Industry: Will there be a shakeout in the pharmaceutical sector?

In my recent blogs, I’ve been writing about if Big Pharma is in trouble. I think that I’ve made the point that it is and probably will be in trouble for the next decade. The question is what happens next?
Probably what has happened in every other industry with excess capacity since the Industrial Revolution. There will be a shakeout. Strong players will survive and the weaker ones will go by the wayside. OK, that’s simple enough, but, how will this occur? I have some thoughts here.
First, the well documented saga of the drying up of Big Pharma’s new product pipeline should put a premium on companies with strong research and development teams. Differentiation will have to come to those who can produce their own products. The feeding frenzies that result from bidding wars for perceived valuable targets generally result in overpriced acquisitions that rarely pay back in the expected manner. Companies that can’t develop their way out of their difficulties could end up as acquisition targets of Indian or Chinese companies.
Next, those self styled health care companies that are really conglomerates in disguise may begin to be broken up. In the balmy days of easy revenue growth, all sorts of synergy arguments (at the risk of dating myself, I can remember these arguments from the Sixties) could be made for having other product groups like medical devices and consumer products. Reality will begin to set in as the oft promised synergies do not materialize. Once managements realize that they cannot continue to deliver the earnings expected by the markets then those private equity groups I was blogging about last time are going to start sniffing around. Even a company like Tyco that is not a pure health care play has spun off its medical device group. Anyone care to speculate on how long they will remain on their own before someone tries to bring it into play with other device manufacturers?
Finally, my last two observations will result in fewer large players in Big Pharma. The ones that remain will have strong research and development groups and be taking advantage of offshore opportunities in places like India and China. These players will focus on pharmaceuticals solely and not be distracted by devices or products like hair shampoos. Medical devices will probably have a shakeout and consolidation like Big Pharma. The consumer products will get absorbed into that game that’s playing out between major players like Proctor & Gamble and Wal-Mart. Foreign competition from new markets in Asia will arise and put pressure on market share and for those new start ups with new patents requiring funds for clinical testing, FDA approval, and marketing. The inevitable bidding wars for these start ups will continue as always. But, if Big Pharma gets its act together in developing new products then the bidding may not be as frenzied.
Friday’s (January 25th) pounding on Wall Street for Big Pharma (check cnbc.com’s Pharma Watch List for details) probably had more to do with overall market conditions than Big Pharma’s own problems. However, unless something changes soon, Big Pharma might have many more days like that one. Unfortunately, the shakeout I’m predicting is inevitable now. Now, it’s all about who makes the cut and who doesn’t.
I’d be very interested in hearing from you about this subject. Also, what companies do you think will make the cut or not? In future blogs, I plan on looking at specific companies and handicapping them. Something tells me that there will be some really good Big Pharma stories out there for the next few years.
Please contact us at larryrothmansblog@gmail.com. We look forward to hearing from you.


Contributed by Guy de Lastin

Industry: Will private equity arise in the pharmaceutical sector?

