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Merck’s Acquisition of Medco
By
Zankhana Desai
FIN 561- Mergers and Acquisition
Professor: Yvan Nezerwe
Keller Graduate School of Management
Table of Contents
C5.1.0 Executive Summary…………………………………………….3
C5.1.1 The Major Driving Force of the Merck-Medco Acquisition.. 3-4
C5.1.2 The Role of PBM Companies……………………………….. 4-5
C5.1.3 Utilization of Medco’s Database……………………………. 5-6
C5.1.4 Competitive Reactions to Merck- Medco Acquisition ……. 6
C5.1.5 SWOT Analysis……………………………………………..6-8
C5.1.6 Impact on Marketing and Sales………………………….. 8-9
C5.1.7 Impact on Operational……………………………………..9- 10
C5.1.8 Impact on Financial Consideration………………………...10 C5.1.9 Benefits of the Acquisitions……………………………… 11 C5.1.10 Recommendations……………………………………… 12 References…………………………………………………… 13
C5.1.0 Executive Summary The purpose of this paper is to present the reader with an overview of the changing Health Care industry and the benefits of a vertical merger to the consumer with the Merger of Merck, the worlds’ largest drug manufacturer, and Medco Containment Services Incorporated, the largest most efficient prescriptions benefits management company. The merger would reflect the dynamic changes that have taken place in providing effective healthcare to consumers based on need rather than on insurance coverage. In essence two major players in the same industry would combine their attributes to better serve their clients and raise return on investments to shareholders and higher profits for the company. The best solution to address the changing demands of the industry would be to acquire a PBM and allow it to co-exist with Merck as a subsidiary without going through a massive re-invention process of building a new PBM company from the ground up. This merger reflects fundamental changes taking place in the pharmaceutical and managed healthcare industry. Merck recognized a need to streamline the process between getting the drugs produced by Merck to patients and the needs of MCO’s allowing Merck to do its’ primary function of R & D and getting new drugs to market while remaining profitable. C5.1.1 What was the major force driving this acquisition? The major driving force of the Merck’s acquisition was the new proposal of healthcare reform during the time of the Clinton Administration. The manufacturer like Merck-Medco, Lilly-PCS were concerned about losing access to their industries to PBM. PBMs are companies that administer drug benefit programs for employers and health insurance carriers. Their contracts are directly to managed care organizations, self-insured employers, insurance companies, Medicare, and almost all Federal and State government health benefits plans. To make the benefit plan more affordable PBM lowered their claims processing fees and also offered rebate retention. PBM also processed prescription drug claims, reviewed prescriptions, offered generic and branded medicines through mail services as well. Hence, due to PBM’s efficiency of delivering and processing the drug cut overall cost of health care benefits, the manufacturer industry got a big hit in their business. So, in the early 1990S, a large growth of managed care changed the health care industry that also had a heavy impact on manufacturers. Thus, PBM provide full coverage for prescription drugs more frequently than traditional medical insurance plans. Industry experts’ estimated that by the turn of the century, over 90% of Americans will have drug costs included in the managed health care plan, and managed care programs will acquire about 60% of all outpatient pharmaceuticals. As managed care providers rely more on PBM’s the benefit of this merger demonstrates the efficiency of a vertical integrated system exemplified by Merck-Medco merger.
C5.1.2 What is the role of prescription benefits management (PBM) companies? The role of PBMs is to manage insurance claims and process, review and analyze prescriptions drugs, recommend certain drugs that are more affordable and yet effective to physicians and pharmacists. In short, PBMs encourage physicians to prescribe more cost-effective drugs, monitor the effectiveness of particular drugs and analyze prescribed patterns and patients usages of drugs. According to given data (1993), PBMs covered about 120 million lives, and were expected to include more than 200 million by the end of the decade. It had helped decrease in drug prices from 9.5% (1989) to 3.l% (1993). So, even though PBS initial role was on claim processing, gradually they design the pan to various way to control the overall cost , for example educating patients on disease prevention, designing database in such that pharmacists would see the alternate medicine on the screen for the patients. PBMs a contributed heavily in reducing overall health benefit costs by improving efficiency of the usage of prescription drugs without compromising the quality of health care.
