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Case Analysis - "Merck-Medco"

Maureen Hergert MGT 362 - SPRING 2004 Professor Steven Francis Case Analysis - "Merck-
Medco" March 7, 2004 Introduction. Merck & Company (Merck) was a pharmaceutical
researcher and manufacturer while Medco Cost Containment Services, Inc. (Medco) was a
pharmacy benefit manager (PBM). On November 18, 1993, Merck purchased Medco for $6.6
billion. Immediately after the merger, Medco operated as a subsidiary of Merck. In 1994, Merck-
Medco was formed. 2 Grant states that corporate strategy involves decisions that define the
scope of the firm. In addition, he states the importance of vertical integration as it has caused
companies to redesign their value chains within their organizational boundaries. 1 The
acquisition of Medco by Merck is an example of Merck expanding its organizational boundaries
while at the same time adding value. Merck added value to its operations by purchasing Medco.
Pharmaceutical companies operated in a relatively stable environment that was characterized by
solid profits and minimal pressure. Different organizations whose processes and values are a
close match with the new task. * Try to change the processes and values of the current
organization. * Separate out an independent organization and develop within it the new processes
and values that are required to solve the new problem. 6 These alternatives and their
ramifications are discussed below. Alternative #1. Acquiring an organization with the
competency of pharmacy management to add to Merck's value chain is an option. This option is
attractive due to short-circuiting the process of developing new, but time-consuming processes.
Over the past few years, there has been increasing pressure to expedite the drug approval process
and for manufacturers to increase the yield from their research and development activities.
Taking into account these pressures and Merck's primary business being drug manufacturing, the
acquisition of a PBM will be the quickest and most effective manner in which to acquire
pharmacy management competencies. Yet, acquiring companies face difficulties in acquisitions,
such as the integration of the acquiree's capabilities with its own. Alternative #2. Rather than
acquiring or buying the pharmaceutical benefit management competencies of Medco, developing
individual competencies, expansion of research and development, and establishment of closer
relationships to customers is an option for Merck to consider. Grant says, "...one approach to
capability development is to develop the human resources required for a particular capability."
Yet, he states that developing human resource competencies can be effective in maintaining and
developing existing competencies, but is limited in forming new capabilities. 1 Due to the highly
competitive and time-to-market issues of new drugs, this option is not advisable for Merck.
Development of new drugs and getting them to market is critical for remaining competitive in
the pharmaceutical industry. Alternative #3. Creating new capabilities may also be obtained
through a spinout organization. Merck realizes that its resources and capabilities are insufficient
to rapidly move into the pharmacy management area. Most of its resources are devoted to drug
research and development. Christensen states that spinout organizations are appropriate when a
separate organization is required when the mainstream organization's values are incapable of
devoting resources on the new processes or innovation. 6 Furthermore, he states that spinouts
should only be used when a threatening disruptive technology requires a different cost structure
or when the current size of the opportunity is insignificant relative to the growth needs of the
main organizations. Neither of these criteria is relevant to Merck. Services provided by PBM
organizations are not disruptive to drug manufacturers. They may be considered as value-added
to drug manufacturers. In addition, the size of the opportunity by acquiring a PBM can be
significant to a drug manufacturer. Recommendation. It is recommended that Merck select
Alternative #1, which is to acquire Medco. Acquiring Medco and its competencies makes the
most sense for Merck. According to Merck's 1993 annual reports, its vision is to create the
world's first coordinated pharmaceutical care company that will optimize discovery,
development, selection, delivery, utilization, and value of prescription drugs. 2 The quickest and
most effective manner in which to achieve this vision is through a PBM acquisition. The internal
development of pharmacy benefit competencies would be very difficult and time-consuming for
Merck. When making its decision, Merck should not view moving into the pharmacy benefit
management area as enhancing existing competencies, but rather expanding into a different
business within the pharmaceutical industry in which new competencies will be needed. Based
on the aforementioned quote by Grant that internally developing new human resource
competencies for new capabilities is limiting, it is not advisable to use Alternative #2. Based on
the criteria presented by Christensen on when to use spinouts, Merck should not use Alternative
#3. Conclusion. The case study states that despite the initial plans to integrate Merck and Medco
upon the acquisition, the companies remained independent. Specifically, it states that
management decided to preserve both cultures. Merck's strengths were in the medical, clinical,
and sciences areas while Medco had strong relationships with employers, plan sponsor, and
managed care organizations. The new CEO says, "Therefore, at Merck and Medco we had
critical and complementary skills to build our strategy looking forward. 2 In August 2003,
Merck-Medco announced the spinout of Medco, which is now named Medco Health Solutions.
Medco Health Solutions is considered one the top pharmacy benefit management companies in
the US. It currently serves about 65 million members. The company assists health plans in
managing drug costs by negotiating rebates with pharmaceutical companies and processing
claims. Patients may fill their prescriptions through a network of 60,000 pharmacies, a mail-
order program, or the company's Internet pharmacy. Medco Health Solutions processes nearly
550 million prescriptions per year for clients that include unions, corporations, HMOs, insurance
companies, and federal employees. 5 In retrospect, the Medco acquisition was beneficial for both
companies. Its website reports the following: Together, Merck and Medco Health have enjoyed
10 years of growth and success. As a subsidiary of Merck, Medco Health grew to become the
nation's leading pharmacy benefits management (PBM) company, providing integrated
prescription health care to 62 million Americans. Medco Health increased revenues from $2.2
billion in 1992 to $33 billion in 2002, and last year, filled or processed approximately 548
million prescriptions. By all measures, the acquisition of Medco Health by Merck has been
highly successful," said Merck Chairman, President and Chief Executive Officer Raymond V.
Gilmartin. "With the spin-off, the market now has the ability to value each entity as 'pure plays'
in their respective industries. We believe that by establishing Merck and Medco Health as two
separate companies, we will enhance the potential for success of both businesses and, as a result,
increase shareholder value." 7 References 1 Grant, R.M. (2002), Contemporary Strategy
Analysis: Concepts, Techniques, Applications, Fourth Edition. Malden, MA: Blackwell
Publishers Ltd. 2 Rangan, V.K. & Bell, M. (1998). Merck-Medco: Vertical Integration in the
Pharmaceutical ...

