The Business Enterprise Trust 9-gg1 -021

fltlerek & Co,, lnc, (A)

This case wss researchcd and
tmittcn by Daoid Bolliq md
adopted by St"phanie Weiss,
wrd-er tlu supercisbn of
K*k O" Hanson, settior lecfurq
at tlu Star{ord Graduate Sclool
af Businss"
n 1978, Dr- P" Roy Vagelos, then head of the Merck research labs,
I{ received a Provocative meuiorandurrr from a serrior researcher in
parasitology, Dr. Willia:n C. Carrpbetl Dr. Cagrpbelt had made an
iottigting observation while working with iver:nectin, a new
artEparasitic compound trnder investigation for use in animals.
Cartpbell thought that ivermectin rnight be dre answer'to a disease
call ed riv er blindness that plagred nillions in the Third World. But
to
find gut if Campbell's hlpothesis had merit, Merck would have to
spertd srillions of dollars to develop ttre right fo::nulation for hrqnarr
use and to conductthefield trials in themostreuroteparts of theworld-
Evenif these efforts produced an effective and safe drrg virtuallyall of
those afflictedwithriverblindness couldnot afford to buyiL Vagelos,
origirnlly a r:rriv ersity rese archer bu t b y then a Mercl< exectrtive, ha d. to
decide whether to investin research 6or a drrg that, evenif zuctessfuI,
might never pay for itself.

River Blindnass
River blindness, forrnally known as onchocerciasb, wds a d.isease la-
beledby the Worldllealth Orgartization (WHO) as aprrblichealth and
socioeconomic problern of corrsiderable magnifud'e in over 35 develop
ing corrrrtries ttuoughout the Third World. Some &5 mrlllion people in
thousands of tiny settlenents throughout Africa and par1s of the
Middle East artd I-atin Amedca were thought to be at risk The cause
a Parasitic worm carried by u tiny black fly which bred along fast-
moving rivers. When the flies bit humans single person could be
bitten thousands of times a day the larwae of a parasitic wo1jar,
-
Onchocerca. ooloulus, entered the body,

