Last week’s Liothyronine judgment in the UK’s Competition Appeal Tribunal (CAT) is essential reading for antitrust practitioners. The CAT upheld the CMA finding of an abuse of dominance but reduced the total fine from £101m to £84m. Liothyronine is one of several excessive pricing cases the CMA has brought in recent years following concerns about large price increases in the UK generics sector. The Phenytoin investigation, launched back in 2013, was the first to focus on this kind of conduct and Liothyronine and Hydrocortisone have been the two highest profile CMA follow-ups to that case.
The facts of the case have a superficial simplicity which bely the 400+ pages of the CMA’s 2021 infringement decision. Between 2007 and 2017, Advanz, the sole provider of the generic drug Liothyronine raised its prices (gradually at first) by 6,000%. NHS spending on Liothyronine increased from approximately £600k per year in 2006 to around £30m per year in 2016 despite volumes staying largely the same.
The CAT’s Liothyronine judgment is about more than just excessive pricing though. It provides analysis of economic techniques and approaches that will be of relevance to almost every damages quantification exercise in private competition cases. It even purports to answer certain existential questions about the purpose of competition law. And its somewhat surprising conclusion on the issue of deterrence is also worthy of note.
The UK generics industry may not have had its pharma bros vilified in the way that Martin Shkreli was in the US. But some of the pricing strategies employed in the UK do not seem so different to the price increases seen there. The CAT’s judgment displays a degree of scepticism towards some of the arguments put forward by the companies in this case. It adopts a moralising tone in one or two places, particularly when discussing penalties. For example, the CAT notes that “the scale of the increases” charged during the infringement period “ought not to have left Advanz in any uncertainty as to their unfairness”. It similarly refers to “society” having a greater expectation that “senior management will lead by example and abide by the law” (a quote from the CAT’s judgment in Ping) in relation to the aggravating factors used in the CMA’s penalty calculation.
The judgment does not however read like a thriller. The CAT methodically weighs up arguments about (i) technical aspects of the Cost Plus assessment, and (ii) comparators that may be a proxy for workable competition. Its detailed assessment of these issues will likely prove useful in a wide range of future competition and competition damages cases.
Cost Plus
Cost Plus refers to the calculation the CMA conducts when assessing prices against the “costs actually incurred” by a dominant company. The CMA split the total costs incurred in the supply of Liothyronine into direct costs, indirect costs and a reasonable rate of return. The “reasonable rate of return” is the “plus” element of Cost Plus and is intended to reflect the opportunity cost to investors of providing capital and funding working capital requirements. The CMA’s calculation gave rise to an average Cost Plus calculation of £4.94 per pack of 28 tablets during the infringement period.
It is not possible to summarize every CAT conclusion on Cost Plus in this blog though we do touch on a couple of points that may be of general interest.
Perhaps to avoid the pitfalls of the Phenytoin case (see previous article here), the CAT did not feel the need to conclude that Cost Plus was a proxy for “workable competition” (see paragraph 281). To do so would risk there being no difference between the benchmark for “workable competition” and that for “perfect competition”. That had been one of the CAT’s criticisms about an over-reliance on Cost Plus in Phenytoin.
The CAT noted that Cost Plus is nevertheless an important benchmark, in particular in relation to the first limb (the excessive limb) of the well-established test for excessive and unfair pricing that is set out in United Brands .
Regarding the rate of return on capital, the CMA adopted a return on capital employed (ROCE) approach. To calculate this it used a weighted average cost of capital (WACC) of 10%. The CMA also did a “sensitivity” calculation with a 15% WACC to show that even if there had been a higher WACC, its overall findings on Cost Plus remained appropriate. These WACC figures were based on averages observed for listed companies in similar markets. In that sense the numbers are sector specific. The CAT supported the CMA approach fully on this aspect of the Cost Plus calculation. 10% and 15% may be useful starting points for others to be aware of in future cases that require calculations for ROCE and WACC for generic drugs.
