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The pharmaceutical industry is characterized by high uncertainty, big investments and complexity. It is a highly competitive industry where the companies have to think strategically in order to survive. This includes finding the balance of in-house/outsourcing, identify the right partners, and using the right amount of R&D investments.
Merck & Co Inc. is one of the biggest companies in the industry and has the longest history. They are however facing the same challenges as its ' competitors and needs to continuously make strategic important decisions. In this paper I aim to explore the pharmaceutical industry, describe appropriate theories, and give my own thoughts of Merck's business strategy with the main focus on R&D. As it is a highly complex industry I will not go in depth, but rather look into the topics relevant to the course "Global Innovation Management".
Merck & Co., Inc.
Merck is an American pharmaceutical company. The company has a long history, which originated in Germany in the 17th-century as an apothecary business. At some point it shifted from merely selling drugs to manufacturing them. In 1903 it moved its base to the United States and New Jersey where it has its main base today (Carson N., n.d.). Through its history it has been growing by mergers, such as in 1929 with Philadelphia-based Powers-Weightman-Rosengarten which enabled Merck to increase its sales from $6 to $13 million and became the largest US drug maker (FundingUniverse, 2002). This kind of strategic growth has proved to be the way to go in the pharmaceutical industry. As late as 2009 Merck completed a merger with Schering-Plough that made it more competitive. Their mission is "to provide innovative, distinctive products and services that save and improve lives, satisfy customer needs and to be recognized as a great place to work" (Merck & Co., Inc., 2012, P 1). They provide this through four main segments; the pharmaceutical, animal health, consumer care and alliances segments.
Merck has for long time been among the best pharmaceutical companies in the world. By 2010 they were ranked as 3rd measured by sales and nr 2nd by profit (Scriptntelligence, n.d.). Though, these numbers are changing rapidly from year to year depending the performance of a few products. Worldwide sales totaled $48.0 billion in 2011, an increase of 4% from 2010 (Merck & Co., Inc., 2012, P 1). The sales are mainly in the US market with 43%, the remaining 57 % are sold worldwide in 120 countries (Merck & Co., Inc., 2012, P 10). In the end of 2011 it was 86,000 employed in the company. However, a merger-restructuring program is planned to reduce the workforce by 17% in order to optimize the cost structure and make it more efficient. The program has so far eliminated over 6,000 positions. (Merck & Co., Inc., 2012, P 19-20).
The pharmaceutical segment is the largest one. It includes human health pharmaceutical and vaccine products. In total sales of 48,047 bn in 2011 in contributed with 41, 289 bn (Merck & Co., Inc., 2012, P 48-50). The company sells these products mainly to drug wholesalers and retailers, hospitals, physicians, government agencies and managed health care providers. At the moment Merck`s most important products are within bone, respiratory, immunology and dermatology (24.6% of 2010 Revenues) followed by products within Cardiovascular (10% of 2010 Revenues). The most important products are Singulair (asthma), Gardasil (vaccine), Januvia and Janumet (blood pressure), Cozaar and Hyzaar (high cholesterol), and Isaentress (HIV infection) (Turner M. 2009). The products has limited period of protection as the patent right only last for a certain time-period before the products become generic and other companies can "copy" the product. It has high dependence on a few products, and it is therefore crucial to have a big sales volume in the protected period of these products.
The pharmaceutical industry is characterized by high investments, though competition and many risk factors. The industry consists of companies that develop, make and sell drugs that have therapeutically effect. It is continually increasing and is expected to be worth more than $1 trillion in 2014 (Reportlinker 2011) (Appendix 1). The industry got even more complex after the "biotechnology"- revolution, which changes the way scientists discovered new drugs. Simply explained, the molecular biology made it possible to understand the underlying condition of a disease. Drug compounds could now be more systematically be design, instead of being found. This opened up several strategies fro drug discovery (Pisano G. 2006).
Developing a new medicine is a tough process with a low success-rate. Even those who reach the market there is only 2 out of 10 that covers the R&D spending (Appendix 2). The cost to research and develop each successful drug is estimated to be $800 million to $1 billion in average.