1. Price controls imposed by the government would have the effect of making
pharmaceuticals available to more consumers, particularly those in lower
income brackets who either cannot afford expensive drugs or who lack
insurance to pay for these drugs. In this way, price controls would eliminate
medical rationing based only on economics and make more drugs available to
more individuals.

On the other hand, government-imposed price controls on the entire drug


industry products are not likely to have the long-term desired effect that the
government would like. While in the short-term, the supply of drugs is unlikely
to be affected, since the price controls would affect drugs already on the market
and would be based on current (or recent) prices, the long-term effect would be
to shut down, or at least radically constrict, research and development in the
pharmaceutical industry. This is because of the high cost of bringing new drugs
to market. Pharmaceutical companies not only must pay for the development
costs of drugs which are actually introduced to the market (and for which the
patent life gives the companies some protection before the drugs are issued in
generic form), but also the development costs of drugs which are never
introduced to the public. The reasons for not introducing a drug can be many,
but generally are attributable to the drug failing to pass the rigorous FDA
approval process. Restricting the prices that companies can charge for drugs
would r

to price controls since the drug companies will be viewed as less greedy by the
public at large. In this way, the public would be willing to accept fewer controls
on the drug companies if they perceive that the companies are co-operating
with regulators. 5. The Merck-Medco merger illustrates the importance of
maintaining a diverse business portfolio when a company's primary business
(drugs, in Merck's case) has a high cost structure. By eliminating the
intermediary between the drug manufacturer and the consumer, Merck was able
to realize increased profits. A market economist would argue that price controls
are not necessary because the drug companies will continue to find ways to
increase their profits without necessarily increasing prices. Quaker/Snapple
Case 1. Current Quaker stockholders and speculators would benefit during the
time that it takes to prove a takeover rumor false. This is because the rumor of
a takeover would drive up the price of the stock in anticipation of the takeover
offer, and those who already own stock could sell it at a profit. Speculators
would be able to purchase the stock immediately after the rumor begins
circulating, then sell their shares shortly after (and before the rumor is proved
fal

The health care industry of the 1990s is moving rapidly toward "integration" of various functions
to achieve greater efficiencies. Companies involved in the delivery of health care are trying
different combinations and alliances in an effort to control health care costs while taking
advantage of the synergies possible with new technologies.

