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Prescription for Success : Drug Maker Watson Thrives in Crowded Generic Market


Who knows where Allen Chao would be today if he hadn't listened to his mother.

Chao was working as a research scientist and product development director at G.D. Searle & Co. in the late 1970s when she gave him some tough advice.

"My mother told me that I'd never be a Nobel Prize scientist," Chao recalls.

She chided her son to give up his cushy, secure job at the pharmaceutical giant and use his "good entrepreneurial instincts" to strike out on his own.

Good instincts, indeed.

Watson Pharmaceuticals, the company Chao founded a few years later as a manufacturer of generic drugs, is one of the success stories in its industry.

(The company name is a tribute to Chao's Chinese-born mother, whose maiden name was Hwa, with a small concession to the English language: "Hwa's son" thus became Watson.)

Boasting a healthy balance sheet in a cutthroat segment of the drug business, Watson has watched sales grow fivefold since 1991. It has consistently been one of the most profitable companies in the generic drug field, earning $47.9 million on revenue of $153 million in 1995.

The Corona-based company, which went public in February 1993 at a price of $12 a share, saw its stock peak at $50 in December 1995. (It closed Tuesday at $43.625, down 62.5 cents, in trading on Nasdaq.)

Watson's success comes amid a continuing explosion in the use of generic drugs as substitutes for brand-name medications. Growth is being propelled by patent expirations on brand-name drugs and by the growing use of generics by HMOs and other cost-conscious managed-care firms. Generics typically cost at least 50% less than brand-name drugs.

The allure of cost savings is compelling government health programs and HMOs alike to encourage--or require--doctors to prescribe generics whenever possible. In Southern California, for example, physicians for Kaiser Permanente ordered generic drugs for nearly two-thirds of the 13 million prescriptions they wrote for Kaiser members in 1995.

"The impact of managed care to the generic drug industry is very important," says Chao, Watson's unassuming chairman and chief executive.

Watson's success, according to analysts, can be attributed to a well-focused, two-pronged business strategy that Chao has adhered to closely since founding the firm in Chicago in 1984.

He later moved the firm to Corona--making it one of a handful of drug makers in Southern California--to be closer to his family, which helped him raise most of his $4 million in start-up capital.

Watson studiously targets drugs that are about to lose patent protection and zeroes in on those that are difficult to manufacture or have relatively small market potential--and thus few potential competitors.

That has helped Watson avoid the "blood baths" that have battered other generic drug firms, said Steven B. Gerber, an analyst with Oppenheimer & Co. "They have chosen products with significant competitive barriers to entry and relatively protected profit margins."

By contrast, analysts note, other generic firms have tended to chase drugs with more sizable markets, only to face a host of competitors and devastating price wars.

A case in point: By the time the patent expired on Bristol-Myers Squibb's flagship cardiovascular drug, Capoten, earlier this year, a dozen companies were geared up to introduce generic substitutes. Prices plummeted by roughly 50%. Watson avoided the fray.

Watson has 29 generic drugs on the market, targeting four areas: women's health care, analgesics, and cardiovascular and central nervous system disorders. Its products range from oral contraceptives and female hormone replacements to antidepressants and narcotic painkillers. For about 10 of them, the company has either no generic competitor or only one.

Watson has used the cash generated from its profitable generics business to fund the second part of its strategy: the development of proprietary drugs and drug "delivery systems" it can patent on its own.

This year Watson will spend roughly 12% of revenue--or about $24 million--on research and development, a higher percentage than most generic drug firms.

Watson has seven new generic drug applications pending before the Food and Drug Administration and is set to introduce five or six products in 1996.

An important area of research for Watson is the development of alternative drug delivery systems, in particular drugs that can be taken through the

nose or other orifices.

Drugs that must be injected--allergy medications, for example--are an inconvenience for many patients because they usually must be administered by medical personnel. That often means taking time off from work to go to the doctor's office.

If patients can take the medication themselves through the skin or mucous membranes, it is less time-consuming and often less costly. And doctors are more likely to prescribe a drug that is more convenient for patients--boosting the drug's sales potential.

Watson watchers say Chao, 50, is the driving force behind the success of the company, which employs 520 people.

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