Examination of witnesses (Questions 54
- 79)
WEDNESDAY 22 APRIL 1998
MR JAN
LESCHLY AND
DR GEORGE
POSTE
Dr Jones
54. Mr Leschly and Dr Poste, thank you very
much for coming to meet us today. Your appearance before the Committee
seems to have generated a considerable interest and you are very
welcome here. We have already received your memorandum to the
Committee, in which I note you mention our recent report on higher
education and the research base, and thank you for that recognition.
What I propose to do is launch straight into our questions but
if, at the end of the session, there is anything you think we
have missed or any points you would like to make, there will be
an opportunity to do so. If I can kick off with this question:
what were the factors that led you to consider a merger with Glaxo
Wellcome?
(Mr Leschly) As you know, SmithKline
Beecham was a merged company between an American company called
SmithKline Beckman and the UK company Beecham, so we have had
experience in mergers, and we have had a very successful merger,
I think you will agree with me. Over the last eight years we have
come from being two good companies to become a major force in
the industry. So it was based on that experience and based on
the environment we are now living in, where health care is changing
dramatically (and I know you are very familiar with this so I
will not go into the details) and most importantly the way technology
is changing. The way we do research and the demand on research
to be productive and develop new medicines is becoming more and
more demanding, and at the same time the tools available, what
we call the platform technologies that you also are familiar with,
those platform technologies have really made a revolution in the
way in which we conduct our business. Because of the importance
of what drives our business, namely research and development,
we are constantly looking for opportunities for how we can strategically
position ourselves better for the future. The discussions we have
had with Glaxo Wellcome were not something new, we are constantly
reviewing opportunities for this. It goes back several years,
when we have had other discussions with other companies on how
we possibly could impact our ability to further strengthen the
engine, if you like. The real opportunity for us with the discussions
we had with Glaxo Wellcome was: could we possibly merge two strong
engines, the engines being R&D which drive our business. We
consider ourselves, as I mentioned before, a very strong company,
we do not need to do a merger, we did not ask for a merger, in
fact when Glaxo called us—remember that—we certainly
said we were interested because we have a fiduciary responsibility
for getting into these discussions, and we could see, also based
on previous discussions, that there were opportunities here for
merging these two engines, not only to become a much bigger research
organisation but most importantly to become a more productive
and more efficient machine we could drive products through. Maybe
I could ask my colleague, Dr George Poste, who can explain to
you the real benefits of merging these two engines.
(Dr Poste) I have little to add in the broad strategic
vein but, as you heard from Sir Richard and my counterpart, Dr
Niedel, there is a very close concordance in the vision of how
science will impact human health and medicine in the coming years
between our respective companies. We have had a lot of discussions
about that, many of our scientists know each other well and, as
you heard from the Glaxo Wellcome testimony, cost, complexity
and scale are now interlinked. The cost of R&D is escalating
dramatically, the complexity of much of the science as well as
the range of science you have to bring together is growing, so
there is an organisational complexity. Then there is this issue
of scale and, as Dr Niedel explained to the Committee last time,
scaleability. These platform technologies which Jan referred to,
such as advanced genetics, combinatorial chemistry and bio-informatics,
are becoming dauntingly expensive, and what we call the table
stakes, how much money you have to invest even to be a participant
in some of these, is in fact alarming for all of us in the industry.
Therefore bringing together, as Jan indicated, two very strong
companies, both acknowledged as research leaders in their own
right, really did merit serious examination and there would undoubtedly
be very tangible advantages from not having to duplicate some
of those expenditures. Once you have made the level of investment
to critical mass, it is then scaleable, as Dr Neidel told the
Committee, across a very large number of scientists and a very
large number of sites.
55. What made Glaxo Wellcome a more attractive
partner than American Home Products, which you were having discussions
with at the time you received the call, I understand?
