Mergers and innovation in the pharmaceutical industry
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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