Diversification Strategy in the Pharmaceutical Industry

DIVERSIFICATION STRATEGY IN THE PHARMACEUTICAL INDUSTRY Ruxandra Ciulu “Alexandru Ioan Cuza” University, Faculty of Economics and Business Administration, Iasi – Romania 22, Carol I Bd., Iasi - Romania ruxandra.ciulu@uaic.ro Abstract The study focuses on the manner in which diversification strategy is applied to the pharmaceutical industry. The paper deals with diversification business models, such as the blockbuster model and the generic drugs model. Also, an important trend in the pharmaceutical industry is related to mergers and acquisitions, as well as the choice between diversification and focus. By way of conclusion, I offered the situation of the Romanian pharmaceutical industry, which will probably undergo important changes in the years to come. Key Words: pharmaceutical, strategies, diversification JEL Classification: L65 1. INTRODUCTION In the past 50 years, the pharmaceutical industry has had a spectacular evolution, especially due to investments in research and development and to the qualitative leap towards new methods of prevention and treatment for different diseases. Diversification has constantly been the center of this process and the basis for developing other company strategies. Within the past two decades especially, the strategy of diversification and the specific manner in which it is applied have become key factors for creating and consolidating competitive advantage in the pharmaceutical industry. 2. DIVERSIFICATION IN THE PHARMACEUTICAL INDUSTRY The pharmaceutical industry is extremely complex. Technologies that lead to research and development of medicines expand the limits of human knowledge. On one hand, Electronic copy available at: http://ssrn.com/abstract=1283129 large dimensions of companies, complexity of their processes and technologies are organizational and management challenges. On the other hand, the development and coordination of the distribution system involves large investments downstream. In this industry, success involves luck in large doses. Most of the things taken into consideration when formulating strategies relate to facing uncertainty. Still, things have not always been the same. Colonel Eli Lilly won his initial competitive advantage by manufacturing medicines that were strictly based on the production formula. This was done at a time when his competitors used many subterfuges to avoid complying with the formula. The special nature of the pharmaceutical industry makes it possible for a medicine to assure the success of a pharmaceutical company, at least for medium and long term. Therefore, the normal principles of large numbers, in which diversified portfolios generate predictable incomes do not apply to this industry. Incomes in the pharmaceutical industry are largely volatile. One of the main targets of companies in the 1990s and the beginning of the years 2000 was to enlarge company size. Only through this growth companies can afford considerable costs of development and distribution for new drugs. This was especially outlined by the PricewaterhouseCoopers’ report ‘Analysis and Opinions on Merger and Acquisition Activities’ published in 1999. Within this approach, at least two main business models can be identified: • • • the blockbuster model, which implies research and development for a small number of innovative drugs, which have the potential to record substantial global sales (of at least 1 billion dollars per year). The success of this model highly depends on the ability of the company of obtain high revenues from a small number of drugs in order to be able to pay the high price of medical discovery and development process for a large number of potentially successful drugs; diversification model, within which a large number of drugs are sold on niche markets. The advantage of this model is that success depends on a small number of drugs. Still, without an innovative product to cover (partially at least) the large costs of development, the model is advantageous only for small markets, where distribution costs are low; intermediate model, which gathers traits from the two above-mentioned models. So far, the blockbuster model has been considered by specialists as dominant in the pharmaceutical industry. Still, the interest for alternative models is increasing as more attention is being paid to distribution of biotechnology products, which imply smaller markets and higher cost of treatment, as well as expectancy of highly personalized medicines. Electronic copy available at: http://ssrn.com/abstract=1283129 2.1. The blockbuster model There are specialists in the pharmaceutical industry who argue that the dependency of global pharmaceutical companies in a small number of blockbuster drugs is more the result of the situation in the industry and less a deliberate strategy. Still, many large global companies highly depend on a small number of drugs, which determine their sales, as well as their profits. According to Table 1, just thirty-five innovative drugs account for approximately 46% of sales for top 10 pharmaceutical companies. Innovative drug percentage in company sales varies from one company to another. Merck has the highest rate for innovative drugs, accounting for 78% of product portfolio. The lowest rate is recorded by Novartis, with 18% of sales assigned to innovative drugs. In addition, we can observe the fact that innovative drugs are mostly owned by the top three companies in the industry. Twenty drugs out of thirty-five belong to Pfizer, GlaxoSmithKline and Merck. Table 1 – Sales of innovative