(Mr Leschly) We had, as I am sure the Committee is
familiar with, very preliminary discussions with American Home
Products. I think it is very obvious why we were interested in
speaking to Glaxo. SB is a British company, Glaxo is a British
company, SmithKline Beecham is owned 65 per cent by shareholders
in the United Kingdom, so that fundamentally is a very good reason
why Glaxo Wellcome together with SmithKline Beecham would be a
better merger. At the same time, as Dr Poste just indicated to
you, we have a very good knowledge of how Glaxo Wellcome conduct
research. We have, as you maybe are familiar with, an agreement
on research with Glaxo Wellcome to do the sequencing and the genome
of micro-organisms, so we have over the years worked very closely
together with them in many ways. I know Dr Poste knows Jim Neidel
very well, so we have a good familiarity with them and therefore
were very confident that when we talked to them about merging
these two engines it made a lot of sense. That is basically the
reason why we considered that a better opportunity.
56. Obviously Glaxo was an attractive research
partner. Was there any Government pressure in this?
(Mr Leschly) Not to my knowledge.
Dr Gibson
57. Were there any indications from Government
at all that this was a good thing to do for the country, for the
nation, for science, for the millennium?
(Mr Leschly) I did not, personally, and I do not think
anybody from my company had any contacts with the Government.
You have to understand that it was very difficult for us to discuss
anything out of a very, very small circle, so I personally did
not have any contacts with anybody from Government, and to my
knowledge there was no pressure from the Government.
Dr Jones
58. Both companies have said the merger created
an opportunity to develop research and development, the synergies
there, there were a lot of advantages to creating this powerhouse;
were there any other benefits which are not related to research
and development?
(Mr Leschly) The driving force and the vision we have
and what really made sense for us was the merging of the research
units. We are, quite honestly, not in the business of closing
plants and making people redundant and squeezing costs out. Some
mergers happen because a weak company merges with a strong company,
or for that matter two weak companies merge and they try in a
short period of time to squeeze costs out of the system to come
through perhaps a difficult period of two or three years and then
use that time to have a proper strategic direction. In the case
of—and I think I can speak on behalf of both—Glaxo
Wellcome and SmithKline Beecham, both companies are very strong
companies, neither of us need to do a merger, and therefore when
we did it it was with a very specific rationale, namely to generate
a much stronger engine in research and development.
Mr Beard
59. Could you say just how the R&D activity
within the two organisations would have been different from what
it was in the separate ones?
(Mr Leschly) Maybe I could refer to Dr Poste who is
really in charge of our science and technology.
(Dr Poste) I think by definition it would have been
bigger. Beyond that, I think it would have benefitted from complementarity,
and I come back to my earlier remarks that as long as you can
achieve critical mass in some of these key technologies, which
you are very well aware of, it is not necessary to duplicate those.
As Mr Leschly has just indicated, it was certainly the intent
that any cost savings which came about through avoiding having
to make duplicate future investments could be redeployed to other
areas of R&D, or to the extensive alliance network we have
developed with new start-up companies in the UK, with universities
and so forth, so this was all a very positive picture. I think
the other element is that every company is slightly different.
I am not sure whether it was Sir Richard or Jim who mentioned
in the Glaxo Wellcome testimony that they are acknowledged leaders
in combinatorial chemistry, and they generously conceded we have
probably been in the vanguard of the genetics effort. So bringing
those two technologies together provides a very powerful complementarity
which not only maximises scale but also brings strengths that
we did not have from the Glaxo Wellcome stable, and reciprocally
the strengths we have in genetics to them.
60. Would you have expected the combined budgets
to have been the sum of the two parts?
(Dr Poste) Absolutely. I can speak in this context
as a Board Member of SB and this was very much central to the
debate which went on. As Jan has already indicated, this was not
a slash and burn approach with regard to what you would do with
the combined R&D budgets, on the contrary it was exactly as
you say, this was combining those budgets and redeploying them
to be even more efficient and competitive.
61. Was that your experience on the previous
merger?
(Dr Poste) Yes. Back in 1989 we maintained the combined
budget from SmithKline Beckman and Beecham Research Laboratories
in the first year and have grown it very productively in the mid-teens
range year by year. The R & D budget was £390 million
in 1989 at the time of the merger and we have grown to almost
£1 billion investment today, of which about £325 million
is in the United Kingdom, and we have grown our research staff
in the UK during that period from just over 2,000 to just over
3,000.
