The new recoupment standard announced in Brooke Group presumes that a firm has behaved lawfully until the plaintiff comes forward with a plethora of evidence to the contrary. In the past, the buzz around making a predatory pricing case was the difficulty of establishing the defendant's cost. After Brooke Group, potential plaintiffs must also show that the defendant can or will recoup its losses. The demonstration of recoupment is particularly difficult in the pharmaceutical industry, which is constantly changing structurally. Moreover, market shares will not remain constant, as generic drugs continue to arise, which are more attractive to consumers and third party payors.


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PART I: Introduction

The possibility of predatory pricing of pharmaceuticals, while virtually unmentioned in the case law warrants discussion due to its relative ease to accomplish. Legal rules currently do not sufficiently discourage predatory pricing of prescription drugs. In AA Poultry Farms v. Rose Acre Farms 1, Judge Frank Easterbrook of the Seventh Circuit proposed that when evaluating whether a business violates the Sherman Act for allegedly pricing predatorily, the proper focus looks for the "high price later." The plaintiff must prove the defendant's probability of future gain from the predatory pricing through the acquisition of a monopoly in a given market. As we will see, the nature of the drug manufacturing industry is such that it would be difficult to meet the predatory pricing standards set out in the Supreme Court's recent decision in Brooke Group v. Brown & Williamson 2.

Numerous problems interfere with demonstrating the possible high price later in an individual case. The plaintiff must show evidence that defendant is selling below its average variable cost, as well as evidence that these losses will be recouped later. This standard is particularly problematic in the pharmaceutical industry. Pharmaceutical companies receive grants and other assistance for their research costs and enjoy valuable resources from alliances with universities, which makes it difficult to gauge actual average variable cost. Evidence of future recoupment is speculative, as the pharmaceutical industry develops and changes at lightening speed.

Part of the problem with the Easterbrook approach lies in its assumption that society is always best off when profit is maximized. This may not necessarily be true for the pharmaceutical industry, and the distinctions between the pharmaceutical and other markets are crucial. When the assumptions change, so must the test for when Department of Justice intervention, or private suits, is appropriate.

Predatory pricing in the pharmaceutical industry would be particularly egregious. In general, predatory pricing often results in a monopoly, which creates a barrier to entry in the market. Such barriers practically eliminate the incentive to engage in research and development. Success in medicine is best-defined in terms of numbers, because medicine is not an exact science. Society is usually better off if there are more, rather than less, companies engaged in pharmaceutical research. The more chances society has at finding an effective drug with fewer side effects, the more likely the best drug will be found, and the better off society will be, theoretically.

Part II. Brooke Group v. Brown & Williamson Tobacco

A. The Case

In 1980, Petitioner Brooke Group (Liggett) gave birth to the economy segment of the cigarette market by introducing the first generic cigarette. When Liggett introduced generic cigarettes, it began taking sales away from the brand products, and disproportionately from B&W. The generic cigarette idea caught on quickly, as the cigarette market had been characterized by declining demand. Respondent Brown & Williamson ("B&W") entered the generic market in 1984, at which time Liggett possessed 97% of the generic cigarette market. B&W and Liggett's products were fungible, so wholesalers had no incentive to carry both brands. At the retail level, the list price of B&W's cigarettes were the same as Liggett's, but B&W's volume discounts to wholesalers were larger. B&W's rebate structure also encompassed a greater number of volume categories than did Liggett's.

Before B&W sold a single cigarette, B&W and Liggett engaged in a rebate war at the wholesale level. Liggett attempted five times to beat the rebates offered by B&W, but at the end of each round, B&W maintained an advantage over Liggett's prices. Liggett contended that by the end of the rebate war, B&W sold its generics at a loss. In mid-1985, Liggett raised list prices, but did not diminish rebate levels. At end of 1985, B&W raised prices and both firms reduced rebates.

Liggett alleged that respondent B&W introduced a line of generic cigarettes in an unlawful effort to stifle price competition in the economy segment of the national cigarette market. Liggett contended that Brown & Williamson cut prices on generic cigarettes below cost and offered discriminatory volume rebates to wholesalers to force Liggett to raise its own generic cigarette prices and introduce oligopoly pricing in the economy segment.

Liggett argued that B&W's volume rebates to wholesalers amounted to price discrimination that had a reasonable possibility of injuring competition, in violation of 2(a) of the Robinson-Patman Act. Liggett also claimed that B&W's discriminatory volume rebates were integral to a scheme of predatory pricing, where B&W reduced net prices below average variable cost. Liggett claimed that these below-cost prices were not promotional, but were intended to pressure it to raise its list prices on generics, so that the percentage price difference between generics and brand names would narrow. This resulting reduction in the price gap, it argued, would restrain the growth of the generic market and preserve B&W's supracompetitive profits in the brand market.3

The trial court found that the evidence indicated that B&W wanted to slow the growth of the generic cigarette market.4 The court also found that B&W priced its generics well below B&W's average variable cost, but granted JNOV for B&W because Liggett had not adequately shown competitive injury. The Court of Appeals affirmed.