Following my recent blogs about the trouble that Big Pharma is in, I thought that it would be appropriate to start talking about private equity and what role it might play in the pharmaceutical sector.
First, let me explain something. For some time I’ve believed that private equity would begin to supplant publicly raised capital. Public stock companies came into being a couple of centuries ago because capital was scarce. Markets and regulations developed over time (not always in tandem) to provide and manage these capital flows. Some argue that the West’s ability to raise and guarantee capital was the primary reason for its global dominance. However, lately, we’ve become very good at raising, if not outright creating, larger amounts of capital than anyone else had ever done before. Probably more than we need. Notwithstanding the excesses, the sub-prime meltdown being a good recent example, availability of capital is no longer an issue. Interest rates levels in modern economies for the ten years have not been terribly exciting. Investors’ willingness to throw cash into the late stages of the dot-com and real estate bubbles only proves the lack of decent returns for financial assets. Next, let’s go back to those regulations that I just mentioned. Regulations have become very cumbersome, expensive, and with the addition of Sarbanes-Oxley, very risky. Once upon a time, if a corporation fell afoul of regulations, it was a civil matter. A civil matter that would be settled with fines and penalties. Worse case, senior management would resign and maybe deal with some unpleasant litigation. Now, a CEO and a CFO could find themselves doing the perp walk with serious jail time because of the actions of a few low level flunkies that they didn’t even know worked for them. That changed the game.
I’m proposing that corporations will begin to avoid the expense and personal risk of these regulations by going private, or, at least leaving the U.S. equity markets. Anecdotal evidence from the New York Stock Exchange seems to hint that companies are choosing to list overseas as a consequence of U.S. regulations. The rise of large private equity firms like Cerberus has facilitated the migration of publicly traded companies into private ownership away from the prying eyes of the markets. One last point, have corporations become too large to effectively manage especially when the stock market’s quarterly expectations are added on? How does a CEO continue to meet analysts’ and investors’ expectations in an economy teetering on recession? It’s difficult enough for companies like GE and McDonald’s. How do you do it when you’re in a regulated industry like the one Big Pharma is in?
Let me go back to my earlier posts where I wrote about the decrease in FDA drug approvals, price resistance by national health services, and a changing political environment that may haunt Big Pharma for the next ten years. This is a very challenging environment. When does Big Pharma begin to feel the effects of all this and begin to move away from the publicly traded markets? When does private equity step in to take advantage of depressed market values and excess capacity? Former J&J COO Jim Lenehan joined Cerberus last year. Somehow I don’t think that he’s working on the Chrysler deal.
In closing, I expect to see private equity firms becoming more active in the pharmaceutical sector. The only question for me right now is which of the big companies will begin to break up and spin off their assets.
Please send your comments or questions to larryrothmansblog@gmail.com.


Contributed by Guy de Lastin

Industry: More Trouble for Big Pharma?

When I blog I normally try to vary my topics from week to week. This week, however, I’m going to stay with last week’s topic. I wrote then asking if Big Pharma was in trouble. I blogged that it was and predicted that the next decade was going to be a difficult one for the industry. After reviewing this week’s media, I decided to stay with this topic for my next several entries because I think that something fundamental is happening out there in this sector.
This week, Mike Huckman in his always topical and excellent blog, Pharma’s Market at cnbc.com, wrote about the problems with clinical trials in Big Pharma. He also had a terrific interview about Big Pharma and its troubles that I encourage everyone to view. I don’t normally use visual aids in my blogs but this one is good and Mike’s blog was kind enough to offer the following code to share the interview. Click on this link, http://www.cnbc.com/id/15840232?video=624890606 , after you’ve finished reading my blog of course, and hear some really insightful discussion.
Mike’s blog questioned the traditional view of drug stocks as a port in a storm because of the Presidential election and the questions arising about the accuracy of clinical trials. Last week, I blogged about the perfect storm of declining FDA new drug approvals, resistance from national healthcare services to increasing drug prices, and ominous noises coming from the Presidential primaries. The long term nature of these deep rooted problems were the basis for the decade long forecast of industry difficulties that I made. The clinical trials disclosures and the risk of political opportunism from the Presidential candidates are doing nothing to make me rethink my original forecast. Can we expect the U.S. Congress to have hearings and call in pharmaceutical executives? (At least not until they get finished with major league baseball.) Can we expect yet more legislation regarding new drug clinical trials? What impact on the sector’s image will all the above mentioned problems have? Will all these problems being to affect Big Pharma’s financial well being? Will we begin to see a shakeout?
Something has got to give with Big Pharma. If we look at other industries in the United States over the last generation (e.g., auto, airlines, mainframe computers) we see periods of growth followed by a slow as conditions change and then realization of problems leading to a shakeout or consolidation of some sort. Sometimes, new competitors or technologies (Japanese auto makers and Microsoft) arise and overthrow the old model entirely. This is what I want to explore in my blogging with the next few entries. As I was recently telling Larry, I think that we’re about to see major changes in Big Pharma unlike anything that the industry has seen before. These are exciting times!
I’ve been doing all the talking here. I’d really like to hear from you. Larry and I would like to receive your comments and contributions too. Please contact us at larryrothmansblog@gmail.com. We look forward to hearing from you.


Contributed by Guy de Lastin

Industry: Is Big Pharma in Trouble?

