Feel the tremors? That's the $200 billion drug industry, in seismic upheaval. Consolidation is reshaping the landscape, as giant multinational producers search for new products and wider distribution. Within a few years, the way pharmaceuticals are invented, made, and sold will bear little resemblance to the methods of a decade ago.
In the space of two days, the drug business provided a powerful glimpse of its future. On May 2, Roche Holding Ltd. agreed to buy troubled drugmaker Syntex Corp. for an astounding $5.3 billion. A day later, suitors began swarming around Eastman Kodak Co.'s Sterling Winthrop unit, now on the block. And SmithKline Beecham PLC unveiled its pact to buy a big distributor, Diversified Pharmaceutical Services Inc. for $2.3 billion, and to ally with Diversified's parent, powerhouse health maintenance organization United HealthCare Corp. Likewise, Pfizer Inc. agreed to a venture with Value Health Inc., operator of the Valuerx drug middleman.
Individually, the deals came as little surprise. Syntex has struggled in recent years, and Sterling, too, has been a weak sister to photography since Kodak acquired it in 1988. Diversified's purchase had been almost inevitable since Merck & Co.'s $6.6 billion acquisition last year of rival distributor Medco Containment Services Inc. and a marketing "alliance" formed in April by three other drugmakers and distributor Caremark International Inc.
"blown away." Taken together, though, the moves reflect a fundamental struggle for financial control in the health-care business. In just a few years, the balance of power has shifted dramatically: Hospitals have won clout by merging or forming purchasing alliances; they and other big drug buyers have contracted with benefit-management companies to negotiate lower prices on their behalf. "Never before have we been confronted with the range of challenges we face today," says Sheldon G. Gilgore, chief executive of G.D. Searle & Co.
Now, amid plunging profits, comes the drugmakers' response. A highly fragmented industry--its largest player, Merck, controls about 5% of the worldwide market--is bulking up. To combat soft prices, the big producers are scrambling to build market share by selling more products. To fight the growing might of distributors, they're buying the distributors.
In the rush to buy new muscle, there will be mistakes. Industry analysts and executives were shocked by Roche's mighty bid for Syntex, a company with little apparent promise in its development pipeline and a core product, the anti-inflammatory naproxen, that virtually collapsed after losing patent protection last December. "I was blown away at the price," says one senior Syntex manager. Likewise, some analysts questioned the heady 50 times earnings SmithKline will pay for Diversified.
But for buyers with deep pockets, such deals represent opportunity. Roche, which bought 60% of biotech leader Genentech Inc. four years ago, insists that Syntex' research and development capability is sound. "Syntex is a research-oriented company with excellent science," says Fritz Gerber, Roche's chairman and CEO. Moreover, the acquisition will give Roche a broader product line to sell big customers in the U.S. There's a wild card, too: Syntex, with its unusual Panamanian charter, may provide a valuable tax shelter.
Likewise, Sterling is for sale because it didn't fit Kodak's business aims. But France's Elf Sanofi, which has the right of first refusal to bid on the $1 billion Sterling prescription business, says it is keenly interested. Germany's Bayer, which has long wanted to win back its aspirin trademark in the U.S., is seeking Sterling's $900 million U.S. over-the-counter business.
Such consolidation among producers will continue: Big manufacturers, too, are investing heavily in small biotechnology outfits with promising products. But the more compelling strategy is represented by SmithKline's deal: Buy the distribution channel. By snapping up Medco and Diversified, Merck and SmithKline essentially swallow up the middlemen that have forced their margins down.
Gentle reminders. Executives at SmithKline, like those at Merck, insist that Diversified will continue to carry rivals' drugs on their recommended lists--but admit that they hope to lift sales of their own products, too. Says J.P. Garnier, pharmaceuticals chairman at Smith-Kline: "We will have preferred positions...that will expand our market share in certain categories."
Millions of consumers will be affected by that strategy. Diversified manages pharmacy benefits for 11 million people, a big chunk of the 50 million Americans so covered. Drugmakers see in that number an enormous opportunity to capture new sales. Now, SmithKline, through Diversified, will have the power to enforce compliance with drug-treatment programs, for example--by sending patients with high blood pressure, say, reminder letters to keep buying their medicine. SmithKline also will get data on the typical pattern of diseases that will help it sell and price their products better.
Eventually, pharmaceutical companies could move far beyond simple drug production and sales into health-care delivery. With its Diversified purchase, SmithKline inked a six-year deal with 1.6 million-member United HealthCare that will give the drugmaker data it can use to compare treatments and their cost-effectiveness. Such "outcomes" analysis could be potent for marketing drugs. Moreover, the HMO can help the drugmaker develop so-called capitation programs, allowing Diversified to cover a particular company's workforce for flat per-employee fees.
Customers who have enjoyed their growing purchasing power aren't thrilled by the prospect of this brave new world. Pharmacy-benefit managers have won low prices for the Group Insurance Commission of Massachusetts, which provides drug benefits for 240,000 state employees, retirees, and their dependents. Now, Executive Director Dolores L. Mitchell is insisting that Medco provide periodic reports to prove she's still getting the best deals, not just Merck products. "We all have to be a little shrewder as purchasers," she says.
First loyalty. Others worry about the effect on quality of care. Patricia Wilson, a consultant on pharmacy benefits at Associates & Wilson in Rosemont, Pa., frets that the push for cost-effectiveness could compromise patients by favoring inappropriate drugs that happen to be on a distributor's sales list. Employers, she adds, must realize that the first loyalty of benefits managers owned by drugmakers now will likely be to their corporate parents, not to the customers. "Who is the client?" Wilson asks.
The confusion seems sure to continue. Already, rumors abound that West Coast distributor McKesson Corp., which has a pharmacy-benefit unit, is hot on the prospect list of such drugmakers as Glaxo Holdings PLC, though neither company would comment. Producers such as Upjohn Co. and Marion Merrell Dow Inc. have long been viewed as takeover candidates. Even Merck discussed mergers with the likes of Pfizer and Glaxo several years ago, and some observers say a combination with another drugmaker is again a possibility. Everyone seems to agree: In drugs, big has suddenly become much better.