Keeping medicine accessible at a reasonable cost is a challenge. An important component of public authorities’ strategies has been to stimulate price competition from generics. Yet a perplexing feature surrounding generic entry is that the price of the other on-patent potential substitutes is barely affected (Jena et al. 2009, Lakdawalla 2018), and their volume market share even tends to increase (Grabowski et al. 2014, Lakdawalla and Philipson 2012, Castanheira et al. 2019). The absence of a price reaction on the part of drugs still benefitting from exclusivity has sometimes led competition authorities to conclude that a single molecule (and not the set of drugs that are used to treat the same condition) may constitute a distinct antitrust market. These findings stirred some controversy.
In the Servier case, for instance, the EU Commission deemed that Perindopril (an ACE inhibitor to treat hypertension) and its generic versions formed an antitrust market on their own.1 The General Court of the European Union thought otherwise and concluded that the European Commission had “made a series of errors in defining the relevant market”.2 At the time of writing, the appeal to the European Court of Justice brought by the Commission is pending resolution.
Operationalising the hypothetical monopoly test
In a recent paper (Siotis et al. 2020), we propose to directly apply the hypothetical monopoly test (HMT) to delineate antitrust markets in the pharmaceutical industry. The HMT identifies the set of products that a hypothetical monopolist would have to control in order to achieve a profitable small but significant non-transitory increase in price (SSNIP) of 5% or more.3
To operationalise the HMT, we estimate time-varying demand elasticities using data on prices, quantities, and promotional effort for a large number of molecules sold in the US, many of which experience loss of exclusivity during our sample window.4 The use of detailed data on promotion is of paramount importance because the fall in promotional spending post loss of exclusivity weighs heavily in the reallocation of demand (Lakdawalla and Philipson 2012, Castanheira et al. 2019). Our estimation strategy consists in assessing the impact of multiple episodes of generic entry – largely exogenous events that can be precisely identified and timed – on pricing and promotion strategies.
Our results indicate that, on average, inter-molecular competition is vibrant prior to loss of exclusivity, pointing to broad antitrust markets encompassing various drugs. However, we also report that the entry of generic competitors for one drug shrinks the initial antitrust market: the genericised drug ‘drops out’ in the sense of no longer constraining the pricing power of the drugs still enjoying exclusivity. That is, the intensification of intramolecular rivalry resulting from generic entry softens intermolecular competition.
Next, we identify competitive constraints from the standpoint of generic producers. Unsurprisingly, we find that own- and cross-price elasticities among generics are high, meaning they have essentially no market power and face very strong competition from other generic producers of the same molecule. Applying an HMT post loss of exclusivity points to narrow markets, limited to a single molecule and only encompassing generic suppliers.
Taken together, these results indicate that there are multiple candidate markets, and the determination of the relevant one must be determined by the context, i.e. the theory of harm. From an enforcement perspective, this naturally leads to the conclusion that market definition cannot be dissociated from the nature of the competitive concern.
The suggestion that the relevant market should be made contingent on the infringement (actual or potential) has been discussed for some time (Salop 2000, Rey et al. 2004, and Glasner and Sullivan 2019 for an in-depth exposition and analysis), but enforcers and courts have so far been reluctant to endorse the approach, at least in the EU.
The consubstantial nature of market definition with the theory of harm can be illustrated with a simple example inspired by our empirical findings. Imagine a market composed of three originator drugs – A, B and C – that initially benefit from exclusivity and that significantly constrain each other, i.e. a hypothetical monopolist controlling all three would be in a position to profitably and durably increase prices by 5–10% (or more). Thus, if the concern is coordinated behaviour, the candidate market should comprise of A, B, and C. In the context of generic foreclosure, we frame the example on evaluating competitive constrains faced by firm C in the factual and counterfactual (i.e. absent the behaviour that is a source of concern). In that case (foreclosure of generics), the relevant competitive constraint is the one that would be exercised by the generic, and the relevant antitrust may well be molecular, even though that market has not yet emerged. The reason is that, once generic entry occurs, an HMT limited to molecule C may indicate that a significant price increase would be profitable. With respect to mergers, our analysis indicates that, for a given theory of harm, market delineation may change in the event of generic entry. This is because vigorous intermolecular competition may vanish quickly if the drugs competing with those of the merged entity experience loss of exclusivity. For instance, suppose that drug C is the market leader with a 60% market share, while A and B each command 20%. A merger between A and B may be cleared under the assumption that the merged entity would face significant constraints from C. Our analysis indicates that if C is close to expiry, and if there are no product launches in the near future, the merger between A and B would create an entity that may rapidly enjoy very significant power, as identified by an HMT. The reason underpinning C’s competitive constraint fading into irrelevance is the dramatic drop in promotional spending that follows loss of exclusivity (Lakdawalla and Philipson, 2012, Castanheira et al., 2019). The situation just described would represent an instance of a Type II error (an anticompetitive merger being waived through).