Creating a new medicine is also very time-consuming. It takes in average 10-15 years to develop a new medicine from the time it is discovered till it is available for treating patients (Innovation.org 2012). Of this reasons the companies need to have a long-term strategy by focusing on R&D to continuously create new products. Failure of creating blockbuster-products each year will hurt the companies financially.
There are few big companies that are dominating as they have the resources to make the investments in research needed to create new products. High budgets do not guarantee success but it gives the opportunity to invest in broader areas and increases the chance of creating blockbusters. It also gives them the alternative of buying other companies that obtain the necessarily knowledge. With the high R&D-costs, long developing time and strict regulations it is very high entry-barriers for new companies. There is therefore few main actors which has the experience, resources and capital needed to makes the necessarily investments. Most of the companies are located in America. In 2009 US companies dominated the global pharmaceutical market with 28%, followed by EU (15%) and Japan (12%) (Pharma (2010). American companies are benefitting from less strict governmental regulation than for example Europe. The Fortune 500 lists Pfizer as the biggest pharmaceutical company in 2012 followed by Johnson & Johnson, Merck, Abbott Laboratories and Eli Lilly. All of them are American-based companies (Madigan N. 2012). Operating in the same geographical region has the advantage of cluster effect. Even though they are competitors there are spillover effect of knowledge and information.
New products may be protected by patents that give the producing company a monopoly for the specific product for a certain period. This period varies from country to country. The exclusive market rights gives the companies chance to get return of the invested time, money and resources put into developing the products. However, the patents are only exclusive for a short time-period before it becomes generic and competing firm is able to enter the market. This will lower the price and the profit significantly. Big companies must therefore keep up the R&D to keep producing new products before all the other products become generic.
Pharmaceutical companies are facing strict governmental regulations. The products affects human lives and need to guarantee safeness before they get license. There are regulations by regional, country, state and local agencies around the world. Governmental regulations are concerning the drugs safety and effectiveness as well as the pricing of the products so that the companies cannot take advantage of consumers. The FDI in the US are having regulations for testing, approval, safety, effectiveness, manufacturing, and marketing (Merck & Co., Inc., 2012, P 10). These high restrictions are making it very time-consuming and expensive to develop and launch new products.
The pharmaceutical industry involves several risks that may have huge economical effects. The companies have to find the balance of investments and risks in order to stay in the business. KPMG (2012) has identified the most frequently risk disclosures in the global pharmaceutical industry by the 34 largest companies in the industry (Appendix 3). The analysis 12 most frequently risk factors was:
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All the 34 companies identified industry/generic competition as a risk, and 94% mentioned protection and expiration of IPR. This involves losing their exclusive protection in the market for a product, which typically leads to rapid loss of sales for that product. The IPR may be challenges by the government or there could occur a potential claim of infringements from other companies. Furthermore, the price and income may be reduced because of the entrance of lower-cost generic products. The patent rights have varying protection, and they have different strength between countries. New regulatory requirements (for example the government changing the IP-law) may also have big impacts for the products` strengths. Moreover, the long development process increases the chance of failure during the process. The product may be rejected by the FDI, other companies may release and protect a similar product, or the estimated costs may be underestimated.
A final point is the risk of being dependent on third parties. All the companies are collaborating with each other and other industries. This contains several risks, as it is hard to know how much effort they put into it, what resources they have, and what other factors that affects their performance.
Merck`s R&D strategy
In a dynamic and fast moving industry Merck have had to face many strategic decision. Even though new technologies are continually rising they cannot afford investing in all of them, but rather choose those who are most promising. The choice has also to be considered in relation to its competitors. Competing for the same patent and products will cause at least one loser. Furthermore, the extent of investment and commitment to external partners are a major strategic decision. Big investments are obviously increasing the possibility of creating blockbusters but may on the other hand lead to great loss if not successful.
