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Merck/Medco Case Analysis

CASE 5. 1: MERCK ACQUISITION OF MEDCO Abstract Corporate mergers and acquisitions (M&A) have become popular across the globe during the last two decades due to globalization, liberalization, technological developments, and competitive business environment (Fisher & Siburg, 2009). The synergistic gains from M&A may result from efficient management, economies of scale, profitable use of assets, exploitation of market power, and the use of complementary resources (Mitchell et al, 2004). Theoretically it is assumed that mergers improve the performance of the acquiring firm due to ncreased market share and synergy impact. This paper reviews the acquisition of Medco Medco Containment Services, Inc. (Medco) by Merck & Company (Merck) and cites reasons for acquisition of Medco. Merck’s acquisition of Medco represents a $6. 6 billion bet on where the future of the pharmaceutical industry lies (Nichols, 1994). In today’s managed-care environment, Vagelos (CEO of Merck in 1993) argues, the company that best controls the information flow from doctor to patient to pharmacist to plan sponsor has the greatest chance of succeeding. Medco has information on 8 million patients, which allows Merck to learn a lot more about how its drugs are prescribed and used and, ultimately, how effective they are in fighting disease. Owning Medco can also help Merck increase its market share in an industry in which no company has more than 5% (Nichols, 1994). Medco pharmacists make about 2 million phone calls a year to doctors, and when it’s appropriate medically, Merck can use these calls to ask physicians to choose Merck products. Merck stands to benefit from acquisition of Merck. Table of Contents Page Introduction 4 Company Profiles 4

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Relationship between Merck and Medco 6 Announcement of the Bid 7 Acceptance of the Offer 8 Motivations behind the Merger 8 Recommendation 10 Conclusion 11 Reference 12 Introduction This report reviews the merger between Merck ; Company (Merck), a pharmaceutical researcher and manufacturer and Medco Containment Services, Inc. (Medco), a prescription benefits management company (PBM). On November 18, 1993, Merck purchased Medco for $6. 6 billion. Immediately after the merger, Medco operated as a subsidiary of Merck (McGahan, 1993). In 1994, Merck-Medco was formed.

According to Grant (2002) corporate strategy involves decisions that define the scope of the firm. In addition, he states that the importance of vertical integration has caused companies to redesign their value chains within their organizational boundaries. 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 (Grant, 2002). Pharmaceutical companies operated in a relatively stable environment that was characterized by solid profits and minimal pressure.

While many of its competitors seem to be faring poorly, Merck seems to have managed the Medco integration superbly. The merger created Merck-Medco, a subsidiary of Merck (O’Reilly, 1993). Company Profiles Merck ; Co. , Inc. , is traded on the New York Stock Exchange (NYSE) with the ticker: MRK. The founders of Merck ; Company are Friedrich Jacob Merck and Emanuel Merck, who, who took over the store several generations later, in 1816. The company is known as Merck Sharp ; Dohme (MSD) outside the United States and Canada and it is one of the largest pharmaceutical companies in the world.

