Steer clear of muddy waters

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Pfizer, Warner-Lambert and American Home Products are flirting with each other – but does it really make sense to talk about a “market for pharmaceuticals”?

As Pfizer, Warner-Lambert and American Home Products flirt with each other, another round of consolidation in the world pharmaceutical industry lies ahead. In this industry – and in others such as oil and financial services – we hear a common refrain. Concentration is lower in our market than in other global industries: it is time for us to catch up.

World sales of prescription pharmaceuticals are around $300 bn per year. If Pfizer won Warner-Lambert their share of this would rise to about 6½ %, slightly ahead of today’s leader, Merck, and well clear of Europe’s biggest companies, Glaxo Wellcome, Novartis and Roche. By most standards, a market in which no firm has more than a 6½% share is indeed unconcentrated.

But does it really make sense to talk about a market for prescription drugs? The ordinary economic concept of a market is a place where substitute products compete. Buses, trains and plains all serve the market of people who want to travel between London and Manchester. But different pharmaceutical products are rarely substitutes: the drug you want depends on your prescription. You don’t want an indigestion remedy for your depression, or an analgesic for your hypertension.

If we define markets by looking at products that are real substitutes for each other, the picture is very different. Anti-ulcerants have been one of the largest and most profitable drug categories of recent years. The two leading products – AstraZeneca’s Losec and Glaxo’s Zantac – together have nearly two-thirds of the market. That combined market share would immediately attract the attention of any anti-trust authority.

The best selling drugs of all are those that control hypertension. The leading product here is Merck’s enelapril, with around 10% share. But there are four different types of anti-hypertensive drugs, each suited to particular clinical situations. Enelapril is way ahead among ACE inhibitors, the most popular product group.

The more narrowly you define the market, the higher market shares become. Merck dominates the market for ACE inhibitors, has a strong presence in the market for anti-hypertensives and has a position that is leading, but by no stretch of imagination dominant, in the world pharmaceutical industry. You can make a good case for each of these market definitions. And when the issue of concentration in pharmaceutical markets comes to a European or American court, as it certainly will, I and my economist colleagues will represent the conflicting parties and do exactly that.

One of the key European cases on market definition concerned the supply of bottled water. Is there a market for bottled water? Or should we distinguish still from sparkling? Is bottled water another soft drink, to be compared with coca-cola, coffee or tea? Or does it compete with tap water, in which case even Perrier’s market share is extremely small? This discussion can go on indefinitely.

That is why almost every anti-trust case involves extensive and expensive argument on the definition of the market. And yet there are hardly any in which the outcome has really hinged on that issue. Because market definition is so flexible, the official or the judge can work back from the desired result to the appropriate market definition. When General Motors was behaving badly, it was abusing its undoubtedly dominant position in the provision of General Motors cars in Belgium. When Hugin was charging too much for servicing its cash registers, it was dominant in the supply of spare parts for its own machines.

For public authorities, the attempt to define market share has become a measuring rod of such extreme flexibility that it has ceased to have any effective value. In both Europe and the United States, the question now posed is: can a firm change prices without being effectively inhibited by its competitors? This is the test Judge Jackson applied in concluding that Microsoft did control the market for personal computers and their applications. But this test renders the definition of the market redundant. You can measure market power directly without asking whether Perrier and tap water are in the same market. Is the price of Perrier constrained by the availability of tap water? (Yes, but not much). Is the price of tap water constrained by the availability of Perrier? (Hardly at all). So Perrier’s control over its market is limited by other suppliers of bottled water, and not by other providers of H20.

If market definition is a poor tool in the hands of government agencies, it is equally a poor tool in the hands of business strategists. The best documented empirical result in business strategy is the correlation between profitability and market share, repeatedly reinforced in analysis of the PIMS database. But that survey asks you to define your market share by reference to your own perception of your market. If you have a strong competitive position, you will naturally define it narrowly – who would Marks and Spencer have seen as their competition in 1990? (Hardly anybody) If you feel more doubtful about your positioning, you will define it broadly – who would Marks and Spencer sees as their competitors today? (Almost everyone) So the PIMS result becomes almost tautological.

And the famous Boston Consulting Group matrix which defines business units as cows, dogs, stars or question marks, classifies activities by their expected market growth and established market share. But if you are free to define markets as you like, you can also classify businesses as you like. Does BMW have a tiny share of the slowly growing world car market, or a large share of the expanding market for luxury saloons? The answer depends on whether you wish to classify it as a dog or a star: are you selling or buying?

A careful analysis of the prospects for BMW depends, not on an argument about how to define its market share, but on an understanding of the changing nature of competitive advantage in the world automobile industry. And the same is true for pharmaceutical businesses, banks, and oil companies.

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