So here we have a very high-profile article on mergers in the drug industry. And it says what <s>many</s> <s>most</s> damn near all of us who have lived through them have been saying (loudly) for years: that they are bad for research and bad for productivity. But now that it’s there in black and white in the Harvard Business Review, maybe someone will pay attention:
Our results very clearly show that R&D and patenting within the merged entity decline substantially after a merger, compared to the same activity in both companies beforehand. Then we applied a market analysis, the same one used by the European Union in its models, to analyze how the rivals of the merging firms change their innovation activities afterward. On average, patenting and R&D expenditures of non-merging competitors also fell — by more than 20% — within four years after a merger. Therefore, pharmaceutical mergers seem to substantially reduce innovation activities in the relevant market as a whole.
It’s not just a bunch of us folks in lab coats standing around sour-graping while our betters in the executive suites get on with what has to be done – mergers hurt R&D. But that’s not what you’ll hear from the occupants of most of those offices, not at all. They’re creating world-class powerhouses of research, pretty much every time. Here’s the paper itself (downloadable as a PDF), which is largely concerned with mathematical modeling of these effects, but has the primary data in it as well. The authors point out that most studies of M&A activity in the field concentrate on what happens to the two original firms themselves, but their work is the first to show that there are follow-on effects across the industry.
Inside the merged companies, there’s a great deal of disruption, as many readers here can testify. But across the industry as a whole, things get less competitive the fewer players there are and the fewer the approaches being tried. I think (and have said for a long time) that the biopharma business is best off when there are a lot of players, a lot of people competing and throwing elbows, and a lot of people hearing, at their back, time’s winged chariot hurrying near. It keeps everything moving to know that there are other people trying something you’re trying (or perhaps something even better). If everyone just merged into one gigantic MegaPharmaCo, that would be lost. I’m sure that there would be a lot of talk at MegaPharm about “sense of urgency” and patient focus and all the rest of it, but in reality, things would sort of roll along at their own pace, compared to what we have now.
And what we have now isn’t what it should have been, honestly. A lot of productive R&D organizations have been taken out over the years, and I think that it’s hurt the entire ecosystem of the industry. Others do rise up, of course, which is a very good thing, but I really wish that we had more kinds of flower in this garden. The tough part is that many of these mergers do, for a time at least, increase profitability:
The results for patent counts confirm that within-firm (and within-market) variation in M&A activity is associated with considerable decline in innovation activity on average. In post-merger periods, innovation output by the merged entity and its competitors decreases on average by more than 30% and 7% compared to other firms, respectively. Similarly, the table shows that M&A activity is correlated with declines in R&D spending. Profitability increases in the post-merger period for both acquirers and competitors (possibly due to a reduction of R&D spending and other investments), which may indicate that mergers in our sample are profitable on average. The correlation between M&As and sales are in line with our theoretical model. Non-merging rivals increase their sales after a merger, while the merged entity decreases its scale of operation compared to the combined activities of acquirer and target before the merger.
What we have, then, is probably a perverse incentive – companies can improve their numbers by doing mergers and acquisitions, but that very activity hurts their long-term prospects and those of the entire industry. The only way I can see this changing is for governments themselves to start approving fewer such deals, on the grounds of competitiveness, which indeed is what the authors of this new paper are calling for. But I’m not sure how well that would work, and it would be subject to ferocious lobbying and gaming as well.