Making Money Through M&As
Do pharma mergers and acquisitions improve R&D productivity and increase shareholder value?
George Chressanthis, Aditya Bhandari, Rashi Thaper | | Longer Read
Mergers & acquisitions (M&As) have long been used as a critical strategic instrument in the pharma industry to spur R&D innovation, sustain financial growth, and generate cost efficiencies (1). Huge mergers in the 1990s and 2000s dramatically altered the landscape of the pharma industry, such as those between Ciba-Geigy and Sandoz (Novartis) in 1996, Astra AB and Zeneca (AstraZeneca) in 1998, and Glaxo Wellcome and SmithKline Beecham (GlaxoSmithKline (GSK)) in 2000. Likewise, large acquisitions by pharma companies of other organizations also pre-date today’s recent activity, again changing the face of the industry such as those by Pfizer (Warner-Lambert, 1999; Pharmacia, 2002; Wyeth, 2009), Sanofi (Aventis, 2004), Merck (Schering-Plough, 2009), Roche (Genentech, 2009), and more recently Actavis (Allergan, 2015).
Scale versus scope
Economies of scale says the average total cost to produce a drug decreases as more volume is produced. Traditionally, the pharmaceutical average total cost curve (total fixed cost + total variable cost)/volume starts off high because of the high total fixed costs relative to low volume. However, this then quickly drops as volume increases until it flattens over a large, relevant production range of output. It is possible the average total cost curve increases at very high levels of output due to diseconomies of scale (e.g., higher total average costs caused by logistical and administrative problems when running an extremely large organization – and other costs – due to size). However, generally in pharmaceutical production and cost theory and practice, we do not see the effect due to diseconomies of scale.
Economies of scope, on the other hand, say that the average total cost of a drug decreases with a greater variety of drugs produced from the same inputs. This is where “diversity” of the R&D portfolio enters and becomes critical – where resources under scope can be complementary to each other that are then used to generate novel medicines. There are numerous famous drug development examples; consider the discovery of Viagra for erectile dysfunction, which was the result of a cardiovascular study for the treatment of hypertension and angina pectoris; the creation of Viagra was an unintended effect. This type of discovery has been repeated many times in the history of pharma R&D discovery.
Further, the nature of oncology development and the building of new indications is likely more consistent with scope than scale (mere size). We see this in firms trying to create highly diversified oncology portfolios to gain economies of scope rather than economies of scale. This effect is also consistent with the fact that many drug discoveries are the result of serendipitous events. So, building R&D portfolios where the resources and clinical trials are more complementary to each other will more likely increase R&D productivity than simply having more (size) of the same resources.
Overall, the research literature is very mixed on the effect of M&As on R&D productivity and shareholder value. However, two effects do continually stand out in the literature: the role of economies of scope (developing a diversity of R&D expertise), and fixed-firm effects, meaning that M&A effects can be dependent on firm-specific attributes. The remarks from the 2017 study mentioned above echo these key findings and would explain, for example, the depth by which recent pharma mergers have taken to delve into the oncology therapy area to build scientific expertise and expand product franchises through additional clinical indications. This effect is also consistent with prior research that noted economies of scope as a more important driver of R&D productivity than economies of scale (size). Lastly, this study affirms the effect of firm-specific decision-making, which can be affected by an array of attributes, such as organizational network design and the role of analytics in helping to improve objectivity in decision-making, on the relationship of mergers and R&D productivity and shareholder value.
The importance of M&As
The preceding analysis highlights the importance that M&As will have on the future performance of pharma companies. M&As will be required to achieve strategic objectives by augmenting and/or complementing existing company R&D pipelines as the risks and costs of developing new innovative medicines increase over time. The challenges for pharma companies are making the right targeting decisions for M&As and tactically ensuring such deals achieve strategic goals.
As closing remarks, pharma executives should consider the following when contemplating M&As:
a) Taking into consideration all the instrumental factors for an M&A, a well-evaluated and orchestrated M&A is an essential instrument for pharma companies to increase R&D productivity and shareholder value over time. Having said that, a poorly planned M&A has equal probability to increase disruptions and prove counterproductive. Thus, detailed examination of the M&A will help shift the scales in the right direction.
b) Relying solely on a company’s internal R&D portfolio without M&As will likely not be sufficient to achieve strategic objectives over the long run.
c) Companies must improve on their therapy class target selection as a starting point for further development, and then seek out the right company targets to satisfy R&D objectives. This means building strength and expertise in selected therapy areas, and realigning your portfolio to the winning agents you find – which are generally found outside the company.
d) Companies are increasing their focus on oncology and rare diseases for further development for a variety of reasons; companies should use M&A to seek out areas of competitive advantage in an increasingly crowded field. However, M&As must not be seen as building “brands” but rather “franchises” based on increasing the indications from a single drug approved for multiple uses. This will increase the return on R&D, while allowing companies to differentiate better their franchises in the market.
e) Point d) also means that companies must decide whether to use M&As to continue with the traditional approach to R&D portfolio development; for example in oncology, by focusing on late-stage cancers and extending the life of patients; or to instead target early-stage cancers in the hopes of finding a cure. AstraZeneca recently announced a change in their cancer R&D portfolio strategy to focus on early-stage cancers as a way to differentiate themselves from the competition (20).
f) The execution of M&As to achieve strategic objectives carries with it many risks and uncertainties, given the nature of limited information at the time of assessing an M&A deal. Analytics need to be employed to assess accurately future costs, revenue, and synergies expected.
g) One key conclusion from prior pharma empirical research is that economies of scope (advantages gained through building research diversity) are far more important on the ability of an M&A to increase R&D productivity compared to increasing economies of scale (size).
h) Finally, another key conclusion from prior pharma empirical research is the effect of firm-specific attributes in realizing gains or generating losses through M&As. As noted by one previous article, achieving success through M&As is acquired through experience gained and learned over time (5). A useful research project would be to review all pharma M&As for the purpose of detecting whether some companies do it better than others and why.
Dr. George A. Chressanthis is Principal Scientist at Axtria, Aditya Bhandari is a Principal, and Rashi Thaper is a member of Aditya’s team.
This article was co-published with Axtria, a big data and analytics company. https://insights.axtria.com/whitepaper-do-pharma-mergers-and-acquisitions-improve-research-and-development-productivity-and-increase-shareholder-value
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