Molecules & Musings - The Pharmaceutical Industry

Pharmaceutical Industry

The pharmaceutical industry includes companies that research, develop, market or distribute generic and branded drugs.  The industry expanded during the 1980’s and drugs to treat heart disease and AIDS were prominent.  Consumer demand for nutritional supplements and alternative medicine increased during the 1990’s with the Internet facilitating direct purchases of drugs.  Advertising for direct consumption of pharmaceutical drugs became more prominent; pharmaceutical companies were criticized for over medicating personality or social problems. 

Society expects drug companies to improve people’s well-being and to behave like a nonprofit company not overly concerned with making large profits.  However, investors expect pharmaceutical companies to earn profits making it unlikely that life-saving drugs will be sold at the lowest possible price.  Some interest group is bound to be displeased with mutually exclusive expectations and the pharmaceutical industry is often criticized.

Pfizer Inc.

Mission & Products: Pfizer’s mission is to help increase peoples’ life spans and help them live healthier lives.  Its products help treat and prevent minor conditions like back pain and more serious ones such as psychotic disorders. 

Strategy: Pfizer is the world’s number one pharmaceutical company.  Its best-selling products include Lipitor, the world’s best- selling medicine, and eight of the top twenty-five medicines in the world.  Acquisition of successful competitors such as Pharmacia and Warner Lambert has helped Pfizer to offer best-selling products and further differentiate itself from competitors.  The acquisition of the latter company helped bring Lipitor under Pfizer’s control. 

Diverse packaging is needed to implement Pfizer’s strategy of a wide product offering and to differentiate its products.  Pfizer reviews more than 5,400 packaging materials and 8,500 package specifications.  Successful diverse packaging earned it the 2003 Drug Packager of the Year award. 

Research and Development : Research and development, major activities of drug companies, are key success factors for profitability.  R&D benefits are not immediately realizable; it may take ten to fifteen years to develop a drug that survives the testing and approval process.  The chances of developing a best-selling drug are lessened as companies who have successfully done so reach maturity.  Another complicating factor in earning profits is that drug companies sometimes lose patent protection without replacement drugs in their pipeline.  Pfizer suspended tests of a new drug for cholesterol treatment in the face of lost patent protection for Lipitor, which generates yearly revenues of about $12 million.

Turnaround Strategy: Lost patent protection and insufficient drugs in its pipeline makes successful controlling of costs an important component of Pfizer’s turnaround strategy.  Talented employees who can help fill the pipeline are especially needed after patent protection is lost and competitors offering generic drugs can more easily enter the market.  Pfizer is trying to use existing employees with similar skill sets needed for open research positions, which could reduce training and hiring costs.  The development of a successful a drug like Lipitor may not happen soon, but creatively using employees’ talents could result in a larger array of products to sell.  The company’s turnaround strategy will hopefully allow Pfizer to quickly and flexibly respond to industry changes and risks. 

Merck & Co, Inc.

Mission & Products: Merck, a global pharmaceutical company, develops and makes vaccines and medicines.  Some of its products are Singulair (asthma treatment) and Vioxx (arthritis treatment).  Merck also publishes health information as a not-for-profit.

Strategy: Merck’s strategy is to maintain a stream of new products that advance patient care and provide consumers with value.  A realistic profit goal coincides with a strategy of cost leadership and helps to sell products during times of concern about health care costs.  Its strategy seems to be successful; sales of five of its products are growing at 25 to 30 percent per year.   

Research and Development: Merck is a research-driven company that has a new research and development model incorporating its business strategy.  Merck hopes to improve the success of is R&D and to reduce costs by focusing on therapeutic areas that have unmet medical needs, and scientific and commercial opportunity.  It plans to develop products within these therapeutic areas that are highly valued by patients and doctors. 

Turnaround Strategy : Merck’s research and development has not always resulted in products that provide value to consumers.  Vioxx was taken off the market in 2004 when people became sick and died after taking the drug.  The company’s reputation suffered after allegations that Merck asked doctors to sign Merck-written research studies for Vioxx.  Merck disputes the allegation, but more than 9,200 lawsuits were filed against the company.  Vioxx had generated $2.5 billion in annual sales.

A turnaround strategy needs to address the following: a suffered reputation, lost patent protection on several drugs, a slowing pipeline, and a decreasing stock price.  Merck is not shying away from lawsuits and is taking cases to court.  Its legal defense budget was increased, but it did not set aside funds for liabilities showing that it confident it will win.  The opinions of 200 employees were solicited in deciding the company’s future strategy.  Cutting costs are needed to help improve Merck’s financial performance and employees were involved in this part of the turnaround strategy too.  7,000 employees were laid off, which could save Merck $4 billion.  Its new R&D model is predicted to generate $1 billion in savings and lead to double-digit earnings growth. 

Merck has experienced some recent successes.  The Food and Drug Administration will review its application for a new diabetes drug.  The Advisory Committee on Immunization Practices recommended that Merck’s drug, RotaTeg, be used on babies to treat the rotavirus infection.  These events will hopefully help Merck successfully implement its turnaround strategy. 

SWOT Analysis:

Pfizer Inc.

