There’s an old expression that when the United States sneezes, the rest of the world catches a cold. In much the same way, experts say the latest cuts in healthcare spending proposed by the Spanish government – valued at a total of 2.8 billion euros as a result of the approval of two consecutive royal decrees — will spread to a dozen European countries, such as France, Italy, Portugal and Greece, which use Spain as a standard for fixing the price of their medications.
In Spain, it is the government that sets prices of pharmaceutical drugs, unlike other countries, where drug manufacturers are free to set their own prices. Among other reasons, that is because it is the Spanish government, not patients, who pays the bulk of the cost of drugs; financing, for example, 100% of the cost of drugs in the case of retirees. Those European countries that do not have a system for fixing prices use the prices set by other countries as a reference point; especially prices in Spain, since it has the lowest prices in the European Union.
Although the cuts on patent medications were ultimately set in Spain as a discount in billing,– not as a reduction in prices– the problem for the pharmaceutical industry in Europe is that other countries could copy the ideas of Spanish Prime Minister José Luis Rodríguez Zapatero. There are other factors that don’t help the sector create stable brands, including the inability to predict how the healthcare reforms of U.S. President Barack Obama will wind up affecting the sector, or to foresee how China or Brazil will lay out the foundations of their public health systems. The United Kingdom, where prices of pharmaceuticals are fixed freely rather than by governmental intervention, has also announced a cut in its healthcare spending, and Germany is studying similar measures. Greece has proposed the most severe cuts; so severe, that one pharmaceutical company has already announced that it will withdraw one of its medications from the country because they say it cannot remain profitable.
“In Europe, the financial condition of pharmaceutical companies is becoming more and more difficult, which leaves less room for research,” says Julian Zabala, professor of health policy and institutional relations at the IE Business School. “When governments give priority to their public balance sheets over research projects, this has consequences.”
While both decrees have been approved and are already in force, Spanish pharmaceutical companies are still waiting for the approval of other laws that will spell out the details of how these cuts will work. They need to know who will make the discounts and who will assume the costs, which will be divided between pharmacies, distributors and manufacturers. Spanish pharmaceutical manufacturers face 2010 with a sense of uncertainty. Already, this year has brought the most severe financial crisis in the country’s history, leaving many investment projects up in the air as companies wait to see how Spain’s austerity measures will affect them, and what further measures other European countries will take.
A Little Bit of History
The first shock for pharma companies arrived this March, when Spain’s minister of health, Trinidad Jiménez, agreed with the autonomous communities, Spain’s local governments, on a spending cut of 1.5 billion euros. The decision materialized in April in a Royal Decree that enacted a reform in the system of reference prices, and especially emphasized cost reduction in the oldest medications, something that the generic pharmaceutical industry did not look kindly on. Nor did the measure please manufacturers of patented pharmaceuticals. According to Farmaindustria, they will face a 900 million euro reduction in their earnings.
Aeseg, the Spanish generic industry manufacturers’ professional association, calculated the impact of the Royal Decree at some 600 million euros. Manufacturers will take that hit in their earnings in 2010, and as many as 2,000 jobs could be at risk. To guarantee growth, and take advantage of the commitment of Jiménez to develop generics to combat healthcare shortages, Aeseg has proposed alternative measures that would increase the market share of generics and guarantee a sales volume high enough to guarantee the profitability of its membership. In return, the association is offering makers of generic drugs an additional savings of between 320 million euros to 1.5 billion euros that would cover the cost of the Health Ministry’s cut.
The second shock came on May 12, when the government announced that it would cut the prices of innovative medications that are still patent-protected but had remained uncovered by the recent Royal Decree on Health. It didn’t take long for Farmaindustria, the Spanish pharmaceutical industry’s professional association, to respond with the statement: “It doesn’t make any sense, if you want to tackle the public-sector deficit, to put the pharmaceutical sector, which represents more than 20% of Spain’s industrial R&D, into a recession.”