The Court held that primary-line injury under the Robinson-Patman Act5 is the same type of injury as predatory pricing schemes under 2 of Sherman Act, except that 2 condemns predatory pricing only when it poses "a dangerous probability of actual monopolization,"6 whereas the Robinson-Patman Act requires only that there be a "reasonably probability" of substantial injury to competition.7

The Court held that there are two prerequisites to recovery under either Act. First, plaintiff must prove that the prices complained of are below an appropriate measure of its rival's costs.8 Second, plaintiff must show that the competitor had a reasonable prospect (or under 2, a dangerous probability) of recouping its investment in below-cost prices.

The Court stated, "Recoupment is the ultimate object of an unlawful predatory pricing scheme; it is the means by which a predator profits from predation."9 Moreover, the plaintiff must prove "a dangerous probability that [the defendant] would monopolize a particular market." 10

The Court explained recoupment as follows: "For recoupment to occur, below-cost pricing must be capable, as a threshold matter, of producing the intended effects on the firm's rivals, whether driving them from the market as was alleged to be the goal here, causing them to raise their prices to supracompetitive levels with a disciplined oligopoly."11 The Court stated that one must look to "the extent and duration of the alleged predation, the relative financial strength of the predator and its intended victim, and their respective incentives and will."12

The Court framed the inquiry as "whether, given the aggregate losses caused by the below-cost pricing, the intended target would likely succumb."

Moreover, the plaintiff must demonstrate that there is a likelihood that the predatory scheme alleged would cause a rise in prices above a competitive level that would be sufficient to compensate for the amounts expended on the predation, including the time value of the money invested in it... Determining whether recoupment of predatory losses is likely requires an estimate of the cost of the alleged predation and a close analysis of both the scheme alleged by the plaintiff and the structure and conditions of the relevant market.13

Resolution of the recoupment issue necessitates analysis of the following factors: price increases and output levels after the period of alleged predation; the likelihood of shared understandings or "signaling" in the industry; the "number of product types and pricing variables" and "the probability of effective parallel pricing."14 Without a finding of likely recoupment, "predatory pricing produces lower aggregate prices in the m arket, and consumer welfare is enhanced."15

Liggett's argument centered around tacit collusion.16 Essentially, Liggett claimed that B&W sought to preserve supracompetitive profits on branded cigarettes by pressuring Liggett to raise generic prices through a process of tacit collusion with other cigarette companies. The Court was not persuaded by this argument, noting that predatory pricing by multiple firms when they conspire is very unlikely. "On the whole, tacit cooperation among oligopolists must be considered the least likely means of recouping predatory losses."17

The Court noted several strengths of the plaintiff's case: a reasonable jury could have concluded that B&W's prices were below its costs for a period of 18 months; price levels for branded cigarettes had been supracompetitive; and a reasonable jury could conclude that B&W intended anticompetitive effects. However, Liggett failed to show that B&W had a reasonable prospect of recovering its losses from below-cost pricing through slowing the growth of generics. The Court was unable to infer recoupment because there was no evidence that B&W would obtain the power to raise prices for generics above a competitive level.18

B. ANALYSIS

1. DEFINITION OF MARKET

In Brooke Group, the court considered the issue of predatory pricing within the framework of the entire market for cigarettes, not just the generic segment of the market. The issue of how to define "market" in the predatory pricing context is important in potential pharmaceutical cases because of the differences between the specific drugs and their respective classes which a firm may manufacture. Courts which have assessed whether a market should be segmented have applied the cost standard to the defendant's entire line or products within the relevant product and geographic market rather than to a specific line.

This approach is favored in the literature. "The existence of nonpredatory pricing in the remaining, competitive part of the market means that competitors in the market are neither threatened with elimination from the market nor likely to be intimidated in to supracompetitive pricing in the future, as required by the recoupment standard."19

Professors Elzinga & Mills further explain, If B&W had in fact priced its discount cigarettes below their average variable cost, Liggett possess a counterstrategy against B&W's low prices for its [generic] line: cut price and expand output in full-revenue cigarettes...Counterstrategic considerations essentially undercut Liggett's contention that B&W was a predator, even if its generic cigarette prices were below cost... More generally, a predator cutting prices in a market segment or submarket cannot succeed. Nor can it injure competition.20

In Brooke Group, the Court failed to explain why it analyzed economy cigarette pricing separately from regular pricing. The parties had stipulated to the existence of a single cigarette market, but the Court never discussed whether this should have happened. One author suggests that "the Court's great emphasis on the unlikelihood of 'sustained supracompetitive pricing' in the economy segment suggests that the Court was looking to that segment for recoupment, which would clearly be error."21

2. MEASURE OF COST

In 1975, Prof. Phillip Areeda and Donald Turner22 proposed their now famous theory that a firm is a predator if it prices below average variable cost.23 The Areeda & Turner test focused almost exclusively on cost data, and asked whether an alleged predator's prices are so low that they are inconsistent with short-run profit maximization. Matsushita Electric Industrial v. Zenith Radio Corp.24 was the first time that the Court shifted the emphasis from short-term losses to recoupment. "The success of any predatory scheme depends upon maintaining monopoly power for long enough both to recoup the predator's losses and to harvest some additional gain."25

There is currently a split among the circuits over whether the appropriate measure of a firm's costs should Average Variable Cost or Average Total Cost. The Court in Brooke Group expressly declined to resolve it.26 However, the Court appears to favor an incremental cost measure.

