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British Pharmaceuticals: a cautionary tale Julie Froud a , Karel Williams a , Colin Haslam b , Sukhdev Johal b & Robert Willis c a University of Manchester b Royal Holloway , University of London c East London University Published online: 28 Jul 2006.

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British pharmaceuticals: a cautionary tale

Julie Froud, Colin Haslam, Sukhdev Johal, Karel Williams and Robert Willis

Abstract

British pharmaceuticals is generally represented as a successful sector which illus- trates the potential of knowledge-intensivc, high-value-added activities. 'l'his article presents a revisionist account based on evidence and argument. Pharmaceuticals is a small sector which combines high-~alue-added and average wages to benefit capital not labour. The knowledge base in the laboratory creates imitative product with mar- keting then applied to capture social expenditure. When product-market growth slows, the sector restructures defensivel~ without solving its problems.

Keywords: pharmaceuticals; manufacturing; UK; industrial policy; competitixe- ness.

And so it happens that in the real Miss Nightingale there was more that \vas inter- esting than in the legendary one; there was also less that was agreeable.

(Lytton Strachey, Eminent Victorzans)

I n all the long-industrialized high-wage countries, new forms of external and internal competition impose industrial transformation and a new division of labour. If these processes hollow o u t manufacturing and crowd labour into low- wage service jobs, they may also create new poles of growth and possibilities of prosperity around knourledge-intensive, high-value-added activities. T h i s paper explores the extent and nature of these possibilities through case study of o n e UK sector, pharmaceuticals, which has been widely represented as t h e practical realization of all t h e possibilities of prosperity in a dynamic British case.

T h i s article comes to revisionist conclusions about British pharmaceuticals, as Strachey's essay did about Florence Nightingale: in both, there is a gap between legend and reality which m u s t be registered and explored by all who wish to move o n intellectually and politically after rejecting sentimental illu- sion. T h e article which argues this case is organized in a fairly straightforward

Econorn)~ ~ n d Soctety Volume 27 Number J Nozenzbev 1998: 554-584 0 Routledge 1998 0308-i 117

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Brztzsh pharma~eutz~als: a cautzonsyll tale? 555

w a y I t s first section delineates a legend by reviewing t h e orthodox story of Britain's brilliant success in pharmaceuticals and relating this to broader American arguments about t h e potential of high-value-added, knowledge- intensive activity. Subsequent sections all show how t h e images, claims and assumptions about Rritish pharmaceuticals offer partial and misleading rep- resentations.

T h e second section shows that the imagery of success diverts from questions about the weight and significance of the pharmaceuticals sector. 'The third section shows how pharmaceuticals combines high-value-added with average lvages so that its distinguishing characteristic is generous rewards for capital. T h e fourth section shows how the knowledge-intensive stereotype misrepresents an activitj- which is about the aggressive marketing of imitative product. A fifth section demonstrates how and whq- the sector must restructure and cannot be a source of stability. T h e end result is a cautionary tale and a brief conclusion dra\vs out the implications of these revisions for o u r understanding of the so- called knowledge-intensive, high-value-added activities.

S e c t o r a l s u c c e s s , n a t i o n a l p r o s p e r i t y ?

L>iscussion of Rritish pharmaceuticals draws on, and is shaped by, a common language which creates a story of success. It can be illustrated with two quo- tations from the right and t h e centre left, represented by a Financial Times edi- torial and a Will H u t t o n column:

[Pharmaceuticals is] . . . the only industry in which the country is an undis- puted world leader.

(Financial Times 29 January 1995)

Pharmaceuticals h a \ e stood as a beacon of UK excellence in an industrial landscape otherwise depressing11 bare of international success.

(Will H u t t o n , Guardtrrn 8 M a r c h 1995)

T h i s language creates its effects by the repeated assertion of exceptional success (against an assumed background of general British failure) which is t h e ~5-ell- deserved outcome of a contest to w-in leadership through excellence. T h e same few factoid indicators of success are used again and again, especially the trade surplus and the development of world-beating drugs which is always linked to the knowledge i n p u t of research.

T h i s legend of our times originated inside pharmaceuticals as part of a re- branding. I n the 1960s and 1970s, after Kefauver's Senate anti-trust investi- gation, American and Rritish d r u g companies were widely accused of profiteering from patents. If this suspicion now lingers o n only in The Econo- mist, this is because, in the 1980s, the British sector used t h e language of deserved success to refurbish its own image. Peter Cunliffe, then Chairman of ICI's pharmaceuticals division, inquired rhetorically:

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556 Jufulie Froud et al.

How dare your industry operate successfully where others fail?. . . How can you trade successfully with the entire world when others cannot compete even in the U K ? You are clearly above average in your performance.

(ABPI 1982: 19)

More recently, Jan Leschly, chief executive of Smith Kline Beecham, self- confidently invited Tony Blair: 'He should meet us. We [in pharmaceuticals] are probably the most successful business in the UK' (Financial Times 29 July 1996).

T h e Thatcher era began with a massive manufacturing recession and promised regeneration that turned out to be elusive. Against this background, Conservative ministers eagerly accepted trade invitations to endorse pharma- ceuticals in familiar terms as a 'British industrial success story' (Redwood in ABPI 1990: 4). T h e sector's export record and commitment to research and development was singled out for special praise. In the trade association's annual report, Geoffrey Howe, as Chancellor, praised pharmaceuticals as 'a remarkable industry . . . [whose] record, in particular in exporting, is one of considerable success' (ABPI 1982: 5 ) . Nearly ten years later at a trade conference, William Waldegrave praised the knowledge base:

we are proud of the success of research and development in this country. As you know, three out of the top six best-selling drugs world wide were researched in Britain, including the number one best seller itself, Zantac. This is an excellent record.

(Waldegrave 1991: 92)

T h e more academic literature on pharmaceuticals assimilates and elaborates versions of the familiar story. This is the case not only in business texts which celebrate success but also in mainstream economics texts and in radical work which aims to unsettle established identifications.

T h e business-school texts take the leading pharmaceutical companies as exemplars of managed success. Their enthusiasm for Glaxo, the leading British- owned pharmaceuticals company, is almost boundless. John Kay identifies Glaxo as 'Europe's most successful company' (Kay 1995: 30), while Davis et al. (1991) represent Glaxo as the most successful company in the world. More sober main- stream texts concur in less extravagant terms and with less hyperbole. A recent academic text on the world pharmaceutical industry argues that 'the existence and vigorous development of a nationally based (British) pharmaceuticals busi- ness had led to substantial benefits in employment, investment and (perhaps most important of all) in the nation's technological capacity' (Taggart 1993: 232). Mainstream economics concurs when Hart asserts that this is one industry where the UK is 'powerful and dynamic' and has little to fear from German com- petition (Hart 1992: 85).

T h e language and the story are so all-pervasive that even radicals get drawn in despite their reservations about its representational and partial character. D

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Brztzsh pharma~eutz~als: a cuutzonar)l tale? 557

Thus, Moran's (1995) account of 'the health care state' emphasizes the strategic importance of the pharmaceutical and medical equipment industries: their size, technological importance and growth rates ensure that the outcome of inter- national competition in these activities is 'central to the industrial policy of states' (Moran 1995: 772). His radicalism is then expressed in a supplementary caveat about representational importance:

T h e pharmaceutical industries therefore have disproportionate importance to a capitalist industrial state such as Britain, because of their economic signifi- cance and because they provide state elites with a rare example of a pres- tigious, world class industry

(Moran 1995: 773)

I n a different way, the same kind of prekaricating relation to the stereotype re- appears in the journalist Matthew I,ynnls book which provides the most imagi- native and informative recent account of the business. Lynn disparages Glaxo as a company which used marketing to turn Zantac, an imitative product, into a world best-seller (1,ynn 1991: 235). But the force of this attack is diminished by the Manichean way in which Glaxo is constantly contrasted with Merck whose success is virtuously based on real innovation (Lynn 1991: 13).

T h e British story- of sectoral success in pharmaceuticals can be set against the background of a broader debate on the possibility of prosperity through high- value-added, knowledge-intensive activity. T h e changing and increasingly pes- simistic assumptions of American debate on these issues can be established by comparing the seminal work by Magaziner and Reich (1982) on industrial com- petitivity with early 1990s restatements of the argument by Reich (1991) and 'I'yson (1992) as well as Krugman's (1994) polemic against competitivity.

At the beginning of the 1980s, Magaziner and Reich's M i n d i n g Amevica ir Busi- ness advocated industrial policy to assist structural transformations which would move the long-industrialized countries into knowledge-intensive, high-value- added activities. 'l'he US could achieve prosperity 'only if (1) its labour and capital increasingly flow towards businesses that add greater value added per employee and (2) we maintain a position in these businesses that is superior to that of our international competitors' (Magaziner and Reich 1982: 4). Suhse- quent American debate about competitivity in the 1990s has been marked by growing intellectual scepticism about the relation between value added and knowledge intensity as well as increasing political pessimism about whether industrial policy can sustain a broadly based national prosperity.

