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Growth Prospects |

Role of Mergers b Acquisitions in Growth: Special Reference Maharashtra's Pharmaceutical


Ms Mrinal Savyanavar* & Dr Pradip Manjrekar*

Industry

ABSTRACT
r/ie pharmaceutical industry all over the world is experiencing increasing amount of growth, which coincides with the occurrence of a large number of mergers 8 acquisitions, particularly since the mid-1990s. The Indian pharmaceutical industry has also experienced similar trends as most of the global leaders have subsidiaries in India. These strategies enabled the firms to grow faster within a short span of time as it does not require much effort compared to the organic route. One of the arguments put forward by many of the neo-classical economists is that mergers and acquisitions will lead to a high concentration of market power, which enables the firms in the concentrated oligopolistic market structures to hike the price level Given this background, this paper which is a conceptual one makes an attempt to find out whether the process of mergers and acquisitions are really contributing to growth in this industry. The findings indicate that mergers and acquisitions have a major role in growth of this industry particularly in Maharashtra's.

Introduction
A MAJOR portion of world pharmaceutical production (US $ 700Bn) is produced in the developed countries, and their share has increased from 75% to 85% while the contribution of the developing countries remained very meagre throughout. The three continents, Asia, Africa and Australia accounted for 26% of the world drug production in the year 1982, which had fallen to a level of 18% in 2008. At the same time, the share of North America rapidly increased to more than half of the world drug production (60%) during the same period. The per capita drug consumption of the developed countries has also remained far higher than that of the developing countries. By the year 2000, the drug consumption of the developed countries reached $100, but the consumption of the developing countries had only slightly * Lecturer, YMT's Institute of Management & Research, Kharghar, Navi Mumbai (E-mail : smrinalc@recliffmail.com ** Professor & Head - Research & Consultancy & Extension Centre, Department of Business Management, Padmashree Dr. D.Y. Patil University, Navi Mumbai. CHEMICAL BUSINESS MAY 2009

increased to $10. Blockbuster drugs constitute about onethird of the world drug production. There were 58 blockbuster drugs in 2005. This accounts for the production of 30 big pharmaceutical companies in the world. The majority of these companies own one to three drugs. In terms of value, Pfizer alone accounts for 18% of the worldwide blockbuster market and Glaxo SmithKline for 12%. It is interesting to note that the sales value of the top selling brand of some of the companies is higher than that of the total pharmaceutical sales of India, which is only 1% of the global share. The top ten pharmaceutical firms in the world constituted 64% of the world drug production in 2007 and fifteen leading firms occupied more than 60% of the global pharmaceutical production in the year 2006. One of the major reasons for this rapid increase in revenue as well as market share of Pfizer within one year is the 'mega merger* of Pharmacia, the 9th largest firm in the world, which held 3.4% of the market share in 2002 with it. Likewise, Glaxo had only 2 % global market share in 1974, SmithKline had 3% and Beecham had 2% market share. After a series of mergers, these firms become today's second largest global firm - Glaxo Smith Kline, which accounts for a market share of 7% in 2003. Ciba

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Geigy had 6% of the market shares in 1974, and Sandoz held 5%. They formed a new company called Novartis, which was the 7th largest firm in 2003. Similarly, most of the leading pharmaceutical firms in the world followed the merger and acquisitionled growth strategy rather than pursuing organic growth. In South Africa, five companies have closed down due to mergers between parent firms and four local firms have shut down due to takeovers by Multinational Companies (MNCs) (Abrol, 2004). In Mexico 225 firms were engaged in pharmaceutical production in the late 1980s, which reduced to 178 at the end of 2000 (Zuniga and Combe, 2002; and Abrol, 2004).

