Healthcare mergers are topping headlines as what the Economist calls “meandering giants.”[1] Most recently, CVS Corp. acquired Caremark Rx Inc. in a $26 billion acquisition agreement.[2] Some wonder whether these mergers will lead to a “meandering giant syndrome,” where companies that grow too much may “stifle innovative culture that smaller companies tend to have,” leading to loss of corporate identity and employee enthusiasm.[3] In other words, the Economist seems to be questioning whether the merger of major companies in the healthcare industry has a contemplated direction, or whether the pharmaceutical giants are “meandering” towards a possible corporate detriment. As a proposed answer to the Economist’s question, I suggest that the pharmaceutical giants are lining up as merged entities to take advantage of the economies of scale, rather than meandering aimlessly.
The Economist points to a number of factors underlying the merger of pharmaceutical giants. The research costs of new drugs are a major factor, as “the number of drugs approved has fallen by half in the past seven years as the cost of developing them has doubled.”[4] Also, “scale helps in developing novel drugs.”[5] Several smaller, previously independent pharmaceutical firms recently realized this through their mergers into larger firms, and more mergers of this type are likely on the way.[6] The latest factor, present in the CVS-Caremark merger, involves consolidating pharmacy benefit management (PBM) and drug store chains, resulting in an increased ability to negotiate lower drug prices for consumers.[7]
To better explain the CVS-Caremark merger, each company previously occupied a unique niche in the pharmaceutical industry. Caremark “buys directly from manufacturers and distributes drugs . . . by mail order.”[8] CVS “operates nearly 5,400 retail stores with pharmacies.”[9] As a merged entity, CVS and Caremark eliminate a substantial middle step of negotiations and sales between the company buying direct from the manufacturer and the company selling directly to consumers.
Considering the Economist factors and the CVS-Caremark merger together, the CVS-Caremark merger sheds some doubt on the Economist’s presentation of pharmaceutical mergers as “meandering.” If one looks solely to costs and scale, it makes sense that a larger company has more resources to invest in research and development of a variety of new drugs, thereby running the risk of “meandering giants.” Taking these two factors in isolation, pharmaceutical giants are free to meander all they want, freely acquiring other companies within their industry niche until the giants possess competing medicine cabinets housing the next potential miracle drugs but stifle corporate innovation, identity, and enthusiasm.[10] Yet, the CVS-Caremark merger takes meandering out the picture by introducing a type of vertical integration that has the potential to change the entire pharmaceutical industry.
If Caremark wanted to meander, it had more than ample opportunity to do so. PBM competitor Express Scripts Inc. also expressed an interest in acquiring Caremark prior to finalization of the CVS-Caremark deal.[11] A deal between Caremark and Express Scripts would have resulted in a combination two of the top PBMs – or a horizontal integration deal.[12] Yet, Caremark’s “refusal to permit confirmatory due diligence by Express Scripts”[13] appears to send a clear message that Caremark was not interested in a horizontal integration deal.
When asked whether Express Scripts would pursue a vertical integration deal after its horizontal integration bid for Caremark was rejected, Express Scripts’ chief executive commented that he is having “a hard time seeing a vertical model that makes sense.”[14] Yet, with CVS and Caremark eliminating the middleman between purchasers from drug manufacturers and suppliers to consumers, it is difficult to see why the CVS-Caremark model wouldn’t make sense, especially when one considers the likely benefits to individual and corporate consumers of pharmaceuticals and benefits plans. Others in the pharmaceutical industry seem to realize these benefits. Walgreens announced it had “a certain amount of trepidation about the merger” and is building from within to create a drug-benefits business called Walgreen Health Services.[15] While Express Scripts may still be reeling from rejection of its offer and from the benefits one of its key horizontal competitors may now be able to offer consumers, other pharmaceutical giants are taking note of the deal by increasing their ability to compete with the comprehensive line of services CVS-Caremark will offer.
In conclusion, the reason we should care about “meandering giants” is because, contrary to what theEconomist suggests, these pharmaceutical giants are not meandering at all. Instead, the giants appear to be engaging in carefully calculated moves of vertical integration. If the giants were meandering, we would expect to see more horizontal integration mergers which combine resources of multiple companies to better cover the increased research and development costs. However, the CVS-Caremark deal introduces vertical integration, which shows that the giants are not meandering, but engaging in an industry changing merger practice.
[1] Health-Care Mergers: Meandering Giants, ECONOMIST, Mar. 24, 2007 at ? (hereinafter “Meandering Giants”).
[2] Associated Press, Caremark Deal Complete; Name Changes, CHI. TRIB., Mar. 23, 2007 at 2.
[3] Meandering Giants, supra note 1.
[4] Id.
[5] Id.
[6] Id. (noting that “Switzerland’s Serono and Germany’s Schering, Altana and Schwarz were all sold in 2006” and that “Britain’s Astra Zeneca and America’s Wyeth and Bristol-Myers Squibb” may be the next targets for larger, acquiring firms).
[7] Id.
[8] Louise Escola, Caremark Shareholders Approve $27 Billion CVS Bid, BUS. INS., Mar. 19, 2007, at 4.
[9] Id.
[10] See supra note 3.
[11] CVS/Caremark Complete Merger, INVESTREND, Mar. 23, 2007 (page unavailable).
[12] Mary Jo Feldstein, Express Scripts’ Future, ST. LOUIS POST-DISPATCH, Mar. 23, 2007 (page unavailable).
[13] Express Scripts Declares Current Offer to Acquire Caremark “Best and Only” Offer without Confirmatory Due Diligence, LIFE SCIENCE WEEKLY, Mar. 27, 2007, at 418.
[15] Feldstein, supra note 12.
[16] Monee Fields-White, Coming Up Fast on Walgreen’s Trail: CVS Takeover of Caremark is Another Challenge for Company, CRAIN’S CHI. BUS., Mar. 19, 2007, at 4.