Paul Krugman (1994: 38) raised the difficulty that high-value-added, know- ledge intensity and high technology were not always positively associated as Magaziner and Reich had assumed. When US industries are ranked in terms of value added per capita, using 1988 data, cigarettes and petroleum refining realize the highest value added per worker of $488,000 and $283,000 respectively; while electronics adds value of only $64,000 per worker which is below the average of $66,000 for manufacturing as a whole. T h e distinguishing characteristic of the

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558 Julie Froud et al.

high-technology industries is not the level of their economic output but the quality of their social input of educated labour. According to Tyson's evidence (1992: 36-7), the average value added per worker is one-third higher in high- tech activities than in American manufacturing as a whole. But, this average covers a substantial range of variation which includes below average perform- ance in activities like aircraft production. T h e economically diverse activities of high tech are, however, united by a social difference in the composition of employment because the high-technology sector as a whole employs eighty-five scientists and engineers per 1,000 employees, twice as many as manufacturing as a whole. Knowledge-intensive turns out to be a tautology.

While these economic relations have been explored, American discussion of political possibilities and social consequences has been growing steadily more pessimistic. Tyson and Reich provide restatements of competitivity for the 1990s where industrial policy is discarded, the economically defensible area is much diminished and the inevitable social consequences of growing inequality and social division figure ever more prominently.

Tyson (1992) is an argument for an American trade policy response against the Japanese and Europeans which narrows the area of the defensible: active trade policy should apply only to high tech with free trade recommended for the 76 per cent of American manufactured imports in the medium and low tech cat- egories. Reich (1991) presumes the consequence will be a general migration of 'routine production' activity to industrializing countries and his of Nations provided an influential restatement of the social consequences of these economic processes. Knowledge is still the key to the future but, as part of a new global division of labour, it is now a recipe for sectional inequality and social division, not national prosperity for all Americans. A 'fortunate fifth' of Americans will prosper as 'symbolic analysts' whose problem-solving and brokering skills are integrated into global networks while many under-qualified Americans are herded into an overcrowded service market because the factory production of global networks is often located outside the USA.

T h e American debate about competitivity is echoed in a British context through selective and up-beat appropriation of positive themes. As long as the Conservatives were in power, the main emphasis was on competition through flexible labour markets and low wages which would attract inward investment. But, there were also glimpses of another knowledge-intensive, high-value-added pathway to competitiveness which pharmaceuticals exemplified. In 1986 the NEDC pharmaceuticals committee (1986: vi) identified pharmaceuticals as 'a sector which typifies the new industry that the UK is anxious to sustain and develop'. By 1995, this was taken up in the government's White Paper, Compet- itiveness: Forging Ahead, which accepted the representation of the British indus- try as an established export success based on knowledge which has established a position 'among the world's leaders in innovation' (Cm 2867 1995: 39). T h e White Paper then elaborated this into a political economy of specialization where the success of pharmaceuticals, chemicals and aerospace showed how 'R and D dependent industries . . . assisted by supportive relationships with suppliers,

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universities and government . . . can harness the nation's brain-power to create wealth and comparative advantage' (Cm 2867 1995: 3 6 ) .

New Labour's rhetoric emphasised knowledge-intensive, high-value-added activities much more prominently- and presented them provocatively as the key to social inclusion (rather than the social division which figured in the Ameri- can debate of the 1990s). Early in 1996, Tony Blair's Tokyo and Singapore speeches presented a light and airy pre-election vision of how a new economic base could (rc)create 'one nation' (Blair 1996a: 8; 1996b: 2). His upbeat tone was sustained by a blurred definition of value added and by the assertive association of added value with knowledge intensity. If value added has a precise technical meaning in company or national accounts, it can also be used simply as 'a synonym for "desirable"' (Krugman 1994: 3 7 ) . Blair uses value added in this rhetorical sense while echoing 1980s Reich: 'when very low labour cost countries can outbid us at the lower end of the market we must be moving up continually to higher value-added products' (1996b: 2). 'This high-value-added activity is then associated with knowledge intensity as in the Tokyo speech which presents no evidence but announces 'Knowledge. Infrastructure. Technologj- . . . are the wellsprings of national prosperity today' (Hlair 1996a: 6). 'The next era will be the creative age' (Blair 1996a: 2) with prosperity derived from a base of human capital strengthened through technology and training. I n this era, education and training can become the policy lever that produces the happy joint outcome of economic competitiveness and social inclusion.

T h e question of whether, and to what extent, knowledge-intensive, high- value-added industries will deliver such results can be clarified by turning to the case of U K pharmaceuticals. T h e next section takes up this task by focusing on a range of evidence which allows us to weigh the contribution of thc pharma- ceutical sector.

B r i t i s h p h a r m a c e u t i c a l s : s p e c t a c u l a r t r a j e c t o r y a n d l i g h t w e i g h t

If the orthodox story of success is always supported by the same few factoids, this section moves back to primary sources so as to lay out a range of relevant statistical evidence. T h e material is laid out in tables so that readers can judge our rather different story about the spectacular trajectory and light weight of UK pharmaceuticals. T h e sector is throughout defined, in the orthodox way, to include all the British-based firms operating in and out of the UK regardless of ownership.

T h e trajectory of British manufacturing as a whole over the past twenty-five years has been dismal. As Kitson and Michie (1996: appendix) show) manu- facturing as a whole has not managed any sustained output increase while employment has declined dramatically: real output at the 1989 cyclical peak was only 10 per cent above the 1973 peak while the employment base has unsteadily eroded so that the sector which once employed seven million people

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560 Jfulie Froud et al.

now employs just over four million. Trade performance is weak; British manu- facturing has a declining share of world trade and, except in periods of cur- rency depreciation, the overall trade deficit has generally increased. British manufacturing has failed to compete successfully against European, American and Japanese rivals. T h e corporate sector has adapted to failure by productive retreat from high-tech competition to low-tech sheltered industries: the leaders of the 1980s and 1990s are companies like Hanson concentrating on bricks and tobacco or privatized utilities operating in sheltered and slow-moving sectors.

Against this background, it is hardly surprising that so many have empha- sized the exceptional success of pharmaceuticals which has moved along a different trajectory. T h e sector's success is not imaginary insofar as the famil- iar claims are vindicated by the evidence about real output, employment, trade share and trade surplus. As Table 1 shows, the real output of the UK pharma- ceuticals sector has increased by nearly three times in the past twenty years while, as Table 3 shows, U K pharmaceuticals employment has not declined but increased by one third. T h e trade success is even more spectacular. British pharmaceuticals has managed to claim a modestly increasing share of the world pharmaceuticals market against all corners: the UK-based sector's share rose from 7.5 per cent in 1982/3 to 9.3 per cent in 1987/8 (EIU 1994: 33). More dramatically, unlike most of the rest of British manufacturing, pharmaceuticals has managed to ratchet up the exports and contain import penetration so that, as Table 2 shows, the trade surplus in pharmaceuticals has grown quite spec- tacularly, more than fifteen times from L100 million to L2 billion over the past twenty-five years.

T h e conventional story of pharmaceutical success relies on the indicators above (plus research and development expenditure). As Tables 1 and 2 show, every one of the stock claims is true but together they provide a very partial

Table 1 UK pharmaceutical sector real output

Year Index (1 97.5 = 100) Year Index (1 975 = 100)

1975 100 1984 151 1976 97 1985 161 1977 106 1986 150 1978 109 1987 174 1979 115 1988 196 1980 132 1989 216 1981 127 1990 227 1982 140 1991 238 1983 141 1992 27 1 Average growth per annum = 9.5 per cent

Source: P A 1002 Census ? f P m d u c t r o n , London: H M S O N o t e Pharmaceuticals includes all activity in SIC 257. Nominal output is deflated by a pharmaceuticals sector producer price index obtained from the C S 0 Red Book. Output equals gross value added defined as gross output minus purchases

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Brztlsh p k u r m u ~ e u t ~ c n l s : a cautzonary tule.7 561

Table 2 UK pharmaceut~cal sector balance of trade

Yeur Exports I m p o ~ t s Esports/ Bulirnce m211 A; mill r mnpovt.s A; m111

1971 160 40 4.00 120 1975 350 111 3.15 239 1980 699 252 2.77 447 1985 1484 660 2.25 824 1990 2397 1224 l .96 1,173 1995 3887 1893 2.05 1,994

S o u r c e : Central Statistical Office, L'K Oz,ersras Tvuile Stutlsttn,., London: HMSO .Vote Pharmaceutical sector includes all imports and exports in SITC Division 54; halance is calculatrd bq subtracting imports from cxports and is positive in all years

representation of the activity which concentrates on the sector in itself rather than the sector's weight and significance in the broader economy. Tables 3 and 4 rectify this absence by relating the pharmaceutical sector to manufacturing as a whole. T h e neglect of the size and weight issue in the orthodox story of phar- maceuticals interestingly parallels similar neglect of this issue in the case of Japanese manufacturing transplants, which were another 1980s symbol of success against a background of manufacturing failure. Academics and journal- ists asserted or assumed that Japanese transplants were carriers of new high- performance manufacturing techniques and could significantly contribute to the regeneration of UK manufacturing: they ignored the fact that this transplant sector was always relatively very small and has recently grown slo\\-ly so that it has never employed more than 65,000 (JETRO communication 1997) and there- fore accounts for less than 2 per cent of British manufacturing employment. Coincidentally, as Table 3 shows, pharmaceuticals is not much larger.