Table 1: Retail formulation sales


Anatomical Group Market Share of Firms Largest Top 2 Tetra cycline and Comb/Doxycline Chloremphenicols, Comb Ampicillin, Amoxicillin Cephalosporins Trimethoprim Comb and similar Streptomycines and Comb Peniciiiin, Streptomycin Comb Totai Antibiotics Source: IDMA 18.9 53.4
9.9 46

No. of Firms
33 13 108 53 46 6 4 146

Top 3 47.2 85.2 26.3 72.1 70.3 97.8 99.6 23.9

Top 4 57.9 93.1


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33.8 70.7 18.4 62.2 64.8 94.7 96.8 17.1

76.8 74.9 98.6


100

51.2 88.7 51.2


9

31.2

Mergers and Acquisitions in the Indian Pharmaceuticai industry


The Indian pharmaceutical industry has been experiencing increasing amount of mergers & acquisitions as most of the global leaders have subsidiaries in India as well as due to the pressure recorded by such strategies on the domestic firms. This industry experienced a large number of mergers and acquisitions particularly since the mid1990s. According to Basanth (2000), the pharmaceutical sector in India accounted for 5.2% of the total mergers and 8.3% of total acquisitions during 1991-1999. Agarwal (2002) found that there were 81 mergers in this industry from 1973-1974 to 2000-2001. It constitutes 4.5% of the overall mergers and ranks the fourth largest merger recipient among all the sectors and the third largest industry in the manufacturing sector (Agan/val, 2002). Besides, initially the four big firms in the industry accounted for only 11% of the total sales of the industry. After 11 years, it increased twofold and reached 25% during 2003-2004. Likewise, the largest eight firms in the industry accounted for only 16% of the total sales during 1992-1993, and the same has inTable 2: Percentage creased more than twofold and reached 35% during 2003-2004. Net Saies
Years iUI NiM

firms in the antibiotics market. Here, the largest four firms constitute 32% of the market share. Within the antibiotics market, different anatomical groups are experiencing high levels of concentration (Ta/e 1). The authors tried to capture the market power enjoyed by the merging firms by making a database on mergers in this industry, which shows that even though they make only a small proportion of the entire firms in this industry, they own a very large proportion of the assets of this industry (Table 2). During the early 2000, the share of net sales held by the merging firms was minimal, mainly because only few companies were involved in merger activity. Since the mid-2000, there was a sudden increase in the share of merging firms. During 2005-2006, the share of net sales held by the merging firms was 46.37 and that of the non-merging firms was 53.63, In the case of total assets, the share of merging firms was 43.54% and that of the non-merging firms was 56.46% in the year 2005-06. From Table 2, we can make an interesting observation that the merging fimis were import intensive in the beginning itself.
share of assets held by merging and non-merging firms Totai assets
M NM

Profit
iU
NiUI

Export
iVI NiU

import M 79.47 82.25 84.90 83.46 84.65 NM 20.53 17.75 15.10 16.54 15.35

Mergers and Acquisitions In Maharashtra's Pharmaceuticai industry


Maharashtra's Pharmaceutical Industry is experiencing high levels of growth in different product market groups. For example, there are 146 32

2001-02 2002-03 2003-04 2004-05 2005-06

33.15 66.85 39.87 60.13 43.86 56.14 45.95 54.05 46.37 53.63

28.65 37.82 40.34 43.34 43.54

71.35 40.15 62.18 60.82 59.66 67.62 56.66 76.49 56.46 77.12

49.89 40.16 31.69 32.17 31.49

40.85 47.74 50.97 53.14 51.89

59.15 52.26 49.03 46.86 48.11

Note: M = Merging firms; NM = Non-merging firmsi. Source: Prowess, CMiE.

