Scenario Summary
This is based on Merck’s Acquisition of Medco: Case 5.1, pp. 124-125.
Your Role/Assignment
You are the Chairman and CEO of Merck. Make a recommendation to the Board of Directors of Merck &
Co. regarding this acquisition based on the recommendations of the three associates and your own
analysis.
You are the Chairman and Chief Executive Officer of Merck & Company, and you will make the final “yes”
or “no” recommendation to the Board of Directors of the company. You are listening to the advice of
various department heads regarding this acquisition. Based on your evaluations and additional analysis of
the recommendations of your three associates, make your recommendation to the Board of Directors.
What will you recommend? Yes? No? Yes with some conditions? What are the reasons for your
recommendation?
Activity
Write an 8-10 page paper (double-spaced) of written analysis, including tables of financial calculations.
Key Players
Key Title/Role/Character Script – Text & Audio
Players -
Image
Chief Operating Officer I’m concerned about synergy and integration issues between our highly
research-oriented development of pharmaceuticals here at Merck, and a
prescription medicine marketing company like Medco. I am concerned that the
cultures and operations of the two companies aren’t going to mix well, and that
this deal would result in an expensive failure.
Executive Vice I’m all for this acquisition! It will open new marketing leverage opportunities in
President, Sales & the Managed Care market. Medco’s marketing database will create market
Marketing expansion opportunities. This is the perfect answer for the current competitive
environment, where other pharmaceutical manufacturers are acquiring drug
marketing companies.
You Decide Page 2
Chief This is my concern; I want to make sure that Merck pays a premium for Medco at $6.6
Financial billion dollars. The combination of the two companies will immediately result in increase in
Officer Earnings Per Share for the combination vs. Merck as a stand- alone company. Although,
I’m still concerned about continuing the growth of the stock price of Merck after the target
company is acquired.
Here is the textbook info for this scenario:
Case 5.1 MERCK ACQUISITION OF MEDCO
On July 28, 1993, Merck & Company, then the world’s largest drug manufacturer,
announced that it planned to acquire, for $6.6 billion, Medco Containment Services
Incorporated, the largest prescription benefits management company (PBM) and
marketer of mail-order medicines in the United States. This merger reflected
fundamental changes taking place in the pharmaceutical industry.
GROWTH IN MANAGED CARE
Perhaps the most significant change involves the growth of managed care in the
health care industry. Managed care plans typically provide members with medical
insurance and basic health care services, using volume and long-term contracts to
negotiate discounts from health care providers. In addition, managed care programs
provide full coverage for prescription drugs more frequently than do traditional
medical insurance plans. Industry experts estimate that by the turn of the century,
90% of Americans will have drug costs included in some kind of managed health
care plan, and 60% of all outpatient pharmaceuticals will be purchased by managed
care programs.
The responsibility for managing the provision of prescription drugs is often
contracted out by the managed care organizations to PBMs. The activities of PBMs
typically include managing insurance claims, negotiating volume discounts with
drug manufacturers, and encouraging the use of less expensive generic substitutes.
The management of prescription benefits is enhanced through the use of
formularies and drug utilization reviews. Formularies are lists of drugs compiled by
committees of pharmacists and physicians on behalf of a managed care
organization. Member physicians of the managed care organization are then
strongly encouraged to prescribe from this list whenever possible. Drug utilization
reviews consist of analyzing physician prescribing patterns and patient usage. They
can identify when a patient may be getting the wrong amount or kind of medicine
and when a member physician is not prescribing from a formulary. Essentially, this
amounts to an additional opportunity for managed care or PBM administrators to
monitor costs and consolidate decision-making authority.
The key aspect of the shift to managed care is that the responsibility for payment is
linked more tightly to decision making about the provision of health care services
than it is in traditional indemnity insurance plans. The implications for drug
manufacturers are far reaching. With prescription decision-making authority
shifting away from doctors to managed care and PBM administrators, drug
manufacturers’ marketing strategies similarly will shift their focus from several
hundred thousand doctors to a few thousand formulary and plan managers. This, in
turn, will result in a dramatic reduction in the sales forces of pharmaceutical
manufacturers.
Several other significant changes in industry structure are expected to occur. Many
industry experts predict that managed care providers will rely on a single drug
company to deliver all of its pharmaceutical products and services rather than
negotiating with several drug companies. This will favor those firms with
manufacturing, distribution, and prescription management capabilities. In addition,
many experts believe that only a handful of pharmaceutical companies will exist on
the international scene in a few years. They point to intense competition, lower
profits, and a decrease in the number of new drugs in the “research pipeline” as
contributing factors.
BENEFITS OF THE ACQUISITION
Merck & Company and Medco Containment Services Incorporated believe that a
merger between the two firms will create a competitive advantage that will allow
for their survival. Merck executives identify Medco’s extensive database as the key
factor motivating the merger. Medco maintains a computer profile of each of its 33
million customers, amounting to 26% of all people covered by a pharmaceutical
benefit plan. Medco clients include 100 Fortune 500 companies, federal and state
benefit plans, and 58 Blue Cross/Blue Shield groups and insurance companies.
Numerous opportunities exist for Merck to utilize the information contained in
Medco’s database. First, the database will allow Merck to identify prescriptions
that could be switched from a competitor’s drug to a Merck drug. Merck
pharmacists will then suggest the switch to a patient’s doctor. This prospect of
increasing sales is enormous. Second, the database will allow Merck to identify
patients who fail to refill prescriptions. The failure to refill needed prescriptions
amounts to hundreds of millions of dollars in lost sales each year. Finally, Merck
will be able to use Medco’s computerized patient record system as a real-life
laboratory with the goal of proving that some Merck drugs are worth the premium
price charged. This will take place by identifying who takes what pill and
combining that information with the patient’s medical records. This might allow
Merck to establish the supremacy of its products.
Additional benefits of the merger include $1 billion annual savings in redundant
marketing operations and a reduction in Merck’s sales force as a result of more
precise marketing strategies brought about by Medco’s database and the industry
emphasis on marketing to plan managers instead of doctors. Merck & Company’s
acquisition of Medco Containment Services Incorporated is essentially an attempt
to increase market share in an industry with decreasing prices by capitalizing on the
most valuable asset in the pharmaceutical industry—information. It also is intended
to increase its competitive position in the growing managed care arena by aligning
itself with a PBM.
Merck & Company’s strategy was quickly emulated when British drug maker
SmithKline Beecham announced plans to acquire Diversified Pharmaceutical
Services Incorporated, one of the four largest drug wholesalers in the United States,
from United Healthcare for $2.3 billion, and Roche Holdings Limited reported that
it planned to acquire Syntex Corporation. Also, in the summer of 1994, Eli Lilly
and Company announced its intention to acquire PCS Health Systems from
McKesson Corporation for $4 billion. These mergers were not only a reaction to the
changing industry structure but caused the change to accelerate.
QUESTIONS
C5.1.1
What was the major force driving this acquisition?
C5.1.2
What is the role of prescription benefits management (PBM) companies?
C5.1.3
What role was envisaged for the use of Medco’s database?
C5.1.4
What competitive reactions took place in response to Merck’s acquisition of
Medco?