The industry change fast and the company has to adapt to the environment, new technologies, competitor and so on. Merck has a history of being in the leading edge by creating big products to the market. In the beginning of the century Merck` president of the research laboratories, Dr. Edward Scolnick stated that they intend to stay as a leading company: "We are going to continue to focus on breakthrough products, for unmet or underserved medical needs, in big markets, in an orally once-a-day form" (Pisano G. 2006). Consequently, this involves big investments in R&D and higher risks than if they had chosen a more reluctant strategy towards niche products. The majority of the R&D activities were at that point done in-house, with some collaborations and mergers (at least compared to the industry).
In Merck`s report, Forward-looking statement, which is based on management current expectations, it is stated that the plan is to continue to focus on a few big blockbusters that can give market-leadership. The total R&D expenses decreased from $11.1 billion in 2010 to $8.5 billion in 2011, but with an increased focus on key programs. This will be done by going for "first-in-class"- and "best in class"-products (Kim P.S. 2011). FIC-products are having the advantage of being protected by patents and are therefore protected for a certain time period from competitors. Since it is new to the market it has great customer value. Developing novel products are however involving greater risks, a risk Merck is willing to take in order to be among the leading companies. BIC-product is giving the same customer value since there exist alternative products from competitors. It is though an important position, as customers tend to buy the best products for their own health. Without patent-protection it will face the risk of losing their position as BIC as competitors are free to develop the same product. An opposite strategy would be to create innovative branded generics, but this is not in relation to Merck`s strategy. This would have low risk as the product has been on the market and It`s performance and customer-reactions have been identified. It includes lower customer value and income because of itÂ´s standardized status.
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(Kim P.S. 2011)
Merck are conducting their strategy by first identifying medical needs and it`s market size. The identified key data's will give basis for decisions on where to spend the resources. The focus is not where they spend their resources today, but where the potential is for the future (Pisano G. 2006). Taking early "go-no" and "go" decision is also important to avoid spending too many resources on a product that are turning out to be less attractive than anticipated. Merck are currently focusing on 11 areas with high priority (Appendix 4).
In order to develop BIC-products they need access to the best resources, talents are important in this manner. The amount of highly skilled talents is rare in such a competitive industry. Merck`s strategy is to hire the very best, regardless of their area and support this by the need for flexibility in the long run. Merck has the advantage of having a long history of innovation. They try to attract talents by a stock option program which reward people who have contributed to developing a drug. Merck are having facilities spread out in the US in order to attract talents with more options. The sites are only consisting of 350 people with the aim to increase productivity (Pisano G. 2006).
Merck has later years shifted towards more external collaborations. This is becoming the typical business model for the industry because of the limitless amount of opportunities. As the CEO of AstraZeneca, Tom McKillop put it: "Ninety-nine percent of everything exciting that happens will happen outside your own research labs" (Pisano G. 2006). Merck has therefore responded to the environment and have increased the amount of external R&D spending. In 2000 one-third of their products came from external research or licensing collaborations, while the goal is to have 25% of their early pipeline from external partnerships within 2-4 years (Turner M. 2009). While the pharmaceutical companies used to do everything in-house, from research, developing and marketing, it is moving towards outsourcing the research and development task to smaller external firms. This is typically done through licensing, joint ventures or through mergers.
The Merck - Schering-Plough merger
The most remarkable action for Merck and the industry later years is the merger between Merck and Schering-Plough in 2009. Merck has a history for making it on its own, but this merger will give the company greater competitiveness with more financial flexibility to invest in strategic opportunities. The merger was an important strategic decision to keep up with the market leader Pfizer, which merged with Wyeth the same year. Merck`s CEO, Richard Clark stated that the merger made great strategic sense and that the "combined strengths" of the companies will "create sustainable growth and meaningful value for shareholders." (Goldman D. and Smith A, 2009). The merger gives Merck access to successful brand-name Schering products with much longer patents, access to global markets and developing research in biologics. It will in addition make the company more cost consolidating research, manufacturing, administration and marketing efficient (Singer N., 2009)
The main joint ventures are with AstraZeneca, Sanofi Pasteur MSD and Johnson & Johnson (Merck & Co., Inc., 2012, P 67). The joint venture with AstraZeneca was done back in 1982 and has been adjusted and renegotiated several times. The collaborations has the advantage for both parts as it lower the risk, increase flexibility and capacity and gives access to new areas they would not have reach on their own. The effects of collaboration are crucial in the pharmaceutical industry that is moving so fast. The alternative of doing everything on its own is often not efficient enough. It is therefore important to decide in each case if to collaborate or not, when, to whom, the way of the contract and so on. Merck has created an external basic research team (EBR) that works towards a balanced portfolio of partnership. They are especially focusing in developing and implementing strategies to expand the early pipelines through external partners. With daily contact and close contact they facilitate for successful collaborations (Turner M. 2009). The article, Building effective R&D capabilities abroad (1997), justify the need for more decentralized R&D by the fact that potential knowledge emerge across the globe. Merck has developed a broad range of collaborations worldwide, and made 918 agreements just in Asia between 2001-2008
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(Turner M., 2009).