Strength

•          Being the industry leader it possesses an inherent advantage of economies of scale with its declining costs per unit of manufacture with increase in volume resulting in higher than average operating profits

•          Considerable sales and marketing capabilities

Weakness

•          Competition from generic sales and exposure to patent expirations

•          Limited penetration in the high growth I $ I and Oncology markets

•          High involvement in low growth therapeutic market and dependency on small molecule products

Opportunity

•          Achieve further operating cost efficiency

•          Intensify their arising position in the small molecule targeted cancer market

•          Further their acquisition activity by acquisition of other biotech ,generic or non-pharma firms

Threats

•          Expiration of Lipitor patent in 2010

•          Failure of Torcetrapib in Phase-iii trails

•          Mergers or acquisitions with other big pharma firms would not diversify its offering and bring long term benefits

Merck& Co., Inc.

Strength

•          Strong industry position has allowed it to have a comeback after major setbacks

•          High growth of cardiovascular franchisee(Zetia/Vytorin)

Weakness

•          Recent patent expiration of biggest selling product Zocor

•          Blockbuster growth strategy tying it to only certain product markets

  Opportunity

•          Diversification and expansion in diabetes, oncology and infectious disease markets

•          Diversification into biologics market by acquisition of Abmaxis & Glycofi

•          Potential; growth in their vaccines business

Threats

•          High competition from generic  competition and high exposure to patent expirations

Ratio Analysis:

Liquidity: Pfizer (PFE) is a much larger and more financially sound organization that Merck (MRK).  PFE has a current ratio of 2.15 and a quick ratio of 1.65 compared to MRK 1.21 and .96 respectively.  PFE also has a much better debt to equity ratio of .2 to MRK .35.  This is not an indicator that MRK is a weak company in fact it is in a relatively good financial position but when stacked up next to PFE it pales in comparison to PFE that is incredibly strong on the balance sheet.  It is often harder for companies that have an impressive balance sheet to have as high of a return on equity as companies that carry a heavier debt load. 

Profitability: PFE had a NOPAT to sales of 17.6% down from 40.9% in 06. This is partly due to a one time sale of Pfizer consumer health care that generated a 7.88Billion boost to net income.  By discounting the one time sale of discontinued operations we lower the NOPAT to sales to 23%.  For the case of this analysis we discount the one time sale for ratio analysis.  The sales to net assets jumped slightly and brought the ROA to 16.5%, still down from last years 18.4%.  PFE ROE is relatively low at 11.4% but this is not an indicator of poor performance.  It indicates that PFE has little debt relative to its equity holdings.  It can be considered as a positive attribute to the company. The NOPAT to sales for MRK dropped from 20.8% to 15.1%.  This is partly due to a net loss of 2.1Billion on a total lawsuit settlement of 4.85Billion.  For the sake of this analysis we discount the 2.1Billion loss.  NOPAT to sales jumps to 23.6% with the change.  This brings operating ROA to 36.4% down from last year’s even more impressive 45.3%.  ROE went up as well to an even more impressive 31.5% up from last year’s 24.7%.

Effect of Vioxx lawsuit        for Merck: The effects that a lawsuit can have on a pharmaceutical firm can reach far beyond the income statement.  We can see from our analysis that MRK has been more profitable than PFE for the past two years.  We discounted the lawsuit from financial ratios because it is an unusual event but if lawsuits become a reoccurring trend than it could be an indication of serious management problems.  A lawsuit coupled with a company that has shown above average growth could indicate that drugs are not tested as thoroughly as they should be and that MRK is bringing drugs to market to early.  If this is the case then this unusual event should be quantified and captured on the expected earnings of the company.  It is worth noting that Pfizer is involved in several litigations involving patent disputes and liability claims against some of its drugs.

Profitability: MRK had a net income margin of 13.5% down from 19.6% the year before due to the lawsuit that consumed 8.5% of net income net of taxes.  PFE has a net income margin of 16.8% down from 40%, 16% of the previous year’s NI was from the one time sale of ops.  MRK and PFE are almost identical in cost of goods sold, SG&A and other expenses.  MRK has a larger EBIT of 35.3% to PFE 25.6% due to investment income totaling 12.3% of sales.

Cash flow statements Analysis:  

MRK has consistently generated around 7B in operating cash over the past 3 years 6.99B in 2007.  Pfizer generated 13.3B from its operations.  Both companies pay dividends and are actively repurchasing outstanding stock.  MRK dividend payout ratio is 101% in 2007 up from 74.9% in 2006.  This could be dangerous in the future if MRK consistently cannot pay its dividend obligations.  MRK has reduced its dividend obligation for the past 3 years through the stock repurchases.  PFE has a dividend payout ratio of 97.9% and its yearly dividend payments have gone up even with PFE repurchasing 9.99B worth of stock in 2007.  We would look for the ratio to drop and the yearly payouts to plateau or Pfizer could find itself in serious trouble.  PFE has an interest coverage ratio of 24 this is an indicator that it has almost no interest expense but that does not mean the company should give it all away in dividends.  MRK has interest coverage of 9.7 but that ratio is normally around 17 and has been affected by the cost of the litigation.

Accounting Adjustments for Research & Development:

Pharmaceutical companies invest in R & D because they expect the investment to produce profitable future products. However if a resultant product is absent these expenditures may have no value to the firm.Accounting for R & D requires all R & D costs be expensed in the period incurred and the amount is disclosed. Thus assets with incertain future economic benefits are barred from the balance sheet. These expenses have a significant impact on the financial statements of firms with significant R & D. Since we view R & D to be the most vital asset for a pharmaceutical firm we capitalized these expenses for both Merck and Pfizer over a period of ten years using straight line method of amortization with an annual amortization rate of 10%. The results of the BAV Model for adjusted balance sheet and income statement from capitalizing R & D can be seen in the BAV model. For Pfizer the Net Income for 2007 shows a drastic increase from $8,144,000 to $11,852,270 and the Long Term Intangible Assets increase from $45,226,000 to $58,770,750. There is seen a similar increase in Merck’s Income Statement after adjustments for 2007($3,275,400 to $5,540,742) and a huge increase in Long term Intangible Assets of $7,814,255.

