Implications of Consolidation in the Pharma and Biotech Sector

Posted on December 12, 2018

Anna Bonomi
Anna Bonomi
Analyst, Healthcare & Chemicals Research
Oana Pop
Oana Pop
Associate, Research Products

Increasing consolidation within the pharma and biotech industry has triggered questions about the ultimate impact on the industry, as well as on its stakeholders. With increased competition from generic manufacturers and rising drug development costs, several pharmaceutical companies have engaged in M&A as a defensive strategy to offset losses in market share and gain cost savings. While M&As are typically scrutinized by authorities for harming competition, another question has emerged: does consolidation harm innovation and ultimately the industry’s capacity to develop lifesaving drugs?

The pharma and biotech sector has seen intensive consolidation in the first half of 2018, with 247 deals totalling USD 175.9 billion being made.[i] The most remarkable story of 2018 has been Takeda Pharmaceutical’s USD 62 billion agreement to acquire Shire, a leading biotech company focused on innovative treatments for rare and specialty diseases. The takeover is expected to propel the combined companies to ninth place in terms of 2017 sales[ii] and enable a leadership position in gastroenterology, neuroscience, oncology, rare disease and blood-driven therapies.

Pharma Biotech M&A Volume since 2010 (in Billions)

Source: Bloomberg[iii]  and PharmaTimes

Other noteworthy acquisitions in 2018 include: Celgene’s acquisition of Impact Biomedicines (USD 7 billion) and Juno Therapeutics (USD 9 billion); Sanofi’s announced acquisitions of Bioverativ (USD 11.6 billion) and Ablynx (4.8 billion); Novartis’ agreement with Endocyte (USD 2.1 billion) and AveXis (USD 8.7 billion); and GlaxoSmithKline’s deal with Tesaro (USD 5.1 billion).

What is causing consolidation in the pharma industry?

Intensifying Generic Competition

Today, generic drugs account for more than 88% of drugs prescribed (prior to 1984, the proportion was only 19%). With significantly lower R&D and marketing expenses, generic drugs can be sold at a much lower price than branded drugs.

Ever-increasing cost of drug development

In FY2017, the R&D return for pharmaceutical companies was 3.2%, compared to 10.1% in FY2010.[iv] Driving this trend is the higher cost to bring a new drug to market and the expectation that new drugs offer greater benefits than existing drugs. In 2017, the average cost of bringing a new drug to market (factoring in pipeline failures) was approximately USD 2.6 billion,[v] compared to USD 1.2 billion in 2010.[vi] It is noteworthy that the overall probability of clinical success is estimated at less than 12% by the Pharmaceutical Research and Manufacturers of America (PhRMA). This points to one of the key problems within the industry, namely the high cost of failure.

Product development risks

While R&D costs have increased dramatically over the last decade, only a small percentage of drugs in the R&D stage receive marketing approval from regulators.[vii] Drug approval standards are incredibly strict and approval standards for specialty drugs targeting complex diseases are even higher, as these drugs could potentially pose more risk to patients. In 2017 only 18% of drugs in pharmaceutical companies’ pipelines received marketing approval and were brought to market,[viii] as highlighted by the graph below.

Pipeline by Development Phase (FY2017)

Source: Pharmaprojects®

Risks and Opportunities for Investors

M&As within the pharma industry will continue as market conditions evolve globally. But will increasing consolidation have a negative impact on innovation, and ultimately, stakeholder benefit?

A study of 65 pharma mergers revealed that measurements of innovation, such as R&D spending and patenting, declined significantly within merged entities compared to the original companies.[ix] This is likely due to merged entities eliminating competing or duplicate projects in their clinical pipelines, or acquiring companies targeting firms to reduce competition in innovation projects. Industry-level competition and innovation prospects suffer following industry mergers as patenting and R&D expenditures at non-merging competitors also decline.

The expensive and often disruptive nature of M&As could also hurt innovation. Acquisitions can create huge debt for the acquiring companies, making it necessary to reduce costs. For instance, Takeda’s plan to pay off its debt following its record deal with Shire involves massive layoffs and the elimination of duplicate drug research.[x] Human capital plays a key role in innovation in the pharma and biotech sectors. Layoffs could significantly disrupt and delay ongoing programs, as well as diminish employee morale and loyalty to the company. M&As can also be disruptive in terms of processes, new appointments in key positions and changes in strategy and corporate culture.

R&D spending and patenting are not the only measures of innovation. Focusing on R&D productivity (“the amount of innovation created as measured by the value of new FDA-approved compounds reaching the pharmacy, relative to input”), Michel S. Ringel and Michael K. Choy of Boston Consulting Group argue that large mergers represent a positive driving force for innovation overall. While disruptive in many ways, M&As help address “the fatal flaw of most research and development enterprises: the high cost of failure.” [xi] According to the authors, mergers can help by improving both scientific and decision-making capabilities in the merged entity, thus enhancing the chances of bringing new treatments to patients.

Whether consolidation hurts or boosts innovation ultimately depends on which company acquirers chose to buy, how the merged entities’ R&D portfolios are combined, which projects get dropped, which cost optimization strategies are chosen, and how human capital is factored in. M&As, if made with the appropriate companies and in the right way, could help the merged entities gain access to new products and markets, grow their scientific capital and reduce the number of projects that fail after significant investments have been made. Focusing on companies with innovative and complementary (not overlapping or competing) R&D portfolios could also increase the ability of the new entity to successfully bring new products to the clinical trial phase and, ultimately, to patients, thus benefiting the entire industry.