M&A has become an increasingly expensive method of securing new assets, capabilities and growth for pharmaceutical companies. This has been a natural consequence of the combination of an abundance of cheap capital with the relentless ticking clock of patent expiries. Cheap capital puts pressure on large firms to “do something”, and in most cases acquiring companies (at a price) can appear quicker and easier than building them. Patent expiries create the constant need for pharma companies to find profits from new products to replace those lost to genericisation. In this paper we argue that for most companies the price required to secure a company through M&A is now too high. We then suggest focused entrepreneurship as the response that will create value for the pharma companies’ owners and great medicines for patients and consumers.

Pharma M&A is too expensive for most

Over the last few years, Novasecta’s conversations with its diverse range of C-suite clients and members of its networks have been pointing to a common theme: for all but the very largest and most well capitalised companies, the amount required to pay for acquiring companies has become almost prohibitively expensive. CEOs and BD executives lament the fact that the price expected by a company to be acquired tends to make the corresponding business case involving expected future net cash flows extremely difficult to add up. So as 2016 drew to a close we initiated some deep-dive research into what is really going on with M&A prices.

To examine the trends over a five year horizon, we explored all global pharmaceutical M&A deals for which the deal size was disclosed from 2009-2011 and from 2014-2016, amounting to 254 deals and 316 deals respectively. We also analysed a subset for which the annual revenue of the acquired company was available, in order to examine the sales multiples (price paid by the acquirer company divided by the last year’s published revenue of the acquired company) as a broad proxy for the “price” a company has to pay to buy another company.

The conclusions from our research validated the insights we had drawn from our client conversations: pharma companies are executing more M&A deals of significantly higher value, paying much more for the revenue they acquire, and taking much more risk than they used to.

Deal Volumes and Values: More and Much Bigger

While deal counts have modestly increased (+20%) in the last five years, the total value of executed deals has more than doubled (2.3x), amounting to $466bn in 2014-2016. The median deal size has correspondingly jumped by 2.4x from $48m to $114m. A further indication of the increasing amount that is being paid for acquisitions is the number and size of “larger” deals, which we define as >$1bn. These represented 90% of the total deal value ($420bn) from just 19% of the deal count in 2014-2016.

Pharma M&A deal values have increased significantly, with US and EU acquirers leading the way

 The dominance of US and EU headquartered acquiring companies in recent years is striking, with US companies responsible for 60% the total value of the larger $1bn+ deals. More recently European companies have joined in, having doubled their share of the larger deal value to 33% largely at the expense of Japanese companies that almost withdrew from large deals in the last three years. Takeda’s early 2017 announcement of its acquisition of Ariad for $5.2bn was therefore a rare exception to this trend. J&J’s announcement later in January 2017 of its $30bn acquisition of Actelion is more in line with the trend: the US’s combination of deep and hungry capital markets with large listed companies that have strong balance sheets and cash to spend is hard to compete with when assets become expensive.

Pharma has to pay much more to secure revenue through M&A

We explored sales multiples as they have the advantage of capturing two related phenomena: (a) the “premium” amount that a company has to pay to acquire a given annual revenue stream, and (b) the degree to which the company is buying “hope” in the form of expected future revenue from either growing revenues from on-market products or adding revenue from R&D pipeline assets or both.

In addition to the more than doubling of deal values, our research shows that sales multiples have been starkly increasing, both over the five-year comparison period we chose (2009-2011 vs. 2014-2016) and more recently in every year from 2014 to 2016. Importantly the sales multiples have increased all deal size cohorts, which further reinforces the concept of “over-paying”, as it is not just that acquirers are taking more risk on by acquiring companies that have more to do to grow revenues.

Median sales multiples are up for all sizes of deals

It is notable from this analysis that the median sales multiples for acquiring companies that already had revenue of $1bn+ per year have increased from 2.7x to 5.2x. So it is not just that pharma companies are acquiring more risk than before: when acquiring a company that has revenues of $1bn+, one is typically acquiring on-market revenue, and pharma now has to pay almost twice as much for this privilege than they had to only five years ago. Again the more recent J&J-Actelion deal illustrates this phenomenon very well, with J&J paying around 15x revenue for a company with ~$2bn of reported revenues.

