Killer acquisitions lead to decreased innovation and competition in the U.S. prescription drug market
There is a long-running debate in economics about whether monopolies or competition spur innovation. This debate is sometimes known as the Schumpeter-Arrow debate after the views of Austrian economist Joseph Schumpeter, who argued monopolies promote innovation, and Nobel Prize economist Kenneth Arrow, who argued that competition drives innovation. In their new working paper, “Killer Acquisitions,” co-authors Colleen Cunningham of the London School of Business and Florian Ederer and Song Ma, both of the Yale School of Management, take a look at today’s U.S. pharmaceutical industry to assess how acquisitions play into this debate today.
The co-authors find that consolidation in the pharmaceutical industry is probably stifling rather than promoting innovation. Approximately 6 percent of pharmaceutical acquisitions are what the authors refer to as “killer acquisitions,” in which an incumbent firm acquires a product in development that could compete with the incumbent’s own product and then subsequently terminates development of the target firm’s product, thus killing competition and innovation.
An example of this kind of acquisition that the three researchers examined is Questcor Pharmaceuticals Inc.’s acquisition of the drug Synacthen from Novartis International AG of Switzerland. United States-based Questcor in 2000 held a monopoly over an adrenocorticotropic hormone drug called Acthar, the then-dominant treatment for rare epileptic diseases such as infantile spasms. In 2000, Acthar was priced at roughly $40 a vial. In the mid-2000s, however, Novartis began developing Synacthen, a synthetic version of Acthar. In 2013, Questcor acquired the production rights for Synacthen and shut down development of the drug shortly thereafter.
As a competitor to Acthar, Synacthen would have been a cheaper alternative that would have taken away significant market share from Questcor. Today, Acthar costs $39,000 a vial, which is a 97,000 percent increase in price over 19 years.
Cunningham, Ederer, and Ma examined how common this type of acquisition is in the U.S. pharmaceutical industry. They find that a pharmaceutical company with an existing product has less incentive to undertake the costs of developing a competing product than to acquire a new product if the new product competes with its existing product. The new product, if successful, could be due to the cannibalized sales of the company’s existing product or the firm could have an incentive to purchase the product in development at a competing firm and shut down its development to eliminate a potential competitive threat to its existing product.
Using data on drug development, acquisitions of drug products, and overlap between drugs, the authors find evidence that a number of killer acquisitions such as these examples above are common in the U.S. pharmaceutical industry. Drug companies complete development of only 13.4 percent of projects when there is an overlap with an existing product. Moreover, projects are less likely—28.6 percent, according to the paper—to be completed if an incumbent firm acquires the firm than if a project remains with the original company. These results also hold when compared to acquired projects within the same target firm. Further, the authors reject a variety of alternative explanations for these results such as information asymmetries (buyers acquiring low-quality products, the redeployment of technology or capital toward production, or others).
According to the three co-authors, killer acquisitions harm consumers by eliminating both new products and competition, but they benefit the incumbent firm, the developer, and the other firms in the market. The authors caution, however, that a comprehensive analysis of these types of acquisitions is more complicated. Companies, for example, may undertake more product development if there is a possibility that it can develop a product and sell it to another company. In other words, allowing killer acquisitions by increasing the expected return on innovation may lead to more products overall—even if each individual killer acquisition eliminates competition.
Nevertheless, the authors are doubtful that such an effect justifies allowing killer acquisitions that create “significant ex-post inefficiencies resulting from the protection of market power.” They argue that preventing killer acquisitions would increase competition in the pharmaceutical market today. The more competition there is, the less valuable it is for an incumbent pharmaceutical firm to try to eliminate potential competition, they contend, because in a competitive market, there is less benefit in eliminating a potential additional competitor via acquisition since there are too many remaining competitors.
The three co-authors suspect that this competitive dynamic is likely to be larger than the impact of increased incentives for pharmaceutical companies to try to develop new products in the hope that another company will pursue a killer acquisition. According to their model, killer acquisitions are most likely to occur in markets where the incumbent drug maker has substantial market power. Therefore, these types of acquisitions are likely to prevent innovation and competition in the very markets where a new drug would likely have the most significant impact.
This new working paper has important implications for U.S. competition policy and antitrust enforcement. It suggests enforcers, in the first instance, and courts, in the final instance, should be more skeptical of transactions in which an incumbent pharmaceutical company acquires a product in development that could be a competitive threat. Historically, concerns about potential competition have been secondary in antitrust enforcement. In addition, courts have been skeptical of such theories. Such an approach—particularly in the pharmaceutical industry—may be denying patients new and better products, while increasing the cost of prescription drug prices.