1. Trust but verify: Trust is important while doing a deal, but blind trust can cause great embarrassment, if not irreparable damage.
In 2013, Daiichi agreed to pay $500 million to resolve a lawsuit and the federal charges that the company sold improperly manufactured drugs.
Daiichi took legal recourse to recover this amount and after years of investigation it has succeeded in getting a favourable order passed. But the ordeal must have left it exhausted and distracted it from pursuing its purpose.
What can companies do to avoid such a minefield? Follow the Russian maxim, trust but verify. Accept all the information and claims in good faith, but put in honest efforts to verify them. Go beyond the Excel-based financial audit. Carrying out physical inspections of assets. Speak to stakeholders and industry veterans who know the company, business and industry to get insight into the company’s ethical and moral standard while doing business.
2. Do not fall in love with your target, it will impair your rational judgment: It appears that Daiichi fell in love with Ranbaxy. This marriage seemed to have been made in heaven, at least on paper. Both entities brought complementary skills to the table: Ranbaxy brought an understanding of the fast-growing (non-proprietary) generic drugs business, a deep understanding of low-cost research, manufacturing facilities and expertise to capitalize on the fast- growing generics sector in Japan. Daiichi brought the mindset and stringent systems and processes of an innovative global drug company.
So what went askew?
Daiichi ostensibly suffered from three behavioural sciences syndromes while negotiating the deal: selective hearing (a bias where people hear that which they desire), confirmation bias (a tendency to search for and interpret information in such a way that it confirms one’s perception), and illusion of attention (people are confident that they notice everything that takes place in front of them. But in reality they see what they are focusing on).
Hence, Daiichi could have selectively looked at data which supported its hypothesis, while erroneously believing that it had taken on board all data points to make a considered decision.
3. Choose a partner wisely: India is a complex country and choosing the right partner to enter the market can make the difference between success and failure. Along with complementary skills, ensure that there is alignment in culture, with similar values and business intent guiding decision making.
Take Starbucks’s entry into India. Its chief executive Howard Schultz wisely waited for the right partner before venturing into India. During this time, the firm held talks with Jubilant FoodWorks and Future Group, among others. It finally tied up with the Tatas.
Tata’s and Starbucks’s purpose/mission statements and values seem similar and the chances of them having a similar business intent seem high, with few conflicts. They both also bring complementary skills to the table. The Tata’s coffee plantation would supply the raw material and the group’s real estate expertise would be handy for housing the stores; Starbucks brings its brand equity and expertise in selling coffee as an experience.
4. Be careful in defining the purpose of your business: Like Jonathan Trevor and Barry Varcoe say in their article ‘A Simple Way to Test Your Company’s Strategic Alignment’ in the Harvard Business Review, a company should be careful in deciding its purpose—what the business is trying to achieve. Because its strategy—how the business will achieve its purpose—gets conceptualized and defined guided by its purpose. After that the organization’s capabilities—human, financial and management systems and processes—are put in place to execute the strategy effectively.
Getting back to Ranbaxy, in the years leading to the sale to Daiichi, its purpose seems to have been maximizing profit (i.e., maximize valuation), with the intention of flipping the asset.
Of course Ranbaxy succeed in achieving its purpose, but at the cost of the credibility and reputation of its promoters.
5. Fit for purpose: In 2013, after inspecting Ranbaxy’s factory in Punjab, the US FDA banned import of drugs manufactured there, citing quality concerns. It declared the factory was not ‘fit for purpose’ for the American market, because it did not conform to prescribed manufacturing standards—which Ranbaxy had undertaken to comply with when it applied for licence to sell in the US. Earlier in 2008 the agency had halted import of 30 different drugs from two of Ranbaxy’s plants in India.
Why this gap in compliance?
A partial answer may reside in the thinking that prevails among many generic drug manufacturers that the FDA specifications are over specified and extremely stringent. This is the platinum standard, so to speak, and many believe that even with a silver standard, the drugs would be effective.
However, the American agencies would not agree to lower standards and would disallow them from selling in the US, which is a large and profitable market.
Hence, many generic drug companies agree to comply on paper, but do not back it with necessary investment in plant and machinery, people, robust systems and processes and record keeping. If they did, it would have an impact on profitability.
But that’s not a path to building an enduring business. Delivering what is promised, and investing to enable this, is the way. The business lessons are simple:
- Quality cannot be injected into a product. It has to be built into it. Take Apple. Its products are manufactured in China. But the factories are designed to meet Apple’s own quality standards.
- If the purpose is to only make money, it will eventually sully the reputation of the business.
6. Knock-on effect: Companies should take on board the unintended consequences of their business decisions.
Did Ranbaxy consider the impact of its decisions on the reputation of generic pharmaceutical companies, Indian businesses in general and the Indian government’s efforts to attract foreign direct investment (FDI)?
Due to the knock-on effect, foreign businesses may pronounce generic pharma companies, including Indian businesses, guilty till proved innocent; their claims would be viewed with jaundiced eyes, vigorously challenged and microscopically scrutinized. They may insist upon carrying out forensic due diligence before finalizing a deal. And a claw back clause, which ensures that money or benefits distributed are taken back as a result of special circumstances, would form an integral part of a deal to protect them from any unexpected liability.
7. Sunk cost fallacy: Daiichi recovered from the ill effects of this deal by not succumbing to the sunk cost fallacy of protecting past investments rather than future benefits.
Many blue chip companies including Kodak and Nokia have been victims of this fallacy. To protect their past investments, both companies ignored initiatives to introduce digital cameras and smartphones, respectively. As events later showed, it was digital cameras and smartphones that dislodged Kodak and Nokia from their preeminent position.
Daiichi had sunk in $4.6 billion in a cash deal to buy Ranbaxy. When it realized that the deal was not a prudent decision, it did not commit additional money to redeem or justify the investment.
In April 2014, it sold Ranbaxy to Sun Pharma, India’s largest drug maker, for $3.2 billion. As a part of the deal, Daiichi got 8.9 % stake in the new Sun Pharma. It later sold its shares in the new company for $3.6 billion and retreated from the Indian market. Viewed purely from a financial perspective, it recovered almost all its investment, but not the opportunity cost of capital.
This deal would have taught Daiichi many valuable business lessons. The next time it wishes to wade into India, it will be better prepared to realize its business objectives.
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In this series, Rajesh Srivastava, Business Strategist and Visiting Faculty at IIM Indore gives you a regular dose of strategy case studies to help you think and keep you one step ahead as a professional as compared to your peers. Rajesh is an alumnus of IIM Bangalore and IIT Kanpur and has over 2 decades of experience in the FMCG industry. All previous Strategy with RS posts can be found here.
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