GlaxoSmithKline’s chief executive tells Andrew Cave the future is about sales in emerging markets and why the company’s Ribena and Lucozade may be sold .
It says much about GlaxoSmithKline (Other OTC: GLAXF - news) ’s progress since 2007 that the biggest controversy in last week’s results was the future of two health drinks representing less than 3pc of the pharmaceutical group’s £26bn annual sales.
In Sir Andrew Witty’s five years as chief executive, Glaxo’s problems have included a “patents cliff” with many of its best-selling drugs facing imminent loss of protection from generic competitors, a paucity in its future drugs pipeline, swingeing price cuts by governments in Europe and a controversy over the availability of its swine-flu vaccine.
Now the focus, however fleetingly, is on Lucozade and Ribena drinks brands that, despite their long histories and iconic status among UK consumers, account for sales of £750m.
Glaxo announced it is to review the future of both brands the usual corporate shorthand for saying they will be sold off with Sir Andrew saying the board will decide by the summer whether to sell one or both, or keep them with changed strategies. He admits that Glaxo has failed so far in its quest to globalise the brands.
“We’ve started but they’ve not gone as well as we would have liked,” he says.
“A lot of drinks in emerging markets tend to be local and one of the key challenges is building distribution and bottling capabilities.
“In Britain, we have our own bottling capabilities. We don’t have that in many of these markets. Building that distribution is one of the challenges.
“Lots of other companies have that, which might lead you to think that some other companies may have an advantage here.
“It raises the question as to whether we’re the best owner of these brands. It may be that someone else can do a ten-times better job than we can do.”
Lucozade is the much bigger brand but two-thirds of its sales are in Britain, with the remainder in Ireland (OTC BB: IRLD - news) , Nigeria and former Commonwealth countries including Singapore and Malaysia, plus a small business in China, where GSK has made three separate attempts to penetrate that market.
In India, there is only a very small pilot programme for the drink that first appeared in 1927, billed as “the sparkling glucose drink invaluable in sickness and in health”, and packaged bottle wrapped in orange Cellophane.
This is in sharp contrast to Glaxo’s Horlicks brand, which is sold at lower prices in small quantities and through chemists as a milk substitute, and has become India’s fifth largest consumer brand.
However, fruit drink Ribena is much less globalised, with most of its sales still concentrated in Britain and New Zealand.
“The health drinks business has really not got off the ground yet in India,” says Sir Andrew. “That category is very small at this point.
“We’ve done such a brilliant job in Britain and Ireland, where Lucozade is the second biggest soft drinks brand and the seventh biggest fast-moving consumer goods brand.
“More people in Britain know Lucozade than anything else we do, probably. But is there more that we or someone else could do with it, particularly in emerging markets but also potentially in North America, where we have never tried to commercialise it?
“It’s great that we have such a powerful brand here in Britain and Ireland, but I think this brand has the potential to be something much bigger than that.
“The proposition of a modern health, energy and sports drink is very appealing, particularly to the growing middle classes in many of these countries.”
Both brands are likely to attract keen demand from drinks groups, with Sir Andrew receiving the first investment banker call about a potential sale of the two businesses only 18 minutes after announcing their review.
Sir Andrew says Glaxo’s consumer arm is here to stay, but he has developed two criteria for synergies that should ensure that products in this division fit well with the core pharmaceuticals business.
“When I took over, I wanted income streams that were not all affected by the same phenomena in the way that we had seen happen previously because we had too much concentration in one drug in one country America,” he said.
Sir Andrew wants to bring together strong pharmacy distribution and brand value in emerging markets with products such as Horlicks, pain reliever Panadol and toothpaste brand Sensodyne. The latter has experienced double-digit growth in 14 out of the past 15 quarters to become a £1bn-a-year brand.
“I’ve gone, in five years, from a belief that these businesses live together to an absolute conviction that the evidence supports that,” he says.
Despite the interest in Lucozade and Ribena, what’s much more material to Glaxo’s future is the company’s pharmaceuticals and vaccine pipeline.
The company now has six promising drugs in advanced trials two apiece for cancer and respiratory conditions, plus diabetes and HIV treatments. It has a further nine, including respiratory, cardiovascular and rare-disease drugs, also in development.
“Five years since I took over, we’re spending less than we spent five years ago on drug development and production and have 50pc less infrastructure, yet we’re producing substantially more product output,” says Sir Andrew.
“We’ve three times the number of patients in clinical trials than we had five years ago and our internal rate of return [last calculated at 12pc a year ago] is rising towards our target of 14pc.