The only thing that industry can do in this situation, notes Zabala, “is to continue to do its research; there is nothing else. The pharmaceutical industry is the leading research sector in the entire world.” At the same time, firms must show the public that their spending produces results. “You have to pay attention to a double goal: Pharmaceuticals are not only goods; they are also medications that benefit our health and our quality of life. It is hard to find anything better to invest public funds in than spending it on medications. In addition, an innovative pharmaceutical industry is the best environment for promoting innovation.”
The Cost of Mergers and Acquisitions
The proposed healthcare spending cuts aren’t coming at the best time for the pharma firms, which have been focusing on making their latest acquisitions profitable. Many companies made those purchases primarily to address the damage to their revenues caused by the loss of expiring patents. To minimize the impact of the shortage of profitable new chemical molecules on their balance sheets, the ten largest multinationals in the sector spent 148.66 billion euros last year on mergers and acquisitions.
Until recently, concentration had been the best weapon for maintaining growth in the sector. At the start of the decade, the first wave of mergers began with Sweden’s Astra merging with Britain’s Zeneca; Britain’s Glaxo with Britain’s SmithKline; and France’s Sanofi with the Franco-German company Aventis. Last year, interest in mergers became more intense, hitting an annual record in terms of dollar value. Overall, more than 50 large deals occurred among the large publicly traded companies alone. In addition, there were mergers between small producers, and purchases by Asian companies aimed at entering mature markets in Europe and the United States.
Last year’s most expensive deal brought together Pfizer of the U.S., and Wyeth, another American company, at a cost of US$68 billion. However, when it comes to the number of deals, GlaxoSmithKline and Sanofi Aventi competed for top position with eight different moves each. But some observers say mergers have not helped to create value and, as a result, are not a good alternative for dealing with the decline in revenues that resulted this year from healthcare spending cuts by governments. The latest news from Pfizer that it will let go 6,000 people by 2015 in order to complete its integration with Wyeth provides an example of the true costs of these kinds of deals.
That’s why companies such as U.S.-based Eli Lilly are placing their bets on organic growth, rather than mergers. This means that such companies may deal with the Spanish cuts — and the consequences they create in the rest of Europe — by imposing hiring freezes. The cuts also lead to uncertainty about Lilly’s plans for making the investments that the company had previously committed to making in Spain, says Eric Patrouillard, Lilly’s new head of operations there. Because there is so much insecurity in the sector, there is widespread disagreement about defining a new strategy, even as the first signs of the consequences begin to show up in the market.
Both Jesús Acebillo and Humberto Arnés, president and general director, respectively, of Farmaindustria have publicly stated that they want to build political consensus to implement healthcare reforms. However, they believe that the proposals made so far, along with the measures that have already gone into effect, don’t help to correct the chronic public-sector deficit. They estimated that pharmaceutical manufacturers could be forced to cut 5,000 direct jobs and another 15,000 indirect jobs as a result of the government’s price cuts. For his part, Raúl Díaz-Varela, president of Aeseg says that the measures currently under discussion will lead to “the disappearance of smaller companies and, even, of some generic medications” that are no longer profitable to manufacture at current prices.
The companies that will suffer the worst losses are the small local labs, experts note, which do not have enough resources to make acquisitions, and whose portfolios of medications are not attractive for the large multinationals that are looking to buy other companies. Farmaindustria calculates that two-thirds of the 250 pharmaceutical firms in Spain will register losses this year. Of these, as many as one-third may even wind up disappearing. The uncertainties are expected to force local pharma producers to postpone some of their more ambitious projects for globalization, as they wait to find out what impact the government cuts will ultimately have on their balance sheets. Meanwhile, other companies, especially the multinationals, are thinking about outsourcing their R&D projects to European countries that have more stable legal frameworks, or about moving their production plants to lower-cost areas such as Latin America and Asia.
According to Zabala, “Asian countries, headed by China, are the ones that are capturing massive amounts of investments in the pharmaceutical industry, fundamentally because these are the countries that understand best the need to commit to innovation. Occasionally, some countries in the EU, along with the U.S., adopt policies aimed at innovation. Generally speaking, any country that commits to this sort of policy is capable of attracting investments.”
