It is plain to see that entry leads to lower prices and expanded output, which benefits consumers. Although the profits of the incumbent fall as the number of entrants increases, the result is positive. Thus, protecting the possibility of entry boosts consumer welfare.
Potential Competition
If a firm is not an actual participant in an antitrust market, but is a potential entrant in that market, it may influence the conduct of existing participants. A potential entrant’s decision to enter or not is rationally driven by profit considerations. The more profitable actual entry appears to be, the more likely a potential entrant will become an actual entrant. Consequently, the conduct of the incumbent firms may be influenced by the threat of entry. If the incumbent curtails its pursuit of short-run profit and behaves more competitively, it will reduce the probability of entry and thereby avoid the enhanced competition that would accompany entry. In this way, preserving potential competition provides some procompetitive benefits.
Under the conditions described above, entry increases the number of firms, output expands, and price falls, which benefits consumers. Given these potential benefits, preserving the possibility of entry in horizontal merger cases should be a policy goal of antitrust enforcement.
However, the likelihood that potential competition will prove to be so beneficial that an otherwise unobjectionable merger should be barred should not be overstated. Whether those conditions are met frequently is an empirical matter, but they are demanding. Nonetheless, when the conditions are met, barring a horizontal merger can have procompetitive benefits.
These unambiguously positive results do not necessarily carry over to vertical mergers. We demonstrate this in our discussion of the Illumina-Grail merger, but first we examine entry in the 2020 VM Guidelines.
Misplaced Concern for Protecting Potential Entry
The Agencies exhibited a misplaced concern for protecting potential entry in the 2020 VM Guidelines. This can be seen in the discussion of an example from the Guidelines involving a proposed merger in a successive monopoly environment, where the Agencies expressed unwarranted concern for a potential downstream entrant.
The example and discussion is as follows:
“Situation: Company A is the sole supplier of an active ingredient required to make an off-patent pharmaceutical drug produced only by Company B. Company A’s supply of the active ingredient is the related product. It sets a constant unit price. Company C is considering entering the relevant market with its own version of the drug. Were it to enter, head-to-head competition with Company B would be significant and prices for the drug would likely fall significantly, leading to increased sales. Company B buys Company A. In the absence of the merger, Company A would benefit from Company C’s entry.
Discussion: The merger may diminish competition in the relevant market by making entry by Company C less likely. In the absence of the merger, Company A would likely have an incentive to facilitate the entry of Company C and to supply Company C if it did enter. The merged firm, on the other hand, may have the ability to prevent Company C from successfully entering the relevant market by refusing to supply Company C with any active ingredient. In this case, Company C’s successful entry into the relevant market may require Company C to produce the active ingredient as well. This two-level entry may be more costly and riskier than entering the relevant market alone, and thus may deter Company C from entering. Moreover, the merged firm may have an incentive to refuse to supply Company C unless it is markedly more efficient or targeting additional customer groups or markets.”
If the FTC or the DOJ blocked this merger, the outcome would be no better than permitting the merger and could be much worse. We illustrate this point in the context of the Illumina-Grail merger. By doing so, we hope to help to assist the Agencies in their expected future revision of the VM Guidelines.
Illumina-Grail: Facts
Illumina
Illumina is a biotechnology company whose areas of interest include oncology, microbiology, and cellular microbiology. Illumina is known for its specialization in DNA sequencing technology. Specifically, its development of next-generation short-read DNA sequencing (NGS) technology. This technology is a key component in Multi-Cancer Early Detection (MCED) tests, like those made by Grail.
In its Complaint, the FTC acknowledges that there are four other companies in the same general market for NGS technology: Thermo-Fisher Scientific, GenapSys, Pacific Biosciences of California (PacBio), and Oxford Nanopore Technologies, but minimizes their competitive significance.
According to the FTC, the latter two companies are actually providers of long-read NGS platforms, and the FTC notes that “MCED developers do not view the long-read NGS platforms of PacBio and Oxford Nanopore as viable alternatives to Illumina’s short-read NGS platform due to their lower read counts, lower accuracy, and higher costs.” They also point out that GenapSys has “significant performance limitations compared to Illumina’s that make it unsuitable for MCED testing,” and that Fisher Scientific’s platform is “difficult to use, its throughput is too low for MCED screening, . . . [and] Thermo Fisher’s error rate is far too high to be used for a commercially viable test.”
