Large companies often acquire other firms to benefit from their products, or to snap up their talent. But in some cases, it appears, an acquisition is made to destroy the potential competition presented by the smaller company. After such “killer acquisitions,” the larger firm simply shelves the competing innovative projects before they are marketed.
“It’s a little bit surprising, where you buy something in order to then shut it down,” says Florian Ederer, an economics professor at Yale SOM.
In a recent study, Ederer, Yale SOM finance professor Song Ma, and London Business School’s Colleen Cunningham looked at acquisitions in the pharmaceutical industry to see how often they eliminated potential competition. The team found that drugs under development acquired by other firms were more likely to be terminated than non-acquired drugs, particularly when the parent company already had a very similar product. The researchers estimated that 7% of the acquisitions were killer acquisitions; if such deals did not take place, the number of drugs continuing development each year would increase by 5%. In other words, killer acquisitions may be holding back a substantial number of medical treatments. “This phenomenon is pervasive and could be very detrimental to society,” Ma says.
The researchers began by creating a theoretical model to study drug development decisions. The model predicted that when the two companies’ products were similar, the acquiring firm was more likely to terminate the acquired project compared to the case in which project was not acquired. But if the incumbent already faced a lot of competition from other companies or if future competition was likely to increase, killer acquisitions were less likely to take place.
The team then tested these ideas on a data set of more than 35,000 drug projects for the U.S. market from 1989 to 2011. The data included information on company acquisitions and drug development milestones, such as clinical trials, patent applications, steps toward commercialization, and termination.
Drugs acquired by another firm had a 92% chance of being discontinued, while non-acquired drugs had an 85% chance. If the therapy treated the same disease as one of the parent company’s products using a similar biological mechanism, the chances of termination were even higher. “Firms try to protect their market power,” Ma says. “Hence, they want to kill future competitors by terminating their innovation projects.” Out of about 750 drug acquisitions per year, the team estimates, an average of 54 were killer acquisitions.
The researchers also considered the effects of market competition on the likelihood of killer acquisitions. They found that killer acquisitions usually occurred in areas where existing competition for the disease treatment was scarce. And, if the incumbent firm’s patent on its drug was due to expire in the next five years—allowing generic competitors to enter the market—the chances of killer acquisitions decreased.
The team tried to determine if other factors could explain these patterns. For example, perhaps the acquiring firms had shelved some of the target company’s projects because they wanted to focus on the best remaining ones. But the data suggested that wasn’t the case: killer acquisitions were even more prevalent when the target company was developing only one drug.
Another possible explanation was that while a particular drug may have been terminated, the incumbent firm shifted the smaller company’s technology and people to more promising projects. But the team saw no evidence that the parent firms’ drugs became more chemically similar to the acquired drugs. Nor did the acquired staff seem to be redeployed more efficiently. Less than one-quarter of inventors stayed with the incumbent company, and those who did saw a 30% drop in their patenting rate over five years. “Even in the acquired firm, they do not seem to be really productive,” Ma says.
Are killer acquisitions hurting innovation enough that they should be subject to antitrust regulation? The overall effect on society isn’t clear, the authors say. On the one hand, the practice could prevent promising treatments from reaching patients and thereby allow prices on existing therapies to rise. On the other hand, perhaps the prospect of being acquired motivates smaller firms to be more innovative in their drug development, so on balance, the phenomenon is not negative.
Since healthy market competition seems to discourage killer acquisitions, regulation may not be needed, Ederer says: “Maybe it is enough just to encourage competition, and then this will settle out by itself.”