Pharma is taking much more risk in M&A than it used to

The sales multiple that acquirers pay for the companies they buy is a good proxy for how much risk that the acquirer is taking, as in addition to the “price” effect discussed above, very high multiples also suggest that the acquired company has either strong growth potential or earlier stage assets or both. In each case this means more risk for the acquirer. And acquirers are taking it on: the number of deals with 100x+ sales multiples has increased five-fold in just five years.

This has been at the expense of deals where the acquiring company has revenues and therefore usually less commercial or scientific risk. The number of lower-risk deals with less than 5x sales multiples is now a third of what it was five years ago.

The number of deals involving the acquisition of pre-revenue and early-stage companies has significantly increased at the expense of those involving on-market products and later stage assets

 In sum, M&A has become an increasingly expensive way to grow pharma businesses. If it can genuinely catalyse and improve the performance of the acquiring company, through some synergistic effect that is more than short-term cost saving, then it can make sense. But the sheer volume and value of deals being done at prices that are substantially more than only five years ago suggests this is not always the case.

Now what? Focus and Strategic Collaborations

One response to the inflation in M&A prices is to simply pay up and think very long in terms of potential return. Our experience with a diverse range of companies, particularly those that are privately held or controlled, is that this is insufficient. We live in highly uncertain political and economic times, and raiding the balance sheet for hope is a risky strategy even in good times.

The good news is that necessity is the mother of invention. Entrepreneurial pharma companies, are already responding to the M&A issue in two ways: First by focusing on what they can really do best, and second by looking to strategic collaborations with other pharma companies, where capabilities and assets can be “traded” in ways that create strength for both parties. In both cases, bespoke is best: building distinctive R&D and commercial capabilities in chosen areas of focus, and finding the right strategic collaborations to complement these, is a more reliable path to sustainable advantage than over-paying for M&A.

After years of success from fully integrated, huge and relatively closed R&D centres in the 1970’s and 80’s large pharmaceutical companies have slowly but increasingly embraced the concept of leveraging innovation from external sources to build and balance their internal R&D pipelines. This has coincided with plenty of statements of how “Open Innovation” adds value for pharma and a massive increase in partnering and networking activities and departments within companies. And yet. Open innovation is easier to put into a box and assign to a new group of executives than integrate culturally into proud and established internal R&D organisations. Management systems that are geared to progressing internal assets struggle to cope with the challenge of dealing with outside parties. In this paper we explore this integration challenge and how companies can have the best of both worlds by applying an Integrated and Open Innovation approach to their R&D and Commercial activities.

In Pharma, Open Innovation needs Closed Innovation and vice versa

The Pharmaceutical industry’s interpretation of “Open Innovation” now embraces two mindsets: an original “combine internal/external capabilities” philosophy and a more recent “open-source/free” approach. For the original idea of combining the best of two parties’ capabilities, pharma Open Innovation can legitimately be argued to be old wine in new bottles: the industry has always relied on partnerships with pharma, biotech, academic institutions and others to innovate. However the open-source/free concept is newer to pharma than it is to the software industry from which it came. Unlike with software, the basis for advantage and value creation for a pharma company is more driven by intellectual property (IP) rather than speed to reach huge critical mass. And since IP is by its nature closed not open, pharma companies are constantly wrestling with being both open and closed. We believe that pharma needs to master this open/closed dichotomy by integrating the two. It is the combination of the best that is outside with the best that is inside the company that enables the best innovation.

Since the lifeblood and biggest opportunity for value creation for the pharma industry is Intellectual Property (IP), pharma companies must find ways to gain or create IP from external partners, for example biotechs, technology providers, and academic institutions. Often the simplest path to achieve this from an IP point of view is for the pharma to acquire a biotech or academic spin-out company outright. While this is a relatively quick and clean way of accessing external assets and/or capabilities, it is not Open Innovation in its purest sense, as it basically just scales up a closed innovation system.