3. THE RECOUPMENT STANDARD

a. What Does "Recoupment" Mean?

One author pointed out that "One can imagine at least three different ways to think about recoupment: 1. whether the defendant reasonably believed recoupment was likely; 2. whether recoupment in fact was likely (measured at the start of the alleged predation); and 3. whether recoupment in fact occurred (or would have occurred but for litigation.)"27 Calkins concluded that the Court was using third meaning, but could have been clearer about what it meant by recoupment.

b. What is the future of the recoupment standard?

The Court in Brooke Group did not focus on Areeda-Turner or any other test. "The court has refocused on a second necessary condition for successful predation: not evidence of otherwise inexplicable losses, but evidence of recoupment prospects... the Court has adopted a different methodology as its primary means of assessing whether allegations of predatory pricing in fact represent antitrust injury."28

Moreover, the Court cited evidence that B&W intended to cause anticompetitive effects in the generic market, but apparently did not care. The Court relied exclusively on the recoupment standard to hold that there was no evidence that B&W would be likely to obtain sufficient power to raise prices for generics above a competitive level.29 The problem with this analysis is that judges then have to become economists If a firm has made a business decision to price below cost in order to shrink the market, should the court second-guess that decision by saying the plan would not be possible? Corporate directors are in a better position than are judges to make a determination on recoupment.30

b. What role does the inquiry of market power play

In general, courts will find that a firm has a dominant market position, when it occupies 60-80% of the market.31 When a firm occupies over 80% of the market, a finding of market power is almost inevitable. However, Brooke Group requires more than market power to find that a firm is capable of recoupment. "Brooke Group's ruling on recoupment compels a careful analysis of 'effects' questions, such as the likelihood of the remaining competitors continuing to compete rather than tacitly colluding, the ease as opposed to practical threat of 'new entry' and whether the market is 'in flux'"32

One should read Brooke Group together with Spectrum Sports.

Spectrum Sports held that a claim of attempted monopolization under section 2 of the Sherman Act required proof that there was 'a realistic probability' that defendant 'could achieve monopoly power' in a 'relevant market' or a 'dangerous probability of actual monopolization.' Thus, plaintiffs in nonconspiracy Sherman Act section 2 predatory pricing cases must satisfy the ordinary standards of an attempt case, including the requirements of likely monopolization in a relevant market and specific intent, as well as proving pricing below an appropriate measure of cost and likely recoupmebnt, as set forth in Brook Group. 33

Thus, one might infer that the standards which will be used to determine whether a likelihood of recoupments exists are necessarily the same as those used to determine "probability of success" in a monopolization attempt claim.

C. Predatory Pricing Claims After Brooke Group

Since Brooke Group there are now two elements to predatory pricing: 1. cost and 2. recoupment. The court has fashioned a two-part recoupment test:

First, the specific target of predation must be 'likely [to] succumb.' This turns on the nature and extent of the predation , and the relative positions of the predator and target. Second, the market must appear conducive to supracompetitive pricing. Predatory pricing suits should be summarily rejected, 'for example, where the market is highly diffuse and competitive, or where new entry is easy, or the defendant lacks adequate excess capacity to absorb the market shares of his rivals and cannot quickly create or purchase new capacity.'34

The Court in Brooke Group stated that:

If market circumstances or deficiencies in proof would bar a reasonable jury from finding that the scheme alleged would likely result in sustained supracompetitive pricing, the plaintiff's case has failed. In certain situations- for example, where the market is highly diffuse and competitive, or where new entry is easy, or the defendant lacks adequate excess capacity to absorb he market shares of his rivals and cannot quickly create or purchase new capacity-- summary judgement is appropriate." 35

Denger and Herfort noted that "This list is an open invitation to defense counsel and trial courts to focus on structural issues other than the defendant's pricing or output behavior in order to determine whether a predatory pricing case warrants a trial."36

D. CASES FOLLOWING BROOKE GROUP

Cases involving predatory pricing following Brooke Group have not fared well. Two examples follow.

1. Vollrath Co. v. Sammi Corp.37

Vollrath is a Wisconsin company engaged in the business of importing stainless steel steamers and mixing bowls from companies in Korea. The defendants are Sammi Corp., a Korean trading corporation, Sammisa Corporation, Sammi's U.S. subsidiary,, and Ken Carter Industries, a subsidiary of Sammisa Corporation. Vollrath won a $29 million award at trial on 1 and 2 charges, but the judge granted JNOV for defendants. The Appellate court affirmed. Vollrath alleged that Ken Carter had predatorily priced stainless steel mixing bowls.

Relying on Brooke Group, the court held that Vollrath had to show that price was below average variable cost and that there was a dangerous probability of recouping its investment in below-cost prices. The court summarily addressed the issue of Ken Carter's cost, and ultimately held that the concept of imputed interest on a loan could not be held a cost without proof that Ken Carter actually incurred a cost. The court stated that the more serious flaw in the argument that Ken Carter predatorily priced was the fact that there was no possibility it could gain monopoly power and recoup its losses, because it controlled only 10% of the market.

