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Today I’m going to offer a few thoughts about why we lack medical supplies, based off an excellent story in the New York Times on a merger of two ventilator producers.
First some updates on what happened on the bailouts. As you know, I find the choices made by Congress last week… distasteful. I wrote a piece for Wired on what these choices mean. We are now in a planned economy, with Donald Trump as our central planner.
Second, some housekeeping. I was just on Democracy Now with Amy Goodman on the bailouts. I’ve been doing a lot of media recently, so I won’t go through all of it, but I keep a list on MattStoller.com.
How A Merger Killed the Ventilator Market
The New York Times had an important story about the ventilator market a few days ago, with Nicholas Kulish, Sarah Kliff and Jessica Silver-Greenberg reporting why a government effort to stock up on the machines after the SARS epidemic failed.
In 2006, in attempt to learn from what might happen should a SARS-like disease hit here, civil servants in government decided to stockpile ventilators. They wanted both more ventilators and better ventilators than were on the market. So government officials found a small innovative corporation called Newport Medical, and contracted with the corporation to design a cheaper and better version.
Ventilators at the time typically went for about $10,000 each, and getting the price down to $3,000 would be tough. But Newport’s executives bet they would be able to make up for any losses by selling the ventilators around the world.
“It would be very prestigious to be recognized as a supplier to the federal government,” said Richard Crawford, who was Newport’s head of research and development at the time. “We thought the international market would be strong, and there is where Newport would have a good profit on the product.”
At first the project seemed on track. Newport built a working prototype, and the government was on track to order 40,000 ventilators to put into the national stockpile. Newport would then be able to sell additional units into the health care market, as well as abroad. But in 2012, Covidien, a large medical device manufacturer and distributor, bought up Newport Medical, canceled the Federal contract, and shut down Newport’s ventilator line of business.
The result, in 2020, is that we don’t have enough ventilators in a pandemic.
There are three failures of policy here. I’ll start with the simplest, which is that the merger should have been blocked.
The merger by any standard was a clear-cut antitrust violation. There are two theories as to why Covidien sought to buy Newport. First, Covidien already had a ventilator product, and didn’t want to compete with a lower priced and better version. Covidien bought Newport to take its competitive product out. That’s called a ‘killer acquisition,’ meaning that the goal is to undermine a potentially innovative or lower prices product line.
The second is that roll-ups were part of a broader consolidation trend in the industry in general. “Manufacturers,” as the Times reported, “wanted to pitch themselves as one-stop shops for hospitals, which were getting bigger, and that meant offering a broader suite of products.”
Both theories are likely true. Covidien from 2008-2014 bought 17 other corporations. Covidien pitched itself not just as a device maker, but as a device distributor to hospitals. It even called itself a platform, saying in its press release bleating about the acquisition that the acquisition would strengthen its “ventilation platform” for patients around the world. In other words, Covidien was both trying to take out a potential competitor *and* strengthen its own bargaining posture against hospital purchasers, who were themselves getting bigger.
The merger should have and could have been blocked on many different grounds, the simplest being the killer acquisition theory. Yet the Federal Trade Commission, led by Jon Leibowitz, just waved the illegal merger through without even asking any questions. Now there are calls, by both FTC Commissioner Rebecca Kelly-Slaughter, and antitrust thinkers across the board, to reexamine this merger. In Congress, Antitrust Committee Chairman David Cicilline made this point on Twitter.
But this was not a one-off failure. There are two other aspects of this catastrophe that deserve some mention.
Concentration Creep and Power Buyers
The roll-up of device makers that Covidien was pursuing was part of a longstanding consolidation in the medical industry that correlated to consolidation more broadly. Because our antitrust laws focus on low consumer prices, what has happened across the economy is the creation of ‘power buyers.’
Most people look at monopolies who made commodities, say, steel, and believe a monopoly manifests by how much that company can raise the price of what it sells. But monopolies can operate on the buying side too. Walmart is a buying monopoly, able to use its market power to push prices down against suppliers and workers. I mean if you sell a large chunk of your product to Walmart, they can tell you what price to take. The price to consumers may be low, but that’s because Walmart is using market power against the supplier and not the consumer. But because our antitrust enforcers don’t see anything but consumer prices, corporations like Walmart became far more powerful from the 1980s to the 2000s.
As Olivia Webb noted, there was a Walmart-ization of the medical industry as well, as hospitals combined purchasing power in cartels called Group Purchasing Organizations. GPOs buy supplies for hospitals, and they are supposed to get better prices. But they often don’t. In 1986 Congress exempted them from anti-kickback laws, so there are huge conflicts of interest in how they operate. GPOs are also big. In 1996, the Clinton administration basically said GPOs wouldn’t be subject to antitrust prosecution. Today, for context, just four GPOs account for 90% of generic pharmaceutical purchasing. GPOs also handle medical devices.
