The executives who ran the largest pharmaceutical companies believed the best way to push back against generics was to develop and patent groundbreaking drugs that gave them years of a selling monopoly. Competing against generics on price only meant lower profit margins. Firms redoubled their research efforts searching for new medications. Ever since the mega-success of Smith Kline’s Tagamet, the focus had been on products that would similarly target specific cell receptors. The difference to a company’s bottom line between a commercially successful drug and an epic seller was enormous. Merck had developed a series of hit drugs starting with Clinoril to treat arthritis in 1978. It had pushed sales up by 15 percent. The following year Merck released Mefoxin for bacterial infections. It too was a hit and sales growth went up by another 20 percent. And in 1980, a glaucoma treatment, Timoptic, went on sale and Merck got another 15 percent sales bump.
“But successful as they were,” said Roy Vagelos, then the chief of Merck’s research labs, “these drugs were not the kind of blockbusters that can change the sales and profit curves of a large corporation for a full decade.”1 The jump in sales was gone a year after the release of the third medication. And the increase in net income was only half the sales increase.
Tagamet’s development highlighted the importance of technological and scientific breakthroughs in the laboratory. Advances in molecular modeling allowed Sandoz researchers to create 3D models that were indispensable in developing cyclosporine, an interleukin-2 inhibitor that reduced the chances of an organ transplant rejection. X-ray crystallography provided precise structural parameters for receptor inhibitor drug design. Parke-Davis developed the first robotic means of speeding the discovery of potential drug compounds (parallel synthesis). Glaxo made the automated techniques that got the most from combinational chemistry, enabling scientists to quickly make millions of structurally similar molecules that were then screened to isolate good drug candidates. Nuclear resonance imaging produced such detailed scans that scientists used them to study how their drugs encountered tissue and cells.
The new technology was not cheap. Only the largest companies could afford the hundreds of millions of dollars required to update their labs. Some swooped up tiny biotech firms to get a leg up on rivals. Eli Lilly acquired Agouron, at the forefront of 3D computer drug design, while Bristol-Myers bought Oncogen and Genetic Systems, both with patents on new techniques for analyzing nerve and brain cell therapies.
Pharma companies were aware, however, that it took more than buying the latest technology or purchasing some promising biotech. The key remained the quality of the researchers in the lab who used the new technology to discover and develop drugs. The richest firms competed to hire the best and brightest scientists. Merck, Squibb, and Glaxo raided university and government labs and offered huge salaries. Smith Kline, to protect its position at the top, joined in the frenetic hiring binge.
The top ten drug companies gambled an inordinate amount of their research budgets on trying to “hit the lottery” with one or two blockbusters. It occasionally worked. Smith Kline’s H2 antagonist anti-ulcer drug, Tagamet, had no direct competition for six years after its 1977 introduction. Its sales accounted for a quarter of the company’s revenue and an extraordinary 40 percent of profits.2 But Smith Kline soon turned into a cautionary tale for the rest of the industry. It did not reinvest its profits into its research division. The company’s researchers produced only a fraction of the scientific papers that came from Merck and Lilly. It had only twenty-eight drugs under development, less than a quarter of what some rivals had under way.
Glaxo introduced Tagamet’s first direct challenge in 1983 with its anti-ulcer drug named Zantac. It had the advantage of twice-a-day dosing as compared to Tagamet’s four times a day. Glaxo launched an Arthur Sackler–styled promotional campaign, emphasizing the results of clinical trials that demonstrated it had fewer side effects than Tagamet.3 Tagamet’s sales fell by nearly 20 percent in the first year after Zantac was released.
Smith Kline made developing a new and improved Tagamet its top priority. But the lab failed repeatedly. Three years after its release, Zantac climbed past Tagamet in sales. Smith Kline’s profits were soon slashed in half.4 Zantac not only became the second drug in history after Tagamet to earn $1 billion in annual sales, it did it twice as quickly as Tagamet. By the start of the 1990s, Zantac outsold Tagamet three to one.5 Smith Kline’s financial troubles were made worse since it did not have another lucrative product in its drug pipeline. In the wake of Tagamet’s demise, the company was forced by the end of the decade into a merger with British-based Beecham by 1989 (the same year that Bristol-Myers and Squibb had a mega-merger).6 I 7
If Smith Kline in the 1980s exemplified the perils of overrelying on a blockbuster and failing to put enough money and guidance into science and research, Dr. Roy Vagelos, Merck’s CEO, was shaping a company that was its antithesis. Vagelos believed that Merck’s reputation for excellence in bringing new drugs to market should not be diminished by chasing only medications that the marketing department thought might be commercial hits.8 Merck was then the only big pharma company that had never had a drug recalled. It was evidence, Vagelos contended, that its unmatched quality and standards were because of the people who chose to work there.
