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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.

Why Marry?

Just like people, firms marry for many different reasons

Marriage

My fascination with Darwinian evolution comes from its intellectual rigour and its practical value but I also find Darwin himself an endlessly interesting man. There is rarely a business question to which his writing – personal or professional – does not offer an interesting perspective. Recent industry M&A activity is a good example of this. Let me digress a little before I come back to what Darwin might say about recent industry news from GSK, Abbvie, Mylan, Allergan and Pfizer.

Many kinds of marriage

As we all know, M&A activity in our industry is very varied in its nature. Although the textbooks differentiate between mergers, acquisitions
and joint ventures, there is a continuous spectrum of ownership structures, with each deal designed to optimise the risk/return ratio. This complexity raises two questions: firstly, why such diversity in deal structure?

We don’t really know the answer to this question but I hope we soon will, as one of my PhD students, Zaki Sellam, is exploring this topic. The second question is what drives these marriages and which motivations make for a happy marriage. Like every friend’s engagement, each industry deal announcement raises this question.

Darwin’s little list

This is where Darwin’s personal idiosyncrasies help us. Six months before he married his cousin Emma Wedgwood, he compiled a list of reasons why he should and should not marry. It’s a wonderfully honest and eclectic document. For example, he considers not only practical factors such as how he might support a family and continue his work but also more intangible issues such as the ‘charms of music and female chit chat’.

In this latter aspect, he noted that female companionship was ‘better than a dog, anyhow’. From a 21st century perspective, it all sounds horribly anachronistic and not a little sexist. But we shouldn’t judge a Victorian gentleman by our modern values. Darwin’s list illustrates that the reasons for marriage are varied and idiosyncratic, in the sense of being case-specific. That gives us a lens through which to look at marriages in our industry.

Love and margins

When I was young, I thought love was necessary and sufficient to a good marriage. Similarly, when I first studied business, I was taught that the primary reason firms merge is to acquire economies of scale and sometimes of scope. This makes a lot of sense in traditional manufacturing, like making cars or washing detergent, but it has less explanatory power in the life sciences.

There are economies of scale to be had, but the fragmented nature of R&D investment and the possibilities to reduce costs by dis-integration and outsourcing make the ‘bigger is cheaper’ argument less compelling. When your big investment is in IP, not in plant, the arguments for economies of scale work differently.

And when the IP transfer between, say, oncology and dermatology is limited, the scope argument is much less clear too. Just as when young couples marry for love and think it will sustain them, wise old heads shake and say that a successful marriage needs to be based on more sustainable foundations. That’s what we can learn from recent activity in the industry.

Power and portfolio

For example, look at the combination of GSK’s and Pfizer’s consumer businesses. I’m sure they’ll eke out any economies of scale and scope they can but I doubt that they are the real driver in this marriage. In a consumer business, it is brand preference and distribution strength, rather than comparative efficacy, that matter.

Both factors drive this joint venture. The power to negotiate – and ideally dictate – terms to huge retailers, agencies and media channelsis a major source of competitive advantage in consumer markets. A similar argument can be seen in Pfizer’s combination of its Upjohn business with Mylan.

Here, again, economies of scale and scope will help with margins but the main driver is market power. As purchasers of various kinds become more powerful, being able to negotiate across many very large volume therapy areas at once will create market power. Both of Pfizer’s deals, therefore, have similar motivations. Compare this with the AbbVie/ Allergan deal which, while offering some scale, scope and market power, is also driven by the need to maintain growth as blockbusters age.

For better, for worse

Observing the industry is a lot like observing your friends’ marriages. Like each bride or groom, each firm comes to the altar for different reasons. Future happiness depends on whether these reasons are good ones.

Like young love, economies of scale are rarely enough. Marital bliss flows from more profound compatibilities. In our examples, Pfizer will succeed if it realises its market power. AbbVie will succeed if it uses the time Allergan gives it to develop new blockbusters. Both marriages will, like all others, need work.

Article by
Professor Brian D Smith

Professor Brian D Smith is a world-recognised authority on the evolution of the life sciences industry. He welcomes comments and questions at brian.smith@pragmedic.com

25th September 2019

From: Healthcare

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