62. Sir Richard touched on the subject of patents
running out when we spoke to him a few weeks ago, and that being
one of the driving forces behind Glaxo needing to boost their
research and development and why therefore they saw advantages
in scale. Are there similar tactics behind your interest in a
merger?
(Mr Leschly) We certainly have experience of that
as well. In 1994—I can tell you the date was March 19th
because I am very familiar with that date—the patent went
off Tagamet, which had played a major, major role, as you can
imagine, as a break-through compound and as an aid to metabolism.
That compound went off patent. At that time we had sales of over
a billion dollars, today we have sales probably around 200 million,
so we have lost 800 million dollars. We lost that within the first
six months of the patent going off, so it was a very dramatic
reduction, which is the nature of this business. You cannot have
a patent and then expect it to go on, so we understand that. So
a strategy for us, right from the beginning when we did the merger
in 1989, was how could we prepare for off-setting that dramatic
reduction, which had a huge impact on our earnings and therefore
as you can imagine on the well-being of the whole corporation,
by having a flow of new products coming through? That is why the
wise men I believe back in the early days of our merger all agreed
that we must invest in research and development. The only way
we can come through this is by generating new opportunities for
new products which really make a difference for patients. So we
did that and I remember we set a goal. I joined in 1990 as chairman
of pharmaceuticals and I remember I said, "Could we possibly
set a goal of achieving 25 per cent of sales of new products,
as a percentage of total sales, coming from products introduced
in the last five years?" I can tell you today, in 1998, 39
per cent of our total sales of pharmaceuticals come from product
introductions in the last five years. We exceeded therefore the
target of 25 per cent dramatically, and that was due to successful
research and development input, a commitment to research, and
a big part of that I have to say came from research done in the
United Kingdom. If you look at the products which have had success—you
maybe know the products—I can tell you the whole array of
products which has been the driving force in that period between
1993 up to 1998, that five year period, the majority of these
products have come from excellent science done in the UK. We are
very proud of that and that was certainly the Beecham heritage.
Now we do not differentiate between Beecham and SmithKline Beckman,
we are now a new company, it was a merger of equals, and now I
have to say that that is the reason why every company which faces
patent decline must do that. Lastly, let me say that we are in
a very fortunate situation today and that is why we consider ourselves
a very strong company today. We do not have major products going
off patent in the US before the year 2003, we have a major product
going off in 2003, another one in 2006, otherwise we do not have
it, and that product which goes off patent in 2003 at that time
we expect will be equivalent to 5 to 7 per cent of our sales,
a very different scenario from when the patent went off Tagamet
in 1994 when it was 28 per cent of our sales. So we have succeeded
with our strategy and it is based on a commitment to research
and development.
63. How would you answer people who might say:
"It is all very well this research and development emphasis
but that is a very good cover story for what are really financial
difficulties which the merger was intended to overcome"?
That the research and development in practice, though presented
as the raison d'etre for the merger, is more a cover
story than the substance of it?
(Mr Leschly) The nature of research and development
is that there is never money enough, and you know that. There
will always be opportunities for further investment. We do have,
and maybe you can address this in a moment, George, a fantastic
opportunity because of genomics and the new way we can identify
targets and validate targets to drive new products through. We
have more than enough funds to carry our company, with growth
in research budget to £1 billion. It is not exactly a small
budget, it is a lot of money, probably about £4 million a
day, including Saturdays and Sundays, so that is a lot of money
being invested. We can drive our business that way. The issue
we are dealing with is, can we also find extra funding for issues
like the icing on the cake, taking advantage of new leads, and
that is something we have major debates on internally, strategically.
64. I believe a merger is notoriously very difficult
to bring about, and the human factor in it is one of the most
interesting parts of welding teams together, when they may be
insecure as to whether they, or somebody else, are going to take
the job; whether they are going to be made redundant; or whether
their particular line of research is going to continue or not;
so you would anticipate quite an upheaval for a period in bringing
two organisations like Glaxo and your own together, because there
will be all that sort of anxiety permeating the whole organisation.
So how soon would it have been before the benefits you are outlining
would have come about, because there would have been surely a
period of turmoil before they were finally realised?
