Pfizer (NYSE:PFE) is currently the third largest pharmaceutical company in the world (after Johnson & Johnson and Novartis) with a market cap of $190 billion. Recently, Pfizer initiated a bid for AstraZeneca for about $100 billion, but AstraZeneca rebuffed Pfizers's offers claiming that they are undervaluing the company and Pfizer has stated that it will no longer pursue AstraZeneca. 

Pfizer, just like most other big pharma companies, is under much pressure to grow earnings in the face of a patent cliff. There are a couple of general strategies that big pharma has followed to remain competitive in the face of patent expirations and slowing innovation: 1) mergers and acquisitions (M&A) of other companies, and 2) investing in R&D and in strategic collaborations to grow internally. For instance, Pfizer acquired Warner-Lambert for $112 billion in 2000, Pharmacia for $60 billion in 2003, and Wyeth for $68 billion in 2009. Over this time frame, Pfizer also focused aggressively on cost cutting-partly by shutting down R&D facilities including those in Kalamazoo, MI, Ann Arbor, MI, Skokie, IL, and Sandwich, United Kingdom resulting in the loss of 51,500 jobs, or about 40% of its workforce. Cost-cutting due to the large acquisitions also resulted in a roughly 40% cut to the R&D budget.

Lower R&D productivity for big vs small pharma
A key question to validate the M&A strategy followed by big pharma is to look at whether it leads to innovation. When comparing innovation as measured by number of new molecular entities (NMEs) approved by the FDA, the differences over time are startling. The 15 largest pharmaceutical companies by revenues have a shrinking contribution to the global drug pipeline from ~75% from the 1980s to ~35% recently. However, the share of NMEs contributed by smaller companies has increased three-fold from ~23% to ~70%. Hence, the trend is for big pharma to represent a decreasing proportion of overall drug development.

Following M&A activity, R&D expenditures grew more slowly than those of comparable firms that did not undergo M&A, suggesting that M&A activity may take some resources away from R&D. Productivity post-M&A activity as measured by patents filed was also lower in companies that underwent M&A. Note that these analyses only apply to large-scale M&As such as those undertaken by Pfizer and that there is no data to my knowledge on the effectiveness of smaller M&As. 

If acquisitions of large companies do not promote innovation, which is the lifeblood of pharmaceutical companies, then it begs the question of why Pfizer is still trying the same strategy? In the case of AstraZeneca, Pfizer intended to use the acquisition to move its headquarters to the United Kingdom, which would result in sizable (potentially $11 billion or more) savings.

Alternative growth strategies for big pharma
If big pharma will not grow by getting bigger, then what is the alternative? An alternative strategy that is gaining traction among big pharma is to break-off into smaller, more focused entities. Sanofi, Merck, and Abbott are looking into selling off mature drugs that have lost patent protection. In one of the biggest moves in this direction, Abbott spun off AbbVie in late 2012. AbbVie focused on biopharmaceuticals and new drug development, while Abbott retained the lower-risk device, nutrition, and generic drug divisions. There are several advantages of such a separation. First, from a legal perspective, the pharmaceutical division carries greater risk of litigation and after spinning off AbbVie, the risk to Abbott is mitigated. Second, it allows the newly organized entities to specialize in different divisions and focus on growing those individual divisions. Third, spinoffs are generally viewed favorably on Wall Street as is shown below by the performance of Abbott (+51%) and AbbVie (+65%) since the spinoff was announced.

Perhaps in light of this successful spinoff, Pfizer announced recently that it also wanted to breakup its company into several different entities. Before doing so, Pfizer would have to provide financial reports for each of the different divisions for at least 3 years. Pfizer began this process just last quarter, but a large acquisition like that of AstraZeneca would reset the clock and delay any proposed spinoffs. While a large acquisition now would make any future spinoffs beefier and perhaps more attractive, Pfizer needs to devise a sound strategy for future growth and execute it consistently. Its current binge of large-scale acquisitions and ever-changing attitude toward how to achieve long-term success is at the very least, confusing long-term shareholders and at worst, may hurt innovation at Pfizer. For investors, confidence in a company's management is of paramount importance and until management shows a willingness to consistently follow a sensible long-term strategy, I'm a little uncomfortable with Pfizer. I think that it's a useful company for people to keep on their watchlist, but that investors should watch and see what strategy management employs and whether it remains committed to it.