The proposed price cuts in Spain won’t have a serious affect on Pharmamar, a biotech subsidiary of Zeltia Group, general director Luis Mora states, because only 10% of the company’s sales take place in Spain. But he thinks the cut, which would amount to 4% in the case of orphan medications, or drugs that are targeted at a limited group of patients, are worrisome. “Instead of rationalizing the entire healthcare sector in Spain and making it more efficient, [government officials] are reducing prices and giving discounts so they can reduce the healthcare deficits.” The government should be taking more effective measures that would have benefits for patients, he said. Nevertheless, Mora says that his company has not frozen any investments that were already underway, although “looking at our new projects, we will begin to evaluate whether it makes sense for us to make Spain the focal point of our investments.”
Juan López-Belmonte, president of Rovi Laboratories, asserts that suppliers should not have to support the country’s healthcare deficit and agrees that the government should not apply the same approach unilaterally. “Companies like us own assets and make products in Spain; maintain a level of employment and export, and do R&D. We are very different from others within the sector that only have offices in Spain and market their products there.” To his shareholders, López-Belmonte has defended the fact that “we will continue to manufacture in Spain, with the fundamental goals of diversifying and strengthening the area of manufacturing … and guaranteeing the renewal of our portfolio of products, which is the principal concern of every pharmaceutical company.”
The Strategy of Multinationals
Pfizer is still studying how the Spanish government’s proposal will affect the company, says Elvira Sanz Urgoiti, president of the firm’s subsidiary in Spain. But she notes that the measures spelled out in the government decrees for reductions and implementing drug discounts to cut healthcare spending “will force the pharmaceutical industry to restructure. There is no doubt that this type of adjustment will have a direct impact on the way research gets done in Spain, and the consequences will also be seen in terms of employment,” he adds. “And so, given this situation, the pharmaceutical industry cannot guarantee that it will maintain its usual levels of employment and investments in innovation.”
As for possibilities for outsourcing, Sanz Urgoiti does not rule out anything. “There is no doubt that when a company has to decide where to invest in R&D or where to develop its industrial activity, it considers the economic framework of the country and its stability.” Measures such as those that were recently adopted in Spain “limit the attractiveness of our country.”
In a statement, Sanofi-Aventis officials pointed out that “the healthcare [price] cuts leave us in a complicated situation when it comes to defending our investments in the country. Since 2006, our investments have exceeded 100 million euros in industrial operations alone. As a leader in the European pharmaceutical industry, Sanofi-Aventi has traditionally been committed to Spain, where it has located two manufacturing plants (Alcorón, Madrid; and Riells, Gerona); a center of basic research; a distribution center in Leganés, and offices in Madrid and Barcelona. Despite all that, we are probably one of the companies that will suffer a greater economic impact.” So far, sources at the French pharmaceutical company have said public that they it will not going to end its commitment to products or to the development of business in Spain.” But officials suggested that “obviously, these abrupt, unexpected and disproportionate cuts have made us reconsider all of the large-scale future investment projects that we had for our factories and research centers in Spain.”
In the view of Martín Sellés, president and chief executive of Janssen-Cilag, the pharmaceutical division of Johnson & Johnson, the new measures introduced by the government will have “dramatic consequences for the sector. Some can be put into objective terms immediately, he notes, “but others won’t be seen until another two or three years, which will make it even more difficult to repair the damage they will cause. In our case, the immediate effect is an annual impact of more than 65 million euros.”
Sellés recognizes that it is still too early to assess the total impact of the cuts, but his company is already beginning to make its decisions with the government’s actions in mind. “We have tried to get over the shock this has caused us by evaluating what would be the best way to manage such a serious situation over the short and medium term. It is clear that over the short term, this will mean a significant reduction in all levels of spending and investment that our company makes in Spain.” Sellés highlights the importance that other locations, such as Latin America and Asia, are playing as destinations for multinational pharmaceutical investments from some European countries, especially from Spain. “Day by day, the lack of confidence in our country is [becoming more] significant, and it will take years before we’re going to dare to ask for more investments in Spain. Actually, the challenge that we face now is to maintain those investments that we already have, which are quite a few.”