Is Big Pharma in trouble? And, if it is, how bad could it be? Or, maybe I should explain why I’m making such an outlandish statement. I’m looking at three events this week. The first is an article that appeared in the Financial Times indicating that the United Kingdom’s National Health Service (NHS) was seeking a 10 per cent reduction in the cost of medicines that it purchases. A spokesperson for the NHS said that he hoped to have these negotiations completed by June. Next, the Newark Star-Ledger ran an article talking about the slow down in new drug approvals at the Food and Drug Administration (FDA). The writer, George E. Jordan, offered stark proof of what many have known for some time, that new drug research is slowing down compounded by an apparently more careful review process at the FDA. Finally, in this election year, there were the results of the New Hampshire primary. The Republicans still have no clear frontrunner. What does pass for frontrunners don’t appear to be too focused on the issues of concern to Big Pharma. With the Democrats, Hillary Clinton is alive and well with renewed vigor and I think we all know how she feels about Big Pharma. Her rivals can’t be expected to be much friendlier. Now, where do all these leave Big Pharma?
The dangers of undue concentration with only a few customers or one is shown in the United Kingdom, especially when they have the full force and authority of a legislature behind them. Combined with key drugs coming off patent and the threats provided by generics, profit margins will be squeezed. Those margins could come under further pressure if new “blockbuster” drugs don’t come out of the pipeline to offset the older products. The cost cutting and employee layoffs that have been the norm lately in Big Pharma may not be over. And, as if this isn’t enough, the impending U.S. Presidential election does not augur a friendlier environment in the future.
So, going back to my original question, is Big Pharma in trouble? I believe the answer is yes for the reasons that I’ve just given. The next question is how bad could it be? With revenues ready to tank, an inappropriate expense base, and no good prospects ahead I’m predicting that we will see several years of Big Pharma earnings declining under pressure. Some of the players may begin to fall out. My friend, Larry Rothman, in an earlier entry (A Challenge to the Life Sciences Services/ Consulting Industry, December 12, 2007) said that he believed Big Pharma management couldn’t buy their way out of trouble currently because of overly high values yielding poor results. If market valuations begin to fall then acquisitions might start again. But, that would only be bottom feeding and a turn around could still be several years off. Without new products, reduced industry capacity, a more realistic cost base, and a predictable pricing formula for its products then Big Pharma will continue to be in big trouble. There will be no quick or easy answers here. We may be looking at a decade or more before things get better for Big Pharma.

Contributed by Guy de Lastin

Healthcare: What Are the Implications for the Life Sciences Sector of the Presidential Election?

With Saturday night’s Presidential debates now part of the historical record, the question can be raised, what are the implications for the life sciences sector of the approaching Presidential election? Personally, I don’t think that they look too good. Except for Mitt Romney’s, ‘Let’s leave the drug companies alone.’, there weren’t any strong supporters on the stage that evening.
Until the parties’ respective candidates are clearly seen, and that might be by February, uncertainty will be hanging over life sciences. And, even then, there may not necessarily be a good outcome here for them. The traditional Republican support for business and free enterprise might not be a foregone conclusion if former Governor Mike Huckerbee becomes the party’s flag bearer. What would the implications of his FairTax be on government spending? Or, here’s a scary scenario, how about former Senator John Edwards as the running mate for Senator Barack Obama? Edwards isn’t shy about touting his past experience as a very successful trial attorney that went after Corporate America. He could cause a lot of mischief while serving as Vice-president. Senator Hillary Rodham Clinton’s views on healthcare have long been known and wouldn’t bode well for life sciences companies. Then there are Senator John McCain and former Mayor Rudy Guiliani where there may be more traditional Republican viewpoints but national security and the global war on terrorism are the primary planks in their platforms. I wouldn’t expect much immediate relief for the sector from either of them. Of course, a wild card like New York City Mayor Michael Bloomberg could make a run for the Presidency as an independent and would probably be the safest free enterprise play for business although this is all merely speculation right now.
2008 may not have much relief for the life sciences sector. Each new primary event in the current campaign could be a nail bitter for life sciences executives and investors. The New Year has started with pressure on the stock markets. On those rare occasions when the media is not dissecting the Presidential campaign, they are speculating on the possibility of a recession. The price of oil and the sub-prime meltdown are still hanging over the economy. If consumer spending flags and the economy falls into recession then the life sciences sector may find itself affected as it hasn’t been in prior economic slowdowns. Especially, those with other non-life science revenue streams.
With all the uncertainty surrounding the life sciences sector the 2008 Presidential election looms large, probably than at any other period in its history. I’ll continue to update this blog on this topic as we approach the November election. I would welcome other opinions from our readers on this subject. I look forward to contributing to Larry’s blog in the New Year and hearing from you!