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lhese worms greq/ to nnore than trvo feet in
leng ttr,
ca using gro tesque b u t rel atively inn ocu o us
nodules in the skiru The real harnr began when the
adult wonns reproduced, releasing milIions of
microscopic offspring, known. as microfilariae,
r,t'hich sn armed through body tissue. A terrible
itching resulted, s bad that some victims- corrr'-
rritted suicide. After several years, the microfi-
lariae caused lesions and depigmentation of the
skin. Eventually th"y invaded the eyes, often
causingblindness.
The World Health Organization esrimated in
Lg7 8 dra t some 340,000 people were blin d becau s e
of onchocerciasis, and thata nillionmore suffered
from varying degrees of visual impairmenl At
that time, I 8 mil[on or rnore people were infected
with the parasite, though half did nor yet have
serious slrnptonls- In some r.illages dose to fly-
breeding sit'es, nearly all residerrts \A'ere infected
and a majoriry of those over age45 rvere blind. In
such places, it was said, children bdieved that
*vere itching, skin infections and blindness were
simply pafr cif Fowing up.
' In desperate efforts to escape'the flio, entire
villaggs abandoned ferdle areas near rivers, and
moved to poorer land. As a result, food shortages
n'ere frequenL Corrrmuniry tif" disfortegrated as
new burderrs arose for alrp^dy impoverished
.fa:rdlies.
The disea-se was firstidentified in 1893 by scien-
tise and in L926 rvas found to be related to fhe
black flies. Butby the l97}.s,there rvas still no cure
rhat could safely be used for cosununiry-wide
' frea tm ent. Two
dru gs, die thylcarbamazine (DEC)
& Suramin, lvere useful in killing the parasibe, but
both had severe side effects ininiected indir.idu-
als, needed close monitoring, and had even caused
deatlrs. Irl 7974,.the onchocerciasis control pro-
gram was crea ted to be adnrinistered by the World
Health organization,'in the hope drat the flies
could be killed through sprayrng of larv'acides at
breeding sites, but success was slol and uncer-
tain. The flies in manv areas developed re;.istance
to the treahnent, and rl'erealso knonrn to disapFlear
and then reinfest areas.
Merck & Co., fhc.
Merck & Co., Inc- ws, rnLgZ9,one of the larges t from ?2,2AA ten years earlier. Ffuman and animal
producers of prescription drugs in the world.
Fleadquartered in Rahway, Nen' Jerse/, Merck
.,:
!
traced its origiru to Germany i:.r L668 rvhen
FrieCrichlacob Merck purchase.a an apothecary in
the city of Darms'tadt. Over three hrrndred years
later, Merck, huring become an American firrn,
employed over 28,000 people and had operations
aII over the world.
In thelate l970s,Merck was comin goffa 10 year
drought in tersrs of nerv products. For nearlv a
decade, the compary had relied on tn'o prescrip-
tion drugs for a significant percentage of its ap
proximately $2 billion in annual sales: Indocin, a
Eea trnmt for rheumatoid arthritis, and Aldomet,
a treatment for high blood pressure. Henry W.
Gadsden, Merck's chief executive from 1965 to
L97 6, al on g r+'ith his su ccessr, I oltn J . FJoran, were
concerned that rhe L7-year patent protection on
Merck's two big moneyrrulkers would soon ex-
pire, and beganinvesting an enonnous amountin
rssearclr
Merckmanagement spenta great deal of money
on researchbecause it knew that its success ten and
twenf;r years in the future critically depaded
upon present investnnerrts. The cornlnny delib
eratell'fashioned a corporate culture to nurture
the most creative, Fuitrrrl researcl'r- Merck scien-
tisE wereamong thebet-paid in the industry,and
were given great latitude to purnre infrigutng
leads. lvloreover, they r*'ere inspired to think of
their H'ork as a quest to alleviate hurran disease
and sufferin g world-wdde. Wi thin c ertain propri-
etaqy consfiaints, resea rchers were encouraged to
publish in acadernic journals and to share ideas
wi th their scienti-fi c peers. Nearly a billion dollars
was spent between Dre and lg7i,and the invest-
srent paid off. In that period trnder the direction
of head of research, Dr. P. Roy Vagelos, Merck
introduced clinorit, a painkiller for arthritis; a
general antibiotic called Mefoxin; a dtrg for
Blaucoma named Timoptic; and Ivomec
(iveirnectin, MSD), an antiparasitic for cattle.
In 1978, Merck had sales of $1.98 billion and net
income of $307 urillioru sales had rlsen steadily
befween 1969 and r978from$691 rnillion to almost
$2 bitlion, Lncome during the sanne period rose
from 5106 million to over $300 million. (See Ex-
'hibit 1 for a 10 year summary
of performance.)
At that time, Merck employed 28,7 A}people, up
health products constitu ted }4"/.ofthe compan/s
