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Darwin's Medicine blog

Professor Brian D Smith is an authority on the pharmaceutical industry and works at SDA Bocconi University and Hertfordshire Business School.

Getting the sizing right

Merger and Acquisition activity in our sector can learn from the natural world

As I write, Shire’s board has agreed to Takeda’s $65bn bid in yet another example of consolidation of the life science industry. Leaving aside the merits and demerits of that particular move, it takes us further along a path to where fewer companies control more of the market. And we see similar trends in the generic sector, in the industry’s supply chain and in channels to market, with the US market in particular seeing consolidation in pharmacy benefit managers and insurance companies. All of these are driven by a convergence of factors, from price pressures in payer-led markets to the increasing cost of competing, whether that’s done on efficiency (as do generics) or innovation (as do research-based companies) or other bases. The basic assumption that bigger is better - more efficient and more effective - is driving CEOs to push for scale. But is that basic assumption sound? As usual, let me digress into the evolutionary science before coming back to some practical insights.

In the animal kingdom, one of the most striking observations is the range of size. Even if we restrict ourselves to animals proper and ignore microbes, the range is huge. From the tiny cat flea (about 1mg) to a blue whale (the largest animal ever to exist at 180 tonnes), successful species can be small or big. This has fascinated biologists for decades. In his 1926 essay, JBS Haldane, one of the fathers of the modern view of evolution, unravelled the reasons for this. Put simply, biological scaling (or allometry, to give it its proper name) is about much more than bigger is better. As Haldane described, you can’t just scale-up a successful animal. If an insect grew much bigger, it wouldn’t be able to absorb enough oxygen through its surface. If you made a warm-blooded mammal smaller, it would lose so much heat (because of its greater surface area to its mass) that it couldn’t survive outside warm climates. That’s why, to quote Haldane, the smallest creature in Spitzbergen is a fox. There are, it turns out, all sorts of non-linear constraints on systems - from air resistance to the thickness of legs needed to support body weight - that mean animals can’t just scale-up without changing their phenotype in many fundamental ways. As a result, evolution creates an enormous range of animal sizes to reflect the many different ecological niches that are found in nature.

So, back to the life science industry. The trend seems to be different from biology. It is increasingly difficult for small firms to survive, while large firms just seem to get bigger. It’s as if our industry climate is cooling and making it impossible for anything smaller than a corporate fox to survive. It’s not hard to see the mechanism underpinning this. Regulatory burdens and costs are the same if you sell 100 units or 1 million. The cost of innovating continues to grow. In a global market, sales and marketing is a huge cost, even with judicious use of partners and distributors.

Cost advantages inferred by new technology apply equally to large and small companies. There seems, on the face of it, no good reason for industry consolidation not to continue until we are left with only a handful of huge companies. In a 2002 Harvard Business Review paper, Deans, Kroeger and Zeisel drew a curve that peaked with 90% of many markets being controlled by a small number of companies. Even after years of M&A activity, our industry is a long way from that peak.

But allometry suggests that our industry might not necessarily go the same way. When a corporation grows, the system for allocating resources efficiently - strategy making - comes under strain. This is especially true when different parts of the organisation are very different, such as we find in business units as different as oncology and small-molecule primary care. There are other systems that struggle with size too. Maintaining culture, sharing knowledge, avoiding legal and regulatory pitfalls and upholding corporate reputation are all things that get harder as a firm gets bigger.

So, what’s the practical lesson that evolution and allometry can teach life science CEOs? In a nutshell, size is good but simply upscaling the current business model won’t work. To reap the benefits of the mega-corps that the industry is consolidating towards, firms will need better, and perhaps entirely different, ways of making the different parts work together. In particular, just as larger organisms needed to involve better ways of moving oxygen and nutrients around their bodies, firms will need to improve how they allocate resources and distribute knowledge. Simply getting bigger probably won’t work. The key to success, in biology and in business, is being both bigger and different.

22nd May 2018

From: Sales

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