Contributed by Guy de Lastin

Globalization: How real is the labor turnover problem in offshore centers?

How real is the labor turnover problem in offshore centers? Here’s a question that can turn a meeting about potentially offshoring a company’s processes into a real slugfest. Proponents of offshoring will argue that turnover is no better or worse than here in the United States or Western Europe. Critics will counter that staff turnover rates are a hidden cost of outsourcing both financially and from a customer service perspective. Something is definitely lurking out there.
Reuters recently reported that a major Indian outsourcing firm had over 90 per cent turnover in its business services. Apparently, major Indian firms have agreed not to steal each other’s employees. (Interesting, imagine doing that in this country. Possibly another example of American and European firms outsourcing to places where neither legal nor public opinion constraints prevent practices that cannot be allowed in their own countries. But, enough of that, I’ll save it for a separate blog entry.) Anecdotal evidence makes the rounds of wage costs slowly rising in offshore markets as more work comes in than can be readily absorbed and workers are attracted to higher wages.
Labor turnover is definitely becoming a bigger probelm in the offshore markets and will continue to do so. There is only a limited amount of capacity available outside of the United States and Western Europe to handle the potential demand for these services. Not to say that this demand can’t be met but it will be expensive. And, it will take time. Just because someone graduates from a university with an engineering degree and English language capability doesn’t mean that he or she is ready to step up to the increasingly higher expectations of the global outsourcing marketplace. Companies that want to meet these expectations now are going to have to hire people with experience from other companies. They may even have to turn to their own countries’ diasporas. There have been mentions in the press over the years of people returning to ancestral homes like Ireland and Korea to pursue new opportunities.
How do these companies begin to differentiate themselves? That’s a good question. The large players with strong technical reputations like Microsoft and IBM can differentiate themselves readily. Other large players whether they are home grown like Wipro or Tata will be able to offer diverse opportunities and advancement to potential employees. All of these firms may not feel the need to overpay and find that the “best and the brightest” are naturally attracted to them. However, other players whether they are pure outsourcing plays or captives of foreign companies will find themselves having to continually raise their wage offerings to attract and keep the types and numbers of people that they need. Of course, this leads us back to the original premise of why to offshore in the first place. The major reason for offshoring has been cost reduction. If wages continue to rise through competitive pressures then why offshore? Will offshoring by American and Western European companies continue as it has been going or will it become simply another tool to be used by global corporations in managing their global portfolios of business activities.

Contributed by Guy de Lastin

Has Big Pharma Acquisition of Big Biotech Peaked?

