Merck - strategic analysis

Ariel Lee Midterm Assignment 10/28/10 Mgmt 780 Professor Dali Ma

Executive Summary In 1950, George W. Merck eloquently explained that Merck achieves its competitive advantage by staying true to its strategic vision: "We try never to forget that medicine is for the people. It is not for the profits. The profits follow, and if we have remembered that, they have never failed to appear." Today, the pharmaceutical industry as a whole faces the challenge of developing fewer, high-revenue blockbuster drugs while simultaneously incurring unsustainably high R&D costs. Merck responded by merging to improve its drug pipeline, reorganizing to reduce costs, and donating medicines to establish ties with developing countries. Thus, Merck's key to survival amongst its industry peers is its ability to generate above-average returns by producing quality products and services that improve both human and animal health.

Company Background Merck & Co., Inc., headquarted in Whitehouse Station, NJ, is the third largest global pharmaceutical company by market capitalization as of 2009. Founded in the United States during 1891 by George W. Merck, the firm is renowned not only for its medications, but also for its medical manuals, innovative chemical syntheses, and cutting-edge research. Merck is organized into 3 major divisions – Pharmaceutical (including bone/respiratory/immunology, cardiovascular, diabetes, vaccines, infectious disease, oncology, neuroscience/opthamology, mature brands, and women's health), Consumer Health (OTC drugs, foot care, sun care), and Animal (livestock, poultry, aquaculture, and companion). Following the 2009 merger with Schering-Plough, the "new" Merck now consists of roughly 100,000 employees worldwide.

Analysis of External Environment Overall, barriers to entry remain extremely high for new entrants to the pharmaceutical industry. Newcomers typically join the market as smaller biotechnology firms without a global presence that produce limited niche drugs or technology services; such firms tend to co-market their products with pharmaceutical partners or are acquired by other large corporations. Skyrocketing R&D costs, high likelihood of new drug failure, significant government regulation, patent expirations and disputes, stagnant pipelines, and intense generic competition that adversely affect the market leaders are sufficiently high to prevent entry altogether or curtail R&D expenditures. Finally, the Obama health care reform creates further uncertainty about future regulations and revenue restrictions that may impact the drug industry. Recently, the trend of the pharmaceutical industry has been to address Wall Street's concerns through mergers, restructuring, and joint ventures. Over the past decade, 1,345 mergers and acquisitions totaling over $694 billion were announced; the high-profile Pfizer-Wyeth, Abbott-Solvay, and Merck-Schering Plough conglomerations occurred in 2009 alone. Finally, Merck also faces intellectual research competition from non-profit, government, and academic institutions, such as the NIH and various university research programs. However, such organizations are not product driven and frequently collaborate with pharmaceutical corporations.

Analysis of Internal Environment Pharmaceutical giants have both the reputation and resources necessary to attract the world's brightest scientists and thus maintain the capacity for innovation. For instance, employee salaries overall have always been dramatically higher than those of non-pharmaceutical

organizations. Pharmaceutical employees maintain close ties with competing firms, regulatory agencies, and academic institutions to create larger collaborative networks than their smaller competitors. However, the enormous bureaucracy needed to organize large numbers of pharmaceutical personnel results in considerable decision-making inertia. Other intangible resources include a historical reputation of quality and corporate responsibility, although these qualities have been publicly challenged by the media during crises. Tangible resources include but are not limited to a wealth of proprietary knowledge, patents, trade secrets, significant PPE, and access to raw materials. In addition, conglomerates formed from mergers benefit from increased pipeline diversity. Taken together, innovation, talent, and product differentiation are the core competencies of the pharmaceutical industry.

Identifying the competitive advantage of Merck & Co. 1. Effects of most recent merger with Schering-Plough On 11/3/09, Merck successfully merged with former competitor Schering-Plough (SP). The primary objective of the consolidation was to revitalize Merck's stagnant pipeline for end stage candidates as well as to establish a significant market presence in the up-and-coming oncology, neuroscience, and biologics franchises. SP has also contributed significant consumer health and animal health products to expand Merck's core offerings. As of 7/30/10, SP pipeline contributions in phase II and III range from asthma/allergy to contraception and schizophrenia. Q4 town hall meetings have identified these disease areas as critical targets for the near future. Because a disproportionately large percentage of the firm's profits and operating cash flows are generated by only a few drugs, market events affecting these products inevitably impact Merck's overall financial health. Such events include loss of patent protection, increased

manufacturing costs, and availability of generics. Merck does conduct joint ventures with competitors such as AstraZeneca to diversity risk and share financial gains while maintaining autonomous entrepreneurial directions. However, Merck merged strategically with SP precisely because both firms enhanced each other's portfolio weaknesses. As mentioned earlier, other giants, most notably Pfizer and Wyeth, have similarly combined for precisely the same reasons. The broader consequence of frequent conglomerations implies that the pharmaceutical industry, at least in the United States, may ultimately crumble under various external market forces when pipeline gains are eventually exhausted.

