Are pharmaceutical mega-mergers in the public interest?

The main reason for governments around the world to encourage the pharmaceutical industry is to support Research and Development –  R&D – with a view to the discovery of new drugs of future benefit to mankind. Commercial pharmaceutical companies have played a central role in the development of almost all medicines available today. The industry has made a major contribution to the health and life expectancy of the world’s population.

Apart from encouraging R&D the most important reasons to support the pharmaceutical industry are economic: to create highly skilled jobs and in the case of individual countries to promote exports. Finally, there is a benefit to the advancement of science, which many economists, pure scientists and academics would see as an end in itself.

The two key questions relevant to any major pharmaceutical company merger are:

  1. Will it cause R&D to benefit or suffer?
  2. What will the consequences be economically, in terms mainly of the location of production and R&D and of where costs will be cut?

The short-term impact on the share prices of merging companies is obviously important to portfolio managers judged by quarterly performance and to shareholders but the future health of mankind is a greater prize.

I was fortunate to have been part of the team working for Beecham’s financial advisers on the merger with SmithKline in 1989. This pioneering deal was the one that triggered the wave of pharmaceutical mergers and consolidation over the 25 years to the present time. The Head of R&D at Beecham when the merger took place was Keith Mansford, who became the first Head of R&D and a Main Board Director at SmithKline Beecham. He is still endorsing me for Mergers and Acquisitions on Linkedin.

Prior to the merger in 1989 Beecham had built up a strong R&D pipeline and product profile. However, its full potential was held back by its limited infrastructure in several important countries, notably the USA. SmithKline in contrast had been a relatively small company prior to its discovery of Tagamet for stomach ulcers, which became for a period the world’s best-selling drug. The very rapid growth of SmithKline on the back of Tagamet could not be matched by a build-up in R&D because of the time lags involved and the need for scientific leads. By the time of the merger in 1989 SmithKline had a bigger global infrastructure than was needed with the patent expiry of Tagamet looming. The merger did not lead to a cut-back in R&D but rather to an accelerated drug development programme made possible by the increased infrastructure. The UK gained in stature in the industry because the merged company’s head office was based here. The UK added to its research reputation as Beecham’s successes became more visible around the world.  Tagamet had been discovered in the UK at SmithKline’s British laboratories and helped the UK’s image in the merged company. Post-merger cost-cutting was largely in administration and manufacturing. There was no need for two local head offices in every country or for so many pill-making facilities. The merger was structured as a deal between equals with each set of shareholders owning 50% of the new company and the Main Board being equally split. There was therefore no stockmarket bid premium enhancing value for one set of shareholders.

I have focussed above on the merger of SmithKline and Beecham 25 years ago because it is thought-provoking and long enough ago for most commentators to be objective rather than paid apologists. The SmithKline Beecham merger went well but what about later mergers? There are examples both ways. In this blog there is only space to consider some general principles.

Following the merger of SmithKline and Beecham I discussed the future of the pharmaceutical industry with many very senior executives from a wide range of companies with varying opinions. I was particularly impressed by the views of Sir David Jack, one of the most successful heads of R&D in history, who ran Glaxo’s R&D in its most productive phase. He strongly believed that mergers would generally harm R&D and that the merged companies would usually discover less than the original businesses would have done separately. Over 20 years ago he was warning that the productivity of R&D would fall as a result, despite advancements in science and technology that should have made R&D easier.

The most important activity in R&D is thinking by individuals leading to ideas for potential new drugs and for what needs to be done to progress them. Good ideas are rare. If a researcher comes up with one idea in his working career that leads to a major new drug, he is doing excellently. The performance of R&D staff cannot therefore be judged entirely by track record. In David Jack’s view an R&D unit will be the most productive if it is small enough for the Head of R&D at the unit to know and understand what everyone is doing. He should also be approachable so that anyone can talk with him and good ideas will not get lost. All these considerations suggest that the maximum size for an R&D site should generally be around 500 people.

The largest pharmaceutical companies have over 10,000 R&D staff globally. In David Jack’s view the only sensible way to run R&D on this scale is to have a series of autonomous, independent sites, each with its own Head of R&D and culture. Only those services of a routine or uncreative nature should be carried out centrally in order to benefit from economies of scale and central expertise.

If David Jack’s view is accepted, R&D used to be more productive because R&D sites were of closer to optimal size and because there was less central direction from outside sites. The last things that should have been wanted are layers of bureaucracy, central direction by policy rather than quality of lead, lack of communication to a strong, local Head of R&D and short-termism caused by people fearing for their jobs after mergers.

The decline in R&D productivity has not occurred because the easiest drugs have been discovered. Nearly all major drug discoveries can be traced back to an individual or a small team. If the person or team had not been there, the discovery would often not yet have been made. US biotechnology companies are on average more productive in R&D than major pharmaceutical companies, despite the funding constraints facing many biotechnology concerns.

In order to justify mergers, pharmaceutical R&D needs to be arranged more like it was in the 1980’s. Pfizer must speak for itself about its future R&D intentions but its actions over the Sandwich site and its recent R&D strategy give grounds for concern over how well placed it is to serve as guardian to a large slice of the UK’s pharmaceutical R&D.

Over 40 years ago in 1971 Beecham bid for Glaxo. Boots then counterbid as a white knight and Glaxo recommended acceptance of the Boots offer. The Monopolies Commission blocked all the moves, principally on the grounds that research in the UK would suffer from too much concentration. In 1971 Beecham and Glaxo were principally antibiotics companies. What would have happened to all the subsequent drugs from Beecham and Glaxo if the two companies had merged in 1971? This question must be asked.

 

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About Barbara Arzymanow

Barbara Arzymanow is a Research Fellow at 2020health and is a founding director of an independent healthcare consultancy firm. She has been an investment analyst specialising in Pharmaceuticals for 25 years, prior to which she carried out academic medical research in university laboratories. Her experience, obtained entirely from outside the pharmaceutical industry, gives her a unique, political perspective independent of commercial lobbies. She has extensive experience in financing the biotechnology industry, which is vital for the long-term standing of medical research in the UK. She has always been inspired by the scientific excellence within the UK and would like to see collaborations between industry, the NHS and academia strengthened. For more information about Barbara's research and writings including submissions to Government Departments please visit http://www.researchideas.co.uk . Barbara also tweets as @barbararesearch .
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