Prospective Analysis - Pfizer & Merck:

Emanating from the business strategy analysis, accounting and financial analysis we performed forecasting and valuation of the two firms using the BAV Model. This model not only produces earnings forecast but a forecast of cash flows and balance sheet as well.

Pfizer:

Forecasting: For Pfizer the key assumptions were taken for a forecast horizon of ten years. Since sales growth rates tend to have a mean reversion (firms tend to revert to a normal level historically to 7 to 9 percent for U.S. firms). As Pfizer is a leading pharmaceutical firm and has the opportunities with resources of R & D and the best sales and marketing forces for internal organic growth as well as growth from mergers and acquisitions we assume that it would attain the level of 8% in a span of ten years from 2007 with a consistent sales growth interval of .5% increment per year till 2017 were it attains 8% and thereafter grows at a constant rate of 8%. Another assumption we make for Pfizer for fiscal 2008 is that its NOPAT margin will be 17%, slightly lower than its previous years margin since from the time series trends for NOPAT margins suggest that companies with high margins will experience a gradual decline in margins overtime. Our assumption for the fiscal year 2008 starts to reflect this trend. Thus the NOPAT margin eventually declines to 15% in 2017. Since asset turns show a flat time series trend and Pfizer has good asset utilization skills as we know from our financial analysis of the firm, we have assumed that its ratio of beginning operating working capital to sales (9.5%) and beginning long term assets to sales (94.9%) will remain unchanged for the entire forecasting period.

Cost of Capital parameters: Assumptions: Tax rate of 35%, market risk premium of 8.5%, cost of preferred equity is 8.6% calculated from the equation preferred dividend/preferred equity,10 year risk free rate of 3% and cost of debt of 3%(since the company’s beginning ratio of net debt to the market value of net capital is negative 24.9% implying that the company is in a lending position and the cost of debt should not exceed risk free rate, thus it is assumed to be 3% which is equal to the 10 year risk free rate). The unlevered beta is calculated to be 0.77 using the equation

Unlevered beta= {Beta of the firm/ (1+ (1-tax rate)*debt to equity ratio)}

Valuation of Pfizer: Valuation is the process by which forecasts of performance are converted into estimates of price. The BAV model uses three valuation methods to value the estimates of the firm’s asset or common equity.

1.         DCF valuation of the equity-calculates the firm’s stock value by expected future free cash flows discounted at the cost of capital.

2.         Abnormal earnings valuation of the equity- calculates the value of a firm’s equity as book value plus discounted expectations of future abnormal earnings.

3.         Abnormal returns valuation of equity- calculates firm value by considering the difference between return on common equity and cost of common equity. Present values of abnormal return are the product of abnormal returns and book value of equity growth discounted at the cost of common equity.

The value of Pfizer for all the three techniques is calculated as $26 which is approximately equal to the firm’s market value $24 on the 31st of December 2007. Thus it can be said that the firm has been correctly valued. The markets assumptions are very close to our assumptions which may be due to the fact that this firm is very large and mature in its industry.

Merck:

Forecasting:  The forecast horizon time for Merck is taken as five years after judgment based on sales growth performance trend. Since it has already attained a sales growth of 6.9% in 2007, we assume that it will increase to 7% after five years i.e. in 2012. After 2012 we assume the terminal sales growth rate of 7.2% as per the performance chart.  During the year 2007 the company realized a benefit from its strategic plan of redesigning   development and distribution of medicine and vaccine worldwide. As a result of this planning the company experienced a sales a growth rate of about 6.9% during 2007.We assume that this combination of redesigned method and the marketing effort utilizing the latest technology to engage with the customer along with seven drugs waiting in its launch pipeline will result in consistent future sales growth rate. Its NOPAT margin is declined slightly overtime from 15.1% in 2007 to 14% in 2012 consistent with the time series performance trend after 2012 we assume constant NOPAT margin of 14%. We assumed that the beginning net working capital /sales ratio and beginning net operating long term assets /sales ratio stay at a constant level (-14% and 74.6% respectively) throughout the forecast horizon based on the historical performance of Merck.

Cost of Capital parameters: Assumptions: Tax rate of 35%, market risk premium of 8.5%, 5 year risk free rate of 4% and cost of debt of 3.5 %(since the company’s beginning ratio of net debt to the market value of net capital is negative 15.9% implying that the company is in a lending position and the cost of debt should not exceed risk free rate, thus it is assumed to be 4% which is equal to the 5 year risk free rate). The unlevered beta is calculated to be 0.60.

Valuation of Merck: Again using the same three methods of valuation it is found that the stock price of Merck is $57.14 for the end of December 2007 which is a very close to the then market value of $58 Hence it can be concluded that the firm has been correctly valued based on our results and its comparison with market value.

