Merck Needs More Gold From The White Coats

One day 15 years ago, P. Roy Vagelos, then the research chief of Merck & Co., rushed down the hall to show a colleague an intriguing item from a scientific journal--only to find the scientist looking for him on the same mission. Their excitement over that study of enzyme defects eventually spawned Proscar. This forthcoming drug will be the first to treat prostate disease--and it looks like Merck's next blockbuster, with expected annual revenues of $1 billion by 1998.

Today, Vagelos, who is now Merck's chief executive, might have to call around the globe to share his enthusiasm over such a breakthrough. The world's No. 1 drugmaker now has 17 research centers and 4,500 R&D employees spread across several European countries, Japan, and North America. Says chemist Gary H. Rasmusson, a 27-year Merck veteran: "Just to keep the communication that's necessary to stimulate new ideas and move research ahead is the real challenge."

Indeed, Merck's rapid expansion has left it "at a crossroads in 1991," says Viren Mehta, a former Merck strategic planner and partner of Mehta & Isaly, a drug-industry research group. In the 1980s, the Rahway (N. J.) company produced a string of new products, such as the antihypertensive Vasotec and the cholesterol-lowering Mevacor, each $1 billion-a-year drugs. Merck's profits more than tripled in five years, to $1.8 billion in 1990, as its sales more than doubled, to $7.7 billion. Shareholders pocketed better than a sixfold total return, including dividends, as Merck's stock soared from 22 in 1985 to 103 this year. But now, an inevitable cooling off has begun. Some existing products are maturing, and there are no obvious blockbusters in the pipeline after Proscar. In short, analysts estimate that through 1995, Merck's annual earnings growth might slow to 15%, with sales rising 8% to 10% a year. Merck might do little better than the average drug company its size.

So as healthy as Merck's numbers still sound, Vagelos sees in them a need to step up R&D. To get "megadrugs" flowing again, Merck has widened its scope of research from familiar targets such as cardiovascular disease to such areas as central nervous system disorders and viral infections. It is boosting R&D spending by 17% this year, to $1 billion. But perhaps most important, Vagelos is trying to weed out bureaucratic sclerosis in his labs. He is decentralizing management of R&D and providing huge new financial incentives for researchers. And increasingly, Merck is depending for speed in R&D on joint ventures with the likes of Du Pont Co.

BRAIN DRAIN. The shift in strategy is essential because Merck's R&D operations have become unwieldy. Until the mid-1980s, R&D did just fine with centralized management. As recently as 1985, when research chief Edward M. Scolnick took over R&D from Vagelos, Scolnick signed off on nearly all decisions himself, including which projects to pursue or shelve. And he closely tracked the work of all key scientists. But as Merck broadened its R&D targets and its research staff swelled by 40%, such micromanagement became unworkable.

Critics say the reins stayed tight too long, stifling creativity and slowing decision-making. Eventually, this drove out some crackerjack researchers, who have sought companies where they hope to make a bigger difference. Former top researchers and R&D executives jumped to Bristol-Myers Squibb, Rhone-Poulenc Rorer, Sterling Drug, and to such biotechnology outfits as Biogen and Vertex Pharmaceuticals Inc. Alan S. Rosenthal, a Merck veteran now running the U. S. research operations of Germany's Boehringer Ingelheim Pharmaceuticals in Ridgefield, Conn., says his goal is to replicate Merck's scientific excellence--but avoid its cumbersome structure. Adds Rosenthal: "It's hard to be entrepreneurial within Merck."

LOSING OUT. One effect has been to slow down work in the lab. As a result, Merck has recently lost several key races in drug development. Du Pont beat it to a so-called A-2 receptor antagonist, a potential blockbuster for treating heart disease and to another promising compound for treating the memory loss associated with Alzheimer's disease. Meanwhile, biotech companies moved ahead in genetic engineering techniques that Merck was slow to pounce on. For instance, startup Praxis Biologics Inc., now part of American Cyanamid Co., has beaten Merck consistently since 1985 in developing and refining a vaccine against a bacteria that causes meningitis in children and infants.

