I. INTRODUCTION
Although the mergers and acquisitions (M&A) plan announced by Glaxo Wellcome and Smithkline Beecham at the end of January 1998 ultimately failed, it demonstrated a strong worldwide tendency towards M&A in the pharmaceutical industry. The combined sales of these two companies, as separate entities, presently amounts to $28 billion – a 9% share of the global prescribed medicine market1. If the plan had succeeded, the world’s largest pharmaceutical company would have emerged. Over the last 4 years, other large pharmaceutical M&A transactions included:- Ciba Geigy and Sandoz in 1996; Glaxo and Wellcome, and Upjohn and Pharmacia in 1995; Roche and Syntex, and American Home Products and American Cynamid in 1994; and Pharmacia and Carlo Erba, Hoechest and Marion Merrel Dow, Hoechst Roussel and Rhone-Poulenc, and Rorer and Fisons in 1993.
In spite of a worldwide trend towards mergers, Japanese pharmaceutical manufacturers have not taken part in such transactions. However, the Japanese economy is changing, and while M&A transactions have been extremely rare over the last few years, they will increase dramatically in the future for many Japanese industries, including the pharmaceutical industry.
A roundtable discussion group, organized by the Ministry of Health and Welfare (MHW) in September 1994, met to discuss the prospects for the Japanese pharmaceutical industry over the next ten years. The committee recommended drastic reforms for the pharmaceutical industry and related changes in government regulations. The MHW report stands out from most ordinary MHW reports because it suggests M&A as a corporate strategy for the future prosperity of the Japanese pharmaceutical industry. This paper will review the current state of the Japanese pharmaceutical industry and examine the potential for future pharmaceutical M&A activities and related regulatory issues.
II. OVERVIEW OF THE JAPANESE PHARMACEUTICAL INDUSTRY
Japan has the second largest pharmaceutical market in the world, with $46.82 billion in sales, or 19% of the global market. The pharmaceutical market in Japan is larger than in any other country except for the U.S., where sales amount to $87.72 billion or 35% of the global market 2 (See table below). However, the Japanese pharmaceutical market is very different from the U.S. market and has a number of features that make it unique. One of these features is the large number of small manufacturers, and the other is the National Health Insurance system (NHI).
Table 1: World Pharmaceutical Market in 1996.
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Market Size Growth Rate from 1995
Country or Region ($ billion) (%)
World 251.28 —
U.S. 87.72 9%
Japan 46.82 1%
France 17.17 6%
Germany 18.73 6%
Asia Pacific 15.61 13%
Latin America 18.73 7%
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Source: “A Year of Prosperity.” Med Ad News, Dec. 1997
Small Manufacturers
According to the MHW report, Japan has about 1,500 pharmaceutical manufacturers. Approximately 1,400 out of these 1,500 manufacturers are classified as medium-sized or small companies, each of which has total assets of less than ¥100 million (approximately $800,000) and less than 300 employees. The largest Japanese manufacturers are also relatively small compared to some of the world’s leading pharmaceutical companies. For example, the largest Japanese pharmaceutical manufacturer, Takeda Chemical Industries, ranked 14th in global pharmaceutical sales in 1996 at $5.20 billion in sales. This is less than half the size of the world’s leading pharmaceutical manufacturer, Merck & Co ($13.30 billion).3 Sankyo Pharmaceutical, the next largest Japanese pharmaceutical manufacturer, ranked 19th in worldwide sales. Sankyo and Takeda are the only two Japanese companies among the top twenty pharmaceutical manufacturers in the world. By comparison, eight of the top twenty pharmaceutical manufacturers are U.S. corporations.
Despite the large number of relatively small pharmaceutical manufacturers in Japan, few of these manufacturers have undergone mergers and acquisitions (M&A) over the last twenty years. Since 1987, there have only been ten small M&A transactions of pharmaceutical manufacturers in Japan.4 By contrast, there have been hundreds in the U.S. The MHW report points out a few explanations for the unpopularity of M&A in Japan. First, Japanese executives tend not to take risks just to increase profitability because the pressure on executives to increase stock dividends is usually minimal. This is because Japanese pharmaceutical companies usually only have a small number of individual shareholders. Second, corporate organizational procedures for decision making are usually very slow. This is generally incompatible with M&A, which require very prompt decision making. Finally, lifetime employment is still a fixture of Japanese labor and employment practices. This makes it difficult for a company to reduce its workforce and build up economies of scale from M&A in the short run.
