Looking For The Right Pill

In drug mergers, cost-cutting matters less than filling the new-product pipeline

It's a kind of magic. Announce a merger between two drug companies that will generate huge cost savings. Then, watch share prices soar. That's what happened when Swiss pharmaceutical giants Sandoz Ltd. and Ciba-Geigy PLC announced their amalgamation on Mar. 7. After the news, the combined market values of the two companies rose $12 billion, to $76 billion, as investors totted up the likely efficiencies. A similar jump in value occurred last August, after Pharmacia and Upjohn Co. revealed plans to merge. No wonder investors are eagerly scouting the market for other likely takeovers and mergers in the global drug business.

But those investors had better be careful: Pulling off successful mergers in this business is a complicated feat. While cost-cutting is a quick and seemingly easy solution to the industry's problems of slowing sales and a scarcity of blockbuster products, the real trick is far more challenging: producing a steady stream of pioneering and profitable products. "Just cutting costs is not enough," says Henri Vannl, a drug industry consultant at McKinsey & Co. in Geneva. "Longer term, it's still an innovation game."

Getting a payoff from innovation could take years as companies sort through the post-merger turmoil. Consider Glaxo Holdings PLC, which last March acquired Wellcome PLC for $14 billion. Glaxo Wellcome PLC became the world's largest drug company. But integrating the two entities has been tough, even though both are British. Some 7,500 jobs are scheduled to get chopped by 1998: 6,000 are gone already. With the exception of Glaxo CEO Richard B. Sykes, all Glaxo and Wellcome staffers have had to reapply for their jobs--which has distracted and demoralized the workforce. What's more, Glaxo pulled all of its U.S. salespeople out of action last summer for retraining. That hurt Glaxo's 1995 results, with sales growth nudging up just 3%.

"WARTIME." Still, Sykes points out the deal has given Glaxo an unusual opportunity to rethink the way it does business. "Everybody is now working under wartime conditions," he says, explaining that the highly charged atmosphere has made staffers more willing to change. While setting a target of bringing three new drugs a year to market by 2000--triple the industry average--Sykes has cut the research staff and stopped the growth of the research budget. With the patents on both Wellcome's and Glaxo's biggest products expiring, Sykes is pushing his R&D personnel to turn out big-selling drugs more efficiently.

Glaxo Wellcome isn't the only newly combined drugmaker reining in research funds. Growth in R&D spending by most major pharmaceutical houses fell to 6.9% in 1995, one of the lowest rates in decades. Companies that join forces can easily eliminate duplicate research projects: The trick is to avoid chopping too much. "Lowering their cost base and doing less R&D is a temporary fix," says David J. Barnes, CEO of Zeneca Group PLC, a drugmaker with a full pipeline that may make it a takeover candidate.

Last year, Hoechst paid $7.2 billion for Dow Chemical Co.'s Marion Merrell Dow Inc. drug unit to break into the U.S. drug market. Neither outfit has many promising new products. Yet Hoechst plans to cut its R&D spending by 10% this year by identifying dead-end research projects and dropping them. Jean-Pierre Godard, head of Hoechst's drug unit, estimates that the payoff of a more innovative R&D organization is still probably a decade away.

GENERIC RIVALS. The ultimate success of the merger between Sandoz and Ciba-Geigy also depends on whether the new company can come up with big new products. The U.S. patent on Sandoz' most successful drug, the immunosuppressant Sandimmun, expired last year. A new patented formulation is taking up some of the slack. But Ciba's top-selling Voltaren, an antirheumatic, is under attack from generic rivals in the U.S. Ciba also has an aging product portfolio and has suffered a number of disappointments recently in clinical trials.

Cutting costs will be the easy part. The pharmaceutical unit will be the prime target, accounting for $840 million out of the expected $1.5 billion in savings by 1999. CEO Daniel Vasella (box) promises to protect R&D spending. But Barrie G. James, a former Ciba executive who now is president of Pharma Strategy Consulting in Basel, is skeptical about whether the deal will pay off in new drugs--unless there's a fundamental rethinking of research strategy. Otherwise, the new R&D organization will be just "throwing money at the wall," he says.

There are some success stories. It took years, but SmithKline's 1989 merger with Beecham has produced a basketful of promising new products. SmithKline Beecham now has 23 compounds in late stages of human testing or awaiting approval--more than any other drugmaker. Likewise, Roche Holding's deal to buy a majority stake in Genentech Inc. in 1990 for $2.1 billion has given it several novel drugs, including Pulmozyme, a treatment for cystic fibrosis. And while Bristol Myers' $11.5 billion takeover of Squibb in 1989 has been a slow starter, its R&D operation has come up with a winner in Taxol, the big anticancer drug. Investors will be looking for other such triumphs as the industry's consolidation advances.

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