2. Reorganization to cut inefficiencies in R&D To streamline operations, reduce cost structure, and increase efficiencies, Merck implemented the BRGOS reorganization in 2008 that reduced workforce by 25% (40% of which were based in the US); SP had a similar Productivity Transformation Program. Another Merger Restructuring Program is currently in effect and will eliminate an additional 15% of R&D personnel and vacancies. Some employees will be relocated to other sites worldwide. Basic research sites in North America, Europe, and Asia will be abandoned. For Merck, the reorganization is a double-edged sword. Wall Street responded favorably to R&D decreases – the one-year total return for MRK is 21.08% as of 9/30/10. While downsizing allows the merged firm to realize the cost synergies of eliminating both PPE and personnel redundancies, Merck seriously risks losing the core competency of its human capital in the long run. And although layoffs and restructuring are common among all of the major industry players, distinguished scientists frustrated with the industrial environment may eventually seek other career paths. For example, many have rejoined academia as professors. Thus, the

innovative capabilities of employees are being eroded by uncertainty for the future and lack of consistent leadership. Furthermore, Merck has damaged its reputation with future workers as well. Fifty years ago, Merck scientists were given their own laboratories until retirement with carte blanche to pursue their individual research. As of mid-2009, entry-level PhD scientists lost their managerial privileges and must abandon novel projects deemed to have a low "possibility of success." The continual lack of transparency between employees and executives is increasing, and staff may not retain job loyalty for Merck when economic conditions improve; in other words, Merck may have trouble continuing basic operations if too many key personnel exit the industry. In addition, fewer students will pursue scientific careers if the industry no longer holds the prestige and benefits of generations past, thus decreasing the overall pool of available future talent.

3. Corporate responsibility Merck was ranked #17 on the 2010 list of the 100 Best Corporate Citizens by "Corporate Responsibility" magazine. Despite the potential of enormous financial liabilities, Merck has always prioritized responsible business practices and manages several departments dedicated solely to charitable activities that improving healthcare, especially in developing countries. In 1987, in conjunction with the World Health organization, Merck made a commitment of unlimited Mectizan donations to Botswana until river blindness is completely eradicated from humanity. Until then, no other healthcare firm had been willing to incur the financial risks of such an ambitious challenge. But by being the first mover in establishing charitable relationships, Merck gained the trust of significant future customers – African governments. Merck has

followed suit in China with AIDS interventions and instituted the US Patient Assistant program to enhance its image domestically. Although rivals have instituted similar donation programs, Merck's first mover advantages combined with its unwavering commitment to charity despite unfavorable market conditions help forge exceptionally strong ties with influential, future clients. In 2010, the Access to Medicine Index ranked Merck #2 among top pharmaceutical companies.

Conclusion When taken together, the recent merger with SP, internal personnel restructuring, and ethical corporate initiatives are the sources of Merck's competitive advantage. However, dynamic market forces may eventually require entirely new strategic efforts for Merck to maintain its leadership position in the long-run.

Figure 1: Selected Financial Data

Figure 2: Biopharmaceutical Investment in R&D

Figure 3: Increasing Cost to Develop One New Drug

Figure 4: Comparison of Merck with Bayer, GSK, and Pfizer

Figure 5: Philanthropy at Merck

Figure 6: Sample of Merck's 2010 pipeline

References

1. http://findarticles.com/p/articles/mi_m0EIN/is_2000_April_25/ai_61656037/ 2. http://www.phrma.org/sites/phrma.org/files/attachments/Profile_2010_FINAL.pdf 3. http://www.merck.com/investors/financials/home.html?WT.svl=content# 4. http://www.merck.com/about/our-history/home.html 5. http://www.merck.com/finance/annualreport/ar2009/pdf/Merck_form_10-k.pdf 6. http://www.merck.com/corporate-responsibility/approach/home.html 7. http://finance.yahoo.com/q/co?s=MRK+Competitors 8. http://www.glassdoor.com/Reviews/Merck-Reviews-E438.htm 9. http://www.thefreelibrary.com/TenYear+Data+on+Pharmaceutical+Mergers+and+Acquisitions,+from...-a0222033052 10. http://money.cnn.com/2008/02/01/news/companies/drug_wrap/index.htm 11. http://www.suite101.com/content/eliminating-river-blindness-a25397 12. Nancy A. Nichols. "Scientific Management at Merck: An Interview with CFO Judy Lewent," Harvard Business Review, Vol. 72, Nº 1, 1994 , pgs. 88-99. 13. Internal conversations at Merck & Co, 2009-2010.