M&a Medco

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Case Analysis - "Merck-Medco" Maureen Hergert MGT 362 - SPRING 2004 Professor Steven Francis Case Analysis - "MerckMedco" March 7, 2004 Introduction. Merck & Company (Merck) was a pharmaceutical researcher and manufacturer while Medco Cost Containment Services, Inc. (Medco) was a pharmacy benefit manager (PBM). On November 18, 1993, Merck purchased Medco for $6.6 billion. Immediately after the merger, Medco operated as a subsidiary of Merck. In 1994, MerckMedco was formed. 2 Grant states that corporate strategy involves decisions that define the scope of the firm. In addition, he states the importance of vertical integration as it has caused companies to redesign their value chains within their organizational boundaries. 1 The acquisition of Medco by Merck is an example of Merck expanding its organizational boundaries while at the same time adding value. Merck added value to its operations by purchasing Medco. Pharmaceutical companies operated in a relatively stable environment that was characterized by solid profits and minimal pressure. Different organizations whose processes and values are a close match with the new task. * Try to change the processes and values of the current organization. * Separate out an independent organization and develop within it the new processes and values that are required to solve the new problem. 6 These alternatives and their ramifications are discussed below. Alternative #1. Acquiring an organization with the competency of pharmacy management to add to Merck's value chain is an option. This option is attractive due to short-circuiting the process of developing new, but time-consuming processes. Over the past few years, there has been increasing pressure to expedite the drug approval process and for manufacturers to increase the yield from their research and development activities. Taking into account these pressures and Merck's primary business being drug manufacturing, the acquisition of a PBM will be the quickest and most effective manner in which to acquire pharmacy management competencies. Yet, acquiring companies face difficulties in acquisitions, such as the integration of the acquiree's capabilities with its own. Alternative #2. Rather than acquiring or buying the pharmaceutical benefit management competencies of Medco, developing individual competencies, expansion of research and development, and establishment of closer relationships to customers is an option for Merck to consider. Grant says, "...one approach to capability development is to develop the human resources required for a particular capability." Yet, he states that developing human resource competencies can be effective in maintaining and developing existing competencies, but is limited in forming new capabilities. 1 Due to the highly competitive and time-to-market issues of new drugs, this option is not advisable for Merck. Development of new drugs and getting them to market is critical for remaining competitive in

the pharmaceutical industry. Alternative #3. Creating new capabilities may also be obtained through a spinout organization. Merck realizes that its resources and capabilities are insufficient to rapidly move into the pharmacy management area. Most of its resources are devoted to drug research and development. Christensen states that spinout organizations are appropriate when a separate organization is required when the mainstream organization's values are incapable of devoting resources on the new processes or innovation. 6 Furthermore, he states that spinouts should only be used when a threatening disruptive technology requires a different cost structure or when the current size of the opportunity is insignificant relative to the growth needs of the main organizations. Neither of these criteria is relevant to Merck. Services provided by PBM organizations are not disruptive to drug manufacturers. They may be considered as value-added to drug manufacturers. In addition, the size of the opportunity by...
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