Commentary: Procter & Gamble: Just Say No To Drugs

Procter & Gamble Co. (PG), maker of Tide detergent, made waves earlier this year when it attempted to buy its way to prominence in the drug industry, an area it had dabbled in for almost two decades. Merger discussions with American Home Products Corp. (AHP) and Warner-Lambert Co. (WLA) went nowhere, but P&G hasn't given up. In August, newly appointed CEO Alan G. Lafley extolled osteoporosis drug Actonel as one of P&G's promising new brands. "We believe Actonel has the potential to be a $500 million to $1 billion business over the next several years," he told analysts.

Don't bet on it. P&G may be a giant in detergent and toothpaste, but when it comes to pharmaceuticals, the consumer-products maker is simply outclassed by the competition. With Actonel, which launched in April, P&G is competing head to head with the world's No. 3 drugmaker, Merck & Co. (MRK) Most analysts think a half-billion in annual sales is the best P&G can hope for. The challenge is far bigger than Actonel. P&G's drug unit has been increasingly dwarfed amid industry consolidation.

All of which raises a basic question: Why is a consumer-products company in drugs in the first place? P&G has been shoveling big bucks into the hugely capital-intensive business of drug development with little payoff. Meanwhile, its core businesses are in need of first aid, and its stock is stalled at around 63, well below its 52-week high of 118. "Given that they are struggling with their base business, I don't think [drugs] belong in a company like Procter," says Rita Freedman, an analyst at PNC Advisors, the investment unit of Pittsburgh-based PNC Financial Services Group (PNC), which holds 10 million P&G shares.

For now, though, P&G is hanging on. Mark A. Collar, president of the $800 million drug unit, has set a goal of building a company with $2 billion in sales by 2005. Actonel is an important piece in that strategy. Despite the fact that the industry is now dominated by a few players with huge testing, manufacturing, and marketing networks, Collar contends that P&G can reach the "critical mass" it needs to become a player.

That may be a pipe dream. Early data on Actonel illustrates the challenges. In July, Actonel's fourth month on the market, new U.S. prescriptions totaled just 31,000, according to researcher IMS Health. That's well below the 89,000 new prescriptions Merck had at the same stage with its rival osteoporosis drug, Fosamax, back in 1995. In August alone, Merck gained nine new Fosamax prescriptions to each one for Actonel.

Moreover, with four of its other major drugs losing patent protection within two years, Merck will fight hard to defend its half of the $2 billion U.S. osteoporosis drug market. P&G claims that Actonel is easier on the stomach than Fosamax and that it is the only such drug proven to cut the chance of spinal fractures. But analysts question whether the company's evidence that Actonel is more effective will be compelling enough to give it a marketing edge.

That kind of direct competition with far larger drugmakers is why Lafely should consider jettisoning the division. P&G admits that it is only near a breakeven level and has yet to develop any big hits. Last year, P&G spent $380 million on drug R&D--some 22% of its total R&D budget. Yet the unit produced just 2% of the company's $40 billion total sales. That may be a ton of R&D money by P&G standards, but it's peanuts compared with the billions spent by big drug players.

CORE FOCUS. Collar says P&G could step up growth by licensing new drug technologies from other companies or by making small acquisitions. But analysts say licensing can be just as risky as drug development. And Lafley may be reluctant to make an acquisition--the market knocked $28 billion off P&G's stock value on the news of the talks with American Home and Warner-Lambert.

P&G needs to boost earnings growth. It must spend more to develop new versions of its proven brands, such as Tide and Pampers, and to create new brands that build on its strength in household products. It failed to do the former with toothpaste and Colgate took the lead. After 20 years of trying to turn a profit in its drug sideline, P&G should pull the plug.

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