Vagelos was a bit of an anachronism. The New Jersey–born son of Greek immigrants who had lost their small candy store during the Great Depression, he was the only major drug CEO whose roots were as a research scientist. As somebody who preferred test tubes to spreadsheets, he had a different long-term view of the industry than many of his rivals. The self-effacing physician who considered it a compliment that he was called “a researcher’s researcher” had become enamored with working in the laboratory after he got his medical degree in 1954 from Columbia and interned at Harvard’s premier teaching hospital, Massachusetts General. From there he went to the NIH, where he worked with some leading biochemists.9 Vagelos left the NIH in the mid-1960s to transform Washington University’s biochemistry department into one of the country’s premier research centers. In the early 1970s he accepted a consulting offer from Merck’s chief of research to help “their scientists better understand what was going on at the cutting edge of biochemistry and enzymology.”10
Vagelos liked what he saw at Merck’s labs and was intrigued that they had independently found a possible drug compound that lowered blood cholesterol, although he noted “they didn’t know the mechanisms of action at the molecular level.”
Merck’s organic drug research was the ideal complement to the intricate science background that Vagelos had developed over years of his own intense research on lipids. In 1974, Merck asked him to become president of all its laboratories and direct all new pharmaceutical projects.
Vagelos went into Merck with statins as his top priority. He knew that a couple of years earlier, a biochemist, Akira Endo, had assembled a small team at Tokyo’s Sankyo Pharmaceuticals. Its mission was to develop a cholesterol-lowering drug. Since the 1960s, researchers knew that cholesterol was mostly manufactured by a single liver enzyme (HMG-CoA). What had stumped everyone, however, was that no one could locate a compound that inhibited that enzyme and thus caused it to produce less cholesterol.11
At the beginning of 1975, Endo’s team, which had tested more than six thousand microbes, found one, compactin. It produced the long-sought enzyme inhibitor as part of its own natural defense against other germs in the body. Rumor of the breakthrough raced through biomedical and pharma labs worldwide. Tempering the enthusiasm, though, were reports that it caused debilitating muscle and tumor growth. Rumors were widespread that Endo had stopped his experiments since so many test dogs had died. Although those later turned out to be inflated accounts, they were serious enough to prevent Endo from conducting human testing. It also scared away several pharmaceutical firms from licensing deals with Endo.
Vagelos redoubled the effort at Merck. Three years passed before his team developed a high-speed process for screening thousands of soil microbes. In a common soil microorganism, they found biological activity that inhibited their target liver enzyme.12 After the chemists isolated the active substance, lovastatin, Vagelos and his team realized their discovery was chemically quite similar to Endo’s compactin. It took repeated testing before the Merck team was confident that lovastatin was a separate, stand-alone product.
It took another three years before the compound met Vagelos’s exacting standards. Human clinical trials began in 1980. The cholesterol-lowering results bested the most optimistic calculations. “In the laboratories we were ecstatic,” recalled Vagelos, and even the marketing group began expressing some excitement. Lovastatin had a brand name by then: Mevacor.
Overcoming all the FDA hurdles for the first drug of its type in an entirely new class of treatment was painfully slow. While it was tied up at the FDA, Vagelos became Merck’s president.
He was in a unique position. Merck was about to release a series of important drugs. As the former chief of research, Vagelos had a familiarity with those drugs that no other pharma CEO had with their products. Anyone who thought that he was a science nerd who did not have the stomach for the hypercompetitive world of selling drugs was disabused of that notion when he oversaw the product launches. First up was Pepcid, Merck’s entry into to the antacid and ulcer competition. Its campaign for Pepcid had been designed before Vagelos took charge. Tagamet and Zantac had a head start that Pepcid did not make up for, but it ended up with revenues exceeding a billion dollars a year.13
Vasotec, an ACE inhibitor that was the first rival to Squibb’s big hit, Capoten, had been designed in Vagelos’s lab and this was his first chance to influence how it was marketed. Merck settled on an understated pitch to cardiologists about clinical test results that demonstrated it was far superior to Squibb’s drug. Vasotec took off after its 1986 release. It not only surpassed Capoten in sales within two years but became Merck’s first ever drug to have revenues of a billion dollars in a single year. It had gotten to that watermark in half the time it had taken Squibb’s drug.14 When Vasotec made the billion-dollar club, Merck was the only pharmaceutical firm that had fourteen other drugs with annual sales of at least $100 million.15
Mevacor was in the final stages of FDA review as 1987 got under way. When it did get an okay later that year, its ten months from the submission of the application to the final approval was an FDA speed record. Merck had a specialized department consisting of 120 employees dedicated only to organizing all the data from clinical trials and preparing and stewarding the applications through the FDA.16
Before Mevacor was ready to release, Vagelos had to make a tough decision about another drug developed in the company’s laboratory. What he decided would help to define his tenure, and Merck itself, as much as sales figures and profit margins. The drug was Mectizan, effective against river blindness and filariasis, parasites that were a scourge in the developing world. Since most of the sales would be to poor countries that had trouble affording it, Merck tried and failed to get the U.S. government and the WHO to subsidize its production and distribution costs.