sa1es, with environmental health products and
 services represerrting al additional 14% of sales.
Merck's foreign sales had growr:r more rapidly
during the 1970's tJran had domestic sales, and in
L978 rqpresented 47% of total sa1es. Much of the
company's research operations were orga:rized
separat*ly * the Merck Stra{p &Dohme Research
Laboratories, headed by Vagelos. Other Merck
opcations induded the Merck Slu{p & Do}rme
Division, the Merck Slurp & Dohsre International
Division, Kelco Division, Merck Chemical Manu-
factrrring Division, Merck Animal Health Divi-
sion, Calgon Corporation, Baltimore Aircoil
ConrpilI, and Hubbard Farrrs.
The company had 2a ptants in the United States,
induding one in Puerto Rico, and 44 in other
o counties- Six research laboratories were located
in the United States and four abroad.
While Merck exectrtives sornetimes sqpirmed
when thuy quoted the "Lmbusinesslike" language
of C'eorge W. ldercl<, son of the company's founder
and its forrner chaimarr' there couldbe no doubt
that Merck errployees found the words inspira-
tiornl'1ffe trynevir to forget that medicine is for
the people," Mercksaid-'It is not for the profits.
iflre profie follow, and if we have resrembered
that" thuy have neverfailed to appear. fhe better
we have remesrbered it, ttn larger they hav ebeen- "
These words forsred the basis of Merck's overall
corporabphilosophy.
The Drug lnvestment Decision
Merckinvestedhundreds of millions of dollars
each year in research Allocating those funds
arnongstvarious proiects, howevet, wa5 a rather
involved and inexact process. At a.company as
l*ge as Merck, there was never a single methodby
which pro!.lce were approved or money dishib-
uted-
Shrdies showed that, on the average, it took 12
years and $20O million to biing, a neiw drug to
"
markel Thousandsof scientisbs were continually
working on new ideas and following new leads-
Drrg d.evelopmerrt was always a matter of hial
"and eror; with eachnlw ihration, scientists would
"ciose som,e doors and open others. Wherr aMerck
. researcher came across an apparerrtbreakthrough
in an uneq)ected direction, or as a deriva
-tiv either
e of the originat lead he or she would conduct
-
prelininary researclr- If the idea proved promir
ing, it was bro--ught to the attentiqn of the depart*
nnent heads"
Every y"N, Merck's research division held a
large review meeting at whidr all research pro-
grams were exasrined. Projecb were coordinated
and consolidated, established programs were re-
viewed and new possbilities were consideted.
Final approval on research was not made, how-
ever, urttil the head of research met later with a
comrrittee of scientific advisors. Each potendal
program was extensively reviewed, analyzed on
the basis of the likdihood of success, the existing
urarket, competid.on, potential safety. problems,
nranufachrring feasibilig. and patent status before
the decision was made whether to allocate frurds
for c ontinued experimentation-
The Problern of Rare Diseases
and Poor Custorhers
lvlany poterttial drugs offered little chrance of
financial return- Some cliqgases were so rare that
treatrrrerrts developed could never be priced high
enough to recoup the invesherrt in research, while
other diseases afFlicted only thepoorin nrraland
resrote areas of the Ttdrd World. These victi:rls
had limited ability to pay even a small arrtount for
drugs or treahenl
In the United States, Congress sought to encour-
age drr.g conrrpanies to conduct reseaicfr on rare
di,*eases. In 1978 legislation had been proposed
which would BFant drrg conparries tax bene6ts
and sesen-year exduuive marketingtightt if thuy
would manufa'cture dnrgs for diseases affl;cting
fewer than 200,000 Americans. It was expected
that thls "orphan drr'g" progran would evenfr-
ally be passed into ldw.
fhere 'was, lroweyer, no IJ.S. or international
progran that would create incentives for coalPa-
" nies to dev"lop dnrgs for diseases Uke riverblind-
ness which aFflicted millions of the poor in the
ThirdWorld. The only hopewas that some Third
World. gov errrrn ent, f or-rn d a tion, o r interna tional
aid organization might step in and partially f':nd
the distribution bf a dn.g thablrad already beerr
cieveloped-
The Discovery of lvermectin
The process of investigating promising drug
compounds was always long, laborious and
fraught v/ith failrrre. For every phararaceutical
compound that beca-me aJproduct carrdidate,"
3
thousands of others Fa,iled to meet the m-ost rudi*
mentarl'preclinical tesfs for safety and efficacy"
With so much roolrr for failure, it beca:ne espe'*
cially inportant for drug companies to have so-
