12/02/2011 10:56 am ET Updated Feb 01, 2012

Child's Play: The PBM Merger That Can Learn From Childhood Lessons

One of the central organizational principles in the US market -- indeed, in all modern Western, non-centralized economies -- is that competition is good for consumers. When market share is diffuse, and multiple businesses have to battle for the same customers, they have to offer the best price possible. All else being equal, customers will choose the business whose products and services are the best value for their money. This, in turn, spurs and rewards innovation, which is the driving factor in a free capitalist economy.

These tenets hold true for innovation in medicines as well: competition among pharmaceutical manufacturers, among wholesalers and among pharmacies (respectively) all accrue to patients' benefit, resulting in the most efficient pricing, quality of services and access to life-saving medicines.

Government meddling is typically antithetical to competition-driven free markets, but there's a paradoxical exception: the role that regulators properly play in dismantling and preventing monopolies or monopolistic behavior, in order to ensure that a free market is truly free.

Why? If you're the only kid on the block selling lemonade during a hot August, you know you can charge a full dollar per cup; but once your neighbor starts selling the same thing for 75 cents, you're going to figure out a way to either drop your price or beat his quality -- unless you're like the steel barons of the early 1890s. That is, in which case you and the neighbor kid form a new company that charges $1.25 per cup.

Maybe you even agree to use the lowest-cost lemonade powder (rather than actual lemons) to increase profits, since you no longer have to worry about quality competition. That's great for each of you, but it's your thirsty neighbors who lose, since they would pay significantly less per cup under a more competitive scenario.

On a scale thousands of times larger, the lemonade stand example illustrates the sort of anti-competitive, monopolistic behavior that could result from a proposed $29 billion merger between two pharmacy benefit managers (PBMs), Express Scripts and Medco. Both of these companies already command significant market share (about one third of managed prescriptions). The proposed deal is currently under scrutiny by the Federal Trade Commission, which must ask: if approved, would US patients end up like thirsty neighbors in August, with prices and quality at risk?

A strong argument can be made that the existing pharmacy market is already too centralized. For one thing, there are a decent number of players in the PBM market; of these, just three account for nearly 60% of the nation's total drug volume. Though that's less than 100%, a well-settled principle of antitrust law is that 100% market share isn't required to give major players an opportunity to engage in monopolistic behavior.

For proof of the power that this gives to the "Big Three," consider the now-broken negotiations between one of those big three, Express Scripts, and pharmacy chain Walgreens regarding TRICARE members. (A quick glossary: Express Scripts is a PBM, Walgreens is a pharmacy chain, and TRICARE serves as the PBM for the nation's military and military retirees.)

At issue in the negotiations was whether Walgreens could continue to serve as a pharmacy provider for TRICARE members. According to reports, Walgreens wanted to remain in the TRICARE network, offering a number of significant concessions to Express Scripts. But Express Scripts thumbed its nose at Walgreens, and as of January 1, 2012, TRICARE members will have to go elsewhere to fill their prescriptions.

One can argue that the lack of competition enabled Express Scripts to snub Walgreens: Express Scripts' size, combined with the absence of competition, gave Express Scripts a sort of monopolistic power in negotiations over pricing. The result: TRICARE members will now have fewer choices about where and when to fill their prescriptions.

How would this get worse if the merger between Express Scripts and Medco -- two of the big three -- is approved? For one thing, it would effectively double the size of Express Scripts, which would become the largest company in an already concentrated field. The new company would singlehandedly control more than 60% of the nation's mail order prescription drug business and manage prescription drug plans for over 150 million Americans.

For patients, this raises the specter of increased prices -- a foreseeable result when market share is concentrated in a small number of players. Moreover, the lack of competition could mean a lower quality of care, since patients will have fewer choices -- meaning that big market players will have fewer worries about losing customers.

Politicians regularly decry high prescription drug prices, but simultaneously draw a blank when asked how to improve medical care in the US. One important answer is found in basic free market principles: competition among pharmacy providers spurs innovation, better service and products, and lower prices. Government properly intervenes in the free market to protect consumers by ensuring that market share is sufficiently diffuse. As regulators consider the Express Scripts/Medco merger, they should consider the patient's point of view -- and whether the market is already so concentrated that the proposed merger will simply make an existing problem worse.