When Chugai, Japan's 11th largest pharmaceuticals company, announced a strategic alliance with Roche, the Swiss group, the news stunned many Japanese corporate executives.

The decision by Osamu Nagayama, Chugai's youthful, English-speaking president, to give a western pharma giant a controlling stake was daring by the standards of Japan's conservative boardrooms.

But, at the same time, Mr Nagayama's move raises the heat on other Japanese pharma executives to come up with similarly bold strategies. Mr Nagayama has given his answer to a question that most Japanese drugs companies are still grappling with: how to survive in an industry where survival is increasingly determined by financial strength and global reach.

In the past, Japanese pharma companies were able to rely on their home market for increasing revenues and were largely shielded from global competition by a protectionist government.

However, as the Japanese government, which is under intense pressure to cut healthcare costs, has repeatedly cut drug prices, it has become difficult for Japanese pharma companies to raise profits in their home market alone.

Consequently, they have been increasingly driven to seek growth overseas. In the first half of fiscal 2001, Fujisawa, which embarked early on a programme to build its overseas presence, made 45 per cent of its sales in overseas markets. The problem for Japanese pharma companies is that most of them are too small to build an overseas presence on their own and compete head-on with the global giants.

"It costs a huge amount of money to sell in overseas markets by ourselves," says Motozo Shiono, president of Shionogi, which recently signed a multi-product development and commercialisation joint venture agreement with GlaxoSmithKline.

In terms of the amount spent on research and development (R&D), Japanese drug companies are minnows compared with their western counterparts. The Ministry of Health, Labour and Welfare (MHLW) calculates the average R&D spending of eight US drugs groups at Y216.4bn, compared with an average of Y43.3bn for 10 Japanese drug companies.

Even Takeda, Japan's largest pharma company by a wide margin, is only 15th in the world rankings in terms of sales and plans to spend just Y105bn on R&D, or about one-fourth of what Pfizer spent in 1999, at just over $4bn. At the same time, the large, western companies are increasingly encroaching on their home territory, the world's second largest national market for pharmaceuticals. Western pharma companies, many of which have had a presence in Japan for decades, are still nowhere near matching their share in Japan with their global market share.

The top 10 western drugs groups accounted for about 45 per cent of the global drugs market, according to Deutsche Bank, but only 25.6 per cent of the Japanese market, according to the MHLW.

But deregulation in Japan is helping them to make inroads in a once highly protected market, worth Y6,700bn last year. The market share of European pharma groups, for example, has increased from 9 per cent in 1985 to 17 per cent in 2000, according to the European Federation of Pharmaceutical Industries and Associations.

Pfizer, the US drugs giant, is now the tenth largest pharma company in Japan.

Foreign companies are encouraged by new rules that allow them to use much of their overseas clinical testing data to win approval for drugs in Japan. Many of them have drugs that are global blockbusters but were not previously sold in Japan.

In addition to the more welcoming environment in Japan, the US market, which had driven growth until recently, is expected to slow down as patents on top-selling drugs expire and the Food and Drug Administration, the US regulatory body's approval process has become longer and stricter, says Mayo Mita, pharmaceuticals analyst at Morgan Stanley in Tokyo.

Consequently, foreign companies are eager to build up their marketing capability as quickly as possible in order to take advantage of the new opportunities presented.

Some of them appear content to do so on their own. Pfizer, for example, now has 1,800 medical representatives, which is more than even Takeda, with 1,350.

But the time it takes to go it alone is leading many others to seek a Japanese acquisition to quickly expand their network, and, if possible, to add to their product pipeline as well.

For Japanese pharma companies, which need to expand overseas and boost their R&D, tying up with a western pharma group would be a realistic solution to achieving their goals.

But most Japanese companies are dead set against losing control over their R&D in particular, and extremely wary of forming anything more than loose tie-ups or joint ventures with their western competitors.

In private, Japanese drug executives question whether Chugai will be able to retain its independence in R&D, as the deal promises.

The Japanese government has also become alarmed by the danger that Japan's pharma industry could be a victim of the Wimbledon syndrome.

"The Japanese pharma industry is under pressure, and there is a possibility that (Japanese pharma companies) will all become foreign-capital based," says Katsunori Hara, director of the economic affairs division of the MHLW. "We would like to see a few (Japanese) mega-pharma companies survive."

To that end, the MHLW is encouraging Japanese companies to tie-up to create larger entities. Even if Takeda continues to grow at a firm pace, "it will take them five years to join the top league," says Mr Hara. "So, in order to speed up the process, M&A is an effective method," he adds.

In spite of the encouragement from the health ministry and the wooing by foreign drug companies, most Japanese companies remain hesitant. "Our aim is clear. We want to continue as Shionogi," says Mr Shiono.

Nonetheless, few people would doubt that Japan's pharma industry is ripe for consolidation in one way or another.

"Nobody thinks the status quo will be the same in 10 years' time," says Ms Mita.

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