We define the essence of Open Innovation to be art of partnering with others rather than acquiring them. Furthermore the approach to Open Innovation can and should be highly open in terms of searching for the right partners that have external expertise and IP that could be of high value, then potentially more closed as two parties create and sign legal contracts with each other to divide up the responsibilities and value captured from the envisaged innovation. This requires an “Integrated and Open Innovation” approach, which successfully integrates innovation from outside with innovation from the inside.

Open Innovation is attracting attention and investment

Pharma companies have committed significant resources to experimenting and establishing a plethora of approaches to Open Innovation that reach beyond traditional one-to-one partnering/licensing into the world of pre-competitive consortia, sharing assets and capabilities, and investing in venture funds.

Pre-competitive Consortia

Participating in pre-competitive consortia is the form of Open Innovation that is most analogous to the open-source software concept favoured by some in the Tech industry. Institutions such as the Structural Genomics Consortium (SGC) bring companies and institutions together in an open fashion to solve tough scientific problems, while not pre-granting any IP rights to the outcomes. Similarly the European Innovative Medicines Initiative is Europe’s largest public-private initiative for speeding up the development of medicines and includes companies and institutions of all sizes. Pharma companies are also present in the Biomarkers Consortium and Pistoia Alliance and are founding members of the Italian Drug Discovery Network. As well as the shared generation of data, these consortia have been identified as a good way to grow a company’s network of academics, KOLs, and start-ups.

However since these activities are truly open, the path to IP, assets and value is less direct than other Open Innovation methods. So though it is of great benefit to scientific progress, it is harder for pharma companies to directly monetise. The consequence is that participation in terms of resources and money is generally skewed towards the largest pharma companies that have the scale that allows them to provide in-kind resources and funding for such efforts. By contrast mid-sized and smaller players have less resources and a harder time justifying the return on investment given the typically very long-term outcomes from the work as well as difficulties in securing IP.

Shared Assets and Capabilities

Many Big Pharmas are promoting direct interaction of internal scientists and biotech start-ups by locating them together in open campuses. Examples include Pfizer’s €145m investment in its Grange Castle site in Dublin and GSK’s Stevenage Bioscience Catalyst hub in the UK. Smaller and mid-sized companies are following in their footsteps.

As is the case with pre-competitive consortia, the directly monetisable outcomes from openly sharing assets and capabilities are not as clear as they are with traditional partnering arrangements. However they do have “softer” benefits in exposing scientists to outside models and thereby developing internal capabilities, as well as improving visibility for the company in the pharma ecosystem. So mid-sized companies are following their Big Pharma peers by now initiating Open Innovation efforts in this way. In December, Pierre Fabre launched its Open Nature Library that will share Pierre Fabre’s private plant collection, as well as its “expertise of the phyto-industrial value chain”. Additionally, LEO Pharma established an Open Innovation platform that provides non-binding, no-questions-asked access to a suite of their cell-based in-vitro assays.

Investing in Venture Funds

Venture funds have a window on innovation that some pharma companies can only dream of. Biotechs and academic spin-out companies are particularly interested in getting attention from such funds, and pharma has to compete with the funds for access to such innovation. So although corporate venturing has been going on somewhat under the radar for decades, but more latterly the concept of pharma working with venture partners has ramped up significantly. 19 of the top 25 pharmaceutical firms are investing directly, or as limited partners in, venture funds. These funds predominantly make strategic investments to secure access to external innovation. Like Big Pharma, a number of Europe’s mid-sized pharmaceutical companies have more latterly chosen to establish venture funds as one way of understanding what is available. Examples of such funds include Norgine, Morphosys, Lundbeck, Merz and Pierre Fabre; interestingly, all have gone it alone so far rather than investing as a Limited Partner in other funds, as some Big Pharmas have chosen to do in addition to their own corporate venturing activities.