As a sector, pharmaceuticals lacks the weight to make illuch difference to many households or communities within the UK or to act as counterweight to the more general manufacturing failure. British pharmaceutical success has not produced a substantial domestic sector, like cars in Germany or electronics in Japan, which accounts for 10 per cent or more of domestic manufacturing value added. In terms of size, what we see is a rapid increase from a very small base. Over the last thirty years the pharmaceuticals' sector share of manufacturing output has increased eight fold but this takes pharmaceuticals only from 0.49 to 4.07 per cent share of total manufacturing output. Similarly, after a large three- fold increase in its share of total manufacturing employment over the last thirty years, pharmaceuticals still accounted for only 1.8 per cent of total manufactur- ing employment in 1992. A good deal of the percentage increase is accounted for by the decline in overall manufacturing employn~ent. 'The absolute number employed increased in pharmaceuticals from 60,000 in 1963 to just under 80,000 in 1992; as Table 3 shows, brilliant success translates into 20,000 extra jobs over thirty years.

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Table 3 UK pharmaceutical sector share of manufacturing output and employment: 1963-92

Year G VA G VA Pharmaceuticals Employment Employment Pharmaceuticals manujacturing pharmaceuticals share i n manufacturing i n pharmaceuticals share

A mill A mzll 000s 000s ( a ) ( h ) f a / b ) (d) f e ) ( d / e )

Source: PA l002 Census of Production, London: H M S O Note Pharmaceuticals includes all activity in SIC 255; manufacturing includes ail activity in SIC Divisions 2 4 . Gross value added (GVA) is calculated subtractively as gross output minus purchases and stock adjustments. Employee numbers include full and part-time and are not full-time equivalent adjusted

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Brztzsh pharmaceutzculs: a cuutzonury tale? 563

Nor does the sector have the leverage to shift the constraints established by more general failure. Thus, pharmaceuticals is an export success but the value of its exports is not large enough to redress the balance by abolishing deficits and trade constraints. As Table 4 shows, the sector's trade surplus may be L2 billion but pharmaceuticals still account for only a modest share of total manufacturing exports; pharmaceuticals increased their share of total manufacturing exports to around 2.5 per cent in the mid-1980s since when the share has been virtually constant.

Finally, we would note that, although the imagery of pharmaceuticals empha- sizes leadership, the British sector does not have the kind of world leadership position associated with American aerospace and software, German cars or Japanese electronics. Leadership in these foreign contexts means a sector which is substantially larger than in comparably sized advanced capitalist countries and which includes a phalanx of domestically owned firms that have strong market positions. T h e difference of U K pharmaceuticals is established by Table 5 which compares shares of national production in world pharmaceuticals output; in each case, national production includes production for the domestic market plus exports made by domestically located firms, regardless of ownership.

In terms of global output share, the much-vaunted U K pharmaceuticals sector turns out to be no larger than the German, French or Italian pharma- ceutical sectors and much smaller than the Japanese sector. National sectors whose export success is much more muted can achieve much the same size as the U K because the culture of pill-popping is more established outside the U K and other national sectors consequently have the benefit of larger domestic markets. European countries, like France or Germany, have a domesticallj~ based sector (consisting of indigenous firms and foreign-owned affiliates) which plays the major role in satisfying domestic demand, just as in the U K where more than

Table 4 UK pharmaceutical sector exports share of UK manufactured exports

Year Manufacturing Pharmaceutical Phi~rmuceuti~~al exports seclor exports share E mill L nziN us ii %I

( ( 1 ) ( h ) ( b / a )

Sourcr: Central Statistical Office, Orerseas 7rrrdc S~r~tistzcs, London: H M S O Note Pharmaceutical exports include all those in category PQ2570 and manufacturing exports include all those in S I T C 5-8.

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564 Julze Fwud et al.

Table 5 National shares of world pharmaceuticals output, 1994

Countrj) Share of world output

U S A 30 Japan 22 Germany 7 France 7 UK 6 Italy 6 Rest of world 22

Source: Key Note Market Review (1995), U K Phurmureuticul Industry, London: Key Note

three-quarters of domestic demand for pharmaceuticals is met by domestically based firms. Table 5 also shows that the world's second largest national sector is the Japanese sector which has been built on import substitution rather than export success, as a variety of impediments have obstructed Western pharma- ceutical exports to Japan. While successful export from the U K is commend- able, other national sectors have used domestic demand to sustain growth.

British success is also precarious because it is based on best-selling ethical products whose replacements may not sell rather than on strong companies whose grip on production and distribution deters entrants. T h e orthodox story praises the British sector for producing more than its share of the world's best- selling drugs. According to BZW (1991) research into the world's fifty best- selling drugs of 1965-89, twenty of those drugs originated in the USA, thirteen in the UK and five or fewer in Germany and Japan. More recently, Key Note has claimed that 'of the top 20 global prescribed pharmaceuticals, five were dis- covered and developed in UK labs' (1997: 7). However, this product-led export success has created only one world-class British company. As Table 6 shows, after the 1995 merger, Glaxo Wellcome was the world's largest drug company by sales turnover. But, if we exclude the Anglo-American SmithKline Beecham, it was also the only British company in the global top ten or twenty. By way of con- trast, up to the point of the CIBA Sandoz merger, the much smaller Swiss sector had three companies in the top ten, whose combined share is significantly larger than Glaxo's.

British pharmaceuticals: high value added, average wages

T h e previous section shows how the orthodox representation of British success has exaggerated the pharmaceutical sector's weight. This section takes the argu- ment further by considering internal activity characteristics. It introduces basic data on value added and wages in the pharmaceuticals sectors of the U K and other advanced capitalist countries and cross-refers to manufacturing as a whole. It shows how U K pharmaceuticals is exceptional in that it combines high value added and average wages to benefit capital not labour.

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British pharrna~.euticals: a cuutionurll tule? 565

Table 6 Pharmaceutical company shares of vrorld market, 1995

Ranking b.y sa1e.s Conzpun.~~ M a r k e t shuve 90

1 Glaxo-Wellcome 2= hlerck 2 = Hoechst Marion Roussel 4 Bristol-Myers Squibb 5 American Home Products 6= Pfizer 6= Johnson and Johnson 8 Roche 9= SmithKline Heecham 9= Ciba 11 Rhone-Poulenc 12 Rayer 13 Eli 1,illy 14= Sandoz 14= Schering-Plough 16= Astra 16= Abbott 18 Pharmacia & Upjohn 19= Sankyo 19= Takeda Total share Average top 20 company share of world market World-wide sales revenue Average company sales

4.7 3.5 3.5 3.1 3.0 2.9 2.9 2.6 2.5 2.5 2.2 2.1 2.0 1.9 1.9 1.8 1 .S 1.5 1.6 1.6

49.8 2.5

$205 billion $10.25 billion

Source: Anuncznl Tzmes S u r v e y , 25 March 1996 N o t e Ciba and Sandoz have since merged.

Some basic relations arise from t h e double identity of value added as cost recovered in t h e product market and coat incurred through production and distribution. T h e y are reflected in t h e ways that value added can be calculated subtractively as sales revenue minus purchases or additively by summing u p the distributions of wages, depreciation, reinvestment, interest, tax, distributed and retained profits. T h u s , value added is both an upper limit set variably by what t h e consumer will pay and a requirement set by the requirements of different stakeholders as rewards for capital and labour. T h e identities are such that high value added cannot be credited with one simple significance as a desired state and index of achievement; a variety of supply and demand side conditions, including the product market and forms of competition as well as technical pro- duction efficiency and wages levels, influence the level of value added. T h e level of value added in a sector like pharmaceuticals can be most easily appraised by bench marking it against the national manufacturing sector as a whole in t h e domestic currency and introducing cross-section comparisons in a common cur- rency.

