Conflict and Change
Harvard Case Study
Professor: Robert Lazer PhD
Team: Zerrin Hejazi, Mark Klabonski, Elizabeth Lamb,
Hari Thenneti Pandurangamoorthi, & Hareshkumar Surani

The History of Merck
U.S. sales office opened in and
George Merck,
Heinrich’s
grandson, was appointed head of the U.S. branch

Friedrich
Jacob Merck opened Merck in Germany

1668

1827

Heinrich E Merck transformed the business and
Merck began manufacturing 1887

Merck merged with
Philadelphia
pharmacy
Sharp & Dohme

1891

The renamed company Merck & Co. opens for business 1953

2009

Merck merged with ScheringPlough Corporation and
Organon BioSciences

Pharmaceutical Industry
• The average drug development time is over fifteen years with an average R&D expenditure of $800 million.
• The FDA requires three phases of testing to assess safety and effectiveness. o Test results dictate what is displayed on the drug’s label and how the doctor will prescribe it.
• Follow-up studies (Phase 5) can be performed to assess the drug after market release (Phase 4) and amend the drug label for improved sales.

Pharmaceutical Success
• 1981 to 2001, Merck experienced an upward trend on several industry metrics.
• Their Return on Sales (ROS) for their Human Pharma line peaked at just over 40% in
2001 with an average of 24% .
• The early 1990’s exhibited a downward trend just prior to
Gilmartin assuming the role of
CEO.

Pharmaceutical Success
• Cumulative Stock Return over the same period had a compound annual growth rate (CAGR) of 45%.
• Again, the early 1990’s exhibited a downward trend, the first in over a decade.

Measures of Success

Merck had the most patents awarded in both the 1980’s and
1990’s.

From 1994-2001, Merck’s patent volume exemplified their scientific edge.

Problem Statement
In 2002, Ray Gilmartin, Merck’s CEO, was under pressure regarding the company's declining stock performance and surfacing concerns about Merck’s ability to respond to competitors’ successful strategies of acquiring drugs and aggressive marketing.
Merck must find a way to increase profits and market share in a competitive and uncertain environment.

Structural Dimensions
Formalization
• As a large company with strict FDA enforced regulations, Merck was a company with many documented protocols, job descriptions, and policies. • Merck is highly formalized to prevent health and safety hazards.
Specialization
• Managing several large key departments, specialization is also high in
Merck.
o The R&D group functioned as the head of the organization dictating science would rule the company. o Manufacturing and Marketing were forced to do their work at the end of the process after being handed a final product.

Organizational Structure (June 1993)
P. Roy Vagelos
Chairman & CEO

SVP Human
Resources

SVP
Human
Health
United
States

J. Jackson
EVP Worldwide
Human Health

SVP
Human
Health
Europe

SVP/VP
Human
Health
Latin
America/
Asia/ Africa

Country
Managers

Corporate Planning
& Development

MMD

Finance

Legal/Public Affairs

E. Scolnick
President MRL

Region
Managers
Country
Managers

SVP
Human
Health
Japan

Worldwide
Human
Health
Marketing

Basic
Research

Pre-clinical
Research

Clinical
Dev

Regulatory

Finance

Legal

Human
Resources

Structural Dimensions
Hierarchy of Authority
• In 1985, Roy Vagelos was appointed Chairman and CEO of Merck. E
Scolnick was acting president of MRL and J. Jackson was the EVP of
Worldwide Human Health.
• Vagelos led with the assistance of the “Chairman’s Staff”. o Each person on the board was the sole contact between their department and Vagelos; a very narrow span of control.
Centralization
• All decisions went up to Vagelos and Scolnick. The science drove all company plans.
• Jackson’s team, the country and regional managers of marketing and sales, despite their responsibility for profit and loss, had no input on board decisions regarding budgeting and resource allocation.

Structural Dimensions
Mechanistic Vs. Organic
• Based on the centralized structure, specialized tasks, formalized rules, vertical communication, and strict hierarchy of authority it is clear that
Merck operates mechanistically. o However, the mechanistic design is unable to fully support the innovative strategies needed to succeed in the pharmaceutical
R&D world and requires a stable environment. Strategy, Organization Design, & Effectiveness
Strategic Intent
• The mission had always been to create the best medicines for people.