In selecting new sites they should articulate the primary objective with each single partnership. The article identifies two possible missions for the R&D sites: home-based-augmenting site, which are used to gain knowledge from universities and competitors, and home-based-exploiting site, which are used to support manufacturing facilities in foreign countries. Merck are most likely using both systems. For their own R&D labs spread around the globe home-based exploiting site are most relevant. The new sites then needs to get adept to Merck's standards and information flow are mainly to the foreign labs from the central home-site. However, the home-based-augmenting site is most relevant towards the many external partners. In theses situations Merck want to obtain knowledge and information from the external sites. This knowledge is obtained from their current partners that consist of universities, biologic and pharmaceutical companies. This is typically within areas that Merck are lacking knowledge internally. The location is preferable in a central place for the industry with cluster effects. This will also keep them in touch with what competitors are doing. The partnerships are normally done using the partner's physical labs. While Merck retains late developed and commercial rights, the partner receives royalties and milestones (Turner M. 2009). Merck gains great advantages by access to a broader knowledge base, a more diverse pipeline, and rapid access to emerging science.
Whether to establish home-based-augmenting or home-base-exploiting sites there are three important factors that need to be in place. The choice of a good leader is very important as he needs to have good knowledge of Merck`s culture and strategies in order to transfer it to the new site. With a home-augmenting-base the leader should also be in touch with the local community so that he can make ties and relevant connections. Without knowing the size of each of Merck's R&D sites, the optimal size is in general 30-40 employees in the start-up phase, and 235 when established. A too small site does not have sufficient depth to utilize each other's knowledge and might find a hard time to gain access to the networks in the community. A too large site may lead to an anonymous culture and isolated researchers. A last point is the importance of supervising the site in the start-up period. A close connection and frequently communication is important with both systems. The degree of empowerment in relation to central control must be decided of each site (Kuemmerle W., 1997).
New organizational structure
With an increased economic pressure Merck has to maximize rate of return not only through product sales, but also by taking advantage of its technologies. They have to consider if they get most value of continuing developing the technology, license it, or sell it. This has to be considered in relation to the technology`s lifecycle, its relevance to the overall strategy and the changing environment. In the same way, they need consider if it is the most efficient to buy/license a technology, or create themselves (Ford D, and Ryan C. 2009). With an increasing amount of external partners they also needed to change their organizational structure. With a history and culture of solving things internally it may be a challenge to have an open mind towards external inputs. A "not-invented-here" approach is limiting the effect of external resources. Scolnick have stated that they didn`t used to have a structure for external R&D. For instance, internal project always got funded before external projects, while now the external project are being allocated their own budget (Pisano G. 2006).
More partnerships also require a change in the organizational structure. Even tough the EBS team is recruiting and facilitating the external collaboration, it contains a lot more complexity. Even though the goal is to create a win-win situation they are still separated organizations and trust issues may be present. As much as possible should therefore be made by explicit contracts. Changes in the environment and new collaborations may make the relationship more complex and lawsuits are not unusual. It will be a need for other skills and knowledge. Even though scientists the most required skill, there will be a more need for economists for calculating financial contracts, lawyers for IPR and negotiators to come to agreements with the partners.
