Annual Report 2014 Annual Report 2014
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Objectives and strategies of the Merck Group

In 2007, Merck launched a transformation process aimed at securing its future through profitable growth in highly specialized niche markets within today’s Healthcare, Life Science and Performance Materials business sectors.

This process started with the large-scale acquisitions of Serono SA in 2007 and the Millipore Corporation in 2010. In 2011, Merck embarked on the “Fit for 2018” transformation and growth program with a new executive management team. In the first phase, the company created the foundation for profitable growth by introducing a new leadership organization and a comprehensive, Group-wide efficiency program. The second phase, which started in 2014, is aimed at successively implementing the growth options identified by establishing three strong platforms for sustainable profitable growth. Merck is building on its core competencies:

  • Closeness to existing businesses
  • Innovative strength
  • Customer proximity (to offer tailored solutions)
  • Focus on specialty businesses

Moreover, Merck is aiming to expand its business model systematically and continuously to include new technologies and partnerships. In 2014, three important milestones were achieved in the implementation of the Group strategy:

  • Through the acquisition of AZ Electronic Materials, which was completed in May, the product base and new customer offerings were expanded by new technologies.
  • With the announcement of the planned acquisition of Sigma-Aldrich in September, the foundation was laid for enhancing Merck’s position in the attractive life science industry. The aim of the planned merger is to offer customers a broader range of products and services as well as the industry’s leading e-commerce platform.
  • With the November announcement of the agreement with Pfizer on a strategic alliance for anti-PD-L1, Merck wants to accelerate its presence in immuno-oncology by combining the strengths and capabilities of the two companies in the highly competitive anti-PD-1/anti-PD-L1 space. Up to 20 immuno-oncology clinical development programs are planned for commencement in 2015, including up to six pivotal registration studies. The alliance also has the potential to accelerate Merck’s entry into the U.S. oncology market through the co-promotion of Xalkori®.

In line with its strategic agenda and focus on three growth platforms, effective January 1, 2015 Merck organizationally repositioned itself. The previous four divisions have been replaced by three business sectors:

  • Healthcare comprises the Merck Serono, Consumer Health, Allergopharma and Biosimilars businesses.
  • Life Science consists of the Merck Millipore business.
  • Performance Materials corresponds to the business of the same name.

The strategic transformation into a specialist for innovative high-tech solutions in Healthcare, Life Science and Performance Materials is reflected by the composition of sales. Within the Healthcare business sector, Merck Serono today generates more than 65 – 70 % of its sales with biopharmaceuticals. In 2006, there was only one such product, Erbitux®, which accounted for less than 10 % of sales. The classic Chemicals business has increasingly become a premium materials business that offers Merck customers a wide range of value-adding products. Today, high-tech materials and life science tools make up around 80 % of sales in the Life Science and Performance Materials business sectors. In 2006, the share was around 30 %.

General principles and Group strategy

The year 2018 will mark the 350th anniversary of Merck. The general principles of the “Fit for 2018” transformation and growth program and the Group strategy are to serve as a compass beyond 2018 as well.

General principles

In its business endeavors, Merck orients towards general principles. They help those responsible within the company to shape strategic plans and to make decisions.

The structure of Merck KGaA with members of the Merck family as personally liable partners requires the Merck Executive Board, whose members are also personally liable partners, to pay special attention to the long-term development of value. Therefore, sustainability plays a special role at Merck. The objective is to align the long-term development of the company with the legitimate interests of shareholders, whose engagement in Merck is normally of a shorter duration. That is why Merck’s business portfolio must always be balanced so that it reflects an optimum mix of entrepreneurial opportunities and risks. Merck achieves this through diversification in the Healthcare, Life Science and Performance Materials business sectors, as well as through its geographic breadth with respect to growth sources.

For Merck, the principle of sustainability applies not only to economic aspects. Instead, it also encompasses responsibility for society and environmental preservation. With its current and future product portfolio, Merck wants to help solve global challenges and shape a sustainable future. That is also why innovation is the basis of the company’s business activities; it is the prerequisite for future growth. Merck is continually working on innovative products and services for patients and customers and relies on a continual process of internal innovation throughout all areas of the company.

Group strategy

Merck focuses on innovative and top-quality high-tech products in the Healthcare, Life Science and Performance Materials business sectors. The company’s goal is sustainable and profitable growth. Merck intends to achieve this by growing organically and by further developing its competencies, as well as by making targeted acquisitions that complement and expand existing strengths in meaningful ways. Building on leading products in all its businesses, Merck aims to generate income that is largely independent of the prevailing economic cycles. Moreover, the aim is to further expand the strong market position in emerging markets in the medium to long term. In 2014, the Emerging Markets region contributed 38 % to Group sales.

Strategic initiatives

Capability initiatives

As Merck continues to grow in size and the business becomes increasingly global, Merck is to be seen as ONE company. ONE Merck stands not only for a strong brand, but also for a performance-oriented global company with a strong sense of “we”. Merck is more than the sum of its parts. Therefore, Merck has launched four capability initiatives.

