In Re Brand Name Prescrip.Drugs Antitrust Lit.

• Decision Date: 09 August 1999
• Docket Number: No. 99-1167,99-1167
• Citation: 186 F.3d 781
• Parties: (7th Cir. 1999) In Re Brand Name Prescription Drugs Antitrust Litigation
• Court: U.S. Court of Appeals — Seventh Circuit

Page 781

186 F.3d 781 (7th Cir. 1999)

In Re Brand Name Prescription Drugs Antitrust Litigation.

No. 99-1167

United States Court of Appeals, Seventh Circuit

Argued June 9, 1999

Decided July 13, 1999

Rehearing and Suggestion for Rehearing En Banc Denied August 9, 1999^*

Appeal from the United States District Court for the Northern District of Illinois, Eastern Division. No. 94 C 897--Charles P. Kocoras, Judge. [Copyrighted Material Omitted] Before Posner, Chief Judge, and Bauer and Easterbrook, Circuit Judges.

Posner, Chief Judge.

Retail pharmacies brought suit under section 1 of the Sherman Act, 15 U.S.C. sec. 1, against manufacturers and wholesalers of brand-name prescription drugs, charging that the defendants had conspired to deny discounts to the pharmacies. An additional claim emerged during the course of the litigation--that the defendants had conspired to peg price increases to changes in the Consumer Price Index. After an earlier decision by this court resolved some of the issues, see 123 F.3d 599 (7th Cir. 1997), the plaintiffs settled with a number of the defendants and went to trial before a jury against the rest. At the conclusion of the plaintiffs' case in chief on liability, which took eight weeks to present, the district judge granted judgment as a matter of law for the defendants. The appeal challenges both the judge's "bottom line" and a number of his subsidiary rulings.

The evidence shows that the manufacturers of brand name (as distinct from generic) prescription drugs engage in price discrimination in the economic sense, selling the identical product to different customers at different prices even though the manufacturers' cost of selling to them is the same. The favored customers are primarily hospitals, health maintenance organizations, and nursing homes; the disfavored are pharmacies. Price discrimination implies market power, that is, the power to charge a price above cost (including in "cost" a profit equal to the cost of equity capital) without losing so much business so fast to competitors that the price is unsustainable. The reason price discrimination implies market power is that assuming the lower of the discriminatory prices covers cost, the higher must exceed cost. There is no general rule against the possession of market power or the use of price discrimination to exploit it, but the plaintiffs argue that the source of the drug manufacturers' market power manifested in their discriminatory pricing is collusion, and if this is right they have a case under section 1.

Manufacturers of brand name prescription drugs generally do not sell directly to the retailers of their drugs, that is, to hospitals, HMO's, nursing homes, and pharmacies, but instead sell to wholesalers for resale to the retailers. A wholesaler is compensated for the warehousing and other functions that he performs in the distribution of his drugs through the difference between the price that he pays his supplier and the price at which he resells to retailers. The danger to a price-discriminating drug manufacturer is that a wholesaler might buy at the discounted price more than he needed to supply his hospital, HMO, and nursing home customers and sell the surplus to pharmacies at a price below the nondiscounted price that the manufacturer wanted them to pay. The industry calls this "diversion" (economists call it "arbitrage") and of course dislikes it. Suppose the manufacturer's profit-maximizing price to an HMO for some drug were $40, his price to a pharmacy for the same drug $65, and the wholesaler tacked on $10 to compensate him for his services in distribution. Suppose that the HMO wanted 10 units of the drug and the pharmacy 2 units. If the wholesaler sold 10 units to the HMO at $50 and 2 units to the pharmacy at $75, as the manufacturer intended, the latter's total revenue would be $530 and the wholesaler's $120 (12 x $10). If instead the wholesaler told the manufacturer that he needed 12 units for the HMO and none for the pharmacy, and the manufacturer therefore sold him 12 units at $40, two of which the wholesaler resold to the pharmacy at some price between $50 and $75 (say, $60), then although the wholesaler's revenue would increase to $140 ($120 plus the added profit from selling 2 units to the pharmacy for $20 above cost rather than $10) and the pharmacy would save $30, the manufacturer would be worse off; his revenue would decline to $480.

