Case

FIN561: Mergers and Acquisitions
You decide: Merck Acquition of Medco
Vikash Sharma

In July 1993, Merck & Co., the largest pharmaceutical company in the world at that time, acquired Medco Containment Services for $6.6 billion. Medco was the largest prescription benefits management company. With the drug industry experiencing the effects of managed care, pharmaceutical companies had to adapt to new means of distribution. Merck realized that the decisions of what treatments and what drugs should be used in patients’ care were increasingly being influenced by the managed care environment rather than by physicians. In the world of managed care, it was no longer sufficient to market just to physicians. The successful pharmaceutical companies of the future would be companies that were able to adapt to the changed distribution system. This was a very strategic move my Merck and this vertical integration was a move that all its competitors were also targeting. In 1994 SmithKline acquired DPS for $2.2B and later that year Eli Lily acquired PCS for $4.1B.

In order to understand why Merck acquired Medco, which was a pharmacy benefits management (PBM) company, we need to look at the role of this so-called PBM’s. These PBM’s have several functions

* Process Pharmacy claims i.e. check for eligibility when an order is placed at the retail store, check for copayment etc * Set up Pharmacy benefit, which is to apply PBM codes to what drugs are covered under a particular employer plan. * Setup clinical plans i.e. evaluate new drugs and looks at market data to help employers choose coverage plans * Establish retail pharmacy network. They work with retailers to agree on discount on drugs. * Provide mail order where they ship prescription to patients

There are other functions they do but these are the primary ones.
So if you look at the functions that these PBM’s provided you would see that they work with employers so they can influence the plan and the drugs that are covered under the plan. They work with retailers on drug discounts, which means that they could influence top line of Merck. Below is a chart showing the major PBM and if you notice Medco had the highest market share so with this acquisition Merck would get a good hold on the healthcare consumers.

Let us now look at what could Merck do with all the information that Medco had in its database. The first use would be to look at the database and look at all the drug prescriptions and see which ones they can switch to their drugs. Next they could have employed pharmacists to suggest patients to switch to their drugs. At the time Merck announced acquisition, Medco’s database had drug information for 33 million patients. It could use the information to show how a client how a particular class of drugs is an effective, cost saving treatment for certain conditions. They could influence all the patients in the database. They could have also started contacting physicians for those patients and asked them to consider prescribing their drugs instead of the competitors. They could have also found out which patients have not had their refill and work with patients to get their refills. The database would have given them access to patients, their drug habits, and doctors prescribing for these patients and Merck would have used all this information to boost its sales. They could have also worked directly with employers and patients that as a drug company they could not have done.
Immediately after Merck’s acquisition of Medco, its competitors followed suite. SmithKline went ahead and bought DPS for $2.2B in May 1994 followed by Eli Lily bought PCS for $4.2B in November of 1994 and Roche holdings bought Syntex Corp for $5.4B. This showed that its competitors realized the strategic advantage that Merck would get with this acquisition and they did not want to be left behind.

I would also like to review this acquisition from FTC’s point of view. How did FTC review this acquisition since this triggered a number of vertical acquisitions by Merck’s competitors.. The Commission alleged that Merck’s acquisition of Medco, may substantially lessen competition in the manufacture and sale of pharmaceuticals, and in the provision of PBM services, leading to higher prices and reduced quality. They view PBMs serve as middlemen in the provision of prescription drugs to managed care plans. The settlement would require Medco to take steps to diminish the effects of any unwarranted preference that might be given to Merck’s drugs over those of Merck’s competitors in connection with the pharmacy benefit management services that it provides.
According to the FTC, when Merck acquired Medco in late 1993, it became the first pharmaceutical manufacturer to vertically integrate into the then relatively-new business of pharmacy benefit management. Since then, several other pharmaceutical companies have joined with PBMs. In 1995, the FTC challenged Eli Lilly and Company’s acquisition of PCS, another PBM, from the McKesson Corporation, alleging violation of the antitrust laws. At that time, the Commission pledged to monitor the industry carefully and cautioned that it might take future action if it concluded there were signs of anticompetitive conduct in the industry.
Their investigation into the PBM industry has revealed that Merck’s acquisition of Medco has reduced competition in the market for pharmaceutical products. They found that Medco has given favorable treatment to Merck drugs. As a result, in some cases, consumers have been denied access to the drugs of competing manufacturers. In addition, the merger has made it possible for Medco to share with Merck sensitive pricing information it gets from Merck’s competitors, which could foster collusion among drug manufacturers. The settlement that we have reached with the companies addresses these consequences of the acquisition to ensure lower prices, better quality and greater choice for consumers.