Substantial market power: now you have it, now you don’t – the decision in ACCC v Pfizer

The recent Federal Court decision in ACCC v Pfizer serves as strong reminder that market power is not static but must be assessed in the context of a potentially changing market over a reasonable period of time. As markets change due to innovation, loss of IP rights or other factors, your market power is also likely to change. 

The decision also illustrates that if you have substantial market power, discounting, exclusivity arrangements and bundling are unlikely to be anti-competitive if such conduct is a legitimate competitive response to the competitive strategies engaged in by your competitors. In this respect, your internal documents will be critical in demonstrating whether such conduct is “good” competition or anti-competitive. 

The ACCC’s case was misconceived in light of its views on the above issues but we anticipate it will appeal the decision. In any event, its failure to win another misuse of market power case may provide added incentive for the Harper Panel to recommend that the purpose test under section 46 of the Competition and Consumer Act 2010 (CCA) be replaced with the proposed “effects” test.

Recap of legal principles

What is a misuse of market power?

Section 46 of the CCA prohibits a company with a substantial degree of market power from taking advantage of that power to damage a competitor, prevent entry or deter or prevent a person from engaging in competitive conduct in that or another market.

In broad terms, a company:

• has substantial market power if it can persistently act free from any competitive constraint (i.e. to increase price or reduce output);
• takes advantage of that power if it could profitably engage in the relevant conduct without market power (i.e. in a competitive market); and
• has the proscribed anti-competitive purpose if that purpose is one of many purposes but is nevertheless a substantial purpose.

What is illegal exclusive dealing?

Exclusive dealing under section 47 of the CCA includes offering to supply goods or services to a person on condition that the acquirer does not:

• acquire (or only acquires to a limited extent) goods or services from a competitor;
• resupply (or only resupplies to a limited extent) goods or services from a competitor.

This conduct is only a contravention if it has the purpose, effect or likely effect of substantially lessening competition in a market.

What were the facts in ACCC v Pfizer?

Background

Pfizer held a 25 year patent over “atorvastatin” (ATV) – a pharmaceutical product used to reduce human cholesterol. Pfizer’s patent over its ATV branded product “Lipitor” was due to expire on 18 May 2012. Until that time, Pfizer would be the sole manufacturer and supplier of ATV but after that time, other “generic” manufacturers would be able to make and sell their own ATV. 

ATV was the highest selling pharmaceutical product at the time so competition from generic manufacturers was inevitable once Pfizer’s patent expired. Indeed, Pfizer believed that its revenue after the expiry of the patent would fall from $770 million to $70 million over 3 years as pharmacies and patients switched from Lipitor to generic ATVs and then one generic ATV to another. 

What were Pfizer’s competitors – the generic manufacturers – doing?

Generic manufacturers are large, well-funded international companies. They are usually aligned to a major wholesaler, as are large groups of pharmacies (under the same banner or within a buying group). Accordingly, a wholesaler could exert its power in favour of one manufacturer over another by supplying products of the favoured manufacturer to a substantial number of aligned pharmacies.

While the Government sets the price of pharmaceutical products including ATV, once Pfizer’s patent expired, there was a 1 month grace period during which manufacturers could enter the market by offering their generic ATV to customers at any price.

Several years prior to the expiry of Pfizer’s patent, generic manufacturers were preparing to make and sell their own generic ATV (on expiry of the patent). They proposed to sell large volumes of generic ATV to pharmacies at significant discounts and with offers of exclusivity. Several generic manufacturers made approaches to pharmacy groups in early 2012, discussed competitive alternatives and secured major commitments.

What was Pfizer’s conduct?

Faced with the prospect of imminent competition from generic manufacturers Pfizer decided to manufacture its own generic ATV (in addition to Lipitor) and undertook the following three steps prior to the expiry of the patent:

1. Direct Supply:  In December 2010, it ceased supply of products via wholesalers and supplied direct to pharmacies. This strategy would minimise the erosion of revenue and would provide access to purchasing information from pharmacies.
2. Rebate Scheme: From early 2011, it established a scheme under which money would accrue to each pharmacy based on a percentage of all purchases made by the pharmacy from Pfizer (including the purchase of Pfizer’s generic ATV). The money would be paid to pharmacies at a later date which Pfizer had not determined. This strategy would incentivise pharmacies to buy Pfizer’s generic ATV (over other manufacturers) to obtain the rebates.
3. Bundling: In January 2012, Pfizer told all pharmacies that it would offer Lipitor and its generic ATV as a bundle with the same packaging and it would provide significant discounts on condition that a pharmacy accepted 75% of its generic ATV from Pfizer over 6, 9 or 12 months. This strategy would enable Pfizer to sell its generic ATV by leveraging its premium product Lipitor to “block” pharmacies from obtaining and selling other generic ATV.

