Speaking Notes for Sheridan Scott Commissioner of Competition

Competition bureau

Myths and Realities: Competition in the Telecom and Generic Drug Industries

C.D. Howe Institute Toronto, Ontario

October 29, 2007

(Check against delivery)

I am pleased once again to have the opportunity to address a CD Howe Institute event. As I said last year, Canada needs your independent, researched and balanced analysis as a basis for our future public policy. And for very nearly fifty years, the Institute and its antecedents have informed Canadian decision making and made Canada a far better place in an ever changing world.

In fact, you have done this in part by doing what I want to do today - addressing myths with reality-based analyses.

My focus will be on work we have been doing at the Competition Bureau - including on telecommunications and generic drugs.

But before I turn to these specifics, I want to talk a bit about the challenge of myths in public policy and why debunking these myths is so important to the work of the Bureau.

According to the modern arbiter of such things, Wikipedia, “social myths reinforce or defend current social values or practices.” And as David Laidler noted in a CD Howe paper last year, marketplaces are very much based on social arrangements, including the networks (or spider webs) of government regulations created over the years.

And it is here that the power of politics and myth come together. The field of regulatory policy is littered with myths - ideas, concepts, beliefs and understandings often founded on now irrelevant experiences and buttressed over the years by edifices of pure self-interest.

To slay such myths, you must overturn what are often entrenched views of the world, views that have taken on the status of instinctual understandings. And to overturn such instincts requires what Bertrand Russell categorized as “overwhelming” evidence.

Such overwhelming evidence can be hard to come by. Marketplace analysis is difficult, costly and contentious. Unbiased, complete data are usually scarce. Truly independent experts are rare. The participants in the marketplace are often themselves the captives of long held myths, and fear change.

But we need to slay the myths. We need more competitive markets built on modern, reality-based regulation. Competitive marketplaces drive innovation and investment. Innovation and investment drive productivity. And productivity is a vital ingredient in our well being. No myth there.

Last year, I spoke about the challenges involved in making the transition from regulation to competition. Since then, deregulation has occurred in one of the most tightly regulated markets in Canada - the local telephone market.

If you think back just a few years, who would have imagined deregulation as anything but a very slow and heavily bureaucratic process? A rapid transition didn’t seem possible. But that turned out to be a myth.

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The ingredients that led to this deregulation may be typical of what is required for other sectors. First, an external change occurred - in this case, technological advances allowed the advent of real and potential competition through cable companies and increasingly via wireless services. Second, there was an outside independent study to validate the need for change - the Telecom Policy Review Panel provided some myth-busting ammunition. And finally, there was present the political opportunity and leadership to drive change.

Many have applauded this rapid removal of regulatory restrictions, which should bring benefits to consumers in terms of competitive prices and improved services as more effective competition takes hold.

Now, we’re not there yet - rapid is a relative term, especially in regulatory circles. And even now, we have a sector that is, in many markets, still in transition from monopoly to duopoly, with the fate of that transition uncertain in some minds.

Naturally, there are serious questions as to whether a duopoly itself is adequately competitive, especially given the large market shares of some participants. Indeed, one of the myths we have to deal with is that high degrees of market concentration mean low levels of competition.

Let me respond to that doubt with a very clear -- maybe. Or if you prefer, it all depends on the circumstances.

The number of competitors in a market is not by itself the sole determining factor in assessing competitiveness. Other considerations are equally relevant. For example: Is the market static or continuing to grow? Is competition driven more by technological innovation than the packaging of products? Are there barriers to entry?

These are among the questions we ask ourselves at the Bureau when we consider concentrated markets, especially in the context of merger reviews.

But to counter a myth that is occasionally trotted out, I want to emphasize the reality that the Bureau fully recognizes that market share and concentration are not determinative of whether a merger should be challenged.

The Bureau goes to considerable length in its Enforcement Guidelines to explain this. Indeed, section 92 of the Act requires that a determination of whether a merger is likely to prevent or lessen competition substantially cannot be made solely on the basis of evidence of concentration or market share.

This black and white reality is reflected in the Bureau's case assessments. For example, earlier this year, we announced that we would not challenge the merger of Abitibi Consolidated and Bowater Incorporated, despite the fact that the parties’ combined share of Eastern Canadian newsprint capacity would exceed 35 per cent.

In this case, we took into account the capacity held by the remaining competitors in Eastern Canada that amounts to more than 3.5 times the demand for newsprint, and the views of sophisticated customers who said they were satisfied that they could effectively source their newsprint supply from the remaining competitors.

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Nor did we challenge last year’s Maytag-Whirlpool merger, despite the high market share the combined companies would hold in the laundry segment. Our team concluded effective competition would remain from a combination of foreign competitors, that these remaining competitors had the ability to expand their operations, and that new entry was occurring.