Three important challenges for effective Integrated and Open Innovation

The reality of pharma R&D today is therefore one of a spectrum of activities with partner companies or institutions involved in almost all innovative activity, and diverse partners providing value in different ways across the spectrum:

The Integrated and Open Innovation Spectrum for Pharma Companies

The key to success is integrating these diverse methods of innovation in a way that gets the most out of each. This presents three important challenges: finding quality, embracing the outside, and managing the integration of outside and inside. All require skills and expertise internally to the organisation that have not necessarily been developed through the organisation’s history, where a culture of “success-from-inside” can take a long time to adjust.

The first challenge of finding the external quality that is needed is significant. It is often hidden in an abundance of companies and institutions and service companies that are more than happy to promote their perceived advantages but less willing to discuss their “Achilles Heels”. The sheer abundance can create complexity and overload in search and evaluate activities, both in terms of the capacity to search and the skilled internal R&D/Commercial capabilities to triage and evaluate.

Secondly, to secure value from partners that have been found in an “open” way, internal pharma executives must genuinely embrace the value of external innovation and the associated notion that innovation performed outside of their own organisations can be of higher value than innovation performed inside. If this is not a widely shared and reinforced cultural belief, internal organisations can directly or indirectly stifle partners’ innovation.

Finally to be fully integrated, pharma executives must manage the realities of multiple partners that are not fully controlled and have very different cultures, management systems and points of view. This requires leadership and influence skills as well as bespoke processes to make sure that the best is brought out of every partner that the company engages with.

Embedding Integrated and Open Innovation successfully

Addressing the three challenges of embedding truly Integrated and Open Innovation that are described above is easier said than done. The leadership, project management and partner-oriented competencies required are very different to the competencies that are traditionally developed through moving up the ranks in large R&D centres. To add to this, the sheer volume of external opportunities creates organisational complexity.

One solution to the challenges is to create entirely separate and dedicated open innovation business units or entities such as Johnson & Johnson’s JLabs and Pfizer’s Centers for Therapeutic Innovation. With Big Pharma scale this can be done, and the philosophy of creating focused and dedicated teams with all the skills needed to address the challenges is sound. However the question is how this leverages the internal capabilities that can understand and create more value from the external partners’ capabilities or assets or technologies. If these are separated organisationally, the company risks working at two speeds, internally and externally. Without internal and experienced eyes on external opportunities the risk is first that external efforts are not triaged well or given the best chance to succeed and second that internal capabilities are not constantly enhanced by wiring to the external world.

Companies must therefore foster a strong external/open innovation culture throughout R&D by carefully managing the interfaces between external innovation groups/entities and internal groups/entities, as well as the R&D-Business Development interfaces when both parties are involved in searching for partners. The interfaces challenges are particularly acute in mid-sized and smaller companies that do not have the scale to create large internal units dedicated solely to open/external innovation. But the opportunity for integrated internal/external innovation is greatest when these challenges are addressed head on rather than separated organisationally.

We expect pharma companies to continue to apply their significant R&D resources and financial muscles to search for and bring in external innovation, going out of their way to be seen as both open to outside sources of innovation and partners of choice for other companies. Not all of the investments will pay off and the integration with internal resources will be difficult, but the competition for quality innovation is so intense that the Open and Integrated Innovation that is required to succeed is here to stay.

In light of the announcement of Novartis’ and Pfizer’s Q4 results, John Rountree, was invited on CNBC to discuss innovation in the pharmaceuticals market.

John highlights the continued strategic drive towards traditional innovation, which helps companies avoid the dangers of being a “one product company” and allows them to protect themselves from the risks of patent expiry.

Traditional R&D is not the only innovation Big Pharma is pursuing, with cell and gene therapy being important future technologies that companies must be present in, but are still in the early stages technologically and commercially.

Pharma companies are compelled to innovate in order to survive, and the rewards for successful innovation are substantial. Innovation as a topic we have always focused on and one that companies should consider carefully.

As Big Pharma continues to innovate, John draws attention to the positive correlation between companies investing in innovation and their stock prices. Investors clearly believe in R&D and so do we.