What actually happened after expiry of the patent?

While some pharmacies accepted Pfizer’s proposal, the introduction of generics made a huge impact on Pfizer’s 100% market share as pharmacies shifted from Lipitor to generic ATVs and between different types of generic ATV. For example, within 12 months, Lipitor’s market share in many pharmacies decreased from 100% to less than 20%, Pfizer’s generic ATV dropped from 100% to less than 20% and other generic ATVs increased from 0% to 80%. 

Did Pfizer engage in a misuse of market power?

The ACCC’s allegations

The ACCC alleged that by engaging in Direct Supply, the Rebate Scheme and Bundling, Pfizer was taking advantage of its substantial market power to deter or prevent generic manufacturers supplying competing ATV to pharmacies.

The relevant market

The Court held that the relevant market was the market for the supply of ATV to pharmacies and not a broader wholesale market for the supply of all pharmaceutical products to pharmacies. This was because if a pharmacy were to be given a prescription for ATV, it could only supply ATV. No other product was substitutable for ATV from a customer or supplier side and pharmacies compared ATV prices to other ATV prices (not prices of other products).

No substantial market power (at the relevant time)

The ACCC alleged that the period of time over which Pfizer’s conduct was to be assessed was December 2010 to the expiry of the patent on 18 May 2012. The issue was significant because Pfizer argued that its market power decreased as the time for the expiry of the patent approached. If Pfizer’s market power were not substantial at the time at of the relevant conduct, the conduct could not constitute a misuse of market power.

Prior to and during 2011, Pfizer was the only supplier of ATV in the market. The Court accordingly held that Pfizer had a substantial degree of market power in the ATV market despite the fact that other generic manufacturers were circling from at least 2010. As expiry of the patent became imminent however, Pfizer’s power gradually decreased. The Court found that in light of the imminent competition from the large, well-funded generic manufacturers and their activity in approaching and marketing to pharmacies, Pfizer’s market power was not enduring and could not be sustained after January 2012. The Court concluded that although Pfizer had a degree of market power until the expiry of the patent, that power was not “substantial” from January 2012. 

Taking advantage of substantial market power

The Court found that Pfizer took advantage of its market power prior to 2012 by establishing Direct Supply and the Rebate Scheme. It said that in a competitive market for ATV, Pfizer could have not profitably engaged in these acts because:

• pharmacies would not have acquired from Pfizer directly on account of being aligned to wholesalers and because they “did not like” direct supply models; and
• Pfizer would have needed to tell pharmacies at the outset how and when rebates would be paid.

As the Bundling occurred at a time when Pfizer was found not to have substantial market power, the Court did not need to address this issue. Nevertheless, the Court responded to the ACCC’s allegation that Pfizer took advantage of its substantial market power by engaging in the Bundling at “below-cost” by noting any company may engage in below cost pricing in the short term to capture market share and this is what Pfizer was effectively doing with its new generic ATV in the face of imminent competition.

No proscribed anti-competitive purpose

The ACCC argued that Pfizer engaged in the three acts of Direct Supply, Rebate Scheme and Bundling for the purpose of deterring or preventing generic competitors supplying ATV to pharmacies. Indeed, internal Pfizer documents referred to this conduct as a “blocking” strategy against competitors.

The Court held that it was not realistic to argue that Pfizer sought to “prevent “ competitors competing given the value of ATV and the fact that everyone (including Pfizer) knew they were very eager to enter the market and compete.

In considering whether Pfizer had the purpose of deterring competition from generic manufacturers, the Court concluded that Pfizer’s purpose was to ensure it remained a viable supplier in the ATV market. It did that by offering customers attractive incentives. The Court held that Pfizer did not have the purpose of blocking competitors but to the extent that it did, such a purpose was not a substantial one.