National Health Insurance System (NHI)
While the factors described above contribute to an inefficient market in Japan, another critical issue is the official pricing system of the Japanese National Health Insurance system (NHI).
Japan’s official pharmaceutical pricing system was introduced in 1950. This system reimburses medical agencies for drugs with similar effects at the “official” price regardless of the actual purchasing price. Unlike in the U.S., prescribers and dispensers of drugs are not separated in Japan. Thus the difference of the purchasing price and the official price becomes the income of medical agencies or the prescribing and dispensing doctor. Since its introduction, many flaws in the system have become evident. The report makes four points to illustrate how the pharmaceutical pricing system has contributed to market inefficiencies.
(1) By prescribing as many high official price drugs as possible, medical agencies or doctors increase their profits. This is a beneficial economic situation for medical agencies, but not for the public or the overall Japanese healthcare system.
(2) Since larger price differences benefit medical agencies, the current pharmaceutical pricing system has resulted in distorted drug pricing competition in the market. As medical agencies are reimbursed for pharmaceuticals at the official rate, they will usually buy the drug with the biggest differential between the market price and the official reimbursement rate. As a result, manufacturers tend to lower their prices in order to increase the differential. This situation has led manufacturers to believe that their drugs are not priced according to quality or “real” medical value.
(3) Under the current system, new, more effective drugs will receive the same official price but may have a higher market price. As a result, medical agencies will make smaller profits, and will therefore less likely to prescribe them. For this reason, Japanese pharmaceutical companies are hesitant to invest in new or innovative drugs with high R & D costs. Thus, Japanese pharmaceutical companies maximize their margins instead of the effectiveness of their products.
(4) Instead, pharmaceutical companies prefer to introduce drugs that are similar to existing drugs with lower costs but which enjoy high official prices. Japanese pharmaceutical companies tend to invest in drugs with lower research and development (R&D) costs. Production and sales are often made in similar areas as opposed to new or breakthrough areas, resulting in the inefficient allocation of resources.
III. CHANGING ENVIRONMENT
While the Japanese pharmaceutical industry has experienced stability in the past, the current environment is changing rapidly. As Japan is the fastest aging country in the world, its pharmaceutical market should continue to expand in the future.
However, as seen in Table 1, the Japanese pharmaceutical market only grew 1% from 1995 to 1996. By the year 2001, it is estimated that the market will grow only slightly above the 1997 level, and Japan’s global market share will decline from 19% to 13%.5
Other factors that hinder the growth of the pharmaceutical market include — 1) the official pricing system reform as a part of the NHI reforms, 2) the international harmonization of drug approval standards, and 3) the level of R&D expenditures.
NHI Reforms and Official Pricing Reform
The NHI has needed reforms to contain excessive expenditures for quite some time. Overall national healthcare expenditures have reached about 27 trillion yen ($208 billion), of which about 25 percent goes to Pharmaceuticals.6 The NHI has lost money since 1993, and it is expected to have a $6.2 billion deficit in 1997.7 As a part of the NHI reform, the Health Insurance Law was revised and its updated form went into effect on September 1997.
At the same time, the “official” pricing system was also reformed and the new pricing system was proposed to promote competition, and hence a system which emphasizes competition for lower prices rather than price differentials between official and market prices.
Under the new health insurance system announced by the MHW in August 1997, the market will determine drug prices. For the purpose of reimbursement the new “standard” prices will be determined according to the market price. Although the old “official” price is also ostensibly set according to market prices, nobody outside of the MHW actually knows the criteria for setting the “official” prices” of drugs because reimbursement rate proceedings are held in private. The new “standard” prices will be determined through public proceedings by a committee of specialists on market prices, medical values of drugs, foreign prices, and the market size. Unlike the current “official” price, the new “standard” price will not be set for a group of drugs that have similar medical effects and can replace one another. Under the new system, patients will also have to pay the difference between the market price and the official price if the medical agency purchases a drug above the official price. If the medical agency purchases a drug below the official price, the government will reimburse the medical agency at the market price (See Fig. 1 at the end of this article). Thus, medical agencies will no longer profit from price differentials.
The new system is scheduled to be introduced on April 1, 1999. If everything is implemented according to MHW plans, the traditional competition for price differentials between official and market prices will be over. Hopefully, pure price competition for lower prices will follow.
International Harmonization for new drug approval standards
Through the International Conference on Harmonization of Technical Requirements for Registration of Pharmaceutical for Human Use (ICH), the U.S., Europe, and Japan are seeking standardized regulatory approval procedures for new drugs. The new GCP (Good Clinical Practice) standards for clinical trials will go into effect starting in April 1998.
