The last edition of the Avani Global Biz Catalyst offered an in-depth look at the wave of mergers and acquisitions in the US healthcare industry and their effects on the economy and participants including branded and generic manufacturers. Now, years after healthcare M&A’s became common among US drug makers, the same trend is being seen in Japan’s pharmaceutical industry.

In April 2005, Yamanouchi Pharmaceutical Co. and Fujisawa Pharmaceutical Co. merged into Astellas Pharma Inc. to become the second largest drug maker in Japan. However, Astellas soon lost that perch after Sankyo Co., integrated operations with Daiichi Pharmaceutical Co. in September 2005 under a joint holding company called Daiichi Sankyo Co.

These three largest Japanese drug makers each have sales of approximately one trillion yen but are still considered small in size on a global level, with Takeda ranking only 14th in the world.

Even more consolidation is expected in Japan’s pharma industry because these two top companies, long with industry leader Takeda Pharmaceutical Co., are still much smaller than the US and European pharma giants. Consolidation can be attributed to drug makers’ need to gain financial advantages in the face of increasing R&D Costs and the cost of promoting products overseas. New drug development takes more than ten years and costs of billions of yen; therefore, Japanese pharmaceutical companies can not recover their costs in the Japanese market alone and must sell their products overseas.

Japanese firms give top priority to the US market, which accounts for 50% of the global market and offers high profitability to drug makers allowed to set their own prices.

Japanese firms have also found difficulty in quickly creating sales networks in the US and Europe and many fare better if forming a venture with an established US or European marketing or distribution partner. For example, Japan’s Chugai created a global sales network after a deal with Roche Holding AG of Switzerland in 2002.

Small and midsize Japanese drug makers do not even have the resources of the larger pharma companies and must rely on domestic sales. Unfortunately, Japan’s domestic market has stagnated at about 6 trillion yen due to government medical expenditure cuts. These smaller companies with no global resources must take other steps to remain viable, including management integration, shifting operations to production to private label or generics, or aspire to new innovations. Drug makers with no pipeline and no innovations will see decreasing profits as drug prices are lowered every two years.

The disparity between overseas opportunity and the Japanese domestic market is evident in the stock increases of Tanabe Seiyaku and Takeda Pharmaceutical. Tanabe Seiyaku's shares have gained 7% while Takeda's stock increased 25%.

The difference: Tanabe, like other medium-size drug makers, depends on domestic sales, where price cuts are being seen. The Japanese government’s biennial price reductions in April 2006 may be as much as 6%, up from a 4.2% price cut in 2004. Tanabe receives 92% of its revenue from the domestic market. Meanwhile, Takeda and Astellas Pharma, Japan's two largest pharma firms, receive more than 50% of their revenue from overseas.

Success to Japanese drug makers will come to those firms that have the potential to potential to develop innovative new drugs and have exposure to foreign markets. Takeda and Eisai meet both of these criteria and are expected to grow in 2006. The Japanese government implements price reductions every two years as part of a plan to limit medical expenses. Deeper reductions may reduce spending on new research, detrimentally impacting the industry in the future.

The Japanese prescription drug market grew 23% in 10 years through 2004, to $64.7 billion, while the US market almost tripled, to $236.4 billion. Average patented drug prices in Japan in 2003 were 18% lower than in the US, but generic prices were more than double than in the US. Therefore, generics accounted for only 16% of the Japanese drug market through March 2004, as opposed to 57% for US generics.

The Japanese government is examining cutting prices and encouraging generics, trends that have already been seen in the US. These cuts will no doubt effect Japan’s biggest generic drug makers (Sawai Pharmaceutical and Towa Pharmaceutical) and also hurt efforts by foreign generic companies, like India’s Ranbaxy and Israel’s Teva to increase their share of the Japanese market.