Merck is becoming increasingly dependent on "me-too" drugs for diseases that already are being treated with drugs from competitors, says Hemant K. Shah, a Merck marketing veteran turned industry analyst. Shah classifies 8 of the 13 drugs Merck has in the wings as these near-copycat compounds, including the calcium channel-blocker Plendil, which treats hypertension, and Venzair, which treats asthma. When these products hit the market, Shah adds, they will compete in crowded fields, practically ensuring only modest sales.

Vagelos argues that not all me-too drugs are bad. He notes that although the forthcoming drug Zocor is a follow-on to Merck's own cholesterol-busting Mevacor, it will expand a largely untapped market of 21 million potential patients, of whom only 2.4 million are treated because most don't know they have a problem. Moreover, he points out, megadrugs are increasingly hard to come by, since the easy disease targets already have been hit. And, he insists that Merck's labs are pursuing far more promising leads than have been disclosed--some of them "absolutely stunning in novelty." Those discoveries, adds Vagelos, will keep Merck performing in the top quartile of the industry when it comes to income and sales growth and return on assets.

STOCK OPTIONS. Still, Vagelos is on a campaign to root out R&D bureaucracy. Since mid-1989, research chief Scolnick has delegated part of his responsibility to two executives below him--one to lead basic research and the other development. Vagelos and Scolnick also are parceling out work to Merck's research sites more carefully, with the emphasis on avoiding duplication. Most work on treatments for respiratory ailments is now being done in Canada, and Merck has headquartered research into viral diseases in its Italian labs, where its experts in that field work.

Both R&D units and researchers also have been given more autonomy. Merck's Italian lab is responsible for both drug discovery and licensing products from the outside. "It's essentially like having a small company," says Vagelos. Going one step further, Merck has begun to break down each unit into project teams organized around specific disease targets or compounds. They take a compound from discovery or development through marketing, instead of just doing the early work and then handing it off to others. The aim is to give researchers a greater stake in the project. Says Vagelos: "It's important to have ownership."

He is putting money behind these words. Some 18 months ago, Merck introduced a stock-option program for researchers whose work leads to products. Key researchers now collect stock options as their drugs reach such milestones as filings for regulatory approval. Rasmuson, who labored on Proscar for 16 years, will be one of the first to profit: If that drug is the blockbuster that analysts expect, his low-priced options on 2,500 Merck shares will be a tidy reward.

FACE-OFF. Beyond all this, Vagelos no longer depends on Merck alone to come up with drugs. While other industry titans have turned to mergers to form such behemoths as Bristol-Myers Squibb and SmithKline Beecham, Merck is expanding through smaller deals. It hopes that modest, autonomous groups it has formed with Du Pont, Johnson & Johnson, and Sweden's 1,500-researcher Astra group will produce results faster--or at least spur Merck's own labs to greater haste. For example, Du Pont Merck Pharmaceutical, a joint venture, competes with Merck in research and sales of some drugs. And the smaller company's 1,500 researchers "come up with their own ideas as to what to work on," says Vagelos.

Merck's challenge isn't limited to research. Its salespeople no longer can master its full spectrum of drugs. So last year, the company split them into four teams, each focusing on separate segments of the product line that pitch doctors on sometimes-competing compounds. Even that system may soon have to change: Doctors are resisting the onslaught of multiple salespeople, says Joy Scott, chief executive of consultant Scott-Levin Associates Inc. What's more, later this year, when rival Bristol-Myers Squibb Co. starts selling itscholesterol-lowering drug Prava, Merck may have to put two teams behind Mevacor.

Still, the company's biggest challenge is getting its labs to turn out more drugs. In growing so fast, Merck has encountered a typical problem: It has won market clout but may have lost nimbleness. Winning its spot atop the heap wasn't easy. Now, staying there may prove even harder.