Sunday Pearlstein: End of the ‘anything goes’ era of antitrust?
Maybe you’ve noticed that companies that are already at the top of their industries have become rather brazen about trying to increase their profits and share prices by buying up their nearest competitors.
Who can blame them? For years now, the courts and regulators have
turned a blind eye as industry after industry consolidates into two or three dominant firms. And for years, fee-driven corporate lawyers and investment bankers have been knocking on boardroom doors peddling the notion that they can win approval for any merger just by divesting a subsidiary or two or establishing some fictitious “Chinese wall” to prevent one division from knowing what the other is doing. (Alas, we’re even importing our metaphors from China!)
That “anything goes” mentality took a hit recently when the Justice Department dared to challenge the purchase of T-Mobile by AT&T. Now its stepsister, the Federal Trade Commission, has the opportunity to definitively usher in a new era in antitrust by blocking the $29 billion merger between Express Scripts and Medco, two of the biggest pharmacy benefit managers -- the companies that handle the prescription drug portion of your health insurance.
This is a fluid and rapidly changing segment of the health-care sector. While two of the big insurance companies, Wellpoint and Aetna, have effectively sold their in-house PBMs, Cigna continues to run its own in-house pharmacy business, and United Health, the largest insurer, recently jumped into the business in a big way.
In 2007, meanwhile, CVS, the big retail drugstore chain, went “upstream,” buying Caremark, another PBM, in the process generating lots of complaints from independent pharmacies that the Caremark PBM is steering much of its retail business to CVS. The independents now fear any further consolidation of PBMs will only add to their woes as more and more prescriptions are routed through the PBMs’ own mail-order pharmacies rather than through the corner drugstore.
The independent pharmacists have good reason to be concerned -- because of competition from the big retail chains and the PBMs, they’ve become an endangered species. Some of this is the result of competition that is thuggish and unfair and results in inferior and less-convenient service for customers. But some of it reflects the hard economic reality that mail order is a cheaper and more efficient way to fill prescriptions and scale is important when negotiating prices with patent-wielding monopolists in the pharmaceutical industry. Over time, we will miss them the way we miss the local ice cream parlor and dressmaker.
There’s little question that combining Express Scripts and Medco will generate operating efficiencies. These companies now invest large sums in sophisticated computer systems to manage orders, control inventory, bill customers, detect dangerous drug combinations and nudge patients to take their meds and fill their prescriptions. Having to invest in one system rather than two will result in significant savings for the combined operation.
More dubious is the claim that the combined company will be able to use its clout to negotiate significantly better prices from drug companies for high-priced drugs under patent. With revenues of $44 billion and $66 billion, both companies are big enough to enjoy whatever negotiating advantages come with delivering a large number of customers. For the most expensive drugs, both are getting the maximum discount that drug companies have to give.
The bigger question is whether shareholders or customers will get the benefit of these efficiencies -- and that depends on how competitive the industry will be. At the moment, there are dozens of regional PBMs that serve regional insurance companies and health plans. For big national insurers and corporations, however, there are really only three independents (not owned by insurance companies) that have the scale and range of services to be fully competitive: Express Scripts, Caremark CVS and Medco. It’s hard to see how combining two of them into a single firm with a market share of 30 to 60 percent (depending on how you define the market) would sustain the same level of price competition.
Markets that are highly competitive are usually ones in which prices are pretty well-known among buyers and sellers. The prescription drug market, by contrast, is renowned for its lack of transparency. Drug companies not only refuse to reveal their wholesale prices, but in contracting with pharmacy chains and PBMs they insist on contracts that prohibit either party from revealing prices to anyone else.
Moreover, the contracts between drug companies and big customers are often filled with complex rebates and volume discount arrangements that are not settled up until year’s end. So when PBMs promise to pass on 85 percent of the discounts they negotiate to customers, it becomes almost impossible for customers to figure out whether the promise is being kept.
In view of this lack of price transparency, any merger among PBM giants should be viewed with great suspicion.
Another reason for suspicion is the consistently high profit that PBMs earn, at least as measured against the amount of equity that investors have in these businesses. For Express Scripts, return on equity last year was 44 percent, for Medco 37 percent -- in both cases, with very modest amounts of debt to leverage those results. That’s probably considerably more than you earned on your 401(k) in any recent year. And it’s probably why Express Script was willing to pay a 27 percent premium over the then-market price to acquire Medco shares.
Perhaps the best reason for blocking this merger, however, is that it feeds the consolidation arms race going on in the health-care sector. When hospitals merge and get bigger, then insurance companies argue they have to merge and get bigger to have the clout to negotiate good rates from the more powerful hospitals. And when the insurers merge, the PBMs say they have to get bigger so they don’t get taken advantage of by the big insurers. Then the drug companies complain they have to merge so they don’t get muscled by the larger PBMs. And let’s not forget the drugstore chains and drug wholesalers, who argue they need to consolidate so as not to get crushed by the big drug companies.
So it goes, consolidation begetting consolidation, until we arrive at our current predicament, where just a handful of big players now dominates each category. The rationale offered for each merger is that it will allow the company to lower costs and allow the savings to be passed on to consumers in the form of lower prices. And yet every year, health-care cost inflation exceeds overall inflation by a wide margin. If anything, a casual observer might suspect that all this consolidation has driven prices higher, not lower.
As longtime readers of this column know, I’ve complained repeatedly about health-care consolidation for years, most of it in vain. Hospital mergers. Drug company mergers. Insurance mergers. The drugstore consolidation here in Washington.
For antitrust regulators, the challenge is that it’s almost impossible to say with the kind of mathematical precision now demanded by judges that any one deal represents the tipping point between robust competition and oligopoly. Like many changes, these happen in thin slices and we only realize it once it’s too late to do anything about it.
We’ve tried consolidation in the health-care industry and the results have been decidedly mixed. Maybe it’s time to give competition a try. Health-care companies that feel compelled to increase their sales, their profits or their market share could do it the old-fashioned way, offering better service at a lower price.