In particular, the Court held that:

• there were many reasons Pfizer changed to Direct Supply including to promote its own generic products and to get closer to pharmacies (given strong ties between its competitors, wholesalers and pharmacies). Direct Supply would minimise the erosion of revenue that Pfizer had enjoyed that would commence on the expiry of the patent; and
• Pfizer’s purpose in establishing the Rebate Scheme and Bundling was to protect its commercial position, not to block competitors. This conduct was consistent with the practices pursued by other manufacturers and given strong ties between its competitors, wholesalers and pharmacies, Pfizer was required to make an attractive offer or “get slaughtered”. 

Did Pfizer engage in illegal exclusive dealing?

The ACCC’s allegations

The ACCC alleged that Pfizer offered discounts on Lipitor and its generic ATV on condition that pharmacies did not acquire or resupply more than 25% of competing generic ATV products. The ACCC said Pfizer engaged in this conduct for the purpose of substantially lessening competition in the ATV market. The ACCC did not allege that the conduct had the effect of substantially lessening competition in the ATV market. 

Were the offers made by Pfizer “on condition”?

Pfizer argued that its discounts and rebates were not conditional upon a pharmacy agreeing not to acquire competing generic ATV.  It said a pharmacy was free to do so but may be less inclined as a practical consequence of accepting Pfizer’s offer. Pfizer accordingly argued that there was no condition on pharmacies inhibiting their freedom to buy generic ATV from other manufacturers. The Court upheld this argument for two of the three rebates or discounts under consideration.

No purpose of substantially lessening competition

The Court held that the ACCC failed to prove on the evidence that Pfizer held the purpose of substantially lessening competition in a market. For the same reasons under its conclusion under section 46, the Court held that Pfizer’s purpose in pursuing the conduct was to ensure its own corporate survival given the alignment between generic manufacturers, wholesalers and pharmacies.

What you need to know

While many commentators consider this case is novel given its unusual fact scenario of an expiring patent, there are broader lessons to be learnt:

• Market power is not static and having a large share of the market does not necessarily mean you have market power. 
• Rather, market power must be assessed in the context of the actual and potential transactions that may occur in a potentially changing market over the medium to long term. 
• The effect of conduct may influence findings on purpose. In this case, generic manufacturers were successful in entering and taking market share from Pfizer. If however Pfizer’s conduct maintained its market position and effectively kept competitors out, it is arguable that the Court would have been less willing to read Pfizer’s purpose as pro-competitive.
• As the purpose of the company rests with its decision makers, their evidence will be critical. Attributing purpose to words in documents drafted by unknown authors however is likely to be unreliable.
• Your internal documents will be critical in determining the parameters and the competitive state of the markets in which you operate as well as your purpose for engaging in business strategies.
• Colourful language in internal documents may give the ACCC a platform to investigate and potentially launch proceedings but inferences of anti-competitive purpose derived from such language can be overcome by credible witnesses who are clear and consistent in their approach.
• If discounting, exclusivities and bundling are strategies to combat the competitive response packages of competitors, they may be characterised as normal competitive behaviour rather than illegal anti-competitive conduct.
• The ACCC’s failure to prove section 46 may provide added incentive for the Harper Review to recommend that the purpose test should be replaced with an effects test.

What you need to do now

• If you have a substantial share of the market and wish to engage in conduct to maintain that share, it may be prudent to seek legal advice to determine whether you have substantial market power and whether your conduct is legitimate.
• If you have a substantial degree of market power in the markets in which you operate, you should seek legal advice to ensure your discounting, exclusivity and/or bundling is legitimate and not at risk of being investigated by the ACCC.
• Discounting and bundling strategies that are “below-cost” may be legitimate if undertaken for a short period of time and for a pro-competitive purpose (i.e. launch of a new product).
• You should monitor the aggregate effects of your exclusivities on a regular basis to ensure that you are not deterring competitors from competing over a sustained period of time.
• If you are engaging in conduct for pro-competitive and efficiency enhancing reasons, your internal documents should reflect this. While colourful language of itself may not prove that you have an anti-competitive purpose, it may give the ACCC a platform to investigate/prosecute.

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).