External and Internal Environments Term Paper

Glaxo SmithKline is a British pharmaceutical company based in London. The company was formed by the successive mergers of a number of pharma companies, the most recent being Glaxo Wellcome and SmithKline Beecham. The current company is jointly listed on the London and New York Stock Exchanges under the ticker symbol GSK.

External Environment

There are several components to the external environment of a business. These include the political/legal/regulatory environment, the economic environment, the competitive environment, external demand drivers and the technological environment (Anderson, 2013). Of these, the two most important to Glaxo are the political/regulatory environment and the external demand drivers. The political/legal/regulator environments are linked as one because it is the politicians who are the drivers of the legal and regulatory environments; though there are some distinctions between them, they are linked. This environment is particularly challenging for a multinational pharmaceutical firm, because governments define the terms of competition in almost every nation. In many countries, governments place caps on pharmaceutical prices either directly or through the bargaining power of national health agencies. Such caps limit the ability of Glaxo to earn profits. The converse is that there is often monopoly protection for new drugs, allowing for the possibility of such profits in the first place as a means of encouraging new drug development. In the United States, the government has become increasingly active in the health care market, and the Affordable Care Act may result in decreased pricing power for pharmaceutical companies, for example implementing upper limits on the prices of some drugs (Medicaid.gov, 2013).

That every government has its own rules increases the complexity of administration in the global marketplace. It is almost impossible for Glaxo to have the ability to set uniform prices and availability across jurisdictions. The laws with respect to marketing drugs are similarly disparate, and this creates significant challenges. In emerging markets, lax regulation leads to a rapid influx of generic competitors, dramatically reducing profit potential, but yet some of those markets are so large that they are attractive anyway. Moreover, in Western markets where drug regulations do exist, they are often arcane in nature, and can be very difficult to interpret. The reason for this is that governments set drug laws in accordance with a balance between social interests and economic interests, and each government has its own interpretation of those interests. With dozens of sets of complex rules under which to operate, not only does the legal/regulatory aspect of the external environment have a significant impact on Glaxo's ability to earn profits, but it increases the company's operating costs substantially.

The second-most important element of the external environment is the demand drivers. There are a number of key demand drivers. One is directly related to the regulatory environment, in the form of protections against competition. The cost of developing new drugs is high, and most markets respond by offering monopoly protections to drug developers in order to encourage development. These protections vary, however, and once generic competition enters the market it is much more difficult to earn monopoly rents, and therefore the company is much less likely to recoup the development costs at that point. So competition, which is typically determined by government more than market forces, is a key demand driver. Other demand drivers, however, are external and not related to government. In particular, age is a key determinant of how many drugs somebody needs -- older people need more drugs. The result is that aging populations are a good demographic trend for drug companies. Thus, many major markets in the West, with population booms that represent favorable demographics for Glaxo today, while rising income levels in nations with large youth populations like Egypt or India represent tremendous opportunity 30-50 years from now. Further the economy can be a demand driver, especially when patients are choosing between the branded drug and a generic one -- during tough economic times generics become more popular.

Five Forces

Porter's five forces of competition act as a means to understand a firm's pricing power. The five forces are supplier power, buyer power, intensity of rivalry, threat of substitution and threat of new entrants (Porter, 2008). The most significant of these for Glaxo are buyer power and the threat of new entrants. The company has strong power over its suppliers, as many inputs are relatively generic in nature, and Glaxo is a major buyer. The company has, however, relatively low bargaining power over buyers. It may be faced, for example, with a choice of taking a price from NHS in the UK or not competing in that market -- clearly with 60 million consumers Glaxo will take the price. Many large entities have significant bargaining power over Glaxo. In the major U.S. market, the federal government is seeking to expand its bargaining power over pharmaceutical companies as a means of controlling health care costs. Glaxo joins with other firms in the industry to lobby extensively to promote the benefits of having a healthy and profitable pharmaceutical company. However, this lobbying can only have limited effect -- voters like to have access to the drugs that keep them healthy, and that leads government to enact price controls where possible. Glaxo and its competitors have been most successful in the United States, but are beginning to lose that battle as well. That said, Glaxo had an operating profit of £8.7 billion last year, so it is obviously getting what it needs from governments (2012 Glaxo SmithKline Annual Report).

The second of the five forces that is important is the threat of new entrants. Drug companies make their money from monopoly protections they receive on new drugs. These protections vary by jurisdiction in terms of their strength and length. The weaker these protections are, the less profitable Glaxo will be in a given region. Thus, extensive work is required on the part of drug developers to ensure that they have adequate protection periods and the support of regulators like the FDA in defending their patents in order that they can earn these profits. Otherwise, a drug-developing firm like Glaxo would need to alter its strategy to de-emphasize drug development and focus on areas that might offer more profit potential.

Future Planning

The key element in both of these forces is government. The U.S. government is perhaps the most important, but the UK and EU are also critical. Other Western governments like Canada, Australia and Switzerland are important, as are major emerging market governments. In general, the trend is for governments to improve their bargaining power, driving down the price of pharmaceuticals. Drug companies like Glaxo can remain profitable while the market is growing, but their margins are likely to shrink. There are several strategies than can address this issue. The first is to find ways to improve bargaining power. This is not a particularly viable option, as governments will not take kindly to blackmail (withholding some needed drugs to get better prices on drugs that have a more competitive market). In general, the drug companies need access to markets more than the markets need any one drug or drug company. There is only limited upside to this strategy.

Another approach, however, is to work with governments to extend patent protections on new drugs. Such an approach would allow the drug companies to make more profits in the near-term, as a counter to the long-run decline of bargaining power. Drug companies could alter strategy away from drug development altogether, but such a shift would be difficult for companies that are built on a development model. This strategy of working with governments to extend patent protections is an imperfect solution, but governments are keen to see new innovations and this is something that gives Glaxo leverage. It will face declining bargaining power, but can counter by negotiating better terms on some drugs in response to deals on others.

This strategy also addresses the threat of new entrants. If patent protection is extended, it gives Glaxo the opportunity to earn monopoly rents for a longer period because generic competitors are kept out of the market. Glaxo and other developers can also lobby to have greater restrictions placed on generic companies, even when they do get to market. The challenge here is that many nations that bankroll their citizens" pharmaceutical needs prefer to use generics where possible, and would view creating new limits on generics as shooting themselves in the foot.

External Threats

The biggest external threat comes, as noted, from the regulatory environment. Governments are major drug buyers and they are always seeking to squeeze pharmaceutical companies. They have the means to do so as well. The Affordable Care Act is a good example, where the drug companies like Glaxo are targets of government efforts to lower the cost of health care. This is a major threat to the profits of companies like Glaxo SmithKline. The ACA is one example, but the situation is generally being repeated in all major markets, where demand for drugs is increasing and both governments…