drugs of large pharmaceutical companies in 2001 Company Sales of drugs (mil. USD) Sales of blockbuster drugs* (mil.USD) Percentage of innovative drugs Number of innovative drugs Pfizer 26761 18241 68,2% 7 GlaxoSmithKline 24777 9372 37,8% 6 Merck 21351 16575 77,6% 7 BristolMyer Squibb 17051 4552 26,7% 3 AstraZeneca 16500 9221 55,9% 2 Johnson & Johnson 14851 5541 37,3% 2 Aventis 13543 2871 21,2% 2 Novartis 12013 2208 18,4% 2 Pharmacia 11970 3114 26,0% 1 Eli Lilly 11542 6054 52,5% 3 Total Top 10 170358 77748 45,6% 35 *generate sales of over 1 billion USD (Source: Annual Reports 2002) 2.2. The generic drug model There is a multitude of generic drugs present on the world pharmaceutical market which enclose a higher or lower innovation degree. According to the innovation and production degree they enclose, generic drug can be grouped into: • • • • generic pharmaceutical ingredients; commodity generics, easy to formulate, with a minimum degree of innovation and small profit margins; specialty generics, which benefit from more sophisticated technologies (such as controlled or immediate release) or from special pharmaceutical ingredients (self molecules or biological active substances); super-generics, drugs superior to original molecules from formulation or conditioning point of view, enclose advanced innovation, they are protected by patents and they are marketed as brands. According to Datamonitor research company, R&D strategies of the main generic drugs manufacturers in 2005 can be synthesizes as following: Table 2 – Types of generic drugs in pharmaceutical company portfolio Company Commodit y generics Specialty generics Supergenerics Self molecules Biological generics TEVA + + + + + IVAX + + + + + + + + + Barr Stada + + + Hexal + + + Andrx + + Watson + + + Mylan + + + Faulding + + + Sicor + + + Alpharma + Ranbaxy + Ratiopharm + Egis + Gedeon Richter + LEK + + From Central and Eastern Europe pharmaceutical production point of view, we can mainly discuss commodity generics. Market growth for generics in Europe should be a key factor for European pharmaceutical industry development. There is a common governmental initiative in Europe to encourage innovative product substitution by generics. This is meant to diminish healthcare costs and to encourage generic product manufacturers. Currently, eleven out of the fifteen ‘old’ EU member states have policies for innovative drug substitution by generic drugs. This includes five large EU markets: France, Germany, Spain, Italy and United Kingdom. Generic drug production is also encouraged by the large number of blockbuster drugs which will lose their patent protection and which originate from the United States. Out of the 57 blockbuster drugs present on the market in 2002, 32 drugs have already lost or will lose their protection by 2008. Accordingly, we can expect the European generic drug market to reach a value of approximately USD 6 billion by the end of 2008. On one hand, the accession of new members to the European Union is another stimulus for generic drug industry, especially because companies in this area are mainly generic drug manufacturers. Central and Eastern Europe manufacturers have been reorganizing their activities and repositioned on the market in order to be able to fully benefit from the opportunities offered by the EU market. On the other hand, the expansion of the generic drug industry will enhance the pressure on companies to generate innovative drugs. Companies have now the possibility to penetrate the new member countries market more easily. Moreover, unitary regulations and prices offer the possibility of a homogenous market, which offers companies the possibility to maximize drug sales in an area which currently exceeds 450 million inhabitants. Generally, the factors that influence the preference for generic drugs are: • • • • • • high prices for innovative drugs; prescription of generic drugs by physicians; market substitution of innovative drugs by generic drugs; pharmacists are encouraged to sell generic drugs; limited budgets for physicians; patients are aware that generic drugs are on the market, with lower prices than innovative drugs. Also, market price level is very important. Low prices for innovative drugs do not encourage market penetration by generic drugs. For example, market prices in the United Kingdom and Germany are high, therefore innovative drug substitution by generic drugs is encouraged. On the other hand, France has low market prices for innovative drugs, therefore low percentage of generic drugs on the market. Eastern Europe countries generally have low prices for drugs, as they are highly regulated and controlled by governments. In Eastern Europe we encounter situations in which innovative drugs compete with generic drugs in terms of price. Even though European and North American pharmaceutical companies tend to innovate, generic drugs play and will continue to play an important role on their home markets. Also, Central and East European markets have a massive presence of generic drugs, but newly marketed generics are not expected to have an important presence until 2009 and even after. The immediate cause is the low income level per capita and the low level of prices on the market, which do not encourage new product presence. 