In the belly of a giant: endosymbiosis and the pharmaceutical industry
The origins and diversification of complex life have largely been driven by endosymbiosis — the engulfment of one cell by another. Plants and algae can make energy from sunlight because they have a chloroplast, which is the relic of an ancient endosymbiotic event. Usain Bolt owes much of his speed and power to the mitochondria within his muscle cells, which are also the products of an age-old endosymbiosis. But endosymbiosis is not limited to the biological world; it is also a prevailing corporate strategy, whereby one corporation swallows or fuses with another via mergers and acquisitions (M&As). And just like cellular endosymbioses, M&As can give rise to complex and thriving companies, but they can also be detrimental. When M&As involve pharmaceutical companies, the outcomes can affect us all.
Big pharma endosymbiosis
Not long ago, there was a lot of publicity surrounding a potential M&A between the pharmaceutical companies Allergan and Pfizer. At an estimated worth of 160 billion dollars, this would have been the largest merger ever in the pharmaceutical industry. Even more remarkable, this blockbuster merger was supposed to be an inversion, in which the new company would be based in Ireland, headquarters of the relatively smaller Allergan. The reasoning behind this inversion was tax avoidance. Pfizer, an American corporation, would stand to save billions of dollars in the merger because Ireland has lower taxation rates than the US. Pfizer would also have convenient access to billions in overseas tax-deferred revenue. But ultimately the two pharmaceutical behemoths walked away from the deal after the US government introduced new regulations, negating the tax benefits.
There are a number of other reasons why pharmaceutical companies might want to merge. For example, M&As can synergize research and development (R&D) costs, can allow smaller subsidiaries to employ the stronger sales force of established pharma leaders, and can also limit price competition between companies. In a 2015 study, 46% of surveyed pharmaceutical executives explained that the main driving point for M&A activity was to gain access to new research and to offset revenue loss caused by the patent expiration of leading drugs.
The dog-eat-dog world of big pharma
Executives of many American pharmaceutical corporations have already invested heavily into mergers. Today, the Pharmaceutical Research and Manufacturers of America group has only 11 members, compared to 42 members twenty years ago. The momentum of M&As seems unstoppable, especially with the financial winds blowing in its favour. There are historically high cash reserves to strengthen take-over bids and low interest rates to fuel acquisitions with debt. Now, it is even more cost-effective to acquire a company’s patents than to develop a blockbuster drug, which takes around 10 years and an estimated $1 billion to bring to market.
Big pharma mergers have also attracted a lot of negative publicity, particularly with respect to surging drug prices. Indeed, the business model for many pharmaceutical companies involves acquiring and then increasing the cost of drugs. One recent example is Martin Shkreli’s Turing Pharmaceuticals, which increased the price of a niche drug from $13.50 to $750 per pill. Public outrage was so strong that another pharmaceutical company decided to develop a cheaper, generic version of the drug.
How a purchase-or-perish mentality affects R&D
As M&A activities rise, fewer and fewer drugs are being developed and approved. In fact, the past decade has seen a 23% decline in drug approvals, but these numbers do not provide a complete picture. For instance, big pharma consolidations can often reduce cost duplication and improve business synergy by resulting in the development of a few novel drugs rather than multiple variants of the same drug. Some industry experts have also argued that R&D productivity is improving, or at least remaining steady.
But following a merger, R&D can be brought to a standstill. M&As can lead to time-consuming reviews to consolidate research data and operations. These reviews also determine the fate of certain drug candidates based on potential commercial success and the strategic direction of the merged company. In addition, establishing a synergy between different research operations takes a long time to complete and execute. Undergoing a single merger can significantly impede the momentum of a research program, but enduring multiple mergers can deliver a mortal blow to R&D.
Historically, the pharmaceutical industry has prided itself on investing more in R&D than any other medical industry — as much as 20% of overall revenue. But an M&A can greatly deplete a company’s war chest and is usually followed by significant financial cutbacks. Before merging, Pfizer and Wyeth spent an estimated $11.3 billion on R&D. Post merger, this number has dropped to $6.5 billion.
What’s next?
Given the current financial landscape and that more and more drug patents are set to expire, we can expect 2017 to be the biggest year yet for M&A pharma deals. Pharmaceutical giants, eager to benefit from M&A, should undertake proper due diligence and ensure a correct valuation price and an effective integration plan. Pharmaceutical industry consolidation has and will continue to synergize R&D, but this increased synergy should not come at the expense of research innovation and productivity. As the urgent need for life-saving medicine increases, we cannot allow M&A to impair long-term drug development.
This article was written by George K. Yuan, an Honors of Business Administration student at the Western University Ivey School of Business. This essay is the product of a science-writing internship in David Smith’s Lab at Western.
