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MERCK: LEADING

PHARMACEUTICAL
SUPPLY CHAIN
INITIATIVES

Merck: Leading Pharmaceutical Supply Chain Initiatives 1

1.0 Abstract
Merck is a pharmaceutical company that strives for strict quality standards and effective
supply-chain management to ensure the efficacy, safety and supply of their products. They
sustain an interdependent, flexible supply chain that works to take into account global and local
market supply needs while engaging and investing in local and regional partnerships to enable
market access. Within this document is an analysis of the Merck supply chain and an evaluation
of how Merck is maintaining their supply chain performance while upholding a high level of
customer service and providing profits to the shareholders. Additionally, the pharmaceutical
industry and their customers needs will be assessed. The paper will look at how Merck has
changed its supply chain structure from a centralized model to duplicating a structure deploying
partnerships locally and what implications that has. Their pricing and inventory management
structures will get discussed as well as their distribution and supply chain. Merck is concerned
with product serialization and security which is specific to the pharmaceutical world and food
supply chains. In conclusion, suggestions will be made on how Merck may improve their
current efforts or what changes would be more efficient.

2.0 Merck Value


The concept that the customer experience is vital to the success of an organization is not a
new theory. Pharmaceutical companies do not have a good reputation when it comes to being
customer driven (Michels, Rebhan, & Ghosh, 2014). Because health care policies are changing,
the pharmaceutical companies have to adopt more customer driven strategies to insure future
performance in a volatile market. Pharmaceutical companies are making production and supply
chain changes leaner in an effort to regulate costs. (Benke, Retterath, Sangster, & Singh, 2014).
Merck specifically is bringing value to the table by updating their supply chain system and
partnering with United Parcel Service to improve the supply chain management, safety and
delivery times (Dunn, 2011).
Figure 1 shows consumer frustrations with the pharmaceutical and medical community
(PWC, 2013). For this reason, the pharmaceutical companies are changing focus to service and
demand strategies (PWC, 2013). Consumers like the convenience of being able to purchase
prescriptions straight from the company and delivered to their home, much like doing their retail
shopping online. In fact, baby boomers with numerous lifelong conditions are willing to pay up

Merck: Leading Pharmaceutical Supply Chain Initiatives 2


to 21% more for home delivery of their meds (PWC, 2013). Some of these concepts affect
Merck but others do not because of the specificity of the Merck market.

Figure 1, Cost and Side effects dominate consumers top frustrations regarding their treatment.
Reprinted from Customer Experience in the Pharmaceutical Sector: Getting closer to the
Patient, by PWC, 2013
Merck Supply Chain is different than dealing with a supply chain that deals with the
production of soap or ice cream, items that do not carry a high risk of personal harm if not used
or handled appropriately. Merck produces medicines and vaccines that they distribute to 140
different countries (Merck, 2015). Merck has changed its supply chain structure recently by
going from a centralized model to duplicating a structure more like Coke-Cola, and deploying
partnerships locally (Fernie, 1995). Merck key performance indicators (KPIs) are shown in
Figure 2 (Merck, 2013).

Merck: Leading Pharmaceutical Supply Chain Initiatives 3

Figure 1 Merck Key Performance Indicators. Reprinted from Corporate Responsibility 2013
Annual Report by Merck, 2013
The suppliers, 3PL firms, distribution centers, and retail stores may be better understood if
we look at Merck's products. Merck makes vaccines and produces medications that support
women's health including prescription and many oncology drugs used in the battle against
cancer. The company as a whole uses their research in veterinary sciences to advance in both
human and animal medicinal fields.
Part of the Merck business plan is to assist in making the world healthier. Vaccines are
needed in the "developing countries" where 1.3 billion people do not have adequate access to
essential healthcare needs (Oschman, 2015). Mercks faces many challenges distributing
products to these countries representative on the map below in Figure 3 (Merck, 2013).