The integration of pharmaceutical manufacturers and pharmacy benefit management firms


(PBMs) has been the subject of criticism by some private groups, including pharmacy
associations, and scrutiny by government agencies, notably the Federal Trade Commission
(FTC).

Most concerns have focused on the potential of these mergers to be anticompetitive under the
antitrust laws. However, there is evidence that what's behind the integration is an effort by
pharmaceutical manufacturers to move away from products and become service-oriented
companies to better position themselves in a managed care world.

Pharmacy-benefit management companies try to control prescription drug costs by creating


formularies of approved drugs for use by participating physicians and pharmacists. PBMs
encourage physicians to prescribe more cost-effective drugs. They also monitor the effectiveness
of particular drugs.

PBMs presently cover about 120 million lives, and are expected to include more than 200 million
by the end of the decade. The recent rise of PBMs has coincided with a reduction in drug price
increases, from 9.5% in 1989 to 3.l% in 1993. Much of the contribution of PBMs to lowered
prescription drug prices has resulted from demanding discounts from pharmaceutical
manufacturers in return for placing their products on the formularies.

In the past two years, three pharmaceutical manufacturers have acquired the three largest PBMs,
which by some measures comprise 80% of the pharmacy benefit management market. In July
1993, Merck & Co. acquired Medco Containment Services for $6.6 billion. British
pharmaceutical manufacturer SmithKline Beecham P.L.C. agreed to buy Diversified
Pharmaceutical Services last May for $2.3 billion. The most recent acquisition, of PCS Health
Systems by Eli Lilly & Co. for $4 billion, was delayed by an FTC review of the deal, which
resulted in a proposed consent decree.

The proposed consent decree requires that Lilly-PCS maintain an open formulary and restricts
the exchange of competitive information between Lilly and PCS. Under the decree, the open
formulary is to be composed of pharmaceuticals selected by an independent committee of health
care professionals. The ranking of drugs on the formulary is to reflect discounts and other cost
reductions which PCS is required to accept from Lilly's competitors.

The decree also mandates a "fire wall" separating the drug manufacturer and the PBM to prevent
Lilly's access to nonpublic information. As a result of its examination of Lilly's acquisition of
PCS, the FTC has taken the unusual step of reopening its investigations of the Merck-Medco and
SmithKline Beecham-DPS deals, which it had previously approved, and has announced that it is
investigating other alliances between PBMs and pharmaceutical companies.

The FTC's power to seek the restrictions contained in the Lilly proposed consent order arises
from Section 5 of the Federal Trade Commission Act and Section 7 of the federal Clayton Act,
which condemns mergers whose effect "may be substantially to lessen competition, or to tend to
create a monopoly."

Mergers among competitors are called horizontal mergers, while mergers among firms serving
different functions in a given market are called vertical mergers. The acquisitions of PBMs by
pharmaceutical manufacturers fall into this second class of "vertical mergers" because the
merging companies previously served different functions in the prescription drug market.
Manufacturers produced and marketed the drugs, while the PBMs arranged large volume
purchases of drugs and compiled patient information for managed care systems.
Horizontal mergers are much more likely to raise antitrust concerns than vertical mergers, since
the former directly eliminate a competing firm. While relatively few vertical mergers have been
condemned as anticompetitive, the magnitude of the recent pharmaceutical company-PBM
combinations and the potential for structural marketplace changes has caused regulators to raise
questions under several theories of competitive harm.

"Foreclosure" theories focus on the competitive harm which might result if pharmaceutical
company-owned PBMs closed their formularies to competitors of the parent manufacturer. The
"facilitation of collusion" theory concerns the relationship of vertical integration to competition
among drug manufacturers. In an "open" formulary such as the one required by the proposed
Lilly consent order, a group of therapeutically equivalent drugs are listed and ranked according
to rebates or discounts promised by the drug manufacturer, with the PBM providing
reimbursement for whichever medication is prescribed. In contrast, a "closed" formulary contains
a limited list of preferred drugs from any therapeutically equivalent class, and the PBM will only
reimburse for prescriptions which conform to the formulary.

