Healthy Public Policy Drives Merger of Drug Firms

Drug company stocks leaped higher last week in response to the merger announcement of the Swiss firms Ciba-Geigy and Sandoz. Investors were betting that even bigger mergers of major pharmaceutical companies are to come.

And that may well be. But the reasons behind the mergers are negative as well as positive. In the near term, they’re a predictor of tougher times for the industry, which paradoxically has been enjoying rising profit margins in recent years, despite public anger and political rhetoric about high drug prices. That’s why drug company stocks have been selling at nosebleed prices--although they too dropped in Friday’s market decline.

But new pressures to lower prices--from governments, insurers and managed-care providers--will hit the industry in the next five years. Also, many drugs will be coming to the end of their patents and facing competition from lower-priced generic drugs. And the costs and difficulties of developing new drugs are rising.

None of those prospects are positive for profits, so big companies are combining to cut costs.

Yet the industry is not in trouble--far from it. The pharmaceutical business, which sold Americans more than $80 billion in medicines last year and sells $700 billion worth of remedies worldwide, is going through a transition from a prosperous past to what looks like an even more exciting future.

Breakthrough products for human health will be coming along early in the next century. And demand for medicines will grow as populations age in the United States and other industrial countries and as the industry reaches out to new populations in the developing world.

To see what’s ahead, it’s best to look at the different kinds of companies that will succeed in the short-term transition and the long-term transformation of the drug business, keeping in mind that this industry is at the center of complex relationships between science and society, between business and the public health.

That’s why pharmaceuticals offer a good illustration of why society forces industries to change and how such pressure brings forth innovation.

In the next five years, makers of generic drugs will find fresh opportunities as hundreds of brand-name medicines come to the end of their 17-year patents. The generic companies, such as Mylan Laboratories, Ivax, Teva Pharmaceutical and Watson Pharmaceuticals, can then offer identical compounds at far lower prices--as cimetidine is now given for the ulcer remedy Tagamet, for example.

Generic companies have grown sharply in the last five years as employers and insurers, objecting to high drug prices, have stipulated generics instead of brand-name medicines where possible.

They have also refused to pay premium prices for many patented drugs, because there were similar compounds on the market. That was an unintended consequence of the 17-year patent for individual drugs: In the past, competitors of a company that made a breakthrough would produce a slightly different compound to treat the same illness, get a patent on it, and sell it at a premium.

Those practices have largely come to an end thanks to Food and Drug Administration reforms in the 1980s and corporate and government pressure in the 1990s to rein in health-care costs.

And pressure on prices will intensify in the next few years, says analyst Steven Gerber of Oppenheimer & Co., because Medicare patients will be joining health maintenance organizations, spurring HMOs to demand even lower bills from drug suppliers.

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It will be a particularly opportune time for generic drug makers because many of the me-too compounds will come off patent, opening a free-for-all in important medicines, says Allen Chao, president of Watson Pharmaceuticals, a Corona-based generic company that has risen to sales of $153 million in 10 years.

The next few years may not be an era of drug breakthroughs but a time of progress toward a flourishing of new medicines in the next decade, as research in biotechnology come to fruition, says John McCamant, associate editor of the Medical Technology Stock Letter in Berkeley.

A lot of investment in the 265 mostly small companies in biotechnology comes from large pharmaceutical firms, including roughly $2.5 billion from Ciba and Sandoz combined. And such investment should increase even as the big companies merge.

“I am confident that billions of dollars will be invested in biotech firms by the giant companies,” says Viren Mehta of Mehta & Isaly, a New York investment firm specializing in the pharmaceutical industry.

“The big companies are well-equipped to work with governmental authorities to register drugs and then to market them around the world,” Mehta says. “But for research, small units are better.”

More than size in involved. Traditional drugs are chemical compounds that act on the body, but the new medicines are genetic compounds that mimic or even improve upon natural genes. Genetic medicines are capable of attacking individual cancer cells without destroying other cells, as chemotherapy compounds do.

Future research will be more “elegant,” experts say. And it will be more expensive whether research funds are invested in biotech companies or spent within the big firm’s lab, searching with the aid of new computer techniques for molecular compounds. Multibillion-dollar research budgets are another spur to mergers.

Analysts speculate that Eli Lilly & Co., at $7 billion in revenues, SmithKline Beecham, at almost $11 billion, and even Merck, at almost $17 billion, may seek partners in the industry’s new environment.

And as mergers continue, we might reflect on the public pressure that ultimately is causing them. By demanding lower prices for drugs and implicitly rejecting comfortable me-too compounds from traditional research, the public pushed the pharmaceutical industry to market generics and to reach for the true innovation of biotechnology. If the business is healthy, it’s because the public gave it a push.