Economic Value added and R & D momentum: Economic Value-Added Analysis measures the amount of value a company has created for its shareholders. It determines how much profit a company has produced after it has covered the cost of its capital. Whereas conventional accounting methods deduct interest payments on debt, Economic Value-Added Analysis also deducts the cost of equity— what shareholders would have earned in price appreciation and dividends by investing in a portfolio of companies with similar risk profiles. Economic Value-Added Analysis thus offers a truer picture of the return a company delivers to its shareholders and provides a framework to assess options for increasing it. By making the cost of capital visible, Economic Value-Added Analysis helps companies identify whether they need to operate more efficiently, to focus investment on projects that are in the best interests of shareholders and to work to dispose of or reduce investment in activities that generates low returns.

The basic formula is:

EVA = (ROC – COC) * C = NOPAT – COC*C,Where ROC = return on capital employed,COC: Weighted average cost of capital,NOPAT: Net Operating Profit after Tax,C: Capital employed.

The result of the EVA analysis for Merck has been summarized in Exhibit -2 . The results depicts that the company reported an EVA of $3.584 million in 2005 and the EVA fell to $.862 million in 2007. Even though the EVA declined in 2007 it cannot be attributed to companies lack in operating efficiency because during 2007 the company did incur a loss of $4850 M as  aresult US Vioxx settlement agrrement charge. We assume it to be e onetime expense. When EVA is recalculated taking into account $4850 M in EBIT, the EVA comes out to be $4014.15M. The positive and growing EVA of the company adds to its intrinsic value. The growth rate of EVA in one year is about 53.65% which is quite promising for the Market and share holders.

The result of EVA analysis for Pfizer has been summarized in Exhibit-1. The result depicts that the company reported an EVA of $3082.67 M in 2005 which declined to $992.13 M in 2007. The decline in EVA in 2007 can be attributed to asset impairment, write off and exit costs associated with their drug Exubera of $2.6 B along with costs associated with cost reduction program which resulted in increase in cost of sales thus decline in EBIT in 2007.

 Both Merck and Pfizer are value creating companies in terms of EVA but analysis shows that these firms have negative or declining R &D momentum which is not a very healthy signal for its internal organic growth.

Conclusion:

Based on our analysis of both the companies, we can justify that both are performing quiet well and based on our forecasting we predict good growth potentials for both the companies and thus we believe that buying their stocks would be a profitable investment.

Main Issue

In 2000, Rich Kender, Vice President of Financial Evaluation and Analysis at Merck & Company was discussing the opportunity of investing in licensing, manufacturing and marketing of Davanrik, a drug originally developed to treat depression by LAB Pharmaceuticals. LAB proposed to sell the right of all the future profit made from the successful launch of Davanrik at the cost of an initial fee, royalty payments and additional payments as the drug completed each stage of the approval process. Merck & Company's organizational goal is to constantly refresh it's company's drug development portfolio and reach as many customers as possible during the patented time. So there was not only the potential of financial gain or quantitative aspect of the offer, but also the qualitative value which will be added by getting better positioning in the risky pharmaceuticals industry.

Presenting team analysis

The presenting team started out by giving a background about the industry and the companies. The main issue and financial terms were explained. However we feel that some of the assumptions such as Merck's flexibility to back out from building the plant in case of failure were not clearly mentioned. They failed to explain why Davanrik's market risk was lower than its stand alone risk. Discounted cash flow method which is the traditional financial tool for evaluating capital allocation was rejected without explanation. We can rationalize not using DCF for its inability to capture risk uncertainty. Passive investments such as stocks and bonds are good candidates to use DCF on. Once these investments are made investors cannot influence the cash flow generation. We agree that decision tree can be used to make preliminary judgment and real option analysis can be used to get more definitive answer. We think that sensitivity analysis and scenario analysis could have been useful since all inputs may change over time. 

Merck's investment valuation

Decision tree approach: This approach is suitable for projects that do not have to be funded all at one time. The alternatives, probability of payoffs are identified using diagrams which are simple to understand and interpret with brief explanation giving important insights. It identifies managerial flexibility to reevaluate decisions using new information and then either invest additional funds or terminate the project.

Results of decision tree:

This analysis shows that the projects NPV as 13.37 million dollar. Our result is slightly different than the presenting team because of rounding. But both of our teams had positive NPV which suggest that the project should be accepted. The presenting team mentioned coefficient of variation as 18.07 for the expected value which should be the standard deviation. In order to explore other uncertainty we would recommend using scenario and sensitivity analysis since variations in the inputs can largely change the successive outputs. In sensitivity analysis base case situation is developed using the expected values of the input. "What if" questions are asked to capture NPV value change with change in unit sales or variable costs. In Scenario analysis worst-case and best-case scenarios are developed using probability distribution. We are confident from our research that decision trees combined with scenario analysis will give us more reliability of our estimate.

Recommendation: Based on the forecast and profitability suggested by the finance team at Merck and Company the decision tree shows positive effect of Davanrik in its portfolio. Further investigations should be done if there are resources since decision tree result may fail if it is not revised periodically. 

Real Option approach: Real option model are based on the assumptions that projects have underlying uncertainty such as the number of sales, variable costs or outcome of a research. The presenting team touched on how opportunities can be compared to managerial options. We would like to add that Merck's current situation can be analyzed using call option analysis where it can choose not to proceed with the project if it does not seem viable at any point. Any start up costs and fees incurred during this process is similar to the exercise price of a regular option. If the value of this option exceeds the cost of the option Merck should go ahead with this project. 

Options available:

It is important that managers always look for ways to create options. The followings are the options that are always common and can be evaluated through real option approach while estimating projects value.