In the last two weeks Biogen-Idec (BIIB) and Genzyme (two of the largest independent Biotechnology Companies in the World) had their respective CEO's announce that they will stay independent, albeit for different reasons. Could this mark the watershed moment that suggests that Big Pharmaceutical Companies will indeed NOT pay any price to buy up companies with attractive pipelines and productsIs it equally possible that these two transactions are anomalies with special circumstances surrounding them?
It may be a bit presumptuous to reach the conclusion that acquisitions may have peaked with AstraZeneca paying $15.6 billion for MedImmune in April and Schering-Plough's acquisition of Organon Biosciences BV for $14.4 billion a month earlier (especially noteworthy since Schering's CEO Fred Hassan had publicly stated that acquisition pricing had become "breathtaking"). One could further point to numerous sub or near billion dollar acquisition of smaller biotech companies and technologies (e.g. RNAi) by bigger players such as Pfizer, Merck, J&J among others.
My thesis is that senior pharmaceutical executives recognize that they may not be able to buy their way to more success in their business. There is a lot of "low hanging fruit" they need to continue to address including bureaucratic, inefficient R&D; bloated sales and marketing forces having less and less impact on their target constituencies; and excess manufacturing capacity resulting from past tax incentives and mergers. There is clear cut evidence that the mega mergers of the past have done little to enhance shareholder value and that many of the smaller biotechnology acquisitions and/or licensing deals have not produced the promised results.
Thus, is there is reduced incentive to buy companies such as Biogen-Idec or Genzyme. The noted investor Carl Icahn bought 1% of BIIB stock earlier this year, increased his stake to 3% quickly, announced that the company was vastly undervalued, driving the stock price up by 50% and forcing management to shop the company. Rumors abounded about interest by Pfizer and Schering Plough among several others, but in the end NO ONE bid for the company and the shares fell over 25%. While Mr. Icahn benefited handsomely form this deal, one could imagine that BIIB's management were greatly distracted and taken away from their duties resulting in lost opportunities for no valued result. The major lesson learned from the acquisition side is that Pharmaceutical Business Development executives will not (and should not) pay any price asked for a deal.
In the case of Genzyme, Henry Termeer the CEO is faced with similar circumstances from the same billionaire investor, Carl Icahn. He will likely apply the same pressure tactics to sell the company. Termeer has seemingly intentionally made a strong case that his company's value is too rich (nearly $20 billion market cap), that he doesn't need a partner since he is in a highly specialized area with good vertical integration and finally that his product set of highly specialized, expensive near-orphan like drugs don't lend themselves to the culture of a big pharmaceutical company. Time will tell whether Temeer's strategy will be viable.
In the meanwhile we are in for some interesting times!

Contributed by Lawrence Rothman, PhD

A Challenge to the Life Sciences Services/Consulting Industry

When one thinks about the money invested by the Life Sciences industry in the services business to improve its processes (likely over $100 billion over the last 10 years; my estimate basis is in excess of $5-10 billion per year predicated on a spend on services equal to 1-2% of yearly worldwide revenues), it is reasonable and of concern that the value and results achieved fall far short of expectations. My challenge is to question how to improve the value received by our clients based on measurable results to date. The evidence suggests our clients are at a crossroads and their ROI and trust in our advice, products and services has not served them well.

Witness a recent article in the Wall Street Journal (12/7/07) that points out that over the next few years, the pharmaceutical business will hit a wall. It states that "Some of the top-selling drugs in industry history will become history as patent protections expire, allowing generics to rush in at much-lower prices. Generic competition is expected to wipe $67 billion from top companies' annual U.S. sales between 2007 and 2012 as more than three dozen drugs lose patent protection. That is roughly half of the companies' combined 2007 U.S. Sales. At the same time, the industry's science engine has stalled." Where are the benefits of all the improvement projects undertaken? Was this crisis unavoidable or could have the "consultants" provided "better vision"?

One particularly challenging issue is that R&D productivity has decreased by 50-75% over the last several years (based on the number of new NCE's approved as a function of R&D spend). The WSJ article further suggests that "during the five years from 2002 through 2006, the industry brought to market 43% fewer new chemical-based drugs than in the last five years of the 1990s, despite more than doubling research-and-development spending.". Combine this with a glut of new sales and marketing initiatives and resources that are yielding at optimistic best little return; significant overcapacity in manufacturing capacity and an overall bloated SG&A component of the balance sheet, management and its advisors should think about a different way of doing their business.

Lest we think that the gurus of Wall Street and other worldwide bourses haven't noticed, valuations of pharmaceutical shares, once considered safe havens worthy of a Price/Earnings premium to the rest of the stock market have witnessed a valuation decrease of nearly 20% while in the last 5 years while the overall market has gained nearly 75%!!! Of further concern is that Moody's Investment Services recently lowered the rating of Pharmaceutical Industry debt to negative (not far from the Sub-prime debt that has caused worldwide turmoil).

My suggestion is that while there are numerous external forces at work and many potential issues to address, it would behoove our brethren in the advice giving industry to think more out of the box and create a win-win situation to help our key clients. Your thoughts are invited.

Contributed by Lawrence J. Rothman, PhD

Healthcare: Is There a Healthcare Crisis in America?

