In the Pharma industry growth through mergers and acquisition has most certainly become a mainstream process, especially as this pertains to biotechs. Many corporations have realised their entire business strategy through this kind of evolution. However many management teams don’t really understand what the core criteria to drive this “merger” activity are. It is imperative to engineer the resulting structures/ combinations so that they have the potential to A) create joint value, B) be governed to realize this value, and C) must share value in a way that provides a reward to each party’s investment.
A) The combination must have the potential to create more value than the entities can alone. One should ask these practical questions: How much more value can we create in the market together? What specific resources must we combine to create this value?
One should focus concretely on the economic and competitive mechanisms that will drive the creation of joint value. What is the actual amount of extra value created? This variable is clearly worth defining before you launch any such venture. If the increased value is great, then the risk of outright failure is probably lower. If the increased value is small, then everything must go right for the combination to pay off— governance must be optimal and setbacks must be minimal. Furthermore, with such a narrow margin of error in the combination, an uneven distribution of gains could well leave one party earning less from the combination than it would if the party kept its assets separate. Consequently, this party would be less likely to want to commit to the combination. This creates an even more fundamental question: How does one even measure value in this context? The numbers make it look easy to add and compare values. But the benefits of a combination/merger may come in various forms — from added cash profits or lowered costs to added technology transfer, learning or sustainability of an advantage. Similarly, the inputs, or contributions, are also valued differently — these could be cash, technology, know-how, and so forth. Especially in the pharmaceutical industry where almost every merger transaction is intellectual property driven, companies are trying to acquire access to research and development pipelines, resulting in most cases with 2 different R & D business units, doubling their cost and with no clear gain in efficiency.
B) The combination must be designed and managed to realize the joint value. Which partners and structures fit this objective best? How do we manage the risk and uncertainty inherent in such combinations?
Joint value does not appear automatically when assets are combined, value creation and distribution also depend on how the combination is shaped and managed after the initial deal is concluded. When the deal is an acquisition, for example, the acquired resources can be merged into existing units or not, and the management personnel and processes may be left in place or replaced by that of the acquiring company. If the main source of joint value is economies of scale in production for example, then the combination—whatever its form—must successfully integrate investment and management of the production facilities. If the joint value comes from sales, then that aspect of the deal, similarly, needs coordinated management. Often, the elements critical to a combination do not reside in every part of the value chain. Thus, many combinations can have successful outcomes even if they fall short of full integration and focus only on collaboration in selective areas. But in such combinations, too, excessive “pride”, conflict, or differences in management approach can sabotage the effort.
C) The value earned by the parties must motivate them to contribute to the combination. How does one divide the joint value created? How will value be shared over time?
Ultimately, the joint gains need to be divided in a way that leaves each party better off than it would have been without the combination. The share of profits is the reward, or incentive, that encourages each party to contribute its resources to the combination. Determining this split of profits is often just as hard as estimating the joint value itself. Just as the joint value depends on future trends in the competitive environment, so too does the division of profits. The balance of power between the parties in the combination usually evolves, and with it, so do the profit shares. Changes in the division of gains over time are also common in acquisitions, though in these deals the changes express themselves differently. In a cash acquisition (or divestment), one party is paid its share and the other gets the remaining returns, including both upside and downside potentials. If the former owners of the acquired resources retain some ownership in the new combination, perhaps because the acquisition is financed by stock, then they share somewhat in the subsequent risk of the combination. In that case, over time, each party may realize more (or less) value than what was initially anticipated.
Merger and Acquisition strategy is more relevant today than ever, multi party consortia are becoming a norm and traditional pharma industry will have to learn and adapt by bringing in assets outside their boundaries. Competition has become a war between allied firms, not between stand alone companies.
M & A has now become a (“traditional” innovation) pathway/tool for the industry. It reminds me of the saying they have for the Academics, you either publish or vanish. One could say, that Pharma companies can either manage innovation or manage their exit from the market.