(Mr Leschly) Mr Beard that is a very relevant question
because one of the issues we were dealing with was that this was
a merger of equals we were establishing, and even in a merger
of equals, even if there is total harmony in all management ranks,
you have to deal with the very complex matter of bringing these
two organisations together where intellectual property is the
key driver, and people in the final analysis are essential for
success. Even in a merger of equals it takes time. In our experience
of SmithKline Beecham's merger, I would say it took us two to
three years before we felt we had one company, and I would not
expect it to be different in a merger of the nature of Glaxo Wellcome
and SmithKline Beecham. We were aware of that and there was no
surprise there.
65. You have looked at this from the point of
view of chief executive of a major company, from a commercial
point of view, but of course there is another aspect to this which
is that between the two companies involved you controlled something
like 20 per cent of the United Kingdom civil research and development,
so there is another dimension and responsibility to these issues.
How would that have been benefitted by this merger?
(Mr Leschly) Maybe I can refer that question to George,
who is really in charge of the administration of our £1 billion.
(Dr Poste) Again, although there is a definitive commitment
to the stockholders of the company, we are very mindful of a very
important responsibility in relation to the science base and the
conduct of science in the United Kingdom. I think the records
of both companies show that through their very consistent expansion
of research and development in the United Kingdom as independent
entities, and the commitment that you heard from Sir Richard and
from us a moment ago that that investment would have continued,
and notwithstanding the vagaries of science (because you can never
not be surprised on occasion by how science works) the commitment
to grow the R&D has been a commitment which both Glaxo Wellcome
and ourselves have made. That does not mean to say that we do
not have worries about the science base, as you know from some
of the testimony we have given, which this Committee has in turn
reflected in its own concerns, so I think we always need to be
mindful of that. But in short I think both companies have a magnificent
historical record of investment in science in the UK. We have
continued to grow our budgets in the UK substantially and with
that a continued expansion in the number of university collaborations,
the number of case studentships that we support, and a continued
expansion in the amount of clinical research we do.
Dr Turner
66. This may be a naive question but your commercial
arguments for the mergers are very convincing and I think your
argument about establishing a critical mass makes extremely good
sense, but I just wonder is there a possibility that you can reach
a point where your R&D organisation gets so massive—and
had your merger with Glaxo Wellcome taken place you would be one
of the handful of the biggest in the world—it becomes less
effective, if you like, on a unit basis? That the organisation
gets beyond an optimal size?
(Dr Poste) As you know, there is a huge body of scholastic
literature on this subject with widely different opinions and
I do not think anyone has really defined what is the effective
size for an R&D organisation at which performance becomes
sub-optimal. I think your question is intrinsically correct, the
larger the organisation becomes the greater the opportunity for
bureaucratic sclerosis and administration becoming strangling
and claustrophobic. On the other hand, I think that the benefits
of scale do have to be taken very seriously. We are now moving
towards an era of big biology in much the same way physics and
engineering did before us. I think the trick is to actually then
look and say, yes, it may be a research organisation if the merger
had gone ahead of 10,000 scientists, physicians and technicians
working together, but in reality the network which any given group
work with is still comparatively small. Science, as you well know,
is becoming very specialised, if not ultra-specialised, so two
categories of biologists can barely talk to each other because
one works on the nervous system and another works on the immune
system. So if you look at the collection of scientists and physicians
you bring together to work on any specific project, it does not
get dramatically large. So, yes, you have theoretically a large
enterprise of 10,000 people but within it you have many, mini-communities,
which are you hope entrepreneurial in their own right. When you
allow administrative frameworks to basically start crushing innovation,
whether that be in government, industry or academia, that is when
you start to lose the best and the brightest, and that by definition
has a subjective element. Some organisations are very good at
running innovative science, whether they are big or small, and
others create an environment which is inimical to science, but
I do not think any sort of scale per se is the limiting
factor here.
(Mr Leschly) You can go the other way and say, "What
is the minimum size you need", because scale is one thing,
and I would rather deal with that problem, if you are too small.