The valuation of product rights was another key debate since this is the most significant asset relevant to the calculation of the return on capital and therefore one of the most material inputs in a Cost Plus calculation for a product like this. The CAT agreed with the CMA that product rights valuations that were based on (likely inflated) prices of Liothyronine during the infringement period were not appropriate (see paragraph 176). The correct approach to the valuation of product rights here therefore turned on the costs of entry. New entrant costs of entry were taken into account and a “risk of failure” was also added to reflect the fact that not all entry attempts were successful. The CAT agreed with the premise that it was necessary to build in a risk of failure, but it was also satisfied that the CMA had taken a conservative approach.
Another issue, and one that goes partly to policy questions about the purpose of competition law, was whether Cost Plus should be calculated on the basis of a multi-firm or single firm market. The importance of the difference between a single-firm and multi-firm Cost Plus model is that in a market, such as the market for Liothyronine Tablets, in which there are significant fixed entry costs, the price needed to sustain multiple firms is higher than the price needed to sustain a single firm because each firm has to recover its costs over a smaller share of the market. The more firms that enter, the higher the minimum price required to cover the costs.
The CAT concluded that the use of the multi-firm Cost Plus is not an appropriate tool for assessing the fairness of a dominant undertaking’s prices. Using multi-firm Cost Plus would enable an incumbent to retain as pure profit the costs of operating in a hypothetical multi-player market even though the higher prices produced by the adjustment are unrelated to the incumbent’s actual costs incurred in a single-party market (see paragraph 228). It agreed with the CMA that “more competition” was not an end in itself and noted the United Brands test said nothing about multi-firm costs.
Comparators as benchmarks for “workable” competition
Comparators are an important aspect of limb two (the unfairness limb) of the United Brands test. Where a dominant company can point to a reliable comparator (ie the price for the same product in another country or the price of a similar product) that is a proxy for normal and sufficiently effective (or “workable”) competition, it will be difficult to prove that prices are unfair under the United Brands test.
On comparators in this case, the conclusions that are likely to be of widest application relate to “contamination” or “circularity”. The CAT notes in several places that it agrees with the CMA that possible comparators put forward by the appellants that were “contaminated” by prices during the infringing period could not be, or were not, a proxy for “workable competition”. They could not therefore be valid comparators for the purposes of the second limb of the United brands test.
This applied in particular to “post-entry prices”. In 2017, new entrants started providing Liothyronine. But the decline in the price of Liothyronine was gradual. The CAT noted the “exceptionally high starting-point” combined with the “unusually slow” and continuing decline in prices meant that even in 2021 (4 years after the first new entrant) the post-entry prices remained contaminated by the infringing conduct and so could not be a reliable proxy for “workable” competition.
This type of analysis may well be relevant to a wide range of competition damages cases in which a “before and after” technique is used to quantify damages. The debate often centres around whether prices charged after a cartel has ended are a relevant comparator, and the Liothyronine judgment may be of relevance to that question although the issue will always be fact specific.
Contamination and/or circularity was also the CAT’s reason for dismissing arguments that forecasts of future prices by potential entrants were a relevant comparator. The future price forecasts made by potential entrants took as their starting point the then prevailing Advanz price and applied discounts over the time. Since the prevailing price used as the starting point was inflated, the CAT agreed with the CMA that these forecast prices were contaminated and did not represent a proxy for workable competition (paragraph 337).
Questions around the purpose of competition law
An interesting debate that comes up a few times in the judgment relates to the purpose of competition law. This is most apparent in the discussions around multi-firm and single firm approaches to Cost Plus as well as possible comparators based on “Entry-incentivising” prices, i.e., prices high enough to incentivise entry.
The CMA had stated that competition is not an end in itself. It considered that the incremental improvements to Liothyronine since the entry of new entrants Teva and Morningside (availability of different dosages, a longer shelf life, a lactose free option and increased security of supply) were too small to justify the increase in prices that had been needed to stimulate entry. The appellants argued that high prices were a “signal” that prompted entry and therefore encouraged competition and that the CMA had not taken sufficient account of the benefits of innovation.