Is there a healthcare crisis in America? Boy, now there’s a question to quickly divide the old cocktail party between the liberals and the conservatives. While I feel there is a certain amount hyperbole from both camps, I will come out early and say that something is amiss out there. Also, some of the solutions that are bandied about may not be as practical as hoped or scalable to the size of the American problem.
Why do I suggest that there is problem with US healthcare. First, the availability of affordable healthcare insurance is becoming a major concern across the country and will undoubtedly be a significant issue in the upcoming Presidential election. I personally have learned firsthand of this through the misfortune of several friends of mine, who when recently downsized from their jobs found their severance packages inadequate for their COBRA payments and had to use their savings sooner than planned. Tens of millions of Americans don’t have healthcare insurance. Emergency rooms across the country are swamped with sick people without coverage who they cannot turn away because of local legislation. The problem is dealt with by closing hospitals and stopping certain services. Not a particularly effective approach for maintaining public health. Also, don’t think for a moment that this won’t be a big part of the impending national debate over illegal immigration.
OK, we’ve talked about the demand side and its increasing costs. Now, let’s talk about the supply side, let’s start with doctors. I can remember growing up in a major American city in the Sixites that doctors made good money, had the best house in the neighborhood, and drove the biggest car. I don’t find that with many young doctors today. My primary care physician recently told me that he’s earning about sixty percent of what he thought that he would be because the insurance companies haven’t kept up with inflation. He said that some of the providers hadn’t updated their reimbursement tables since the Eighties. Now, he’s a general practitioner who says that he’s very happy with his practice otherwise. He’s doing what he loves. I won’t pretend that this is a scientific survey but I don’t get the feeling that the ordinary doctors and dentists we meet everyday are the cause of the surge in healthcare costs. He doesn’t even complain about his malpractice insurance costs, although he does say that certain specialties are being priced out of his state.
Another component of the demand equation are the hospitals. But, again, the evidence doesn’t seem to support this. Hospitals are going under and are struggling to pay their bills. Also, several have begun to use some pretty heavy handed collection agencies to collect from their indigent patients. Now, a case can probably be made that hospitals haven’t been the most efficient organizations but this has been gradually changing.
Next up on the demand side are the pharmaceutical, medical device, and other suppliers whose products both the doctors and hospitals use. There’s probably a case that these have been making excessive profits by comparison to their customers, but, as has been written elsewhere in this blog, this will probably begin to change soon. While their prices and practices may have contributed to the run up in healthcare costs, I haven’t seen any evidence that lays the blame solely at their doors.
The last part of the demand equation I’ll write about are the health insurance providers. No one seems to like them. Patients, their doctors and hospitals, and the employers who provide their service to their employees do not like them. Politicians of all political stripes seem to feel that they are fair game as do late night talk show hosts. The last group of people that I can recall being this generally disliked were Saddam Hussein and his sons and look what that got them. But, let’s also not forget what we’ve had to live with once they were taken out. No simple solutions here.
So, something’s wrong here. No one seems to be very happy about the current situation especially those who depend on it either for their wellbeing or their livelihood. (I would be interested to know if Senator Bob Dole still thinks everything is fine but I don’t know how to contact him.) People talk about the Canadian system but their drug prices are only low because of their beggar thy neighbor policy that foists the costs of US drug research and development back onto their southern neighbors. France has been recently mentioned in the media for a successful system but haven’t French workers been striking lately about proposed cutbacks in their benefits? And, I won’t waste any more space over the failure of public healthcare under the Communist regimes in Russia and China.
I wish that I could propose a simple, easy and affordable solution that everyone would jump up and immediately agree with. I’m sorry, I can’t. I’m not that smart. Sometimes I wonder if anyone is. But, I do know this, if we don’t develop the national will and resolve to deal with this issue, whether or not it’s a full blown crisis now or only later, then somewhere down the road both for the public at large and the healthcare industry there will be very serious consequences.

Contributed by Guy de Lastin

Globalization: Are US Based Nearshored Outsourcing Centers Cost Competitive with India?