Manufacturers could prevent this evasion of their discriminatory pricing scheme by selling directly to the retailers, thus bypassing the wholesalers. The plaintiffs argue that fear that this would happen led the wholesalers to adopt a chargeback system--the focus of this litigation-- under which the manufacturer sets a uniform price to the retailers, contracts directly with the favored retailers for discount prices to them, and reimburses the wholesaler for the difference between that and the full, uniform price. In the previous example, the price to the wholesaler would be a flat $65 regardless of whom he was reselling to. But upon proof by him that he had resold to an HMO at, say, $60 ($50, the price agreed upon between the manufacturer and the HMO, plus the wholesaler's service fee, negotiated with the retailer, for performing the wholesale function, and assumed in this example consistent with the previous one to be $10), the manufacturer would reimburse him $15. And so he would net the $10 service fee to compensate him for performing the wholesaling function. The chargeback system eliminates diversion (arbitrage) by requiring the wholesaler, in order to avoid a loss when he resells at a discounted price, to report to the manufacturer his sales to that customer, so that the manufacturer can determine whether the customer is indeed one entitled to a discount. With the chargeback system in place, the manufacturers were content to sell through the wholesalers rather than directly to the retailers. The latter prefer, other things being equal, to deal with a single supplier who stocks the drugs of the different manufacturers (namely a wholesaler) than with each manufacturer separately. And if the manufacturers took over the wholesaling function, they would have to charge a higher price to the retailers to recover the cost of performing that function.

The plaintiffs presented evidence that the wholesalers adopted the chargeback system collectively rather than individually. Even so, the system would be a per se violation of the Sherman Act--and only per se violations are charged in this case--only if it were either a device for eliminating competition among wholesalers, which is not charged, or an instrument of a conspiracy among the manufacturers to eliminate or reduce competition among themselves. If, instead, each manufacturer was engaged in lawful, noncollusive price discrimination, it would no more be illegal per se for the wholesalers to devise collectively a system by which each manufacturer could engage in discriminatory pricing while selling through wholesalers than it would be illegal per se for them to agree on a standard form for inventorying drugs or a common method of inspecting drugs to make sure they are safe. Competitors are permitted by the antitrust laws (and certainly by the per se rule) to engage in cooperative behavior, under trade association auspices or otherwise, provided they don't reduce competition among themselves, e.g., National Collegiate Athletic Ass'n v. Board of Regents, 468 U.S. 85, 100-04 (1984); Broadcast Music, Inc. v. Columbia Broadcasting System, Inc., 441 U.S. 1 (1979); Polk Bros., Inc. v. Forest City Enterprises, Inc., 776 F.2d 185, 188-89 (7th Cir. 1985), or help their suppliers or customers to reduce competition. Business Electronics Corp. v. Sharp Electronics Corp., 485 U.S. 717, 727-30 (1988); United States v. General Motors Corp., 384 U.S. 127 (1966); Eastern States Retail Lumber Dealers' Ass'n v. United States, 234 U.S. 600 (1914); JTC Petroleum Co. v. Piasa Motor Fuels, Inc., 179 F.3d 1073 (7th Cir. June 22, 1999); Morrison v. Murray Biscuit Co., 797 F.2d 1430, 1438 (7th Cir. 1986); Rossi v. Standard Roofing, Inc., 156 F.3d 452, 462 (3d Cir. 1998). If the wholesalers in this case were merely helping individual manufacturers maximize their profits by methods permitted by antitrust law, which include noncollusive price discrimination, there was no violation of antitrust law at either the manufacturer or the wholesaler level.

The plaintiffs had therefore to prove that the defendant manufacturers agreed to deny discounts to them. When last this case was before us, the district judge had denied summary judgment for the manufacturers and so we were required to assume for purposes of the appeal that the manufacturers had indeed colluded. On remand the assumption fell away and the plaintiffs had to prove that the manufacturers had colluded. There were two ways in which they might have been able to do this: by presenting direct evidence (admissions or eyewitness accounts) that the manufacturers had agreed to collude; or by presenting circumstantial evidence, economic in character, that their behavior could better be explained on the hypothesis of collusion than on the hypothesis that each was embarked on an individual rather than a concerted course of action--that each, in other words, was merely exploiting the market power it had, rather than seeking to create or amplify such power through an agreement with competitors not to compete. Monsanto Co. v. Spray-Rite Service Corp., 465 U.S. 752, 764 (1984); JTC Petroleum Co. v. Piasa Motor Fuels, Inc., supra, at 1076-77; Serfecz v. Jewel Food Stores, 67 F.3d 591, 599 (7th Cir. 1995); Reserve Supply Corp. v. Owens-Corning Fiberglas Corp., 971 F.2d 37, 48-49 (7th Cir. 1992); Market Force Inc. v. Wauwatosa Realty Co., 906 F.2d 1167, 1171-73 (7th Cir. 1990); Blomkest Fertilizer, Inc. v. Potash Corp. of Saskatchewan, Inc., 176 F.3d 1055, 1060-62 (8th Cir. May 7, 1999); ...