CHEMICAL BUSINESS MAY 2009

The above-mentioned facts point out that Maharashtra's pharmaceutical industry is experiencing an increasing amount of growth, which coincides with high amount of mergers and acquisitions. It once again emphasizes the arguments put forward by the neo-classical economists like Bain (1956) and Modigliani (1958) that mergers will increase growth. This in turn, increases market power as it allows the larger firms in concentrated oligopolistic industries to raise prices. The high incidence of mergers and acquisitions in the Maharashtra's pharmaceutical industry deserves special attention due to the specific characteristics of this industry. The supply side factors play a major role in determining the price level of drugs because the demand for drugs is inelastic due to the complete separation of identity between the purchaser (the patient) and the choice maker (the doctor) in this market. Here, the decision of the doctor determines the demand for drugs while patients are obliged to obey the doctor's decision. The doctors are less sensitive to the price of drugs, rather, other factors such as brand names play a major role in determining the demand for drugs (Lali, 1974). So, if mergers and acquisitions increase the price ievei through increased concentration, it would adversely affect the consumer's welfare. Mergers and acquisitions have played significant role in changing the level of growth in the Maharashtra's pharmaceutical industry.

Table 3

study
Weston (1953) Nutter (1954) Stigler (1956) Butters (1955) Weiss L (1965) Goldberg (1973) Desvousges and Micheal J Piette (1979) Hart and Prais (1956) Samuels (1965) Hanna and Kay (1977) M A Utton (1971) Mueller (1976)

Period 1904-1948 1904-1948 1904-1948 1940-1947 1929-1958 1954 and 1963 1955 and 1975

Country
USA USA USA USA USA USA USA

1885-1939 1950-1960 1919 and 1953 1954 -1965 1958-1971

UK

UK UK UK

West Germany

Results & discussions


Mergers and acquisitions and growth : A Theoretical framework The relationship between changes in industrial growth and the level of merger activity has frequently been investigated and there has been a surprising diversity of conclusions. These studies are mainly based on three major merger waves that svyept the US economy during the late 19th and early 20th century. There is a general feeling that merger waves in the US and to a lesser extent in the UK towards the end of the 19th and the early 20th century changed the structure of many manufacturing industries and increased the ievel of growth by eliminating many previously independent firms (Scherer, 1980). Table 3 summarizes some of the major studies on the impact of mergers and acquisitions.

Variables selected for the analysis of mergers and acquisitions


Mergers and acquisitions are expected to create moCHEMICAL BUSINESS MAY 2009

nopoly of power in the market in two ways: Firstly through reducing the number of firms in the industry, which would increase the market share of the existing firms and secondiy through the growth of the assets or marketing network of the merged or acquired firms with the merging firm. Ijiri and Simon (1971 and 1977) identified two conditions under which mergers and acquisitions would not lead to increase in growth. They are, if the probability of survivai is the same for all the firms and if each surviving firm increases its size as a result of aliocating the market share or assets of the acquired firms by a constant percentage of its pre-ailocation size. However, the latter argument is valid oniy in extreme rare situations. Therefore, we expect a positive and significant infiuence of 'mergers and acquisitions', variable in changing the Ievei of concentration. The magnitude of assets invoived in mergers and acquisitions would have been an ideal measure for capturing the intensity of mergers and acquisitions. Since we did not have information on these aspects, we have used the number of mergers and acquisitions as an indicator for the intensity of mergers and acquisitions. The logic being that more mergers and acquisitions will involve more additions to the asset value of the merging firms and this proxy has been used as a measure, of intensity in almost all studies relating to mergers and acquisitions in the Indian context (See for e.g., Agarwal, 2002). 33