Are US based nearshored outsourcing centers cost competitive with India? Now that the initial hysteria over all our jobs going away to India, or wherever else they were going to go, is over, is this the time to discuss the possible use of other US sites to gain competitive advantage? There are two sets of variables in these types of decisions, objective and subjective. Let’s use classical economics factors of production to begin our review.
We’ll start with land. While most overseas locations that are considered for outsourcing have plenty of land, do they have the infrastructure that goes with it? Also, and let’s be honest here, American and European businesses were taking advantage of the, until recently, lax environmental and OSHA-like regulations in these locations. Buildings with the necessary fixtures to support global businesses, communications infrastructure, power grid, and public transport for workers are all required. The earlier locations, Mumbai and Shanghai, have been built out and are expensive. The second tiers are being identified and are being moved to. However, how smooth this transition will be remains to be seen. While major American cities like New York and Los Angeles are still expensive, sites in the Midwest (South Dakota) and the Southeast (Mississippi) offer promising alternatives. As businesses begin to find the true costs of building overseas and the increasing regulatory environment (or, are held accountable by public opinion for seeking out locations without these protections), local sites should begin to see interest. And, these locations are not shy about promoting themselves. Michigan has been very aggressive in getting its message out across the country lately.
Next is labor. By now, most people have probably heard about the rapidly increasing wage costs for staff with the appropriate language and technical skills and the high staff turnover resulting for those that don’t keep up. The media has reported stories of call centers that probably compromised on their hiring standards and have had bad customer experiences when they couldn’t understand the operators. Obviously, this topic is a very sensitive one. But, as with land, labor offers potential in this country particularly as US corporations begin to shed themselves of expensive health insurance and pension plans. Costs are rising offshore and regional costs in this country are starting to look somewhat appealing. Some US companies are beginning to place centers at locations near state university systems away from major metropolitan areas.
Finally, capital. The overseas locations are still not as efficient as the US. Sometimes, it’s the simple things like the low rate of adoption of credit cards in these markets. Payment systems while improving are still not at US and European levels. Then there’s the foreign exchange issue. Then there’s the long term question about the tax policies of the countries where these facilities are located. Will they see this as an opportunity for revenues when their overheated economies begin to cool down?
OK, those were the quantitative. And, while I don’t think anyone is going to rush out and throw out their current offshoring plans, the points mentioned are intended to help thinking about future trends, challenges, and opportunities. Let’s review some subjective considerations. Admittedly, these by there their nature cannot be measured and do have a somewhat emotional aspect to them. But, they shouldn’t be dismissed too lightly. Let’s group them around the three criteria that we’ve just used. First, land. Many of these places are a long way to go. As the second tier cities are used that’s even more distance to go on the ground which is why those roads and public transportation are so important. Also, physical security becomes more important the further you go form the main cities. Then there’s the political/economic risk associated with these locations. Next, there’s labor. Language and culture are very important considerations. The quality of education becomes very important. People are people. If their government is unhappy with our government then they may become happy with us. In a dictatorship like the People’s Republic of China that’s a very real possibility. Finally, we have capital. Nationalization and market risks are some of the possible difficulties here. The point here is that businesses shouldn’t be putting too many of their eggs in any one basket. I haven’t been trying to dismiss offshoring out of hand because I believe that it has a place in the regional strategies for global companies. I just want to lay out for discussion some factors that could change in the not too distant future. The current business environment is in a state of flux and I think that earlier choices that have fallen from favor may come back into consideration soon.

Contributed by Guy de Lastin

Industry: How Will Public Healthcare Reimbursement Affect Drug Research and Development?