Investment timing options:

Rich Kender should check if delaying the project can offset the harm that might cause for delaying. This option adds value by giving the managers more time to analyze the size of the market and viability of the research. One downside would be the threat of competitor companies developing similar product and creating market loyalty.

Growth options:

The opportunity of adding new products has been the strategic mission and competitive advantage of Merck & Company. Even though NPV analysis can show negative result with the current market condition, some projects add value to the company by reaching out to new customers.

Abandonment Options:

Real option analysis considers the value of abandoning project which should be reflected while calculating the NPV.

Flexibility options:

Merck will have the option to alter its operations depending on the outcome of the project. It can increase capacity or cut down production depending on events.

Limitations:

Merck is a multinational pharmaceutical company established in 1891. Merck researches, discovers, develops, manufactures and markets numerous vaccines and medicines through far-reaching programs that help deliver them to the people who need them.

Although Merck publishes unbiased, not necessarily the same biases used when preparing research (Bazerman, 2006), health information as a not-for-profit service, it appears that Merck misused data to delay the decision to withdrawal Vioxx. 

It goes without question that Merck indeed successfully conducted research that gathered information related to the possible ill effects Vioxx may introduce. The controversy lays with their data analysis preparation techniques during the VIGOR (VIOXX Gastrointestinal Outcomes Research) & APPROVe (Adenomatous Polyp Prevention on VIOXX) studies (Sekaran, 2006).

The VIGOR study was primarily designed to examine the effects of Vioxx on side effects such as stomach ulcers and bleeding. The study did quantifiably show that patients prescribed Vioxx had fewer stomach ulcers and bleeding than patients on another drug but also revealed that there was a statistical increase in the number of cardiovascular events and stokes occurring in Vioxx patients (Kweder, 2004). But this was no great revelation. In 2001 an FDA advisory committee had to pass a vote to ensure that physicians were being informed of the VIGOR study findings (Kaiser, 2005). 

APPROVe was a 156 week, 2600 person Vioxx vs. multi-centre, randomized, placebo-controlled double-blind quantitative study that investigated the side effects of Vioxx (Merck, 2004).  APPROVe found that after 18 months of treatment, patients taking Vioxx had twice the risk of a myocardial infraction compared to those receiving a placebo. This study is believed to have tipped the risk benefit equation leading to the September 30th, 2004 global withdrawal (Emerson, 2004).

Merck policies maybe legal but are they ethical? Merck used outdated and misleading data to indicate that Vioxx was safer than alternatives.  This prevented the release of educational data to physicians related to Vioxx's potential health risks so restructured sales campaigns based upon the information would meet sales goals. (Kaiser, 2005).

Did Merck hide behind the FDA labeling guidelines with intent to misuse and restrict data? According to the FDA, Merck only had to release information related to approved labeling guidelines. Coincidently, new content and formatting requirements quickly followed the withdrawal of Vioxx.  The Drug Information Association in conjunction with the Office of Medical Policy, the Canter for Drug Evaluation and Research, and the FDA briefed the newly revised safety requirements and the adverse reaction definition to demonstrate the necessary adaptations needed to ensure that there is a need for a better risk communication and management tool (Behrman, 2006).

The results of these studies did ultimately result with the voluntary withdrawal of Vioxx but did it does not appear to have happened rapidly enough not because of the result but due to the ethically questionable interpretation & use of those results.  The ethical implications of Merck's decision may cost Merck Research Laboratories as much as $30 billion in product liability claims (CBS, 2005).  It has already instigated a revision of labeling guidelines.

References:

Sekaran, U. (2006). Research methods for business: A skill building approach (4th ed.).

Hoboken, NJ: John Wiley & Sons.

Bazerman, M. (2006). Judgment in managerial decision making (6th ed.).

Hoboken, NJ: John Wiley and Sons.

Kaiser Family Foundation. (2005, May 6). Prescription Drugs.

Congressional hearing focuses on Merck's marketing for COX-2 drug Vioxx. Retrieved November 26, 2006, from http://www.kaisernetwork.org/daily_reports/rep_index.cfm?hint=3&DR_ID=29882

Merck and Company, Inc. (2004, September 30). News Release. Merck Announces Voluntary Worldwide Withdrawal of VIOXX®. Retrieved November 26, 2006, from http://www.vioxx.com/vioxx/documents/english/vioxx_press_release.pdf

Kweder, S. (2004, November 10). U.S. Food and Drug Administration. Drug Regulation in Controversy: Vioxx. Retrieved December 01, 2006, from http://www.fda.gov/cder/drug/infopage/vioxx/Vioxx_Kweder_20041110.ppt#375,5,Vioxx 2000

Behrman, R. (2006). Drug Information Association. The new content and format requirements for prescription drug labeling – Leaner, Cleaner, More Precise. Retrieved December 01, 2006, from http://www.fda.gov/cder/present/DIA2006/Behrman.pdf

CBS News. (2005, April 13) Business. Merck Asks Judge to Dismiss Vioxx Trial. Retrieved December 01, 2006, from http://www.cbsnews.com/stories/2005/04/13/ap/business/mainD89EA10G0.shtml

Emerson Poynter LLP. (2004, November). Vioxx Recall. Chronology of events leading up Merck's decision to recall Vioxx. Retrieved December 01, 2006, from http://www.vioxx-fraud.info/events.asp

Merck, being on one of the biggest pharmaceutical companies in the world today, came from a meek beginning and still encounters many problems today while trying to maintain a lead amongst its competition. While being looked at as a research and development driven company, Merck now has to go beyond R&D to stay competitive in the pharmaceutical industry. Attracting talent to work for the company has never been a problem for Merck, but the bigger question was whether or not this talent would be able to keep Merck's profits at a maximum and keep developing drugs in the pipeline.  