When Vagelos raised the possibility of giving Mectizan free to any country that asked for it, and absorbing potentially tens of millions in costs, many executives objected. As a public company Merck had a duty to its shareholders. Launching a program that would cut into profits was not good business. Moreover, some contended, if Merck gave away Mectizan, it could set a dangerous precedent in which groups affected by virulent diseases, from malaria to HIV, might demand free drugs for those who could not afford them. All that would do, said the naysayers, was to end research on any medicines for such illnesses. Vagelos too worried about doing something with Mectizan that forced the company to do it time and again on future drugs. However, he concluded, “If we decided to sell Mectizan, it wouldn’t reach those who needed it most regardless of how low we set the price.”17
In the fall of 1987 Vagelos announced Merck would donate Mectizan free of charge to any country that asked for it. The WHO pitched in to help on the distribution. It marked the only instance in modern pharma history in which a leading firm gave away a drug they discovered and patented in order to eradicate a disease. It matched the spirit, he thought, when George Merck told the 1950 graduating class of the Medical College of Virginia that “medicine is for the patient… not [just] for the profits.”18 “(By the time the scientists who discovered Mectizan won the Nobel in Medicine in 2015, Merck had distributed over a billion doses in thirty-three countries.)19 II 20
When Mevacor launched that fall, it set its own sales record, the fastest drug in history to reach the $150 million to $200 million category.21 That was just one record it notched on the way to becoming Merck’s second billion-dollar-a-year drug.
While those medications went on sale, Merck’s research and development teams were preparing their replacements. One of Vagelos’s principles was that any successful drug should be replaced by a better and improved one by the time the first one lost its patent. Zocor, a second generation of Mevacor, was far along by the late 1980s. Prinivil would be version 2.0 of Vasotec. When Losec replaced Pepcid, Vagelos struck a partnership with consumer giant Johnson & Johnson, and the duo made Pepcid the most successful ever OTC acid-reducer. Besides the next generation of each star drug, the company had almost one hundred other medications in its pipeline it expected to dominate different categories.
Merck’s remarkable success through the 1980s made Vagelos something of a legend. His peers thought of him as a throwback to the days when the focus was as much on cures as it was on profits. He somehow managed to do both better than his rivals.
Vagelos reinvested a large percentage of profits back into Merck’s research labs, more than a billion dollars a year. It was far more than any of his predecessors. It helped generate the creative freedom he felt was the hallmark of his early years at the National Institutes of Health. Some competitors thought he was wasting Merck’s profits. They spent their own money buying biotech firms or each other. Roche took Genentech, American Home Products bought American Cyanamid, and Pfizer spent $115 billion to acquire Warner-Lambert and $60 billion to get Pharmacia, which by then had merged with Upjohn.22 Glaxo purchased Burroughs Wellcome and Smith Kline bought Beecham, Bristol-Myers. It was not long before Glaxo and SmithKline Beecham merged into the new Glaxo SmithKline.23
Some of Merck’s top executives urged Vagelos to consider a merger with a rival. As the industry consolidated, the size and scope of the new firms might afford them significant advantages. The strengths of one would complement the weaknesses of the other so the combined company would be a more formidable competitor. Vagelos’s contrarian approach, however, paid off. He had predicted that the merger of different cultures would prove more difficult a challenge than the companies expected. Some wasted hundreds of millions on research projects that did not produce any new drugs. Others botched licensing and expansion opportunities, endured internal upheavals, defections of their best researchers, and clashes between the marketing departments of one firm with the research labs of another.
