Transcript The GSK France case: in search of a consistent story

The GSK France case:
in search of a consistent story
Michele Polo
(Bocconi University and LECG)
2007 ACE Conference, Toulouse
The case
• Very complete summary in Choné’s presentation
• I do not enter into relevant market issues
(interesting comments in Avenel’s presentation)
• I focus on the predatory pricing issue:
– Identify the anticompetitive story proposed by the CC;
– Build an alternative competitive explanation
– Which factual elements allow to discriminate between
the two?
– Did the decision run a proper evaluation of these
factual elements?
The anticompetitive story of the CC
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Actors: Glaxo France (predator); Flavelab (prey); Merck, Panpharma, Lilly,
…(other firms)
Markets: pharmaceutical markets at the turning point when patent
protection is expiring; supply to hospitals (bidding markets).
– Market A: Acyclovir;
– Market B: cephalosporins (2 molecules: cefuroxime and cefamandole,
but only the former is considered!)
Qualitative argument: the patent holder establishes a reputation of
aggressive behaviour in one (small) market and deters entry also in other
markets where patent protection is going to expire. Predation strategies
establish a link across otherwise different and separate markets
Reference to two models of predatory pricing:
– Reputation: below cost pricing in market B (cefuroxime) where Glaxo is
not dominant with the aim of constructing a reputation of aggressive
player and deter entry in market A (acyclovir) where Glaxo is dominant;
– Financial Predation: aggressive pricing to induce negative
performance and inability of the entrant to rely on external finance to
cover losses
The anticompetitive story of the CC
(2)
• 1999-2000: Glaxo prices Zinnat® (market B: cefuroxime)
below purchasing price in hospital procurements where it
faces Flavelab as a competitor>> selective price cuts;
• Glaxo establishes a general reputation of aggressive
incumbent towards entrants (also in other markets,
including market A)
• Flavelab exits in 2000 and goes bankrupt in 2001
• Glaxo maintains a dominant market share in market A
(thanks to reputation) after patent protection expires
A competitive story
• Supply to hospitals: procurements, bidding markets;
• Bertrand-type competition if more than one participant;
price = AVC
• Price not greater than the reservation value of the
hospital (bargaining? repeated interaction?) when only
one participant; price > AVC
• Efficient competitors survive (even if modest margins)
while inefficient ones exit.
• No (strategic) link between market A and market B.
A comparison
• The anticompetitive story:
– Entry of competitors
– Selective price cuts:
• price below cost in
procurements where the
competitor participates;
• price with positive margins in
procurements where only
Glaxo participates;
– the competitor exits and Glaxo
remains monopolist in market
B or restarts predation against
new entrants;
– Glaxo maintains dominance in
market A due to reputation
• The competitive story
– Entry of competitors
– Prices driven by the bidding
processes in hospital
procurements:
• price close to average
variable costs when Glaxo
and the competitor
participate;
• prices higher than AVC in
procurements where only
Glaxo participates;
– Efficient competitors survive
and inefficient competitors
exit;
– Market A: an independent
market whose evolution is not
affected by market B
Predictions
The two stories give two different empirical
predictions:
1. Evolution of market B after a period of low
prices:
–
–
Anticompetitive story: Glaxo remains monopolist
in market B or restarts predation against new
entrants;
Competitive story: efficient competitors survive in
market B while inefficient competitors exit
2. Level of low prices:
–
–
Anticompetitive story: p < AVC
Competitive story: p ~AVC
1. On the evolution of the market
Market B
1999
2000
2001
2002
2003
2004
2005
Glaxo
81.4
75.0
73.0
51.0
35.0
22.0
18.0
Flavelab
16.0
16.5
Panpharma
2.6
8.5
27.0
49.0
65.0
78.0
82.0
Market A
1999
2000
2001
2002
2003
2004
2005
Glaxo
99.5
90.5
80.9
57.4
65.0
46.0
52.0
Mercks
0.5
9.5
19.1
42.6
33.5
44.4
25.4
1.5
9.6
22.6
(cefuroxime)
Others
1. On the evolution of the market
(2)
•
The CC argues that Glaxo predates Flavelab in market B until Flavelab exists (2001) and
therefore establishes a reputation of aggressive incumbent.