Figure 2 Developing countries were Merck is present with vaccines from Corporate
Responsibility 2013 Annual Report by Merck, 2013
In the US, Merck is structured based on the Food and Drug Administrative licensing. Plants
are located in Durham, North Carolina, West Point, Pennsylvania, Elkton, Virginia and Carlow,

Merck: Leading Pharmaceutical Supply Chain Initiatives 4


Ireland. Vaccines from those plants need to be distributed worldwide and timing would become
crucial in epidemic situations were vaccines would be needed quickly. The Merck supply chain
network needs to be able to respond to these worldwide needs if an epidemic was to occur.

3.0 Merck Supply Chain Network


Pharmaceutical companies have similar networks to everyone else but the end customer is
pharmacies and hospitals, or pharmaceutical mailing houses. A Merck network may look like the
following as shown in Figure 4 (RX Response, 2104).

Figure 3: Pharmaceutical Supply Chain Network Example, From


http://www.rxresponse.org/resources by RX Response, 2014
Figure 4 shows a practical network with raw material inputs from suppliers, finished product,
packaging, distribution to hospitals, pharmaceuticals and patients. Because Merck deals in
vaccines, they fall more on the development side of the supply chain, and would distribute direct
to pharmacy, as opposed to wholesale. Figure 5 shows how the supply chain would break down
as far as people, skills, and collaboration (Price Water House, 2014). The information systems is
a critical part of the network. Automation will be a factor in numbering or serializing the product
for tracking through the entire network from manufacturing until the time the seal is broken at
the pharmacy, by the doctor, or the patient (Merck, 2014). Pharmaceutical companies must
maintain traceability and be able to maintain efficiency in supply chain networks while providing
regulation of controlled substances. Choosing 3PLs that can maintain the traceability needed for
moving controlled substances is critical for pharmaceutical companies (Price Water House,
2014).

Merck: Leading Pharmaceutical Supply Chain Initiatives 5

Figure 4: Pharmaceutical Supply Chain Planning. From Pharma Supply Chain 2020 by Price
Water House, 2014.
Merck personally takes responsibility for global serialization of their product and has a
public commitment to the following (Merck Global Serialization Public Policy, 2015):
1. GLOBAL STANDARDS: Merck will provide product serialization consistent with the GS1
Data Matrix, the Electronic Product Code Information Services (EPCIS), the Global Trade
Item Number (GTIN), and the Global Location Number (GLN) as the unique trading partner
identification number. Products will be traceable to the point of production, facility, time and
date of production, as well as that the seal was not broken through transport.
2. PRODUCT AUTHENTICATION at each supply chain node: Merck will have each point in
the supply chain verified so that the product is secure in transport.
3. SIMPLIFIED REQUIREMENTS: Merck encourages governing policies to consider
simplification and flexible requirements for the consumer and the needs of the business.
4. GLOBAL HARMONIZATION: Merck favors global standardization on serialization to
simplify business practices on a worldwide level.
5. NATIONAL REQUIREMENTS: Merck favors national level policies on drug transportation
and serialization. Public Policy Statement: Supply Chain Security - Global Product
Serialization. As an example, the United States legislation enacted in late 2013 - The Drug
Supply Chain Security Act which establishes uniform federal standards to improve the
security of the drug supply chain and reduces the impact of the burdensome patchwork of
state laws related to pedigree requirements for drug distribution by establishing a national
system for tracing pharmaceutical products through the supply chain. Merck supports such
measures.
6. DATA SECURITY AND ACCESS: Merck is dedicated to securing the data generated by
serialization so that authenticity of product is not compromised in any form.
7.

ITEM LEVEL SERIALIZATION: Merck believes serialization should be at the closed item
level. This means the package being opened by the consumer or the seal on the bottle at the
point that the syringe takes the product (Merck Global Serialization Public Policy, 2015).

