Merck is expected to follow its manufacturing cost-cutting program with future initiatives that will impact sales, marketing and R&D and have a more significant impact on new product innovation and top-line growth.

The company is calling the changes to its manufacturing program the first step in a global restructuring effort. While Merck's manufacturing cuts were designed to yield billions of dollars in savings, the announcement only fueled speculation over how much more cost-cutting the drug maker will need, and be able, to undertake to return to consistent sales and earnings growth.

With Merck trying to recover from the withdrawal of Vioxx last year and facing a string of patent expirations - beginning with its blockbuster lipid-lowering drug Zocor in June - enhancing product innovation and commercialization of new drugs could prove to be the bigger hurdles that Merck needs to overcome.

"This plan represents an important first step in positioning Merck to meet the challenges the company faces now and in the future," CEO Richard Clark said of the manufacturing program during a Nov. 28 conference call announcing the plan.

A Taste Of More To Come...

Merck declined to comment on future cost-saving programs during the call, but hinted that additional plans would be addressed during the company's annual business briefing on Dec. 15.

"Certainly this is phase one, and obviously this started as I was the president of manufacturing, so this is the first phase that we're able to announce," Clark said.

The exec headed Merck's manufacturing operations prior to taking the helm in May; at that time, he announced that he would undertake a complete business review, which would include re-evaluating the company's traditional strategy of avoiding large-scale mergers (¹ Also see "Merck Taps Clark As CEO In Nod To Medco Heritage; Gilmartin To Retire" - Pink Sheet, 9 May, 2005., p. 14).

Merck is engaged in an ongoing effort to enhance efficiencies throughout the company, including a review of everything from discovery and development to manufacturing and marketing of medicines and vaccines, Clark told analysts on the Nov. 28 call.

The initial phase of the cost-reduction program is expected to yield cumulative pretax savings of $3.5 bil. to $4 bil. between 2006 and 2010. Approximately $2 bil. of the savings will come directly from the implementation of the new supply strategy by Merck's manufacturing division, the company said.

The cumulative pretax cost of the program is estimated to range from $1.8 bil. to $2.2 bil. through the end of 2008, when the initial phase of the restructuring program is expected to be substantially complete.

Job Cuts Total 13,000 Since 2003

As part of the restructuring effort, Merck plans to eliminate approximately 7,000 positions - or 11% of the company's workforce - both in manufacturing and in other divisions worldwide, by the end of 2008. About half of the reductions will occur in the U.S., Merck said.

The latest job cuts bring the total reduction in Merck's workforce over the past few years to roughly 13,000. The firm announced a headcount reduction program in October 2003 that resulted in the elimination of 5,100 positions and, in the third quarter, the elimination of approximately 825 positions related specifically to Vioxx.

The company also plans to close one basic research site and two preclinical development sites. Merck declined to provide details on which facilities would be impacted, but said they are expected to close by the end of 2008.

In addition, the company plans to divest or close five of its 31 worldwide manufacturing facilities and reduce operations at a number of other sites.

Merck's Lean Manufacturing Machine

Merck's plans to streamline manufacturing are designed to reduce the time it takes to launch new products as well. According to Manufacturing Division President Willie Deese, the implementation of lean manufacturing principles will reduce cycle time, inventory and manufacturing costs.

The program calls for the creation of a new commercialization organization that will operate under the manufacturing division, bringing together units from manufacturing and R&D.

"Under this initiative, Merck will create dedicated commercialization facilities that will support production needs from late-phase clinical trials through the launch phase," Deese explained. The goal of the program will be to cut 12 to 15 months from the time it takes to develop new production processes and manufacture launch supplies, he added.

"Implementing this strategy will make us more competitive today and it will enable us to launch the next generation of Merck medicines and vaccines with levels of speed and efficiency that will not only lead our industry, but put us on par with the best of all manufacturers," Deese said.

Merck's new supply strategy includes creating a global facility network that combines in-house manufacturing "with the manufacturing capabilities of key external suppliers," the company reported. Inventory levels will be reduced by $400 mil. relative to the 2003 level, "and we are planning further inventory reductions as part of the new supply strategy," Deese said.

Reductions Will Not Reach R&D Spending

Despite cost cuts and the planned closing of research and development sites, Chief Financial Officer Judy Lewent said Merck's R&D expense in 2006 will continue at the same level as in 2005. Merck's R&D spending in 2004 was 17.5% of sales, among the highest in big pharma.

Although the restructuring initiative aims to give the company a stronger foundation, attention remains focused on Merck's pipeline as the firm is expected to need new drugs to offset future losses.

Among Merck's near-term product candidates are three vaccines: the human papilloma virus vaccine Gardasil , for which Merck plans to file a BLA by the end of the year, the herpes zoster vaccine Zostavax and the rotavirus vaccine Rotateq . FDA's Vaccines & Related Biological Products Advisory Committee will review the latter two in mid-December (² 'The Pink Sheet' Nov. 28, 2005, In Brief).

Nonetheless, these vaccines are unlikely to offset the sales erosion Merck will face from generics. In addition to the loss of Zocor sales, the launch of simvastatin generics could impact sales of Vytorin (Merck/Schering-Plough's Zocor/ Zetia combination).

Merck's prostate cancer therapy Proscar (finasteride) also is scheduled to go off patent in 2006, while the osteoporosis therapy Fosamax (alendronate) could face generic competition as early as 2008.

M&A Shopping Cart: Products Or Firm?

One way the company could strengthen its product portfolio in the near term is through a merger or acquisition. At the time Clark became CEO in May, the executive said Merck's M&A activity would likely continue to focus on targeted acquisitions and licensing, but would employ a more aggressive approach.

An acquisition of a drug company could help Merck return to growth more quickly, Prudential Equity Group analyst Tim Anderson said in a Nov. 28 report.

"We have felt that there are probably decent targets in the mid-cap space potentially with some of the specialty pharmaceutical names," Anderson said.

Merck's "history in M&A, however, is a short one but given the company's cash position and earnings position, it may be time for [Merck] to break from this trend," he stated.

Continuing Liability Costs Remain Uncertain

In addition to the pending exclusivity losses, the outcome of ongoing Vioxx litigation remains another uncertainty for the company. Merck is facing thousands of lawsuits related to Vioxx. The company has so far not established a potential liability reserve related to the Vioxx litigation.

Vioxx hurdles aside, however, many of the challenges facing Merck, such as generic competition, increasing price pressures and drug safety issues, also are being felt by other U.S. pharma manufacturers.

Cost-Cutting Strategies Across Industry

Efforts to contain costs are extending across the industry. In April, Pfizer announced plans to undertake a cost-cutting program aimed at generating annual savings of $4 bil. by 2008 (³ Also see "Synergies Without The Merger: Pfizer Sees $4 Bil. In Cost Cutting By 2008" - Pink Sheet, 11 April, 2005., p. 10).

Lewent defended the extent of Merck's projected savings during the analyst call: "I would say $3.5 bil. to $4 bil. is a pretty significant number when you think about our revenue base and even actions in the peer group in which we operate."

Other pharma companies have concentrated restructuring initiatives on single business areas. Abbott said in July that it was eliminating 700 positions in its global manufacturing operations, while Wyeth announced plans to reduce its full-time primary care sales force of 2,500 reps by 25%-30%.

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