Like any major industrial sector, the pharmaceutical industry is vulnerable to the vagaries of the free market. Balancing the demands of cutting-edge research with the need to make a healthy return on investment and satisfy shareholders is a tricky tightrope for pharma companies to walk, particularly at a time when the pipeline for innovative new blockbuster drugs is slowing to a trickle and patent expiries are biting deep into the sales of drugs that have provided a massive and steady stream of revenue for decades.
The result of the modern squeeze on pharmaceutical innovation has been the rise of a risk-averse mentality among pharma companies and a greater tendency to hold huge amounts of cash on hand, coupled with a surge of mergers and acquisitions (M&A) as the industry consolidates and firms endlessly restructure and realign their portfolios.
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By GlobalDataThe era of M&A
M&A activity in the pharmaceutical industry is showing no signs of slowing down. According to data compiled by Bloomberg, the month of April 2014 saw more than $118bn worth of pharma deals proposed or announced, a figure not too far off the $174bn spent on M&A in the industry during the whole of 2013.
In the US, sustained consolidation over the last 20 years has meant that only 11 original members of the Pharmaceutical Research and Manufacturers of America industry lobby still remain in operation today, compared with 42 in 1988.
Pfizer, at the head of the M&A pack by a country mile, has spent more than $219bn since 1994 on large-scale takeovers of rivals like Warner-Lambert, Pharmacia and Wyeth – an already eye-watering sum that could have been much higher if its aborted takeover bid for UK pharma company AstraZeneca had gone ahead earlier this year.
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In the current climate of consolidation, pharma mergers and takeover bids are often used as cost-saving measures through the streamlining of operations, which frequently includes the termination of research and development (R&D) activity that doesn’t fit with the larger company’s broader goals or early-stage research that is deemed too risky to continue.
Cost-cutting M&A: slashing research investment?
Of course, pharmaceutical companies operate in the private sector and have the right to pursue mergers and takeovers as a means of securing future growth for their shareholders. Nevertheless, critics argue that an over-reliance on M&A in the pharma industry is ultimately unsustainable because of the damaging effect it has on the industry’s R&D capacity. Business goals must be met, but when it’s at the cost of R&D in a research-intensive industry like pharma, there’s a risk that companies are fuelling growth through the synergies and efficiencies that come with mergers, while reducing what should be their raison d’être – the development of new drugs.
John LaMattina, a former president of global research and development at serial M&A player Pfizer, has been particularly prominent in his criticism of mergers and their affect on pharma research. “A consequence of any merger is the inevitable consolidation of the two companies,” he wrote in a June 2014 editorial for Forbes.
“The goal, of course, is to streamline the new organization, make it more efficient, and wring out redundancies. In this process, however, cost cutting is inevitable…The Pfizer acquisition of Wyeth is a perfect example. In 2008, the combination of the R&D investments of the two companies was close to $12bn. In 2013, Pfizer spent $6.55bn. Clearly, $5.5bn in R&D savings post the Wyeth acquisition is not only the result of efficiencies. Rather, it comes from the elimination of research sites, programs and scientists.”
The cost-saving, research-cutting pattern LeMattina describes appears to have been borne out by Actavis’s $66bn acquisition of Allergan in November 2014. To achieve expected cost savings of $1.8bn a year from 2016, Actavis CEO Brent Saunders noted in a call with analysts that the combined company would undergo a “mid to high teens cut to our R&D spend”. Again, ready cash and market presence goes up while innovative research is cut back.
During a speech at Yale University earlier this year, LaMattina summarised his position succinctly when he described pharma mergers as “bad for science, bad for patients, bad for medicine”. It’s a position fully endorsed by Nick Bosanquet, professor of health policy at Imperial College London.
“I would agree 100% with that statement,” says Bosanquet. “If you compare the record of the industry in the 15 years from 1985 to 2000 with its record since, I think that makes the overwhelming case.”
Bosanquet points to the major innovations developed by the industry in the ’80s and ’90s, and the positive effects they’ve had on public health on the largest scale, from anti-emetic treatments making cancer therapies immensely more tolerable to the introduction of statins and the associated 40% fall in heart disease mortality. Ongoing consolidation, he believes, has made the industry turn away from developing medications for mass use in primary care and towards therapies for smaller patient bases, which are cheaper to take through the approvals process.
Competition breeds innovation
Another side effect of the pharma industry’s M&A binge is the decline of healthy competition, which is key to successful investment in R&D, says Bosanquet. “[M&A] produces a preoccupation in management with internal re-structuring, rather than pressure to actually produce a new generation of drugs, which hasn’t really emerged. The areas where there has been the most competition have been the ones where there has been continuing success, like the AIDS area, where there are some powerful new challengers like Gilead.”