In these and other examples, we have demonstrated it is a myth that market share is the sole or determinative factor in our merger reviews.

There are two further points I would like to mention, both in the world of information technology, before I turn to our generic drugs study and the myths we uncovered there. The first telecom point pertains to our role, while the second returns us to the world of myths.

The deregulation that is under way in telecom increases our role in the sector, not as a regulator, but as the locus for complaints of anti-competitive behavior. And I want to assure you we are ready.

Indeed, the Competition Bureau has a long history in telecom, in both policy and enforcement.

We have for years been regular intervenor at CRTC hearings, laying out our principles on deregulated markets, and playing a hand in the model for deregulation of long-distance markets. The CRTC also used our proposed test in launching its recent look at essential facilities pricing. And our submission on how to deregulate local markets was reflected in the previous Industry Minister’s decision on how the CRTC should proceed.

And on the enforcement side of our mandate, I can tell you we are, as I speak, working to help consumers who use prepaid telephone calling cards. We have just given a positive advisory opinion on the marketing plan of one of the major companies that sells these cards. They have agreed to standards of disclosure for their advertising to potential customers that we believe will avoid the possibility of a misunderstanding of the actual price customers are expected to pay. We consider this opinion to form the basis of a standard of disclosure in the prepaid telephone calling card industry that all companies will have to adhere to.

But enough about us. Let’s now return to the broader world of economic policy and the persistent myths that can dog the thinking even of those of us who are business or economic thought leaders.

It is conventional wisdom that information technology is a, and perhaps THE, key driver of innovation and productivity growth. But what if it isn’t?

A fascinating paper by the McKinsey Global Institute in San Francisco suggests just that. Author Diana Farrell and her colleagues conducted in-depth case studies of 20 industries in three countries, including the United States, but not, alas, Canada. Nonetheless, they found that “I.T. is of great, but not primary, importance to the fate of industries and individual companies.”

They found little correlation between IT investment and productivity gains. In the case of the US, they studied six industries, including retailing and telecommunications.

And they reached a conclusion guaranteed to warm the heart of any competition lover. “The answer is clear: Intensifying competition led to productivity-boosting innovations in the six key sectors.”

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The same point was true more broadly, they concluded. And I can’t leave this topic without one more quotation from the study. “In sectors where competition was promoted - through the dismantling of regulatory constraints, primarily - innovation flourished and productivity soared. But wherever regulation or other forces warped the competitive environment, competitive pressures eased, innovations failed to develop or to spread rapidly, and productivity growth slackened.”

It’s very tempting to use this as a següe into one of our favorite speech subjects at the Bureau, the desirability of reduced barriers to foreign ownership in the telecom sector. I will say that we will continue to advocate for the removal of any barriers to entry by new players, including foreign entrants, who would provide Canadians not only with the benefits of an additional competitor or competitors, but also with access to the innovative services and business acumen that characterize their success.

But I want to get to the exciting work we have done in another area, so I will restrain myself.

A study of the generic drug industry brings one up against at least two myths, one general and one specific to the industry. First, health care is seen by many Canadians to be, in its entirety, outside the normal bounds of competition. It is thought to be either run or regulated by government to such an extent that it is almost un-Canadian, in many circles, to talk about the role dynamic, competitive markets might play in some areas.

The fact is that vast swathes of the health care field are competitive, or quasi-competitive, and always have been.

A second myth, particular to the generic drug industry, is that it is not a very competitive market. There was a time when a small handful of generic manufacturers dominated the landscape. But while they may still be big, they are no longer alone on the playing field.

The Competition Bureau isn’t in a position to comment on the broad strokes of health policy in this country. We leave that to others. And I should add that we recognize, in this as in every other field, that there can be legitimate reasons for government regulation or policy based on economic, social or other reasons.

But what we do have an interest in, and opinion on, are competitive markets, particularly when we identify one that does not appear to be working as well as it should.

Last September, the Bureau announced that it would be undertaking a study of the generic drug sector as part of its mandate as competition advocate. The Bureau initiated this project in response to several studies that found the price of prescription generics to be high in Canada compared to other countries.

As I noted, Canada's health system is an area where competition is often seen as playing a limited role. The reality is that competitive markets are responsible for delivering many of the products and services on which our health system relies. Given their importance to the welfare of Canadians, health-related markets have been a key enforcement and advocacy priority for the Bureau for several years.

Let me cite a few statistics on this market. In 2006, total retail and hospital expenditures on pharmaceuticals at invoice cost were $17.8 billion. Generic pharmaceuticals account for a large and growing portion of pharmaceuticals dispensed in Canada, and in 2005, 43 per cent of all drugs dispensed through retail pharmacies were generic. Total generic drug spending was $3.2 billion.