This, and other measures that have been discussed in the ICH, will quicken the globalization process for the Japanese pharmaceutical market. In the past, the top ten multinational pharmaceutical manufacturers in the world had 34% of the world market share in 1996, but only had 15% of the market share in Japan.8 The international harmonization process will put the Japanese pharmaceutical manufacturers in direct competition with multinational pharmaceutical companies in Japan where most Japanese manufacturers feel threatened today.
R&D expenditures
Over the past ten years, world global pharmaceutical R&D expenditures have quadrupled, and it now takes at least 12 years to develop a new drug. Global R&D expenditure was $19 billion in 1997, a $4 billion increase from the 1996 level.9 Because larger companies tend to spend more on R&D, the large number of small-sized manufacturers in Japan indicates that the total R&D expenditure by Japanese pharmaceutical companies is smaller than R&D expenditures by their foreign competitors. The same holds true for investment. Inefficient R&D expenditures and investment can only be resolved by enlarging company sizes and decreasing the number of manufacturers.
IV. A TIME FOR ACTION
While there are many factors that affect the Japanese pharmaceutical industry, the three described above have had the greatest impact on efficiency. Given these factors, Japanese pharmaceutical firms must reorganize if they wish to compete aggressively in the global marketplace. If Japanese pharmaceutical manufacturers wish to compete with foreign multinational manufacturers in the domestic and global markets they must move to a system of pure price competition and globalize the pharmaceutical industry
The Roundtable Discussion Group Report Recommendation
The roundtable discussion group report of June 1996 analyzes the size of Japanese companies, their competitiveness, and their level of investment in R&D. R&D activities can be divided into two categories: researching promising chemical compounds, and actually developing new drugs. At the initial research stage, outcomes depend more on each researcher’s ability, and less on the amount of money invested. However, in the developmental stage, fixed expenditures are large, and the principal of economies of scale applies. The report concludes that since the expansion of a firm’s size will enhance its R&D ability and its subsequent sales, increasing the size of Japanese Pharmaceutical companies will increase their profitability and competitiveness.
The report further considers a strategy for globalizing the market. The report points out the necessity of investing in new drugs for both the domestic and global markets. As a general recommendation, the report warns manufacturers to take flexible and appropriate measures, such as M&A.
The report encourages the Japanese manufacturers to pursue a structure similar to one of the following types of companies:
(1) A large and productive general pharmaceutical company, which has a certain share of the world market.
(2) A pharmaceutical company that develops a specific area of drugs and receives a certain worldwide market share.
(3) A manufacturer that provides a drug similar to an existing drug with high quality, but at a lower price.
Winners and Losers
Financial reports for the interim fiscal year 1998 were announced in November 1997, and the winners and losers in the Japanese pharmaceutical industry are becoming clearer. Earnings for Shionogi Pharmaceutical, Daiichi Pharmaceutical, Taisho Pharmaceutical and Fujisawa Pharmaceutical decreased between 1997 – 1998. The top three firms, Takeda Chemical Industries, Sankyo Pharmaceutical and Yamanouchi Pharmaceutical recorded increased profits. Tanabe Seiyaku also recorded a sharp increase in its earnings despite its relatively poor performance in terms of sales. Eisai’s earnings were flat, but it maintained its profits.10 (See Table 2).
The key factor that set winners apart from losers was globalization. The top three companies aggressively explored global markets, while the others remained in the domestic Japanese market where very little change has occurred. For example, Yamanouchi started its R&D activities in the US and Europe, and is also tying to establish a direct sales network in Poland, Russia, and the Czech Republic. Takeda also showed signs of a more global outlook by establishing a fully owned subsidiary in England in June, 1997.11
Table 2: Top 10 Japanese Pharmaceutical Manufacturers (by Sales)
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Interim Net Sales Interim Net Income
(Millions of yen) (Millions of yen)
Rank Company FY98 FY97 FY98 FY97
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1 Takeda 320,507 311,267 26,835 24,091
2 Sankyo 237,493 220,472 31,798 22,108
3 Yamanouchi 162,116 154,808 16,724 16,320
4 Eisai 128,646 128,402 10,484 9,584
5 Taisho 127,039 122,493 18,817 18,923
6 Daiichi 117,354 114,137 12,609 14,444
7 Fujisawa 105,674 111,265 3,882 3,899
8 Shionogi 102,613 113,391 4,291 4,892
9 Tanabe 94,677 96,416 4,175 2,998
10 Chugai 88,263 87,063 7,031 5,262
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Source: COMLINE Daily News Biotechnology and Medical Technology and each company’s home page.