2. Advo, Inc. v. Philadelphia Newspapers, Inc.38

Advo distributes ad materials to households via mail and hand deliveries. It is the nation's largest full-service direct mail marketing company. It brought suit against PNI, which owns the Philadelphia Inquirer and the Philadelphia Daily News, alleging a violation of 2. Advo also alleged that PNI attempted to monopolize and has monopolized the market for high density distribution of printed advertising materials and advertising circulars.

Plaintiff alleged that PNI used predatory pricing of PNI's Run-Of-Press ("ROP") advertising to induce advertisers to use PNI's Total Market Coverage ("TMC") program. Plaintiff claimed that in 1991, PNI developed a TMC plan to enter the advertising circulars market. During phase one of the program, PNI lost $1.81 million. PNI made free or deeply discounted ROP offers along with extremely discriminatorily low rats for PNI's TMC program.

Plaintiff alleged an incident of predatory pricing where PNI offered to distribute for $29 per thousand to one of plaintiff's customers, forcing plaintiff to drop its price from 44.00 to 36.00 per thousand. Plaintiff asserted that if PNI continued to offer Plaintiff's customers predatory rates, the financial consequences would cause Plaintiff to leave the Philadelphia market.

The court first addressed the ease of market entry. Plaintiff argued that barriers to entry in this market are high, and that PNI had 57.6% market share of ROP market and 40.1% share of advertising circulars market. The court pointed to the fact that a new mail company entered the Philadelphia market and created a program reaching 2 million households each week within five months as evidence that barriers to entry in this field are not high.

The court looked to Brooke Group for the standards to apply on the attempted monopolization claim. The court stated that Plaintiff must prove: 1. defendant engaged in predatory or anticompetitively conduct with 2. a specific intent to monopolize and 3. a dangerous probability of achieving monopoly power in the Philadelphia advertising circulars market.

The court held that plaintiff did not show that PNI's 40.1% market share established monopoly power. The court did not address whether PNI operated at a loss, but looked to whether PNI would be able to recoup, and held that the advertising circulars market suggested that recoupment was not a dangerous probability.

Part III. PREDATORY PRICING CASES IN THE HEALTH CARE CONTEXT

There have been no predatory pricing or price discrimination cases in the health care context since Brooke Group. It is nevertheless useful to examine such cases decided before the Brooke Group opinion to determine how the court might decide a case of predatory pricing of prescription drugs today.

A. Barr Laboratories v . Abbott Laboratories 39

There were two claims made by Barr which are relevant here: 1. Abbott sold ethylsuccinate to warehouse chains at discriminatory prices with predatory intent, in violation of Clayton Act, as amended by Robinson- Patman Act. 2. Abbott attempted to monopolize the erthromycin market in violation of 2.

Erythromycin is antibiotic developed by Abbott in 1953. There are four major categories of the drug, including ethylsuccinate. Abbott had a patent on ethylsuccinate ("EES-400") until 1978. In 1981, Barr obtained approval from FDA to manufacture and sell a generic version. A number of other companies also had such approval. The structure of the erthromycin market, which included three leading manufacturers, remained stable from 1984 to 1990. Abbott's market share of all erthromycin products increased from 49.34% in 1984 to 51.19% in 1990. The average price of erthromycin increased from $11.52 to $18.66.

Price Discrimination Claim

Barr claimed the contracts (which provided for lower prices than charged to other customers) Abbott entered into with warehouse chain drugstores constituted price discrimination and attempted monopolization of the national EES-400 market. It was not disputed that Abbott did not sell EES-400 below cost at any relevant time.

The court held that Plaintiff could establish competitive injury either from market analysis or by inference from evidence of defendant's predatory intent. Barr's claim hinged on predatory intent, which the court held could be demonstrated either by express evidence or by inference from below-cost pricing. Barr relied exclusively on express evidence of Abbott's intent, in the form of Abbott internal documents. But the evidence did not show that Barr was competitively impaired during the time Abbott entered the contracts at issue. Barr pointed to Abbott's price cuts to the warehouses, but court noted that the price cuts constituted a business decision with advantages and that Abbott's behavior did not fit predatory pricing.

Attempted Monopolization Claim

Barr claimed that Abbott attempted to monopolize erthromycin market in violation of 2. The court held that to establish claim of attempted monopolization, plaintiff must demonstrate that defendant: 1. had specific intent to monopolize; 2. engaged in anti-competitive conduct; 3. possessed sufficient market power to come dangerously close to success.

The court stated that there is a dangerous probability of success when defendant has significant market share; but this is not the only factor. One must also look to: strength of competition, probable development of the industry; barriers to entry; the nature of the anti-competitive conduct, and the elasticity of the consumer demand. Despite Abbott's 50% market share, other factors showed that Abbott did not have a dangerous probability of success in the attempt to monopolize. These factors included: the number of erthromycin manufacturers increased proving that there were no high barriers to entry, and the continued entry of competition.

B. A possible atttempt at predatory pricing

Over the past couple of years, Congress has issued reports noting skyrocketing costs of prescription drugs.40 Former Sen. David Pryor, former chairman of the Senate Special Committee on Aging, cited eight major drug manufacturers for failing to honor public pledges made in 1991 to hold down price increases on prescription drugs in 1992. Consequently, Sen. Pryor called for government intervention, in the form of the now defunct Health Reform Bill proposed by Bill and Hillary Clinton.