Through the late 80's to early 90's, Merck was able to boast profits and sales through biochemistry drugs that were seen as breakthrough drugs in this new market. With this sudden boom competitors started to take notice and emulate Merck's business model. This success also brought up a number of questions within Merck as a company; mainly how was Merck going to keep up with its numbers and keep pumping new drugs into the market. By assessing some strengths, weaknesses, opportunities and threats (SWOT Analysis) of the firm itself and offering some recommendations of how Merck may be able to conquer this challenge, you will be able to conclude that the success of Merck as a company relies heavily on its management and how they adapt the business model that is already in place to that of the ever-changing pharmaceutical industry.

Strengths:

       Merck has an effective record and has increased its performance through various features. Merck has greatly achieved success with its long history of breakthrough drugs, many of which became known as "blockbuster" drugs. For example, during WWII, Merck had already developed three key technologies of the period, antibiotics, vitamins and hormones. Merck created a world class reputation for itself in revolutionizing pharmaceutical research. Deadly bacterial infections were being treated. Drugs such as Mevacor for arthrosclerosis and Vioxx for arthritis were emerging. This success of Merck's novelty drugs not only reaffirmed Merck's reputation in the market but it also increased sales and profits to imaginable numbers. The organization garnered in 2001 a total of $50,691,000,000 in sales and $13,909,000,000 (Exhibit 1) in profits pertaining to human health management, prescription, animal health and other departments.

       A second strength for the Merck organization is the establishment of the Drug Development Process for new potential drugs. After the pre-clinical phase and animal study trials, Merck files an Investigational New Drug application with the Food and Drug Administration (FDA). Through the FDA system, the potential drug goes to Phase I where it is given to a small sample of volunteers and at different level of dosages. Next is Phase II in which the drug is studied in patients for long durations. Phase II provides preliminary evidence regarding safety and appropriate doses for larger studies. In Phase III the drug is studies in two groups, the double-blind test placebo group and the inert substance group. The group study will look at the risks and benefits and establishes labeling for the drug. After Phase III, Merck would file for a New Drug Application which is then reviewed by the FDA.  Phase IV can be used if Managed Care Organizations (MCOs), outside researchers or the FDA requested for more study and evaluation after the drug is approved and goes into the market.

       A third strength for Merck is the hiring and appointing of top-notched doctors, researchers, and scientists in the Merck Research Labs (MRL). In 1985, the organization appointed Dr. Edward Scolnick as head of MRL who like his predecessor, Dr. Roy Vagelos, continue to increase MRL profile, access to resources and encouraging researchers to publish their research in science journals. One top-rated biologist indicated that the reason he moved from academic to joining Merck because scientists are valued and first-rate science is done (Gilbert and Sarkar 4). MRL has also caused the organization to become a leader in patent filings. Between 1990 & 1999, the number of patents awarded to Merck has been at least 2,500 (Exhibits 2).  The organization's drug approval rate was recorded by outside scientists at 70% which is higher than the average industry approval rate of 50% (Gilbert and Sarkar 4).

       Finally, Merck's drug marketing campaign has led to increased exposure and demand for potential drugs. In the early 1990s, the FDA allowed "direct to consumer" (DTC) advertising of prescription drugs in newspapers, television and other forms of media. This was a devastating blow to Merck during the Zocor debacle but to reestablish the name Merck, CEO Ray Gilmartin, developed the Product and Cycle of Time Excellence (PACE) which allowed a better flow of information between research, marketing and manufacturing. In combinations with PACE David Anstice, President of U.S. Human Health for Merck, elevated the marketing organization. He reorganized marketing in the United States into Franchise Business Groups allowing each group to be responsible for their own P&L for Merck products. Ray Gilmartin helped as well to strengthen skills inside marketing. Merck began strengthening marketing skills and focusing on customer and brand marketing instead of industrial marketing. For example, Gilmartin, with assistance from the marketing firm Monitor Consulting, developed a marketing staff trained in data-driven methodologies and analytical approaches such as in market buyer segmentation (Gilbert and Sarkar 10). Web-based software for training was also instituted in the PACE approach as a curriculum that trained market staff members to be more professional and responsible.

Weaknesses:

       Although Merck has encountered success, the organization has confronted weaknesses and disappointments.

       One weakness that Merck has confronted is the duration of the drug development, the value of the drug being evaluated and the length of the FDA application for drug approval. For example, of the 5,000 molecules that are discovered, only couple of hundred are investigated, only one enters into the market and only a third becomes a marketable success (Gilbert and Sarkar 3). A drug development time may take on average over 15 years and expenditure R & D total costs of about $880 million (Gilbert and Sarkar 2) (Exhibit 3). The length for and FDA application is at least 100,000 pages, which details the potential drug's usage, production, formula and labeling.

       Another weakness with Merck is that too much power is given to scientists in decision-making of candidate drugs.  The MRL was somewhat the main decision-makers in organizing the drug development process including final say on whether Phase V or post-evaluation drug studies could be used. MRL, at one time, did not show a lot of emphasis on Phase V and wanted to move on after Phase III. Figures like Per Wold-Olsen, President of Human Health Europe, had to fight to get approval and funding for Phase V research.

