Merck At Risk

From the late 1980s through the mid-’90s, under CEO P. Roy Vagelos, Merck & Co. was the undisputed king of the pharmaceutical industry. It pioneered groundbreaking drugs for cholesterol and hypertension, topped all rivals in sales and was named America’s most admired company by Fortune seven years in a row-a record still unmatched.

Today, although Merck remains a powerful company, no one would call it the king of anything. It has been unable to come up with blockbuster products to replace its five big-selling drugs, which recently lost their patent protection. Turnover has reportedly doubled, while morale has sagged. Archrival Pfizer is now the world’s largest drug company and Wall Street’s darling.

A number of factors-including plain bad luck-contributed to Merck’s slippage. Among them were two management decisions that had the unintended effect of stifling research: the move to a new headquarters and the choice of a new CEO. But to understand what went wrong, it helps to understand first what Roy Vagelos did right.

In 1975 when Vagelos arrived at the old red-brick plant in Rahway, N.J., then Merck’s headquarters, the great labs that had produced streptomycin and cortisone and Vitamin B2 were far behind in the newest molecular research and had little in the pipeline. He revamped the research operation, bringing in hundreds of new scientists, creating a managerial fast track for them, modernizing the labs and focusing on categories such as cardiovascular treatment and his own specialty, cholesterol. Vagelos sought and found, he says, “better people who wanted to work in drug development.” In his first five years as head of research, from 1976 to 1981, he increased the research and development budget an average of 17.2 percent a year, up from just under 2 percent annually. He set up a program to ensure that half the new hires would come directly from universities and interviewed many of them personally. Even after he became CEO, Vagelos would meet with the senior scientists who were hired, and often reviewed clinical results.

Like George W. Merck, son of the company’s founder, Vagelos wanted the labs to have the feel of those in a university. He made publication in academic journals a criterion for senior promotions. He gave scientists time to work on their own projects. “There was incredible freedom to think and to explore new ideas,” says Alaina Love Cugnon, a researcher in immunology at Merck in the early ’80s.

One reason Vagelos inspired the troops was that he met so many of them directly. He ate regularly in the company cafeteria, even chatting with union workers-some of whom, after all, had probably been his high school classmates. As chief of research, and even for a while as CEO, he drove his own Honda to work. If he needed information, he went to whoever might have it, grabbing managers he saw in the hallway. Merck was, in many ways, made in Roy Vagelos’s image: intense, driven, loyal, scientifically brilliant, collegial and arrogant.

His intensity never waned. At dinner parties, Vagelos’s social conversation consisted of asking other Merck people what they thought of some news item related to the industry. Three weeks before he retired in June 1994, Vagelos and his wife, Diana, flew to Lyon, France, to help marketing executive Boyd Clarke officially launch a joint venture for vaccines with what was then Pasteur Mérieux Connaught. With the clock winding down on their tenures, “a lot of people might be doing victory laps,” Clarke points out. But Vagelos wasn’t letting go. Throughout the 40-minute drive from the airport, “he worked me over-how I needed to manage this organization, how I needed to control the headcount, how I needed to control the assets, how I needed to work it to make sure the kinds of standards we were used to were done.”

As Fortune kept anointing Merck the most admired company in America year after year, from 1987 to 1993, employees came to expect the accolade, but also felt almost panicked about maintaining it. It made even Vagelos edgy. “After we were €˜most admired’ two years in a row, you start saying, €˜Oh my God, what if we’re not most admired [next time]?’ ” he says.

Of course, Vagelos made his share of mistakes. His acquisition of Medco Containment Services, a pharmacy benefits manager, has mired Merck in lawsuits and bad publicity. And his decision in 1992 to relocate executive and marketing functions away from the complex in Rahway may have had even greater consequences.

A new home for Merck

Except for the ID check at the security gate, visitors can almost stumble onto the Rahway property without realizing where they are. The Merck facility sits right on Route 1-9, with World Wide Auto, Dinettes Beautiful and Murphy’s Towing on one side and a row of vinyl-sided houses on the other, anchored by a McDonald’s on the corner. Inside, it’s like a small city-Merck folk liken it to a college campus-with a population of 4,700 on 250 acres of one- to three-story office buildings, research labs, manufacturing plants, parking garages, a power plant, a health club, a fire station and lawns with picnic tables. The thoroughfares are named Seventh Street, Avenue A, Gadsden Avenue-in honor of a former CEO. No one wears a jacket and tie, not even plant manager Larry Naldi.

To researchers, one of the glories of Rahway is the collection of brainpower and facilities all in one place – from production lines to chemistry labs to animal testing. Not only does Rahway house all that research, but for many years global marketing, the executive offices and some manufacturing were also jammed in with the scientists and lab rats. There was, inevitably, the kind of socioeconomic mingling that occurs in a pedestrian city. Because car and truck traffic were strictly limited, vice presidents as well as factory workers had to hoof it between buildings. “You’d see the CEO walking down the hall, you’d say €˜Hi,’ ” recalls Guy Fleming, president of Local 2-575 of PACE, the Paper, Allied-Industrial, Chemical and Energy Workers International Union, the largest of Merck’s labor groups. Keith Elliston, who headed Merck’s bioinformatics research in the 1990s, says that with all the stopping and chatting, it could take two hours to walk across the plant.

