Also, since Novartis is based in Switzerland, Hexon in Germany and Eon in US, by increasing the firm’s geographical presence it is diversified into these different countries with different market demands, so the risk of fluctuating demand is lower and more stable. Since the product lines of the acquired companies are different, the market demands of these products manufactured are also diversified; even if one product faces a dropped demand the others may not be affected. Less risk bearing means less need to hold stocks, which lowers the cost of stockholding. Lastly and most importantly, since
the production of drugs is capital and machinery based, the production processes are expensive to run on small scales. With large scaled output the machinery based and
indivisible production lines will be undergoing full capacity production, so the average cost will decrease.
With the average cost of the firm decreasing along the increasing returns of scale region of the long run cost curve, the short run average cost together with the marginal cost curve shifts right. As a result, the output Q1 increases to Q2, while prices P1 decreases to P2. The area of profit increases from P1ACE to P2BDO. Therefore the producer gains from increased profits and the consumers gain from increase in consumer surplus. However, there is no allocative efficiency or production efficiency, but the productive efficiency has improved as lower costs bring larger output now.
The firm will be closer to the minimum efficient scale, where the internal EOS’s are fully exploited. Here with lower costs, the prices can be forced down, increasing its competitiveness with existing firms, which is important as the generic drug market is dominated by pressure on prices. It may even force some firms to exit the market and causes a barrier to the entry of new firms. Acquiring the two big firms will also mean that two major competitors leave the market. However, since the market is highly fragmented, Novartis will still only get a maximum market share of 10%, and thus its power to monopolize or set up high prices is still very limited.
Generally, the decrease of generic drug prices will be good for the public as it makes these drugs readily affordable, meaning more people can attain the medical treatment they need. This will also decrease the government’s expenditure in medical care as it usually buys in generic drugs, which would now be even cheaper. Clinics will have larger profits as the price of drugs they buy in decrease.
Therefore the acquisition of Novartis is justified. As it would enjoy economies of scale through expansion, it could lower the prices as costs are lower. The prices would be lowered in face of competition. It can still have increased profits as costs are reduced. Thus consumers and the firm itself will benefit.
February 22, 2005 Independent, The (London, England)
First Section: Business Page: 34 Author: Rachel Stevenson
“Novartis becomes world’s biggest generic drug firm”
Novartis is poised to become the world’s biggest generic drug maker after agreeing to buy the German company, Hexal, and its US affiliate, Eon Labs, in a cash deal yesterday worth EUR6.4bn (pounds 4.4bn).
The Swiss pharmaceutical giant will buy all of Hexal, a privately owned business, and 67.7 per cent of Eon Labs from Germany’s Struengmann family for EUR5.65bn. This will give it the leading position for generic versions of drugs whose patents have expired. Novartis will also make a tender offer to buy the rest of Eon Labs shares, which are listed in the US, for $31 per share at a cost of about $1bn (pounds 526m). It will merge the companies into its Sandoz unit, which will then command sales of more than $5bn (pounds 2.6bn).
Daniel Vasella, the chairman and chief executive of Novartis, said: “Generic drugs are crucial to meeting the needs of patients in industrialized and developing countries, as cost pressures continue to mount due to the ever-increasing demand of an ageing population.
“Generics are a critical complement to innovative medicines, freeing up resources and providing a stimulus to continued innovation. The acquisitions of Hexal and Eon will significantly strengthen our geographic presence and product portfolio.”
Novartis predicts the market for generic drugs will grow to more than $100bn in the next five years and it plans to make cost savings of EUR200m within three years of the deal, with 50 per cent achieved in the first 18 months. Job losses are expected.
The deal will give Novartis access to higher-margin versions of branded drugs and will also bring it scale to reduce costs in a market dominated by cut-throat competition and pressure on prices. Generic drugs are chemically identical to their more expensive branded rivals and manufacturers copy branded products after the protection of their patent has expired. This means they can sell them more cheaply because they do not have to pay for the research and development costs.
Hexal had been rumoured as a takeover target for Novartis for some time. Novartis is paying about four times the combined sales of Eon and Hexal, which has led to fears that it is overpaying to secure the top market position. But shares in Novartis climbed more than 3 per cent in Switzerland yesterday – a sign that investors approved the multibillion-dollar deal.
Mark Clark, at Deutsche Bank, said: “Investors should be confident that Novartis is buying robust and profitable businesses with strong combined margins and decent market shares. Novartis now has critical mass in Germany, one of the largest markets for generics…. The deal looks very sensible.”
Novartis has about $8bn of cash on its balance sheet, and analysts have expected an acquisition for some time. The new power of Novartis in the generics market could spark other takeover deals in the sector, with rivals forced to bulk up to compete. “The generics market is fragmented,” Mr. Clark said. “Even by 2010, Novartis expects to have a market share of no more than 10 per cent.”
Hexal, whose products include a generic version of a cholesterol-lowering drug, had sales of $1.65bn last year and commands the No. 2 spot in Germany. Eon Labs, which sells a version of GlaxoSmithKline’s Wellbutrin antidepressant, is expecting to make a $30.2m profit for the last three months of 2004, up 57.3 per cent on the same period last year.
Novartis will remain dominated by branded pharmaceuticals. The addition of Hexal and Eon, is expected to push revenues from generic drugs to about 15 per cent of the group’s sales, compared with 10 per cent at present.
