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Watson Pharmaceuticals, Inc. develops, manufactures, and sells off-patent, or generic, pharmaceutical products. In 1996 it was selling more than 80 different products throughout the United States and parts of the world. Formed in 1985, Watson was still working in the mid-1990s to become a fully integrated pharmaceutical company, one that also researches, develops, and markets proprietary drugs and related delivery systems.
Watson Pharmaceuticals was launched in the mid-1980s, when the market for generic drugs was blooming. Generic drugs are off-brand drugs that are chemically the same as their brand-name cousins. When a pharmaceutical company develops and patents a new drug, the patent protection typically allows the inventor to sell the drug (at a premium) for several years free from direct competition. Once the patent protection terminates, however, other companies are free to copy and produce the same drug. The generic drug industry began to emerge as a force in the early 1980s, when many pharmaceutical goods that had been developed in the 1970s lost their patent protection. When the manufacturers of those propriety products continued to charge high prices, generic drug makers jumped into the game, offering drugs that were identical in effect but much lower in price.
Coming to America
Enter Taiwan native Allen Chao. Chao had left Taiwan in 1968 to study pharmacy sciences in the United States. After only five years, Chao earned his doctorate in industrial and physical pharmacy at Purdue University. He then took a job with pharmaceutical developer and manufacturer G. D. Searle & Co. There, in a span of five years, he rose from a position as researcher to the director of new product and new pharmaceutical technology development. After a few years in that post, however, Chao was restless. He wanted to strike out on his own and build a pharmaceutical company from scratch.
Chao's motivation to start his own enterprise came partly from his parents: "You know, you'll never win the Nobel Prize," Chao's mother told him after he went to work with G. D. Searle, according to Forbes. In fact, Chao's parents had originally hoped that their son would return to Taiwan to run the family pharmaceuticals manufacturing business. When Chao's father realized that his son was going to begin a career in the United States, he sold the business and he and his wife moved to California to retire. Throughout his career at Searle, Chao's mother prodded him to start his own company. She got her wish in 1983, when Chao left G. D. Searle and launched the venture that would become Watson Pharmaceutical.
Chao's long-term goal was to build a fully integrated pharmaceutical company that, like Searle, developed and marketed its own drugs. Such a venture, however, typically required massive sums of money to fund the research and development of new drugs. Of import were the huge costs and risks related to getting a new drug approved for market by the Food and Drug Administration (FDA); if a proposed drug failed to receive FDA approval, which was often the case after months or years of FDA studies, a larger company could suffer greatly and a startup company would likely be destroyed. Lacking the resources needed to launch a fully integrated drug company, Chao decided to start with generics.
The chief appeal of the generic segment of the pharmaceutical industry for Chao was that drug approval was much less complicated; the FDA had already accepted the original drug and had only to complete cursory research to ensure that the generic counterpart was safe. Although generic drugs didn't offer the huge profit margins intrinsic to patented products, many generic producers were able to profit handsomely. Success in the industry depended largely on the generic drug producer's ability to move quickly to fill a void in the marketplace, but also on its ability to minimize overhead costs related to production, packaging, marketing, and distribution.
Joining Chao in the startup was David S. Hsia, who started out as vice president of product development and would later become senior vice-president of scientific affairs. Although the generics strategy reduced their capital requirements, Chao felt that they still needed about $4 million to develop their first generic drug, and possibly as much as $2 million more to achieve FDA approval. Few investors were interested. Venture capital companies snubbed the entrepreneurs, and the banks in Chicago (where Chao originally wanted to locate the company) wouldn't even loan him money against the family's personal property in California.
Unable to find startup capital from conventional sources, Chao returned to California and tapped his connections in the Taiwanese community. Family members and friends eventually contributed nearly $4 million, which helped the founders to land another $1.5 million from U.S. venture capital firms. All the while, Chao and Hsia scurried to develop the company's first drug, Furosemide, a treatment for high blood pressure. Chao and Hsia incorporated their venture in January of 1985 as Watson Laboratories, Inc. The name was an amalgamation of "Hwa," Chao's mother's maiden name, and "son," Americanized into "Watson." By the end of 1985 Watson Pharmaceuticals had received FDA approval for Furosemide, which it began selling almost immediately.
Developing a Formula for Success
Watson was able to turn a profit in its first full year of sales. The company used cash flow from that first drug to fund the development of other generics, or off-patent drugs. Watson survived a period of more than two years in the late 1980s during which it received no new drug approvals from the FDA. Despite that hindrance, however, Watson continued to profit and to research a string of new generics. Sales rose to about $13.25 million in 1988 as net income inched up to $259,000. Despite heavy investments in ongoing research and development, Watson managed to boost profits to $1.26 million in 1989, from sales of nearly $21 million.