Then, in 1992, Vagelos moved global marketing and the executive headquarters 20 miles west to Whitehouse Station, in New Jersey’s upper-crust horse country, a world and in some respects a century away from Rahway.

Instead of vice presidents and janitors, wild turkeys and deer wander through Merck’s 1,000 acres of trees, lawns, ponds and rolling hills. The access road takes its time winding up the hill from Route 523 to the security gate. Inside the main building, White-house has the serenity of a monastery and the luxury of a presidential suite. It is built around a five-story central atrium, with hand-woven tapestries mounted on the walls from countries where Merck has had some presence. The dark wood of the banisters and furniture is smooth and thick. No expense was spared. Frank Lichtenberg, a finance professor at Columbia Business School, remembers going out to the new headquarters on its second day of operation. “They hadn’t figured out how to open the doors, it was so high-tech,” he recalls.

Trouble is, people at Merck hate it. They call it “the mountaintop,” a place where everyone wears suits and ties and no one meets in the halls-the antithesis of Rahway. “Whitehouse reminds me of going to a wake sometimes,” Guy Fleming grins. Some say the move also has had repercussions-bad ones- for Merck’s new products pipeline. With top management no longer bumping into scientists as a matter of routine, there’s a lot less batting around of ideas.

Choosing a successor

In 1994, President Clinton’s health care reform plan seemed to augur a future of increased control by government and managed care. So, with Vagelos facing mandatory retirement at age 65, Merck’s directors decided that the next CEO should have experience dealing with managed care-type institutions.

However, their choice, Raymond V. Gilmartin, lacked other crucial experience. He walked into the top job in June 1994 with at least three strikes against him. First, unlike every predecessor going back to founder George Merck, he was an outsider. He hadn’t spent a single day working at the company; he didn’t have the network or know the corporate culture.

Second, he was the choice of the board, not Vagelos. For that matter, he was at least the second choice: Vagelos had been grooming a “dream team” of insiders, including executive vice presidents Jerry T. Jackson, Francis H. Spiegel Jr. and John L. Zabriskie, as well as the presumed heir apparent, COO Richard J. Markham. It was only when those plans fell through, and Markham left abruptly for never-explained “personal reasons” after less than a year as COO, that the board looked outside.

Finally, unlike Vagelos, Gilmartin wasn’t a scientist; he wasn’t even from the pharmaceutical industry. He was a Harvard MBA.

True, Gilmartin had worked for 18 years at Becton Dickinson and Co., a manufacturer of medical devices and diagnostic systems, rising to chairman, president and CEO. But to people bred in the pharmaceutical industry, medical devices companies are a lower order of being. A Lou Gerstner may jump from Nabisco to IBM, or a Paul O’Neill from International Paper to Alcoa, but the pharmaceutical business is so technical and complex, so dependent on knowing the regulatory ropes, you really have to come from inside to handle the top job effectively, management experts say. “Maybe if they’ve served on the board of directors for a number of years”-which Gilmartin hadn’t-“and they’re very bright, they might be able to switch industries,” muses William W. McCutchen Jr., an associate professor at Baruch College’s Zicklin School of Business in New York. “I think it would be extraordinarily difficult.”

Still, if Gilmartin inherited a bad hand, he also played it poorly. For one thing, he increased the layers of bureaucracy, adding a superstructure to the research teams Vagelos had created. Called worldwide business strategy teams, they consist of people from the manufacturing, marketing, regulatory and research sides, possibly joined by others from finance and public relations. Group members are expected to work with each other from the very earliest research to develop long-range strategies. But trying to coordinate so many players from such different cultures easily leads to turf wars, culture clashes and new layers of bureaucracy.

In the old days, if a scientist had a new idea, “it would have been a couple of people and you’d argue your case,” says Al Alberts, former biochemical regulations chief. Now the scientist has to wait for the strategy team’s monthly meeting and prepare a formal presentation. “If the genesis is in a committee, a project will tend to get squashed,” says former international and vaccines executive Simon Benito.

To submit a business proposal in the Vagelos era, one had to include tremendously detailed criteria and get sign-offs and approval from a host of sources, including the CEO, Benito recalls. Gilmartin eliminated a lot of the paperwork, but also introduced all sorts of other committees and processes, which probably had a more paralyzing effect on the organization. “People felt that they needed to get someone’s written approval to make sure that the top management was on board,” says Benito. “At least under Vagelos they already had the sign-off.”

Gilmartin’s personality and management style also had the effect of slowing things down. Because Vagelos was so accessible at Rahway, it was easier to get an informal approval for a business proposal. “You would see him almost every day in the cafeteria and may have joined him for lunch, during which he would let you know how he felt about your project,” Benito points out. “If he said okay, you knew you could go ahead.” But Gilmartin doesn’t hang out at the cafeteria. “Employees seldom see him and therefore feel that they do not know him,” Benito says. “Consequently, they are afraid of taking risks in case they make a mistake.”

But if it is no longer Roy Vagelos’s Merck, that doesn’t necessarily mean it can never again be a great company. The drug business is notoriously fickle. All it takes is the next set of test results or the next edict from the U.S. Food and Drug Administration-maybe on Merck’s new cholesterol drug or its cervical cancer vaccine. What matters is whether Merck still has the brainpower in its labs and the fire in its belly.

Adapted from Fran Hawthorne’s new book, The Merck Druggernaut: The Inside Story of a Pharmaceutical Giant (John Wiley & Sons).