Big Mergers 2+2=3
This article was orignally published at stephenarcher.eu.
Mergers and acquisitions may excite the markets and shareholders on both sides, but their record of success in delivering the anticipated benefits is not good. Around 80% fail on the key measures of synergies, costs savings, and growth in shareholder value. No matter if they are small, medium, or large, mergers hold high risks. Nonetheless, ambition, hubris, and corporate desperation mean that boards often move with the heart rather than the head. Pfizer is a good example. It has made acquisitions of $240 billion in the past 15 years and yet its current market capitalization is just $189 billlion today.
How the mindset begins
Was the Pfizer ambition for Astra Zeneca one of hubris? Actually I don’t think so. It was certainly overreaching ambition with a hint of desperation. To understand the Pfizer move, we need to consider the state of the pharmaceutical industry. It has been in relative decline for the past decade. Relative because compared to most industries it is still very profitable, stable, and with growing markets, ie, the sick, who are generally getting wealthier. With a global population over 7 billion, the market is as big as a market can be. But compared to 20 years ago, the industry now has far fewer novel drugs and a weaker pipeline of new drugs. This is despite an annual global R&D spend of $88 billion* per annum by the top 50 Pharma companies. The costs of a new drug coming to market is now circa $1.3 billion, but the painful statistic in that the return on R&D investment has halved in the last five years in round numbers.
This situation is something of a paradox given that research tools have advanced, and doubly paradoxical given that the slowdown in drug innovation coincides with the emergence of genomics as a mainstream science, allowing companies in theory to match compounds to individual genes and individual genomes, ie, a person’s unique gene constitution. The truth is that with advances in science have come complexity and cost. Managing R&D is very difficult—difficult to select the right target therapies and difficult to manage the process of R&D itself. In the last decade this issue has been partly answered by the growth in pharma investment in outside organizations: Biotech’s, research institutes and more who do the heavy lifting of research and can then pass the development and trialing back to pharma. But still, the R&D cost is returning less for each pharma company. On top of that, two other pressures are working on the industry.
Firstly, as drugs come off patent, then the generic copies come to market and decimate the product revenues of the patented version. In the past a patent expiry would be more often compensated for by the emergence of a newly patented therapy and even a blockbuster drug. These high revenues from patented and expensive drugs have funded R&D in the past.
Secondly, the state health systems in most wealthy, mature economies have been pushing down prices of drugs quite aggressively as their own sovereign deficits have been under pressure in recent years and with healthcare a large and increasing cost to states.
All of these factors threaten shareholder value and have pushed pharma leaders into protecting or trying to enhance shareholder value through mergers and acquisitions. These should reduce costs and increase the R&D pipeline. The consolidation of the past 10 and even 20 years has been huge. The motivation for these consolidations has been varied but they fall into the following categories:
- Access to additional R&D pipeline projects, some of which may hold out high promise
- Access to skills in R&D
- Reduction in overall R&D spend
- Strengthening presence in certain markets, eg, diabetes, heart, etc, to build market credibility in these therapeutic areas
- Access to new or more markets through additional sales channels
- Synergies and cost savings in general operating costs
- Access to new markets and new therapies to add to the existing portfolio
The conspicuous absence from this list is “the ability to make the world a healthier place to live.” Pharma is a business and despite the nature of its products, there is little sentiment to be found in this industry nor even interest in public health—unless it generates profit. Of course, pharma leaders will claim that they cannot generate profit without delivering therapy to patients, which is a strong argument. However, the balance is not always in favor of the patient. Rare diseases affecting small numbers in the population tend to get far less, or no investment, and yet thousands of people can suffer as a result. It can be argued that pharma does not consider social impact of diseases as much as the numbers of patients. Dementia is a good example of a disease with huge social costs.
So as we see consolidation in the industry and such takeover attempts as Pfizer’s, we will also see that R&D is consolidated and more outlying conditions being left behind as the fewer R&D functions focus on the drugs that will bring the best returns and most likely success in clinical trials.
In short, if two pharmas have a pipeline of 200 potential drugs each, then the consolidated company and its R&D will likely focus on the top 100 combined prospects more and focus less on the next 100 as it seeks to increase its return and reduce its risk. The potential for success in trials and marketing goes up when the pool of potential is increased, but the return on investment in riskier areas looks even more risky compared to the new combined pipeline. Clearly this is not good for society and it was this risk that was causing the UK government considerable concern when it looked into the Pfizer takeover.
In the next ten years we can expect the cost of getting drugs to market to rise and the potential for new drugs to be blockbusters and cure major diseases to remain a challenge. At the same time patient diagnostics will improve with the result that the “shotgun” approach to prescription where this happens will become far more “rifle” like. This will also reduce the chance of broad-spectrum drugs having appeal and increase the potential for niche drugs, which are currently not able to be marketed very strongly.
So the good news is that diagnosis will improve for patients and smaller niche pharmas could come back into play as viable businesses, though they, like the recent crop of Biotechs, will inevitably be swallowed by larger pharmas who will want to buy revenue streams and downstream profits, as well as access to new markets and patients.
Competition and the pursuit of differentiated drugs may have been sacrificed on the alter of consolidation and profits, but the patient will likely win in the long run since every disease or condition represents a market and an opportunity for R&D to produce winning therapies.
In the final analysis, I believe that competition through R&D innovation, better disease understanding, better diagnostics, and more targeted compounds will lead to the emergence of new players in the market who can serve communities better than “big pharma” is willing to risk doing.
R&D is going to get tougher to succeed in and returns may not improve, but diagnostics and genomics will enable Pharma in general to reach more people with more therapies. Until that time we should remain skeptical of the motives and effectiveness of pharma to serve the population.
* European Commission
Stephen Archer
Stephen Archer is a founding partner of UK business strategy and leadership consultancy, Spring Partnerships.