I t is also possible to make the same bench-mark comparisons in the case of

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566 Julie Froud et al.

wages in pharmaceuticals and in manufacturing as whole. In doing so, it is important to bear in mind some basic points about the relation between value added and wages. In any going concern, value-added will be normally greater than wages because the value added fund includes a surplus that covers pro- ductive renewal and payments for finance capital. Nevertheless, in advanced country manufacturing, labour normally takes a 70 per cent share of value added and the surplus for capital is usually a precarious residual: the question about any manufacturing sector is whether and how it deviates from this norm. T h e one general law is, of course, that distributive claims expand to appropriate the value-added fund that remains when purchases have been deducted from sales revenue; and, if labour claims on the value-added fund do not expand, the share of capital will increase mechanically as this is the reciprocal of labour's share.

With these points made, we can now turn to examine the evidence on the relation between value added and labour cost in pharmaceuticals and in manu- facturing as a whole in Britain and other advanced capitalist countries. In each case, the comparisons are made in domestic currencies and we use ratios to provide an intelligible comparative measure of the extent to which the pharma- ceuticals sector in each country generates higher value added or pays higher wages than the national manufacturing sector as a whole.

By this standard, in the U K and five other advanced countries, pharmaceuti- cals is everywhere and increasingly a high-value-added activity vis-a-vis manu- facturing as a whole. As Table 7 shows, in every country and in every year since 1979 the per capita value added in pharmaceuticals is higher than in manu- facturing as a whole and that margin of superiority has generally increased: by 1993 in three of the countries, including the UK, pharmaceuticals value added was more than twice as high as in manufacturing. T h u s in 1979, when the French ratio was 1.1, the value added per capita in pharmaceuticals was in this case little higher than in manufacturing as a whole; and, if we exclude Japan as an outlier, in 1979 the highest ratio and the upper limit is set at 1.7 times manufacturing value added per head in the USA. By 1993, the range of variation begins at what was the top end in 1979 and runs much higher: across six countries in 1993 pharmaceuticals value added per capita is between 1.6 and 2.9 times manu- facturing value added; while, in two countries, USA and Japan, the value added per capita in pharmaceuticals is three times that in manufacturing as a whole. T h e U K is unremarkably in the middle of the distribution for much of the period with pharmaceutical value added per capita at 1.6 times manufacturing in 1979 and 2.1 times in 1993.

If pharmaceuticals is within each national economy a high-value-added sector, its status as a relatively high-wage sector within each national economy is much less certain. Table 8 presents the data on the ratio between labour costs per capita in pharmaceuticals and in manufacturing as a whole in the same six countries. T h e pattern is different because the ratio of per capita pharmaceutical labour costs to those in manufacturing as a whole tends to long-term stability in most of the economies and the amount by which sectoral wages exceed the manu- facturing norm is also fairly modest; in most years, in most advanced countries,

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British pharmaceuticals: u cazltionary tale? 567

Table 7 National value added per employee in the pharmaceutical sector and against manufacturing

F r u n c r

Source: OECD, S ~ r u r t u r u l I n d u s t r j ~ .4nirl]~sis ( S 7 : - l h T ) Dutabasr, OECD: Paris; Eirrostut K w r Book if l n i l u s t r r ~ ~ l S t u ~ t s t i i . ~ , Eurostat: 1,uxembourg. l\rlllr~

Pharmaceuticals includes all activity in ISIC 3522 and manufacturing all activit! in ISIC 3. Employ- ment includes all employees, full and part time, not adjusted to full-timc equivalent. .ill1 compari- sons arc of real value added per employee in 1995 prices in domestic currencies; deflated using a national consumer price indcv taken from the IMF Yearbook r ! f ' F ~ n u n c i a l S t u t i s t ~ c s . Value added is calculated subtractively as gross output minus purchases and stock adjustments representing the contribution of each sector to GDP. 1990 total for Italy refers to calendar year 1989.

the ratio of per capita labour costs in pharmaceuticals to those in manufactur- ing as a whole is in the range 1.3 to 1.5 times manufacturing as a whole. 'The two exceptions are Italy where the wage premium is substantially higher and the UK where the wage premium starts lower and then moves towards the norm of 1.3 to 1.4. Ratios of this sort do not mean that pharmaceutical sectors pay those doing comparable work more than they would obtain if they worked elsewhere in national manufacturing. T h e pharmaceuticals workforce is heavily biased towards white collars and white coats with most of the workforce engaged in selling, administration and research and development rather than in manu- facturing: in Glaxo in December 1995, for example, the world-wide workforce numbered 54,000 but only 19,000 or 35 per cent worked in manufacturing oper- ations. In such cases, the wage premium presumably mainly reflects a bias in the composition of employment. T h i s is more or less what might be expected in the case of any small sector operating in a large host economy: a small, high-value- added sector should be able to obtain as much labour as it needs without paying more than the national average rates defined by more mundane performers.

Consequently, British pharmaceuticals, like pharmaceuticals in other advanced countries, is not so much high value added/high wage as high value added/high capital share. T h i s is the logic of the national economies described in Tables 7 and 8 where the ratio of per capita pharmaceuticals value added to manufacturing value added is generally rising and always higher than the ratio of pharmaceutical wages to manufacturing wages. T h e benefits are appropriated by capital in the form of a generous surplus. T h e capital share is simply the reciprocal of the labour share shown in Table 9, so a low labour share implies a

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Table 8 National labour cost per employee in the pharmaceutical sector and against manufacturing

It.6

Liru ratio m to

mJk

59.8 1.7 63.6 1.8 76.9 1.9 n/a n/a

Yen ratio m to

mj'i

A ratio '000 to

m f i

US

$ ratio '000 to

nlf'i

52.0 1.2 55.5 1.3 60.8 1.5 64.1 1.5

Source: OECD, Structural Industi:)~ Anal]~sis (STAN) D~tubase, O E C D : Paris; Eurostat, Yearbook of Industvial Stutzstzcs, Eurostat: Luxembourg

Note National labour cost pcr employee is calculated by dividing numbers employed in manufacturing (ISIC 3 ) and pharmaceuticals (ISIC 3522) into total labour cornpensation which includes wages and the cost of supplements such as employer contributions to pension schemes or health insurance.

high capital share. T h e norm of 70 per cent for manufacturing as a whole immediately appears to be something of an oversimplification: the national average does range between 65 and 75 per cent for most years in the U K , USA, Germany and France, but labour's share in manufacturing as a whole is con- spicuously lower in Italy and Japan where it hovers around 55 per cent in recent years. T h e other notable tendency is that, increasingly, the labour share in the pharmaceuticals sector tends to be lower than in manufacturing as whole. Although the pattern was initially different in French and Italian pharmaceuti- cals, these countries have now joined the rest which have traditionally run with labour shares 10-30 per cent lower than in manufacturing as a whole. In Japan and the USA, pharmaceuticals has always been a capitalist's dream because the Japanese pharmaceuticals sector has traditionally run with a labour share of less than 30 per cent and the American share has fallen to less than 35 per cent. From this point of view, the British are again in the middle of the rankings with a phar- maceutical labour share which is not falling but gratifyingly low at 48-56 per cent, in an economy where the labour share in manufacturing as a whole is usually over 70 per cent. Thus, a pharmaceuticals business in the UK has been a licence to pay dividends which delight shareholders.

If the national figures for pharmaceutical wages and value added are trans- lated into a common currency, they provide another supplementary perspective on the comparative advantage of British pharmaceuticals. Generally, cost and value added calculations in terms of domestic currencies are more reliable because time-series common currency comparisons are biased by the effects of currency appreciation and depreciation. However, the data presented in Tables 10 and 11 are interesting because they show that, after translation of pharma- ceutical per capita value added and labour costs into ECU, the British sector

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Brilish plzurrnacez~~zcrrls: 11 c r r u t i ~ n a r ~ ~ i t u l e 569

''xble 9 I n t c r ~ l a t i o n a l c o m p a r i s o n s o f labour's s h a r e o f value a d d c d i n p h a r m a c e u t i c a l s a n d m a n u f a c t u r i n g

Ph. , M ( / n . "0 "0

Ph. ,$Tan. Oo ('1'

7 0 . 7 59.5 58.5 55.6 6 4 . 7 5 5 . 4 n / a 56.0

S o z ~ n . r s : OECI), S / r ~ c i . i u r ( i / I N [ / L I S / I . ] J -Incr/)~rrs (S7: l.\) L ) I I I N ~ I I S I , , O E C U : Paris; Eurostat, Yearbook q / ' I n ~ l r r s / r r u l S ~ o t ~ s r l i r , Eurostat: Idu~einbourg.