How will public healthcare reimbursement affect drug research and development? With an aging population looking to Medicare for assistance the American Federal government is looking at a chronic spending increases well into the twenty-first century. The recent enormous Federal budget deficits cannot last. The latest freefall of the US dollar in the currency markets won’t permit this. The other usual tools of fiscal policy, tax increases and spending cutbacks may not be as effective as they once were because of electoral resistance. Logically, we’re led back to the spend itself.
There are two aspects of the current US government’s spending for healthcare, also including the various states and local municipalities, which could come under scrutiny. First, current Federal legislation prohibits Medicare from negotiating pricing discounts based on volume. (Which has led some wits to wonder why when corporations use their purchasing volume to lower prices it’s capitalism, but, when the governments do it, it’s Communism.) This goes beyond the usual debate over generics and non-generics. Even generics would be considerably cheaper if Medicare were to seek volume discounts. Next, the nature of prescription drugs could be open to government scrutiny. Drug companies have been coming under criticism in the popular press for their tendency for the last several years to treat the symptoms of chronic illnesses rather than actually curing anything. How many people do we all know who are taking statins for chlolesteroel and have been told by their physicians that they will probably stay on these drugs for the rest of their lives? In addition, some public healthcare systems like the United Kingdom are only willing to reimburse for drugs based on their effectiveness. While these approaches might not significantly reduce the cash outflow to the drug companies assuming the savings would be used to either hold costs down or to purchase additional product, they could be faced with pressure on their profit margins.
Faced with aggressive purchasing authorities at Medicare, the drug companies will have to re-look at their costs and investments as they struggle to maintain their earnings and meet Wall Street’s expectations. Drug research and development could be the first target of opportunity. Significant sums are spent here every year by the world’s pharmaceutical companies and not all research leads to a successful drug let alone a blockbuster. Add to this the risk that the treatment might not be approved by government watchdogs and the drug businesses might decide not to take certain risks. So, short term, everybody’s happy, right?
Not so fast. Medicare and drug company senior management might be happy, but, investors shouldn’t be. The industry’s future product pipeline is already under pressure. Reductions in spend, shutting down of facilities, and laying off of research personnel would not do anything to help here. We would see consolidation around the few companies that are true thought leaders in research and development and have the funds to purchase assets that might be available for something less than the premiums that they once carried. As the US Presidential election draws closer in November, investors should be thinking about the implications for the drug companies. A strong showing for the Democrats could lead to changes in public policy in purchasing drugs which will continue the trends in the industry that this blog has been writing about.

Contributed by Guy de Lastin

Globalization: Offshoring: Too Late for Labor Arbitrage?

Offshoring: too late for labor arbitrage? The recent near panic in the American media over the loss of jobs overseas, reminiscent of the dot-com hysteria about tearing down all the buildings and all of us working from home, overlooks the simple fact that original conditions change and change quickly.
The original assumption behind offshoring was reduced expenses arising from exploiting lower wage societies and when English was a first or strong second language, so much the better. Early starts were in Ireland, India, and China. Initially, manufacturing processes went and then services began with the advent of improved technologies. However, what happens when everyone goes the same route, and not only in the US, but Europe and Japan begin to follow? And, then let’s not forget the developing economies in India and China with their own needs.
Labor rates have been increasing in countries such as India that have led to significant staff turnover there. The old joke about nobody quits their job for a nickel more an hour isn’t true in Mumbai. Ireland, once notorious in Europe for high, persistent unemployment, now has full employment. Furthermore, as businesses continue to chase labor arbitrage across the globe, what happens then? Firms moving across Europe are moving into eastern Europe and Russia. From the East, it’s the Philippines, China, and India. Where will these movements come together, Kyrgyzstan? And, then what? There’s no place left to go. Putting aside the political/security considerations for a moment, when the labor arbitrage game is played out, how will potential offshore centers differentiate themselves?
Here’s where we go back to those annoying political/security considerations. The recent political emergency in Pakistan, no wait, let’s be accurate, the latest manifestation of the political emergency in Pakistan potentially destabilizes a nuclear armed military dictatorship which borders America’s favorite offshore location. Other potential offshore locations, the Philippines and Brazil, have chronic security problems. Even China has significant internal problems in its interior away from the prosperous coastal regions. Other factors are different time zones, language and cultural differences. Anyone who has tried to fly in and out of the Mumbai international airport lately knows what I’m talking about. Other factors such as real estate costs are still relatively expensive.
What I’m suggesting here is that, shortly, labor arbitrage, while remaining a consideration in the future, will no longer take precedence. Like all other fads, whether they are the Internet or tulip bulbs, it will run its course and burn out. Offshoring for pure labor arbitrage, especially places far, far away will run its course too. While it will always be a component in business strategy, it will no longer have precedence over other more traditional business drivers. The restructuring that has been underway in American business will ultimately make its wage base more competitive when other factors are taken into consideration. Future outsourcing arrangements should take this point into consideration when being negotiated. Regional offshoring will make sense for multinationals with a truly global presence. However, simply sweeping all US based operations offshore in the hopes of saving money doesn’t seem to make much sense for much longer.

Contributed by Guy de Lastin