Watson's successful development efforts following the introduction of Furosemide provided the formula for its work on Loxapine, a tranquilizer used to treat schizophrenia. Chao began developing a generic substitute for the original patented product in 1986, and it eventually won the FDA's blessing. At that time, the market for the drug was only $10 million. Soon the sales volume of the drug more than doubled and Watson was able to capture a full 50 percent of the market. By 1996, Watson was still the only pharmaceutical company selling a generic version of the original drug.
Loxapine was a good illustration of Watson's unique operating stratagem. It was true that Chao was competing in the typically low-margin generics industry. But his company had managed to avert many of the downsides of generics manufacturing by pursuing a singular market approach. Rather than target the markets for big drugs that were coming off patent, such as Tagamet and Valium, Chao decided to chase smaller market segments that were of less interest to the big generics manufacturers. Watson was willing to chase drugs with markets of less than $30 million annually, while its bigger competitors often ignored drugs with less than $150 million in annual sales.
Watson was able to profit, though, because it was often the only company competing in its selected niches. The big drugs, in contrast, were often copied by as many as ten or more generics manufacturers that competed fiercely on price. In addition to pursuing smaller market niches, Watson focused on developing drugs that were difficult to duplicate. That tactic allowed the company to utilize its advanced research and development arm to generate relatively high profit margins, even in the generics industry. To find those high-margin, small-market drugs, Watson's researchers regularly plied public records, searching for little known drug prospects with big potential.
Imitation Leads to Innovation in the 1990s
Success at developing generics for niche drug markets allowed Watson to post steady gains in the early 1990s. Sales increased from $23.4 million in 1990 to $34.7 million in 1992, while net income more than quadrupled during the same period to about $2.4 million. In 1993, moreover, sales nearly doubled to $67.6 million, a hefty $12.2 million of which was netted as income. The big jump in 1993 was the result of several new drug introductions. By late 1993, in fact, Watson had the exclusive right to produce 17 generic products, and was also making about 40 drugs for other companies. It also had about a dozen new products in its research and development pipeline that were awaiting FDA approval.
Bolstering its niche market strategy in this period were Watson's efforts to develop proprietary value-added delivery systems that enhanced its generics and gave it an edge in the marketplace. For example, Watson would develop a generic substitute for a drug that was typically administered to the patient through a syringe by a trained professional. Watson might then create a new dose delivery system--such as a patch worn on the skin or a device that administered the drug through the nose or mouth--that allowed the patient to administer the drug. Not only would Watson benefit from revenue from the new delivery technique, but it would profit from an often significantly expanded market for the drug.
To take advantage of rising sales, Chao and fellow executives pursued an aggressive plan to expand Watson's manufacturing operations. To that end, they had taken Watson public in February of 1993 with a stock sale that raised $25 million. A subsequent offering brought a total of more than $100 million to Watson's war chest. The cash was used to add manufacturing capabilities. For instance, Watson purchased the patent on an injection-molding technology that would let Watson make suppository products that were less waxy and messy. The money was also used to fund research and development of new generics and delivery systems. Importantly, Watson's cash surplus allowed Chao to move closer to his initial goal of making the company a fully integrated pharmaceutical firm.
Toward Full Integration
Watson's revenues rose to $87 million in 1994 as it introduced new drugs to market. The company followed those gains early in 1995 with the acquisition of Circa Pharmaceuticals, another maker and marketer of generics. Circa had formerly operated as Bolar Pharmaceutical Co. before being disgraced in a fraud and bribery scandal. In 1989, in fact, the FDA announced that several of its employees had accepted bribes from various generic drug makers. Watson wasn't involved in the scandal. Bolar, on the other hand, ultimately lost nearly all of its government drug approvals and was fined $10 million (the largest penalty ever levied against a generic drug maker). In addition, several Bolar executives went to jail.
By 1995 Circa, after changing its name from Bolar, was staging a recovery. Chao saw an opportunity to buy the company at a reasonable price and add a number of drugs and related proprietary products to its own portfolio. Watson paid the equivalent of about $600 million for the company. Management at the two companies planned to work together to create a global, one-stop shop pharmaceutical company that sold both generic and proprietary products. After the merger was complete, Watson's product line had grown to include more than 80 different drugs (variations of 30 major pharmaceutical products). Sales for 1995 increased to $153 million, reflecting the merger as well as revenue growth related to new and established products.
Despite the challenges presented by such rapid growth, Chao remained focused on his goal of making Watson a fully integrated, global pharmaceutical company. To that end, Watson entered two joint ventures with Chinese companies that would allow the company to begin manufacturing and marketing its products to Chao's native region. The company was also working to develop its own patented drugs through joint ventures and partnerships with other drug makers.
Principal Subsidiaries: Circa Pharmaceuticals, Inc.; Somerset Pharmaceuticals, Inc. (50%); Watson Laboratories, Inc.; Watson Pharmaceuticals (Asia) Ltd.