Back in February, McKinsey published an article claiming that the pharmaceutical megamergers of the past two decades have generated significant value for shareholders. The article set off a substantial amount of debate.
It got me thinking. Why did this end up becoming such a big problem? What was it about the way they communicated their finding that created so much pushback? Were their calculations incorrect? Based on improper data? Were their conclusions patently false?
No, I think it’s much simpler. They didn’t consider enough context. And it’s a very common mistake in case interviews as well.
What Is Context?
I will give you an example. The other day I was doing a case about a company that wanted to grow its revenues by 10% annually for the next five years.
I discovered that by investing in a certain initiative they could grow their market share from 20 to 26% in the next five years.
The first thing that I thought was, there’s no way that increasing our market share by 6% over a five year period would result in us growing our revenues by 10% annually. The math just doesn’t add up. So I concluded that the company can’t achieve this target. And this conclusion set off a substantial amount of debate with my friend.
It got me thinking. Why did this end up becoming such a big problem? What was it about the way I communicated my finding that created so much pushback? Were my calculations incorrect? Based on improper data? Were my conclusions patently false?
No, I think it’s much simpler. I didn’t consider enough context.
Firstly, a company increasing its market share from 20% to 26% doesn’t sound big on its head, but if we’re assuming the market size stays the same that’s actually a 30% increase in revenues.
Secondly, the total market size probably wouldn’t stay the same. Let’s do a bit more math. For a company to grow its revenues by 10% annually they would have to increase their total revenues by 60% over a five year period.
Now let’s say the total market size now is $100, and we have 20%, making our revenues $20. For us to hit our goal we need to increase it by 60%, making our revenue target $32.
So, let’s say the market grew in size to $150, and we have 26%, making our revenues $39. We more than exceed our target.
You see why I got so much pushback? There’s much more going on than just increasing our market share by 6%. Yeah, it sounds small in an absolute sense but relatively that’s a big increase. Also, the growth of the overall market is just as important of a factor as the growth of our market share, but I didn’t touch on it at all.
Context means always putting your numbers in perspective. How do they compare to historical trends? How do they compare to industry benchmarks? How large are they in relative terms? Have you accounted for all of the factors that would affect your numbers? Why is this particular calculation the best proof of your conclusion? Why not a different calculation?
Context also means softening your conclusions. It means saying things like, this program we’ve come up with will only boost our total revenues by 30% (assuming the market size stays the same), but we haven’t taken into account growth in the entire market. Growth in the market would substantially effect any conclusion you could draw.
Now let’s talk about pharmaceutical megamergers.
So what disagreements did this article trigger? Well, I think it was a couple of things:
1. They used stock price as a proxy for shareholder value.
Admittedly, many of the companies that were involved in these megamergers did see their stock prices go up. But I’m not sure you can just attribute this to the merger itself. Many of these companies implemented massive stock buyback programs
that boosted their stock prices. And although many of these companies outperformed the industry average, I’m not really sure what that means. Wasn’t everybody doing these megadeals in those days? How’d they even come up with this calculation?
2. Their timescale was too short
. As John LaMattina (former R&D chief of Pfizer) wrote about in this article
, the pharmaceutical industry requires long range vision. Many of these pharmaceutical megamergers seriously disrupted the R&D functions of both the acquirer and the acquired.
These disruptions probably wouldn’t be apparent for somewhere between 12-15 years afterwards, because of the long lead time on drug development. In other words, McKinsey may be right. Maybe these mergers did create value for shareholders, in the short term. (As you can see from above, they only looked before and 2 years after).
But the problem is, many people who actually work in the industry thought a different time scale should be used, and that there should be some sort of accounting for the value that was lost due to the disruptions associated with megamergers. That’s why there was so much debate.
Context is extremely important to make accurate conclusions. It means always putting your numbers in perspective by compare to historical trends, proper industry benchmarks, putting them in relative terms, accounting for all of the factors that would affect your numbers, and justifying why the particular calculation is the most accurate one to use in this situation
Context also means softening your conclusions. It means putting in caveats, and making sure that your conclusions follow from your data. And it isn’t always easy to do.