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Mega Mergers Can't Cure the Pharmaceutical Industry

A flurry of major pharmaceutical company mergers and acquisitions got plenty of attention this spring. Pfizer's (PFE) acquisition of Wyeth, Merck's (MRK) purchase of Schering-Plough and Genentech's (DNA) deal with Roche all made headlines for their potential to help the resulting entities reduce costs and add new, promising drugs to company pipelines.

But a recent string of quieter agreements that signal collaboration on research and development—as opposed to takeovers—point the way to the real future of the industry.

Collarborate to InnovateMerck and AstraZeneca (AZN) combined two of their leading pipeline products to develop an innovative cancer therapy, GlaxoSmithKline (GSK) and Concert Pharmaceuticals pooled pipeline assets in part to distribute risk, and Pfizer and GSK combined their HIV pipelines and marketed products into a joint venture to increase their chances of success.

These arrangements represent new, promising ways for the industry to make its innovation machine run more efficiently. And they stand in contrast to long-held R&D strategies that focused on out-spending and out-innovating the competition. Drugmakers pursued drug discovery and development on their own, bearing all the risk and reaping all the rewards. But that model is proving unsustainable.

According to Bain & Co. estimates, annual cash flow of about $30 billion—roughly half of the $60 billion spent on R&D by the industry—will evaporate in the next four years as patents on big blockbuster drugs expire. That puts the challenge in stark terms: Senior pharmaceutical executives will be compelled to do more with less capital, with very little industry-specific experience to draw upon. This, in part, explains the rash of big merger announcements that often serve as last-ditch efforts to fill sagging pipelines.

Yet mergers have typically contributed to declines in R&D productivity. Rather than streamline and focus R&D, management tends to retain most of the drug pipelines, physical assets, and R&D talent of the combined companies—which makes decision-making and resource allocation even more difficult. With the costs of discovering, developing, and commercializing a new drug now exceeding $2.2 billion, the industry needs to find a new way to deliver innovative medicines from its collective pipeline.

A Sustainable Solution Enter the R&D collaboration model. Instead of acquiring resources, a more sustainable solution for the pharmaceutical industry lies in pooling resources, particularly intellectual capital and increasingly limited financial resources.

By effectively pooling research assets within a disease area, the industry would benefit in three ways. First, partners would make resource allocation decisions much earlier than before and fund only those projects with the highest likelihood of showing real differences in medical outcomes. For example, rather than pursuing several expensive late-stage programs in parallel, competitors could combine their resources and fund only the most promising candidate. Second, this approach will reduce the number of duplicative or "me-too" products, many of which now struggle to get access and reimbursement. Finally, the new model will distribute risk—and returns—across partners to increase the predictability of pipelines and long-term revenue.

These were exactly the reasons that pushed AstraZeneca and Merck to work together to test a new, experimental cancer regimen based on a "cocktail" consisting of drugs made by each. If the approach doesn't work, the partners can kill both compounds early and minimize the cost. If it works, they'll have a more effective, proven cancer treatment they can get to market faster and cheaper. This approach does not reduce the competitiveness of the industry, but rather refocuses it on those areas where its true strengths lie—global footprint, access to emerging markets, and relationships with increasingly demanding regulators and reimbursement authorities.

Better Allocation of ResourcesIn the near term, more collaborative business models for R&D can improve the dismal return on investment in the drug development process (which we currently estimate at approximately 4%, versus 9% during the period from 1995 to 2000). It can also lower costs, speed time to market, spread risk, and improve market potential.

Most importantly, collaboration can help reduce wasteful overlap. In a number of primary care diseases, including diabetes, hypertension, and hypercholesterolemia, many pharmaceutical companies have focused intensively on the same opportunities. Oncology is the latest area where these trends are increasingly apparent. The current development pipeline is jammed with overlapping products across oncology pathways. But the existing model offers no way to rationalize these duplicate investments until the products reach the market. The endgame for oncology is heading to the same point that primary care finds itself in now: declining returns on R&D, a crowded competitive landscape, significant price competition, and higher commercial costs.

The pooling model, on the other hand, shifts the basis of competition to late-stage development and commercialization, which is where the big drugmakers' strengths lie—and frees up resources to invest in a broader range of therapeutic areas. For Pfizer and GSK for example, the HIV space was a challenge on their individual portfolios. But their recent decision to set up a jointly owned company that focuses on HIV therapeutics makes the best of both worlds. The new company not only merges HIV pipelines, but it also creates a much stronger commercial proposition by splicing GSK's marketing skills with Pfizer's more robust early-stage HIV products.

Our health-care system needs continued innovation but at lower cost. For pharmaceutical companies, it's time to evolve.
Preston Henske is a partner with Bain & Co. Tim van Biesen is a Bain partner and head of Bain's Americas Healthcare Practice.

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