Merck ; Company is headquartered in Whitehouse Station, New Jersey. It was established in the United States as a subsidiary of Merck KGaA (German company) in 1891. It became an independent company in 1917. Currently, it is one of the seven largest pharmaceutical companies in the world in terms of market capitalization and revenue. Merck discovers, develops, manufactures and markets a broad range of innovative products to improve human and animal health, directly and indirectly through its joint ventures (Datamonitor, 2004). The products of Merck ; Company include Antivenin (for the treatment of black idow spider bites), Cosopt (reduces intraocular pressure in people with glaucoma or ocular hypertension), Cozaar/Hyzaar (used to treat hypertension, to reduce the risk of strokes and to treat diabetic nephropathy), Crixivan (a protease inhibitor HIV medication), Fosamax (osteoporosis medication), Singulair (an asthma medication that blocks leukotrienes), Recombivax HB (a vaccine that protects against hepatitis B), Zocor (a cholesterol-lowering statin), and Zostavax (a vaccine for prevention of shingles in adults older than 60 years of age)(Datamonitor, 2004). The Medco Containment Services Inc. s the largest prescription benefit management company (PBM) and marketer of mail-order medicines in the United States. Medco is listed on the New York Stock Exchange (NYSE) under the ticker MHS and it is member of the Standard ; Poor 500. It is ranked number 14 on the 2004 Fortune 500 list. The company controls more than 50 percent of one of the fastest growing segments of the health-care industry. Through its mail service pharmacies the company delivers prescription drugs nationwide at lower costs than retail. Through its wholly owned Paid Prescriptions Inc. , laims are processed through 55,000 pharmacies in its network of preferred providers (Datamonitor, 2004). The company was established by Martin Wygod in 1983. Wygod formed Medco as a holding company so he could buy National Pharmacies for $30 million in cash and Porex stocks. National Pharmacies, owned by APL Corporation, was a vitamin distributor and a small mail-order prescription drug business. It had yearly revenues of about $25 million and profits of about $400,000. Wygod eliminated the vitamin business and built up the mail-order drug business. Although Medco was not the first mail-order prescription company, it was the irst company that aggressively sold its services to large corporations, labor unions, and health plans. Through the computer network system Medco was able to gather information on consumer prescription drug spending and sell that information to the nation’s largest health plan sponsors. This system forms the core competency of Medco (Datamonitor, 2004). Medco specialized in maintenance drugs for high blood pressure, arthritis, diabetes, and other chronic diseases. Patients still shopped at local pharmacies for antibiotics and other prescriptions needed for acute illnesses, but chronic ailments which called for regular drug herapy were increasingly being serviced by Medco and smaller mail-order companies. Medco claimed to save at least 20 percent on most prescriptions because it encouraged the use of generic drugs and it could negotiate healthy discounts from manufacturers (Medco Containment Services, Inc. , 2011). Relationship between Merck and Medco The two companies are both health care firms. Merck & Co. manufactures develops and manufactures drug related products. Medco as a health care retailer designs and manages prescription drug benefit plans to control plan sponsors costs (George, 2002).

As part of its PBM services, Medco maintains drug formularies, which are listings, by therapeutic category, of ambulatory drug products that are approved for use by the U. S. Food & Drug Administration, and which are used by pharmacies, physicians, third-party payors, and other persons, to guide in the prescribing and dispensing of pharmaceuticals. Merck pharmaceutical products are included on Medco’s formularies (Clark, 1999). Medco also provides other PBM services, including claims processing, drug utilization review, pharmacy network administration, mail service, and related services. Medco negotiates with harmaceutical manufacturers, including Merck, concerning placement of drugs on Medco’s formularies, rebates, discounts, prices to be paid for pharmaceutical products purchased pursuant to pharmacy benefit plans managed by Medco, and similar matters. Medco thereby influences the prices of pharmaceutical products and the availability of such products under the Medco pharmacy benefit plans (News Release, 2002). Announcement of the Bid Merck, the largest pharmaceutical company in the world, said on July 28 that it had agreed to acquire Medco, the largest mail-order pharmaceutical company in the United States, for $6. billion. There was a competitive reaction following the announcement and subsequent acquisition of Medco. This acquisition was quickly followed by SmithKline Beecham’s $2. 3 billion purchase of Diversified Pharmaceutical Services (McGahan, 1993). Then PCS Health Systems was purchased by Eli Lilly ; Co. for $4 billion. Caremark, a division of J. C. Penney with roughly 15 percent of the PBM market, instituted alliances with Pfizer, Bristol-Myers, Rhone-Poulenc, and Lilly in 1994. This announcement did not receive much media coverage and stock did not exceed the level it reached on July 13 (McGahan, 993). |Merck                                                                                                                         | |Whitehouse Station, New Jersey                                               |    |    |    |                          |    |    | |                                                                              |    |    |    |                          |    |    | |SALES (last 4 quarters) |    |    |    |$10. 0 billion             |    |    | |Change from year earlier                                                     |    |    |    |Up 11. %                   |    |    | |                                                                              |    |    |    |                          |    |    | |Net Profit                                                                   |    |    |    |2. 0 billion               |    |    | |                                                                              |    |    |    |Down 11. 0%                 |    |    | |Return on Equity                                                             |    |    |    |31. 0%                     |    |    | |                                                                              |    |    |    |                          |    |    | |Total Return to investors                                                     |    |    |    |13%                       |    |    | |(1/29/88 – 7/30/93)                                                           |    |    |    |Annual rate               |    |    | |                                                                              |    |    |    |                          |    |    | |Price / Earnings Multiple                                                     |    |    |    |23.                       |    |    | |                                                                              |    |    |    |                          |    |    | |Dividen Yield                                                                 |    |    |    |3. 40%                     |    |    | |                                                                              |    |    |    |                          |    |    | |Source: Company Report, Worldscope, 1993                                     |    |    |    |                          |    |    | Figure: Condensed income statement for Merck Acceptance of the Offer The acceptance of the merger offer by Medco from Merck created a subsidiary named Merck-Medco and later Medco Health Solutions (MHS). Medco Health provides harmacy benefit services in the United States. Through its home delivery pharmacies and national network of retail pharmacies, Medco Health provides sophisticated programs and services for its clients and the members of their pharmacy benefit plans, as well as for the physicians and pharmacies the members use. Medco Health’s programs and services help its clients control the cost and enhance the quality of the prescription drug benefits they offer to their members. Medco Health’s clients include Blue Cross/Blue Shield plans; managed care organizations; insurance carriers; third-party benefit plan administrators; employers; federal, state and local overnment agencies; and union-sponsored benefit plans (McGahan, 1993). Motivations behind the Merger Merck has long thrived by being a technological leader and premier marketer of high- priced medicines. Merck had become a victim of its own success. Like a handful of other top drug makers, its strategy had been to develop so-called annuity drugs   –   medicines for common chronic diseases, such as high blood pressure, that patients have to take every day for years (Black, 1993). With pressure mounting on governments and private medical plan sponsors to rein in spending, the outsize yearly bill for Merck’s annuity drugs quickly made them the focus of the most aggressive cost cutting in the U. S. and abroad.