piris tica ted res ear ch n'r ana g e rs w ho co ul d i d en tify
'the mostproductive research strategies. '
Merck had long been a pioneer in developing
maj or new antibiotic comp ounds, b eginnin g with
penicillin and sheptomycin in the 1940s. In the
7970s,Merik Shury & Dohme Research Laborato-
ries iverecontinuing tLis hadi.tion. To help inves-
tigate for ner,v microbial agents of potential
therapeutic value, Merck researchers obiained 54
soil samples from the Kitasato Instihrte of ]apan in
1974. These sampled seemed novel and the re'
senrchers hoped they might disdose some natu-
rally occurring anft io ti cs.
As \{erck researchers methodically put the soil
through hundreds of tests, Merck scientists rru'ere
pl eas an tly su qprised to detect s trong antiparasitic
activity inSampleNo. O$ls3,ascoop otsoil drg
up at a golf course near lto, Iape The Merck labs
quickty bro ught bgether aninterdisciplinary tearn
to bry to isolate a pure active ingredient frorn the
m-icrobial culture- The compound evenflrdly iso-
la ted -,-- avennectin prov ed to hav e an as tonish-
irgpo -
tency and. effectiveness agairrs t a wide rzrnge
of parasites in cattle, swine, horses and other ani-
mals. Within ayear,the Merck teasr also began to
suspect that a group of related compounds dis-
coveEedin tlte same soil sautple could be effective
agairrst narry other intestinal rvorms, mites, ticks
and insects.
After toxicological tests suggested th3t
iversrectin would be safer than rela hd cornpoun d s,
Merck dedded to d.evelop the substance for the
aninnal trealth marke t In I97 8 the first iv errrrectin-
based *,imal'd* & fvomec, was n&ariog uppro v aI
by dtu U5, Departmen t ofAgricultr:re and forei gn
regulatory bodies. \{any variations would likely
follow: dn.gs for sheep and pigs, horses, dogs"
and ot{rers. Ivomec had the potendal to become a
*uio. advance in animal health treatment-
As clinical testing of ivermectin progressed in
the Ia te 797As, Dr. William Campbell's ongoing
r ese arch brou ght him fa ce- to-fa c e with an ihtrigu-
it g hfpothesis. [v elsrectin, n'hen tested i n h ors es,
was effective againstthe microfilariae of an exotic,
f,enrly unimportant gastrointestinal parasite,
Onchocerca cervicalis. This particular wonn, n'hile
harrnless in horses,'f,aa characteiistici sinrilar to
the in-.idiow human parasite 'r-hat causes river
blindness, Onchocerca v o1v ulus.
Dr. Campbell wondered: Could iverrnectin be
formulated bo work against the human parasite?
Could a safe, effective drrg suit:ble for com:nu-
nity-wide treatrnertt of river blindness be deve!-
oped? Both Ca:rrpbell arrd Vagelos kne*' that it
lvas very mugh a ganrble that it would sucieed.
Furthermore, both Iqew that even if success lr'ere
attained, the econornic viabili V of such a project
rvould be nil. On the other hand, because such a
significant arnount of money had already been
invested in the developurerrt of the animal clrug,
the cost of d ev el oping a hu man formula ti on would
be much less than that for developing a new
compound. It n'as also r+'idely beJieved at this
point that ivermecdn, though still in its final de-
vel oprn ent s ta ges, lt,as likuly to be verv successf ul.
A decision to proceed vn'ould not be rrithout
risks. If a new deivative prbved to have any
adverse trealth effects rrvhet used on humans, its
reputation as a veterinary dnrg could be tainted
an d sal es nega 6vely affec tcd, no ma tter how irrel-
evant the expgrience with humans. In eafly bests,
iverrrrectin had had some negative side effects on
somespecificspecies of mamrnals." Dr. tsrian Drrke
of the Arrned Forces Institute of Pathology in
Wa^shin gton, D.C. s4id the cross- sp ecies effe'ctiv e-
ness of antiparasitic dn gs are urrpredictable, and
there is "always a h'orry that sorne race or sub
section of the hurnan population" might be a.{-
versely affected
Isolated instances of harm to humans or im-
proper use in Third World settings might also
raise some unsettl.ing questions: .Could drrg
residues hrrn up in meat eaten by humans? Would
any hu::ran version of iversrectin disbibuted to
the Third Worl d b e di verted int o the bla ck marke t,
undercuttirgsales of the veterina.ry itrug? Could
the drugharm certain animals in unknowrrways?
Despite these risks, Va gelos wondered what the
innpact mi gh t be of turning down Campbell's p ro-
posal. Merck had built a rearch team dedicated
to alleviating human zuffiering. What would a
refusal to prrrsue a poss$le treatment for river
blindness do to morale?
Ultimately, itwas Dr. Vagelos who had to make
the decision whether or not to fund research to-
ward a heaturent for riverblindness"
 MercJc and Co.,lnc" (A)

