Mergers and innovation in the pharmaceutical industry

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Abstract

Conflicting trends confound the pharmaceutical industry. The productivity of pharmaceutical innovation has declined in recent years. At the same time, the cohort of large companies who are the leading engines of pharmaceutical R&D has become increasingly concentrated. The concurrent presence of these trends is not sufficient to determine causation. In response to lagging innovation prospects, some companies have sought refuge in mergers and acquisitions to disguise their dwindling prospects or gain R&D synergies. On the other hand, the increased concentration brought on by recent mergers may have contributed to the declining rate of innovation. In this paper, we consider the second of these causal relationships: the likely impact of the recent merger wave among the largest pharmaceutical companies on the rate of innovation. In other words, have recent mergers, which may have been taken in response to lagging innovation, represented a self-defeating strategy that only made industry outcomes worse?

Section snippets

The merger wave

Before starting our analysis, we present evidence on the contours of recent “Big Pharma” merger activity. Our attention was directed to this phenomenon most dramatically by two massive mergers consummated in 2009: the acquisition of Wyeth Laboratories, fifth-ranked on Fortune magazine's 2008 list of U.S.-based pharmaceutical firms, by Pfizer, even before the merger the largest U.S. pharmaceutical producer5

Parallel paths and the dispersion of technological initiative

When concentration ratios are analyzed by economists, the conventional rationale is that sufficiently high concentration of sales among the four or eight largest companies in well-defined product line segments can lead to cooperative oligopolistic pricing. This was apparently the principal but not sole focus of U.S. antitrust agencies when they evaluated the most recent Pfizer and Merck mergers, among others.8

Uncertainties in pharmaceutical discovery and testing

The essential rationale for parallel paths strategies depends upon two conditions: (1) uncertainty about the correct solution among numerous possible approaches to a technological challenge; and (2) the desirability of achieving the rewards from solving the problem earlier rather than later. The second mandate is clear in pharmaceuticals: effective new drugs are profitable to their originators and even more valuable to the population whose ills they alleviate. The first condition is readily

A simple example

At this point, we illustrate a relatively simple parallel-only example, adapted from Scherer, 1966, Scherer, 2007. We assume that decision-makers are unable to discern ex ante which of diverse contending molecules has a higher probability of success, i.e., single-approach success probabilities PS are assumed homogeneous.13

Actual evidence

In this section, we consider whether the leading pharmaceutical companies actually support anything like the degree of parallelism in R&D suggested as profit-maximizing by the analysis above. For this purpose, we reviewed the portfolios of Phase II and Phase III clinical trials that were ongoing during 2009 and 2010 for five leading U.S. pharmaceutical firms.18 The trials were classified by narrowly defined disease areas such as, for example,

Industry-level analysis

The rationale of Fig. 1 applies not only at the level of individual firms optimizing their R&D decisions but also at the level of the entire pharmaceutical industry. If there were a conscious “invisible hand” guiding the industry's investments, that decision-maker would implement enough parallelism of aggregate R&D approaches in any given therapeutic area to maximize the discounted surplus of benefits over R&D costs. For a planner concerned with society's well-being, however, the benefits

Optimal portfolio scope

Pursuing parallel research paths helps ensure that, when several uncertain R&D prospects are available, at least one will yield a technical success. But there is another dimension to uncertainty. Depending upon the market served and timing, some successes are much more profitable than others. Indeed, the distribution of payoffs, measured as the discounted present value of quasi-rents gained by FDA-approved new drugs, has been shown by Grabowski and Vernon (1990) to be quite skew. In their

Conclusions

Our conclusions are suggestive rather than definitive. There are reasons rooted in the logic of uncertainty and parallel paths strategies to believe that large mergers adversely affect R&D investment and the probability that new drugs will be created. There is also some evidence that parallel (read pejoratively, “duplicative”) paths are pruned in the wake of mergers. With fewer centers of initiative and decision-making, the chance that new technological prospects will gain large-scale support

Acknowledgements

We appreciate helpful comments and suggestions from Iain Cockburn, H.E. Frech, Ray Gilmartin, Giorgio Monti and Rudolph Peritz. We are especially grateful for the careful research assistance of Karleen Giannitrapani.

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