3. DIVERSIFICATION THROUGH MERGERS AND ACQUISITIONS For pharmaceutical companies, the answer to uncertainty of processes for new product development was to enlarge company size through mergers and acquisitions, so that final phases of their production processes have at least a number of potential new innovative drugs. Large companies have the ability to finance internal research, as well as to attract external researchers through a variety of arrangements and alliances based on licenses. Also, a large company benefits from big marketing resources in an industry that allocates approximately 35% of incomes to marketing. Another strategy for pharmaceutical companies is diversification of business in less risky fields, such as cleaning products. Johnson&Johnson has chosen this field and developed its division for cleaning products, but there is no proof that the financial markets appreciate this type of diversification. Among the large multinational companies, Johnson&Johnson and GlaxoSmithKline have included in their portfolio OTC products (over the counter products – drugs that can be sold without prescription), based on which they have developed strong divisions. Starting with the 1990s, in the United States two major changes has taken place. One is the increase of companies offering mail delivery for drugs. The second one is associated with the development of a certain type of companies, the so-called Pharmacy Benefit Managers (PBM). Mail delivery companies have focused on offering drugs to chronic patients that need long term medication, all for a fixed tax. PBMs (that can also offer drugs by mail delivery) have a large impact on the drug being chosen by the doctor. PBMs ask doctors who take part in their programs to prescribe based on an approved list of medicines, and then they guide the option for one drug or another, based on what they consider to be more efficient from the economic point of view (the cost of the product). Therefore, pharmaceutical companies are asked to sell to PBMs according to PBM rules and to a highly standardized process. Merck shook the industry in1993, when it acquired the PBM Medco, and it was followed by SmithKline and Eli Lilly, who purchased their PBMs in 1994. American authorities have restricted the ability of manufacturers to influence PBM lists so much that Eli Lilly sold its PBM. Merck owned Medco until 2002 and during this period its sales increased annually by 30% and the percentage of transactions between Merck and Medco increased from 10% (before being acquired) to 15% in 1997. No only do PBMs influence sales of new medicines but the special attention that they pay to generic drugs immediately after patent expiry for innovative drugs can have dramatic effects. For example, patent expiry for the drug Prozac manufactured by Eli Lilly led to Medco replacing 80% of Prozac prescriptions with generic substitutes within one week after patent expiry, proving a much quicker reaction than the market. While large companies have chosen to enlarge company size in order to ensure survival, companies that use new discoveries have assumed the risk of developing new drugs, sometimes in partnership with a global pharmaceutical company that is able to ensure the marketing and distribution. These are generally biotechnology companies that financed independent discovery of new drugs through direct access to financial markets. In some cases, their research is financed by large pharmaceutical companies through alliances and licenses. On one side, companies that have successfully implemented this type of strategy have created new drugs that promoted them as first class pharmaceutical companies. On the other side, many biotechnology companies have not managed to reach their goal and ended up as subcontractors for large companies or were even forced to get out of business. A category of specialists support the theory that the true added value of the global pharmaceutical company is its ability to organize, co-ordinate and finance different stages of product development and its distribution system. This implies that the global company reduces its part in the process and that most research and distribution tasks are subcontracted. However, this can lead to specialization and to important economies for the overall process. In some cases, companies combine their abilities. For example, a company can be specialized in production, another one in sales and distribution. By merging, they create a new company with a credible business model, able to develop a valuable product, which they can successfully promote and distribute. An example of the past decade is the company AstraZeneca. Astra owned the product Losec and Zeneca (former ICI Pharmaceuticals) had the financial strength and the dimension necessary to continue the research and development process. Mergers, acquisitions and license sales at high prices are a strategic answer for lack of new drugs in development phase. These universal initiatives are costly and are also accompanied by significant hidden costs. Nevertheless, this is an opportunity for local companies specialized in a certain stage of the development process to sign long and medium term contracts with global pharmaceutical companies and offer their competences. 