Result: Merck’s income growth, after climbing 24% to 34% a year in the late 1980s, was widely expected to slow to a relatively modest 10% this year and then slide into single digits (McGahan, 1993). Medco, by contrast, has been growing at 35% a year by riding the very waves that threatened to capsize Merck. From offices in Montvale, New Jersey, across the state from Merck’s headquarters in Whitehouse Station, Medco contracts with big medical plan sponsors – companies, unions, and HMOs – to lower the cost of the prescription drugs used by their patients. Its 1,450 customers, among them GM, General Electric, and the California Public Employees Retirement System, insure 33 million patients – 26% of all Americans covered by drug benefit plans (Black, 1993). In spring of 1992, Merck executives started negotiating with Medco to get their roducts into preferred positions on Medco’s lists of recommended drugs. According to Martin Wygod, 53, Medco’s chairman and founder, the two companies promptly impressed each other. From their first meeting the two executives, Wygod and Vagelos, continued to meet to go further in business. With Medco, Vagelos reasons, Merck will know precisely which doctors have patients in particular need of its drugs, and can focus its marketing efforts in their direction. The big advantage of Merck combining with Medco is to be able to use Medco’s patient record system as a real-life laboratory. The goal: to prove that some of Merck’s drugs really are worth their premium price. By tracking who is taking what pill, arrying that information with a patient’s medical records, and studying the long-term health effects, Merck might establish, for example, that Mevacor not only reduces cholesterol levels but actually postpones or prevents the onset of coronary artery disease. This would give Merck a very powerful weapon for arguing that its products should be used in place of cheaper drugs whose usefulness is less well documented (O’Reilly, 1993). Merck has at least two alternatives to select from regarding its business restructuring. First, Merck could acquire a firm such as Medoc with competency in pharmacy management to add to Merck’s value chain. This organizational restructure is attractive due to short- ircuiting the process of developing new, but time-consuming processes (McGahan, 1993). Prior to the 1990s 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 target firm’s capabilities with that of the acquirer. Second, Merck could restructure its business by creating new capabilities through a spin-off.

This would be appropriate when the mainstream organization of Merck’s value is incapable of managing and devoting resources on a new process or innovation (Nichols, 1994). Recommendation The acquisition of Medco and its competency is highly recommended giving the time and vision of the management of Merck in the health care industry. According to Merck’s 1993 annual report, 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. The quickest and most effective manner in which to achieve this vision is through a PBM acquisition (Clark, 1999).