       The third weakness is the inadequacies and lack of communication between marketing and research. For instance, Zocor, a drug for reducing cholesterol, went through a dramatic saga that ended up becoming a fiasco for Merck. Their was a conflict between outside Scandinavian doctors and the MRL to run a Phase V study on Zorcor's effect's on the mortality and morbidity of patients with coronary heart disease (Gilbert and Sarkar 7).  Per Wold-Olsen, who was head of marketing with Merck, fought and got the post-marketing study approved which was called the Zocor 4S study or the Scandinavian Simvastatin Survival Study. Although the study showed that the drug lowered mortality and morbidity, Pfizer was able to take the cholesterol market when along with Warner-Lambert came out with Lipitor. Lipitor was twice as effective with dosage use being half than Zocar. Pfizer's drug had more success in reducing cholesterol and decreasing triglycerides. Lipitor's success caused Pfizer to increase its sales force from 2,800 to 4,200 representatives. Pfizer spent 50% more on promotions or DTC marketing strategies than Merck. Pfizer also had 28% of new prescriptions than Zocar's 27% (Gilbert and Sarkar 8). The sales received from Lipitor, enabled Pfizer to buy Warner-Lambert and Lipitor for $116 billion in 2000. Merck failed to use marketing and advertising when necessary Zocar. Merck's marketing and research needed to realize that the making of the drug is not only the most important part in increasing sales, but it also included a strong advertising campaign that will satisfy the needs of the customers.

Opportunities:

       Merck has looked at various opportunities that can help the organization in the long run.

       One opportunity that Merck has initiated was combining functional departments with a core cross-functional structure that focused on strategies and implementation (Gilbert and Sarkar 11). For instance, Ray Gilmartin established the Worldwide Business Strategy Teams (WBST) in 1995. The WBST, which consisted of 12 or 15 members from the US Human Health, marketing and MRL's internal group, focused on managing, improving efforts and coordinating therapeutic franchises worldwide. Cross-functional groups can promote resources for category drugs, decide if marketable drug be evaluated in Phase V studies, look at possible impact sales and push for initiatives. An example would be the WBST's initiative push and study to review Prosacar, a sideline drug that would decreased an enlarged prostate which was later approved and experienced a 15-20% growth in the early 1990s. If cross-functional groups are designed and perform correctly, then they will be taken serious from larger organizations such as the MRL. Also, these strategic groups are basically a team of mix participants who are looking to use critical thinking and solve issues in Merck. The formation of cross-functional group will improve Merck's productivity and sales.

       Another opportunity that Merck has enacted was its' commitment to using the Phase V approach. By using Phase V, the organization could conduct post-studies on market drugs. If the drug shows that it is effective such as a decrease in morality or morbidity to a large representative of patients at a long period of time, then the drug is seen as a success. If the drug is found to be ineffective, then the approach could be a valuable detector to either remove or limit the supply and improve on the drug. An example on the success of Phase V was the study conducted on the drug Cozaar, used to fight high-blood pressure, by the Losartan Intervention For Endpoint Reduction (LIFE).  The study, which evaluated 9,200 patient's between1995 and 1997, showed it reduced cardiovascular morbidity and prevented strokes and diabetes in patients (Gilbert and Sarkar 12). Using the Phase V approach can help Merck determine which drugs will be safe and successful.

       The final opportunity that can be beneficial to Merck is the increase emphasis on external relationships and broadening new drug fields with other organizations. Acquiring or collaborating with outside partners can increase drug discoveries, joint ventures and provide better technology. The competition is fierce and Merck needs to align with other external organizations to establish and market new drugs first. Merck has entered the generic drug business developing a line of products and managing cared formularities. Some of Merck's acquisitions included Medco Attainment Services, the largest pharmaceutical benefit manager, in 1993. Merck collaborated with the Worldwide Licensing Group in 2000. Ray Gilmartin then integrated the group within MRL and appointed Dr. Ben Shapiro, a senior MRL employee, as head. In 2001, Merck once again acquired Rosetta Inpharmatics, a leading gene expression and biological analysis organization for $620 million dollars. This opportunity is a must for Merck because other competitors will look at ways to increase their performance and become the top pharmaceutical company in the world.

Threats:

       Merck has encountered threats from outside sources that have hurt the organization financially.

        One external threat that Merck has encountered is from competing pharmaceutical companies such as Pfizer. New technologies and law made it easier for companies to market drugs. For instance, in 1984 the Hatch-Waxman act was passed to make it easier for generic drugs from companies to enter the market. Also, with the FDA allowing the direct to consumer advertising of prescription drugs, long developed and product exclusivity periods decreased. Newly developed drugs were put in the market within a matter of months and companies focused more on marketing and advertising their drugs. Pfizer took advantage of DTC marketing, especially in the 1990s when it introduce Zoloft, an antidepressant, in 1992 and Viagra, an erectile drug, in 1998. Both drugs became a huge success for Pfizer as the company garnered more than a billion dollar in annual sales.  Smaller companies collaborated or merged with Merck's competitors to enhance technology, drug discovery and development. Pharmaceutical companies actually doubled their sales force between 1995 and 2001 to 80,000 sales rep.

       Another threat that Merck must deal with is from Manage Care Organizations (MCOs) such as Health Maintenance Organization (HMOs).  In the early 1990s, the MCOs began taking control and restricting the type, prices and number of drugs on their formularies or approved list (Gilbert and Sarkar 5). MCOs could demand or compel companies to conduct studies on marketable drugs. The MCOs presence and control on pharmaceutical companies led to slow sales and growth. This also led to a 35% decline in drug company valuations in the early 1990s.