4. DIVERSIFICATION OR FOCUS? Another strategy adopted internationally is focus on a large number of niche markets instead of creating new drugs, protected by patents. Willingly or by accident some European companies adopted this strategy. Even though they are first class pharmaceutical companies, they probably have only one or two new drugs. Marketing a large number of drugs obviously reduces dependency on new drug discoveries, but development and marketing costs must be strictly followed in order to ensure that small markets are profitable. Current market conditions, with annual growth below 10% and R&D costs of about USD 750 million for every successful product launched make focus an essential aspect for all companies in the industry. Even a world market of 10% (2.5% more than any company has reached so far) would imply a strict approach of therapeutical areas, a careful selection and focus. Companies estimate that 75% of large investment costs are engaged in the development phase and less in discovery, production or marketing. Considering this, it would be necessary to have a better choice of fields (therapeutical areas and indications within), fields that would have to be periodically revised. Also, company competences in drug discovery and market knowledge would have to be integrated on purpose more than by accident. Therefore, a challenge for the organization is building independence and innovation within discovery and development processes. As the struggle for new product launch intensifies, more and more contradictions appear. Too much attention can be given to mergers, licenses or even scientific research. There was a time when launching a new successful drug every five years was enough. The situation is extremely different nowadays. For example, AstraZeneca has publicly stated that its objective is to launch three new innovative drugs per year. With a cost of approximately USD 750 million per drug in development phase, this means that these three drugs must generate sales of USD 4 to 5 billion annually. But, in order to maintain leader position in a therapeutical area, a constant flow of new drugs is essential. AstraZeneca and GlaxoSmithKline for the respiratory system drugs, Merck or Aventis for the cardiovascular system drugs must protect their competitive advantage and to build specialization abilities in these markets. Global companies benefit from a lot of experience and focused on certain therapeutical areas such as: - GlaxoSmithKline focuses on discovering new drugs for treating asthma, migraines, HIV infections; - Novartis chose to gather knowledge in life sciences while in the pharmaceutical field it focuses on transplants, malfunctions of central nervous system, cardiovascular, endocrine and respiratory diseases, dermatology, oncology and hematology, rheumatism, replacements of bone system and hormone therapy; - Roche offers a range of pharmaceutical products, diagnosis, vitamins, perfumes and scents within a category of healthcare products; - Eli Lilly targets people with urgent and unexpected medical needs in neurology, diabetes, cancer, cardiovascular diseases, infectious diseases and women healthcare. The issues that pharmaceutical companies need to overcome do not appear in the research phase. The main issue is in the narrow development phase, where companies record unpredicted expenses, as well as the time needed for product development, from preclinical tests to marketing. In 1999, only 32 new drugs have been successfully put on the market. For example, only one product was put on the market in the respiratory system therapeutical area, a market of USD 20 billion, with significant unsatisfied demand. Still, there are over 2000 registration patents in this area, 650 drugs are in development phases and 120 drugs are about to be launched. The top 7 pharmaceutical companies have 55 drugs out of these 120. In the next 10 years, total development costs in the respiratory system therapeutical area will probably exceed USD 60 billion. These figures are not extremely attractive. There are too many companies with drugs ready to be launched and which compete in a system that is highly organized, too crowded, too complicated and over regulated. Additionally, companies have an increasing technical ability of offering personalized medicines. Companies specialized in certain therapeutical areas have the opportunity to target smaller groups of patients, in which case mass distribution by global pharmaceutical companies becomes less relevant. 5. PRODUCT DIVERSIFICATION GOALS AND STRATEGIES OF TOP 3 PHARMACEUTICAL COMPANIES Considering the fact that in the past few years the international pharmaceutical market has been dominated by companies Pfizer, GlaxoSmithKline (GSK) (first and second place) and even by Merck (third place in 2003, seventh place in 2005), I have analyzed their strategy, especially from innovative (blockbuster) drugs point of view. 5.1. Pfizer The world market leader in the pharmaceutical industry, owns the license for the best sold drug in the world, Lipitor. The drug entered the market in 1997 and generated sales of 9.2 billion USD, more than the entire business volume of Pfizer at the beginning of the 1990s. At the beginning of 2004, Caduet started being marketed. The product combines Lipitor and Norvasc (another blockbuster owned by Pfizer) and is a treatment against arterial hypertension. Also, Pfizer estimates the ophthalmologic product Xalatan (discovered by Pharmacia, company acquired by Pfizer in 2003) to be the first product in this area to generate sales of over USD 1 billion. Company Pfizer is continuously preoccupied of putting on the market new medicines in other therapeutical areas, such as breast cancer, kidney cancer, Parkinson’s disease. We must remember the estimation that in 2050 the number of people of over sixty years of age will triple worldwide, reaching 2 billion people. Also, 35% of Europeans will be over 60 years of age, compared to 20% in 2003. Pfizer’s new medicines currently in advanced development phases address arteriosclerosis (Lipitor / torcetrapib), cancer (Edotecarin), asthma (Roflumilast), diabetis (Exubera), HIV / AIDS (Capravirine), insomnia (Indiplon), macular degenerescence (Macugen), neuropathic pain / epilepsy / generalized anxiety (pregabalin), osteoporosis (Lasofoxifene), schizophrenia and bipolar turbulence (Asenapine). From Pfizer company data, out of 400 molecules in research phase, only 225 reach development phase, from which 130 are new molecules and 95 are improved old molecules. Pfizer’s five year goal (until 2008) was to put on the market 20 new important drugs and to bring major improvements to products already on the market. These 20 drugs were estimated to have a large market success and to become blockbusters, with sales of over USD 1 billion per year, a large market and sustained growth. A typical example for the strategy of Pfizer is the blockbuster Avandia (insulin synthesizer for type II diabetes). The research for this product began in 1984 in a research institute. GSK took over the project and, except for Avandia, GSK also put on the market Avandamet, a medicine that combines Avandia and a treatment for blood sugar control. Also, GSK marketed Avandaryl, which is a fixed dose treatment for type II diabetes. 5.2. GSK The research and development activity of GSK is structured so that it takes advantage of company size, especially at the beginning and the end of the R&D process (compound analysis, drug toxicity, clinical studies). In order to create an interface between research and development, the organization is divided into small biotechnology units called “excellence centers for drug discovery”, which focus on flexibility and therapeutical areas. The purpose of their structure is to make the R&D process as efficient as possible and the large number of innovative drugs in different development stages is proof of this efficiency. In December 2003, GSK presented to the public a number of 35 new drugs in different development phases, selected based on novelty criteria, impact on the disease and commercial potential. At that moment, the strategy of GSK was based on 148 projects in clinical development phase, out of which 83 were new molecules, 45 were extensions to current products and 20 were vaccines. The declared purpose of GSK is to become indisputable leader of the world pharmaceutical industry. This implies taking three challenges that affect both the industry and the entire society, such as: • • • improved productivity in research and development phase; ensuring patient access to new treatments; developing company-consumer relationship beyond the strictly medical one. The strategies adopted by GSK lead us to believe that it will be possible to reach its goal in the years to come. 5.3. Merck Merck declared that new drug discovery is the purpose and the passion which guides the company. Except for many developments of current Merck product markets, as well as the kickback of withdrawing two third stage products, the biggest success of Merck in the past few years is considered to be the registration file for the product Vytorin, a medicine generated by the co-operation between Merck and Schering-Plough. This is the first treatment based on a tablet that contains double inhibition: two powerful substances with strong cholesterol diminution effect. Vytorin is a combination of Zetia, a medicine that limits the absorption of cholesterol in the intestine, and Zocor, a medicine that diminishes the production of cholesterol in the liver. Also, Merck has developed a series of co-operations with other companies, such as research institutes and universities (Dundee University, Edinburgh University) for the research activity and this led to discovery and development of new medicines. The strategy of Merck is based on offering price competitive new medicines, which led to a good positioning on the market for this company. Franchise sales for its main drugs are ranked as first or second worldwide in the major, strongly developed therapeutical areas. This success was attained by offering to patients, physicians and payers better options for treatment and a proven value, supported by compelling studies. In the fourth quarter of 2003, Merck implemented a new strategy destined to wholesalers in the United Stated, so that Merck drug distribution is more efficient and is able to reduce sales fluctuations caused by distributor buying habits. The program reduces the top limits of monthly acquisitions of Merck pharmaceutical products that address the US market. The company expects that the long term benefits will be cost decrease and a more efficient distribution. As we can observe, the strategies of large multinational companies in the pharmaceutical industry are relatively similar in terms of the products they promote. They are all focused on developing innovative drugs, preferable blockbuster drugs, or in improving the drugs they currently market. On the short and medium term, it is expected that this tendency will continue. On the long term, it is possible to expect a technological revolution, which will change the mentality of researchers and of the international environment in the pharmaceutical industry, producing a qualitative leap. Some say that companies with best performances are those which manage to create abilities that are not common among competitors, especially abilities concerning product development. The more production among pharmaceutical forms is diversified, the more they benefit from accentuated diversification. The larger the production capacity for the same pharmaceutical form (e.g. tablets), the more the company has the ability to run production processes. Except for innovative companies, in the past decade the main interest of the pharmaceutical industry has been directed towards the process of ‘innovating around’ or production of generic drugs (the so called ‘me too’ drugs). When companies diversify their portfolio towards adjacent therapeutical areas, they are interested in exploiting their experience. Therefore, all products are in the ‘innovating around’ category, by linking new activities to already known compounds. The research and development / marketing interface brings an essential contribution to creation of new abilities in new product development in order to reach market success by differentiation strategy. The more diversification degree is distributed among marketing activities, the more important are the marketing experiences of the company. 