In March 1993, the Pharmaceutical Manufacturers Association ("PMA") asked the Justice Department for an exemption from the antitrust laws so that the association members could discuss price restraints.41 In a March 12, 1993 proposal, the PMA stated that each company would keep its annual increase in price at or below the inflation rate.42

On October 1, 1993, the DOJ announced that it would challenge the PMA's proposal to coordinate price caps for prescription drugs as anticompetitive.43 Although not expressly stated, some members of Congress clearly feared that the PMA members would engage in predatory pricing to gain market power.44

One Senator then proposed an agreement whereby individual manufacturers would limit annual price increases for individual products sold, which PMA members did not sign. The fact that the PMA members sought permission to share information in order to set maximum prices, but would not individually agree to limit price increases is perhaps indicative of a group effort at predatory pricing.

Part IV. THE CURRENT STATE OF THE PHARMACEUTICAL MARKET

A: The Drug Price Competition and Patent Term Restoration Act of 198445 and generic drugs

Any examination of how predatory pricing jurisprudence may affect the pharmaceutical market should begin with the impact of the Act on the market.

The Act restored part of patent life lost during premarket regulatory process for new pharmaceuticals. The average effective patent life for new pharmaceuticals is approximately half of the statutory life of 17 years. The 1984 Act increased patent life up to five years.

The Act also facilitated the entry of generic competitors after patent expiration. Prior to the Act, an imitator had to duplicate many of the pioneer's tests to gain market approval. The cost was several million dollars and a two year wait. 46 Grabowski & Vernon examined the conditions prior to the Act as an entry barrier. In 1983, 34 out of 52 drugs, which were ranked within the top 200 pharmaceuticals, and had expired patents had no generic competition.

Under the Act, a generic drug company need only demonstrate that the drug is bioequivalent to the pioneer's product. For example, in one year, Valium and Inderal, which experienced generic competition for the first time, lost 1/4 of their respective market shares on new prescriptions to generics which sold for 20% less.47 Hence, the Act has removed a barrier to entry.

Grabowski & Vernon hypothesized that if the Act resulted in lower market shares and/or lower prices for innovators after patents expire, this could adversely affect the expected returns from R&D and lead to lower future drug innovations. They concluded, however, that the net efect of the law is not favorable or unfavorable to R&D.

In a later paper48, Grabowski and Vernon published a study of 18 major products first exposed to generic compeition over the period 1983-1987 (drug had to have had $50 million or more in sales at time of patent expiration to be included). In descriptive terms, they found that in the pricing of generics, there is strong downward price dynamic over time. Moreover, they found that prices of pioneering brands remained higher than generic competitors and increased in nominal terms in the period after generic entry. However, the average market price for a drug(total sales for generic and pioneer divided by total units) decreases over time as generic achieve gains in market. Each 10% market-share gain by generics is associated with a market-price decline of 6.1% two years after entry.

Grabowski & Vernon noted that pioneer brands do not try to meet the prices of generics, rather they increase prices at a rate that exceeds the inflation rate. However, the typical product in the study lost about half the market to generics two years after initial entry. The approach of the pioneer companies may be characterized as a "harvesting" strategy: a maintenance of premium price positions while market shares erode over time.

Generics are expected to be 66% of all prescriptions written within the next few years, up from 40% in 1993 and 23% in 1980. "Unlike primary producers, companies that manufacture generic drugs are not encumbered by the need to recover the costs of years of research and development, the lengthy FDA approval process, or advertising. These savings are passed on to the consumer in the form of discounted prices, which average 50% less than their brand-name competitor." Drugs which have lost patent protection over the past two years include: Tagamet (SmithKline-Beecham), Naprosyn (Syntex), Xanax (Upjohn), and Seldane (Marion Merrell Dow).

Perhaps these manufacturers have little to fear. Brand-name manufacturers now sell generics by acquisitions, the formation of their own generic divisions, and alliances with independent generic companies. Brand name firms account for 55% of the generic market.

In the past, firms tended to raise the price of a brand name product after its patent had expired... Nowadays, the brand name pharmaceutical manufacturers are making preemptive strikes by launching generic copies of their own brand name products prior to patent expiration. The generic versions are typically offered at sharply reduced prices in order to maintain market share with key managed care customers. Both Syntex and Upjohn employed this strategy in 1993, sharply discounting the price of Naprosyn and Xanax prior to the expiration to these drugs."49

Of course, this assertion contradicts the earlier finding by Grabowski & Vernon.

B. Price trends in prescription drugs

The hyperinflationary rise in drug prices in 1980s was due to two factors: strong patent protection which allowed drug manufacturers to enjoy virtual monopolies within key pharmaceutical markets, and the inelasticity of drug prices. Prices in 12 month period ending August 1994 were up only 3.2%, where prices had been soaring to almost double digits in the 1980s.50 Managed care providers use collective bargaining clout to get discounts for bulk purchases of pharmaceuticals. They substitute low cost generics for higher priced name brand products.