•
However, in the same market Panpharma enters in 1999 and grows steadly reaching 82% of the
market in 2005. Panpharma grows also in the parallel market of cefamandole cornering Lilly. This
is inconsistent with the reputation model, that predicts to predate every time entry occurs.
•
At the same time, the CC claims that Glaxo maintains a high market share in market A and
interprets it as the result of successful predation in market B
•
The evolution of market shares in market A and B in the interpretation of the CC is inconsistent
with the reputation story:
–
–
Glaxo is claimed to remain dominant in market A due to successful predation in market B,
but Glaxo tolerates to leave market B to Panpharma, inconsistently with a successful reputation building
strategy.
•
Panpharma prices are aligned to the lowest offers by Glaxo (in the SoO): consistent with an
efficient competitor surviving (and growing!).
•
Since patent protection expires in 1999 in market B and in 2002 in market A, it is not obvious that
the two markets are following different patterns: in both cases after 4 years the old patent holder
has around 50% of the market!
2. The level of low prices
• The second key element in identifying the explanation consistent
with facts refers to the level of prices in the competitive episodes:
p<AVC or p~AVC in procurements where Glaxo faces a competitor
• This requires a careful assessment of AVC
• Since Glaxo France purchases the cephalosporine from a
production unit of the same group, Adechsa, CC uses the transfer
price as a measure of the AVC
• A key point is whether an internal transfer price can be considered
as the average variable cost for the downstream unit.
Transfer prices vs AVC
•
The argument put forward by CC is formalistic:
§201 “…Glaxo has significant autonomy to determine its sale price, in particular with respect to the
other companies in the group or the parent company. Its purhcase prices, paid to any of its
suppliers, are indeed relevant costs in applying the cost test”
•
Significant autonomy has not a clear economic meaning:
– it means that the downstream unit (Glaxo France) is the subject setting the final
price (through its hospital sales section).
– but it does not imply that Glaxo France, in its price setting decision, is maximizing
the downstream unit profits rather than the group profits.
– For instance, Glaxo France might set the final price under the constraint that p ≥
AVC, where AVC is the average variable cost of the production unit.
– Behaving this way, Glaxo France would be autonomously maximizing the group’s
profits!
Transfer prices vs AVC (2)
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The Akzo test is intended to identify a lower threshold (e.g. AVC) below
which a firm would not set the price in a competitive environment, >>
minimize probability of type-I errors.
It uses the predator’s costs to ensure that an “as efficient” competitor would
make losses only below this threshold.
When we compare competing firms with different size and architecture, as a
large multinational company as Glaxo and a small firm, we want to check
whether Glaxo pricing would prevent the rival from competing when this
latter produces the drug at the same level of efficiency of Glaxo.
Hence, the proper measure is Glaxo AVC in the production unit, that
corresponds to the equivalent process of the competitor, and not the
transfer price (TP), that may reflect a policy of the large company in
allocating the fixed costs (not incurred by the producer of generics) across
units.
The CC fails to construct, or to require Glaxo to produce, these data.
Transfer prices vs AVC (3)
Running the Akzo test based on TP is problematic:
•
p<TP
is consistent with p<AVC (i.e. predation) if TP ≤ AVC,
-----------p---TP----AVC------but
•
may be also consistent with p>AVC if AVC < TP, i.e. if the transfer price fully
covers the average variable production costs with a margin for the fixed
costs (not implausible). In this case, as it is with Bertrand competition
(competitive story), the equilibrium prices should be lower than TP.
-------------AVC---p---TP-----------
Hence, using TP in the Akzo test when TP>AVC induces a type I error
according to the competitive story, and a test based on TP does not
allow to identify predation.
Conclusions
I’m not convinced of the arguments put forward by
the CC on two grounds:
1.
The evolution of market shares tells us that in mkt B
Glaxo was almost replaced by Panpharma while in mkt
A Glaxo retains a dominant position. The evolution of
mkt B is inconsistent with successful predation in mkt
B but the evolution of mkt A is explained by successful
predation: a contradiction!
2.
The key quantitative test to discriminate between the
competitive and anticompetitive stories is not properly
run: transfer prices rather than AVC are used.