6. INFLUENCES OF COMPANY STRATEGIES ON THE ROMANIAN PHARMACEUTICAL INDUSTRY From organizational, capital structure, company size and used strategies point of view, pharmaceutical companies present on the Romanian market can be divided into two categories: 1. large multinational companies (e.g. Pfizer, GSK, etc.) 2. national companies (e.g. Sicomed – Zentiva Romania, Terapia - Ranbaxy, Antibiotice, etc.) There are essential strategic differences between the two categories, but we can also identify variations within the category. The Romanian pharmaceutical market is more and more affected by international competition, especially from multinational companies. Even though this can have positive effects for inhabitants (by diversification, as well as registered and marketed drugs increase), there are many negative effects in what Romanian manufacturers are concerned. Basically, multinational companies use worldwide strategies to promote innovative drugs on a large number of markets. These companies invest huge amounts of money into drug research and development (USD 750 million per product, on average), investments that they hope to recuperate during the patent protection period. Also, these companies have huge promotion budgets (that can reach even 40% of total income) and they promote their drugs aggressively, through complex teams of physicians and pharmacists, very well trained and motivated. Regarding their relationship with distributors, multinational companies have very strict policies. They prefer to work with large distributors, who cover the whole country and can offer a unitary distribution policy. Within the group, variations appear especially on the type of product they promote. For example, Novartis has a worldwide division of generic drugs (Sandoz), while GSK acquired local companies, manufacturers of generic drugs (e.g. Europharm), that can facilitate access to the local market. Even privatized (with one exception – Antibiotice), national pharmaceutical manufacturers are convicted to a lifetime of generic drugs manufacturing or, at most, creating drugs in co-operation. Sicomed and Terapia have the opportunity of manufacturing some original drugs of companies they are owne by. Still, this is very unlikely, as Zentiva has recently announced that it will close the production site of Sicomed and move the entire production in Czech Republic. On the other hand, Ranbaxy is one of the largest generic drug manufacturers in the world and it is very unlikely to develop innovative drugs in the next few years. Typically, generic drug manufacturers are doomed to wait for patent protection expiry before bringing a new product onto the market. In order to avoid this situation and to ensure survival, in the next few years Romanian manufacturers will be forced to sign cooperation contracts for drugs still under patent protection by ‘in-licensing’ procedure. The patent owner offers the know-how and the raw materials, while its business partner is only responsible for production. Should we consider a recent study on the Romanian pharmaceutical market, pharmaceutical drugs sales estimations show that by 2009 the percentage of innovative drugs sales in total market sales will increase up to 81,1% (the equivalent of USD 1.9 billion), while the percentage of generic drug sales will constantly decrease to 18,9% of total market sales (the equivalent of USD 0.4 billion). These are figures that should influence national manufacturers into reorienting towards innovative drugs (mainly through in-licensing). Even though their market share will decrease, the market for generic drugs will be relatively stable in terms of value, but real valuable growth is likely to be recorded only for innovative drugs. 6.1. Diversification strategy on the Romanian market After 1990, the tendency of Romanian pharmaceutical manufacturers has been to focus on certain types of products for which they accumulated long term know-how and experience and also for which they had available production capacities. Current tendency is to continue focus on a few types of products or therapeutical areas that are considered important for the company and which generate important cash-flows. Also, the biggest Romanian manufacturers have made important investments into perfecting production flows in order to reach European standards. Diversification is regarded as development in adjacent fields (such as life style products) and less as diversification in different fields, as Romanian manufacturers have not yet taken this chance. 