Industry earnings growth has slowed to about 10% in 1993 and is expected to narrow further (down from high double digits in the 1980s).51 Certain companies will perform, nevertheless provided that they are "firms with dominant market positions in major or niche-oriented therapeutic categories, strength in research and global marketing, and solid balance sheets."52

C. Mergers in the industry

Mergers in the pharmaceutical industry increased in 1994. Swiss-based Roche bought Syntex for $5.3 billion; American Home Products bought Cyanamid for $9.7 billion; and French-based Sanofi bought Eastman Kodak's Sterling Winthrop pharmaceuticals for $1.7 billion.

One recent trend among pharmaceutical manufacturers is acquiring PBMs (pharmaceutical benefit managers). PBMs are retained by managed care providers to determine which drugs the providers should purchase on a cost-containment basis. Pharmaceutical manufacturers are linking up with PBMs to secure and increase market share for their products. In 1993, Merck acquired Medco Containment for $6.6 billion. At this point, all the major PBMs are hooked up with pharmaceutical firms; therefore, drug companies might strive to acquire minority stakes in HMOs.

The trend in mergers and acquisitions in the pharmaceutical industry may be driven by the need to "offer a full complement of prescription and generic drugs for all major therapeutic classes, achieve a secure global marketing reach, and invest heavily in research and development."53

Part V: PREDATORY PRICING OF PRESCRIPTION DRUGS

There are many different opportunities for those involved with the pharmaceutical industry to benefit from predatory pricing. However, this section argues that the manufacturer is the main predator. With massive sales losses forced on the industry, the ease with which one may price predatorily may prove too tempting for the big pharmaceuticals seeking to retain market power. Moreover, industry experts argue that declining revenues will force firms to cut R&D expenditures54 which are valuable to a pharmaceutical's future business. One can see why a major manufacturer would not want to see a loss of market power come to fruition.

A. Manufacturers

The first example involves a manufacturer as the predator. In a two - tiered agreement, a manufacturer would sell its product to a wholesaler below average variable cost and the wholesaler would sell the drugs only to those pharmacies which would agree to sell the drug at a below market price. The effect of such agreement is to create manufacturer and wholesaler monopolies in a given drug market. An alternate form of the agreement would be a manufacturer offering giant rebates to wholesalers, who then passed off the savings to the consumers.

The biggest risk for predatory pricing in the industry is in those cases where a patent is about to expire, or has just expired. The first obstacle to such litigation is the establishment of the firm's costs. The determination of average variable cost is a difficult judicial inquiry. Moreover, a large pharmaceutical firm would have the ability to manipulate its accounting to cover costs, ie. by changing the way in which it allocates overhead. The difficult in determining average variable cost in such litigation increases the ability of a large pharmaceutical firm to price predatorily. This proposition is troublesome in two respects. First, in a situation where a substitute drug were developed and its manufacturers sought to enter the market. Second, at the point where the patent is about to expire and it is foreseeable that generics will be introduced. Under the recoupment standard, a court might determine that the manufacturer had no possibility of recouping due to expiration of the patent. Analysis under the recoupment standard must take account of the many trends in health care described earlier in this paper. The Court will look to the structure of the pharmaceutical industry, and the relatively new advent of generic drugs as factors pointing away from a single firm's ability to later recoup losses spent while pricing preditorily.

By the same token, the Court would look at a firm which does not possess market power and conclude no possibility of recoupment. The Court, however, should be sensitive to the dynamic changes in the health care environment which could greatly impact a firm's ability to later recoup losses. For example, that same firm which lacks market power, but nonetheless acquires a PMB might be able to recoup.

It is very unclear how the Court would consider recoupment in the context of a changing market. In the pharmaceutical context, such important changes include the addition of generic products to the list of brand name products. Earlier we saw that courts are inclined to look at all of a firm's sales in a given industry (ie. the entire cigarette market) to determine the relevant product market. This analysis is incorrect in the health care context.

We should reject Professors Elzinga & Mills' counterstrategy proposal55 in the health care context. As a policy matter, we do not want such shifting of production in pharmaceutical markets. Therefore, when determining the relevant market for a predatory pricing claim, the Court should examine each classification of drugs, rather than all prescription drugs.

There are many opportunities for a manufacturer with an expired patent, or a patent which is about to expire, to manipulate the predatory pricing law. This is primarily due to the fact that firms can employ product- differentiation strategies to thwart generic competition. For example, a pioneer brand can release a slow-release dosage form. Moreover, the prescription drug market is highly concentrated, with the four largest players accounting for more than 1/3 of US pharmaceutical sales in 1992.

B. Pharmacies

Pharmacies stand to benefit from predatory pricing of prescription drugs, particularly where the demand for a given drug is inelastic. If one pharmacy (or, more likely, a retail pharmacy chain) is granted, due to the sale of the drugs at below average variable cost, exclusive rights to distribute the drug at a below market price, that pharmacy has a monopoly with respect to distributing that drug. In such a situation, the wholesaler is subject to liability for refusal to deal with other pharmacists, and that decision which would be subject to the rule of reason. If the pharmacy can demonstrate that it engaged in this behavior for the purpose of driving its rivals out of the market, it will also be subject to liability.