“We were really determined that we would not use big M&A to try and buy ourselves time and we’re one of the few big pharmaceutical companies that hasn’t done a major acquisition in the past 11 years. What that’s done is force us to address the challenges organically.
“We’ve got though our patent cliff without an acquisition and have been able to come out the other side essentially still a very big company with a very healthy economic profile.”
Sir Andrew says a new approach has seen Glaxo rethink its attitude to research and development and give more power to the 11,000 scientists the company has in its 104,000 worldwide workforce.
The result, he says, is that Glaxo has had at least 30 major late-stage development programmes in each of the past five years.
“The approach is more differentiated and novel, and our cost per new drug is falling significantly, which is important because payers want to pay less,” he says. “I’m not going to say we’ve fixed R&D, but we’re well on the way to fixing the challenge.”
The bigger strategic problem is probably the geographical shape of the group, with Europe where 30,000 of Glaxo’s employees, including 15,000 working in Britain, are based becoming less important to the company.
Some 40pc of the group is now outside Europe and North America a key shift for a business that has traditionally been seen as either British or US-dominated.
More significantly, 80pc of the business is now in strong growth markets, assuming that the United States returns to that category. The big exception is Glaxo’s European pharmaceuticals operation.
“I think the real shape of the company that we’ve been striving to build is really becoming visible now,” says Sir Andrew.
“We’re a much more balanced business now. Emerging markets and Japan, the consumer business and vaccines have really grown in importance.”
His outlook for Europe, however, is not bright and it has much more to do with continued moves by Europe’s governments to rein in spending on drugs than it does with the debates over the European Union and the future of the euro.
“It’s much more fundamental than that,” says Sir Andrew.
“The key issue for us is the macroeconomic scenario for Europe, because Europe has an ageing population, a very extensive social contract that is in place and what appear to be anaemic growth prospects.
“What does that mean for whether we should expect more cost-cutting or not by European governments?
“I am relatively pessimistic about that. It’s very hard for me to see how Europe becomes a high-growth region. We therefore have to make decisions accordingly.”
The result, he says, will be more restructuring of Glaxo’s 9,000-strong European commercial operation, where “there are likely to be fewer jobs”, particularly in sales and administration functions.
Glaxo has reduced its headcount by 25,000 in the West but increased the number of employees in emerging markets by a similar amount over the past five years.
In Britain, the workforce has also increased over this period and Glaxo is to build a factory in Cumbria, its first new production base in the UK for many years. The move was made possible by the Government’s new tax regime around patents. Glaxo is also to move most of its intellectual property operations to Britain.
“European governments are sending a very clear signal that they want to spend less on pharmaceuticals,” says Sir Andrew.
“We’ve had probably a decade of annual price cuts now. Last year, the cuts were 6pc-7pc. I’m not sure any other business absorbs that kind of price pressure in the way that governments inflict on our industry. Inevitably, we have to cut our cloth accordingly.
“Europe is saying it’s not very interested in new products. It doesn’t mean we’re not going to develop them for Europe but we’re going to prioritise countries that want to prioritise innovation and that’s clearly America, Japan and some of the leading countries in emerging markets.
“Ten years ago, Europe really dominated that decision-making. Europe was the home of the company and very much the demander of innovation. That’s changed.
“Europe is 20pc of our sales. It was about a third seven years ago. Whether it will go down to 10pc, I don’t know.
“But last year, our emerging markets sales grew 10pc and our European sales fell by 7pc. That gives a sense of the dynamics. Our emerging markets business now is basically the same size as, or bigger than, our European business.”
Glaxo remains a major contributor to the UK economy, paying £483m in corporation tax 20pc of its global corporation tax bill in 2011, despite Britain contributing only 5pc of its worldwide sales.
The company also pays 6pc of all dividends into UK pension funds. However, Sir Andrew says that the controversy about the levels of UK corporation tax paid by Starbucks and other foreign companies has largely passed him by.
“To be honest, I don’t think it’s been relevant to us at all,” he says.
“We’re proud to be British and proud to be here but everything about GSK is global, other than our heritage and our location.
“We’re bringing back huge amounts of profits from our global trade. That’s a great contribution. But we’re not looking for credit for the tax that we pay.
“I don’t want people to say they love GSK because we pay lots of tax in the UK. I want people to like GSK because they trust us, because we invest in trying to find medicines in diseases that they care about and because we’re transparent. I’d like people to respect us for that.”