Merck at risk: the company the flourished under Roy Vagelos has struggled under Ray Gilmartin. Can the one-time No. 1 get back on top? - Book Excerpt

Chief Executive, The, June, 2003 by Fran Hawthorne

From the late 1980s though 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 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 m 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 searcher 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 awhile 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 Merieux 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.