C5.1.3 What role was envisaged for the use of Medco’s database? Medco's large database would allow Merck to (a) identify prescriptions which can be switched from a competitor's drug to a Merck drug and promote such a switch with managed care doctors thereby increasing the potential for sales; (b) identify and seek out patients who fail to refill prescriptions once again increasing sales; (c) utilize the database to determine which drugs are worth a premium and which are not, using patient records as a real life laboratory. The Merck-Medco database is a gold mine of accurate and timely information about customers, prescribing physicians and their patients. Medco’s large database allow Merck’s sales force to identify prescriptions that would be alternative to competitor's drug and could be promoted as an affordable and effective options of drugs, hence increase in sales potentials. Second, the database designed also help to identify and seek out patients who fail to refill prescriptions, thus, increase in sales. Third, database design would determine which drugs are worth a premium and which are not, using patient records as a real life laboratory. In other words, Medco database allows a new way of segmenting customers and targeting the right products. It allows Merck to design and execute highly information-intensive marketing strategies that simultaneously satisfy customers' needs and reduce Merck's marketing costs. (D. Hanssens, UCLA)
C5.1.4 What competitive reactions took place in response to Merck’s acquisition of Medco? Merck's acquisition of Medco was imitated by other large vertical mergers; such as SmithKline Beecham-Diversified and Eli Lilly-PCS. Merck's move proved to be a catalyst for an industry change that was deemed inevitable. Merck appears to have been able to successfully use the PBM segment. Following Merck’s footsteps, Elli Lilly’s executives made a move and acknowledge that company’s role in health care has changed, “becoming a broader organization, more capable of meeting the customers’ expectations and moving away from a product orientation to a service orientation is win-win situation.” The role of government in health care through PBM brought uncertainty in drugs manufactures industry, however the theory of survival through diversification brought the industry in a different light. C5.1.5 SWOT Analysis
Strengths:
Merck is an industry leader in the development of new drugs and bringing them to market. And Medco is a trusted name with the MCO’s and doctors. Merging two segment leaders in the pharmaceutical industry will give Merck a strong competitive advantage as it will control the entire process from manufacturing to delivering the product to patients. The streamlined developmental efforts by Merck in concert with the efficient administrative know how of Medco would eliminate redundancies and greatly cut promotional costs. The savings realized will result in lower prices for consumers which will allow for broader markets and accessibility to Merck products while increasing profits substantially. The gained Metadata from the extensive files that Medco has would also help reduce developmental costs and make it faster for Merck to bring new products to Market.
Weaknesses:
There is a perceived weakness on the issue of operational effectiveness of the two companies seeing as they are two dissimilar segments within the same industry. There is concern over the synchronization process as both companies have distinct operations cultures and aims. This could affect the fluidity of the merger and also offset any perceived profits if not addressed immediately and during the merging process. The resulting disharmony could affect Stock prices and hinder future expansion.
There is also the fear that the newly formed entity would close their formularies to competitors and restrict access to more effective drugs made by competitors.
Opportunities:
Obtaining Medco will open up many possibilities that were not previously available to Merck. Most notably, it will have a strong and permanent presence in the managed care market. This will give Merck a huge advantage in the future against competitors. The extensive database kept by Medco on their thirty-three million customers will allow Merck to analyze the prescription practices of doctors and other care providers. It would also help in the effectiveness of analyzing the manufacturer’s drugs, and consumer behavior such as refill frequency. This Metadata would become invaluable to Merck as a sales generating tool and also could use this information to show the ineffectiveness of drugs manufactured by the competitors. As such it could use this to justify the cost of premium drugs.
Threats:
The biggest threat to this acquisition would be the political firestorm that might be sparked in the name of protecting consumers along with the perception of the public of a megalomaniac takeover by a greedy corporation of a health services firm. The other challenge possibly faced may be the questions posed by current Medco clients to the level of unbiased services that they may get once Merck takes over. The notion that Merck may push its’ own products in liu of other more effective drugs may have a detrimental effect. Combined with these two major concerns there is a high probability that some Medco clients may leave. Lastly, there is always the possibility of competitors following in this trend which may ultimately cause a price war to ensue, driving profit levels down across the industry.
C5.1.6 Impact on Marketing and Sales The merger would allow Merck access to Healthcare files of the nearly 33 millions of Medco’s customers and the extensive information that is kept in them. Merck would have access to the types of medications being prescribed, the manufacturers of those medications and the dosage levels. This trove of information would allow Merck to identify competitor drugs that could be replaced with Merck products. This acquisition would also give access to other major MCO’s in the industry, which would help reduce overall marketing costs. So rather than soliciting individual doctors, Merck would be able to concentrate its’ efforts on addressing the needs of major MCO managers and PBM administrators. This would substantially reduce costs of hiring, training and retaining staff and reduce the redundancies of overhead. The tremendous amount of data would also allow for a development of algorithms that would forecast future needs in sub markets as based on patient information and seasonal needs. This would help in substantially increasing sales overall.