Growth of the Industry


Growth rate of the industry is one of the important determinants in changing the ievei of concentration in an industry. If an industry is growing at a high growth rate, it attracts the new firms to enter into the market because they can do so without encroaching on the existing firms' market and the smail firms use this occasion to expand their market size (Bain, 1968). During this phase, the growth rate of the successful smail firms may be higher than that of their larger competitors because big firms may be subjected to constraints on their maximum feasible growth rate due to their large size (Caves et al., 1980). Scherer (1980) also expressed a similar point and argued that "the more rapidly a market is growing, the more likely it is that increases in market size wiii outstrip increases in minimum optimal plant size and so the more feasible decreases in concentration will be". Thus, in this situation, a faster growth rate should reduce the share of the dominant firms directly. Whereas, many studies have identified mergers and internal growth as the two major determinants of changes in the level of market concentration (Weiss, 1965; Mueller, 1976; Hanna and Kay, 1981). Internal growth again comprised of 'Gibrats' effect' and 'differential growth'. Gibrats effect states that the growth rate is independent of size, whereas differential growth suggests that the large firms grow more rapidly than the small firms (Ijiri and Simon, 1971; Ijiri and Simon 1977; and Hann and Kay, 1981). Thus, if the small firms outweigh the growth rate of the large firms, this variable, exerts a negative influence in our models otherwise, if the differential growth is high, then this variabie would exert a positive influence. Different studies have used this variable to find out the determinants of market growth (Mueiier and Hamm, 1974; and Jenny and Weber, 1978).

is through medical journals. Whereas, in the Over The Counter (OTC) market, advertisement takes place as in a typical advertising-intensive industry via mass media because the products are sold directiy to the consumer (Matraves, 1999). The marketing strategy in this industry is so much powerful that even the off-patent products tend to keep large market share. Therefore, we may predict that this variable will have a positive influence on changes in the level of growth. We have used advertisement and marketing expenditure as percent to sales to capture the effect of this variable.

Changes in Growth : The Dependent Variable


Changes in the industrial concentration are uniquely significant because they reflect changes in other structural variables. For example, if entry barriers are declining because of growing market or whatever this tends to become refiected in lower concentration ratios. Hence, changes in market concentration may reflect what is happening to other structural variables affecting the discretionary power of the sellers (Mueller and Hamm, 1974). Therefore, we used the changes in the level of concentration as the dependent variable. Many studies like Mueller (1976), Desvousges and Piette (1979), Weiss (1965) and Mueller and Hamm (1974) have used changes in the level of concentration to measure the impact of various factors on concentration. Our results shows that mergers and acquisitions had a positive and significant role in changing the level of four firm concentration ratio. Even though the growth rate of the industry exerts a negative pressure in changing the level of concentration, it is not significant. It indicates that the 'differential growth' is not taking place or the small and medium-sized firms are growing faster, which attempts to reduce the share of dominant firms. Likewise, product differentiation is exerting a positive pressure, but it is statistically insignificant. Interestingly, the coefficient of growth rate of the industry is positive unlike in the case of changes In four firm concentration ratio, which indicates that the 'differential growth' is higher than that of the growth rate of the small firms. It indicates that when more big firms are included, the small and medium firms are not able to catch up with the growth of big firms or they are not in a position to reduce the^market power of the dominant firms. However, this variable is not statistically significant. Here also product differentiation plays a positive but insignificant role in changing the level of concentration. CHEMICAL BUSINESS MAY 2009

Product differentiation
Empirical studies prove that for many industries, product differentiation is a major entry barrier. Such entry barriers exist either because of the advantages that existing firms have over potential entrants or because of real or pecuniary economies of scale in achieving product differentiation (Mueller and Hamm, 1974). In the industry for which product differentiation is important, a few firms are favored over all others and are thereby enabled to maintain their market shares. One of the major characteristics of the Maharashtra's pharmaceutical industry is the existence of promotional effort (Panicker et al., 1990). Marketing is carried out through two channels in the case of prescription drugs. One is via sales representatives and the other way 34

The above results reveal that mergers and acquisitions have a positive and significant role in changing the level of four firms and significant impact on changes in the level of growth of this industry

