Merck Medco -

Vertical Integration in the Pharmaceutical

Industry

Made By:
Group 1L
Harsh Sharma Snehal Lokare
Pankaj Ranjan Vaishali Mathpal
Vikas Goyal
2 Agenda
 Case Background
 Industry Background
 What is PBM ?
 Sources of Income
 Our Insights & Analysis

Questions & Answers

3 Case Background
 Period between 1993-94 saw 3 pharma manufacturers acquire distribution
intermediaries called Pharmacy Benefit Managers (PBM)
 Merck – Medco
 SmithKline – Diversified Pharmaceutical
 Eli Lilly – PCS Health System
 PBMs had huge market coverage. Also they assisted in various ways like creation
of pharmacy benefit plans, prescription reviews and so on
 PBMs according to Eli Lilly helped provide information for total quality approach
which helped integrate the needs of all stakeholders in the industry
 While Merck profited from Medco acquisition, Eli Lilly suffered losses
 Merck as well as Medico profited from the acquisition. Merck’s profits increased
four fold while Medico also doubled its number of clients
4 Industry Background
 Three major product types:
 Brand Name Drugs Prescription Drugs (80% of sales)
 Generic Versions of off-patent brand drugs
 Over-the-counter (OTC) drugs Non Prescription Drugs (20% of Sales)

 2 channels of distribution:
 Wholesaler Retailer (Wholesaler made 5-8% Gross Margin)
 Mail Service Pharmacy (No wholesalers)
 Industry was also classified according to therapeutic category
 Traditional Success – Development of patented brand name ethical drugs
 Traditional boosted initial sales, but on expiry of patent sales declined rapidly
 So originally therapeutic efficacy was key element for success, over time
manufacturer’s reputation and sales & marketing effectiveness also important
5 Industry Background
 3 phases of FDA approval. Successful approval in all phases needed
 Manufacturers applied for patents at time of compound discovery, Patents only
for 17 years, hence only 5 years in market as patent drug
 To supplement new product flow, firms formed joint ventures with other firms
 In early 1990s, due to growing healthcare expenditure, pharma companies
were accused of hyper inflation
 Also market went from being physician controlled to managed care
organizations which led to transfer of purchasing power from manufacturer
 In mail distribution channel, cost containment was achieved by reducing co-
payment costs for customer. Led to dispensing process being more efficient
6 Pharmacy Benefit Management
 Initially, manufacturers supplied products to wholesalers, chain and
independent pharmacy retailers and mail service retailers
 PBMs negotiated lower reimbursement rates in comparison to traditional insurers
 They got networks of retailers which increased competition between them
thereby reducing dispensing prices
 This network created by PBMs also helped them reimburse the pharmacies
based on a previously agreed discount price based on AWP index
 PBMs customer base: 1/3rd self insured employers, 1/3rd HMOs, 1/3rd PPOs
 PBM focussed on claims processing, discount negotiation, formula development
& mgmt. and rebates from manufacturers
 Also they had to take care of the mail order division.
7 Functions of a PBM
 Developing and maintaining a network of providers
 Claims processing
 Benefit program design input
 Drug use control through formularies which were of 3 types:
 Open
 Incentive based
 Closed
 Drug use control through Drug Utilization Reviews: improve quality of pharma
care& generate savings
 Retrospective
 Concurrent
 Drug use control through Health Management: helped reducing costs of
chronic disease treatment
8 Sources of Income, Effect on Customer
 Manufacturer rebates: from manufacturer
 Administrative fees: from plan sponsor
 On Discounts from retailers on prescription drugs
 As a central repository & distributor of information

 Effect on Customer
 Customers who used formulary drugs had more benefit from PBMs
 Customers who were not on regular drugs ended up paying more than before for the
same drug in case the drug wasn’t covered in the formulary. This happens especially
when physician prescribes a specific brand name which is not on the formulary of PBM
 Vertical Integration
 Comments from Roy Vagelos, former Merck CEO
“In classic terms of competition, we could see that the power of the
buyers was growing…PBMs were…bringing together the person who
chooses the drug and the person who pays for the drug.”
“Having salespeople visit doctors’ offices does not allow us to reach
PBMs, HMOs, or plan sponsors -- the major players in the emerging
market.”
 Merck bought Medco as a response to managed care
 Strategic attempt to capture market power
 Follow-up on patients with chronic illness who may stop taking
prescribed meds
 Position Merck drugs favorably on formulary
e.g. lower patient copay, or lower cost to plan sponsor
10 Motivation
 Project Paradigm, studied the changing industry environment
 Redefine their role, not just as purveyors but as providers of healthcare solutions
 Views on the effectiveness of drug therapy. team drawn to an alliance with or
the acquisition of a PBM
 With R&D expenses that running at 8% of sales, any process that lessened
development risk, impact on profits
 By 1993, Project Paradigm considering the advantages of acquiring a PBM
 Merck’s move to become part of Medco’s formulary was important, willingness
to enter the Pharmacy benefit environment
11 Industry Reactions
 Reacted strongly against Merck’s association with Medco
 Independent pharmacies shrunk from 33000 to 25000 lost business to PBM’s and
HMO’s
 Despite the vehement response from druggists, many discounted a potential
threat to Merck-Medco
 Shortly after acquisition, two of Merck’s key competitors, Eli Lilly and SmithKline
also purchased PBM’s
 No single company has a sufficient broad product line to fulfil customers’ needs
 Despite the difficulties Merck remained pleased with Medco
12 Merck-Medco Evolves
 Increased covered lives by 6%, 40% in drug spending
 Merck’s share Medco’s $9 billion drug spend has risen to 15 %, up from approximately
10% prior to the merger
 Merck’s corporate growth target of 15% to 20%
 Merck-Medco’s health management programs targeted a potential patient
population of about 50 million patients
 Health management is where Merck-Medco can add real value and where the
margin opportunities exist
 Merck-Medco invested heavily in Information systems, spent in excess of 50$ million
on its customer service and 120$ in IT
 Name reflects the change-used to be Medco “Containment Services,” now Merck-
Medco “managed Care.”
13
Questions and Answers
 1. What was the rationale for PBMs?