Merck: Leading Pharmaceutical Supply Chain Initiatives 6


Serialization and security are major factors that Merck considers when choosing supply chain
partners. Merck has chosen to partner with United Postal Service due to their relentless track
record in providing services. UPS was chosen by Merck because of UPS's global reach, and
their understanding for secure distribution of pharmaceutical products. UPS is also familiar with
the import and export needs of Merck's business and would be able to handle the issues
involving the transport of vaccines and drugs.
Choosing a 3PL provider requires high scrutiny over their business practices, capabilities,
credentials, and track record for storing, handling and distributing products safely (Marcum,
2007). Traditional 3PLs are not adequately trained to handle these materials and could lead to
the loss of millions of dollars. They must select a partner that specializes is pharmaceutical
supply chain; this will allow them to leverage their best practices in (Marcum, 2007):
Just In Time (JIT) inventory
Streamlined supply chain
Tighter control and better documentation
Increased customer confidence
Enhanced focus on core business competencies
Over 3.5 billion prescriptions are filled annually in the United States. Even though Merck
only has a small percentage of that market, Merck does not have time to allow mistakes in the
supply chain to jeopardize customers health. (Follow, 2005). Merck has a public commitment to
provide security and serialization throughout the manufacturing and supply chain process
(Merck, 2015).

4.0 Pricing Management


Pharmaceuticals are priced based on when they are released by the Federal Drug
Administration (FDA) after development. This decides on the time line that a drug may be
considered a named brand and when the patent expires and other people are allowed to make it
under other generic names. Economically this creates competition against the branded
pharmaceutical, which gives the customer a choice (Winegarden, 2014). How new a drug is, will
determine its saturation in the market based on availability.
However, the newer a drug is, the more expensive it will be due to engineering research and
design costs, as well as testing before going to market. The FDA process to market alone, can
take up to 14 years. An example of a Merck tested product is the Herpes Zoster Vaccination that
is a response to the influx of what is commonly called shingles. A 3.5 year random study was
done with the Veterans Administration to verify the validity of the drug after the vaccine was
developed by Merck (Simberkoff, et al. 2010). Testing is costly and directly affects the price of

Merck: Leading Pharmaceutical Supply Chain Initiatives 7


pharmaceuticals. The shingles vaccine is around $200 to the consumer. Lu explains some
general issues with pharmaceutical pricing.
The pricing is typically driven by costs of production with little or no consideration given to
demand (Lu, 1998). Patents in the pharmaceutical world tend to be given based on the chemical
composition of the drug which leads to the over saturation of the market of many different drugs
that in the end provide the same therapeutic relief to the patient (Lu, 1998). Two different
strategies that historically have been used are skimming and penetration. Skimming is the
process of setting a high initial price and then lowering it over time with a focus on new products
that significantly have advantages over the products already on the market (Lu, 1998).
Penetration is releasing products at lower prices that increase over time and benefits drugs that
are being released into a saturated market (Lu, 1998).
In addition to market saturation and drug release phases, pharmaceutical companies price
differentiate their products in regards to customers based on geographical and socio-economic
segments. This type of differentiation falls into the grouping strategy that is defined as providing
discounts or lowered pricing to specific groups of customers (Simchi-Levi, Kaminsky, & SimchiLevi, 2008). This method of pricing establishes the tiered pricing system that is so common in
the pharmaceutical industry. Three drivers push differential pricing in the pharmaceutical
market: social responsibility, new market openings, and competition (Yadav, 2010).

5.0 Inventory Management


To keep up with the urgent needs of patients in a dynamic healthcare marketplace,
pharmacies and pharmaceutical companies partner up to have an accurate and efficient inventory
management system in place. Upon interviewing Walmart pharmacy manager, Kay Lemmerman,
Merck supplies data via electronic systems on refill orders of stock through use of a pharmacy
inventory management software program (personal communication, March 20, 2015).
Due to market variability caused by generics and named brand drugs, Merck keeps
inventories levels high enough to fulfill 98% of all orders placed. Having the policy of the
availability of all drugs, inventory levels increase and consequently so does cost. In order to
move away from this supply structure Merck instead has set sales targets. If they do not have
enough inventories on hand to fulfill an order it then determines if a generic version is available
or if a competitor can easily supply a similar or generic version of the drug. This requires data

