Monday, March 9, 2009

Having Trouble Staying Focused? Pharmaceutical Companies Increase (Market) Concentration

This morning, pharmaceutical giants Merck and Schering-Plough announced merger plans. Merck will acquire Schering-Plough, in a deal worth about $41 billion.

Will the marriage prove a winner? Many anticipate more such unions between larger pharmaceutical companies, citing excess capacity among larger firms, in an industry in which recent innovations have come from smaller upstart firms.

Alas, the historical track record of mergers is not good. Nevertheless, at the start of many such marriages, there is the (perhaps faint) hope for what economists refer to as economies of scale. Simply put, these "economies" can arise when it is possible for a firm to reduce its average production costs as it adds to capacity. In this case, by streamlining things like research, production, distribution, marketing, etc., it may be possible for the larger merged firm to be more cost effective than its separate predecessors.

But the streamlining is not without short-term pains for some. As the firms consolidate operations, early estimates by the Merck CEO are that there will be a reduction in employment of 15 percent, and most of those layoffs will happen outside of the US, which makes companies like Fulford, a Schering-Plough subsidiary, nervous about the future.

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