Our interest piqued, we began our work by examining the structure of the market. We quickly found that generic manufacturing has become more competitive over the past 15 years. It appears that strong competition exists in the supply of many generic drugs in Canada, with well more than a dozen manufacturers supplying products to the Canadian marketplace.

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So we delved deeper.

What we found, in a study we are releasing today, should give all of us pause, and in particular policymakers and industry players.

First, there is competition. It’s just that it seems to exist almost entirely at the manufacturing level. In most provinces, an important way in which manufacturers compete to have their product stocked by pharmacies is to offer them rebates off invoice prices. Rebates provide incentive for pharmacies to select a particular manufacturer's product.

Public sources and information provided by parties interviewed for this study indicate that these rebates resulted in actual prices to pharmacies that, on average, were at least 40 per cent below the official price the pharmacy is invoiced.

Some provinces have taken action on this. Rebates are currently prohibited in two provinces, Ontario and Quebec. However, legislation adopted in Ontario in 2006, and under consideration in Quebec, allows generic drug manufacturers to compete by paying for pharmacies’ professional services such as patient counselling. It is unclear to us at this time just how big those professional allowances are.

Second, and very importantly, these rebates and allowances are not typically reflected in the amounts paid for drugs by public or private drug plans, or out-of-pocket by consumers.

Let me be clear: the available evidence suggests that competition stops at the pharmacy level, and does not accrue to the end payor, whether that is your insurance plan provider, you as a taxpayer in the case of publicly-funded plans, or you as a consumer who has to pay out of pocket.

Our third conclusion is that while public plans incorporate various policies intended to reduce their generic drug costs, they provide limited incentive for manufacturers to compete by offering competitive prices to end payors. Shifting the focus of generic competition from the pharmacies to public and private insurers and consumers could provide Canadians with large savings.

Well, what to do? There is generally nothing wrong, under the Competition Act, with suppliers offering incentives.

As well, as noted above, it is not our role at the Competition Bureau to prescribe solutions for the health care system.

What we can do is shine light on areas of competition concern. I think we raise some interesting questions in our study. I hope you will join us in seeking answers.

You can find far more detail on our findings in the study, which should be available on our website this afternoon.

I can also tell you our work in this area is not finished. We have already identified several possible ways to improve the situation, which you will find in the study. Over the next year, we plan to study them in more depth, to identify which are most promising and what the possible impediments are to their implementation.

Let me briefly mention a few:

• Providing manufacturers with incentives to compete to be listed on provincial and private plan lists of drugs that will be reimbursed;
• Having plan providers decide which versions of generic drugs will be dispensed at the pharmacy based on a bidding process by manufacturers;
• More in-depth monitoring of the net price paid by pharmacies for generic drugs to ensure the price paid by the plan reflects the rebates given to pharmacies; and
• An increased role for private plans in obtaining lower prices for their customers.

These ideas may not be a panacea, but we believe they merit serious consideration, and we will certainly be making our views on them public when our work is done.

At the Competition Bureau, we believe that the health and efficiency of the publicly-funded sector is dependent in part on the health of many of the more or less competitive markets within it. That is why, in addition to the generic drug study, we have focussed on other areas, including medical equipment, services and supplies; pharmaceuticals; some of the self-regulated professions; and the vast array of products and services bought directly by consumers in the interests of improving their well being.

Those interested in this aspect of our work can find more information in a speech I made last year at a roundtable discussion organized by the Canadian Medical Association¹. We have been particularly active in preventing fraud in these markets, including in the weight loss and diabetes treatment areas, two markets that affect millions of Canadians, and we will be expanding our work into another important area in the coming months. But I won’t delve further into that area for now because our time is short and it’s time to conclude.

I have been talking today about some of the work that the Competition Bureau has undertaken to slay myths by exposing them to analytically sound reality. This is a critical quest.

John Kennedy recognized this. He observed that: “The great enemy of the truth is very often not the lie - deliberate, contrived and dishonest - but the myth - persistent, persuasive and unrealistic.”

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The challenge of taking on these myths is perpetual - after all, new ones emerge every day.

The job of those of us in this room is to be ever alert to them, and to subject each and every new economic or competitive myth to a rigorous analysis. The goal in the end, for the C.D. Howe Institute, as for the Competition Bureau, remains the same as it always has been - excellent, fact-based public policy in the interests of Canadians.

I salute you again for your constant efforts in this regard, and I thank you for your time.

Thank you.

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¹Here to Help You: Healthy Markets for the Health of Canadians, Information Session with National Health Care Organizations organized by the Canadian Medical Association, Ottawa, Ontario, November 9, 2006