In industry circles the minimum research budget in an industry
like ours, competing in this industry, to be successful as a global
player not as a niche player, is probably around £700 million
or 1 billion dollars. That is the minimum. There are many pharmaceutical
companies who do not have a research budget of 1 billion dollars.
Therefore what you can anticipate, I believe, is that there will
be a network where companies would be not only interested in but
forced into alliances and networks. That certainly can benefit
the UK universities; there will be alliances with them. We certainly
have that, we have alliances with biotechnology companies in the
UK, we are very interested in spreading our network, utilising
resources, working together in partnership. Therefore the only
way you can offset this enormous demand for research dollars is
by being much more flexible and interacting with the institutions.
They are very interested in working with us and they are much
more amicable to that than they used to be; it is a very different
climate these days working with universities and academic centres.
So I see that as an opportunity for academic centres.
Dr Gibson
67. Am I right in thinking that your whole being
depends on the human genome project coming to fruition? Is that
the basic science which drives you and if something goes wrong
with that, that you cannot get your hands on it and the drugs
do not develop in the right sequences and so on, that will be
a problem for you? How would you relate all that to what Glaxo
are doing, what others are doing? How much co-operation and competition
is going to be involved in the health problems you are looking
at? I have heard Dr Poste talk before, so I know some of the drive
which is behind this, but can you foresee problems which might
drive SmithKline Beecham into a corner and you might lose out?
(Dr Poste) You have correctly highlighted genetics
combined with combinatorial chemistry and bio-informatics, as
we have heard from Dr Niedel. Those have become the key driving
technologies. The other thing that they have done is to dramatically
expand the number of molecular targets available for drug discovery.
There is sustained competitiveness between the major players,
but if you look at the way drug discovery used to be done, even
as recently as seven to ten years ago, the same companies had
to chase the same target because that was the limit of science
and medicine at that time. What the genome project has done for
SB and Glaxo Wellcome and all major companies has been to dramatically
expand the number of targets we have available because, as you
well know, the whole essence of what modern molecular biology
allows us to do is actually define the basic mechanisms of disease.
By understanding the basic mechanisms of disease, therapeutic
intervention becomes much more rational. Up until essentially
1995, in the first 95 years of this century, the industry has
essentially worked on 500 molecular targets. SB now works on 200
in any given year and that is matched by other companies, simply
because the human genome project has just dramatically expanded
the number of targets available to everyone. So I cannot theoretically
say there is not a target which Glaxo and we are working on too,
but I think we have all got much more room for manoeuvre.
68. Are there diseases you are interested in
which Glaxo are not?
(Dr Poste) Yes, by definition, since this is a business
and the nature of the size and scale of the market opportunities
provided by the major diseases means that there are obvious overlapping
attractions for every company in which diseases they may choose
to go after. As you well know, many of the drugs which may act
on the same disease still work by very different mechanisms. One
of the real opportunities which has now been opened up, I would
argue, is the fact there is this unmatched opportunity in oncology
and the neurosciences as a result of dramatic advances in cancer
research and the neurosciences, and vital public health initiatives
in terms of dealing with the growing challenge of antibiotic resistance
which could not have been tackled without the same tools we apply
to the human genome project being assigned to look at bacterial
genes.
Dr Jones
69. Before I bring in Dr Kumar could I just
go back over a point that we were discussing earlier and that
is what happened when the patent on Tagamet ran out? You were
telling us how there had been accelerated growth in your research
budgets. Was there an hiatus when the patent ran out? The reason
I ask is because Glaxo told us the reason why their budget had
stabilised rather than continued to grow, as it had been growing
in the separate companies, Wellcome and Glaxo, was because of
the expiry of patents. I wondered whether you had a similar experience?
