UC Berkeley

This dissertation develops and applies an economic framework in industrial organization that allows us to empirically study vertical relationships in supply chains. This type of relationship is a common feature across markets and important for understanding policy-relevant questions related to two-sided market power in non-platform settings. The general setting is as follows. There are a small number of upstream firms, each of whom produces a single horizontally differentiated good. A small number of intermediaries sit in-between these upstream firms and downstream firms, who in turn sell to end consumers. The empirical setting of this dissertation is the US pharmaceutical industry. Chapter 1 considers the upstream implications of this market structure. One rationale for the existence of large middlemen is their ability to exercise countervailing market power to upstream monopolists. However, having market power may also exacerbate misaligned incentives between middlemen and consumers. Therefore, there is a trade-off between countervailing market power and agency frictions in this market. Pharmacy Benefit Managers (PBMs) are large middlemen who negotiate with drugmakers on behalf of insurers for rebates, which may in turn inflate list prices -- sticker prices set by drugmakers -- and make drugs less affordable. At the same time, high rebates may benefit consumers through lower insurance costs. To assess the role of PBMs, I estimate a vertical model of drug and insurance demand, rebate negotiation and list price setting for oral anticoagulants in Medicare Part D. I find that PBMs reduce dispersion in rebates, which helps smaller insurers. Moreover, policy solutions that remove agency frictions while preserving -- or even enhancing -- countervailing market power may improve consumer welfare by up to 17% of annual premiums. Chapter 2 considers market power in interactions between middlemen and downstream firms, who are insurers in the pharmaceutical setting. Here, PBMs fill a crucial role in the supply chain for drugs by creating drug formularies that include drugs in a bundle that is sold to insurers downstream. Increasingly, PBMs have integrated insurers, so the nature of the interaction is typically a merged PBM-insurer entity vs a standalone insurer. With co-authors Zarek Brot and Benjamin Handel, we study the role of vertical integration between PBMs and insurers in driving access to drugs. Vertical integration allows the two integrated parties to share the rents accrued from the PBM's upstream rebate bargaining effort, eliminating double marginalization and aligning incentives between these suppliers. However, this integration can also have anti-competitive effects, inducing the PBM to be less willing to deal with rival insurers, passing through a lesser portion of the accrued rebates. We develop a model of the industry, and use it to empirically study the impacts of vertical integration. We find that consumers place a higher revealed value on premium reductions than cost savings due to drug tiering. Vertical integration does lead to integrated PBMs raising rivals' costs, but by a small amount because rival insurers can ultimately substitute to back-up formularies at cheaper costs.