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:
- Will it cause R&D to benefit or suffer?
- 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.