By Dr. Marcus Ehrhardt, Michael Bronstein and Stephen Suellentrop
Animal health, which for decades was little more than a side business for big pharma companies, has emerged as a beacon of growth and an important profit driver in the industry. The rise of animal health as a growth engine has set off a flurry of dealmaking, attracted an influx of capital and created an increasingly dynamic marketplace for pet and livestock pharmaceuticals.
Last year we saw our first major (and successful) public offering when Pfizer ($PFE) spun off its industry-leading animal health business into Zoetis ($ZTS). Some big players are considering similar divestitures, while others are pursuing the opposite strategy: building on their animal health businesses with acquisitions, as when Lilly ($LLY) recently paid $5.4 billion for Novartis' ($NVS) animal health division.
As more deal talk swirls, the burning question in the pharma world is whether animal health divisions are better off as stand-alone companies, focused exclusively on animal health, than as divisions of human-pharma organizations. It's a sensible question--animal health is fundamentally different from the human pharma business, with unique demands and complexities.
Though the differences between human pharma and animal health might appear to call for a separation, independence doesn't guarantee success. In fact, we believe there are also significant advantages for animal health players that remain part of larger organizations. And ultimately the winners in animal health will be determined not by corporate structure, but by which leadership teams most effectively manage the ways they go to market, along with the unique complexities, costs and quality and compliance requirements of the animal health marketplace.
In the last decade the animal health industry has posted 7% annual growth, as sales in North America, Eastern Europe and the Far East outgrew human pharma expansion. We expect sales to continue growing at least 5% per year through 2017. Not surprisingly, we've also seen M&A activity jump, rising 12% in 2013. And a number of prominent private equity players have entered the space--most notably European fund Permira, which bought Pharmac in 2013, and Private Equity powerhouse KKR which recently bid for Lohmann Animal Health, eventually acquired by Lilly/Elanco.
For executives of big pharma companies--which own 5 of the 6 biggest animal health businesses--this presents opportunity, but also a dilemma. If they choose to divest their animal health divisions, they can almost certainly find willing, deep-pocketed buyers. If they choose to hang on to these accelerating units, they can capture that growth opportunity.
Creating a stand-alone animal health business allows leadership to focus exclusively on the unique dynamics and demands of the animal health market, and to attract the right talent in a more consumer-driven business. Operating within a pharma company, on the other hand, has advantages that can pose serious challenges to independent competitors--namely, synergies that help manage costs in a highly competitive business.
In our view, animal health businesses can thrive within human pharma organizations. But only if their leadership is permitted to tailor their businesses to the unique demands of the animal health market. This can be very challenging inside a large corporation, which tends to have a strong human pharma perspective, but we believe it is possible for executives who understand the following market differentiators--and the management responses they require:
Customers: Animal health companies sell directly to end users and consumers, rather than through a reimbursement model, making them more like consumer goods or business-to-business enterprises.
Animal health requires distinct customer engagement models and marketing capabilities.
Complexity: Whereas human pharma sales come mainly from blockbuster drugs, animal health revenue derives from a broad portfolio of smaller products. Steady product introductions also create complexity. Each species requires unique products. And emerging markets, which drive sales growth, have diverse regulatory and consumer climates.
Animal health companies must manage country-specific regulation and consumer tastes; they must adjust to global production footprints and master overseas production of a diverse product portfolio.
Margins/Cost: Gross margins typically run 60-70% in animal health, as opposed to human pharma's 80% plus.
To deliver on profit promises, animal health executives must focus intently on costs: effective marketing and sales organizations, efficient supply chains with high plant utilization and levels of service that meet industry demands and the leanest possible organizations.
Quality & Risk Management: Animal health has clear, rigorous quality and safety requirements, but human pharma's standard, where meeting FDA standards is highly costly--and failure to comply can have catastrophic results--should not be copied directly.
Animal health executives must stay focused on compliance but also take advantage of unique quality requirements and manage their risk portfolios accordingly.
We're still in the early stages of a tectonic shift in the animal health landscape. The decisions made in the coming months and years will determine who wins the race to capture dramatic growth--and whether focused animal-health businesses like Zoetis can outperform competitors that remain within human pharma organizations. It's our belief that the winners will be those who stay most focused on the distinctive market requirements and dynamics in animal health.
Dr. Marcus Ehrhardt is Partner with Strategy& based in New York and leader of the firm's Lifescience Operations business. Michael Bronstein is Senior Associate with Strategy& based in New York and member of the Operations practice. Stephen Suellentrop is Consultant with Strategy& based in Chicago and member of the Operations practice.