By requiring that PCS maintain an open formulary, the FTC is responding to charges that
pharmaceutical manufacturers might place their own drugs on closed formularies of their own
PBMs. This would eliminate competition for formulary slots which might otherwise lead to
lower drug prices. Enhancing these concerns are the actions and statements of the drug
companies themselves. Already, the PBMs owned by Merck and SmithKline reportedly have
closed their formularies to some extent. Eli Lilly Chairman Randall Tobias triggered similar
concerns with his statement, reported in the August issue of AMERICAN DRUGGIST, that the
PCS merger "will help sell even more Prozac."

By automatically placing their own drugs on closed formularies of vertically integrated PBMs,
the pharmaceutical manufacturers are said to "foreclose" these slots on the formulary from other
pharmaceutical manufacturers. The weight given to "foreclosure" as a theory of competitive
harm has fluctuated according to changes in political and economic thinking. Early Supreme
Court vertical merger cases disallowed mergers which foreclosed more than a de minimis share
of the supplier (here, the pharmaceutical manufacturer) or the distributor (PBM) market. Vertical
integration was especially quick to be condemned where, as here, there was a pattern of
integration in the industry.

The rise of the so-called "Chicago school" of antitrust analysis in the 1980s limited the
application of the foreclosure theory. These scholars and judges emphasized the potential
efficiencies of vertical mergers, limiting the foreclosure theory to those situations in which
integration is so widespread in the industry that simultaneous entry into both markets is required
to compete.

According to the Chicago school, any attempt by the vertically integrated firms to lower quality
or increase prices will result in consumers, taking their business to the "independent" firms. If the
consumers remain with the integrated entities, it is because the merger has produced efficiencies
or other procompetitive benefits, at least some of which are passed on to the consumer. In other
words, as long as there are any unintegrated firms in the market, a vertical merger, at most,
would cause a "realignment" of the lines of distribution.
In recent years, however, "post-Chicago" scholars have suggested that foreclosure need not rise
to the level of requiring dual-market entry in order to be anticompetitive. As applied to
pharmaceutical company-PBM mergers, the theory suggests that an integrated manufacturer
might charge a rival PBM more for its unique products than it charges its own PBM, thereby
placing rival PBMs at a competitive disadvantage.

A review of the early market responses to the manufacturer-PBM mergers indicates the
"realignment" theory, so far, best explains the effect of vertical integration. Independence may
even be a benefit. Caremark, an independent PBM which has supply arrangements with four
major drug manufacturers, recently renewed a pharmacy contract covering 150,000 lives when
the employer "ruled out two other competing vendors - DPS and Medco - because of their
alliance with drug makers." Robert Pfotenhauer, former chief executive officer of Pharmacy
Direct Network (the pharmacy-owned PBM), said PDN "has an opportunity to help level the
playing field and ensure that there will be fair competition" and is predicted to be "a significant
entity that will have some fairly immediate impact on the prescription benefit management
world." Bill Jenison, president of Pharmacy Gold, said the pharmaceutical company-PBM
mergers will allow his independent PBM to "leverage more enrollment because of our clinical
objectivity and independence."

With existing PBMs prepared to handle increased market share, and new PBMs forming, the
arguments that the manufacturer-PBM mergers increase the barriers to entry into the industry, or
foreclose unique products or services, are weakened. Additionally, no pharmaceutical company
makes every drug on a formulary list, so the possibility of strict foreclosure is diminished
because the PBMs must maintain supplier relationships with other manufacturers. A different
issue arises from these continued supplier relationships concerning more subtle ways in which
vertical mergers can facilitate collusion among the drug manufacturers. By requiring that Lilly
maintain a "fire wall" to prevent access to competitive pricing information, the FTC addresses
the possibility that vertical mergers between pharmaceutical manufacturers and PBMs might lead
to anticompetitive information exchanges.

Price-fixing, explicit or implicit, is one of the principal anticompetitive activities condemned by


the antitrust laws. In fact, an agreement to fix prices is a per se violation of the antitrust laws.
Consequently, government agencies such as the FTC may use their pre-merger review powers to
ensure that a market does not become conducive to collusion as a result of the proposed
acquisition. The risks of collusion are believed to be high in concentrated markets where a few
competitors hold much of the business.