The immediate and most relevant implication of these findings for competition enforcement is that there is no such thing as a single/natural antitrust market, even for a fixed set of products (and absent technological, regulatory, or trade shocks). As noted by Glasner and Sullivan (2019: 52), “Because there is no economically meaningful natural market, relevant markets must be analytic devices. Because analytic devices are tied to the subject of analysis, relevant markets can be defined only by reference to specified theories of harm”.
What our empirical exercise does is to provide a concrete and quantified illustration of the ontological relationship between the theory of harm and a cogent market definition. Applying these conclusions to the Servier case leads to the conjecture that this is an instance of type III error: the right decision (a finding anticompetitive foreclosure) based on the wrong premise (flawed market definition that failed to convince the General Court).
Authors’ note: Siotis worked at the European Commission at the time of the investigation into the Servier case as a member of the Chief Economist team. The views expressed in this column are strictly his own and rely solely on the published decision and judgment.
Castanheira, M, C Ornaghi and G Siotis (2019), “The Unexpected Consequences of Generic Entry”, Journal of Health Economics 68: 22.
Glasner, D and S Sullivan (2019), “The Logic of Market Definition”, forthcoming Antitrust Law Journal.
Grabowski H, G Long, and R Mortimer (2014), "Recent trends in brand-name and generic drug competition", Journal of Medical Economics 17(3):207-14.
Jena A, J Calfee, E Mansley and T J Philipson (2009), “Me-Too Innovation in Pharmaceutical Markets”, NBER Chapters, in: Frontiers in Health Policy Research, Volume 12, NBER.
Lakdawalla, D (2018), "Economics of the Pharmaceutical Industry", Journal of Economic Literature 56 (2): 397-449.
Lakdawalla, D and T Philipson (2012), “Does intellectual property restrict output? An analysis of pharmaceutical markets”, Journal of Law and Economics 55 (1): 151–187.
Regan, T L (2008), “Generic entry, price competition, and market segmentation in the prescription drug market”, International Journal of Industrial Organization 26: 930-948.
Rey, P, J Gual, M Hellwig, A Perrot, M Polo, K Schmidt and R Stenbacka (2004), ‘An Economic Approach to Article 82’, Report of the Economic Advisory Group on Competition Policy, Brussels.
Salop, S (2000), “The First Principles Approach to Antitrust, Kodak, and Antitrust at the Millennium”, Antitrust Law Journal 68: 187-202.
Siotis, G, C Ornaghi and M Castanheira (2020), "Market Definition and Competition Policy Enforcement in the Pharmaceutical Industry", CEPR Discussion Paper No. 14035.
1 General Court of the European Union, Ruling Case T-691/14, Servier/Commission, December 12 2018.
2 General Court of the European Union, Press Release # 194/18, Luxembourg, 12 December 2018.
3 The HMT approach to market delineation was first endorsed in the US’s Federal Trade Commission 1982 Merger Guidelines. The HMT also inspired the EU Commission Notice on Market Definition (1997) and is common reference point in academic textbooks (Motta 2004).
4 The dataset at our disposal comprises individual prices, quantities and promotional efforts for 125 molecules sold in the US during 40 quarters. Of these, 64 molecules in 31 different candidate markets experienced loss of exclusivity during the period of analysis.