C5.1.7 Impact on Operational
Mergers among competitors are called horizontal mergers, whereas merger like Merck-Medco, mergers of firms serving different functions in a given market are called vertical mergers. The acquisitions of PBMs by pharmaceutical manufacturers is also a vertical mergers, since the merging companies previously served different functions in the prescription drug market. So due to the vertical nature of this acquisition Merck will continue to be run independently of Medco and at the same time utilizing each other strength would make operation more efficient and less costly. Merck would have the ability to manufacture drugs specific to each patients needs with collected information via Medco efficient database. Further, overlapping of operations would save about $1 billion in marketing and sales. However, there were some differences on whether Merck should fully takeover Medco operation and completely integrate the manufacturing and selling process or allow Medco to operate as a subsidiary company. A complete integration may raise skepticism by MCO participants; questing the integrity of Medco and as a result may destabilize the acquisition efforts. Therefore it is recommended that Medco remain as a separate subsidiary company but operating under Merck. This will allow Merck to continue focus on operations within the medical, clinical, and science areas, and Medco will continue work on maintaining the relationships with employers, plan sponsors, and managed care organizations and managing the database. As discussed earlier that information on patients collected by Medco database will be used to help Merck’s R & D team to develop new drugs that have greater demand to MCO. C5.1.8 Impact on Financial Consideration In this acquisition the purchase method of accounting will benefit the shareholders more than the pooling method. The advantage of this method is that they would be able to dispose of acquired assets at depreciated book value, sell them at their current book values, and record any profits on sale of assets. The CFO’s preliminary calculations indicate an immediate positive return on EPS. Though, there will be initial concern over the growth of future stock price as stockholders brace for any negative effects. At a purchase price of $6.6 Billion Merck would be paying an extensive premium to acquire Medco; had reported revenues of $2.2 billion in 1992, 22% increment since 1991 with the revenue of $1.81 billions. According to 1994 financial, Medco's revenue was increased an average of 47% annually and earnings was increased an average of 45%. Further, they saved about $1 billion through consolidation of operations, eliminating many operations and marketing expenses. By initiating change in drugs manufacturing industry, Medco demonstrated to the drug companies that it had the power to move market share.
C5.1.9 Benefits of the Acquisitions The merger of Pharma Giant Merck and PBM leader Medco has ushered in a new era of profits for Merck and its’ shareholders plus opened up a new business model in the managed healthcare industry. The advantages gained by Merck have been on multiple levels. Merck gained access to over 33 million Medco customers and the whole database. It capitalized the information by using the prescribing data and the refill-failure data t optimize sales and promotions at no extra cost. Secondly Merck utilized the data to switch customers to Merck products where applicable gaining a tremendous windfall. And using Medcos’ reputation with Health care providers and Insurance plan Administrators Merck gained access to decision makers gaining access to being on the formulation lists of other MCO’s. Furthermore Merck was able to show ineffectiveness of other drugs to doctors and showed how its’ products justified the premium prices and superiority of its products. Additional benefits were realized due to the $1Billion savings in redundant marketing and operational costs and reduction of a huge safes force by utilizing more accurately targeted marketing strategies aimed at Plan managers rather than hundreds of thousands of individual doctors. And finally the resulting efficiencies allowed Merck to spin off Medco in 2003 as its’ own stand -alone company, Medco Health Solutions, that serves over 65 million members and growing revenue from $2.2 billion in 1992 to $33 billion in 2002 while filling an approximate 548 million prescriptions. By all measures this was a successful merger and acquisition.
C5.1.10 Recommendations It is highly recommended that Merck acquire a Prescription Benefit Management company to remain profitable in the dynamic Health Care industry. The choice of Medco would best fit the needs for the future of Merck. As the premier manufacturers of drugs Merck cannot afford to lose market share or resources re-inventing a PBM to service MCO’s. It is advantageous for Merck to capitalize on the goodwill earned by Medco with Healthcare plan managers and Insurance companies and position itself to service the 33+Million members. It would greatly help Merck to utilize the massive database of Medco to mine for crucial data pertaining to patient prescription practices, drug recommendations and refill rates. The enormous metadata in Medco files would also yield access to other industry MCO’s and PBM managers and allow Merck to consolidate Marketing and promotional costs by directly targeting those decision makers. This would be the perfect time to consolidate costs and maintain applying resources to the manufacturing of new drugs and getting them to market in a streamlined manner, As more legislation is gearing to loser controls on Generic manufacturers it is imperative that Merck take immediate steps retain its position as the industry leader now and in the future.
References • A well.managed customer databas. (n.d.). Retrieved May 16, 2015. • (n.d.). Retrieved May 20, 2015, from http://www.nber.org/chapters/c8653.pdf • Medco Containment Services Inc. History. (n.d.). Retrieved May 23, 2015, from http://www.fundinguniverse.com/company-histories/medco-containment-services-inc-history/ • (2001, June 1). Retrieved May 24, 2015, from https://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/Reports/downloads/cms_2001_4.pdf • (n.d.). Retrieved May 25, 2015, from http://www.merck.com/finance/annualreport/ar2002/merck_financial_section.pdf • Weston, J. Fred, Mark L. Mitchell, and J. Harold Mulherin. Takeovers, Restructuring and Corporate Goverance, 4th Edition. Pearson Learning Solutions. VitalBook file. • http://devry.vitalsource.com/books/9781256086611/id/ch05bx1 