Merck's Risky Bet on Research

In early January, not two weeks into his job as chief executive officer of Merck (MRK), Kenneth C. Frazier got word that a safety panel had shut down a nearly completed 13,000-patient study of an experimental drug. It was vorapaxar, a blood thinner touted as the prize jewel in Merck's pipeline. Some analysts had predicted sales could reach $5 billion a year.

Despite the setback, the litigator, 56, with just three years of operational experience at Merck, announced on Feb. 3 that the company was doubling down on new-drug development and plans to spend as much as $8.5 billion on research in 2011. That hefty sum vaults Merck to the top ranks of research spending worldwide, neck-and-neck with longtime leaders Pfizer (PFE), the world's biggest drugmaker, and software giant Microsoft (MSFT).

Stumbles like vorapaxar are, in Frazier's view, the price of doing business in the drug industry. "Scientific innovation is hard, it's complex, it's risky, it's uncertain as to timing," he says. "At the same time, we have huge opportunities. That's the way a company like Merck needs to exist in the world."

Raising the research ante is Frazier's response to an existential crisis facing Big Pharma. The well of innovation that led to dozens of billion-dollar drugs in the 1980s and 1990s has run dry. Merck, the second-largest U.S. drugmaker, is no exception. Sales at the company may drop 4 percent from 2011 to 2013, according to the average of 13 analysts surveyed by Bloomberg. The company faces generic competition in two years to drugs that generate a quarter of its $46 billion in annual sales, including its top-selling drug, asthma treatment Singulair. Merck's best hopes to replace those drugs are years away from hitting the market.

When Frazier announced the $8.5 billion research bet, Merck shares fell 2.7 percent. That's because research dollars spent today can take a decade to turn profits. Development of a new drug can cost as much as $1.3 billion. The cost is particularly high for the cholesterol pills, diabetes medicines, and vaccines that distinguish Merck's pipeline because they may be widely used and require more rigorous testing. The potential payoff, though, can be huge. Pfizer's cholesterol-lowering Lipitor, the world's best-selling drug, generated $10.7 billion in sales last year. "As CEO, I have the responsibility to make sure we make smart bets," says Frazier.

Frazier didn't follow the typical path to the top of a drug company. The death of his mother when he was 12 left him in the care of his janitor father, Otis, a man who "demanded excellence," says Clarence Cobb, Frazier's college roommate. After graduating from high school at 16, Frazier attended Pennsylvania State University. He told friends he would be a lawyer, inspired by civil-rights leaders and Supreme Court Justice Thurgood Marshall. Acceptance letters from law schools at Columbia, Stanford, Cornell, and Yale weren't enough. "He told me, 'I'm not happy until the Harvard letter arrives,'" Cobb recalls. "Of course, the Harvard letter arrived the next day."

At the Philadelphia law firm Drinker Biddle & Reath, Frazier built a reputation as an aggressive litigator. In his most famous case, in 1991 he and two colleagues took on the case of James Willie "Bo" Cochran, an Alabama man who spent about two decades on death row for murder. They won a new trial, and Cochran was acquitted in 1997. Frazier's work defending Merck in liability suits caught the company's attention; hired in 1992, by 1999 he was appointed Merck's general counsel.

In 2004, Merck's own research found that its blockbuster drug Vioxx, posting $2.5 billion in annual sales, was doubling the risk of heart attack and stroke. It was pulled from the market and thousands of plaintiffs filed suits claiming that Merck had withheld earlier research that showed similar risks. Frazier was faced with two options: He could follow the industry's longtime custom of settling tough cases quickly and quietly, or he could fight each case to a verdict—risking huge legal costs and courtroom failures that could tarnish the company's name. Raymond V. Gilmartin, Merck's CEO at the time, says that to Frazier the choice was clear: "We were fighting every case." It was a risky strategy, but Merck won 11 of 16 lawsuits at trial before agreeing in 2007 to establish a $4.85 billion settlement fund. At least two cases were later overturned, and more than 99 percent of plaintiffs agreed to settle. The final legal bill was about $7.7 billion—no small sum, but far less than the $18 billion Merrill Lynch (BAC) analysts had estimated.

After spending the next three years as head of Merck's human health business and as president, Frazier on Jan. 1 took the helm of a company with a pipeline of experimental drugs considered one of the riskiest and most promising in the industry. In cardiovascular therapies alone, Merck had four drugs each with the potential for more than $1 billion in annual sales, figured analysts.

The halt of the vorapaxar trial dimmed Merck's hopes for a clot preventer to rival the success of Plavix, which booked $9.43 billion in sales last year for Bristol-Myers Squibb (BMY) and Sanofi-aventis (SNY). In March, Merck walked away from a second blood thinner to treat heart-rhythm irregularities, betrixaban, after development fell behind competitors. Two weeks later, an 8,000-patient trial of a staph vaccine was suspended.

After taking a $1.7 billion write-down on vorapaxar, Frazier also withdrew Merck's 2013 earnings target, saying the company wouldn't be able to meet that forecast without shortchanging investments in researchsomething he's unwilling to do. Merck's compound with the most profit potential, a cholesterol pill called anacetrapib, remains on track. The drug raised so-called good cholesterol by an unprecedented 138 percent and reduced bad levels by 40 percent in a late-stage study released in November, positioning it as a possible successor to Lipitor. Results from final tests are years away. Explains Frazier: "If you're going to be in the business of breakthrough research, you have to accept that the timing can be uncertain and the risks are large."

The bottom line: Frazier will spend $8.5 billion on research this year—a huge bet, given that only 16 percent of drugs win approval.

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