(Mr Leschly) I just happen to have a piece of paper
in front of me that says our R&D spend in 1992 increased 11
per cent over 1991; 1993 was 20 per cent over 1992; and in 1994,
which was the critical year we are talking about—remember
the patent ran out in May so at least we had the first four months,
we did not have the impact—R & D spend increased eight
per cent. Then we had, of course, the dramatic impact all year
in 1995 and the budget increased 5.2 per cent. Then in 1996 it
increased 17 per cent. In 1997 it increased ten per cent. I can
tell you we had our first quarter result announcement yesterday
and we took a little bit of a beating because we announced that
we would commit to an expansion of our research budget between
16 and 17 per cent in 1998 over 1997. So the £293 million
spent in 1997 in the UK will be in the neighbourhood of £325
million in 1998. In other words, if the numbers are correct here,
a 16 per cent increase in the UK. Why do we do this? Because we
just happen to have an enormous opportunity with the 60 projects
we have in development. The spending level we increased here was
not necessarily due to the extraordinary expenses that we have
had in the last four or five years in discovery. The benefit of
the discovery effort is now moving into development and in development
that is where the big money is spent. We have a new product in
diabetes, a new product in asthma, a new product in irritable
bowel syndrome and new products in osteoporosis and breast cancer.
We have a new quinalone that hopefully will be helping us with
resistance. Those key products have huge market potential. We
have to drive through and we have to start it now, even if the
products will not really give a return to us maybe before 2000/2003.
That is the nature of our business. We are willing, therefore,
to accept that we have to lower our earnings forecast for this
year. We had expected a mid-teens growth in earnings share and
yesterday we announced that it would be the low teens. It is still
very, very good but not as good as the expectations were. That
is good management. We have to do what is right for the business
and investment in the future.
70. It would be very helpful if you could let
us have those figures.
(Mr Leschly) Yes, I would be delighted.
71. Were they in real terms or cash terms, the
increases you have just quoted?
(Mr Leschly) I guess this is an increase in pound
terms over the previous year, yes, in cash.
72. You have to take an inflationary allowance?
(Mr Leschly) Yes.
73. How were you able to do that when, as you
told us earlier, your sales declined so dramatically, 200 million?
(Mr Leschly) That is a very good question. I can tell
you it was not easy and it was not very pleasant but I remember
that year, there were no salary increases across the Board, there
were no bonuses across the Board, on the other hand we developed
our stock options. This is how you use an incentive system.
Dr Gibson
74. Are you saying within the whole company
there were no pay increases?
(Mr Leschly) Right across.[1]
75. Right across?
(Mr Leschly) At every level, including mine.[2]
76. How were the share options allocated?
(Mr Leschly) I cannot give you all the details here.
The whole idea was by giving a stock option you were saying "if
we are successful five, six, seven years from now you benefit"
but you have to pay a price now.
Dr Jones
77. Did that make the company vulnerable during
that period?
(Mr Leschly) We were very nervous at that time. We
were vulnerable in the sense that at that time when I got back
just four years ago, I started as CEO of this company in April
1994 and the market value of the company at that time was £12
billion. We were, in retrospect, very vulnerable because as you
know we were not a pure pharmaceuticals company. We are very strong
in pharmaceuticals but we are also the third biggest company in
the world in consumer health care. We had major investments in
laboratories. Therefore, we were vulnerable to a possible takeover
which then could split up the company and sell the different units.
Therefore, we restructured the company, we sold our animal health
business, we acquired Sterling, we focussed on what is our strategy
for the future to become a health care products and services company
focussed on pharmaceuticals. The market value today is around
£40 billion up from the £12 billion four years ago,
a dramatic increase. Of course, it is not only due to good management,
it is also due to the fact that the market has been very attractive
so everybody has made great progress. Today we do not feel we
are vulnerable. We do not feel that we have any concerns about
takeovers. As I said to you, we feel very confident about the
future and as an independent company we will be very successful.
78. And this is a strategy that you would recommend
to other companies?
(Mr Leschly) Absolutely. I must add that we look constantly
for opportunities for how to become even stronger. We cannot just
sit back and say "this is good enough". We have to constantly
look for opportunities and strategic initiatives that can further
enhance shareholder value and competitiveness.
Dr Kumar
79. Mr Leschly, you said that a merger between
the two companies would have been a merger of equals?
(Mr Leschly) Yes.
1 Note by witness: This
information is incorrect. There were no pay rises for Board members
but there were increases for other staff. SmithKline Beecham apologises
for any confusion caused by this error. Back
2 See Note 1. Back
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