On July 29th, Pfizer announced that it would follow the lead set by GSK three months previously and divide up its business so as to create a separate unit containing its off-patent (i.e. generic) products. The new division, which is described as the Value business segment, will cover both emerging and developed markets and will thus be much larger than the company’s current Value Products Group, which extends to the developed markets only. The total size of the new division will become apparent in 2014, when Pfizer begins to report its results under the new structure. This should also reveal its profitability, which will somehow have to be calculated by allocating country overheads between the innovative and value segments – a challenging task that will presumably involve a lot of guesswork.
As far as we can see, the main motivation for pushing older, off-patent products into standalone business units is to give the parent company the option of jettisoning them altogether in an effort to improve earnings growth. Since these older products are generally extremely cash-generative, this strategy only makes any sense when there is a strong pipeline of newly-launched products that is capable of delivering both good top-line growth and high profits. Pfizer and GSK obviously believe that their R&D pipelines are strong enough to stand the loss of a few billions of cash flow, but relatively few other big pharma companies are in the same position. AstraZeneca, for instance, would have little left if it got rid of its older products, and Merck, Bayer and Lilly have much the same problem. Novartis and Sanofi, of course, already have dedicated generics subsidiaries, but they also have large numbers of off-patent products that sit in the ‘innovative’ part of the company. Logically, it would make sense to shift these products into Sandoz and Zentiva respectively, but the cultural divide makes this relatively unlikely to happen in practice.
Internal culture will also be a vital determinant of how the ‘generic’ divisions of any big pharma company fare. In theory, putting older products into their own division ought to mean that they get more attention from management and hence perform better than they would otherwise. In practice, this may not be the case because of the difficulty of motivating and retaining management. Whereas most generic companies would be very happy to be handed a portfolio of well-known brands, the prospect of being responsible for off-patent products with declining sales and little or no marketing budget is anathema to the average big pharma exec. Being transferred to the generic part of an innovative pharma business is rarely seen as a positive move and hence the main aim of most managers is to get out as soon as possible, preferably back to IP-protected growth brands. Finding ways of persuading talented managers to stick around is thus going to be one of the biggest challenges for the MDs of the generic sub-units of big pharma companies.
Tied up with this issue is the question of how far these units should move towards being ‘proper’ generic companies. A true generics company aims to grow, not shrink, via the simple expedient of launching enough new products each year to cover the decline in sales of the old ones. The only obvious pipeline for a big pharma generics division is products losing patent elsewhere in the company and it is not certain in either the Pfizer or the GSK case that products will automatically move across from one division to another as they approach patent expiry. Pfizer has said that its Value division will get all the products that are either patent-expired now or will lose patent protection by the end of 2015, while GSK’s announcement simply said that it would be bundling around 50 older brands with total sales of c£3bn into its Global Established Products unit. Creating an independent generic pipeline for a company with billions in sales would require a major R&D effort, whereas these new divisions are likely to have minimal marketing, regulatory or technical resources and none at all for R&D (other than Pfizer’s biosimilars – see below). Of course, they could grow by buying up additional tail-end brands from other pharma companies, but this would require their MDs to take control of their own cash flow, rather than simply allowing it to fund the other parts of the group, a move that is likely to meet some resistance from the innovative divisions.
One interesting aspect of the new Pfizer Value division is that it includes the company’s biosimilar programmes. We have previously argued that biosimilars sit uneasily in big pharma (which has traditionally promoted products on the basis of differentiation and superiority, not similarity and price) and that most companies developing them are only doing so as a defensive measure rather than because they have any real enthusiasm for them. For Pfizer to give its biosimilar development programmes to its generics division is a vindication of this view and also a handy way for Pfizer to shift the associated development costs off the P&L of the rest of the company. It does provide a partial answer to the pipeline issue for the Value division, though, even if US launch dates are still some years away.
Overall, our view is that bundling together off-patent products within big pharma companies will only improve the performance of the products themselves if their new parent divisions are given the flexibility and autonomy to invest for growth. If the generic parts of innovative firms are simply seen as a dumping ground for everything that is unwanted elsewhere, then they will languish. Provided that the idea is to sell off these old products quickly, giving them strategic independence is irrelevant, since what matters is maximising short-term profitability and hence the exit multiple. But if generic brands are going to remain part of a big pharma company for the longer term, a lot more effort will be required to ensure that they thrive.