References
1. Goldberg G L (1974), "Conglomerate Mergers and Concentration Ratios', The Review of Economics and Statistics, Vol. 56, No.3, pp. 303-309. Granger C W (1986), 'Developments in the Study of Co-integrated Economic Variables', Oxford Bulietin of Economics and Statistics, Vol. 48, pp. 213-228. Hanna and Kay (1977), 'The Contribution of Mergers to Concentration Growth:. A Reply to Professor Hart', The Journal of Industrial Economics, Vol. 29, No.3, pp. 305-313. Hannah L and Kay J A (1981), 'The Contribution of Mergers to Concentration Growth: A Reply to Professor Hart', Joumal of Industrial Economics, Vol. 29, pp. 305-313. Hart and Prais S J (1956), 'The Analysis of Business Concentration: A Statistical Approach", Joumal of Royal Statistical Society, Series A, Vol. 119, pp. 150-191. Ijiri Y and Herbart A Simon (1971), "Effects of Mergers and Acquisitions on Business Firm Concentration' Joumal of Political Economy, Vol. 79, pp. 314-322.

Conclusions
Even though the Maharashtra's pharmaceutical industry experienced a rapid growth in production as well as consumption, the share of other parts of country in this remains very meager throughout. Further, it attracts the attention of policy makers as well as academicians due to its structural shift towards growth. The industry is also experiencing the process of mergers and acquisitions both nationally as well as in globally. The increasing amount of growth along with the presence of large number of mergers and acquisitions raise further issues on the ground that the former may be the result of the latter, which is very important in the case of socially-sensitive sectors such as pharmaceutical industry that have certain industry-specific characteristics. This paper attempted to find out the role of mergers and acquisitions in changing the level of growth in this industry. The findings suggest that mergers and acquisitions are the major factors in changing the level of growth in this industry. Thus, the results are in line with the arguments put forward by the neo-classical economists like Bain (1956) and Modigliani (1958), who argued that mergers would increase growth. This in turn increases market power as it allows the larger firms in concentrated oligopolistic industries to raise prices. However, the results only point to the fact that mergers can increase concentration, but it does not mean a strict reduction in competition. Sometimes, consolidation can strengthen competition despite the increased concentration ratios. Due to this industry's specific characteristics such as importance of brand names, it is necessary to expect an adverse effect of concentration rather than a simuitaneous increase in competition. There is a debate on what should be the appropriate competition policy towards mergers, whether the government should enhance it in order to facilitate the domestic firms to consolidate their resources and enable them to compete internationally or control it due to the adverse consequences of concentration that it is likely to create. The findings of this paper point to the need for sector-specific policy frameworks to curb the abuse of market dominance and proper coordination between pharmaceutical policy and competition policy. The paper being a conceptual paper has its own limitations. Further, studies could be initiated in this direction. CHEMICAL BUSINESS MAY 2009

2.

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7. Abrol D (2004), 'Post TRIPS Technological Behaviour of the Pharmaceutical Industry in India", Science, Technology and Society, Vol. 9, No.2, Sage Publications, New Delhi. 8. Agarwal M (2002), 'Analysis of Mergers in India", M.Phil. Dissertation Submitted to the Delhi School of Economics. Bain (1956), Barriers to New Competition. Harvard University Press, Cambridge. Bain (1968), Industrial Organization. 2nd Edition, John Wiley and Sons Inc., New York.

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11. Butters and Lintner J V (1950), "The Effects of Mergers on Industrial Concentration 1940-1947", Review of Economics and Statistics, Vol. 32, No.1, pp. 30-48. 12. 13 CMIE, Various Publications. Goldberg G L (1973), "The Effects of Conglomerate Mergers on Competition", The Joumal of Law and Economics, Vol. XVI, April, pp. 137-158. Goldberg G L (1974), "Conglomerate Mergers and Concentration Ratios', 7776 Review of Economics and Statistics, Vol. 56, No.3, pp. 303-309. Hanna and Kay (1977), 'The Contribution of Mergers to Concentration Growth:. A Reply to Professor Hart', The Joumal of Industrial Economics, Vol. 29, No.3, pp. 305-313. Hannah L and Kay J A (1981), 'The Contribution of Mergers to Concentration Growth: A Reply to Professor Hart', Joumai of Industrial Economics, Vol. 29, pp. 305-313. Hart and Prais S J (1956), 'The Analysis of Business Concentration: A Statistical Approach", Joumal of Royal Statistical Society, Series A, Vol. 119, pp. 150-191. Ijiri Y and Herbart A Simon (1971), "Effects of Mergers and