The degree of concentration in the pharmaceutical manufacturing market depends on whether the
market is evaluated according to aggregate market share or market share within individual drug
categories. In 1993, at least 18 companies had worldwide sales of over $3 billion. Until the
Glaxo-Burroughs Wellcome merger, Merck was America's largest drug company, although it
only had a 10% share of the "highly fragmented" U.S. pharmaceutical market.

On the other hand, competition in each of the major drug categories is limited typically to only a
handful of manufacturers.
If the market is evaluated in terms of individual drug categories and thus considered highly
concentrated, vertical mergers are thought to enhance the possibility of collusion by making it
easier to monitor the prices of competitors. When a group of companies agree to form a cartel
and fix prices, individual companies have an incentive to cheat on the cartel by offering a
slightly lower price and capturing a larger market share. Thus, the cartel has an interest in
monitoring the prices charged by each of its members to ensure that prices do not go below the
agreed-upon level.

By controlling PBMs, drug manufacturers may learn the prices of pharmaceuticals being charged
by their competitors. Requiring a pharmaceutical manufacturer-PBM to open formularies might
actually encourage such information monitoring, since the PBM will gather price information on
drugs directly competing with those manufactured by its parent. Even absent collusion
competitive pricing information could replace "blind" bidding with a bid which was only slightly
below that offered by a competitor. It is thus no surprise that the FTC joined its requirement of
formulary access with restrictions on information exchanges between the PBM and its parent
manufacturer.

On the other hand, the exchange of pricing information can be procompetitive. Information from
customers about the pricing practices of competitors often leads a company to lower its price.

The major precompetitive benefit claimed to result from manufacturer-PBM mergers is the
assimilation of patient information from various sources. PBMs are developing large databases
of patient information gathered from health care providers which can be used to monitor' whether
drug therapy has helped patients to avoid hospital or physician visits. The theory is that PBMs
(and their manufacturer parents) will create a market for disease management systems, which
will offer patient education, monitoring, and distribution, as well as pharmaceuticals.

By gaining access to patient data, pharmaceutical manufacturers hope to demonstrate that greater
use of prescription drugs is a more efficient method of controlling diseases. If the mergers
encourage the development and utilization of patient information, the potential benefits of
lowered overall health costs should be recognized. By stressing the greater cost-effectiveness of
drug treatment as compared to other health care products, such as doctor visits, disease state
management could be a form of enhanced interbrand competition among pharmaceutical
companies, hospitals and other health care providers.

Nonetheless, many wonder whether access to PBM databases was worth the $13 billion paid.
According to the Financial Times, "It is clear that there are less expensive ways of accessing
such patient data. Indeed, health maintenance organizations hold far more complete treatment
information than distributors and are quite willing to share it for relatively small consideration."

If patient information is an insufficient justification for PBM mergers, the acquired companies
must have offered something more. By placing these mergers in the context of changes to the
pharmaceutical industry generally, it becomes apparent that what the PBMs offered
manufacturers was a better chance for success in the managed care world of the future.
Consolidation is widespread throughout the pharmaceutical industry. In addition to the PBM
mergers, during the last year Swiss drug manufacturer Roche Holding Ltd. purchased U.S.
pharmaceutical company Syntex Corp. for $5.3 billion in cash and French pharmaceutical
company Elf Sanofi S.A. bought the prescription drug business of Sterling Winthrop Inc. Last
August, American Home Products offered $8.5 billion to purchase American Cyanamid Co.

In January, Glaxo Plc. made a surprise bid for Wellcome Plc., its British rival. The $14.8 billion
deal is expected to be finalized this month. Also, Hoechst AG, the German chemical and
pharmaceutical giant, is in talks with Dow Chemical to buy Marion Merrell Dow for an
estimated $7.1 billion. Many analysts consider this pattern of consolidation the beginning of a
general contraction of the pharmaceutical industry from its present 40 or so companies to
perhaps four or five.

In light of market flaws which have removed the ultimate consumer from appreciating the full
costs of prescription drugs in the past, it is likely that the pharmaceutical industry simply
contained more companies than a competitive market could support, and the pharmaceutical
manufacturers acquired the PBMs in an attempt to diversify and enhance their chances of
survival in the changing market.

In describing the benefits of acquiring DPS, J.E Garnier, SmithKline's executive vice-president,
said, "SmithKline can move rapidly into the blossoming business of managed care. This is our
future."

