Spanked by Wall Street, Merck CEO Orders U-Turn: 13,000 Layoffs

Last Updated Jul 29, 2011 11:19 AM EDT

After a spanking from Wall Street analysts in February, new Merck (MRK) CEO Kenneth Frazier is suddenly doing what they want: Making huge cuts to his workforce. Merck announced it will lay off up to 13,000 yesterday, 13 percent of the workforce, in addition to the 17,000 it implemented as part of the acquisition of Schering-Plough.

Frazier's sudden desire to swing the ax is driven by one thing: Singulair. The blockbuster asthma drug loses its patent in August 2012, at which point it will face cheap generic competition and most of the revenues from that drug -- $1.3 billion a quarter in Q2 2011, up 8 percent -- will disappear.

It's a sharp U-turn from the position in February, when Frazier, still new to the job, told investment bank analysts that he preferred to make investments and that he was against "short-term-oriented cost cutting":
That would result in significant under investment in our longer-term growth prospects, and could limit our ability to pursue external opportunities. Instead, I have decided that investing in our growth is the best long-term strategy for the business
MRK went down 3 percent that day as analysts described Frazier's performance as "disingenuous" and "befuddling."

Six months later, and Frazier appears to have experienced a road-to-Damascus-style conversion: "Investing in our growth" is for the birds -- now there will be cuts aplenty!
Merck is taking these difficult actions so that we can grow profitably and continue to deliver on our mission well into the future. The environment we operate in is changing rapidly and dramatically, and these steps will help us more efficiently serve customers and patients around the world.
Merck's recent sales record does not make the needs for cuts obvious. The company's revenue yield for every $1 invested in sales, marketing and admin -- its biggest expense, mostly in the form of salaries -- is going up. But its gross profit yield -- the money it keeps after manufacturing costs -- is going down. Even though Merck was already becoming more efficient, its drugs are becoming more expensive to make, probably through commodity price inflation:


All Merck's products have rising sales, except for three and those have seen only modest declines:


Merck's good news is the source of its bad news, however. Singulair represents 11 percent of the entire company. That one drug is the same size as its consumer care and animal health businesses combined. In 2012, those revenues will wither. It is not a coincidence that Merck must now get rid of a similar proportion of its employees.

The only mystery is why it took Frazer six months to figure this out.

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