Global sales of pharmaceuticals reached over $1 trillion annually each of the past three years and the trajectory of growth is expected to continue in the coming years. In the United States alone, pharmaceutical sales topped $500 billion in each of the past two years, making it the largest market in the world. The importance of the pharmaceutical market was thrust into the spotlight during the COVID-19 pandemic, as both policymakers and individual companies raced to provide access to life saving medicine to those in need. Large pharmaceutical companies engaged in partnerships with small research start-ups, developing breakthrough vaccines that reached the market in record time. Two of the leading vaccine manufacturers, Pfizer and Moderna, are projected to approach $50 billion in sales in 2022 alone.

News publications have been replete with headlines about astronomically high costs to consumers for essential treatments over the past decade, featuring stories about EpiPens and insulin. The increase in innovation and resulting market dominance of large pharmaceutical companies has brought with it renewed scrutiny from regulators about pricing concerns. In response to increasing prescription drug prices for many Americans, President Biden and Congress worked to include drug pricing reform in the Inflation Reduction Act of 2022 (“IRA”). Under the IRA, the Secretary of the Department of Health and Human Services is empowered to establish a “Drug Price Negotiation Program,” under which he shall negotiate prescription drug prices and enter into agreements with manufacturers of selected drugs. Regardless if it were the correct normative approach to reduce prices for consumers, the current administration took a substantial step to address the concern over individual social welfare, likely coming at the expense of future profits for pharmaceutical companies.

Amidst concerns over future regulation and the sustainability of profits from existing products, pharmaceutical companies have turned largely to mergers and acquisitions (“M&A”) to supplement their own internal research and development (“R&D”) and to find the next “blockbuster” drug. Over the past few decades, spending on R&D has increased dramatically, and on average, pharmaceutical companies spent approximately one quarter of their revenues on R&D in 2019. The disproportionate spending on R&D appears logical when considering the “costly and uncertain process” of developing a drug that passes all milestones during clinical trials and is granted approval by the United States Food and Drug Administration (“FDA”). According to research done by the Congressional Budget Office, only 12 percent of drugs that enter clinical trials are approved by the FDA, and the cost of R&D spending on an individual approved drug can be as high as $2 billion. Large pharmaceutical companies have turned to small biotechnology startups and partnerships with nonprofit research institutions as a means of outsourcing R&D to those who have the ability to specialize on certain biological processes or individual small molecules, and have the flexibility to research in the manner they see fit. Given the high cost associated with developing new drugs, and the risk of failure in one or more stages of development, smaller startup companies are incentivized to engage in transactions with larger incumbent firms in order to commercialize new products.

While the value of M&A to large pharmaceutical companies and their shareholders has been debated for years, both scholars and regulatory officials have begun to focus on whether consolidation between firms will harm innovation, and thus negatively impact downstream social welfare for individuals. The debate intensified following the release of a working paper by economists Colleen Cunningham, Florian Ederer, and Song Ma, which introduced the concept of “killer acquisitions” – an incumbent firm acquires a nascent competitor with the motivation of terminating development in order to reduce competition to its existing or pipeline products. While subsequent research papers have begun to echo similar concerns over the anticompetitive nature of M&A in the pharmaceutical industry, others have discussed the problems associated with proving such phenomena exist. To explore the issue further, leading antitrust authorities, including the FTC, the European Commission (“EC”), the Department of Justice Antitrust Division (“DOJ”), the Canadian Competition Bureau, and the United Kingdom’s Competition and Markets Authority (“CMA”), issued a notice seeking public comment on how to best inform their approaches to analyzing pharmaceutical mergers.

While the concentration of market power may lead to increased prices in the short term for consumers, antitrust authorities should be wary of examining the deleterious effects on innovation as a standalone theory of harm because countervailing interests in synergy and innovation stemming from pharmaceutical M&A may increase total consumer surplus in the long run. Additionally, the current patent system, which provides a limited term of monopoly for patent holders, and requires companies to license existing products or face liability for patent infringement, provides consistent incentives for large pharmaceutical companies to acquire new products and ideas through acquisition, rather than through organic development. Many startup biotechnology companies develop specifically for the purpose of selling the business in order to profit, instead of adopting the role of a true competitor to larger incumbent firms. In examining the actual effect on competition resulting from an acquisition, the counterfactual world is not observable, and it would be impossible to predict a nascent company’s future effects on competition.

Instead, this note will argue that government and regulatory authorities should focus on easing access to downstream innovation by broadening research exemptions to patent infringement. Part I of this note will focus on the current state of patent protection and exclusivity afforded to pharmaceutical companies. Part II will discuss incentives created that lead rational actors to engage in M&A instead of through internal R&D. Part III will address the development of innovation as a standalone theory of harm in merger review, and the fallacies associated with labeling certain transactions as “killer acquisitions.” Finally, Part IV of the note will look at the intersection of pharmaceutical transactions and intellectual property protection, and how encouragement of collaboration between firms may offset the negative externalities associated with high costs to consumers and terminated R&D projects.