The relationship between competition and risk should lead the antitrust agencies to change merger policy in three main ways. First, the agencies should move to block mergers projected to increase risk significantly even when that is a merger’s main or only predicted anticompetitive effect. Mergers that threaten to eliminate firms with idiosyncratic production techniques—production mavericks—are especially concerning on these grounds. Second, the agencies should consider risk when evaluating purported cost-cutting efficiencies such as closing redundant factories because achieving such efficiencies may in some cases increase risk. Finally, when exercising investigative and enforcement discretion, the agencies should focus on those mergers that would likely increase systemic risk by creating especially large or economically central firms.
* * *
In 2015, the first- and third-largest manufacturers of generic prescription drugs in the United States, Teva and Allergan Generics, merged in a $40.5 billion deal that left Teva with more than a fifth of U.S. generic-drug sales. The combined company sold more than 720 drugs, a portfolio more than 50% larger than either party before the merger, and far larger than the distant third competitor. The Federal Trade Commission scrutinized the deal for compliance with the Clayton Act and eventually cleared it after the merging parties agreed to divest almost 80 drug lines in which they had substantial competitive overlap.
The merger soon proved disastrous. Teva had funded the acquisition with billions of dollars in debt, and when generic-drug prices declined shortly after the deal closed, the merged company had to take drastic action to avoid bankruptcy. Teva announced plans to close half of the combined firms’ factories, slash drug production, and raise prices on many of its remaining therapies. These changes have real consequences for consumers. According to the U.S. Government Accountability Office, a decrease in suppliers over the prior two years is the single most important variable in explaining drug shortages, which in turn typically lead to significant price increases. Prior shortages have also been associated with increased mortality for patients who must receive alternative medicines. Among the drugs Teva stopped producing in 2019 was a sedative used to manage patients on ventilators, which went into shortage soon after Covid-19 struck the United States, and a pediatric oncology drug with no known substitutes that physicians were forced to ration because of the lack of supply.
Even today, almost a decade after the merger, Teva continues to stagger under its debt burden. In 2023, the company announced a new round of manufacturing cuts, along with plans to permanently reduce the number of generic drugs it will produce in the future.
Permitting this merger was reasonable under the agencies’ 2010 Horizontal Merger Guidelines, which gave significant credence to merger-specific, cost-cutting efficiencies and were most concerned with mergers that further concentrate uncompetitive markets. The FTC did its job scrupulously, requiring the manufacturers to divest many drug lines in which they directly competed or were likely to compete in the near future. And Teva could point to substantial cost-saving efficiencies that were highly valued by the agencies, such as shutting down separate factories making similar goods.
Yet, as they approved the merger, antitrust officials failed to consider how the deal would affect customers in the event of a supply shock. As they generally do, the agencies analyzed the merger on the assumption that business as usual would continue indefinitely after the transaction, without considering the risks of any low-probability but highly consequential events. In this case, by reducing spare capacity, concentrating customers’ exposure to its idiosyncrasies, and eliminating each firm as a potential competitor to the other in lines that were not divested, the Teva-Allergan combination made shocks to the combined firms more painful for customers and the economy at large. Because Teva suffered an idiosyncratic blow soon after the merger, the deal ultimately harmed customers by subjecting them to shortages, price increases, and reduced competitive choice across the range of the integrated firm’s portfolio.
This example is not unique. As this article shows, mergers that increase customer dependency on a single or small number of firms can increase direct risk—risk affecting immediate trading partners—and systemic risk—risk affecting society more broadly. There is substantial evidence that firms transmit negative supply and demand shocks to customers and to society at large, and that this effect is mediated in part by competition. These effects are larger, on average, when a shocked firm has greater market power, although this result is likely mitigated to some degree because larger firms, and those with market power, are less subject to negative shocks. Firms also face greater risk when they rely on one or a small number of trading partners for a large share of their total purchases or sales across products. (In what follows, this article often uses “customers” as a shorthand for trading partners, i.e., suppliers, workers, and purchasers.)
Risk is a natural concern under the antitrust laws. Section 7 of the Clayton Act bars mergers when the “effect of such acquisition . . . may be substantially to lessen competition, or to tend to create a monopoly.” Like a forecast of increased prices or reduced output, a prediction that a merger will increase risk can indicate that the merger will substantially lessen competition. Mergers can increase risk by reducing the ability of the merged firms’ customers to diversify and by reducing the incentive to invest in resiliency (i.e., to take measures that will reduce risk). Increased risk can be thought of as an average increase in future prices when weighing the consequences of future shocks. Supply shortages are effectively price hikes because they prevent customers from securing goods or services they want either at any price or for less than an exorbitant price. Thus, like other harms caused by competition-suppressing mergers, increased risk falls squarely within Section 7’s concerns and can be analyzed by courts under existing case law.
Continue reading the full text of this article in PDF format.