The CAT judgment is clear that the purpose of competition law is about more than simply protecting competition itself (see paragraph 109). It referred to case law confirming the law around abuse of dominance is aimed at practices which may cause prejudice to consumers directly in addition to the protection of competition. It noted competition law is concerned with the protection of consumers from “the unfairness” which arises “when a dominant undertaking is freed from competitive shackles”.
Particularly in markets such as the market for Liothyronine – where barriers to entry are high – the CAT was not persuaded that competition itself, or new entry, was a sufficiently important end in itself to justify the prices.
Benoit Coueré, the head of the French competition authority, recently described competition as protection against rent-seeking. Most competition policy makers, including at the CMA, would probably say the goals of competition policy also concern the promotion of innovation and economic dynamism. But economic rents certainly seem to have been the main focus in a case like Liothyronine.
Neither the CMA nor the CAT consider that incremental innovations for Liothyronine (“an old and established drug with limited scope for improvement”) merited the price increases.
Any lingering doubt (following the CAT’s original Phenytoin judgment) about how seriously the CAT takes exploitative abuse of dominance cases also appears to have been dispelled in this judgment. The CAT says at paragraph 451 that unfair pricing is one of the “key harms” that competition law is designed to prevent. The prices – and consequently the direct financial benefit – resulting from excessive pricing “may well be higher, more immediate and more certain to be achieved than those which may be achieved from other forms of anti-competitive behaviour such as cartelisation”.
Deterrence uplifts in penalties calculations
The CMA calculates penalties using a formula set out in its Penalties Guidance. According to that guidance, it is possible to uplift fines for both specific deterrence (in relation to the undertakings subject to the penalty) and general deterrence (regarding the need to deter others from similar conduct).
The CAT described the CMA’s goal of seeking to ensure deterrence by making its penalties exceed the financial benefits of the conduct as “unimpeachable”. It then proceeded to knock around 17% off the CMA’s fine, essentially on the basis that it disagreed with the CMA’s reasoning on its specific deterrence uplift since the penalties already exceeded the financial benefit (even if only marginally).
This is a little surprising. The CAT’s reasoning on deterrence (at paragraph 490), was that the reputational harm of the proceedings would deter future anticompetitive conduct by the appellants. But that point must apply in every enforcement case except perhaps those involving recidivism (which constitutes a separate reason for increasing fines). The CAT’s second point (at paragraph 491) was that the CMA had not found any evidence that a failure to impose a deterrence uplift is something that would make recidivism more likely in this case. Quite how the CMA could have been expected to prove that adding a deterrence uplift would reduce the chance of recidivism (other than through high level logic on business incentives – see footnote 37 of the Penalties Guidance) is unclear. The CAT’s final point, around regulatory changes (the Department for Health has obtained greater intervention powers since the conduct took place) (paragraph 493) is perhaps the main reason why the CAT reduced the penalties. If the reasoning in paragraphs 490 and 491 alone were to become the legal standard the CMA must meet when applying a specific deterrence uplift then we should not expect to see too many such uplifts in future penalties.
The CMA’s argument that deterrence uplifts are necessary since other anticompetitive conduct may go unpunished (so penalties should “significantly” exceed the financial benefit of the conduct) does not seem to have resonated with the CAT.
Conclusion
The CAT’s fine reduction (the £101m fine was reduced to £84m) may disappoint the CMA, but even after the 17% reduction this remains the largest antitrust fine the CMA has imposed that has subsequently been sanctioned by the CAT. That the CAT upheld the CMA almost entirely on the merits is notable. Further appeals to the Court of Appeal are no doubt being prepared. So this is unlikely to be the final word on Liothyronine. Whether the CMA will obtain a similar outcome from the CAT in the pending Hydrocortisone case remains to be seen.
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