Pharmaceutical mergers and acquisitions were not the only industry trend that Vagelos monitored from a distance. American pharmaceutical companies had for decades benefited from unrestricted power in setting their drug prices. Employer-provided health insurance paid for 90 percent of brand-name prescriptions at their full list price. What caught Vagelos’s attention was that an emerging group of new insurance providers, offering lower-cost options and more restrictive coverage, were challenging the generous private policies that had been a mainstay of American corporate benefits since World War II.
“Managed care was one of the domestic areas in which I thought Merck was responding too slowly,” Vagelos later noted. “In 1988, about 30 million people were already enrolled in managed care, and our studies indicated that many more Americans would soon join them.”24
“Managed care” had been virtually nonexistent before the Nixon administration marshaled the Health Maintenance Organization Act through Congress in 1973. It was a trial program to support the development of HMOs, independent networks of doctors and hospitals that provided services for a fixed annual fee paid up front. Medical costs were covered only if a patient stayed with health care providers in that network.
Nixon garnered bipartisan support from a Democratic-controlled Congress by pressing the case that managed plans like HMOs might slow the nation’s accelerating health care costs. It was an opportune time to make that argument since rising drug prices had busted the Veterans Administration and Medicaid budgets for four consecutive years. As the country entered a recession in 1973, the economy was marked by stagflation, a term coined for the rare combination of a sluggish economy and high unemployment buffeted by escalating prices. Inflation jumped dramatically in 1973 from 3.4 percent to 9.6 percent, putting further pressure on finding a way to slow the upward pressure on drug prices.
Before the HMO Act, managed care insurers were a negligible part of the health care market. The first one, Kaiser Permanente Medical Care Program, had opened after World War II in San Francisco and most of its enrollees were unionized shipyard workers who were required to join.25 Although Nixon made a good case for the lower fixed costs of managed care, no one then put together that Kaiser was founded by Henry Kaiser, the CEO of eponymously named industrial conglomerates in construction, shipbuilding, steel, and aluminum. Kaiser’s son, Edgar, ran the HMO. The family backed Nixon in his unsuccessful runs for president in 1960 and California governor in 1962, and again in his successful races for the presidency in 1968 and 1972.III26
The 1973 statute directed millions of dollars in federal subsidies, loans, and grants to HMOs. The Nixon administration forecast that HMOs could cover as many as 50 million Americans in a decade. To achieve that goal it required that any employer who already offered medical insurance and had twenty-five or more employees had to present an HMO as a choice. Managed care policies had been off the radar for the country’s employers. Once the law required it to be considered as an option, HMOs seemed attractive because they were priced at substantial discounts to the individual policies that had dominated the medical insurance marketplace. The early HMOs did not include prescription drug coverage. After a few years some covered a limited list of approved medications.27
The pharmaceutical industry was slow to respond to the ramifications HMOs might have on drug pricing. Even some of the smartest CEOs underestimated their impact. The greatest beneficiary was Kaiser Permanente, which had nearly 50 percent of all new enrollees in the first decade. The New York Times later dubbed Kaiser “The King of the HMO mountain.”28 (It is still one of the nation’s largest as of 2019, with nine million members and $22.5 billion in revenues.)29
An unintended consequence of the momentum toward managed health care was that it opened the door to a new service-oriented segment of the prescription drug industry. Just four years before Congress had passed the HMO Act, a small company called Pharmaceutical Card System (PCS) opened in Scottsdale, Arizona. It was not a health insurer but had adapted to prescription drugs the concept developed by payroll companies that processed employee wages, taxes, and withholding for corporations. PCS was the first firm to process prescriptions for medical insurance companies, maintain formulary lists, and reimburse pharmacies. It removed the burden of voluminous bureaucratic paperwork associated with drug benefits programs. PCS got paid by collecting a small fee for every claim it processed. It might have remained a mostly unknown company that had carved out a small niche of the medical insurance market had it not been for McKesson, the country’s largest drug distributor. McKesson saw in the PCS business model an opportunity to create a new sector of the American pharmaceutical industry. In 1970, less than a year after PCS had opened, McKesson bought it.
McKesson used that acquisition to create pharmacy benefit managers (PBMs). The McKesson model was not simply a data processor that saved insurance companies time and paperwork. The PBMs McKesson envisioned would assemble vast patient networks and exert independent power as middlemen in the drug distribution network. Their profits would be the difference in discount prices they negotiated from manufacturers and lower reimbursement rates they paid to pharmacies. Pharmacy benefit managers emerged by serendipity when many of America’s Fortune 500 companies were struggling to control soaring drug costs for their employees and retirees. Benefit programs for federal and state workers faced the same cost crunch.