Merck: Leading Pharmaceutical Supply Chain Initiatives 8


from other drug companies, which is supplied by the North American Supply Chain Project,
started in 1996-1997. Each month, the project collects from, and supplies to, the major drug
suppliers a standard set of data on physician prescriptions over the previous 24 months (Rapp &
Lair, 2002, pg. 84). Based on this information, Merck then sets productions and drug availability
by the region.
Setting drug availability and production requires intricate calculations and formulas in order
to improve sales forecast accuracy, manufacturing planning to drive production efficiency, as
well as to reduce inventory levels. To do this the company looked at JDA's industry-leading
Demand, Fulfillment, Collaboration and Master Planning solutions to achieve this. JDA
advertises their inventory management solution (JDA Inventory Optimization, n.d.) to provide
companies with end-to-end capabilities for managing inventory strategy, planning and execution,
enabling them to achieve superior service levels, gain market share and reduce costs (Inventory
Management, n.d.). This is accomplished by:
Quickly adapt inventory policies and stocking strategies to address changing market
conditions, business objectives, supply chain constraints, customer segmentation and
buying behavior.
Eliminate excess inventory and reduce obsolescence costs while maintaining customer
service levels.
Develop inventory strategies that maximize the profitability and volume of key
materials, components and products.
Reduce stock-outs and excess exceptions through early warning and performance
analysis.
This order and inventory management system conforms to Mercks analysis of needs and
regulates shipments to each pharmacy with information regarding actual patient demand for
prescriptions. The organization has less orders lost due to the inventory management system
provided by JDA as it has decreased back orders and increased the availability above Mercks
98% target (Rapp, et al 2002). The system has also reduced inventory and waste from drugs that
have passed discard or expiration dates as the drugs are held in stock for shorter periods.

6.0 Minimizing Bull Whip Effect


Information exchange is important to improving the efficiency and effectiveness of all supply
chains and the same holds true for the Pharmaceutical industry (Schwarz and Zhao, 2011).
Improved production planning, reduced stock levels, and reduced total costs are all positive

Merck: Leading Pharmaceutical Supply Chain Initiatives 9


outcomes of allowing for information about downstream inventory replenishment policies to
flow upstream (Scwarz, et. al, 2011). Two approaches must be taken to ensure proper
information exchange. In the short run, Merck inventories should either decrease or increase in
the short run with the net effect dependent on the opposing forces (Scwarz, et. al, 2011). In the
long run, Merck can take advantage of information sharing in their planning which would lead to
reduced inventory and increase turnover (Scwarz, et. al, 2011).

7.0 Merck Distribution Strategies


Merck US distribution is different than Africa distribution strategies and distribution of
vaccines varies depending on the type of vaccine. One distribution example for Merck of an
older drug was Ivermectin used to stop the transmission of worms (Waters, 2004).
Merck donated the drug to the World Health Organization and distribution was organized in
Africa based on passive components, mobile teams, community based, and community dictated.
Waters says that economically it benefitted communities by decreasing the spread of worm
related diseases.
Passive distribution is when someone goes to a clinic and a doctor prescribes medication
based on the symptoms. Mobile teams are medical teams sent to problem areas to disseminate
drugs. Community based distribution is like when the military requires all members to get shots
before deployment or flu shots every winter. Community dictated is the same as public schools
requiring vaccinations to attend facilities. Merck products are disseminated in each of these
situations.
At times, distribution can depend on agreements between companies and regional restrictions
based on marketing. For instance Merck and Johnson and Johnson went to court over the
distribution of Remicad and Simponi. It was decided in 2011, that Merck would market specific
regions and the other regions would belong to Johnson and Johnson (Merck vs. Johnson and
Johnson, 2011).
In the US, the Federal Drug Administration must license vaccines for them to be distributable
in the US. A list of those vaccines is available on line. It may sound simplistic, but licensing to
be able to distribute would have to happen before marketing and could be a major issue in the
pharmaceutical supply chain when things go wrong. Licensing also affects non-vaccine
products.
Part of the tracking between drug manufacturers and pharmaceutical distribution companies
and hospitals is keeping up with the government regulations of the controlled substances. This is
where contracting obligations would be critical, not only with supply chain distribution, but
execution of raw materials, and serialization processing, as well as communication of these
needs to impact pricing and marketing.