Since the FTC did not find these alternatives to be reasonable substitutes in the NGS market, for all intents and purposes, it is appropriate to view Illumina as a monopolist in the market for NGS equipment and supplies. The FTC even goes so far as to say in its Complaint that “Illumina is the only NGS platform capable of meeting the technological demands required by MCED test developers” and that “Illumina’s NGS technology serves as a critical input to MCED tests, and there are no alternatives to it,” essentially conceding that Illumina is a monopolist in the NGS market. Therefore, if the merger between Illumina and Grail is permitted, Illumina would be the only vertically integrated supplier of MCED tests.
Grail
In 2016, Illumina founded Grail, Inc., a biomedical technology company that is now known for its development of Galleri Multi-Cancer Early Detection (MCED) tests. These are early cancer screening blood tests that can easily be administered by a general health practitioner. Before the development of these MCED tests, doctors were only able to detect four different cancers before they are symptomatic – breast, cervical, colorectal, and lung. With MCED tests, doctors are able to detect 50 different types of cancer before they are symptomatic.
Grail is not the only producer of MCED tests. Exact Sciences Corp. and Thrive Earlier Detection Corp. are just two of Grail’s rivals in the market for MCED tests. Despite the existence of competitors, there are no MCED tests sold commercially besides those sold by Grail. These competitors are developing their technology with the intent of entering the market for cancer screening technology. Illumina claims that these tests will not come with other modalities of cancer screening, and as such will not be in the exact same market despite being substitutes.
Illumina’s Acquisition of Grail
Illumina sold 88 percent of the equity in Grail in 2016, the same year it founded the company, and in doing so may have avoided the cost and risk that Grail faced to develop MCED tests.
Illumina has now re-acquired almost sole ownership of Grail. Alongside the FTC, the EU is also investigating the legality of the merger and asked Illumina to treat Grail as a separate company until further investigations are completed. Illumina has complied with this request, so as of now Illumina and Grail are not technically vertically integrated.
Regardless of the merger, Galleri MCED tests are available at a price of $950 per test. Unfortunately, at this time, health insurers do not cover the cost of these MCED tests since they have not yet been approved by the FDA. Illumina claims that it will drive down the price of each test by more than 40% by the year 2025 if the merger is permitted.
Illumina has previous experience in expanding biomedical testing for prenatal applications, and believes it can do the same with MCED testing. More specifically, Grail will need assistance in areas such as developing more effective ways to produce and distribute MCED tests on a larger scale, communicating with third-parties such as insurance companies and governments (both foreign and domestic), and getting pre-market approval in countries outside the US. These are all areas in which Illumina has had previous experience. By merging with Grail, Illumina believes that it will be able to produce more MCED tests sooner, in turn saving more lives.
The FTC has also issued an administrative Complaint to block or unwind the Illumina-Grail merger. The Complaint asserts that the vertical merger between Illumina and Grail would be anticompetitive by hindering potential entry in the market for MCED tests, and thereby harm consumers. In the next section, we show why this concern is unwarranted.
Economic Analysis of Illumina-Grail Integration
The Illumina-Grail integration is vertical in nature, and consideration of various alternative market structures will aid in evaluating competitive concerns regarding potential entry of Grail rivals and show why the FTC has failed to recognize that “a bird in the hand is worth two in the bush.”
Illumina-Grail Integration
The FTC alleges that Illumina is a monopoly supplier of Next Generation DNA Sequencing equipment and supplies that are adequate for MCED tests. For purposes of our analysis, we will assume that that this is correct. As for MCED tests, Grail’s Galleri seems to be ahead of others. Assuming that Grail finishes first in the technology race, it will have a monopoly in the market for MCED tests, which is expected to be both large and lucrative. For over 70 years, we have known that vertical integration in the presence of successive monopoly is procompetitive: the downstream price falls and quantity expands following vertical integration. The impact on consumer welfare is necessarily positive. These positive results flow from the elimination of double marginalization (EDM), which the FTC recognizes as a possible consequence of a vertical merger. We argue that this positive outcome would be both certain and immediate, and should be viewed as “a bird in the hand.”
The FTC contends that one or more of Grail’s rivals may be foreclosed from the MCED test market if the Illumina-Grail integration is permitted. On this basis, it wants to forbid Illumina’s complete re-acquisition of Grail. It argues that blocking the merger will have desirable economic effects that presumably will go unrealized if the merger were permitted. The FTC’s reasoning seems faulty. Even if their reasoning were sound, those positive effects would be both uncertain and deferred. In our view, this outcome should be viewed as “two in the bush.”