Throughout the 2000s and 2010s, one of the results of these choices, as well as the refusal to enforce merger law or antitrust, was the concentration in these corporations that sell things to hospitals, everything from syringes to software. During the HIV epidemic, a corporation called Retractable Syringes developed a safer syringe that doctors and nurses wanted to prevent accidental needlesticks, but GPOs prevented them from selling their product to hospitals. None of this went unnoticed. Congress held hearings, to no avail, on all sorts of innovative medical devices that couldn’t make it into hospitals. Retractable won a private antitrust lawsuit, but more recently it lost one on appeal. Without legal redress, much of the medical device industry consolidated. Covidien itself was bought by Medtronic a few years ago.
Today, hospitals, pharmaceuticals, chemical inputs for drugs, medical devices, and nearly every aspect of our medical supply chain is consolidated and fragile. This ventilator story is just the best example of what that means in real terms in a pandemic.
The final notable aspect is a failure of government procurement policy. One of the more problematic columns about this catastrophe was written by Steve Kelman, a critical voice on government purchasing. Kelman counter-intuitively observed that the ventilator episode shows how government can actually do things correctly. Civil servants, he noted, were proactive and skilled, and were on the verge of getting the ventilators we needed.
Then, “sadly, the effort went south -- but not because of anything the agency did wrong.” Kelman pins the problem purely on the merger, and says the government did a good job. He congratulates the procurement officers, saying that “the most important story for students of public management is a story of feds doing their jobs very well.”
This may seem correct on first blush. I mean clearly public servants saw a need in 2006 and pursued a sound strategy. But Kelman is avoiding something important. The contracting officers in government should have mandated as a part of the contract that Newport Medical give the government all its research and proprietary information on the product, and put in safeguards to ensure that the product would be delivered. The government paid for the development of the intellectual property, it should have had rights to that property.
But the government didn’t. And why not? Largely it’s because of the work of Kelman himself. From 1993-1997, Kelman reorganized government procurement through his job as the Administrator of the Office of Federal Procurement Policy in the Office of Management and Budget. On his bio, Kelman brags about helping pass two of the most important laws in procurement history, the “Federal Acquisition Streamlining Act of 1994 and the Federal Acquisition Reform Act of 1995,” both of which were part of the Reinventing Government privatization initiatives that eroded our capacity to govern.
These laws stripped power from contracting officers, and made it much harder to shape markets through procurement. As a result, the government had no ability to take the research it had paid for, and give that to another contractor or just do the work itself. Had contractors put these provisions in place, the merger likely would have not gone through. After all, why would Covidien buy Newport if the government could ensure that cheap good ventilators would be produced regardless?
But we didn’t have rights to products developed with taxpayer money. Instead, that money and research evaporated.
And the net effect is we don’t have enough ventilators.
There are a lot of lessons here. The first is don’t allow illegal mergers to consolidate power over product markets. The second is don’t let consolidation happen throughout industries in general. And the third is make sure that when the government pays for research and development, it can serve as a latent competitive threat if its contractors get bought out.
So those are the lessons. Hopefully we’ll learn some of them before too many of us suffer.
Thanks for reading. And if you liked this essay, you can sign up here for more issues of BIG, a newsletter on how to restore fair commerce, innovation and democracy. If you want to a book to hunker down with while sheltering in place, read my book, Goliath: The 100-Year War Between Monopoly Power and Democracy.
P.S. How’s the bailout working out for you? Are you applying for loans?
excellent analysis of a 30 year pandemic that has crept into all crevices of society: unrestrained consolidation blowing by any and all considerations of risk distribution and containment.
I agree with so much of this article, especially on the GPOs, that I hate to take issue with a small point but here goes...
First and third lessons seem right. First, if a merger is illegal, of course don't allow it.. I totally agree on the importance of the third lesson: if you're paying for development and guaranteeing a market, you must have recourse in the event the small contractor is bought (or far more likely, and not discussed) fails entirely. There's a huge risk in trying to develop a ventilator at one-third the cost of prevailing devices and still meet all the government requirements. But Matt points out that the contract is by law, limited.
I felt that the NY Times authors were too eager to blame Covidien and private enterprise vs poor gov't contracting that could have prevented this and might have served as a poison pill for Covidien (you can buy Newport Medical, but you must produce the ventilators). Also, the government may well have set the price to the point were too few companies would have taken the job knowing all the constraints. Remember, we're assuming Newport Medical would ultimately have succeeded in delivering all those inexpensive ventilators, flawlessly, at the government's price.
The second lesson on stopping consolidation seems to me too difficult to mandate. Small companies innovating in the hyper-regulated world of government commerce, whether medical or anything else, often need the help of large companies to take products past a launch and into production. Medical instruments are a prime example since FDA regulations and multi-center clinical trials are so expensive. Shut off consolidation and you pull most of the carrot for entrepreneurs. Without the possibility of a buyout, the likelihood of success becomes significantly lower and may fail to gain financing. Risky ideas, like low-cost ventilators, will strangle.