More than a million customers came to PBMs from General Electric, IBM, and General Motors. Tens of millions more would become part of PBM patient lists in the coming decade. PBMs not only relieved the HMOs and other private medical insurance companies of the bureaucracy of processing their own benefit programs, they took over the responsibility for creating and maintaining the all-important drug formulary lists.
Over time they introduced mail order drug delivery programs that put pressure on the corner drugstores that had been the mainstay of how Americans had long filled their prescriptions. PBMs also developed computer software that increased the speed and accuracy of processing prescriptions. That forced national retail pharmacy chains to hire them as their own in-house service providers. All their different roles as middlemen meant that pharmacy benefit managers became repositories of the drug history for tens of millions of patients, able to provide potential side effect or contraindication data to pharmacists when patients switched doctors, went to work at a new company, or moved to another state.
Merck’s Vagelos watched the power of PBMs increase through the 1980s. They were, he said, “revolutionizing the way many Americans purchased our medicines.” By 1990, for instance, the largest PBM was seven-year-old Medco. It serviced 38 million patients, “an astonishing number for such a young enterprise,” marveled Vagelos.30 PBMs like Medco did much more than drive a hard bargain for the best prices from pharmaceutical companies. They could make or break a drug’s commercial prospects by deciding whether it got listed on their formularies. Each PBM had a slightly different list of approved medications. Low prices were initially the most important factor in deciding whether a drug got on the list. When Congress passed the Hatch-Waxman Act in 1984 and opened the door to generic competition, the PBMs were situated to give patients the lower-cost copies on the formularies. If there was no generic in a category, the PBMs negotiated to find which pharma company was willing to discount its branded drug most heavily.
The largest drug companies slowly realized the PBMs were threats to their unrestricted pricing power.31 That concerned Vagelos and other pharma CEOs. They worried about spending many years and hundreds of millions of dollars to develop a drug and then running into an obstacle with pharmacy benefit managers about whether it would be placed on a formulary for insurance coverage. Discounting list prices from the first day of sales to get on the formulary was anathema to the large pharma companies.
While Vagelos kept a wary eye on the growth of PBMs, it was not yet worrisome enough to mar what had become a golden era at Merck. Starting with Mevacor’s release in 1987, Fortune ranked Merck as America’s most admired company for a record seven consecutive years (“a stunning demonstration of managerial excellence”).32 Fortune concluded Merck was a “pioneer in discovering lifesaving drugs” and noted that Vagelos “has personally recruited some of the brightest academic researchers to work in his labs.”33
Vagelos and Merck’s executives relished the company’s sterling reputation. It served as a magnet for recruiting the top scientists to its research labs at the same time as it encouraged doctors to dispense more Merck-branded drugs. At the halfway mark of what would be Vagelos’s six-year tenure, the company’s stock had risen 500 percent.34IV Vagelos’s decision to give Mectizan free to the developing world to eradicate river blindness, while at the same time turning out record profits, is why author Barry Werth said, “Merck was both the Arnold Schwarzenegger and Mother Teresa of American businesses.”35
I. There were smaller “one-drug” companies that ran into problems. Robins was bought by American Home Products after it was decimated by lawsuits over its Dalkon Shield contraceptive. Rorer fell back on Maalox after its hit Quaalude was banned as a Schedule I controlled substance. French-based Rhône-Poulenc bought Rorer at a discount in 1990. And Mexico’s Syntex had a big hit with Naprosyn, its nonsteroid anti-inflammatory, which it produced from its Palo Alto subsidiary. It went from $800 million annual sales in the second half of the 1980s to less than 20 percent of that once its patent expired. Roche bought Syntex in 1995 and immediately laid off one third of the U.S. workforce.
II. Some critics claim that Merck got tax credits for the value of the Mectizan it donated. Moreover, the company took advantage of the considerable good press it received as a result of Vagelos’s altruism. Still, Merck has continued the good work to the current day, and as a result the WHO has forecast that by 2021 river blindness might be eliminated completely.
III. The idea for HMO legislation was something Nixon discussed with his domestic affairs assistant, John Ehrlichman, during his first term. In 1971, the two talked about what Ehrlichman called “these health maintenance organizations like Edgar Kaiser’s Permanente thing.”
IV. While Vagelos had turned Merck into the industry’s top profit earner, he was personally rewarded very well. Evidence is that since his retirement, he and his wife, Diana, have donated $450 million to his alma mater, Columbia University. A third of that is to pay for loans that students would otherwise have had to take.