If Illumina’s re-acquisition of Grail is prohibited, there are several possible outcomes. None of these outcomes matches the benefit of EDM, which would be certain and immediate.
First, suppose Grail is successful with Galleri and no one else can compete. The would-be competitors either fail to deliver or their MCED tests are decidedly inferior to Galleri. In that event, we do not realize the benefits of EDM, i.e., lower price and higher output. Since higher output means more MCED tests and more lives saved, there is obviously an important loss. Therefore, consumers would be worse off if the FTC (or EU) successfully compels Illumina to divest Grail.
Second, suppose that one of Grail’s rivals successfully entered with a viable alternative to Galleri. The economic consequences are unclear. The market structure would be monopoly upstream and duopoly downstream. If Grail accommodates its rival’s entry, tacit collusion may result and nothing changes. In effect, the market remains one of successive monopoly, and the benefits of EDM are lost, at least in part.
Third, suppose that Grail and its rival behave as Cournot duopolists. Since some double marginalization will remain, the economic results will still be inferior to those flowing from vertical integration. Consumers will face higher prices than would have prevailed if the acquisition had been permitted. The outcome will be better than with successive monopoly, but still inferior to that of vertical integration.
Finally, suppose that Grail and its rival compete on price and, therefore, behave as Bertrand duopolists. First, suppose that MCED tests supplied by Grail and those supplied by the entrant are perfect substitutes. In that event, consumer price and quantity will be precisely the same as those that would accompany a vertical merger. But there is still a cost associated with blocking the merger. For one thing, successful entry of a rival is not certain. As a result, benefits of entry must be discounted by the probability that entry may not occur. Moreover, the entry is not immediate. Consequently, the probabilistic benefits must be discounted to their present value.
Second, suppose that the MCED tests are somewhat differentiated. If the incumbent and the entrant produce identical products and compete on price, preventing vertical integration does no harm. If, however, they produce somewhat different products while employing the same NGS platform and consumables, blocking the merger of Illumina and Grail will yield deleterious results. Some double marginalization will remain. Consequently, Illumina’s profits will be lower, prices to consumers will be higher, and both consumer welfare and total welfare will be lower.
In sum, preventing vertical integration by merger provides no obvious benefits.
Numerical Example
A numerical example may be useful in gaining an appreciation for the quantitative significance of the qualitative results that we have presented. The demand and cost conditions are purely hypothetical and are intended to be illustrative. Suppose that the demand is
P = 150 − 0.1Q
while the constant marginal (and average) cost of production (MCP ) is $50 and the constant marginal (and average) cost of distribution (MCD ) is $10. The price, quantity, and social welfare losses under various market structures are as follows.
Successive Monopoly
With monopoly upstream and an independent monopoly downstream, the price to consumers will be $127.50 and the quantity consumed will be 225 units. In this case, the social welfare loss will be $22,781.25.
Vertically Integrated Monopoly
There is a profit incentive for successive monopolists to merge. Such a merger increases total profits, but also eliminates double marginalization and thereby decreases the price to the consumer, increases the quantity consumed, and reduces the social welfare loss. In our example, following the vertical merger, price falls to $105, the quantity consumed rises to 450 units, and the social welfare loss falls from $22,781.25 to $10,125. If the upstream monopoly is lawful, these economic results are as good as they are going to be. As we will see, the results of entry are never better and often worse.
Upstream Monopoly and Downstream Duopoly
If there is entry at the downstream stage, the market structure downstream becomes a duopoly. The economic results of that entry are unclear. If the duopolists collude—either tacitly or overtly—the economic results are precisely the same as those with successive monopoly. In that event, there is no gain from preserving entry, but there are continuing, avoidable losses in consumer welfare.
If the duopolists compete on quantity in Cournot fashion, the price to consumers will be $120 and the quantity will be 300 units. The social welfare loss will be reduced to $18,000, which is an improvement over successive monopoly, but not over vertical integration.
If the duopolists compete on price in Bertrand fashion, the price will be $105 and the quantity will be 450 units. The social welfare loss would then be $10,125, which is precisely the same as the social welfare loss with vertical integration.
As these numerical results show, there is no gain to prohibiting a vertical merger of successive monopolists, but there may be costs.
These results are summarized in Table 2, which is shown below.
Table 2 Comparison of Economic Results