EC229 Economics of Strategy
Introduction
1. GlaxoSmithKline (GSK) is a global healthcare company specialized in the research, development, manufacturing and marketing of pharmaceutical and consumer health-related products. The company has operations in 120 countries, with products being sold in over 150 countries. (Description)
2. As a dominant player in the pharmaceutical industry, GSK operates in an oligopolistic market. It is highly cash generative, with increased sales growth and shareholder returns. (Oligopoly)
3. Its main competitor is American pharmaceutical giant, Pfizer. Financially, GSK is not the best performer (with $108 bn compared to Pfizer’s $161 bn), but it manages to differentiate itself, which is the key to success in an oligopoly, through a number of strategies which we will explore in this paper. (Pfizer)
Vulnerability
1. Business vulnerability is the ‘hurt’ done to business costs and profits by external events; it increases average total costs, thus reducing profits. (Definition) 2. Type 1 vulnerability is the extent to which the magnitude of fixed costs will affect the strength of the company. It is represented by the firm’s SRATC curve, which is affected by the scale of fixed costs. (Type 1 definition)
3. In GSK’s case, the fixed costs are immense, however, due to economies of scale and vast amounts of specialization, GSK’s operations are likely to be somewhere near the bottom of the SRATC curve. (GSK)
4. This type of vulnerability may be offset by Increasing Returns to Labour. Although investment in labour is a quasi-fixed cost for firms in the short run, it amortises in the long run and becomes a valuable asset to GSK. (IRL)
1. Type 2 vulnerability is the extent to which the firm is exposed to macroeconomic shocks, and is determined by the external brought in costs. (Type 2 definition) 2. As many pharmaceutical products are formed through a
cracking process of crude oil, the volatility in oil prices in recent years impacted upon GSK negatively. It has made GSK susceptible to type 2 vulnerability. (Oil)
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Exposure
1. As a multinational firm, foreign exchange rates will have a major effect on the company’s overseas assets and demand. (X-rates)
2. In GSK’s case, the constant high valuation of the pound provides an advantage to GSK in regards to inputs such as labour and raw materials, e.g. oil, which will become cheaper (more expensive) in the event of an appreciation (depreciation) of the pound. (Appreciation)
3. Gradual depreciation of the US dollar since 2007 has resulted in a decrease in cash sales of GSK. This has an adverse effect on its long term revenues, as the US continues to be a high volume market for the company. (Depreciation of $)
1. In an event of a spike in oil prices, GSK will experience a spike in its total costs. It will affect its internal costs, such as transportation costs, as GSK maintains a large and complex supply network. (GSK = large – oil?)
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2. Also, rising oil prices cause inflation to increase. This will decrease aggregate demand. (AD decrease)
3. However, GSK will, very often, pass on the price increase to consumers,
given that GSK has monopoly rights over many drugs. This forms a safety net for the firm as it is for the same reason that the decrease in aggregate demand will not impact upon GSK significantly. (Monopoly rights)
4. Additionally, GSK will have contracts with their suppliers for many goods, such as crude oil. Thus, the impact of the increase in oil price could be reduced. (Forwards)
Strategy
1. The central purpose of strategy is to create and exploit market imperfections to protect the business from its vulnerabilities and exposures to external shocks. In response to reduced profits in Europe and USA due to competition from generics, GSK has derived a number of strategies to address these issues. (Definition; generics) 2. (Advertising) GSK invests heavily in its brands, including consumer-driven scientific innovation and industry-leading consumer marketing. This is critical to differentiating its products and maintaining growth.
a. Its 5-year partnership with McLaren is one of the more notable marketing strategies.
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b. Divestment has also helped GSK raise profits in 2012, as it refocuses on its core brands. The graph shows the impact of advertising on profits.
3. (Collusion) The ViiV healthcare, a collusion between GSK and Pfizer, helps both companies reduce costs in the race in HIV R&D, one of the most expensive public health programmes. In an oligopoly, the explicit collusion of two firms will pay because it enables the players to jointly charges monopolist prices and earn monopolist profits. However, it is for the same reason that there is an incentive to cheat.
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4. (R&D) Ultimately, if oligopolists want to achieve and enhance supernormal profits, they need to erect barriers to entry to protect their competitive advantage. This is why the ultimate strategy lies within R&D. It ensures that GSK remains a sustainable business. a. Over the past 4 years, GSK has had 16 new drugs and vaccines approved in the USA, more than any of its competitors. It has also sustained late-stage pipeline of around 30 assets.
b. R&D is a long run investment that allows GSK to enjoy reduced MC, which further extends its profits. Nonetheless, it is essential that it protects these assets through patents, in order to achieve monopoly powers over these assets.
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5. Other countries (Emerging markets, Japan)
6. Acquisition (China, Argentina) -> Horizontal growth
Conclusion
As one of the major players in the pharmaceutical oligopoly, GSK continues to enjoy economic benefits, notably through their strategies. In the face of the threat of generics, GSK has seen its profits rise due to its efficiency in protecting its assets. This is reflected in its rise in profits in Q1 2012, as opposed to rival firm AstraZeneca, which announced a sharp fall in profits in the previous quarter, for the same reasons.