Comments by Eli Lilly executives concerning PCS indicate a similar goal of expanding the
company's role in health care to "become a broader organization, more capable of meeting our
customers' expectations." Some industry analysts characterize the manufacturer acquisitions of
PBMs as the first step in moving away from a product orientation to a service orientation.

The theory of survival through diversification is logical in light of the uncertainty about the role
of the government in health care. Through the acquisition of PBMs pharmaceutical companies
may simply be trying to assure themselves of a more secure place in the evolving health care
system of the future.

Case study analyzing the strengths, weaknesses, opportunities, & threats of pharmaceutical giant
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Paper Abstract:

Case study analyzing the strengths, weaknesses, opportunities, & threats of pharmaceutical giant
Merck, called by some the best run company in America.

Paper Introduction:

Merck is a leading U.S. drug company that has also entered the evolving field of biotechnology.
The company is seeking to remain competitive, and tap into a potentially lucrative means of
developing new treatments for disease. Merck has been the undisputed leader of the prescription
drug industry. The company has examined the external environment and changes taking place
there. They have also examined the opportunities available because of new technologies, which
can be threats as other companies are also turning to new techniques. The company determined
in 1992 that it needed to enhance its position, and it merged with Medco, a medical distribution
company, as a way of diversifying within its field while also using the information gathered
through Medco to develop new products and strategies. A strategic plan for Merck today
involves increased R&D.