Recommendations:

     By exposing the strengths and weaknesses of Merck as a company, we were able to come up with some recommendations as to how Merck could improve itself from the company's standpoint. One area Merck might want to look at is its relationship with the generic drug makers of the world. By forming a relationship with a generic drug maker, which have hurt Merck's sales by creating similar drugs at a cheaper price, Merck would be able to receive some sort of payment from them. In order to do so Merck would first develop the drug, then before bringing it to market, approach a few generic drug makers about the drug and from there enter into an agreement for them to distribute a generic version with Merck receiving some of the royalties. This would benefit both the profitability of Merck as well as create new business relationships. Furthermore we would also like to see Merck reevaluate its business model. The model it has in place has proven to be successful and there have been changes along the way that have proven to be successful, but by reevaluating it from the bottom up, there are changes that could be made to make it more efficient. For the subgroups that Gilmartin formed to add responsibilities to the WBST could be revised. Members and even the head of WBST, see this area as non-influential because of the lack of decision making they have within Merck. If Gilmartin were to add a decision making aspect to this group, they may be able to be more influential within the company. Top management seems to have all the say within Merck and rightfully so, but why then waste other workers time and increase their responsibilities if in the long run they have no say. Management needs to address that issue and come up with a solution to be more efficient and effective. The final recommendation we have is to shift focus from its core objective which is research and development to areas that have not been exposed enough, like marketing and distribution. It is easy for Merck to stay research driven because that is what the company was founded on, but now that they have all those parts in place they should look to market their products better and form distribution relationships that will get their drugs to the consumer most effectively. By doing so they will develop internally as a company as well as experience growth is sales. 

Conclusion:

     Merck knew from its inception that it would have no problem keeping up with its competitors because its business model was research driven with some of the most intelligent scientists in the world. But what they did not realize is that overtime, even having the most gifted people in the world working for you, you are going to run into problems in other areas along the way. Such issues like generic drugs, not getting drugs to market fast enough, internal conflicts within Merck, and marketing problems all were issues that Merck had to face through the years. Each one of these issues was a hurdle that management did not anticipate and thus had to adapt to along the way. The marketing issue was one of the most important aspects in the industry that Merck had to adjust to in order to remain at the top of its industry. Although they did eventually notice that to be successful they had to bring in a experienced marketing team, one can only think of how efficient they might have been if during the years where drug sales were soaring, how a highly effective marketing team would have increased sales even more. What Ray Gilmartin did through the years that benefited all areas of Merck was create these subcommittees or teams to handle certain aspects of Merck's business. In doing so each area was able to focus on a company specific area and then make suggestions to management on how to correct or enhance that area. By delegating these responsibilities Gilmartin was able to have other people be influential in Merck's business decisions. Merck as a company still remains amongst that top in its industry, but has to realize that in the future there are going to be problems along the way and the way they encounter and overcome these problems will define how successful they will be in the coming years.

The Pharmaceutical Industry: Key success factors       High profit after launching the product:    Before a pharmaceutical company establishes a new product it takes them a lot time and work. The whole project, from the beginning until the end, where the medicine can be launched can last about 12 years. But once the drug is on marked the producing company has very high margins. On average, a Blockbuster drug is for about eight years on the marked and each year it has revenues in the range of one billion US$. That means, that the producing company has with one Blockbuster drug in eight years about eight billion US$.       High demand:    There is not only a demand for all kind of drugs, there is a strong need for some of them.  Another very important reason is the fact, that in some countries, the healthy system is passed into private hands. That turns the medical health care to a luxury good. People with less money, stay in the normal public insurance system. Those who have a higher income can change to the private health care system. If you are in this private system, doctors prescribe very expensive drugs and provide you with a better service, because they make more money with it. (Example from Germany)       Demographic reasons:         Strict legalizations    Before you bring a drug on the marked, it has to be legal approved by government organizations. But before the drugs can be approved companies have to start developing. That takes them a lot time and over all a high amount of money before they know, that there product will be really approved. The research and development costs in this industry are very high. The fact that companies have to invest such a high amount of money is a big risk for them.  Those companies that have already established some successful drugs have advantages against smaller companies. You need money and time, which smaller and new companies probably not always have. So once you are an established and successful company in this industry, you have an advantage against new companies that want to enter the marked. This is a key success factor for the existing companies.       High marked entry         Important to have a brand for the developed product    This is not so important in the beginning of your process, but when your drug gets on the market, a good marketing and a strong brand could be a key success factor for your product. For example the drug “ASPERIN”, which everybody knows, shows us how important a brand could be. I believe that there are also other products on the marked that are as good as “ASPERIN” and probably cheaper. But if you have a headache you would also buy “ASPERIN” without checking the price and see if there are also cheaper products on the marked. This example shows us, how important a brand and a good marketing could be for some products.       Innovative Industry    The pharmaceutical industry is very innovative. Companies are researching for new drugs and technologies. In the future we probably will have technologies from the genetic engineering and from the nanotechnologies. People will demand these new products, if it helps them to stay younger or the get better.  There will also be new delivery technologies for drugs, so that you can for example buy food and they implement the drug you need into it.       Products stay only for 8 years on the marked    Also due to the technological process, a blockbuster drug stays on average for about 8 years on the marked. That means that there is always a circulation of new products and companies launch new products every eight years.