Merck: Leading Pharmaceutical Supply Chain Initiatives 10

8.0 Merck Product Supply Contract Strategies


Current pharmaceutical production systems are costly and have shifted towards more of a
creating value for the business as opposed to just optimizing the current system (McKinsey &
Company, 2012). In order to accomplish this, companies like Merck must look past just efficient
production but look at a major overhaul that is driven by innovation (McKinsey & Company,
2012). Merck started the process in 2008 by looking towards the future by establishing a
production system that is focused around the customer (Arnum, 2008). They improved their
processes and innovation levels to bring products to the market faster than ever before while
reducing overall capital spending and allow for better understanding of the magnitude of market
penetration (Arnum, 2008).
Merck has increased their focus on keeping and innovating essential elements of their
internal production to maximize and ensure the quality level of these core items (Arnum, 2008).
While the goal is to outsource non-core elements, the core-elements of their supply chain will be
maintained in house and they focus their time and energy into improving these elements turning
them into their core business values (Arnum, 2008).
As with any supply chain but more predominately a healthcare supply chain, the governing
parties must ensure high level of quality when it comes to its suppliers and the associated
contracts that go along with such a relationship (MSH, 2012). Although Government agencies
play a big role in regulation of the medical industry, pharmaceuticals tend to fall into the private
sector with much of the supply chain being contracted to outside sources (MSH, 2012). The
basis to move forward with the decision to go with the contract takes into account how the
contract as a whole will affect the whole system not just one individual item (MSH, 2012). The
main reason for contracts or outsourcing of production is because internal manufacturing
processes are too expensive and the cost savings can be applied to research and development
(MSH, 2012).
Trade terms are the first element of establishing pharmaceutical supply contracts establishing
the division of the costs and responsibilities between the supplier and the buyer. Trade terms
have been the standard as defined by the International Chamber of Commerce (MSH, 2012).
The terms tend to be established by the buyer and the risk of the contract is established in regards
to damage or loss goods (MSH, 2012). At this point common trade terms are defined that
include establishing the knowledge of transportation costs etc. (MSH, 2012). As part of the
process, the supplier additionally establishes that they can financially accomplish what is
expected out of them through the contract (MSH, 2012).
Purchase quantities are established within the contract and whether or not minimum order
quantities will be required are decided upon at this time (MSH, 2012). The supplier does not
benefit from the contract if the discounted price is not tied to a guaranteed order quantity (MSH,
2012). Suppliers usually set buffers in pricing to account for changes in pricing of raw materials
(MSH, 2012). Once the contract is signed, prices proceed through a validation period where the

Merck: Leading Pharmaceutical Supply Chain Initiatives 11


prices are maintained until the terms of the initial contract are completed (MSH, 2012). The
standard for contract terms is one year but can vary in environments that experience high
inflation fluctuations (MSH, 2012). High variability or uncertainty on the end of the supplier
will be incorporated into the overall final price (MSH, 2012).
Currently, Merck, like many of the other industrial leaders practice what is called Investment
Buying Model contracts. Investment buying is defined by distributors buying large amounts of
product to avoid future price increases that are typical in the pharmaceutical industry (Zhao,
Xiong, Gavireni, and Fein, 2004). This type of process leads to many disadvantages as high
levels of inventory at the distribution level and big fluctuations in orders making planning and
inventory at the supplier level difficult (Zhao et al, 2004). The ideal contract situation for Merck
to move towards that has been the trend is a move towards Fee-For-Service where the revenue at
the distribution level is driven by fees that are charged to the supplier for specific services that
are provided to them (Zhao et al, 2004). The main service provided is proper inventory
management agreements that control and maintain the inventory levels are both the supplier and
distributor at predetermined levels (Zhao et al, 2004). The main focus of this agreement is to
ensure that the distributor has a level of inventory to maintain its service level while still low
enough to eliminate investment buying (Zhao et al, 2004). Although investment buying still
occurs to reap the benefits of a lower price it is controlled by a pre-determined maximum level of
inventory per the contract terms (Zhao et al, 2004). Overall this contract is ideal because it
reduces investment buying, provides production stability for the supplier, and establishes proper
transparency for both the supplier and the distributor (Zhao et al, 2004).