“We never try to forget that medicine is for the people. It is not for the profits.
The profits follow, and if we have remembered that, they have never failed to appear.”
- George W. Merck

Strategy, Organization Design, & Effectiveness
Strategic Intent
• MRL’s core strategy was always to develop breakthrough drugs in new therapeutic categories.
• Gilmartin’s team agreed that drug discovery and commercialization was the only competitive strategy after the environmental shift. o They would focus on investing in innovative R&D and sales and marketing through late-stage development.

Strategy, Organization Design, & Effectiveness
Competitive advantage & Core competence
• Merck’s competitive advantage through the 1980s was their reliability based on their core competence of high quality science. o Merck created their own very high internal standard of efficacy and safety. They earned the trust of the FDA, from which they attained 70% approval rates for new drug applications, 20% higher than the industry standard. • The success of MRL created an overconfidence bias that they would be best at making company wide decisions even when pertaining to the market sector and other areas beyond the R&D.

Strategy and Design
Porter’s competitive strategies
• Differentiation o Merck’s goal to create the best medicines led them to success through the 80s. They developed the highest-quality drugs, but did not invest in the extensive advertising. It was as if Merck expected the drugs to sell themselves based on their high quality.
• Low cost leadership o After the Hatch-Waxman act, Merck’s profits and market share were severely diminished when low-cost led generic brands were able to undercut Merck’s prices after eliminating the R&D cost.

Strategy and Design
Miles and Snow - Prospector, Defender, Analyzer, or Reactor
• At the point when the environment began to shift, Merck’s defender strategy let them down. Their high degree of centralization and clear focus on producing reliable, high-quality medicines allowed other companies to enter the market with more aggressive and innovative strategies. • As a company with stakes in both R&D and manufacturing, Merck required a balance between the prospector and defender strategies.
• Their inner dichotomy elicited an analyzer strategy which would be more adaptable to environmental change and emphasize innovation while balancing efficiency and maintaining tight cost control.

Effectiveness Analysis
When Vagelos stepped down, Gilmartin’s Management Committee evaluated their position with a resource and goals based approach.
• Goals based o Return on Sales o Cumulative Stock Return o Sales and Profits Comparisons o Patents Awarded o Net Sales o Years of Exclusivity
• Resource based o R&D Expenditures per Phase

Effectiveness Analysis
They heavily focused on the numerical data and created benchmarks from an exclusively commercial frame of reference.
They agreed that combining expert drug discovery and mass commercialization was the only competitive strategy after the environmental shift.
He directed them to focus on investing in innovative R&D and sales and marketing through late-stage development.

Structural Groupings
Structure Type (Functional, Divisional, Geographical, Matrix, and Hybrids)
• During Vagelos time the company had a combined functional, divisional, and geographical structure. o At the highest level the company had a functional structure. o Worldwide Human Health Marketing and Sales department had responsibilities were broken out into Country and Region based zones and were geographically controlled. o MRL had their own division structure with separate finance, legal, and human resource departments in addition to the core researcher, development, and regulatory functions.

Structural Groupings
Structure Type (Functional, Divisional, Geographical, Matrix, and Hybrids)
• Gilmartin attempted to flatten the company and expanded the seven person “Chairman’s Staff” into the ten person Management Committee with more line responsibility at each level and greater access to resources. Ray Gilmartin
Chairman, President & CEO

D Anstice
President US
Human Health
The Americas

H Lipmanowicz
President
Human Health
AP and LA

P Wold-Olsen
President
Human Health
Europe

E Scolnick
President MRL
EVP Science
& Technology

P Lofberg
President
Merck-Medco
Managed Care

J Lewent
SVP & CFO

Marketing and Sales

Management Committee

J Preston
President
Animal Health
Division

RG Douglas
President
Merck Vaccine
Division (MVD)

S Darien
SVP
Human
Resources

M McDonald
Legal / Public
Affairs

Structural Groupings
• Gilmartin replaced Jackson as the EVP of Worldwide Human Health with three other geographically zoned presidents. o These divisions were both functionally divided by therapy area into
Franchise Business Groups, regionally for the international markets, and functionally for finance, legal, and the clinical/medical division.
The remaining departments did not change.
David Anstice
President Human Health
US, Canada & Latin America

