilator….
Surely if Covidien had intended to capture the portable ventilator market by killing off its competition it would have continued to actually sell its own, competing device. The fact that the only portable ventilators produced by Covidien by 2014 were those it acquired in the Newport deal strongly suggests that its objective in that deal was the acquisition and deployment of Newport’s viable and profitable technologies — not the abandonment of them. This, in turn, suggests that the Aura was not a viable and profitable technology.
(Admittedly we are unable to determine conclusively that either Covidien or Medtronic stopped producing the PB520/540/560 series of ventilators. But our research seems to indicate strongly that this is indeed the case).
Putting the Newport deal in context
Finally, although not dispositive, it seems important to put the Newport purchase into context. In the same year as it purchased Newport, Covidien paid more than a billion dollars to acquire five other companies, as well — all of them primarily producing in-hospital medical devices.
That 2012 spending spree came on the heels of a series of previous medical device company acquisitions, apparently totally some four billion dollars. Although not exclusively so, the acquisitions undertaken by Covidien seem to have been primarily targeted at operating room and in-hospital monitoring and treatment — making the putative focus on cornering the portable (home and emergency) ventilator market an extremely unlikely one.
By the time Covidien was purchased by Medtronic the deal easily cleared antitrust review because of the lack of overlap between the company’s products, with Covidien’s focusing predominantly on in-hospital, “diagnostic, surgical, and critical care” and Medtronic’s on post-acute care.
Newport misjudged the costs associated with its Aura project; Covidien was left to pick up the pieces
So why was the Aura ventilator discontinued?
Although it is almost impossible to know what motivated Covidien’s executives, the Aura ventilator project clearly suffered from many problems.
The Aura project was intended to meet the requirements of the US government’s BARDA program (under the auspices of the U.S. Department of Health and Human Services’ Biomedical Advanced Research and Development Authority). In short, the program sought to create a stockpile of next generation ventilators for emergency situations — including, notably, pandemics. The ventilator would thus have to be designed for events where
mass casualties may be expected, and when shortages of experienced health care providers with respiratory support training, and shortages of ventilators and accessory components may be expected.
The Aura ventilator would thus sit somewhere between Newport’s two other ventilators: the e360 which could be used in pediatric care (for newborns smaller than 5kg) but was not intended for home care use (or the extreme scenarios envisioned by the US government); and the more portable HT70 which could be used in home care environments, but not for newborns.
Unfortunately, the Aura failed to achieve this goal. The FDA’s 510(k) clearance decision clearly states that the Aura was not intended for newborns:
The AURA family of ventilators is applicable for infant, pediatric and adult patients greater than or equal to 5 kg (11 lbs.).
the company was unable to secure FDA approval for use in neonatal populations — a contract requirement.
And the US Government RFP confirms that this was indeed an important requirement:
The device must be able to provide the same standard of performance as current FDA pre-market cleared portable ventilators and shall have the following additional characteristics or features:
• Flexibility to accommodate a wide patient population range from neonate to adult.
Newport also seems to have been unable to deliver the ventilator at the low price it had initially forecasted — a common problem for small companies and/or companies that undertake large R&D programs. It also struggled to complete the project within the agreed-upon deadlines. As the Medtronic press release explains:
Covidien learned that Newport’s work on the ventilator design for the Government had significant gaps between what it had promised the Government and what it could deliver — both in terms of being able to achieve the cost of production specified in the contract and product features and performance. Covidien management questioned whether Newport’s ability to complete the project as agreed to in the contract was realistic.
As Jason Crawford, an engineer and tech industry commentator, put it:
Projects fail all the time. “Supplier risk” should be a standard checkbox on anyone’s contingency planning efforts. This is even more so when you deliberately push the price down to 30% of the market rate. Newport did not even necessarily expect to be profitable on the contract.
The above is mostly Covidien’s “side” of the story, of course. But other pieces of evidence lend some credibility to these claims:
Newport agreed to deliver its Aura ventilator at a per unit cost of less than $3000. But, even today, this seems extremely ambitious. For instance, the WHO has estimated that portable ventilators cost between $3,300 and $13,500. If Newport could profitably sell the Aura at such a low price, then there was little reason to discontinue it (readers will recall the development of the ventilator was mostly complete when Covidien put a halt to the project).
