Saturday, March 28, 2015

Challenges for Merck's Venture in Weight Loss Management

In the week before Christmas, Merck announced (see here) that it was starting a weight loss business as a self-supporting enterprise. In the past, whenever pharmas launched businesses outside of prescription and non-prescription pharmaceuticals, they were typically "value-added" enterprises designed to promote one or more drug brands. In a few cases, pharmas ventured outside of drugs into fields such as diagnostics/devices where they could leverage their close relationships with leading physicians and various competencies developed through the drug business. But the more typical cases were those similar to the multi-billion dollar acquisitions of Pharmacy Benefit Managers (PBM) in the early '90s by Merck, SmithKline and Eli Lilly. These were essentially defensive efforts to protect the pharma golden goose from potential moves by payers to reduce drug payments.

Challenges for Merck's Venture in Weight Loss Management

In the week before Christmas, Merck announced (see here) that it was starting a weight loss business as a self-supporting enterprise.  In the past, whenever pharmas launched businesses outside of prescription and non-prescription pharmaceuticals, they were typically "value-added" enterprises designed to promote one or more drug brands.  In a few cases, pharmas ventured outside of drugs into fields such as diagnostics/devices where they could leverage their close relationships with leading physicians and various competencies developed through the drug business.  But the more typical cases were those similar to the multi-billion dollar acquisitions of Pharmacy Benefit Managers (PBM) in the early '90s by Merck, SmithKline and Eli Lilly.  These were essentially defensive efforts to protect the pharma golden goose from potential moves by payers to reduce drug payments. 

Merck claims their current move into weight loss services is unlike these earlier ventures because it seeks to genuinely diversify.  If so, that's a good sign, but the effort faces many potential challenges.

As a bit of background, Merck has long maintained a venture fund that, up until the last few years, contained $100 million for new acquisitions.  Its long time director was a Swede, Per Lofberg, who has since moved on to positions in private equity, pharmacy-PBM and other enterprises.  The central problem of Merck's investment fund was that its primary criterion required potential acquirees to demonstrate a capability for supporting the core pharma business. 

When growth, P/E ratio and other measures of pharma's stock market robustness began to decline during the past several years, Merck decided to increase this venture fund to $500 million.  Merck has stayed with its larger investment fund now that the market indicators are moving upward in spite of dubious fundamentals across the pharma sector.  While half the available capital remains committed to protecting the pharma business by augmenting the R&D portfolio, the other half, the Global Health Innovation Fund, looks for unrelated, health service businesses. 

Merck's venture into weight loss management can run in either of two directions and both face their own obstacles.  Despite the talk about "Pharma Plus" services that aren't tied to drugs, if the weight loss venture does fall prey to the old approach of trying to support Merck's business in oral antidiabetic pills, it amounts to making better buggy whips, electric typewriters and Walkman music players.

There is a strong temptation for that to happen in weight loss because Merck's largest therapeutic franchise is the Januvia line of oral diabetes products.  Falling back into that old pattern presents a problem because public and private payers are currently driving the oral antidiabetic drugs toward commodity status and applying increasing pressure to force down prices.  The situation in diabetes is substantially different now than it was ten years ago when several Big Pharmas took note of the rising incidence/prevalence and tried to enter that market.  The fact that pharma's new, oral diabetic products produced only negligibly better outcomes, even as the companies charged constantly higher prices for them, made payers reluctant to pay premium prices for new brands.

The pharmas that were capable of acknowledging this reality thereupon decided to get out of diabetes. For example, Roche had a GLP-1, a dual-PPAR and several glucokinase activators in their pipeline but exited diabetes three or four years ago.  Bristol-Myers Squibb stated last year that they would discontinue all diabetes R&D.  Then last month they sold their interest in a diabetes joint venture to pharma partner, AstraZeneca.  So if Merck is redoubling its commitment to Januvia with what amounts to using a service business as a line extension, their thinking must be exclusively short term or otherwise a rearguard action.

The path of true diversification, where companies seek a return on capital from self-supporting health services, makes sense for pharmas, given their trough of breakthrough innovation and the concomitant refusal by payers to support marginally different, new drug brands. 

