Thursday, March 3, 2011
There is an interesting article at Xconomy San Diego on the growing tensions between venture capitalists, biotech startups, and pharmaceutical companies. Many entrepreneurs feel like they’re getting a raw deal from big pharma firms. One source alleges that dealmakers are about to kill the geese that lay the golden eggs.
In an earlier post, I worried that big pharma firms were becoming virtual to the point of ghostliness, mere nexuses of certifications, patent and trademark portfolios, tax dodges, and contractual obligations. If these trends continue, what types of controversies are likely to develop?
Gains from Gatekeeping
The just-in-time, ad hoc nature of movie production has led many economists to see in it a model for collaboration in other industries. As Marty Neumaier puts it, “By switching to a network model, the studios . . . avail themselves of the best talent for each project, thereby creating unique products and shedding unnecessary overhead. ” But one-off, one-sided contracts can lead to epic conflicts. Consider, for instance, the recent rash of news about Hollywood accounting:
Michael Moore . . . claims $2.7m in unpaid royalties from Fahrenheit 9/11 [from his studio]. . . At the heart of the lawsuit is a dispute about Hollywood accounting practices that have for decades been a source of contention between the studios that release movies and “the talent” . . . Moore alleges the Weinsteins improperly deducted expenses from his share of the film’s profits – including the cost of a private jet to fly Weinstein from the US to Europe.
Here, again, when an intermediary has access to extraordinary distribution networks, it has enormous leverage vis a vis “the talent.” Studios might respond that it’s a lot more fun to be Michael Moore than it is to be Harvey Weinstein: one gets to express his ideas, the other has to meet a payroll. But the enormous amounts of money generated by the film (between $228 and $500 million, according to Moore’s lawyer), and the frequency of complaints like Moore’s, lead to concerns about transparency and bargaining power in the industry.
Terry Fisher has written compellingly on the economics of Hollywood and pharmaceutical research (with Talha Syed). Intellectual property is key to both industries, and that’s one natural point of connection. Another is the economic role of middlemen, a topic that’s becoming increasingly important as certain dominant companies aim to own the “celestial jukebox,” “master switch,” or “Digital WalMart” of content connectivity.
Consider Apple’s demand for 30% of revenue from publications delivered via the iPad–and its refusal to share key customer data (for example, ads clicked on, time spent per page, etc.) with publishers. Seth Godin does not approve of this move:
The web has been a hotbed of siloed content, of deep dives for small audiences. The large scale stuff, though, has tended to be mostly about gossip and other quick reads that’s cheap to produce. Tablets offer a new chance to create content worth paying for.
[But] Apple has announced that they want to tax each subscription made via the iPad at 30%. Yes, it’s a tax, because what it does is dramatically decrease the incremental revenue from each subscriber.
These debates are very old in the tech world: when the VCR was introduced, Hollywood said its makers should pay for all the copyright infringement it enabled. Sony eventually retorted that the studios should be glad to see all the new customers that electronics would bring them.
Health Care’s Middlemen
Moore, the disgruntled biotech firms, and Godin each in their own way bring up issues that are going to be very big in health care over the next decade. Private insurers were supposed to be the magical mediators between providers and consumers in health care, demanding value and driving down prices. But, as Joseph White has shown, it was far easier for insurers to “stick it to” their customers than to constrain prices of “must-have” providers:
Remembering the pain of the late 1990s, [by 2001] managers of health care providers and insurance companies were determined to keep prices up through “pricing discipline.” “I’ve never seen discipline in the industry from a pricing standpoint like I’ve seen now” (HSChange 2004, p. 2), said one insurance industry consultant, providing part of the answer to why the underwriting cycle had yet to turn back toward lower margins. . . . .
One might wonder why consolidation among insurers did not allow them to resist the providers’ demand for increased payments. The simple answer is that there were two concentrated parts of the market and one fragmented part. The insurers had to choose between fighting a full-pitched battle with the providers or exploiting their own market power vis-à-vis the employers. Raising premiums to employers was a lot easier. In theory, employers could have demanded restrictive networks (at lower prices). But since everyone had agreed that employees did not like restrictive networks, and providers (especially hospitals) were not willing to discount much to get into such networks, there were not many available for purchase. Individual employers could not invent such a product; they could only shop around and find the relatively best deal by customizing other contract terms, such as cost sharing.
Just as insurers began to align more with the interests of concentrated providers than with fragmented, disorganized consumers, so too do many Group Purchasing Organizations appear to be failing to fulfill their promise as cost-constraining intermediaries. As one analyst testified before the DOJ and FTC, “the compensation of most GPO management is almost always based on . . . fee income [from suppliers] rather than on the real savings to hospital members.” Again, the ostensible “protector” of one side of the health care equation ends up aiding one side of the deal.
Of course, the masters of all such deals work in finance. As Karen Ho suggested in her excellent ethnography, Liquidated, their values inform all the tough and opportunistic dealmaking mentioned above. As I taught health care finance over the past few years, I continually felt the topic stood in relation to finance proper as chemistry might stand in relation to physics: a discipline in its own right, but ultimately reducible to a more fundamental science. (I’m not saying I endorse this reductionism, just that it is an intuitively plausible model for what’s really driving developments in health care.)
How will these developments affect health care? As Louis Uchitelle suggested, we might want to question an economic system that delivers risk-free riches to those who invest or market future cures and little but anxiety (with limited or very unlikely upside) to many of those who create them. If we hesitate at awarding Apple a perpetual 30% bite of publisher profits merely for becoming the hippest platform, or question a finance sector that grabs 30% of all corporate profits, we might also want to articulate some decent maximum multiple of dealmakers’ over researchers’ compensation.
Reflecting on his book “The Great Stagnation” a few weeks ago, Tyler Cowen noted that many of the biggest winners in today’s economy are structuring “heads I win, tails you lose” deals. Wall Street has mastered the concentration and privatization of gain and socialization of loss. Will key players in pharma and the rest of the health care sector scramble to follow its lead? [FP]
Hat Tip: Megan McCardle.
X-Posted: Concurring Opinions.