Covidien/Newport is not the only firm to have struggled to offer suitable ventilators at such a low price. Philips (which took Newport’s place after the government contract fell through) also failed to achieve this low price. Rather than the $2,000 price sought in the initial RFP, Philips ultimately agreed to produce the ventilators for $3,280. But it has not yet been able to produce a single ventilator under the government contract at that price.
Covidien has repeatedly been forced to recall some of its other ventilators ( here, here and here) — including the Newport HT70. And rival manufacturers have also faced these types of issues (for example, here and here).
Accordingly, Covidien may well have preferred to cut its losses on the already problem-prone Aura project, before similar issues rendered it even more costly.
In short, while it is impossible to prove that these development issues caused Covidien to pull the plug on the Aura project, it is certainly plausible that they did. This further supports the hypothesis that Covidien’s acquisition of Newport was not a killer acquisition.
Ending the Aura project might have been an efficient outcome
As suggested above, moreover, it is entirely possible that Covidien was better able to realize the poor prospects of Newport’s Aura project and also better organized to enable it to make the requisite decision to abandon the project.
Moreover, the relatively large share of revue and reputation that Newport — worth $103 million in 2012, versus Covidien’s $11.8 billion — would have realized from fulfilling a substantial US government project could well have induced it to overestimate the project’s viability and to undertake excessive risk in the (vain) hope of bringing the project to fruition.
While there is a tendency among antitrust scholars, enforcers, and practitioners to look for (and find…) antitrust-related rationales for mergers and other corporate conduct, it remains the case that most corporate control transactions (such as mergers) are driven by the acquiring firm’s expectation that it can manage more efficiently. As Henry G. Manne put it in his seminal article, Mergers and the Market for Corporate Control (1965):
Since, in a world of uncertainty, profitable transactions will be entered into more often by those whose information is relatively more reliable, it should not surprise us that mergers within the same industry have been a principal form of changing corporate control. Reliable information is often available to suppliers and customers as well. Thus many vertical mergers may be of the control takeover variety rather than of the “foreclosure of competitors” or scale-economies type.
Of course, the same information that renders an acquiring firm in the same line of business knowledgeable enough to operate a target more efficiently could also enable it to effect a “killer acquisition” strategy. But the important point is that a takeover by a firm with a competing product line, after which the purchased company’s product line is abandoned, is at least as consistent with a “market for corporate control” story as with a “killer acquisition” story.
“Killer acquisitions” can have a nefarious image, but killing off a rival’s product was probably not the main purpose of the transaction, Ederer said. He raised the possibility that Covidien decided to kill Newport’s innovation upon realising that the development of the devices would be expensive and unlikely to result in profits.
In conclusion, Covidien’s acquisition of Newport offers a cautionary tale about reckless journalism, “blackboard economics,” and government failure.
Reckless journalism because the New York Times clearly failed to do the appropriate due diligence for its story. Its journalists notably missed (or deliberately failed to mention) a number of critical pieces of information — such as the hugely important fact that most of Covidien’s and Newport’s products did not overlap, or the fact that there were numerous competitors in the highly competitive mechanical ventilator industry.
And yet, that did not stop the authors from publishing their extremely alarming story, effectively suggesting that a small medical device merger materially contributed to the loss of many American lives.
What is studied is a system which lives in the minds of economists but not on earth.
Numerouscommentators rushed to fit the story to their preconceived narratives, failing to undertake even a rudimentary examination of the underlying market conditions before they voiced their recriminations.
The only thing that Covidien and Newport’s merger ostensibly had in common with the killer acquisition theory was the fact that a large firm purchased a small rival, and that the one of the small firm’s products was discontinued. But this does not even begin to meet the stringent conditions that must be fulfilled for the theory to hold water. Unfortunately, critics appear to have completely ignored all contradicting evidence.
Finally, what the New York Times piece does offer is a chilling tale of government failure.
The inception of the US government’s BARDA program dates back to 2008 — twelve years before the COVID-19 pandemic hit the US.
The collapse of the Aura project is no excuse for the fact that, more than six years after the Newport contract fell through, the US government still has not obtained the necessary ventilators. Questions should also be raised about the government’s decision to effectively put all of its eggs in the same basket — twice. If anything, it is thus government failure that was the real culprit.
And yet the New York Times piece and the critics shouting “killer acquisition!” effectively give the US government’s abject failure here a free pass — all in the service of pursuing their preferred “killer story.”