EVP
Primary &
Managed
Care Sales

VP
Osteoporosis
FBG

VP
Hypertension
& Heart Failure
FBG

SVP
Arthritis &
Analgesia
FBG

VP
Artherosclerosis
& Diabetes
FBG

VP
Respiratory
FBG

Region/
Country
Managers

Latin America

Human
Resources

Canada

Finance

Legal

Clinical
And
Medical

Structural Deficiency
Symptoms of failing Functional Grouping
• Slow response time
• Poor horizontal coordination
• Fewer companywide innovations
Symptoms of failing Divisional Grouping
• Reduction of the economies of scale
• Worsened cross company coordination

Information Sharing
Effective Coordination, Communication, and Integration
• Vertical information o Hierarchical referral
• Slow decision making under Vagelos o Rules and plans
• The detailed rules and specifications outlined in company manuals under Vagelos, limited creative planning within the marketing department. o Hundred page ‘strategic plans’ detailed little strategy for the marketing teams and enforced specific minutia like regional head counts.

Information Sharing
Effective Coordination, Communication, and Integration
• Vertical information o Rules and plans (cont’d)
• Gilmartin implemented the Product and Cycle Time Excellence
(PACE) process, a best practices protocol for communication introduced to bring effective communication between MRL and marketing. o It created a specific development plan and set of milestones for each new drug. o It instituted a senior-level Product Approval Committee.

Information Sharing
Effective Coordination, Communication, and Integration
• Horizontal information o Information systems
• Under Gilmartin Merck instituted a web-based marketing tool designed as element of PACE. This would work in conjunction with the marketing curriculum designed to increase professionalism and to better link MRL, marketing, and manufacturing.

Information Sharing
Effective Coordination, Communication, and Integration
• Horizontal information o World Business Strategy Teams (WBSTs)
• Introduced in 1995 to manage the therapeutic franchises on a global basis.
• Their main goal was to drive the development and implementation of each franchise’s strategy and integrate all aspects of the product life in one process discussion.
• Composed of 12-15 people from the US Marketing, Worldwide
Marketing, MRL’s Regulatory group, and MRL’s Clinical group.
• They would plan for both positive and negative study outcomes and ideally run the proper interference.

Information Sharing
Effective Coordination, Communication, and Integration
• Horizontal information o World Business Strategy Teams (WBSTs) (cont’d)
• While the WBSTs sped up communication in support of the needs of the company, the implementation was slow.
• The follow through of action plans could not be ensured because
WBST leaders had no actual authority.
• Team members were not the decision makers and would have to take things to a higher level.
• WBST membership was added on to traditional job roles and some viewed it as a sideline task. o Some team members displayed uneven commitments and were not held accountable.

Information Sharing
Effective Coordination, Communication, and Integration
• Horizontal information o World Business Strategy Teams (WBSTs) (cont’d)
• WBSTs seem to need their own structure and power to accomplish their multi-functional responsibilities.

Task Environment
Government sector
• In 1984, the Government approved regulations opening up the pharmaceutical industry to the free market with the Hatch-Waxman act.
• The FDA then began to allow “direct-to-consumer” advertising in the
1990s. This form of advertising was incredibly effective. It has been shown that, when a patient discusses a drug with a doctor, they will get prescribed that drug 60% of the time.
Industry sector
• With the institution of the Hatch-Waxman regulation, many smaller companies began to manufacture generic medicines, making profits off of the costly drug development of Merck and other competitors.

Task Environment
Tech sector
• New technologies allowed small R&D companies to make significant discoveries and sell to larger manufacturing firms. o This ate away at the need for companies to complete research, development, marketing, and manufacturing all in house.
• Product exclusivity periods declined sharply as a result since the wider range of competitors could more easily bring a similar drug to market.
Market sector
• Managed Care Organizations (MCOs) and physicians that restricted the drug numbers and types prescribed to patients.
• MCOs and potential consumers also put pressure on the pharmaceutical companies to differentiate their products with higher standards of testing and studies.

Task Environment
Socio-cultural sector
• The enhanced competition allowed MCOs and potential consumers to demand lower prices. • A simultaneous increase in interest in
‘lifestyle-enhancing’ drugs offered a new and possibly lucrative franchise group.

Changing Environment
Simple/Complex
• More and more external elements were affecting Merck’s business.
Regulations were changing, technology was advancing, and the market had increasing requirements. Previously prohibitive to small scale businesses, the market now allowed many new companies to enter
Merck’s domain and push them into a highly complex dimension.
Stable/Unstable
• The shifting task environment only seems to be increasing in frequency in the tech age across all industries. These continuing changes through the
90s make the domain unpredictable and unstable.

Changing Environment
The complex and unstable dimensions yield a high-uncertainty environment which would typically solicit an organic design, decentralized decision making, highly differentiated departments, many integrating roles and boundary spanners, and extensive forecasting combined with high-speed response.
Without any specific boundary spanners or an intelligence team,
Merck was not working proactively against the changing environment in a proactive way.

Manufacturing and Service Technologies
Core Technology
• The MRL - R&D departments of Merck represent the core technology. The entire company is set up to support the drugs that MRL create.
Interdependence
• The PACE process ineffectively brought together the three departments responsible for bringing the final product from concept to consumer in a sequential interdependency.
• The complex development and drug release process required reciprocal interdependence or close collaboration back and forth between MRL, marketing, and manufacturing.

Manufacturing and Service Technologies
Variety and Analyzability
• Despite enacting the PACE process, there is high variability and low analyzability of tasks within roles because every drug formulary outcome requires different procedure and most individual situations do not have a specified process.
• Merck’s R&D and marketing are non-routine technologies. A high amount of expertise and training begin to be required of both as Merck intensifies their marketing strategies along with their innovative research. o Non-routine technology also elicits low formalization, low centralization, heavy amounts of training and expertise, in addition to expansive horizontal communication.

Organization Size, Life Cycle, and Decline
Dilemmas of large size
• Economies of scale allow Merck to compete globally and invest in risky
R&D activities.
Formalization stage
• Merck is creating more procedures and control systems.
• Communication is stilted by the hierarchy and Merck’s size.
• Merck needs to open communication, invite innovation, and develop better collaboration between all departments.
The level of bureaucracy impeded Merck’s ability to function effectively within the changing environment.

Perception and Individual Decision Making
• Merck organization uses the Bounded rationality decision making process: o Define the problem o Identify the decision tree o Allocate weights to criteria o Develop the alternatives o Evaluate the alternatives o Select the best alternative
• Overconfidence bias was present because most employees in leadership positions were highly educated scientists.

Leadership Styles
Dr. Roy Vagelos leadership can be classified as a Transactional
Leadership style. This leadership style was not compatible with implementing changes quickly:
• Contingent Reward
• Active Management by Exception
• Passive Management by Exception
• Laissez-Faire

Bases of Power: Mostly legitimate power with rational persuasion

Leadership Styles
Ray Gilmartin displays Transformational Leadership style which means he inspires followers to transcend their self-interest for the good of the organization:
• Idealized influence
• Inspirational Motivation
• Intellectual Stimulation
• Individualized Consideration

Bases of Power: Referent power with inspirational tactics

Root Causes
1. Overly hierarchical functional organizational structure.
2. Deficient integration of contributions between MRL and marketing.
3. Defender strategy is incompatible with the uncertain environment.

Proposed Solutions
The main barrier to Merck’s success through the 1990’s and into the 2000’s was the divide between MRL and Human Health marketing and sales departments. They exhibited inabilities to communicate and incompatibilities in collaboration in an uncertain and changing environment.
Their organization had outgrown their organizational structure and to maintain their innovative development of new drugs and their market-share
Merck needed a company-wide change.
MRL would need to create marketable drugs and the marketing department would need to be more innovative in their approach. These are not exclusive ailments, but rather symptoms of a larger issue. If a large scale systems approach is taken, Merck may see an increase in sales, stock-return, patent approvals, customer retention and health, employee morale, further global expansion, and corporate longevity.

Solution 1: Improvement of Communication & WBSTs
While WBSTs do serve to bridge the gap between MRL, manufacturing, and marketing, they still face structural challenges that lead to uneven results.
The fact that their members do not always have the proper authority to address the issues is one of the biggest hurdles on the MRL side. Sometime
WBSTs would have to discuss issues with three or four layers of MRL management to get the resources needed to solve the problem.
Cross functional information systems provide opportunities for coordination and collaboration groups and help to achieve unity of effort. To eliminate the hierarchical struggle within the WBSTs, the team members need direct reporting relationships between franchise heads and the president of MRL, similar to the communication structure on the marketing side.

Solution 1 (cont’d)
Accountability is a second big issue within WBSTs since they were initially added on to current responsibilities and viewed as a sideline task. In 2002,
Ray Gilmartin enacted performance grids to start holding WBST members more accountable for their work on the team. A follow-up assessment of those performance grid should be made to ensure accountability. Full-time integrator positions, such as therapeutic franchise managers, should also be created for each WBST to ease communication and manage accountability follow-up. Merck also needs to expand the PACE concept and establish a framework for best practices across the global enterprise. This solution would incorporate adding boundary spanners and people in buffer positions which would help to streamline the needs of the WBSTs while integrating analytical tools and methods in the PACE process for better planning and forecasting.

