Mergers and Acquisitions in the Global Pharmaceutical Industry

CONTENTS

ABSTRACT

INTRODUCTION

QUESTION ONE

QUESTION TWO

QUESTION THREE

QUESTION FOUR

CONCLUSIONS AND RECOMMENDATIONS

References

Appendices
APPENDIX 1: Porter’s Five Forces Model
APPENDIX 2: Global Pharmaceutical Industry - Overview
APPENDIX 3: SWOT Analysis – Pre-merger (SKB & GW)
APPENDIX 4: SWOT Analysis – Post-merger (GSK) & Outcomes
APPENDIX 5: Pharmaceutical Relationship Alternatives
APPENDIX: 6 Sales Growth of Astrazeneca – Pre & Post-Merger
APPENDIX 7: McKinsey’s 5-Step Table

ABSTRACT

Mergers and acquisitions are of major importance in the pharmaceutical industry. In order to evaluate the dynamics of this particular industry, this paper critically evaluates the pre- and post- merger situation of GlaxoSmithKline concerning its ready-access to markets, know-how and management capability. Furthermore, strengths and weaknesses and merger’s outcomes will be outlined. Critical push and pull factors affecting M&A activity in North America will be analysed, using Pfizer and Pharmacia as an example. In addition, general reasons for M&A failure in the pharmaceutical industry will be illustrated focussing on the M&A activity of GlaxoSmithKline. Finally, using two global pharmaceutical players (GSK and Astrazeneca), the merits and demerits of the McKinsey’s five step programme will be discussed.

INTRODUCTION

The pharmaceutical industry is the most profitable industry in the world. In order to evaluate the dynamics of the industry, Porter’s five forces analysis was carried out which emphasises all elements that may drive competition in an industry (see Appendix 1). The business is characterized by a high level of concentration of fifteen multinational companies dominating the industry (see Appendix 2) (Davidson and Greblov, 2005). The majority of the largest pharmaceutical companies are not diversified. They are either concentrated exclusively on pharmaceutical products or, although they develop and manufacture other health care products, they still have pharmaceutical divisions as the core of their business that provide more than 50% of their revenues. Other products manufactured by these companies usually include medical devices, nutritional products, consumer healthcare products and products for animal health. Annual sales are $ 400.6bn, and the gross profit margin around 70%-80% of revenues. The global pharmaceutical industry still has average 8% annual sales growth every year (Innovationlaw, 2006).

This paper aims to use strategy management to analyse mergers and acquisitions in the global pharmaceutical industry since the 1990’s. Merger means a full joining together of two previously separate corporations. “Mergers usually arise because neither company has the scale to acquire the other on its own (Lynch, 2003, p. 505).” Comparing pre- and post-merger profitability, there is “no consistent pattern of either improved or deteriorated profitability. Mergers would appear to result in a slight improvement here, a worsening there (Mueller, 1980).”

In order to critically evaluate the pre-merger situation of a major global player, the first question addresses GlaxoSmithKline, which was formed in 2000 and holds 6.9% of the world’s pharmaceutical market. The second question focuses on push and pull factors driving M&A activity in North America, using Pfizer, the worlds largest pharmaceutical company with a market share of over 10%, as an example. Question Three is discussing the reasons of failure of mergers in the pharmaceutical industry (example GSK) and the future tendencies. Finally the merits and demerits of McKinsey’s five step programme will be assessed using Astrazeneca which merged in 1999 making it the second largest pharmaceutical industry in Europe and GSK.

QUESTION ONE

In order to critically evaluate how mergers and acquisitions gave ready-access to markets, know-how and management capability, GlaxoSmithKline will be taken as an example. The organisation consists out of two major players from the pharmaceutical industry; Glaxo Wellcome (GW) which was one of the ten largest drug companies with an annual turnover of £7.98bn and SmithKline Beecham (SKB), the result of a transatlantic merger and a leader of prescription medicines with an annual turnover of £ 8bn (BBC, Jan. 2000). GlaxoSmithKline was finally incorporated in 2000 and is now a research based organisation with a wide range of pharmaceutical products (GSK, 2006). A SWOT analysis was conducted in order to outline the internal strength and weaknesses of the pre-merger activities (see Appendix 3) as well as a post-merger analysis (see Appendix 4).

The reasons for the merger where various, but according to the BBC news in 2000, one reason was that Glaxo Wellcome’s shares suffered as they were underperforming the market by 27% due to missed profit targets (BBC, Dec. 2000). For SmithKline Beeham the merger was a plausible conclusion as they were under pressure to enlarge their drug range (BBC, Jan. 2000). This merger dealt with a horizontal merger as the two companies were operating in the same business area (Lecture Notes, 2006).

