Merck’s hard choices

Nov 28th 2005
From The Economist Global Agenda

Merck’s boss, Richard Clark, has announced heavy job cuts in an effort to revive profitability. But the American drug giant faces not only the same travails as its rivals but potentially huge liabilities over Vioxx, an anti-inflammatory drug it withdrew last year. Mr Clark has yet to make his hardest decisions

EVEN for a firm used to dealing with powerful pharmaceuticals, Merck’s announcement on Monday November 28th that it would lay off 7,000 employees and close or sell five of its 31 manufacturing plants was a stiff dose of medicine. But dismissing 11% of its workforce and streamlining its facilities will yield some $4 billion in pre-tax savings—and Merck is in need of a little respite. The American drug giant shares many of the problems affecting the industry. On top of which it also faces the possibility that it will have to shell out tens of billions of dollars in damages to thousands of patients around the world who took Vioxx, an anti-inflammatory drug that was withdrawn last year after being linked with heart problems.

Even before its troubles with Vioxx, Merck’s profitability had begun to slip. Although drug firms are still reasonably profitable—Merck itself made a net profit of $6 billion in 2004—many observers have questioned the industry’s over-reliance on a small number of blockbuster cures to keep the money rolling in. In common with most other drug giants, Merck has seen its earnings fall over the past couple of years as the patents expired on its leading drug and the flow of new medicines from its research-and-development pipeline dried up, highlighting the drawbacks of concentrating too much effort on a limited range of cures.

Furthermore, the world’s big pharmaceutical companies have come under pressure from generic-drug firms, which copy branded medicines whose patents have expired and sell them more cheaply. The big sums on offer—Vioxx, for example, brought in revenues of up to $3 billion a year—have made tempting targets for generics firms. And Merck is not the only big drug firm that has been forced to withdraw high-profile medicines. There are fears that the huge marketing efforts that go behind such drugs may discourage their makers from disclosing fully problems relating to them.

Merck’s recent difficulties began in September 2004, when the firm voluntarily withdrew Vioxx after the results of clinical trials suggested that taking the drug for prolonged periods could cause heart problems. Merck’s share price plunged (see chart) and in May 2005 its chief executive, Ray Gilmartin, quit over his handling of the problem. The restructuring announced on Monday is the first significant effort by Mr Gilmartin’s replacement, Richard Clark, to put things right. Mr Clark is, naturally, confident of success. But he knows he could soon face another blow in court over Vioxx.

In the first of over 7,000 Vioxx-related lawsuits to come to court, Merck was found liable in August for the death of a Texas man who had taken the drug. Jurors were horrified by evidence that Merck may have known about the dangers of Vioxx years before it withdrew the treatment. The Texan’s widow was awarded $253m in damages, though a cap will reduce the pay-out to around one-tenth of that. Merck intends to appeal. A second trial, in New Jersey this month, absolved Merck of responsibility for causing a heart attack in a 60-year-old Voixx user. This week, a third trial begins in Houston.

An adverse result could increase the pressure on Merck to settle the outstanding cases. However, the company has elected to fight each case separately, and may choose to fight on in the hope that it can win the bulk of the contests. That is risky: if it fights on and loses a large number of cases, and is punished with vast awards against it, the costs of any final settlement are sure to rise accordingly.

If Merck decides that it will settle the outstanding cases, estimates of the sums it may have to pay run to tens of billions of dollars. If the cloud has a silver lining, it is that other drug firms have managed to survive litigation of this kind. Wyeth, for instance, set aside over $20 billion to settle claims associated with Phen-Fen, a diet drug.

Worryingly for Merck, the patents on Zocor and Fosamax, two of its remaining blockbusters, will expire by 2008. And the launch of Arcoxia, a successor to Vioxx, has been postponed in America. Making cost savings now in anticipation of fewer blockbusters and falling profits in the future is sensible. Making plans for fighting or settling legal cases that could break Merck is a much tougher call. By taking a knife to the company, Mr Clark has made his mark. But he may yet be remembered as the man who brought an American giant to its knees.

Copyright © 2005 The Economist Newspaper and The Economist Group. All rights reserved.