Merck has lately started pressuring its researchers to pursue blockbuster drugs and thus has
shunned the smaller sales potential of other drugs, while other companies have been very
successful with small drugs. Drug Company that has also entered the evolving field of
biotechnology. The company determined in 1992 that it needed to enhance its position, and it
merged with Medco, a medical distribution company, as a way of diversifying within its field
while also using the information gathered through Medco to develop new products and
strategies. Merck is in a strong position after posting a 17 percent year-over-year fourth-period
increase in share earnings in the last quarter of 1993.The full year showed a 13 percent gain,
considered especially impressive given a 2 percent negative currency impact and an absence of
help fromprice increases. One way apharmaceutical company can improve its position is by
finding new marketniches where the company can become a leader. The company desires the
creation of an electronic information linkfrom patients to Merck marketers and
laboratories.Threats Most of the threats are clear to management. The company has committed$6
billion to the acquisition at a time when the company's R&D expenditureis facing a shortfall.
Merck is a leading U.S. "Merck is showing its age." Business Week (August 23, 1993), 72-74.
Two important drugs held by the company were Proscar andMevacor, both up 22 percent, a gain
far better than anticipated. The Medco merger provides the company with a means of distribution
that it formerly lacked as well as a source of information on the use of pharmaceuticals by the
consumer that will serve the needs of the company in the long term. "Merck Acquisition of
Medco: Meaning & concerns." Employee Benefit Plan Review (October 1993), 1 -12.Weber,
Joseph. Hamilton, "In Medical Testing, Abbott Is the Name of the Game," Business Week (June
1, 1987), 9 -91."Drugs and Biotechnology." U.S. Biotechnology is an opportunity for the
company to enter a new area that will provide new products and new problems to be addressed
by R&D. The company has a new biotechnology plant in Pennsylvania to work with vaccine
operations. "Is this Rx too costly for Merck?" Business Week (August 9, 1993), 28.Weber,
Joseph. "A week of woes raises more questions about Saint Merck." Newsweek (August 2,
1993), 35.Deveny, Kathleen and Joan O'C. Today, efforts to develop new drugs for complex
diseases have combined with a reluctance to embrace new research methods through
biotechnology to reduce the product flow. Merck is thus saddled with an aging product line and
the potential for further reduced sales. Once the systems are working, Merck will need to
develop a decision-making system that assesses the information, and the possibilities raised by
that information. In addition, the company has a bureaucracy that has slowed the scientific
process even more. The company intends to use data gathered through Medco to produce drugs
with greater appeal and directed toward specific problems uncovered by Medco's information.
Such an assessment should be made an ongoing part of the system to provide feedback and
evaluation of every project undertaken. The key competition for this company includes other
pharmaceutical giants such as Johnson & Johnson, Dow Chemical, Du Pont, Procter & Gamble,
American Cyanamid, Bausch & Lomb, and Unilever, among others. The company pledged to
keep price increases below the U.S. Many of the new products offered by Merck have grown
more slowly than desired. The company has worked to maintain is lead and to increase its
strengths. Merck was willing to cut the work force while profits were still strong, and this was
appreciated by Wall Street. The acquisition of Medco poses a threat if the two companies do not
mesh, and many analysts believe they will not. While the company continues to spend
considerable sums on R&D, the corporate bureaucracy has grown in such a way that it has
slowed down the pipeline for new products and made R&D less effective at creating new
products and sending them through the marketing process. Merck is presently under new
leadership, which could also be weakness, but which is clearly an opportunity to introduce
needed change and to redirect the fortunes of the company. The company also faces changes in
its traditional markets as managed-care providers, rather than private physicians, decide which
drugs doctors may prescribe, and health-maintenance organizations are also pressing for lower
prices. In the intermediate term, developing these systems is vital. A strategic plan for Merck
today involves increased R&D and the adoption of new technologies with the exercise of
considerable control to assure that this R&D does not lead to dead ends and those opportunities
are not missed any more than they are leaped on unthinkingly. Strengths a SWOT analysis shows
first the strengths on which the company can build. Biotechnology may provide away of
accomplishing this task today, though it is also a risky proposition. The fit between Merck and
Medco must be monitored carefully to assure that the operations of neither are suffering from the
new structure and that each is benefiting the other because of the merger. The competitive
environment is only one aspect of that environment. Government regulation and other legal
strictures are an important part of the business environment. Based on the available information
the system must be guides to what products to research or how to reshape the production of
existing products to fit better with the marketplace. And Europe. The strategy will be considered
successful if new products are put into the mix, and if costs can be reduced on products already
being produced. Some of the top drugs offered by the company have been hit by sagging sales.
Further research efforts have been slowed by the company culture that has developed. Merck had
a steady 27 percent growth rate in the late 198 s, and that has now slowed. The company's labs
are found all over the world, but decision-making is centralized and bureaucratic. Much
scientific talent has fled the company to work for the competition. The purchase of Medco may
not solve these problems. Opportunities The Medco acquisition is an opportunity as well as a
potential weakness. Merck has already undertaken a means of improving its competitive position
by its merger with Medco, a form of vertical integration that allows the company to distribute the
products it makes. Since 1991, Merck has had a joint venture with Du Pont for marketing drugs
in the U.S. The company is seeking to remain competitive, and tap into a potentially lucrative
means of developing new treatments for disease. This ability to spend has allowed the company
to move quickly into the fast-growing markets as they are identified (Deveny and Hamilton,
1987, 9). Merck's company objective is to improve its position in the pharmaceutical field
through product diversification and on the basis of its merger with Medco. Industrial Outlook
1993. All drug companies face this change, but Merck had been best at doing things the old way,
and so needs to make the biggest adjustment now. ReferencesAnnin, Peter and Anne
Underwood. The company is entering the biotechnology field but is admittedly new at it and will
have some difficulty catching up to companies already in the field. Merck's recent acquisition of
Medco is a case of vertical integration between the world's largest pharmaceuticals company and
the world's largest distributor of pharmaceuticals. The drug industry as a whole is seen as a
growth industry at this time, with a growing demand from elderly Americans for new chronic-
care medicines. This includes data on patient use and misuse, such as lapses in taking medication
that can help with the creation of new drugs. The strategy will give Merck an advantage over its
competition in that the competition does not have access to the same distribution data and instead
relies on outside companies for drug distribution to pharmacies, hospitals, and doctors. A second
prong of the strategy is to use the data gathered from Medco on drug use and distribution to plan
for the next generation of drugs. Inflation rate and so cannot use price hikes to make up the
difference. In addition, the acquisition price of $6 billion will put a strain on Merck in the near
future. Merck spreads its risk in some cases with joint ventures with some of the other major
firms in the industry. In the longer term, the working system will alter the way Merck makes
decisions, the budgeting for R&D, and the product mix offered by the company. This allows the
company to recoup its investment and make a profit, but at some point the "patent “on the drugs
expires so that other companies can distribute the drugs, often at a lower price. At the same time,
the acquisition of Medco reduced overall profits by 6 cents ashore. The board of directors must
also decide on the viability of the biotechnology program and determine its future direction, and
this requires an assessment of the program to date, an analysis of the field of biotechnology as it
has developed throughout the industry and the nature of the specific projects being undertaken by
Merck. In the past Merck succeeded with a product pipeline that was always full. Companies
with a leadership position generally have a strong R&Dprogram to develop new products on an
ongoing basis. They have also examined theopportunities available because of new technologies,
which can be threatsas other companies are also turning to new techniques. A feedback system is
also to bebuilt into the fit between Merck and Medco to assure that the informationflow
continues and that the information is used properly and to the benefitof Merck, leading to
decisions that will lead to actual products or to achange in how products are produced. Success
in the biotechnology field would also giveMerck an advantage, but this is subject to the vagaries
of research as wellas difficulties associated with the development of biotechnology ingeneral.
Drugs developed by a company are marketableexclusively by that company for a period of time.
The company has examined the externalenvironment and changes taking place there. The
external environment has a major impact on the operation of Merck. The drug market is expected
expand over the next several years, and today Merck is one of the healthiest pharmaceutical
companies. The pharmaceutical industry is highly competitive, and most companiesbase the bulk
of their business on a few major drugs which they havedeveloped and which they have exclusive
control over for a certain periodof time. Health-care cost containment is also threatening growth
andprofits for the company. Merck has been the undisputed leader of theprescription drug
industry. Any restructuring shouldaddress the problems noted for the excessive bureaucratic
structure whichreduces the value of R&D for the company, preventing new products frombeing
produced as rapidly and economically as in the past. "Why Merck married the enemy." Fortune
(September 2 , 1993), 6 -64.Ullman, Richard O. The company is developing a line of generic
drugs toappeal to health-maintenance organizations and third-party payers such asinsurance
companies and corporate benefit plans. In the short term, the merger may put a strain on the
company becauseof the debt involved, but Merck is in a good position to weather
this.Coordinating the merger is a major element in the strategic plan for theorganization, and
such coordination includes developing a strong programfor the transfer of the needed data from
Medco to Merck on an ongoing basisand for a system of evaluation of the data involved in a way
that servesthe needs of Merck and contributes to the development of new products. Consider the
successof competitor Abbott Laboratories, for instance, which has an annualresearch and
development budget of more than $15 million, which is alsomore than the total sales of many of
its competitors. For this reason, companies must work constantly toproduce new drugs and new
treatments, which is one reason the industry hasbeen structured in this fashion. Merck isalso
noted for a dedication to R&D, a key to much of its success.Weaknesses The weaknesses of the
company include its merger with Medco, seen bymany competitors as weakening Merck's
position.