C. Insurers

Insurance companies can also benefit from participating in a predatory pricing scheme in two ways. Suppose an insurance company charges a flat co-payment fee for its prescriptions, as opposed to a percentage co- payment. Insurers might have an incentive to agree with a drug manufacturer or wholesaler with a highly elastic demand curve to charge a lower fee for that particular drug, and a higher one for the competing drug.

In the second instance, assume a pharmacy is able to accept a low (below cost) reimbursement rate from contracting insurers for a prescription drug because it has acquired the drug from the wholesaler and/or manufacturer at below average variable cost. Also assume that the insurer provides its subscribers with a percentage prescription benefit plan, whereby the customer pays a set percentage of the cost for each prescription. If the insurer is aware that the pharmacy is able to offer to the consumer a below-market price on its prescription drugs because it obtained the drug at below average variable cost, the insurer is in a position to pay the pharmacy to offer below-market prices to pharmacy customers who are also potential subscribers to the insurance company. If the pharmacy has an exclusive contract with the wholesaler for the drug, then customers will be enticed to sign up with the insurance company in order to receive the lower rate on the drug.

In such a case, the insurance company should also be subject to 2 liability, but under the Court's current predatory pricing jurisprudence, it would not be. Liability should especially be the case when the insurance company is reimbursing for drugs which have inelastic demand curves. In such instances, customers are dependent upon a given drug. Thus, the pressure for these customers to sign up with that particular insurance company and receive the better deal is enormous. This creates, in effect, the possibility of 2 violation on the part of the insurance company for attempting to monopolize the insurance market in a given geographic region.

This scenario has a curious effect on providers. Specialists who prescribe a drug subjected to predatory pricing may be forced to align with the insurance company which provides for the lower drug rates to its subscribers. If only a small number of physicians in a given specialty ultimately align, they may then possess monopoly power in a certain geographic region in their given specialty. This begs the question of whether society and legal rules should distinguish providers who actively pursue participation in predatory pricing schemes. Thus far, this paper has indicated that legal rules should punish those who have knowledge of a predatory pricing scheme in the prescription drug market, and seek to use and/or exploit that scheme for their own benefit. What may trouble us about the position of such providers is when they also have a capitation agreement with the insurer, from which the provider gains an automatic patient base, as well as guaranteed fees. Whereas it is questionable whether to hold providers participating in predatory pricing schemes to antitrust liability, it is in the public interest to punish those providers who actively seek out alignment with insurers which participate in predatory pricing schemes and the provider also operates under a capitation agreement with that insurer.

Part VI: CONCLUSION

The new recoupment standard announced in Brooke Group presumes that a firm has behaved lawfully until the plaintiff comes forward with a plethora of evidence to the contrary. In the past, the buzz around making a predatory pricing case was the difficulty of establishing the defendant's cost. After Brooke Group, potential plaintiffs must also show that the defendant can or will recoup its losses. The demonstration of recoupment is particularly difficult in the pharmaceutical industry, which is constantly changing structurally. Moreover, market shares will not remain constant, as generic drugs continue to arise, which are more attractive to consumers and third party payors.

I would be inclined to place less weight on the recoupment standard. In doing so, I would simply be stating that I assume the firm has some legitimate reasons for pricing below average variable cost. It is not likely that firms would do so to provide a consumer gift.

Therefore, in the predatory pricing test, I would continue to emphasize the Areeda-Turner test. This test can be especially effective in the health care context due to the tremendous research efforts into the actual costs of providing health care.

While I have contemplated the benefits, in general, of the new stricter predatory pricing standard, I have concluded that if we are to err in the pharmaceutical industry claims, we should err on the side of false positives, rather than false negatives.56 The health care profession will best be served by ensuring that each drug market will have the most players. 1881 F.2d 1396 (7th Cir. 1989). 2113 S.Ct. 2578 (1993).

---- [first 2 footnotes missing]

3 Professors Elzinga and Mills best summarized Liggett's proposal of a complex chain of events as follows: 1. B&W priced below AVC; 2. B&W sought to extinguish the generic market; 3. there was tacit collusion on brand names; Liggett's theory makes B&W the martyr because B&W alone incurred losses to drive Liggett out of generic market while all manufacturers shared in the recoupment; 4. B&W was recouping the losses from its alleged predatory pricing in the generic markets simultaneously on alleged monopoly profits in brand market. See Kenneth G. Elzinga & David E. Mills, Trumping the Areeda-Turner Test: The Recoupment Standard in Brooke Group, 62 Anti.L.J. 559, 568 (spring 1994).

4 Brooke Group v. Brown & Williamson, 748 F.Supp. 344, 354 (M.D.N.C. 1990).

5 Essentially, Liggett's primary-line injury claim was that B&W introduced discriminatory volume rebates to wholesalers which threatened competitive injury by furthering a predatory pricing scheme designed to purge competition from the generic market.

6 Spectrum Sports, Inc. v. McQuillan, 113 S.Ct. 884 (1993).

7 Falls City Industries, Inc. v. Vanco Beverage, Inc., 460 U.S. 428, 434 (1983). A Robinson-Patman claim has an advantage over 2 claims. There is no need to establish that defendant is liable for attempted or actual monopolization, as is the case with a 2 claim.