If Merck is really taking this path, however, they do so with a different set of obstacles.  First, they lack competence in consumer businesses.  In previous years Merck acknowledged this and, in fact, they set up a joint venture with Johnson & Johnson to market prescription products that eventually received regulatory approval for consumer marketing and over-the-counter sales.  That venture withered away and Merck has shown no subsequent signs of enhancing its own acumen in consumer marketing.

Then there's the fact that Merck's hidebound processes may be acceptable in the glacially moving prescription drug business, but they doom enterprises in consumer packaged goods and other businesses where swiftness is essential.  At Merck and other pharmas, for example, middle managers need to obtain a dozen signatures and vetting by legal counsel before taking the most commonplace actions. 

Even the business of making and selling generic prescription drugs, because it is based on the time value of money, requires fast action and dealmaking.  Business there often resembles a boiler room operation.  The situation was well described by a former CEO at Teva, Shlomo Yanai, who was an Israeli army general before entering the drug business.  A reporter asked Yanai if it worried him that some Big Pharmas were considering entering the generic business.  "You can't take a Persian cat and educate it to become a street cat," he briskly replied (see here). 

Merck doubtlessly knows about its lack of consumer marketing capability and its lawyer-ridden, smothered-in-molasses pace of operations.  That means they will likely keep the operating management of their diet business at arm's length.  If they do, then the main problem of developing a business that is unshackled from pharma lies in the intrusive, soul-destroying role of finance/accounting as the corporation's goal-setter and scorekeeper. 

Finance/accounting determines the objectives for all operating functions at pharmas these days and their henchmen in departments such as Purchasing and HR carry out the implementing tactics.  

Merck is not unique to pharma in this respect and the destructive influence of CFOs running operations that cater to Wall Street pervades most sectors.  In Merck's case, one need only look at how the company responded to its 2013 first quarter earnings report to see that finance/accounting runs the show.  Last year's first quarter was worse for Merck than the same period of 2012.  Management responded by setting aside $15 billion for a stock buyback program, an amount that exceeds two years’ of total R&D spending.  Then they borrowed another $5 billion by floating a bond issue to keep paying high dividends.  

The sole purpose of both moves was to buoy up stock price, even if that meant taking money from the only functions capable of generating long-term growth and survivability.

In the second quarter of 2013, CEO Ken Frazier even reversed his earlier decision to grow or maintain Merck's R&D budget.  Two years earlier, when Pfizer and Sanofi decided to cut their R&D budgets, Frazier announced that Merck would maintain its R&D spending.  Cutting research, he proclaimed at the time, amounts to betraying pharma's historic mission.  Now it appears that the mission consists of catering to the short-term interests on Wall Street and, thereby, keeping current management in control.

Given this hegemony of finance/accounting, the looming danger is that Merck's CFO will inevitably point to the thinner profitability of a service business and cite it as a drag on net operating margins.  If /when that happens, pharma managements eventually follow the call to “unlock shareholder value” by dangling in front of investors the prospect of spinning off the service business to boost the stock price.  After the tease drags on for several quarters, the pharma companies then announce a return to their core drug business and jettison service ventures such as weight loss.

But these remain possible downsides and, perhaps, Merck will show more resourcefulness, thereby providing reasons for making this assessment more sanguine.  Seasoned operating managers such as Roger Perlmutter, Merck's new head of R&D, offer reasons to believe that the company's traditional culture of arrogance, not-invented-here and paralysis-by-analysis is fading. The challenge remains one of giving these new initiatives sufficient freedom from the deadening hand of finance/accounting.


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Daniel R. Hoffman, Ph.D. President, Pharmaceutical Business Research Associates
About this blog

Check Up covers regional health news and a wide array of healthcare topics from pharmaceutical happenings to patient safety. Read about some of our bloggers here.

Portions of this blog may also be found in the Inquirer's Sunday Health Section.

Michael R. Cohen, R.Ph. President, Institute for Safe Medication Practices
Daniel R. Hoffman, Ph.D. President, Pharmaceutical Business Research Associates
Hooman Noorchashm, M.D., Ph.D. Cardiothoracic surgeon in the Philadelphia area
Amy J. Reed, M.D., Ph.D. Anesthesiologist and Surgical Intensivist in the Philadelphia Area
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