Commentary: Big Pharma: Getting Too Big for Its Own Good?

There are two forces driving drugmakers Pfizer Inc. (PFE ) and Pharmacia Corp. (PHA ) into each other's arms--one readily apparent, the other less obvious. First, there are the cost savings from the deal, which Pfizer Chairman and Chief Executive Officer Henry A. McKinnell figures could hit $2.5 billion by 2005. Over the next few years, that should propel Pfizer's compound annual earnings growth to nearly 20%. But secondly, as political pressure mounts--particularly in states like Michigan, where laws have been passed to bring down drug costs--companies with a broad array of important products may have more leverage in fighting off requests for discounts. "This is one big power play on Pfizer's part," says Jon M. Fisher, head of equity research at Fifth Third Bank.

The problem is, while the rush to get bigger may help in the near term, it is the wrong remedy for what is really ailing Big Pharma these days. The new Pfizer will have nearly $50 billion in annual sales. More than ever, this behemoth will need blockbuster drugs like Viagra to generate earnings growth. But there is no evidence that bigger research and development operations produce more valuable drugs. On the contrary, Pfizer-size companies run the risk of giantism. "Without real management diligence, they can get slow, ineffective, and infrastructure-bound," says David L. Blumberg, a pharmaceutical industry managing partner at consulting firm Accenture Ltd. (ACN ).

Certainly, the evidence on drug R&D offers no support for megamergers. A study by McKinsey & Co. earlier this year looked at the net present value of products out of research vs. the spending on R&D for the top pharma players over the last decade. It found no correlation between the return on investment and a company's size. And according to London-based market research firm Datamonitor, midsize player AstraZeneca PLC (AZN ) has the best pipeline currently, with potential sales of $7.2 billion from three new products by 2008. That's well ahead of giants Pfizer and GlaxoSmithKline PLC (GSK ), which have R&D budgets that exceed AstraZeneca's $3 billion operation by $1 billion or more.

What's more, companies like Pfizer run the risk of becoming addicted to mergers. Already, SG Cowen Securities Corp. analyst Stephen M. Scala warns that Pfizer's earnings growth will slow considerably in 2006 when patents expire on some big drugs, including $2.4 billion antidepressant Zoloft. Scala says he wouldn't be surprised if McKinnell did another deal ahead of those patent expirations to boost earnings. But with each successive deal, Pfizer's top line becomes larger--upping the need for new products.

It's true that scale brings some benefits. Larger companies can support bigger sales forces and afford to buy more consumer advertising--key drivers of revenue growth. And adding Pharmacia's sales force to its own will transform Pfizer into the largest drugmaker in nearly every major market around the world.

But even on the sales side, analysts warn that giants like Pfizer may garner little payoff from expanding their already-swollen armies of sales reps. The top 40 drug companies have added more than 40,000 new U.S. salespeople over the last decade, notes research firm Verispan Scott-Levin. "The number of doctors hasn't risen as fast as the number of reps," says Barrie G. James, president of Pharma Strategy Consulting. "We are getting to the point of diminishing returns."

So if big mergers aren't the pick-me-up the industry requires, what can big drugmakers do to improve growth rates? Accenture's Blumberg says one important step may be to rethink the blockbuster business model. Many big companies tend to let small-to-midsize products languish with little management attention, focusing exclusively on the billion-dollar drugs. Blumberg argues that, with pipelines so lean, drugmakers can ill afford to let those products wither. Instead, he says, they need to focus more on maximizing the potential of such medicines, striking deals to outsource the marketing of those drugs, or licensing them to smaller outfits. That sort of innovation, not a wave of megamergers, may be a better prescription for what ails the drug industry.

By Amy Barrett

With Kerry Capell in London

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