8 There is a conflict among the lower courts over the appropriate measure of cost. The parties in this case agreed that the relevant measure of cost would be average variable cost, which is what the Court used for its analysis. The issue of appropriate measure of cost will be addressed later.

9 Brooke Group, 113 S.Ct. at 2584.

10 Spectrum Sports v. McQuillan,113 S.Ct. 884 (1993). At issue was the 9th Circuit's rule for attempted monopoly, which permitted plaintiffs to prevail by showing unfair or predatory conduct from which the fact finder could infer the "dangerous probability" of successful monopolization (this is an independent element of the offense in other circuits). The court rejected the 9th Circuit view.

11 Brooke Group, 113 S.Ct. at 2584.
12 Id.
13 Id. at 2592
14 Id. at 2595.
15 Id. at 2589.

16 Tacit collusion (also known as oligopolistic price coordination or conscious parallelism) is when firms in a concentrated market share monopoly power by setting prices at profit-maximizing, supracompetitive levels. These firms engage in this behavior because they recognize their shared economic interests and their interdependence with respect to price and output decisions. Tacit coordination is facilitated by a stable market environment, fungible products, and a small number of variables upon which the firms seeking to coordinate their pricing may focus. Uncertainty in the marketplace does not foster oligopoly.

17 Id. at 2596.

18 B&W had 12% market share, which is about 1/9 of market. For each nine dollars in monopoly profits earned, B&W would gain only one dollar of recoupment.

19 Michael L. Denger & John A. Herfort, Predatory Pricing Claims After Brooke Group, 62 Anti.L.J. 541, 552 (spring 1994).

20 Elzinga & Mills supra note 3 at 572

21 Stephen Calkins, The October 1992 Supreme Court Term and Antitrust: More Objectivity than Ever, 62 Anti.L.J. 327, 390 (1994)

22 Areeda & Turner, Predatory Pricing and Related Practices Under Section 2 of the Sherman Act, 88 Harv.L.Rev. 697 (1975).

23 Prof. Areeda & Turner analyzed predatory pricing using marginal cost as a measure, but then noted that the marginal cost is almost impossible to determine, and substituted average variable cost as the appropriate measure. See Areeda & Turner, supra note 22 at 716.

24 475 U.S. 574 (1986).
25 Id. at 590.
26 The parties had decided that it would be Average Variable Cost.
27 Calkins, supra note 21 at 399.
28 Elzinga & Mills, supra note 3 at 579.

29 See also A.A. Poultry Farms v. Rose Acre Farms, 881 F.2d 1396 (7th Cir. 1989), which held that in Sherman Act cases, the courts need not consider corporate planning documents and price-cost comparisons unless the structure of the market makes recoupment feasible.

30 I believe Justice Stevens had similar thoughts in mind when he wrote his dissent: "That B&W executives were willing to accept losses of this magnitude during the entire 18 months is powerful evidence of their belief that prices ultimately could be 'managed up' to a level that would allow B&W to recoup its investment." J. Stevens, dissenting, Brooke Group, 113 S.Ct. at 2601.

31 Since Brooke Group, the Eleventh Circuit has dismissed a Section 2 predatory pricing case without recoupment analysis where defendant's market share was less than 50% of the market throughout the period of the alleged predation. U.S. Anchor Manufacturing v. Rule Industries, 7 F.3d 986 (11th Cir. 1993

32 Denger & Herfort, supra note 19 at 554
33 Id. at 554-5.
34 Calkins, supra note 21 at 399.
35 Brooke Group, 113 S.Ct. at 2589.
36 Denger & Herfort, supra note 19 at 555.
37 9 F.3d 1455 (9th Cir. 1993); cert. denied, 1994 U.S. LEXIS 4321.
38 854 F.Supp. 367 (E.D. PA 1994).
39 978 F.2d 98 (3rd Cir. 1992).

40 Margolis, Robin, Prescription Drug Manufacturers get Warning on Prices, 10 No. 3 Healthspan 19, March 1993.

41 Id.

42 Antitrust Division would Challenge Drug Association Plan to Control Prices, BNA's Health Law Reporter, 10/7/93.

43 Id.

44 "In a March 18 [1993] letter to Attorney General Janet Reno, ... two senators also wrote that they worried that companies would hike prices if allowed to set maximum prices."

45 (Pub. L. No. 98-417, 98 Stat. 1585--- codified in scattered sections of 21 USC and 35 USC)

46 Henry Grabowski & John Vernon, Longer Patents for Lower Imitation Barriers: The 1984 Drug Act, 76 Am. Econ. Rev. Papers & Proc. 195 (1986).

47 Id.

48 Henry G. Grabowski & John M. Vernon, Brand Loyalty, Entry, and Price Competition in Pharmaceuticals After the 1984 Act, 35 J. Law & Econ 331 (October 1992).

49 Health Care Products & Services: Basic Analysis, Standard & Poohs Industry Surveys (section 2) (October 6, 1994) 15, 26.

50 Id.
51 Id. at 44.
52 Id. at 23.
53 Id.

54 Robert M. Goldberg, Race Against the Cure, Policy Review (spring 1994).

55 Elzinga & Mills, supra note 20 and accompanying text.

56 Essentially, we should be more concerned with allowing a firm which prices predatorily get away than we should be with falsely accusing an innocent firm.
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