Aligning R&D activities with commercial realities is an issue as old as the pharmaceutical industry itself. The importance of a commercial perspective in R&D is increasing as the downward pressure on drug prices and limitations on market access from private and public payers continue to increase. This is particularly pressing in areas where medicines do not offer differentiated advantages over existing treatments. In parallel, as pharmaceutical organisations have become more complex, regions have become more fragmented, and organisational functions have become larger, it has become increasingly difficult to ensure integrated and holistic commercially-oriented behaviour in R&D. Our experience is that this causes significant frustration in both R&D and Commercial functions, not to mention unrealised value creation. In this Novasecta Note we explore the R&D-Commercial interface and what can be done to improve it.


Every year, the pharmaceutical industry spends in the region of $140 billion in the pursuit of innovation, yet productivity has fallen consistently over the last 60 years. Much has been made of this decline, with Scannell et al. proposing Eroom’s Law –  “the number of new U.S. Food and Drug Administration (FDA)-approved drugs per billion U.S. dollars of R&D spending in the drug industry has halved approximately every nine years since 1950, in inflation-adjusted terms” (Nature Reviews Drug Discovery 11, 191-200, March 2012). Regardless of where one stands on the productivity debate, most will agree that opportunities for improvement exist within any R&D organisation, and internal effectiveness is paramount to preventing the already-high cost from soaring out of control. In this Novasecta Note, we ask how can pharmaceutical companies ensure that the increasingly expensive costs of drug development will result in assets that get patients, physicians, and payers excited?

Novasecta believes that improvements can be made by actively fostering better relationships between the right Commercial and the right R&D colleagues. Solidly connecting the R&D organisation to the realities of the market and customers can seed the development of products that will meet stakeholder needs in the future. This requires persistence and patience: it is as much a people issue as it is a technical issue, and as such delivering impactful change requires appropriate effort, focus, and a long-term perspective.

A Conversation Culture

Despite significant investments and substantial experimentation with different R&D models, the delivery from R&D of value-enhancing products that are commercially successful remains inconsistent. That is not to say that reorganisations or operational excellence initiatives lack merit – they can, of course, add value. It is simply that these approaches often fail to address the underlying problem: the culture and ethos of the organisation. How do the people who make up the company interact with one another, seek input from colleagues, and approach decision-making?

In our experience, critical decisions are often left unaddressed until a development checkpoint is reached. While these milestones are necessary for good governance, they should never become the sole forums for decision-making. Rather, major milestone gates should serve to ratify decisions made by an on-going series of conversations between the people with the relevant expertise and perspectives, armed with relevant commercial and scientific data and insight. This will create an organisational understanding of the end-to-end process of R&D and commercialisation and, crucially, bring that understanding to day-to-day decision-making.

Speaking the Same Language

It is possible to create better commercial instincts and capabilities for decision-making in any R&D organisation. This involves bringing clear commercial thinking into the process at the very early stages, well before clinical proof of concept. Importantly, this dialogue must flow in both directions, for commercial functions to understand the R&D process and future assets.

Across the pharmaceutical industry, many intelligent and well-intentioned employees operate in systems that consign them to generate sub-optimal outcomes. Insight into the commercialisation process and deep corporate knowledge of payers, regulators, clinicians, and patients is lost in translation between the often highly diverse and somewhat disconnected market-facing functions where these insights are captured, and the R&D organisation that must apply them to capture future value.

Commercially-Oriented R&D

In our experience, commercially oriented R&D requires three core enablers:

These enablers are deliberately focused on people, process and capabilities; as we have found these are the ultimate keys to success. Deep knowledge of, and existing relationships with, external stakeholders is the foundation. To unlock the power of this knowledge, companies must systematically translate and incorporate the explicit and implicit knowledge into the thinking and decision-making processes of the organisation. This way, sizable investments can generate outcomes that are relevant to, and valued by, the market place.

In time, organisations can be evolved to make better choices related to both R&D and commercialisation. R&D can be better enabled to generate more products of value, while commercial functions can be afforded the time necessary for optimal launch planning. There are many benefits from making the effort to understand one another.