It's now official: the Japanese drug industry is succumbing to consolidation. The only question is whether the consolidators will be Western companies or the Japanese themselves. The latest and least unexpected transaction: Merck & Co. Inc.'s takeover of the remaining 49% of Banyu Pharmaceutical Co. Ltd. it didn't already own, in a $1.52 billion tender offer.

Japan presents huge opportunities for new product launches, but Western companies often squander them, failing to understand the unique aspects and requirements of the market. They often mis-estimate the size of commercial opportunities in Japan because of the differences in epidemiology and medical practice or run into pricing problems because they've chosen the wrong local comparator product or ignored the Japanese tendency to prescribe lower doses of products. But Westerners can do better--taking advantage, for example, of the liberalization of development rules and even the possibility of DTC advertising.

Two of Japan's largest pharmaceutical companies, Tanabe Seiyaku and Taisho Pharmaceutical, are merging in response to hard times in the Japanese pharma industry. Their union, which will take at least a year to complete, will create a combined company with $4.3 billion in sales, ranking it third in Japan in revenues. The move won't solve both companies' weak pipeline problems, but it will increase their total R&D budget and give them more sales clout in the domestic market. And as many Japanese pharma companies struggle for survival, analysts believe more merger activity is inevitable.