The mixed results of the top 10 Japanese manufacturers above illustrate the business environment for Japan’s pharmaceutical manufacturers. Japanese pharmaceutical companies that pursue overseas expansion or keep strategic relationships alive are extremely rare. The losers in 1998 or 1999 may be forced to seek a new strategy, one of which is restructuring through M&A transactions. Even those few Japanese pharmaceutical companies who have expanded their operations globally must adopt common global strategies, such as M&A. Otherwise, global competition with multinational pharmaceutical manufacturers will reduce the success, sales and net profits of Japanese pharmaceutical manufacturers.
Benchmark for a Future M&A Trend
There is one relatively large M&A agreement between two pharmaceutical manufacturers which is now in progress in Japan between Yoshitomi and Green Cross Corp. However, this merger is considered to be a “rescue” M&A for Green Cross, which is suffering from lawsuits related to its HIV-infected blood products. Although the merger is not a proactive business strategy, the significance of this M&A agreement should not be underestimated. Because pharmaceutical manufacturers will face significant foreign competition in Japan in the 21st century, they will need to reorganize through agreements like the one between Yoshitomi and Green Cross in order to remain competitive.
Within the pharmaceutical sector another M&A trend is evident among distributors and wholesalers. The official price reductions have dramatically eroded the profits of distributors and wholesalers since 1994. Since then, numerous reorganizations have taken place. These reorganizations have not directly included M&A amongst pharmaceutical manufacturers. In some cases, however, manufacturers have merged with their wholesalers. Whether an M&A trend in the pharmaceuticals wholesaler sector will lead to M&A transactions between manufacturers still remains to be seen.
V. CONCLUSION
The stable domestic market for the Japanese pharmaceutical manufacturers is now becoming a thing of the past as the Japanese pharmaceutical industry merges into the global pharmaceutical market. Japan’s pharmaceutical industry will have significant changes as a result of — 1) The harmonization of registration requirements, 2) the replacement of the traditional official pricing system with the new pricing system based on the lower market prices, and 3) the increasing R&D expenditures and length of time involved for developing new drugs. A new era of competition among domestic Japanese manufacturers and foreign multinationals with abundant capital and advanced technology is emerging.
This changing domestic environment is challenging the inefficient Japanese pharmaceutical sector and forcing manufacturers to seek alternative strategies. As the interim report of the top ten pharmaceutical manufacturers illustrates, losers and winners in the pharmaceutical markets are becoming clearer. A new strategy is key for their success in the 21st century. As the discussion group suggests, they need to become –1) global manufacturers, 2) specialized manufacturers, and 3) manufacturers that produce drugs similar to existing drugs but with lower costs. By pursuing one of these strategies, M&A is inevitable. If a Japanese pharmaceutical company continues to stick to the past strategies, it will not enjoy global success in the next century.
1 Green, Daniel et al. “Glaxo and SmithKline Plan $165bn Merger.” Financial Times, Jan. 31/Feb. 1 1998: 1.
2 “A Year of Prosperity.” Med Ad News, Dec. 1997: Obtained from Lexis/Nexis.
3 Green, Daniel. “Prescription for the Future.” Financial Times, Feb. 2 1998: 15.
4 Hutton, Bethan. “Japan: Consolidation Prescribed.” Financial Times, April 24 1997: Survey IV.
5 “Japanese Pharmaceutical Industry Sees Globalization as Major Trend in 1997.” Nikkan Kogyo Shinbun Dec. 10 1997: 19.
6 “Pharmaceuticals and Feed Additives/Amino Acids Pharmaceuticals.” Japan Chemical Week, Jan. 15, 1998: 15.
7 “Drug Prices Cut For Second Straight Year (Part II).” COMLINE Daily News Chemicals and Materials, May 19 1997: Obtained from Lexis/Nexis.
8 “Japan vs The Multinationals.” Marketletter, November 17, 1997.
9 Cookson, Clive. “Research and Development: Industry is Aiming for Harder Target.” Financial Times, April 24 1997: Survey V.
10 “Top Nine Pharmaceutical Companies Announce Interim Financial Reports.” COMLINE Daily News Biotechnology and Medical Technology, Dec. 24 1997: Obtained from Lexis/Nexis.
11 “Local Drug Makers Looking to Develop Overseas Markets.” Mainichi Daily News, October 11 1997: