MERCK AND COMPANY

CASE ANALYSIS
INTRODUCTION
The global pharmaceutical market is estimated to have grown by around 10% in 2000. The
economic upswing in the chemical industry also continued in the year under review. Chemical products
account for about 10% of the goods traded on the world market. As the second largest export nation in
the world, Germany is on a par with the USA for chemical exports, while it is by far the export leader for
pharmaceutical products. With about two-thirds of all sales in the German chemical industry being
generated abroad half of these in Europe it profited from the continuing good global economy and
achieved double-digit sales growth. The European pharmaceutical market continues to be characterized
by government interventions, which took effect in the form of price regulations and allowance of parallel
imports from low-price countries. The good development of business abroad over the past years
continued.
Numerous new biotech companies trade their technologies in either finished or early stage to
larger companies in need of financing to have a business, while those bigger companies acquire
technologies to lead to a more profitable business. This process requires numerous decisions and
agreements from both parties on the valuation methods as it is vital here.
As an outstanding pharmaceutical company in the world concentrated on R&Ds, Merck is
performing various researches and developments upon medical supplies for human and animals. Merck
and Co., Inc. is a global research-driven pharmaceutical company that discovers, develops, manufactures
and markets a broad range of human and health products, directly and through its joint ventures, and
provides pharmaceutical benefit management services (PBM) through Merck-Medco Managed Care.
Apparently it is a giant pharmaceutical company with more than 15 blockbuster medical supplies, revenue
of $3270 million and net profit of $590 million, ever since 1995. One constraint of Merck is that most of its
profit is over-concentrated on the major top 4 items, and in order to diversification of profits Merck is
facing a pressure to launch a new business item or take another complementary strategy through biotech
and internal R&D.
LAB Pharmaceuticals has already finished developing Davanrik, a new drug with the potential to
treat both depression and obesity. Though it has substantial medical and economical feasibility for being
effective, LAB cannot afford the capital to proceed clinical demonstrations ahead the actual sale to
acquire licensing. This is the reason why LAB offered Merck of technical affiliation.

MORALES, Faye Diane; ALVARAN, Arianne Kaye; AUSTRIA, Roda Jane; GATORIAN, Dorothy
In order to make accurate projection of profitability by the managers to the company, quantified
decision making process is necessary. In this case, the problem is for Merck to give financial support to
the Research and Development project of Davanrik offered by LAB Pharmaceuticals, and about the
process of valuation and the final decision. First we are to make short LABs business proposal and have
a detailed DCF valuation to decide if the proposal is cost-effective or not. Then, finally, we will make a
decision based on the valuation process in perspective of Rich Kender, Vice President of Financial
Evaluation & Analysis of Merck.

STATEMENT OF THE PROBLEM

Based on the groups analysis, we came up with a question:
Should Rick Kender, the Vice President of Financial Evaluation and Analysis at Merck, with his team,
license Davanrik or not?
This case involves Merck and Company which has to assess a drug licensing opportunity.
In this problem, the company has to decide on licensing a new drug called Davanrik. Davanrik was
developed by a company named LAB. Because the company lacked the resources to complete the

approval process it approached Merck to license the drug. Merck is a huge company and had the capital ,
expertise and previous experience that is need for the approval of the drug.
PORTERS FIVE FORCES ANALYSIS
Porters Five Forces Analysis

Rivalry Among Competitors

4
Threat of New Entrants

Threat of Substitutes

Bargaining Power of Suppliers

Bargaining Power of Buyers

LEGEND
0 No threat to the business
1 Insignificant threat to the business

Threat of Substitutes- LOW

Basically, medicines have no substitutes especially to critical diseases. Even with the presence of
Biotechnology. It does not pose a big threat because it is not considered as a substitute. The only
similarity that it has to pharmaceutical products is research and development. The cure that medicines
MORALES,
Diane;
ALVARAN,
Arianne Kaye; AUSTRIA, Roda Jane; GATORIAN, Dorothy
may give is Faye
still different
and
vital to consumers.
The only substitute that can affect the industry heavily is prevention. People themselves with the
help of the government and non-profit organizations are now more aware creating campaigns and
personal changes to avoid diseases. This will give people the initiative to live a healthy life and equip
them with thorough knowledge of such diseases. This will affect the profitability of the Pharmaceutical
Companies especially on the demand side. Although there are times that they themselves promote
awareness as a marketing strategy. These are the factors that led to the evaluation of LOW threat of
substitutes.
Bargaining Power of Buyers- LOW
Although prices of medicines can be affected by bulk purchases, tax exemptions and government
policies, customers still have reduced bargaining power because of absolute need for certain products
like medicines. Doctors who usually give prescriptions have brand identity and patients have no choice
but to buy that certain medicine making them less price sensitive. Also, these doctors usually have strong
brand recognition showing loyalty to a certain product.

The customers are also highly fragmented causing little change in the price of the medicines.
Consumers tend to be less price sensitive because of the necessity to buy the product. The only true
alternative that can pose a threat are generics that are less pricey but as long as the medicine is
patented, there will be very little threat for companies. These barriers give buyers LOW bargaining power.
Bargaining power of suppliers- MODERATE
Even though chemicals used in production are a vital ingredient, their availability becomes
rampant. Most chemicals used in the production are standard and can be bought locally. The switching
costs are also low because there are numerous suppliers that can provide pharmaceutical companies
with the same quality inputs with lower price. Companies have a wide variety of choices that suppliers
themselves compete with each other considering the level of demand for medicines or drugs. Also,
pharmaceutical companies usually buy in bulk giving them power to somehow dictate the price over its
suppliers. There barriers gives an evaluation of MODERATE bargaining power of suppliers.
Threat of New Entrants- MODERATE
The barriers for new entrants include Research and Development and Patents. The amount of
capital needed to support the Research and Development of a new product is huge with high risk of not
being approved by the government after a long process. The loss you can bare is highly probable.
Another barrier is in the form of patents stopping the entrants of new firms. Patents are used so that
companies cannot imitate the medicine. This will give the owner a lawful claim over the product which is
very hard for new entrants to contest.
Although economies of scale can improve the performance of companies, there is still a
probability that the medicine will not be a hit. And the emergence of existing companies creates higher
risks for new entrants. On the lighter side, government policies are very accommodating as long as the
price is regulated. That is why new entrants only have a MODERATE threat for the industry.
Threat of Existing Rivalry- SIGNIFICANT
The group considers existing rivalries the highest threat which is SIGNIFICANT. The industry is
very fragmented and highly competitive where in some small companies out-license their products just to
MORALES,
Faye
Kaye;
RodaofJane;
GATORIAN,
Dorothy
minimize the
risk Diane;
they will ALVARAN,
take and to Arianne
ensure cash
flow. AUSTRIA,
The emergence
lifestyle
drugs also created
opportunities for the industry creating tighter competition. Lifestyle drugs include medicines that are
mostly for beauty and such. Also, the emergence of biotechnology creates new competition although they
are different in most cases. Lastly, the greatest threat is the generic products. The economy calls people
to try generic products that offer highly similar with much lower price. Also, the costs incurred by generic
products are much lower than those original. If patented products chose not to renew the patent,
profitability will be highly at risk.
SWOT Analysis
Strengths
A well- known and trusted name in the Pharmaceutical Industry.
Strong position in the Global Market and Industry hold.
Large department of Research and Development which is vital for product development.
Offers products for anyone including animals.
Product variation and continuous effort to introduce a new product.
Weaknesses

Low liquidity
Expenses incurred for Research and Development is too high.
Faced serious charges over the span of its existence that created various controversies.

Opportunities
Strong Research and Development team creating more possibilities for product innovation and
development.
Captured the attention of consumers and potential investors due to its good industry hold.
Globally Offered.
Good product diversification.
Threats
Fragmented and tight competition within the industry.
Government regulations imposed.
Threats posed by the introduction of generic products.
ALTERNATIVE COURSE OF ACTION
The main question to be answered in this case is:
Should Rick Kender, the Vice President of Financial Evaluation and Analysis at Merck, with his team,
license Davanrik or not?
There are two alternatives that are available for the company:

i
ii

Do not license the drug

License the drug

Under the alternative of licensing the drug, in every phase of approval, there are probabilities that the
drug will be successful or it will fail and whether it can cure either depression or weight loss or both. The
probabilities are as follows:
License the drug
MORALES, Faye Diane; ALVARAN, Arianne Kaye; AUSTRIA, Roda Jane; GATORIAN, Dorothy
Phase I failure 60%
Phase I success 40%
Phase II failure 10%
Pursue Depression

Success
Failure
Pursue Weight Loss
Success
Failure
Pursue Both
Depression
Weight Loss
Both

Failure

RECOMMENDATION
After computing the Net Present Value under the two alternatives, Rick Kender, the Vice
President of Financial Evaluation and Analysis at Merck, with his team, should go for licensing the new
drug, Davanrik. They should pursue the licensing of the medicine for the reason that the computed
expected monetary value despite its high probability of failure can give the company benefits. If this
project succeeds, the company will earn and recover the additional equity used in financing the testing
and licensing of the drug as it gains large amount of profit. With the potential additional equity or profit that
they will earn, the company will be able to finance other projects and pursue company growth.
There are relevant reasons for accepting the offer such as: the company might lose its
competitive advantage as the companys patents will expire soon and the company needs to capture
more market share and it is necessary for them to invest in new project. Merck and Company is one of
the leading companies in the Pharmaceutical Industry, and they cannot afford to lose their industry hold if
they will not continue to invest in a new project. Their loss in market share may affect their value as firm
and their stock value.
A

MORALES, Faye Diane; ALVARAN, Arianne Kaye; AUSTRIA, Roda Jane; GATORIAN, Dorothy

APPENDIX A

APPENDIX B