Are Pharmaceutical Company Mergers Rational?

Brad FitzpatrickAfter decades of relative stability, pharmaceutical industry mergers burgeoned about 15 years ago in three distinct waves. The first occurred in the late 1980s/early 1990s, the second happened a few years later, and the third at the beginning of this century. The first wave involved Bristol-Myers Squibb and Smith-Kline Beecham. The second saw: in 1994, American Home Products join with Ayerst and Wyeth, two subsidiaries that had been run independently; in 1995, Glaxo Wellcome, Pharmacia and Upjohn, and Hoechst; and in 1996, Novartis, previously Ciba-Geigy and Sandoz. In 2000, Pfizer merged with Warner Lambert. Recently, Pharmacia was added to the Pfizer family.Several major econometric studies have looked at mergers and acquisitions across various industries and concluded that, in general, such activity does not create or release synergy.12 However, a different picture emerges when using patents and New Drug Application (NDA) approvals, awarded by the Food and Drug Administration, as research-process output, instead of sales.3We examined NDAs deemed New Molecular Entities (NMEs) by using a metric that gave greater weight to those NMEs that the agency judged to be important therapeutic gains or that were selected for priority review. We found that first-wave companies were more productive than both non-merged companies and the overall pharmaceutical industry.3For companies in the first wave, results show that research and development (R&D) costs, per weighted NME in constant dollars, increased by only 29% as compared to the five previous years. In comparison, the cost increased 43% for nonmerged companies and 41% for all companies.Using the same analytical method, second-wave companies also were found to be more productive than their nonmerged counterparts and the industry in general. The constant-dollar R&D cost per weighted NME for the second-wave firms increased by only 1%, whereas costs increased 48% for nonmerged companies and 34% for all companies. While it is too soon to assess the R&D consequences of the third wave, using chemically novel new drugs to measure company performance appears to indicate that increases in productivity follow merger activity.The results are more ambiguous when analyzing R&D costs per pharmaceutical and life sciences patents. First-wave companies lost ground to nonmerged companies, whereas second-wave firms gained ground over nonmerged companies. R&D costs per patent for first-wave companies increased by 303%, whereas costs increased 281% for nonmerged companies and 244% for all companies, indicating that first-wave companies were less productive than both nonmerged firms and the overall pharmaceutical industry. Second-wave companies, however, were more productive than both nonmerged companies and the overall pharmaceutical industry. Constant-dollar cost per patent for the second-wave companies decreased by 21%, compared to a 3% cost increase for nonmerged companies and an 8% cost decrease for all companies.While patents are important to a pharmaceutical company, they are merely tools with which to stake a claim to a new drug entity. The industry's axiom, "the NDA is the name of the game," speaks for itself. Thus, when both drug and patent data are considered, it seems safe to draw the provisional conclusion that mergers within the pharmaceutical industry have resulted in increased R&D productivity.Merger mania has received significant coverage in the business press. One interesting point of view offered is that the first wave resulted from necessity, and the second represented attempts to capitalize on opportunities. The data presented above, indicating that the second wave was more successful than the first, does not confirm this hypothesis, but it is not inconsistent with it. If the assumption is made that NMEs are drugs that have been synthesized in the past, while patents represent a closer measure of current activity, the improved patent position of the second-wave companies may be taken as evidence that merger synergy arises not only from "pipeline opportunism" but also from improved R&D capability.Michael E. D. Koenig, PhD, is dean of the College of Information and Computer Science; Elizabeth Mezick, CPA, is assistant professor in the Center for Business Research. They are both at Long Island University, Brookville, NY.

Are Pharmaceutical Company Mergers Rational?

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