Merck - Medco
Merck-Medco

1. Pharmacy Benefit Management

Pharmacy benefit managers (PBMs) are companies that administer drug benefit programs for
employers and health insurance carriers. PBMs contract with managed care organizations, self-
insured employers, insurance companies, unions, Medicaid and Medicare managed care plans,
the Federal Employees Health Benefits Program and other federal, state, and local government
entities to provide managed prescription drug benefits.

They designed the pharmacy benefit plan, processed prescription drug claims, reviewed
prescriptions, encouraged the use of lower cost, generic and branded drugs and dispensed drugs
through mail service pharmacies. Essentially, PBMs reduced the cost of health care by
improving efficiency of the usage of prescription drugs without compromising with the quality
of patient care.

Initially, PBMs focused on claims processing. Later, they looked at various other ways to control
costs. They negotiated big discounts with pharmacy networks and branded drugs manufacturers.
PBMs also analyzed the usage of drugs by patients and did not hesitate to contact doctors if they
felt that inappropriate drugs had been prescribed. When an enrollee presented a prescription, the
PBM’s information system determined whether there was a cheaper alternative. The pharmacist
was provided the alternatives on the screen. Physicians and pharmacists fell in line because the
PBMs represented big clients and gave them large volumes of business.

PBMs also saw an opportunity to cut costs through disease management. They educated patients
and physicians on measures to be taken to prevent diseases wherever possible. PBMs worked
with patients to make them accept good health practices. They stayed in touch with patients
through newsletters and information hotlines.

2. Relationship between Pharma & PBMs:

Pharmacy benefit managers (PBMs) are private companies that administer pharmacy benefits
and manage the purchasing, dispensing and...

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