The main outcomes of the conducted pre-merger SWOT analysis (see Appendix 3) were as follows. The major strengths of the companies were Glaxo Wellcome's investment in technology to automate the chemistry of developing drugs and its high level of expertise and SmithKline Beehams's leadership in genomics, which promised a wealth of drug development opportunities. Furthermore, SKB had a strong presence in markets like Central and Eastern Europe. The strongest weakness of GW was the loss of its core skill in 1997, which was the ownership of the Zantac patent. SKB in contrast neither had the budget for new product launches nor the capability to become a global player on its own. Concerning the opportunities it can be said that without the merger, each of the companies could have acquired smaller pharmaceutical firms. Furthermore, SKB sustained competitive advantage in genomics which they could have developed further. The main threats for both were the potential takeover from other global players, the general threat of substitute products and the intense competitive pressures in the pharmaceutical industry (Bátiz-Lazo, 2005 and BBC, Jan. & Dec. 2000).

The new created company, with market sales of 6.9%, is now, after Pfizer (10% market sales), the second largest pharmaceutical giant in the world. Through the merger, GSK now had the opportunity of strengthening their budget to finance mass R&D which is crucial in the overwhelming pharmaceutical industry. According to GSK’s new announced chairman Sir Richard Sykes (1999, cited by Bátiz-Lazo, 2005), the merger was a step where “two big successful organisations came together, not to protect future earnings growth but actually to increase critical mass to really outperform the industry…. The more effort, the more money, and the more power you can put to research, the stronger the company is going to be.”

Through the combination of the two companies, GSK had the opportunity to sustain competitive advantage and each others chief rival was removed. It created value that would not exist without the combination of the two companies (De Witt and Meyer, 2004).

- Ready Access to Markets

The combination of SKB’s leading over-the-counter brand and GW’s only approved anti-smoking prescription drug allowed the company control of over 90% of this market. Apart from its enhanced product line, GSK was now able to strengthening its global presence (US; Central and Eastern Europe) and to move its operational headquarter to the US, where the market accounts for 45% of the global pharmaceutical market. (Davidson and Greblov, 2005) Finally, it can be said that with their financial stability through added purchasing power and borrowing capacity, it is easier to access new markets in order to sustain competitive advantage.

- Know-How

Know-how, knowledge and information were transferred in both directions. Therefore, the company was able to build up a combined mass R&D which promised savings of £250m. SmithKline Beecham’s existing pipelines of four promising drugs enhanced the company’s competitive position as Glaxo Wellcome relied strongly on their generic sales of its best-selling drug Zantac. The company’s combined know-how strengthened efficiency and opened new possibilities. SKB for example, was the world leader in research into the genetic basis for disease and GW could enrich the company through its advancement in computerised molecular design (Bátiz-Lazo, 2005).

According to the BBC news (2000) both companies had an enormous amount of capital which they spent on R&D (SKB = £ 750m / GW £ 1bn) which will be a significant source of know-how.

- Management Capability

“Capability transfer requires creating and managing interdependencies between both organizations (De Witt and Meyer, 2004, p.334).” In the case of GSK, resistance to change was obviously concerning management capability as managers argued that there was no evidence of a distinctive identity because of the different management philosophies that are still much alive and people stuck to their usual way of doing things (Bátiz-Lazo, 2005). According to De Witt and Meyer (2004, p.335), the “transfer of management capability can create value through improved strategic or operational insight, coordination, or control”.

QUESTION TWO

There are numerous factors driving merger and acquisition activity within North America. The number of M&As has risen substantially during the last ten years due directly to the current crisis facing the pharmaceutical industry. The crisis is a drought in new drug development and in an attempt to overcome this, drug companies are forced to undertake mergers and acquisitions in this market, otherwise they are facing financial problems. The reason for the paramount importance of dealing with the drought is that pharmaceutical companies rely on new drugs to keep up their revenue as older drugs become obsolete or drug patents expire. The companies see mergers as a way of achieving economies of scale, and allow for a greater budget in research and development.

However, there is little evidence that mergers guarantee an increase in research and development. Since the popularity of mergers, “new drug applications to the Food and Drug Administration (FDA) have been sliding for the past five years. Through the first five months of 2002, FDA had received just two new applications (Wall Street Journal, 2002).” Critically, some industry analysts are actually making the M&A activity accountable for the drop in new drug development, bureaucracy and changes in post-merger procedures are blamed. Mergers could reduce R&D productivity through loss of jobs; closure of research centres; relocation of staff and laboratories; productive teams dispersed and post-merger companies being unable to fully utilise their best scientists and engineers.

“Employees represent the intellectual capital of a firm. In a merger, these people may face uncertainty about their job, status, compensation, and work environment (Wall Street Journal, 2002).”

Further factors likely to accelerate the North American merger wave is the need to consolidate in fragmented pharmaceutical market areas that are proving inefficient as well as “the major pharmaceutical companies remaining under pressure to increase drug output (Arnum, 2003).” Even so, this again is not necessarily positive pressure as the same article goes on to describe that M&As, although the “preferred response”, can lead to the ‘value’ in the value chain being “simultaneously created and destroyed because of declining return on investment.”

Generally, certain companies are targeted for M&As due to their ownership of key strategic brands, which would allow the new company to add the best seller to their portfolio increasing market share and growth. Further still, a particular reason for M&A activity in North America is the purchase of companies by European pharmaceutical companies in order to obtain a foothold in the desirable US market.

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