Mergers and acquisitions are a very commonplace occurrence in the pharmaceutical industry. The number of closed deals and dollars spent on pharma M&A outdo all other industries.
Key factors triggering changes in the pharma industry
The rising costs of drug development
The main factor leading to change in the pharmaceutical industry is the increasing cost of drug development. A considerable fraction of all pharma M&A activity occurs due to individual pharmaceutical companies being unable to afford the R&D costs of producing innovative medicines.
Pharmaceutical development is a long-term investment. It may take a new drug more than a decade to go from synthesis to approval and the associated costs are counted in the billions of dollars. The creation of new medicines has become costly enough that, more often than not, only the larger companies in the industry can cover the costs of development and still make a profit.
The advancement of medicine
Paradoxically, producing new useful pharmaceutical products has become more difficult due to the abundance of functional and successful treatments available on the market. In the current drug development environment, the only two ways a new drug can be successful are by promising to heal a previously untreatable ailment or by being more efficient than any counterpart on the market.
Substantial R&D investments
Pharmaceutical companies must put a considerable amount of time and effort to create new drug products and treatments. Research & development (R&D) is often one of the first tasks performed by pharma companies to create a new product. It is indispensable to bringing medicines to the market. On average, a pharmaceutical company will spend around 25% of its revenue on R&D expenses, more than other knowledge-based fields (source).
According to research, the pharma sector spent more than $80 billion on R&D expenditures in 2019 alone (source). These expenses are used to cover the costs of a variety of processes, including the discovery and testing of new substances, the development of incremental innovations, and the performance of clinical tests for safety and marketing purposes.
Consumer demand for generics
Generic medicines offer the market a more affordable alternative to several medicines. There is practically no chemical difference between branded and generic versions of common drugs such as paracetamol and ibuprofen, and the general public is starting to become aware of that fact.
A study on the public perception of generic medicines acknowledges that more than 80% of consumers are aware of the cost-effectiveness of generics and 69% understand their equivalent quality to branded products. Furthermore, 77.7% of the people who were aware of the existence of generic drugs had a preference for them (source).
Different strategic archetypes
There is no superlative M&A strategy. Every deal has its own strategic logic behind it, and the most successful deals possess a well-defined set of value creation ideas ready to put into action.
Improving the performance of the target company
This is an ideal value-creating proposition. Simply put, the target company will drastically reduce operational costs leading to an improvement in profit margins and cash flows. The acquiring party can use this strategy to rapidly accelerate the revenue growth of a small company.
Naturally, it is easier to boost the performance of a company with lower margins and returns. For instance, reducing the operational costs of a company with a 6% operating profit margin by 3% would lead to a 9% profit margin, an effective 50% increase in operating profits.
Removing excess capacity from the industry
The maturation of an industry leads to excess capacity. Companies are constantly trying to maximize production in the same environment where new competitors are constantly on the rise. Sometimes larger companies wish to acquire competitors to shut down their plants, as no pharmaceutical company would shut down their plants out of their own volition.
Consolidation can lead to significantly reduced R&D challenges for both the acquiring and acquired parties. Likewise, the capabilities of the salesforce can be enhanced by mergers, as they will have access to more complete product portfolios.
Accelerate market access
The marketing potential of smaller companies is very low compared to their larger counterparts. Without a solid sales force, a pharma company is going to find it difficult to form relationships with doctors and other persons of interest. Bigger pharma companies may purchase other companies to aid in the sale of innovative medicines.
Ownership of the acquisition target’s technologies and expertise
A company may have developed a piece of technology that could positively impact the product of another. Acquiring this tech via a merger or acquisition can be more cost and time-effective than reverse-engineering it or paying royalties on patented technologies. Furthermore, ownership of the tech and employment of highly capable personnel keeps those assets away from the hands of competitors.
Sponsorship of promising pharma companies
If an acquisition is performed early in the life cycle of a new company or product, development can be given guidance. This can create massive amounts of growth on a very short scale. In order to achieve this, investments must be made early, when the target company’s true potential is still in question and competitors don’t recognize it as valuable. This brings a risk for larger companies, which may have to bet on companies that will end up failing. Furthermore, even if a company is receiving a steady flow of capital, it must be properly managed, so administrative capabilities are also a crucial requirement.
Why is M&A used for strategic repositioning?
Pharma companies implement M&A as a repositioning strategy for three main reasons: the inability to keep up with critical size requirements, the consolidation of more stable companies, and as a strategy to adapt in an industry where drastic change is the norm.
If a company’s growth is outpaced by the requirements of the market, then it will be severely disadvantaged. The originators and drug providers of today wouldn’t exist if it weren’t for M&A, as none of them would’ve survived on their own. Mergers help companies in the pharmaceutical sector combine competencies and create more efficient workflows. Very few biotech companies have successfully gained stability as originators.
M&As for efficient capital allocation
Capital allocation is a major driver of M&A activity. Since originator organizations possess a complex structure, their capacity for incentivizing innovation is considerably stunted. An entrepreneurial approach to R&D and manufacturing helps larger companies maintain their competitive edge.
This gives smaller pharma companies an incentive to adopt methods to attract venture capital. In today’s pharmaceutical environment, venture capitalists look for acquisition targets vehemently, and early-stage development for pharma companies is often pre-financed.
M&A is also useful to outsource manufacturing. A very functional strategy comprehends the selling of manufacturing plants to contract manufacturing organizations (CMOs) together with agreements for long-term manufacturing and supply. This method is cost-effective for both parties involved. CMOs gain a reliable business partner and originators increase their return on capital through the reduction of their asset base while their assets remain useful.
M&As as a source of innovation
Innovative medicines are booming as a more substantial source of profits for pharma companies. Therefore, large pharmaceutical companies use M&A strategies to bolster their capacity to innovate.
The main challenge faced by innovative research is a lack of funding. Early-stage drug development requires a considerable amount of resources for a very dubious return on investment. In addition, there is a critical need to cover expenses during late-stage trials, which may include having to deal with complicated bureaucratic regulations.
This workflow has created an ecosystem where small companies will most likely fund their own research during its early stages, while larger companies will pick up the slack once the product begins showing promise. In conclusion, the funding of innovation is driven by the smaller pharma sector companies, while larger companies tend to handle the more expensive trials and marketing of innovative medicines.
M&As to realign portfolios
The realignment of portfolios can serve many purposes. Biopharmaceutical companies may wish to realign their portfolios because the perceived value of their assets has changed, their commercial pipelines are being enhanced, or new strategies are being implemented.
As in every industry, pharmaceutical companies desire to work as efficiently as possible, and that includes taking their nonstrategic assets out of their portfolios. Companies looking for target companies due to strategic reasons will be adamant about their need to innovate. Small innovators can receive benefits such as early licensing and access to partnership agreements.
Pharma business development network
If you wish to develop the operational efficiency of your pharmaceutical company, then you can discover many opportunities by joining a professional pharma business network. Good partnerships are an indispensable asset in the pharmaceutical industry and guarantee the most fruitful pharmaceutical mergers.
Pharma companies of all sizes and backgrounds can communicate and find common ground through the use of Nubinno Connect. This revolutionary pharma business development network gives pharma companies new management and negotiation opportunities. Nubinno’s team of pharmaceutical sector experts is ready to assist and provide guidance, ensuring the most streamlined M&A operations.