Exhibit I 10 Year Sum:rrary of F'inancial Perfonnance

Merck & Co:, [nc. and Subsidiaries

(Dollar a:nounts in thousand,s except per-share figures)

Resulg for Year: a97g L977 t976 t975 L974 t973 l97Z t97l L970 19

Salgs o.. - o........... s1,981,44O ltxZ4,*10 $155L1L7 51,401,979 tt,260,{16 9tJO4"035 Sg4'',ASt $832,{116 $761,109 $691
Materials and production costs 744,219 552,703 596,963 525,E53 459,937 383,979 3:4,5A4 286,646 256340 232
Marketin g/adminis tra tive
exPenses .. -.. 542"186 437 579 396,975 35{,525 330,2;92 3O4,gA7 268,855 219,005 201^5{3 L7E
Res earcVdevelopment expenses 161,350 1{4.S96 133"925 121,933 1OO,95Z 89,155 79,692 7l-,6t9 69 2O7 61
Interest expense -. ... , . 25,743 ?5,743 z5,gl4 zLSLg 8,{{5 6,703 .1J33 3,085 2,964 t
Income before taxes . .. - 5A7,gl2 453,497 416,{39 378349 361.990 319,{91 2;74X46 252,061 ?.28,555 zLi
Taxesonincome .--..:- 198,100 173J0O 159,100 t47,70O 149J0O 134,0{8 121,Oil{ 11E,703 LOE,8Z7 105
Net incomet r 307 .534 'r77 S?S 25s,482 ?,?,8;778 210,{92 182681 151,180 131.381 1L7,878 10(
Per com:non share" . . l4-Ot $s.dz $33S $r.Or SZ.7s $2.{3 $zo1 sL.75 $157
(
i

Dividends dedared on
comrnon stock 732,,257 117,101 107JE{ 105J64 106J41 93,SSZ 8{,103 822A6 7 6,158 7:
''' - F-r romrnnn ghaic SLJS S15s sl.{Zti - 5.1.{o 51.{O s1-231/1 $1.12 51.10 sl.OZtA !
' Gross plant additions 155,853 777
"167
153,894 2{9,015 159,1{6 go,1g4 69,4n 67 )iJ 7:; it 4t
Depreciation 75,477 66:ZAS 58,1gg 52,091 46,057 40,617 36,283 32,10il A,ELg t,
Year-End Position:
Working capital ..... -.. ... . 66 6,8!7 629-5t5 ilg"alo sozz6z 359J91 3{2"{34 2;96378 250J50 226,08{ 72
Property, plant, and
, .equipment(net) .,t.oo 92l,!79 846;784 7 47 ,aO7 652,g04 459,245 352,1,{5 305,{16 27 4240 239,638 L9
Totalassets.-.. 2,35I,359 l,gg3 389 L,759,37L 1536,999 7213257 968,9E5 834,847 736-5O3 .664291 60
lsto.kholders'eguity
.-.. 1,455,I35 L277,753 1,102,15{ 949,99L E?2,7 g2 7A9,6t4 62lJ92 s42,978 {93:U {5

Year-End Stafistics:
Average nurnber of comrnon
shares outstanding
(inthousands) ....... 75,573 75,546 75,493 7 S,4ZO 75.3OO 7 5,193 7 s,Ola 7{,S50 74,85A 7

Number of stockholders 62,900 53,goo 63500 63JOO 61,{OO 5o,o0o 58,000 5{Joo 5{,600 s
Number of emptoyees . .. . -. . 28,70a 26,100 26,800 . 26,300 z6JO0 zs,Loo 24,100 t3;300 z3,oco I

'The abovc data are as prcviously reported. restalcd for poolings-of-intcrestsand stock sptits.
raNct income for 1977 and related per- share amounts exslude gain on disposal of busincsscs of $13.225 and l8l, respectively.