Solution 2: Organizational Structure Switch
As Merck moves through their elaboration stage of the organizational life cycle, they continue to show symptoms of structural deficiency. With
WBSTs, Merck improved overall decision making, but they continued to fail at innovatively responding to the changing environment.
Merck needs to split their organizational structure into multiple divisions and follow a less bureaucratic structure in order to return to a small company philosophy, increase the level of interdepartmental coordination, and continue organic development. Introducing knowledge-based teams in each division would help to more quickly examine and resolve the emerging environmental market changes. Replacing the top managers when needed and following social control and self-discipline would reduce the need for additional formal controls.

Solution 2 (cont’d)
When the organization grows, the professional support group ratio also increases in proportion to organization size. Merck needs to cut the overhead costs by keeping administrative, clerical, and professional support staff low. Further reducing the bureaucracy by cutting layers of hierarchy,
Merck needs to streamline their corporate headquarters and give lower level workers greater freedom to make decisions.
Introducing formal training develops professionalism in staff which gives creativity to employees allowing them to solve problems more quickly. Merck would continue to evaluate the organization performance using market control mechanisms.

Solution 2 (cont’d)
Merck needs a team of people dedicated to overseeing each drug through the development process and a switch to the matrix structure with product managers. Solution 2 (cont’d)
S.M. Davis and P.R. Lawrence’s proposed conditions for the use of a Matrix
Structure:
1. Insufficient personnel for each product line to have an exclusive team
2. Environmental need for in-depth technical expertise and the frequent development of new products
3. A complex and uncertain environmental domain.
These three conditions indicate vertical and horizontal lines of authority require equal and balanced power. A matrix structure will facilitate discussion and teamwork and swift adaptation to unexpected problems.

Solution 3: Outsourcing, Alliances, Acquisitions, & Mergers
In an era which values generics almost as much as brand name medicines and where drug sales are directly related to advertising dollars, a sciencefirst mission can no longer keep up with the uncertain environment.
Remodeling their traditional and expensive R&D operations would prove fiscally beneficial for Merck.
Taking advantage of a virtually integrated and outsourced R&D program would significantly reduce expenditures. Merck should also outsource noncore functions such as IT and human resources in order to focus on producing and marketing finished products.
These changes would require changing the strategic vision of Merck and partnering with other companies to maintain growth.

Solution 3 (cont’d)
Simultaneously, Merck should cut down their manufacturing units by 25% and seek strategic alliances with major drug manufacturing organizations in low cost destinations to maximize short and long term revenues.
Merck should partner with these competitors, license each drug, and enter into critical multinational marketing segments to open up broader opportunities in the target industry. This type of alliance also increases the customer base. Acquiring other small companies, merging with other industry leaders, and forming an international conglomerate would allow
Merck to expand its product line and its reach into international markets.

Our Recommendations
After changing leadership, instituting the PACE process, and adding WBSTs, Gilmartin asked,

“What actions should we take at this point? Have we gone far enough? How far can we progress and still preserve Merck’s distinctive science-led culture?”

Our Recommendations (cont’d)
Above all Merck wanted to maintain their scientific reputation, but also wanted to see an improvement in their stock performance and show they were ready to adapt to future changes. Before the highly uncertain environment pushes
Merck out, they need to complete an offensive structure switch that will allow them to thrive under any condition.
We believe Merck should take a strong restructuring approach and use our second proposed solution. The key to the success of the proposed matrix structural change is working together along both functional and divisional lines.

Our Recommendations (cont’d)
The matrix structure switch requires
• Significant training for upper-level associates to implement these complex changes. o They specifically will need to work on developing skills to share power and facilitate communication across the dueling chains of command.
• For the plan to succeed, all staff will need to continue professional training to work on developing their problem solving creativity and flexibility to work in a nontraditional environment.

Our Recommendations (cont’d)
Once implemented, the structural change will have reduced the hierarchy, fully integrated the product development process across
MRL, manufacturing, and marketing, and redirected the company into an analyzer strategy better preparing Merck for the future.

...what would you do?

Thank you!
We look forward to your comments.