.l ntr PI1 = pharrnnceuticals, h l a n = rnanuficturing. 12abour's share of \ d u e added is calculated h! di\iding total labour compensation (including eniplo!cr pension contribution and health insuraslce) into \alue addcd in the acti\ity categories of ISlC 3522 (drugs aiid medicines) and ISIC: 3 (munufiucturing). Value addcd is calcul,~ted subtrac- tile]! as gross output minus purchases and stock adjustments. 1990 total for Itall refers to calendar !ear of 1080.

occupies a different position in the league tablcs of value added and labour costs incurred. In both cases the fiftecn-year series shows that there is a first and second division in terms of costs rccovered and labour costs incurred and some movement between the di\-isions. T h e British never make it into the first div- ision, but, interestingly, are differently placed in tllc second division of value added and costs. T h e value-adding performance of the different national sectors she\\-S a very wide nriation partly because prices and cost recovery are very different in various a d u n c e d country markets and each sector primarily feeds its domestic market. As 'I'able 10 shows, Japan and the USA are in a premier league of their own. T h e British sector lags behind the rest of the second div- ision but does so by a modest margin and in some years, such as 1990, British value added more or less equals that of French and Italian pharmaceuticals and is only l 5 per cent behind that of Germanj. As Table 11 shows, in terms of per capita labour costs incurred in ECU, the pattern of variation is also fairly pre- dictable. It is hardly surprising that, partlq- due to yen appreciation, the Japan- ese pharmaceutical sector joins Germany and America, the established payers of high industrial wages. Nor is it surprising that the UK pharn~aceutical labour costs per head are, in ECU, always substantially lower than those in France and Italy, as well as in Germany: in 1993 German labour costs were 42 per cent higher and French costs 35 per cent higher. With nearly average cost recovery and u~ell below average labour costs incurred, the U K pharmaceutical sector was set up to provide a large margin for capital.

O n this evidence, the stakeholders who do well out of pharmaceuticals are not wage earners but shareholders. O u r previous section showed how the U K pharmaceutical sector is too small to counterbalance poor performance

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570 Julie Froud et al.

Table 10 National pharmaceutical sector value added per capita in ECU

F r a n c e G e r m a n j ~ I t a l y J a p a n U K US - - -p--p

1979 22.3 33.4 18.8 36.7 16.2 33.5 1985 40.7 49.0 44.6 84.6 43.9 123.5 1990 56.8 65.0 57.9 118.1 56.8 111.5 1993 82.4 75.4 n/a 167.3 66.1 153.2

Sources: OECD, S t r u c t u r u l I n d u s t q ~ .4nal~1sis ( S T A N ) Dutuhusr, OECD: Paris; Eurostat, Yeurbook ~J'Industrial Stuttstzcs, Eurostat: 1,uxembourg

N o t e T h e pharmaceutical sector includes all activity in ISIC 3 5 2 2 . Number of employees includes full and part time with no correction for full-time equivalent. Value added is calculated as gross output minus purchases and stock adjustments. Converted into ECU at the relevant yearly rate taken from Eurostat Yearbook r!flndustrial Stulistics. 1990 total for Italy refers to 1989.

Table 11 National pharmaceutical sector labour costs per capita in ECU

F r a n c e G e r m a n y I t u l y J a p a n D-K U S

Sources: OECD, S t r u c t u r a l Industy11 Analyszs ( S T A N ) Database, OECD: Paris; Eurostat, Yearbook yf lndustrzul Statistics, Eurostat: L~uxembourg

'V0 tc T h e pharmaceutical sector includes all activity in ISIC 3 5 2 2 . Number of employees includes full and part time with no correction for full-time equivalent. Value added is calculated as gross output minus purchases and stock adjustments. Converted into ECU at the relevant yearly ratc taken from Eurostat Yrurhook q f Industrial Stutzstzcs. 1990 total for Italy refers to 1989.

elsewhere. This section suggests that the causal arrows run the other way, as shareholders in UK-based pharmaceuticals companies benefit from the more general British manufacturing failure which makes it possible for a small sector in Britain to employ good labour for less money than in other European coun- tries. In the next section we look more broadly at the part played by structural conditions in the sector's expansion of the 1970s and 1980s.

Structural conditions of British success

T h e story of success suggests that pharmaceuticals is driven by knowledge in the form of research and development labs and men in white coats. But, closer examination of context and activity characteristics suggests that the U K sector was structurally sustained by unusually favourable demand conditions at home and abroad which were exploited by aggressive marketing. T h e long boom which

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ended in thc early 1970s carried on into the late 1980s for pharmaceuticals and, throughout that period, the typical pharmaceutical employee was not a labora- tor!- researcher but a sales representative.

As background, it is important to recognize that the British success was achieved by that part of the sector which consists of household-name companies that concentrate on ethical pharmaceuticals, that is, products which are in patent, marketed under brand name and available only on medical prescription whose cost is generally covered by social or private insurance. Ethical pharma- ceuticals should be distinguished from generics, which are out-of-patent substi- tutes made by various firms to one standard formula, and from over the counter (OTC) medicines which are branded medicines available without prescription at pharmacy counters likc any other consumer product. With the exception of Glaxo and Merck, the major drug companies have important OTC businesses, but they all make most of their money from ethicals, the products which account for British success. T h e pattern of specialization is important because firms which produce ethicals operated under unusually favourable structural con- ditions through the 1970s and 1980s when their success was underwritten by social expenditure and the value of company property rights in individual drugs could be maximized by aggressive marketing.

I n ethicals, the long boom continued globally for two decades after its general curtailment in the mid-1970s. T h e market for ethicals was effectively confined to the high-income capitalist countries in Western Europe, North America and Japan, which together accounted for 90 per cent of world consumption (Key Note 1995: 10). Throughout the 1970s and 1980s, this market for ethicals grew at double figure rates each year without any cyclical downturn. Successful ethical companies could hope for growth rates of 20 per cent per annum. T h e buoyant market was generally supported by some form of socialized medicine in these countries: mass medication was paid for through social insurance in Western Europe and corporate welfare or private insurance elsewhere. These monop- sonistic purchasers of ethicals never fully exercised their bargaining power because drugs account for a small proportion of total health care costs in systems where labour costs are dominant: as Table 12 shows, pharmaceuticals account for no more than 11 per cent of all National Health Service expenditure in the UK and the share of ethicals is significantly lower. Crucially, the social pur- chasers also created a huge marketing opportunity for drug companies by allow- ing the prescribing doctor an unfettered choice of ethicals. Under social medicine the patient consumes what the doctor chooses and the State or private insurance picks up the bill: in the early 1990s, the National Health Service paid for 84 per cent of all prescriptions in the UK (Key Note 1993: 104).

All the advanced countries have some form of regulatory scheme intended to limit the prices charged to social agencies and to curtail the profits made by ethical companies. None of these, until recently at least, has been particularly severe. In the UK, the Pharmaceuticals Price Regulation Scheme (PPRS) has, since 1957, provided the companies with an unusually favourable environment. 'I'he British PPRS is unique because it regulates, not price, but return on capital

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572 Julze Froud et al.

Table 12 National Health Service expenditure on pharmaceutical services

Year filrrl N H S N H S expenditure Mer/ici?zes I n d e x r!f'e.vpenditzrre e.vpenditure on medicines us PI cent on medicines

L mill m i l l r!f'total 1980 = 100 ( a ) ( 6 ) @ / a ) %)

Sources: ABPI, Phartnn: Fucts tint/ Ftgurrs, various years N o t e Includes all pharmaceuticals, generic as \!-ell as ethical, hut excludes dressings and appliances

employed (Danzon 1997). T h e permitted level of return o n capital has been generous so that the sector's rate of return is, in effect, maintained by its major customer. T h e 1988 scheme, for example, offered a 'maximum allowable rate of return' of 30 per cent. T h e current version of the scheme (Danzon 1997: 23-4) came into operation in October 1993 amid much publicity that the rate of return had been greatly reduced because the sector had voluntarily offered a 2.5 per cent price cut: the target range is now a basic 14-18 per cent return on capital employed with an extra 25 per cent allowed for companies meeting certain cri- teria about exports and spending on research and development. T h e allowable rate of return remains generous in itself when most industrial and commercial companies accept lower rates of return and the form of the PPRS scheme inci- dentally provides a direct incentive to invest and raise the capital base on which the return is calculated.