 A PBM is an intermediaries that purchase drugs from manufacturers and

pharmacies at a reduced price for health insurers
 PBMs provide drugs at lower costs
 Achieve economies of scale in pharmacy benefits by serving multiple plan sponsors
 PBMs can use their patient information to their strategic advantage (e.g.
Medco’s 60m patients)
 How drugs prescribed, used, impact on disease
Can prevent inappropriate drug interactions, under/over medication
 PBM’s Role in Pharmaceutical Flows

1
Patient Pharmacy

2 3
1 4

Doctor 4
Wholesaler
PBM
1
2
Insurer/HMO 3
Pharmaceutic
2 3 4 al
1 2 Manufacturer

Employer 2 3 4
Disease
Monetary/Transactio 3 DUR/formulary 4 managem
1 Service/prescript on flow 2 n flow management
 PROGRAM DESIGN:

Program
Information
Provided to High Risk
physician and Education,
patient Counselling, Case
Patient
Patient Management
identified
completes Referral
through STRATIFY
drug questionnaire
claims
Physician gives
HbA1c Rx Mod/Low Risk

Newsletter, 1-
800 Infoline
 2.Strategic fit of Merck-Medco
 Needs of Merck
A R&D firm looking for Increased sales of their drugs

 Industry Back ground in USA:

Declining share of traditional distribution channel
Increasing share of Mail service channel for repeat filling required medicines (Low
cost in comparison to retailers)

 What Medco provides:

Mail service channel
Connectivity to Wholesalers, retailers and Health management organizations
 Strategic fit of Merck-Medco(Cont.)
 Merck-Medco Evolves:
a. Elimination of key information gaps like price, demand etc.
b. Readymade platform for market research
c. Just in 3 years o merger, covered lives increased by 6%, Drug spending
increased by 40%
d. Critical role of Medco’s Health management programs in Merck growth rate
goals of 15-20%
 3. What does Medco bring to Merck? What
19 are the advantages and disadvantages?

Advantages:
 Medco Containment services Inc. a firm that specialised in integrated drug
benefit plans and pharmacy services to managed care markets
 Marty Wygod, saw an opportunity to revolutionise the distribution system through
centralised mail service distribution that would save the cost associated with
intermediaries margins
 Merck found that Medco’s clients base was complementary to chronic care
drugs
 Their clients were predominantly Fortune 500 companies, Blue Cross/ Blue Shield
plans, insurance carriers, Federal, State, and local governments, and union
plans which covered their enrolees for life
 These clients would be more interested in chronic care therapies which,
although more expensive in the short term, would likely save cost over the life of
patient
 3. What does Medco bring to Merck? What
20
are the advantages and disadvantages?
(contd.)
 Medco offered “integrated pharmacy services”
 Medco’s competitive strength lied in mail service which offered efficient, economic
delivery
 Medco offer retail card program, clinically driven programs
 Medco again challenged the industry by offering its clients benefit plans with built in
cost savings
 Retail card program for prescriptions dispensed from PAID network
 Medco delved further into clinically driven programs such as patients profiling and
outcomes research, however, it recognized a need for further clinical expertise
 Medco’s strength was in mail service which offered efficient, economical delivery of
long term prescriptions via its 23 pharmacies
 Mail Room

Coding of new
Mail Service Pharmacy prescriptions
Delivery “Edits”/Protocols for
incomplete or
Data Entry inconsistent data

Prescription
Filling

Pharmacist
Check

Shipping
 4. What does Medco get from the Merck
22 acquisition?

 Acquisition would eliminate key information gaps in the drug delivery system
 Acquisition of Medco - Step for a new paradigm for pharmaceutical industry
 Vision to create the world’s first coordinated pharmaceutical care
 Merck - America’s most admired company, 7th straight time in Fortune magazine, a
repeat winner of Best sales Force in the Industry
 6/8, Recruiting Top Salespeople, Quality of training, Opening New Accounts,
Holding Accounts, and Reputation Among Customers
 No company had better exemplified the drug industry’s resistance to managed
care than Merck
 Merck had sales of $9.6 billion, Medco had sales of $ 1.8 billion
 Medco growing at 35% a year by riding the very trend that had threatened to
capsize Merck
 5.Future of Health management
 Health management: Specific planned programs for treatment of chronic
diseases
 Programs developed based on existing medical research suggesting better
therapy and low cost treatment
 A rarely found marketing strategy of More for less
 This is what customers always want
 Using this program customer was saving 440$ per year on an average
 Future of Health management(Cont.)
 Targeted population of 50 million patients
 Era of rising medical costs, in 1973 HMO act – to respond to that
 Increase in HMO and decrease in Hospital and private care after that

70 % Market Share in Medical

60
60 industry Health
Manitenance
50 43
organizations
40
30 26
20 Hospitals
20 11 12
10 7
2 2
0
1986 1992 1998(Projected)
25
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