6.2. Concentric diversification Approaching a true concentric diversification is a distant dream for Romanian pharmaceutical manufacturers. This is especially due to Romanian authorities policy to control the market by imposing many restrictions. Considering the fact that Romanian manufacturers (especially Antibiotice, that is state-owned) cannot include the R&D costs in production costs and also do not have the financial strength to invest hundreds of millions of dollars in developing an innovative product, they are forced to settle with the generic market, in which multinational companies are not primarily interested and which does not generate high revenues. Therefore, Romanian manufacturers have two options: • • to find development sources for off-patent generic drugs, field in which they encounter a strong competition from Chinese and Indian manufacturers, who dominate the market by low prices; to look for or to initiate co-operations with research institutes and independent researchers, who are looking for company support in order to put new products on the market. Each option has its disadvantages. If we choose the first option, we must not forget that in the years to come the salary level and utilities expenses will increase, which will put more pressure on companies and will not allow them to maintain a low price level for their products. Still, if a Romanian manufacturers decides to use this strategy, it will have to find solutions to increase quality and productivity, therefore trying to obtain competitive advantages against most Chinese and Indian manufacturers. Currently, most Romanian manufacturers follow patent situation on the international market and start manufacturing generic drugs immediately after patent expiry. The second option seems to be the medium and long term winning solution for the Romanian pharmaceutical manufacturers. They have experience, they know the market, they know what physicians, pharmacists and patients require, they have highly trained marketing and sales teams and they can enter into successful partnerships. This is a rather risky business, in which the role of marketing is extremely important. When choosing a partnership, it is very important to be able to estimate the success of the drug and to do it extremely realistic. Otherwise, the company faces a very high risk which can lead to bankruptcy due to the high investments that do not always pay back. 6.3. Vertical diversification Romanian pharmaceutical manufacturers are mainly focused on downstream integration. The upstream integration is regarded as ‘study of potential production’ for different offpatent molecules. Especially before 1990 but also until 1998-2000, Romanian manufacturers produced raw materials used in their production of finished drugs. Due to market situation and strong price competition coming from Asia, this has changed. They now import raw materials to manufacture finished drugs. Downstream integration has become some sort of tradition for Romanian manufacturers. Many of them, especially the biggest ones, have chosen to create their own distribution channels with their own sales force. Still, drug distribution has been affected by a number of contradictory regulations after 1990. For example, in 1999, when many manufacturers had already created strong distribution channels, authorities have decided to change the legislation and to force them to outsource distribution. Afterwards, this was changed again and, in theory, Romanian manufacturers are allowed to manage their own distribution, but laws are not clear. Basically, Romanian manufacturers do not have the right to sell their products directly on the open market (pharmacies), so they must do it through distributors. Should they not have debts to the state, Romanian manufacturers have the right to enter into electronic auctions for drugs required by hospitals. Should they have debts, they can auction in their name but in a third party’s benefit (an authorized distributor) who will work based on commission and will be able to deliver the product should the company win the auction. Therefore, downstream integration is no longer a winning option for Romanian pharmaceutical manufacturers. Actually, vertical integration / diversification no longer offers attractive solutions for Romanian companies in the field. 6.4. Geographic diversification Geographic diversification is a realistic option for Romanian manufacturers especially due to the inability of the local market to absorb the entire production and to integration in the European Union. In the first years after 1990, it was rather easy for Romanian manufacturers to continue co-operations with former communist countries, especially with former USSR countries, but also with Asian countries (e.g. China). Still, by the year 2000 market situation forced many companies to reorganize and even to eliminate many drugs from production, which also affected their co-operations on these markets. Currently, Romanian manufacturers are constantly attracted by the Russian market, as it is large (USD 3.4 billion) and records a important growth rate. Out of the first three Romanian manufacturers, the second and the third (Antibiotice and Terapia-Ranbaxy) opened commercial offices in the Russian Federation, therefore an important part of their production is targeted to this market. Also, the EU integration brings some advantages but especially duties to the Romanian pharmaceutical industry. From the beginning of the 1990s and especially after 1996, Romanian manufacturers have had no other choice but to start investing in quality. The basic quality recognition is the ‘Good Manufacturing Practice’ Certificate (GMP). Nevertheless, it is compulsory to offer full documentation for production processes and laboratory analysis in what any drug registered in Romania and/or the EU is concerned. The US market is a distant dream for most Romanian pharmaceutical companies. Extremely strict regulations and costs amounting to hundreds of thousands of dollars are strong entry barriers. These do not include the investments needed in order to reach the standard required by the Food and Drug Administration (FDA), the US agency for drugs. Still, big Romanian manufacturers such as Antibiotice have managed to enter the market and to sell their drugs, especially bulk active substances (e.g. Nystatin, market in which the company ranks as third in the world). Before Romanian manufacturers manage to reach the standards required by the EU or the US, they can focus on exporting bulk active substances or finished drugs in Asia, Central and South America or Africa, less regulated but also less profitable markets. 