Valuation Techniques: Discounted Cash Flow, Earnings Quality, Measures of Value Added, and Real Options

GUIDELINE ANSWERS: THE MERCK CASE

The Current Issues Involved in Marketing Pharmaceuticals

The major issues in the marketing of pharmaceuticals can be viewed from the perspectives of pricing and of sales volume. The rationale for viewing marketing issues in this manner is that the valuation analysis must address whether Merck’s historical growth will continue and where its future growth is likely to come from. The case observes that the demand for pharmaceuticals is relatively price inelastic because most payments are made by third parties. Another observation is that pharmaceutical prices in recent years have increased at roughly three times the U.S. rate of inflation. Thus, the discussion of marketing issues is organized around the question of whether Merck’s future growth will come predominantly from price increases or from sales volume increases.

Pricing and volume issues can be evaluated by discussing the implications of four recent developments: the growth of managed health care programs, the aging U.S. population, changes in the role of the consumer/patient, and changes in the U.S. political environment.

Growth of Managed Health Care Programs

Health management organizations are growing in number and are establishing drug utilization programs that have broad decision-making power. Merck’s strategic response to this trend was the creation of a Managed Health Care Affairs Department to develop relationships with major HMOs. The widespread presence of such groups could put downward ...