T h e favourable terms of the PPRS reflect the close relation between the spon- soring ministry, the Department of Health, and the producers' trade association, the Association of the British Pharmaceutical Industry (AHPI). A cynic might describe this relation as one of capture, symbolized by the location of the ABPI's head office in Whitehall and might also observe that this relation had attracted much less criticism than the similar one between the Ministry ofAgriculture and the National Farmers' Union, partly because the pharmaceuticals sector repre- sents itself as successful national champion. Despite the strong export orien- tation of the UK pharmaceuticals sector, the favourable terms of the PPRS are a significant source of advantage because they cover nearly half the sector's output: in 1992, over 40 per cent of national pharmaceutical output was sold to

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the National Health Service (AHPI 1993: 14) and 60 per cent of that was pro- vided bj- British-owned firms. T h e U K sector has benefited from drug prices which arc higher on its homc market than in most other advanced countries: in 1991, UK prices on a basket of drugs n e r c 25 to 30 per cent higher than in Italy, France or Belgium though lower than in Germany (Financial Times 6 November 1991). 'l'hc differential is partly sustained bl- the sector's successful defence of the British doctor's freedom to choose: against a background of favourable media comment (FinrincWI Tiines 7 August 1993), political lobb!-ing defeated a 1993 attempt by the government to extend a modest list limiting this freedom in seven categories including mild analgesics, laxatives and tonics.

Ethical companies made money out of this regime because they had intellec- tual propcrty rights in a succession of patented products which doctors could choose but competitors could not make. From the 1940s to the mid-1970s, the modern ethicals sector was built on a series of relatively straightforward bio- chemical advances which produced new products including antibiotics, tran- quillizers, respirator!- drugs and anti-ulcerants, which all created new possibilities of treatment. T h e companies prospered because the high initial profits of the innovators were protected when the! could patent new chemical entities and effectively block new entrants who nould compete profits away. It may be true, as the ABPI argues, that property rights are essential to encourage research and development whose costs cannot otherwise be recovered; it is also true that any firm which sells ethical product in volume will certainly reap a handsome return on investment. T h e prices charged for patented ethical prod- ucts are much higher than those charged for similar generic products: in 1990, while 43 per cent of UK prescriptions were filled bj- generic drugs, they accounted for only 10 per cent of the value of the pharmaceutical market ( F T Management Report 1994: 6). O n patented ethical products, 'gross margins of 90 per cent or over are common' ( F T Management Report 1994: 63).

As a result of property rights, the margins and cost structures of pharma- ceutical companies producing ethicals are sharply different from those produc- ing generic products. T h e BZW estimates, reproduced in 'Table 13, show that generic companies have cost structures which are like those of successful man- ufi~cturers in other areas like car components. But the 'international company' looks completel!- different because manufacturing costs are much lower and profit margins on ethicals are much higher in a firm which combines much higher spends on research and development to find new drugs and on selling to push existing drugs. Interestingly, thc hypothetical 'international conipam' is . . spending up to three times as much on selling as on research and development. T h i s observation raises a large question about the image of pharmaccuticals as a 'knorvledge-based' industry drir-en by research and development and the cre- ative activity of men in white coats; the reality is that marketing and sales reps are much more important objects of expenditure.

Kesearch and development is the acceptable public face of ethical pharma- ceuticals whose virtue is celebrated in the annual British corporate league table of expenditure on research and development: in 1993 four of the six top spenders

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were drugs companies (Glaxo, SKB, Zeneca and Wellcome), while the pharma- ceutical sector accounted for nearly one-third of all industrial R&D in Britain (Financial Times 17 June 1994). This large expenditure does not imply creativity when most of the newly discovered products are imitative variants on existing products and most of the expense is in development (not research). T h e early 1970s were a creative high-point for the UK pharmaceuticals but, in 1972, of 1,500 products patented in the United Kingdom, forty-five were classified as 'genuinely new', 150 as 'major innovations' and all the rest as imitative variants which were molecularly distinct but therapeutically identical (Hancher 1990: 51). Not a bad record, but far from the impression the sector wishes to give. Equally pertinent is the fact that research typically accounts for less than 10 per cent of total research and development expenditure with development in the form of product testing accounting for all the rest. Development, from synthe- sis to first launch, typically takes ten to twelve years while clinical testing of safety, dosage, efficiency and side effects typically takes about five years (FT Management Report 1995: 32).

T h e unadvertised reality is that aggressive marketing of product is certainly the major object of expense and probably the main lever of advantage in ethical pharmaceuticals. This hardly registers as a public political issue because the ethical marketing effort is invisible to the patient when it concentrates on influ- encing the doctors who write prescriptions. All informed observers agree that ethical companies generally spend twice as much on marketing as on research and development. Many of these ethical companies are also aggressively pro- moting O T C products for headache, indigestion and such like, with adverts pitched to final consumers as well as pharmacists. As a result, the international pharmaceuticals business of the top twenty companies is best envisioned as a gigantic conversion machine which turns social and private expenditure on drugs into salaries for sales reps and copy writers. U p to one-third of the total global spend on ethicals and O T C is used to fund marketing and maybe half of that goes on the salaries of sales reps. One recent estimate suggested that drug companies spend one quarter of their sales revenue, or $60 billion world-wide, on sales and marketing (Financial Times 24 March 1994); another estimate put the percentage slightly higher at 26 to 30 per cent with half of that total going to the sales force (EIU 1994: 20).

Insofar as ethical pharmaceuticals is a marketing-led, imitative activity, it is typical of the property-rights business where the usual recipe for success is not

Table 13 Company cost structures in international pharmaceuticals and generics

Generic International

Cost of sales: manufacturing 70% Selling and general administration 15% Research and development 3% Profit margin 12%)

Source: BZW (1991: 162-3)

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Brztzsh phnrmuceutzcals: a cautaonarjl tale? 575

fundamental innovation but secure patents on the right imitative product plus effective marketing to create a reference product. In this respect, the success of Microsoft with DOS and Windows is not so different from that of Glaxo with Zantac which became the world's best-selling ethical drug of the 1980s. In this area, the fundamental advance was made by SmithKline whose Tagamet was the first effective anti-ulcerant in the marketplace. Zantac was a direct copy and use- fully a clinical improvement which allowed it to command a higher price. Zantac was then patented to prevent direct competition for fifteen years during which it was effectively marketed. Glaxo used Hoffman La Roche's sales network to get Zantac into the crucial American market where it had no distribution. Else- where, Glaxo responded to marketing research which suggested a correlation between sales volume and the number of calls made by a sales representative: in the UK, where drug companies would typically employ 100 reps to visit doctors, Glaxo came to use 800 (EIU 1994: 18-19).

Against this background, it is easier to understand why British-based ethical companies of the 1980s should have been more successful, certainly in export markets, than many competitors who enjoyed similar structural advantages. This was an activity which did not require productive mastery in the form of factory technik or ability to co-ordinate a supply chain: in businesses, like cars, where these competences mattered British managers did badly. But, insofar as market- ing skills were crucial to pharmaceuticals, this was an activity peculiarly suited to British (or American) skills; the success in pharmaceuticals is coherent with Britain's established strength in retailing and all the different forms of trade and direct selling.

Conditions of restructuring

T h e imagery around high-value-added activities suggests they can be a refuge for the retreating advanced countries. UK pharmaceuticals shows the reality is more complex. In the early and mid-1990s, the UK sector was caught up in a global wave of corporate restructuring and defensive mergers in pharmaceuti- cals, which is at least as prone to restructuring as other less glamorous sectors. As this section argues, in pharmaceuticals the cause is not the absence of profit but the difficulty of maintaining and increasing high profits in a volatile busi- ness as structural conditions deteriorate.

Globally, pharmaceuticals remains a fragmented sector. T h e world's three leading drug companies of 1995 (Glaxo Wellcome, Merck and Hoechst Marion Roussel) each had market shares of less than 5 per cent and the average top twenty drug company had a 2.5 per cent market share. In 1994, the top twenty companies together accounted for no more than 50 per cent of the total global market (Financial Times 30 September 1994) and there were no fewer than fifty drug companies with annual sales of more than $1 billion (Financial Times 22 August 1995). In these years, the sector was also consolidating rapidly through merger and acquisitions. Table 14 lists the main deals in the two peak years of

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1994 and 1995 when the purchasers spent four times as much on buying other pharmaceutical companies as they did on research and development.

At the global level the restructuring has taken two main forms: first, defen- sive horizontal merger between ethical companies; and, second, joint ventures taking companies into related health-care business to reduce dependence on ethicals. Defensive merger started in 1988-9 when Bristol Myers Squibb joined Rhone Poulenc Rorer, and SmithKline acquired Beecham. In the 1990s, it con- tinued with significant acquisitions by major companies which, in the peak years of 1994-5, included Marion Merrell Dow by Hoechst; Syntex by Roche; Well- come by Glaxo. These were paralleled by mergers between medium companies such as Pharmacia and Upjohn. T h e second trend of diversification out of ethi- c a l ~ was given a major impetus in 1994 when Merck spent $6 billion o n Medco Containment Services, a wholesaler and agent for hospitals and health manage- ment organizers. SKB and Eli Lilly have since made similar moves into distri- bution, while Bayer, BASF and Hoechst have moved into generics and SKB into over-the-counter sales (Financi~cl Tirnes 25 April 1995).

