Pfizer vs. Merck and the Future of R&D

Two brand new CEOs take very different approaches to address the same problem: what to do about unrealistic expectations for growth in 2012. The different strategies chart different courses through a stressful period. We've seen this debate before, and it is hard to argue that either company prevailed last time around.

Pfizer and Merck begin 2011 with brand new CEOs and not a whole lot else in common.

Merck's new CEO, Ken Frazier, took over the reins as part of a planned succession on January 1. Ian Read took over as CEO of Pfizer much more suddenly, when Jeff Kindler resigned abruptly in December.

Both faced essentially the same challenge as 2011 began: how to deal with unrealistic expectations for growth in 2012.

By now you know the story. Pfizer's Read responded by acknowledging that revenues would not meet expectations, but pledged that earnings would, thanks primarily to some deep cuts in R&D. Frazier, in contrast, said simply that Merck would no longer stand by its guidance, taking the position of defending R&D spending rather than sacrifice new opportunities for relatively short term earnings targets.

Ah, its good to have Merck and Pfizer posing a strategic dichotomy in R&D again!

A dozen years ago, Pfizer (under CEO Hank McKinnell) and Merck (under Ray Gilmartin) waged a similar battle for the hearts and minds of investors during an earlier (and much, much smaller) patent cliff period.

Remember when Pfizer swooped in to buy Warner-Lambert away from American Home Products? Though Pfizer wasn't the loudest advocate of the view, the acquisition put the company in the camp of those who argued that the future of R&D depended on "critical mass"--building the scale to allow huge investments across a range of therapeutic areas and targets to drive growth for the decade ahead. Pfizer followed the Warner-Lambert deal with the acquisition of Pharmacia, and built its position as the biggest of Big Pharma in that era.

Merck, on the other hand, declared its intention to eschew big mergers, with Gilmartin saying any mega-deal would be a "distraction" from the core business of delivering organic growth from internal R&D supplemented by licensing or small, targeted acquisitions. And Merck stood by its guns, become the first Big Pharma to weather a genuine patent cliff (Zocor, primarily) without making a big acquisition (or being bought up itself).

Today, the theme isn't how best to sustain R&D as whether to sustain it at all—and that debate has implications in the public policy sphere as well, where the brand name industry in the US is urging policymakers to recognize that the country's historic leadership role in biomedical innovation may be in peril. (Or, to translate, that the concessions made by industry in the health care debate should preclude any further attempts to wring savings out of prescription drugs in the context of deficit reduction.)

Indeed, for both Pfizer and Merck, the situation is likely not as dire as the headlines make it sound: the reform law's good side doesn't really kick in until 2014, when both companies will be coming to the other side of the patent cliff. The strategic debate today is really about how to position for the post-cliff era.

So who was right last time the two companies so publicly charted different courses?

Well, its hard to argue that "critical mass" was such a great idea, what with Pfizer's Read taking the scissors to his company's bloated R&D budget. On the other hand, it isn't like Merck did so well with that organic growth thing either; the company's acquisition of Schering-Plough two years ago was, if nothing else, a repudiation of the "distraction" argument.

The fact is that neither company succeeded in delivering a sustainable product flow over the decade that followed the strategic divergence. That is why both are in the pickle they are in today.

Read and Frazier are now charting different paths. It seems unlikely that both are right. But history says both could well be wrong.