MRK: R&D Productivity, as Compared to Peers

Richard

MRK’s economic returns to R&D spending (the relationship between Yr1 R&D spending and Yr10 adjusted earnings) have been slightly below the (falling) industry average since 2009. For reference, industry returns to current R&D spending appear to be below cost of capital

MRK’s lower relative returns to R&D spending appear to be driven by at least two underlying characteristics of its R&D operation: MRK spends 23 percent more in R&D for each quality-adjusted ‘unit’ of innovation produced as compared to peers; and, the average quality of a ‘unit’ of MRK innovation is below the peer benchmark

Across the peer group, we believe an assortment of unforced management errors result in weak R&D productivity. For MRK, two in particular stand out:

Across the 24 research areas that account for 80 percent of MRK’s pre-phase 3 innovation, MRK has an average competitive rank of less than 5th, and ranks among the top 3 in just 11 of these 24 areas. Unlike its best-in-class peers (BMY and Roche have average ranks of 1.9 and 2.0, respectively) MRK has not actively managed its discovery efforts to ensure that all of its teams are competitive

MRK generates 1.8% of global biomedical innovation, but two-thirds of the products in MRK’s human testing originated in the Company’s own laboratories. Given its relatively small share of biomedical innovation (true even of peers with the largest R&D budgets), and its relatively low average rank in targeted research areas, MRK’s development bias in favor of its own discoveries drives unacceptably high opportunity costs

MRK’s legacy of breakthrough innovation arguably has been achieved at a too-high dollar cost; high spending per idea and lower than average quality per idea were overpowered by very large levels of absolute R&D spending. As a result, despite its legacy of innovation MRK’s economic returns to R&D spending now lag the peer group’s. MRK can make substantial productivity gains by exiting discovery areas in which it is not world class and re-deploying these resources to discovery areas in which it can compete; and, by more actively and honestly assessing whether externally available molecules are better options than each internally-sourced lead it plans to place into human development

These and other R&D productivity metrics covering the 22 largest publicly-traded companies (by R&D spending) are available in a comprehensive benchmarking report at hiddenpipeline.com

For our full research notes, please visit our published research site

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