Historically, the fragmentation of the sector had been a condition of success for the British-owned firms who had traditionally accounted for more than half the output of the British sector. In the 1960s and 1970s, pharmaceuticals was one high-technology activity where the Americans could not shut the door on the British as their market-dominating firms did in aerospace or computers. Consolidation in the 1990s was more threatening as, almost incidentally, the British-owned part of the sector merged and disappeared. Boots sold its pharma- ceutical business to BASF and Fisons sold out to Astra and RPR (Financial Times 18 March, 8 April, 28 August 1995). Zeneca, recently created through de-merger of ICI, was left as the only surviving independent medium-sized British company, around position 20 in the international league table of companies and widely regarded as a company whose days of independence were numbered (Financial Times 28 August 1995). LVellcome, another medium-sized player, was acquired by Glaxo to create what was then the world's largest drugs firm.

This restructuring is triggered bp deterioration in hitherto favourable product-market conditions. T h e most obvious symptom is a decline in the rate of growth of the international market for pharmaceuticals. Until the early 1990s annual growth rates had long been 10 per cent plus; the 1994 rate was in the range 6-8 per cent (EIU 1994: 10) and projections envisaged 4-5 per cent per annum in future. Slower growth has been accompanied, and partly caused, by a general tendency to place greater curbs on expenditure on drugs. At national level, governments and companies which pay the bills are beginning to press down on prices. For example, reforms introduced in Italy at the beginning of 1994 aimed to reduce the bill for drugs by 30 per cent and progress had been made in this direction by the end of the year ( F T Management Report 1995: 24).

T h e general attempts to control health-care costs encourage the increasing substitution of generics for ethicals: mid-1990s estimates suggested that Euro- pean sales of generics would double to L12 billion by the year 2000 (The

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Table 14 Pharmaceutical merger and acquisition activit!; 1994 and 1995

Dute PIITL./ZNSCI. 7irl:qel Cost

4-94 R Poulenc Rorer C:oopcr FFr 2 2 . bn 5-94 Roche S!-nteu $5.3 bn - 9 SmithKline 13eecham DPS $2.3 bn 5-94 Sandoz Gcrber $3.7 bn 7-94 1,iIl~- PCS $4.0 bn 8-94 Ivax Zenith $0.6 bn 9-94 Bayer SB $1.0 hn 4 AHP Cynamid 969.7 bn 9-94 BhIS UPSrl $0.7 bn 11-94 Ciba Chiron $2.1 hn 12--94 Pfizer SB $1.4 h n

1994 Year's deals S37.9 hn 9 4 1994 purchasers K&D spend 38.3 bn 1991 Pharms \\orld R&Ll $30.0 bn

9 <:olgatc .%HP $1.04 bn 1-95 Cilaso Lliellcomc $11.8 bn 1-95 Glavo .%f'f!max SO..i3 bn 2-95 Hoechst h l M D $7.14 bn 4-95 R A S F Boots l'harm S1.i hn 4-95 Watson Circa $0.6 bn 7-95 Clariant Sandoz $2.0 1x1 - 9 . Pharmacia and Upjohn hlerger 8-9.5 KPR Fisons $2.7 bn 11-95 J a n d J Cordis $1.8 bn

1995 Year's deals 1995 purchasers R&D spencl

19Ki Pharms world R&Tl

Soiil-~-es: k'~:r,zalzr.i~rl T ~ m r r , Survey of 2.i Rlnrch 1906; FT Management Report, l905

Rcot~ointst 30 September 1995). T h i s internal competition from out-of-patent products undermines the premium pricing of newer products. I n the United States generics already account for 10 per cent of total prescription units, though only 12 per cent of dollar market share, and t h e effect is that new drugs 'have to be discounted to gain market share' (The Econonzist 30 September 1995). T h e effects are evcn more marked for established ethicals when rival products become out of patent: in ACE inhibitors, Merck expected market-leading Vasotec would be seriously affected when Bristol Myers Squibb's Capoten came off patent ( F i n n n c i ~ i l Times 28 M a r c h 1994).

If the ethical companies were getting less effective protection from intellec- tual propert! rights by the early 1990s, this partly reflected their apparent inabil- ity to produce major biochemical advances despite increased expenditure o n research and development. Pharma Consultants estimate that companies are now spending 16 per cent of sales revenues on innovation, more or less double

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578 Julie Frond et al.

the 1970s proportion, while Merck's chief executive claimed that the sector expenditures on research and development had been growing at 14 per cent a year for fifteen years Uordans 1993: vii). If effort was rewarded with new dis- coveries, the financial benefits would come through only slowly because of another structural shift as clinical trials are now taking much longer and cost more. Estimates of the current cost of bringing a product to market range from $255 to $369 millions (EIU 1994: 17) and costs are high partly because clinical tests which took an average of seven to ten years in the 1970s took ten to twelve years in the 1980s ( F T Management Report 1995: 32; Key Note 1995: 7).

If ethical companies faced less favourable product-market conditions in the mid-1990s, these conditions were still much easier than in most other activities where regular 5 per cent per annum growth is a dream. T h e product-market con- ditions were a problem in pharmaceuticals because they interacted with company-level problems about revenue volatility and difficulties about meeting the stock market's expectation of high and rising returns. These problems are worth analysing because they are typical of those faced by firms whose earnings depend on intellectual property rights in fast-moving sectors.

Revenue volatility is not a new problem. Before the 1970s blockbusters gave many firms a large protected income stream, the Hinchcliffe Committee of 1959 summarized the general view when it concluded 'there must be very few indus- tries in which a market can be lost as quickly as in pharmaceuticals'. I n many traditional industrial sectors, firms typically gain and lose market share and sales revenue gradually as installed capacity limits, dealer networks and brand loyal- ties act as stabilizers. Thus, after two decades of retreat before Japanese compe- tition, in the late 1980s the American big three auto producers still held two-thirds of the U S market and were well placed to fight back. In pharmaceu- ticals, the reliance on patents and property rights is a double-edged weapon and a destabilizer because effective patent protection can quickly generate huge rev- enues which vanish even more rapidly when patents expire. As a generalization, 'on losing patent protection, branded ethical drugs annually lose up to 50 per cent of sales within two years to cheaper generic competition that could cost as little as a quarter of the branded drug' Uordans 1993: xi).

T h e volatility problem arises in most acute form for small or medium com- panies with limited portfolios which fail to find replacements for previously suc- cessful drugs. T h e classic case of the 1990s is Syntex, an American company with 10,000 employees and sales of $1.8 billion, mostly accounted for by its anti- inflammatory drug Naprosyn. When the Naprosyn patents expired in 1993, within four months sales fell by 50 per cent and Syntex had no alternative but to sell out to Roche (Financial Times 4 May, 17 June 1994). Similarly, the much smaller Boots Pharmaceutical had to sell to BASF when its replacement product, the heart drug Manoplax, failed in clinical tests after fourteen years and E l 0 0 million had been spent on development (Financial Times 20 July 1993). Even major companies are vulnerable if they depend heavily on ageing blockbusters as Glaxo did in the early 1990s. T h e one drug Zantac accounted for L2.5 billion of sales in 1993 and in the second quarter of 1994 generated 43 per cent of all

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Brztzsh pharrnacez~tzcals: u cautzonar), tale? -579

Glaxo's sales revenue. At this point it was clear these revenues could not be sus- tained; within eight months of losing patent protection in Germany, Zantac lost half its sales to generic copy cats and its main rival Tagamet, which was fully out of patent, had lost three-quarters of its sales to generics inside the year (SKB company communication). Glaxo's best-selling anti-asthma drugs Becotide and Vcntolin W-ere also close to expiry and possible replacements - such as Zofran, Immigran and Serevent - seemed incapable of filling the sales gap (Finrtizcial T i i ~ z e s 9 September 1994). At this point, the purchase of another company, like Wellcome, was necessary if the shareholders and the capital market were not to be disappointed.

In relation to the capital market, British (or American) companies like Glaxo with PLC status arc victims of their own eariier success, impelled to try and find through acquisition the increases in earnings and distribution which once came from organic growth. Successful quoted pharmaceutical companies accommo- date good fortune and create shareholder value by making large and growing distributions to shareholders in a sector where share prices have risen more than twenty fold since 1977 ( F i n a n c i a l Ernes 5 January 1998). T h e distributions are difficult to maintain or increase under current conditions when research and development shows diminishing returns in the long term and aggressi\-e mar- keting is required to generate revenue in the short term. 'Ijbles l 5 to 18 illus- trate these problems by presenting basic data on Glaxo, SmithKlinc Beecham and Zeneca.