7. PERSPECTIVES OF THE ROMANIAN PHARMACEUTICAL INDUSTRY WITHIN THE EUROPEAN MARKET The past 17 years have been a period of major changes in the Romanian pharmaceutical industry. If in 1989 companies in the US and Western Europe had already discovered hundreds of blockbuster drugs and were trying to discover the human genome, Romanian pharmaceutical companies were mainly bulk active substance manufacturers, which they exported to multinational companies in order to be used for finished drugs. Especially in the past 10 years, the need to adjust to the international market, as well as to the EU standards have led to investments of tens of millions of dollars in all big Romanian pharmaceutical companies, both privatized and state-owned. Implementing GMP standards is just the first step, as Romania is forced to continue investments and to adjust strategies in order to be able to face competition on the European market. Should we compare market dimensions in Central and Eastern Europe, we observe the fact that EU accession and the degree of development for a country are directly proportional to the degree of development for the national pharmaceutical industry. For example, Russia has a population of about 200 million inhabitants and has a pharmaceutical market similar to the one of Poland, a country of only 50 million inhabitants. On the other hand, Hungary has a population of 10 million inhabitants and a pharmaceutical market twice the size of Romania, a country of 22 million inhabitants. By comparison to the world or Western European market, Romania is a small market, but with a good growth rate and with good perspectives as economy will develop (GDP and living standard will improve). Compared to other Central and Eastern European markets, Romania is a big market, currently ranking fifth after Russia, Poland, Hungary and Czech Republic. Considering the population of Romania on one hand and the population of Hungary and Czech Republic on the other hand, in the years 2010-2015 Romania has the opportunity of becoming the third largest Central - East European market. Especially in the next 10 years Romania will continue to be a generic drug manufacturer, as production of blockbuster drugs is still far away. As large multinational companies develop their presence on the Romanian market and as co-operations with Romanian research institutes intensify, it is possible for some research activities to be transferred to our country. Therefore, Romania may have the opportunity to play an indirect part in the elite of the pharmaceutical industry. On the medium term, it is highly unlikely for Romanian pharmaceutical manufacturers to have the capacity to diversify in other field, as Johnson & Johnson, Merck or GlaxoSmithKline have done. They will probably choose to focus or to create a portfolio that will ensure development of a comfortable market share. Still, the winning situation would be to initiate co-operations with foreign companies or research institutes, which could lead to new innovative drugs. Considering the incidence of cardiovascular diseases and the growing rate of central nervous system disease patients, we can estimate an important increase for the consumption of such products on the Romanian market for the years to come, as patients become more aware of the need for treatment and the national health system has the ability to offer compensated or free medicines. Also, we can predict a decrease in antiinfective drugs as Romanians become more educated and are restricted to self medicate with antibiotics. Considering mergers, it is highly unlikely to witness a merger between Romanian pharmaceutical manufacturers. This is due especially to the fact that they are all (except for Antibiotice) private companies, some owned by multinational companies, and with different shareholders. Still, it is possible to witness shareholder change in some national companies in case market conditions become less favorable and the need for a strategic investor becomes reality. Romania is definitely integrated in the European and world pharmaceutical industry, fact proven by the expansion of Romanian companies’ business activities worldwide and by the continuously stronger presence of multinational companies on the national market. Currently, there are many differences in how Romanian and multinational companies apply their strategies, but we can witness a tendency of our industry to align and adjust to the world market situation. BIBLIOGRAPHY Bavec, S. (2004), “Changing European and CEE Pharmaceutical Market Strategic Perspectives”, CEE Pharmaceutical Conference, Budapest Berek, R. (March 2004), “Pharmaceutical Product Management Today – in Europe” Business Monitor International, Romania (March 2005), “Pharmaceuticals & Healthcare Report Q1 2005, London – UK” Ciobanu, I. and R. 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