Consolidation in the Global Pharmaceutical Industry

question 103

Essay

Consolidation in the Global Pharmaceutical Industry:
The Glaxo Wellcome and SmithKline Beecham Example

By the mid-1980s, demands from both business and government were forcing pharmaceutical companies to change the way they did business. Increased government intervention, lower selling prices, increased competition from generic drugs, and growing pressure for discounting from managed care organizations such as health maintenance and preferred provider organizations began to squeeze drug company profit margins. The number of contact points between the sales force and the customer shrank dramatically as more drugs were being purchased through managed care organizations and pharmacy benefit managers. Drugs commonly were sold in large volumes and often at heavily discounted levels.

The demand for generic drugs also was declining. The use of formularies, drug lists from which managed care doctors are required to prescribe, gave doctors less choice and made them less responsive to direct calls from the sales force. The situation was compounded further by the ongoing consolidation in the hospital industry. Hospitals began centralizing purchasing and using stricter formularies, allowing physicians virtually no leeway to prescribe unlisted drugs. The growing use of formularies resulted in buyers needing fewer drugs and sharply reduced the need for similar drugs.

The industry’s first major wave of consolidations took place in the late 1980s, with such mergers as SmithKline and Beecham and Bristol Myers and Squibb. This wave of consolidation was driven by increased scale and scope economies largely realized through the combination of sales and marketing staffs. Horizontal consolidation represented a considerable value creation opportunity for those companies able to realize cost synergies. In analyzing the total costs of pharmaceutical companies, William Pursche (1996) argued that the potential savings from mergers could range from 15–25% of total R&D spending, 5–20% of total manufacturing costs, 15–50% of marketing and sales expenses, and 20–50% of overhead costs.

Continued consolidation seemed likely, enabling further cuts in sales and marketing expenses. Formulary-driven purchasing and declining overall drug margins spurred pharmaceutical companies to take action to increase the return on their R&D investments. Because development costs are not significantly lower for generic drugs, it became increasingly difficult to generate positive financial returns from marginal products. Duplicate overhead offered another opportunity for cost savings through consolidation, because combining companies could eliminate redundant personnel in such support areas as quality assurance, manufacturing management, information services, legal services, accounting, and human resources.

The second merger wave began in the late 1990s. The sheer magnitude and pace of activity is striking. Of the top-20 companies in terms of global pharmaceutical sales in 1998, one-half either have merged or announced plans to do so. More are expected as drug patents expire for a number of companies during the next several years and the cost of discovering and commercializing new drugs continues to escalate.

On January 17, 2000, British pharmaceutical giants Glaxo Wellcome PLC and SmithKline Beecham PLC agreed to merge to form what was at the time the world’s largest drug company. The merger was valued at $76 billion. The resulting company was called Glaxo SmithKline and had annual revenue of $25 billion and a market value of $184 billion. The combined companies also would have a total R&D budget of $4 billion and a global sales force of 40,000. Total employees would number 105,000 worldwide. Although stressed as a merger of equals, Glaxo shareholders would own about 59% of the shares of the two companies. The combined companies would have a market share of 7.5% of the global pharmaceutical market. The companies projected annual pretax cost savings of about $1.76 billion after 3 years. The cost savings would come primarily from job cuts among middle management and administration over the next 3 years
-What do you think was the major motivating factor behind the Glaxo SmithKline merger and why was it so important?

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Definitions:

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