Pharma innovation has been positive in Switzerland, Bosanquet contends, precisely because its major players, Roche and Novartis, have resisted the urge to form a single, giant corporate entity. “The Swiss industry has been a success story of the last 15 years because there’s internal pressure,” he says. “Porter’s competitive advantage of nations is widely misunderstood, [as people believe] what you need to do is clusters with government monopolies; in fact what it said is that it’s absolutely essential to have competing firms in these clusters.”
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Given the strategic importance of having a healthy pipeline of innovative new drugs coming on to the market, shouldn’t anti-trust regulators be looking much more closely at pharma deals to prevent the excessive contraction of the industry and the resulting loss of competition? For LaMattina, traditional competition regulations are designed to break up unfair monopolies in market share, rather than protect pharma research innovation. “The problem is that none of the drug companies currently has enough market share to make that happen under existing anti-trust provisions,” he said in September. “It would require new legislative action and I just don’t see that happening.”
The permissive environment in pharma M&A regulation is a reflection of the soft line taken on mergers in many industries, a trend that may have disturbing implications for the biopharmaceutical sector. “There are all kinds of mergers that have been going through that block competition, not least anybody who studies air fares across the Atlantic in the last five years compared with air fares in Europe, where there’s a lot of competition between airlines,” says Bosanquet. “They’ve slipped through various mergers for the convenience of the big American carriers, what might be called ‘Chapter 11 mergers’, which haven’t happened in the pharmaceutical industry, though give it time and that kind of merger may develop.”
Positive steps: divestment, asset swaps and new competitors
With much of the evidence stacked in favour of more big pharma mergers in the future, it’s easy to become pessimistic over the state of private sector research and the chances of new innovations emerging. Still, there are positive steps that are or could be taken in the industry to improve the situation.
First, it’s important to remember that not all M&A deals are created equal. While major takeovers often involve slashing R&D budgets, there is scope for deals that are more research-oriented. Asset swap arrangements, in which companies trade research divisions to realign their portfolios and exchange assets based on their respective expertise, at least maintain research as the main priority.
GlaxoSmithKline (GSK) and Novartis’s deal earlier in 2014 – GSK traded its oncology assets for Novartis’s vaccine business – is welcomed by Bosanquet (who, it should be noted, acts as an advisor for GSK). “I think it’s an open secret that Novartis has been making continuing losses on its vaccines – it clearly wasn’t able to run the business effectively for various reasons,” he says. “All credit to them for saying ‘Let somebody else who seems to be making a success of it have a go.'”
Small, agile biotech firms and university labs can help to plug the innovation gap, and even some mid-size pharma firms are operating with bolder R&D visions and the patience to bed down in a therapeutic area to build detailed knowledge. “You’ve had examples of companies such as Novo Nordisk, which have been highly successful,” says Bosanquet. “They are a good example of a company that is deeply into a particular disease area [diabetes], with a great understanding of it. And they’ve been able to be very successful even though they break all the business school maxims – they’re putting all their eggs in one basket, and they’re based in a small country with a small market.”
Ultimately, Bosanquet and other critics of cost-cutting M&A in the pharma industry would like to see more companies reverse course and look to make divestments and spin-outs, create separate companies that can enjoy the support of their corporate parent but maintain the competitive advantage inherent to a small, research-centric team. “Industry and the regulators should consider much more divestment – setting up branches as independent, quoted companies, and then giving the researchers and the managers equity stakes,” he says. “That’s a proven way of getting more dynamism, as has been shown with what happened after ICI Pharmaceuticals and then Zeneca, and what’s happened with Forest Labs and others.”
In reality, the debate over pharma mergers really forms part of a larger discussion about the extent to which companies should have the right to make business decisions that diminish their capacity to deliver life-saving treatments to patients. Reconfiguring assets and realigning areas of therapeutic investigation is all well and good, but if the end result is a continual shrinking of collective research muscle, the entire point of the endeavour falls into question. As LaMattina put it: “Literally dozens of pharmaceutical companies have disappeared over the last 20 years, not just small companies but major ones like Upjohn, Pharmacia, Searle, Warner-Lambert and Schering-Plough. They have disappeared for excellent business reasons. But as a result, at a time when there is an explosion in the understanding of the cause of diseases, industry contraction has resulted in fewer scientists pursuing these new insights. In the long term, that doesn’t benefit the world’s health.”