9.0 Merck Performance and Executive Strategy


Merck sets their standards based on ISO 9000, company expectations, FDA expectations,
customer expectations, shareholder expectations, and international pharmaceutical standards.
Above everything, Merck must provide good science. Part of the way that Merck measures
supply chain performance is setting up expectations at the start of a contract and then doing
periodical reviews of those standards. Merck expects its suppliers to perform according to Merck
standards set up in their contracts. Key performance indicators (KPIs) are used in each of the
Merck groups. Executives then tie those KPIs to the company goals. Merck has been rebuilding
in the last few years. Evidence of this is that they sold off non-pharmaceutical research items
and their veterinarian medicine divisions to streamline their performance. This is discussed in
their 2012 and 2013 annual reports that are publicized since Merck is a publicly traded company.

Merck: Leading Pharmaceutical Supply Chain Initiatives 12

Figure 5 Merck Supplier Standards Retrieved from Manufacturing & Supply Chain - Merck
Responsibility by Merck, 2014
Annual Report 2013
Merck Group | Key figures
million

Total revenues
Sales
Operating result (EBIT)
Margin (% of sales)
EBITDA
Margin (% of sales)
EBITDA pre one-time items
Margin (% of sales)
EPS (in )
EPS pre one-time items (in )
Business free cash flow

2013

2012

Change in %

11,095.1
10,700.1
1,610.8
15.1
3,069.2
28.7
3,253.3
30.4
5.53
8.78
2,960.0

11,172.9
10,740.8
963.6
9.0
2,360.2
22.0
2,964.9
27.6
2.61
7.61
2,969.3

-0.7
-0.4
67.2
30.0
9.7
111.9
15.4
-0.3

Figure 7, Merck Group Key Figures From from Corporate Responsibility 2013 Annual Report by
Merck, 2013

Merck: Leading Pharmaceutical Supply Chain Initiatives 13

Figure 8 Merck Product Pipeline From from Corporate Responsibility 2013 Annual Report by
Merck, 2013
2014 is also expected to show a decline due to the rearranging in assets that are going on.
Corporate strategy is to continue focusing on what Merck is good at which centers on research
and development in the vaccine markets as well as some other targeted medications.
Executive strategy would be to employ the means to market and deliver the medications
coming down the Merck pipeline as efficiently and quickly as possible. This means maintaining
good relationships with suppliers, understanding licensing and patent agreements, as well as
marketing to the people and physicians that need the medications. Figure 2 shows that Merck
has increased the number of local and regional partnerships in the manufacturing and supply
chain markets to make this happen. In 2011, regional and local partnerships were at 0. In 2013,
the regional and local partnerships were at 354. Future success means keeping these partnerships
that coincide with future developments and communicating those developed products as they
occur.
Adding goals to maintain or gain market presence in specific medical areas will keep Merck
moving forward and profitable. If Merck can be ahead of the game in the cancer medications
and continue to derive drugs for HIV and AIDS patients then they can be a major market
provider in critical health prevention areas. Mathew Herper of Forbes ranked Merck number 8
among the fortune 500 pharmaceutical companies (Herper, 2015):

Merck: Leading Pharmaceutical Supply Chain Initiatives 14


1

Total return: +16.9%

8. Market capitalization: $162 billion


9. Quarterly sales: $10.5 billion
10. New drug approvals: 3
11. Five-year total return: +89%
One of the reasons why Herper gave Merck a higher grade this year was because they beat
Bristol Meyers to the punch on bringing new drug approvals to market. Merck also improved
their antibiotic line.
Merck is keeping their plans realistic in markets that are being used and are on the forefront:
AIDS, Cancer, Hepatitis, Antibiotics, Mycobacterias, and Herpes. These health issues are also
worldwide issues. Part of Mercks success, if not all is dependent on maintaining their supply
chain, keeping drug authentication and serialization under control with supply chain security, and
being able to respond to health needs in the US, Europe and developing countries. Merck has
done this by making their suppliers hold to standards, modernizing their information systems,
and making their supply chain as lean as possible, while increasing presence locally and
regionally.
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