An organizational structure with many partners brings several challenges. Even though it lowers many risks, other ones may occur. The partner may not deliver as promised, and can bring great financial consequences. It is hard to know how serious it is for the partner and how much resources he puts into it. They might get a more lucrative contract with a third party and put less effort in the collaboration with Merck, or they might get bankrupt during the process. In is in general an uncomfortable position to be reliant on outside parties even if explicit contract are lowering this risk. Another challenge is to facilitate for an effective collaboration. External partners have their own working structure and it is time-consuming to adapt. The way of communication is also an issue in this manner. Videoconferences, telephone-conversations, and mails are helpful tools. However, time-differences may be causing problems and tacit knowledge is not transferrable through virtual communication tools.
The internal culture is a huge potential problem. The employees are key resources with its high knowledge and skills. Even if this knowledge may be available through external partners there will always be a need for some knowledgeable people internally. It is an advantage to be able to control and understand the external contributions. The merger with Schering-Plough initiated a restructuring-program that would reduce the work force with 17% (Merck & Co., Inc., 2012, P 3). If such strategic alliances will continue to decrease the number of employees, it will likely lead to dissatisfaction by the remaining employees. It will also make Merck as a less attractive place to work for newly educated talents that they are dependent on.
Compare with competitors
The industry is as known characterized has highly competitive. This forces the companies to invest in R&D in order to stay in the business. Merck has as one of the highest R&D budgets both in relation to $ bn and % of sales (Appendix 5).
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(THE ECONOMIST INTELLIGENCE UNIT, 2012)
It is a balance of risks, and the decisions of prioritizing short-term or long-term profit. Investors are pushing for return of investment, while the managers are aware of the need for investing in R&D in order to create profitable products for the future. The R&D budgets have increased steadily for decades; most of the companies are now cutting their budgets. This is because of the challenges the industry is facing in general. The market leader Pfizer has for instance stated that they will cut their R&D budget by a third over two years, and CEO Ian Read defended it by: "At some point your shareholders and stakeholders demand you have a return on investment in research," (Randall T., 2011). Merck are in comparison keeping their R&D spending relative stable and are not planning any cut for the future. Their CEO, Kenneth Frazier defended the amount of money that the company devoted to research saying, "the most sustainable strategy is really around innovation". Both companies have important products that go generic within a short time period, but are responding to this differently. Merck bets higher risks for the future, but has on the other hand almost 20 candidates on phase III clinical trials because of the Schering-Plough-merger (THE ECONOMIST INTELLIGENCE UNIT, 2012). The company is thereby showing their loyalty to the strategy of continuing investing for the future.
Merck are also differencing from its competitors with its parallel internal and external programs (Pisano G., 2006). While most of the competitors are using the external partners to quickly get access to information and resources, Merck are acting more carefully. Parallel to the partners research are Merck having internal teams working on the same project. This is apparently a costly strategy and is reducing the advantage of easily accessed knowledge. The idea is however to reduce the risk and dependency of external sources. If something were preventing the external partner to deliver as promised, Merck would not be facing the same loss. It also gives the ability to control their performance and being more informed about the development of the project.
Furthermore, Merck are focusing on focused deals in their alliances, instead of having collaborations with a broad range of technologies (Pisano G., 2006). A bigger focus on few projects increases the success-rate, but may lose out on potential products
Merck are currently among the top companies in the industry, and have increased their competitiveness by the Schering-Plough-merger. The effects of the merger are yet to be identified, but have given the company a bigger product-line and more financial freedom. Such a big merger are differing from the company`s previously history of staying relatively on their own. I am however concerned about the potential internal effects that may occur. Dissatisfied employees may be a negative consequence. The employees have been an important reason for the companyÂ´s long-term success and should not be taken for granted. At the same time, they need to adapt to the changing environment where external collaboration becoming more important. Merck have not enough resources and knowledge needed to solve everything in-house as the market is becoming more diverse. The key is therefore to maintain the internal winning-culture at the same time continue to adapt to the changing environments.
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(IMAP Healthcare, 2011)
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(Kim P.S. 2011)
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(THE ECONOMIST INTELLIGENCE UNIT, 2012)