In the early 1990s, Glaxo's operations were hugely cash genera tic.^ because it was 100 pcr cent ethical and, thanks to Zantac, this yielded thc best ratios in the business; with a purchase/sales ratio of around 40 per cent and a labour share of under 40 per cent, Glaxo generated 40 pence in the pound as cash or roughly twice as much as S K B and Zeneca which combine ethicals with other activities.

Table 15 Operating ratios for Glaxo, SKR and Zer~eca

Glrwo SrrrilhKlirre Beechrrm Zcvzccrt

C i i l z r ~ Lrzhnrrr i. birlur Lalloz~r :S CLLILLP /.~hour k irilrlcil 10 shrrre of' trdded t o share qf' it~lrked t o s/zilre r!f

.sales E4 srrlrs (96) VA .s[11es (9:)) I.:4

Sozri.~~e: C:ompan! annual report and accounts Ante Value addcd (K.\) is calculated additivel? as labour costs (including social charges) plus depreciation and operating profit. I,'~hour costs include social charges such as pension contributions and National Insurance contributions.

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580 3ullr Fraud et al.

Table 16 Cash generation as percentage of sales in Glaxo, SKB and Zeneca

1989 42.8 1990 44.0 1991 42.2 1992 39.5 1993 38.5 1994 3 7 5 Average 40.8

Sonue: Company annual report and accounts

'\~Otl, Cash from operations is defined as opcrating profit plus deprcciation.

Table 17 Dividends as percentage of value added and sales at Glaxo, SKI3 and Zeneca

Glrr.uo SmithKline Bec~~.ham Zet2ecu p--- -.p- --

Dzuihnds Dit'irlenrls Diuidenrls Diz~idends Diz.iden~ls Diridenlis ris a (% /i/' rrs a W) q /' S I h I S I 1 I as rr 96 qf' as rr 96 oJ'

sa les P54 sirle.~ Cl4 sales K4

Sozrrc~,: Company annual rcport and accounts .h'-(/ t L > 1 ) i ~ i d c n d s arc those paid to ordinar) shareholders, as reported in the annual accounts.

Table 18 Research and de\elopment as percentage of \ d u e added at Glaxo, SKR and Zeneca

G l r ~ 4 11 SnzzrhKlznr Beeclzam Zelzer cl

1989 19.7 18.2 n/a 1990 22.1 17.1 n/a 1991 21.1 17.8 n/a 1992 23.2 18.0 29.9 1993 23.9 19.1 26.7 1994 25.1 24.1 26.3

Sozrrcr: Company annual rcport and accounts

i l ' n te Rcsearch and de\elopment expcnditurc is discloqed in the notes to the relevant accounts.

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TI:ables 17 and 18 show how Glaso accommodated its good fortune b j a distri- bution of value added as dividends which was well above the a\-erage for the sector and accounted for 25 per cent of value added in 1994. Glaxo's spending on research and development \$as merely average for the sector but that accounted for another 25 per cent of value added. T h e composition of employ- ment, with three times as many engaged in sales and administration as in research and development, suggests that Glaxo may spend up to half of I-alue added on marketing. Every penn! in ever>- pound of revenue is applied to cspen- ditures which cannot be cut back without hazarding current or future sales revenue or compromising the stock-market valuation of the company whose price/earnings ratio reflects the expectation that past increases in di\-idends can be sustained in the future.

From this perspective, it becomes easier to understand the motives behind defensive horizontal merger because in this case two into one \vill go, to leave better ratios with some improvement in cash generation and useful gain in dis- cretionarl- margin. 'The onlj. precondition is that there must be some scope for rationalizing two overlapping R&D operations and t n o marketing networks. T h i s was the motive behind Glaxo's acquisition of LVellcome which manifestly did not solve Glaxo's major strategic problem about patent expiry because Zovirax, Wellcome's best-selling herpes treatment, was (just like Zantac) close to patent expiry (Fiizancial Tirrzes 27 January 1995). It is less casy to see the attrac- tions of diversification out of ethicals into other health businesses which (except in Glaxo and Merck) already account for 33-66 per cent of sales turnover. Table 19 shows that SKH's cash generation is twice as high in pharmaceuticals as in its two other divisions, with performance limited by health care and clinical labora- tories that account for 40 per cent of sales. Adding to the non-ethical divisions may deteriorate the ratios but it will normally increase the lump of sales revenue and value added from which the distributions must be made; and the earnings from businesses like OTC, while unspectacular, are verq- steady and likely to stabilize firms which fear revenue instabilitv in pharmaceuticals.

Such defensive restructurings do not of course address any underlying problem. Defensive sackings and bolt-on acquisitions will not keep the stock market happy for long and more restructuring will be required in due course. By early- 1998, this point had been registered in brokers' circulars which were full of gloom about patent expiry Kearney complained that companies which took part in the 1990s acquisition spree generally had 'lower economic returns' and attributed the exceptional success of the L4merican Home Products takeover of Cynamid to 'the most ruthless cost cutting of any company involved in the sector' (Financial Times 5 January 1988). In this respect, again, pharmaceutical firms are not different and better as the imagerq- suggests. In terms of consoli- dation, the restructuring of pharmaceuticals in the mid-1990s recalls the British manufacturing mergers of the late 1960s, when GEC and BLMC combined defensively by putting together different firms from the same industry in a way which bought time but solved nothing. Maybe pharmaceuticals is not so much the future as thirty years behind the rest.

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582 Julie F~ozid et al.

Table 19 Divisional cash generation at SKB - - ppp~p

Sales Tmdzng Depreciatzon Operatirlg Operutitzg ( A mill) pr@ts ( E mzll) cash cash per A

( E mill) ( m ) r[ sales (p)

P h a r m a c e u t i c a l s 3612 926 167 1093 30.26 Health care 1431 199 28 227 15.86 Clinical labs 834 99 21 120 14.39

Source: Companl- annual report and accounts Note Depreciation for each division is estimated on the basis of each division's share of total trading assets in 1904. Cash from operations is defined as operating profit plus depreciation.

A cautionary tale

Those who analysed pharmaceuticals success in the 1980s and 1990s were inter- ested partly because they wanted to learn the lessons of success: 'if only it was clear why Britain spawned such success, it might be possible to apply the lessons to other sectors . . . such as electronics or engineering' (Guardian 24 January 1995). T h e argument so far provides a double answer to this question about the lessons of success.

T h e first lesson is that there is no simple transferable formula because, although the activity of pharmaceuticals is much less different than most com- mentators suppose, it did operate under unique structural conditions which made cost recovery much easier. T h e second lesson is that Britain's international success came in an activity which rested on the abridgement of competition and its channelling into forms (such as marketing) which perhaps better fitted British management strengths: in this respect, the parallel and similarity between British international success in pharmaceuticals and the sheltered success in retailing is striking. This second lesson must seem paradoxical to those brought up on the orthodox economic rhetoric about competition improving perform- ance and the more competition the better. On the evidence of pharmaceuticals, the bias in favour of competition is too simple by half.

If the pharmaceuticals case is fascinating, it is also not unrepresentative of the range of activities which are conventionally bundled together as knowledge- intensive, high-value-added activities, from Microsoft to defence contracting. Apart from the doubts raised earlier about the validity of this bundling, none of these sectors has the weight and significance to compensate for the deficit of good jobs created by the waste of medium-tech manufacturing employment in the high-wage countries, which is the conjunctural result of saturated and cycli- cal durables markets combined with the onset of low-wage competition. Many knowledge-intensive sectors have high capital shares which limit their capacity to create and sustain employment, while any employment created is likely to be on the tcrms and conditions defined by retreat and flexibilization in other sectors

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of t h e economy. All of them are vulnerable if not unstable because these firms and sectors re-combine, in variable and unstable form, one or more of t h e three characteristics which pharmaceuticals united: marketing, intellectual property rights and a relaxed purchaser. O u r argument about the o n e sector t h u s raises questions which are relevant to them all.

T h e general assumption of those who praise these activities is that technology, skills and knowledge are not only a direct barrier to entrq; but also the basis for autonomous, self-sustaining success. T h i s is simply not so in sectors like pharmaceuticals whose success from early 1970s to early 1990s reflected struc- turally favourable conditions which sheltered this o n e sector from the forces which wasted t h e rest of British manufacturing, without fostering any distinc- tive internal innovative capability which would secure the output and employ- ment base in t h e long term. T o that extent, British pharmaceuticals is less a brilliant success than a cautionary tale.

Julze F r o u d a n d K u t e l Pfillzunzs

Unlz'er.szty of Mrcnchestev S u b h d e z J o h u l u n d C o l z n I T a s l u m

Royul H o l l o w a y , U n z c e r ~ z t y o f L o n d o n R o h e r l Wzllzc

&.st L o n d o n D n l c e r s l t y

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