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Acquisitions on Business Firm Concentration' Joumal of Political Economy. Vol. 79, pp. 314-322. 19. Ijiri Y and Herbart A Simon (1977), Skew Distributions .and the Sizes of Business Finns, North Holland Publishing Company, New York. 20. Lall Sanjay (1974), "International Pharmaceutical Industry and Less Developed Countries: Oligopolistic Power of Leading Firms", Economic and Political Weekly, Vol. IX, No. 47, pp. 1947-1958. 21. Modigliani F (1958), "New Developments on the Oligopoly Front", Joumal of Political Economy, No. 66, pp. 215-232. 22. Mueller Jrgen (1976), "Impact of Mergers on Industrial Concentration: A Study of Eleven West German Industries", Joumal of Industrial Economics, Vol. XXV, No.2, pp. 113-132. 23. Mueller W F and Larry G Hamm (1974), "Trends in Industrial

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25. Samuels J M (1965), "Size and the Growth of Firm", Review of Economic Studies, Vol. 32, No.2, pp. 105-112. 26. Stigler G J (1956), "The Statistics of Monopoly and Merger", Joumal of Political Economy, Vol. LXIV, No.1, pp. 33-40. 27. Utton M A (1971), "The Effects of Mergers on Concentration: UK Manufacturing Industry 1954-1965", The Joumal of Industrial Economics, Vol. XX, No.1, pp. 42-58. 28. Weiss L (1965), "An Evaluation of the Mergers in Six Industries", Review of Economics and Statistics, May, pp. 172-181.

Specialty chemical industry: Managing transitions, creating value (Contd. from page 27)
While companies like Hoechst and ICI reorganised their portfolios through mergers and acquisitions other major players like BASF adopted a smother approach which involved strengthening existing core businesses through operational excellence and selected M&As. in becoming better at managing those aspects of complexity that cannot be eliminated. It is likely that in the next few years there will be major changes in areas with potential for consolidation and in particular, textile chemicals, surfactants, adhesives/sealants, paints/coatings, food ingredients, personal care chemicals, and water management chemicals, a trend which holds true for India too. The specialty business is also likely to witness major changes as restructunng and consolidation wiii continue to occur in shorter cycles. Developments in new technologies and new pathways for fine and specialty chemicals will be complemented by increasing regulatory and complex customer space requirements. It will be critical for specialty companies to focus on value creation strategies for future growth. Developing a successful value creation model is just a beginning. The major challenge for the specialty chemical players is in sustaining the created value as new pressure points emerge on financing, manufacturing and market spaces. In future, strategies and counter strategies will continue as efforts to gain critical mass, widen geographic reach, and improve competitiveness increase in the speciaity chemical business where today's high performance specialties become tomorrow's commodity products. Acknowledgement: ICT magazine, Bombay Technologist [2009 - 2010 issue] CHEMICAL BUSINESS MAY 2009

Moving forward
Hybrid players to stay but will find growth slow
Given the typical size of chemical markets, single segment focused companies will find it difficult to survive but many niche players are expected to grow faster.

Growth will be driven by new maritet appiications


Demand will come from industrial markets, customer made specialties, and high performance applications in aero space, sports, medical and high tech applications.

Consolidation wiii continue


More M&A wili be seen across Asia Pacific as local players opt out of non profitable and non core business '

investments in R&D will focus on innovations


Deveiopment of new products, refining old products for new applications and managing commoditisation of specialties will be a key focus.

In conclusion
In this complex industry the key to long-term survival is 36