[Note: If the unknown author contacts us, we'll be happy to give full
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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 &
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
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.
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
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.
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.
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
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
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.
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
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.
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
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.
42 Antitrust Division would Challenge Drug Association Plan to Control
Prices, BNA's Health Law Reporter, 10/7/93.
44 "In a March 18  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).
48 Henry G. Grabowski & John M. Vernon, Brand Loyalty, Entry, and Price
Competition in Pharmaceuticals After the 1984 Act, 35 J. Law & Econ 331
49 Health Care Products & Services: Basic Analysis, Standard & Poohs
Industry Surveys (section 2) (October 6, 1994) 15, 26.
51 Id. at 44.
52 Id. at 23.
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
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