A Dose of Reform for Japan's Drugmakers

Foreign rivals are spurring the once-protected outfits to get in shape

Tadashi Hirata is getting ready for a fight. Last September, the president of Tokyo-based Kyowa Hakko Kogyo Co. sold off the company's small beverage operations. Now, he's spinning off its chemical division, and in February he launched a biotechnology outfit in Princeton, N.J., to develop a new cancer drug and line up deep-pocketed investors. The plan: pare down Kyowa's operations from five core areas to just pharmaceuticals and bioengineered products -- while hanging on to annual sales of $3 billion. "This is all about survival," says Hirata. "We have to be aggressive."

What's the big rush? After decades of easy profits in a protected market, Japanese pharmaceutical companies are facing an onslaught of new competition as Tokyo eases regulations that kept foreigners out. Multinationals such as Pfizer, Roche Group, Novartis, and Merck are eagerly eyeing Japan's $50 billion prescription-drug market, the world's second-largest. As foreign players have increased their sales forces and the range of products they offer over the past five years, they have boosted their combined share of the Japanese market from 22% to 28%.

A handful of savvy Japanese drugmakers have been getting ready for the challenge. The most successful -- Takeda Chemical Industries, Eisai, and Fujisawa Pharmaceutical -- have been pouring resources into research and development and today have promising new drugs in the pipeline. They have streamlined management and merged factories to improve efficiency. And they have promoted managers with experience running European and U.S. operations to senior executive posts while expanding abroad. "The smart companies saw the writing on the wall and realized they needed to go global," says Stephen Barker, an industry analyst at UBS Warburg Japan. These front-runners are an inspiration to other likely survivors, such as Kyowa and Sankyo Co., which has put its U.S. office in charge of global R&D.

The result is impressive profit growth. Fujisawa Pharmaceutical Co. saw earnings jump by 9.5% in 2002, to $240 million, thanks to its leading position in the U.S. market as a maker of immunosuppressive drugs for organ transplants. Takeda Chemical Industries Ltd. is expected to show 2002 profits of $2.2 billion, up 5% from a year earlier, on sales of $8.7 billion. A big factor is the 25% spurt in sales of its four key drugs in the U.S. And Eisai Co.'s profits are expected to rise 18%, to $239 million, thanks largely to a 10% jump in sales overseas.

Until a few years ago, Japanese drug companies didn't need to look abroad to prosper. They didn't need to innovate much, either. Government regulations required that any companies selling drugs in Japan had some production facilities there, which discouraged much foreign competition. And middlemen, who sell drugs directly to doctors and hospitals, often favored domestic brands. Another problem was that the government, which controls prices, set the highest ones for new drugs, even if they were only slight modifications of existing medicines. So instead of spending big money on groundbreaking research, companies tended to focus on improvements to existing products, which is a lot cheaper.

Japanese regulators realized that the sector needed a stiff dose of competition, and in 1998, they eased rules for new-drug approval by accepting clinical data on drugs developed outside the country. This spring, they barred physicians from collecting a commission on the drugs they prescribed -- a long-standing practice that led doctors to prescribe domestic drugs, which offered higher payments. The biggest shock of all will come in 2005, when Tokyo scraps the local-manufacturing regulation. Japan is "in a dynamic state, and things are possible today that weren't as possible 10 to 20 years ago," says David W. Anstice, Merck & Co.'s president for human health, who oversees the company's operations in Japan.

The savviest Japanese players made their move early on. Fujisawa -- long one of the most innovative Japanese drugmakers -- decided to take on the U.S. market in 1994, with the launch of its organ-transplant drug, Prograf. Today, the immunosuppressant is administered to 70% of all U.S. liver-transplant patients and half of those receiving kidneys. The company has streamlined operations, too. In contrast to the laborious decision-making process common in Japan, Fujisawa's regional managers and research chiefs from around the world hold twice-monthly videoconferences at which they quickly make key decisions, such as when and where to launch new products. "Everything is centered on improving speed," says Masafumi Nogimori, a dynamic manager who helped run U.S. and European operations before returning to Fujisawa's Osaka headquarters, where he's tapped to be the next CEO.

The most successful outfits have established R&D centers in the U.S. and Europe, where most innovation takes place. In recent years, Eisai has shifted one-third of its drug research and two-thirds of its clinical studies to labs in the U.S. and Britain. The company plans to invest $100 million over the next three years in its U.S. operations. "Since we aim to apply for drug approval in the U.S., we need to conduct good studies in the West," says CEO Haruo Naito. Next on the agenda is China, where Eisai has already established a factory to produce its popular drugs for treating dementia and ulcers.

As Japan's biggest drugmaker, Takeda has become the pacesetter for the sector. It leads in terms of profitability and is developing blockbuster drugs. It has sought out strategic partners, such as Abbott Laboratories (ABT ) in the U.S., to help market its products overseas. And late last month, Takeda announced that Yasuchika Hasegawa, who since 1998 has built up the company's North American operations, will take over as president in June.

But for every winner in this shakeout, there will be a dozen losers. "The only way many of these companies can survive is to be acquired," says Mitsuo Ohmi, an analyst at J.P. Morgan Securities Asia. Last October, Roche purchased a 50.1% stake in midsize Chugai Pharmaceutical Co. And Merck in March bought the 49% of Banyu Pharmaceutical that it didn't already own.

In the long run, Japan stands to benefit. Japan "needs internationally competitive drug firms," says Hisao Endo, a Gakushuin University industry expert. What's more, a lean and mean drug industry could show the way for Japan's inefficient homebuilders, truckers, and legal firms, all of which could use a dose of foreign competition to get in shape. The pharmaceuticals sector swallowed its medicine. It's time for Japan's other industries to take theirs.

By Irene M. Kunii in Osaka, with Amy Barrett in Philadelphia

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