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 (Nichols, 1994). Also Merck should pay attention to the culture mix to make the merger a success (Chief Operating Officer at Merck). Merck is a product-oriented company with 36% operating profit and Medco is a service business that generates 8% operating profits. The acquisition of Medco is ecommended because the management of Merck believes that Medco will provide direct access to patients and payers, which will become the most important consumers in the future (Black, 1993). Medco’s role as distributor provides the broad basket of products required to sell coordinated pharmaceutical care effectively to those customers. Moreover, Merck improves its positioning in Medco’s book of business, and acquires powerful drug-use data at the physician and patient levels. Merck’s objective five to ten years out is to control the relationships, data, and products required to provide cost-effective coordinated pharmaceutical care (Black, 1993).

The acquisition of Medco will save $1 billion in annual savings in reluctant marketing operations and also reduce Merck’s sales force as a result of more precise marketing strategies from Medco’s database. Information on patients and the pharmaceutical industry as a valuable asset will be available to Merck through the merger. This what Merck need to increase earnings since the industry is experiencing decreasing price on products (Mitchell et al, 2004). Conclusion Merck’s strengths were in the medical, clinical, and sciences areas while Medco had strong relationships with employers, plan sponsor, and managed care organizations. Merck and Medco have critical and complementary skills to build their strategy looking forward.

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. Medco Health Solutions is considered one the top pharmacy benefit management companies in the US. It currently serves about 65 million members. The acquisition of Medco would be beneficial for both firms. According the Medco Health Solutions Web site, Merck and Medco Health have enjoyed10 years of growth and success. As a subsidiary of Merck, Medco Health grew to become the nation’s leading pharmacy benefits management (PBM) ompany, 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 548million prescriptions (McGahan, 1993). According to Vagelos (CEO of Merck in 1993), the company that best controls the information flow from doctor to patient to pharmacist to plan sponsor has the greatest chance of succeeding. Medco has information on 38 million patients, which allows Merck to learn a lot more about how its drugs are prescribed and used and, ultimately, how effective they are in fighting disease. Owning Medco can also help Merck increase its market share in an ndustry in which no company has more than 5% (Nichols, 1994). Medco pharmacists make about 2 million phone calls a year to doctors, and when it’s appropriate medically, Merck can use these calls to ask physicians to choose Merck products. Merck stands to benefit from acquisition of Merck. This supports the recommendation that Merck should acquirer Medco for it survival in the future. Reference Black, Book (1993). Health-Care Cost Containment: A Bitter Pill for The Pharmaceutical Industry (November 1993); 1993, p63-63 Clark, Donald S. (1999). MERCK ; CO. , INC. , a corporation, and MERCK-MEDCO MANAGED CARE, L. L. C. , a limited liability company. Retrieved March 16, 2011, from http://www. ftc. ov/os/1999/02/9510097merckcmp. htm Datamonitor (2004) Merck ; Co. Inc, Company Profile, Ref 1088. Fisher, Howard W. ; Siburg, Daniel R. (2009). How Acquisitions Succeed. Retrieved March 18, 2011, from http://www. thefishercompany. com/articles/HowAcquisitionsSucceed–TheFisherCompany. html George, John (2002). Merck to spin-off Merck-Medco. Retrieved on March 17, 2011 from http://www. bizjournals. com/philadelphia/stories/2002/01/28/daily15. html Grant, R. M. (2002). Contemporary Strategy Analysis: Concepts, Techniques, Applicatio, 4th Edition. Malden, MA: Blackwell Publishers Ltd. McGahan, Anita M. (1993). Industry Structure and Competitive Advantage.

Harvard Business Review, Nov/Dec94, Vol. 72 Issue 6, p115-124 Medco Containment Services Inc. http://www. fundinguniverse. com/company-histories/Medco-Containment-Services-Inc-Company-History. html Mitchell, Mark L et al (2004). Takeovers, Restructuring, and Corporate Governance, 4th Ed. Prentice Hall, Upper Saddle River, NJ News Releases (2002). Merck ; Co. , Inc. Plans to Establish Merck-Medco as a Separate, Publicly Traded Company. Retrieved March 17, 2011, from http://medco. mediaroom. com/index. php? s=43;item=195 Nichols, Nancy A. (1994). Harvard Business Review, Nov/Dec94, Vol. 72 Issue 6, p104-114 O’Reilly, Brian (1993). Fortune, 9/20/93, Vol. 128 Issue 6,

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