The capability initiative ONE Merck Brand aims to strengthen the value of the Merck brand, to increase the company’s global visibility and reputation and to become more attractive to customers, partners and talent globally.

The framework for talent development, compensation and performance management is to be harmonized globally (ONE Talent Development, Rewards and Performance Management). As part of this initiative, Merck will focus on establishing a consistent and integrated talent and performance management process and improving the talent portfolio by proactively identifying and sourcing talent as well as ensuring workforce diversity.

The goal of the third capability initiative ONE Process Harmonization, Standardization and Excellence is to better coordinate processes and apply them consistently. This is particularly the case with software applications. Continuous improvement will take place through benchmarking. Ultimately, this will allow Merck to adapt rapidly to business changes as well as to integrate future acquisitions both seamlessly and efficiently.

The importance of Merck’s global headquarters in Darmstadt is to increase along the lines of ONE Global Headquarters. Merck in Darmstadt is to become a vibrant home for creativity, scientific exchange and innovation. By laying the cornerstone for a modular Innovation Center in 2014, Merck created the basis for cross-functional and Group-wide cooperation on projects.

Business initiatives

Furthermore, Merck has set up a range of business initiatives in order to expand the existing portfolio as well as to capture new business opportunities. The following initiatives are of major significance:

Biosimilars

Merck wants to use its expertise in developing, manufacturing and commercializing high-quality biotechnological medicines in order to create a competitive biosimilars portfolio. The focus is on developing molecules through in-house research and development as well as through partnerships.

Research & Development at Merck Serono

Merck Serono introduced a more entrepreneurial model to elevate the performance dynamics of its research and development. Based on Translational Innovation Platforms (TIPs), Merck Serono wants to foster long-term planning and an entrepreneurial mindset, validated by an independent advisory board of external experts (see below).

OLEDs

Performance Materials aims to further expand its global leadership position in display materials. Merck expects OLED technology to increase in importance in the future. Performance Materials is therefore investing in developing a comprehensive OLED portfolio. By 2018, Merck aims to be a leading supplier of OLED materials.

Business strategies

Healthcare business sector

Merck Serono

Merck Serono aims to become a preferred global biopharmaceutical partner through its enduring commitment to transforming patients’ lives with innovative specialty medicines, leading brands and high-value solutions. Global megatrends such as world population growth and a general increase in life expectancy are bolstering the demand for Merck Serono’s products. Merck Serono is well-positioned for sustainable growth.

The first pillar of Merck Serono’s strategy is to deliver innovation globally. The portfolio decision-making process has been improved and a rigorous project prioritization implemented with shorter timelines to phase transitions. Efficiency in R&D has been strengthened with the development of biomarkers to improve patient outcomes, with a focus on selected core therapeutic areas and with the creation of Translational Innovation Platforms. Merck Serono has three priority development programs: atacicept in immunology, evofosfamide (TH-302) in oncology and avelumab in immuno-oncology, an anti-PD-L1 antibody that Merck Serono will develop and commercialize with Pfizer as a potential treatment for multiple tumor types.

The second pillar of Merck Serono’s strategy is to maximize the existing portfolio in developed markets. In the Multiple Sclerosis franchise, the vision is to remain a leader by providing innovative solutions that include drugs, devices and services to help people living with multiple sclerosis. Merck Serono plans to fully exploit the potential of Rebif®, its top-selling product, in an increasingly competitive multiple sclerosis market and to position it as the best interferon-based therapeutic option for patients who suffer from the relapsing form of the disease, driving differentiation via smart injection devices and the first multiple sclerosis e-Health platform. In Fertility, the focus is on expanding market leadership and on providing innovative services and technologies beyond drugs. In Oncology, Merck Serono promotes the value of Erbitux® to personalized treatments, especially in Europe and Japan, and emphasizes the importance of offering patients complete testing for RAS status in order to ensure optimum treatment. Merck Serono will also ensure launch readiness in these innovation-driven markets. Through the co-promotion of Xalkori® with Pfizer, Merck Serono is entering the U.S. oncology market and preparing for the future launch of its anti-PD-L1 antibody.

The third pillar of the Merck Serono strategy is to expand further in Emerging Markets. With a growing middle class, extended health care coverage, a shift towards chronic diseases, and rising demand for biologics, Emerging Markets are a key driver for Merck Serono, accounting for over 60 % of organic growth between 2011 and 2013. In Emerging Markets, Merck Serono is implementing strategic growth initiatives in its General Medicine and specialty medicine franchises to address specific needs. Merck Serono is leveraging capabilities and local channels, for example by extending the breadth and depth of promotion in China, expanding its portfolio via regional and local licensing, and supporting market developments in Fertility. Merck Serono is also investing selectively and growing its flagship brands with new formulations (Euthyrox® or Glucophage®), fixed-dose combinations (Concor®) and devices (Saizen®). Merck Serono is repatriating business, taking back the promotion of Merck products from industry partners where attractive. And it is expanding the focus of its portfolio with growth initiatives in biologics.

Biosimilars

The Biosimilars business is committed to providing access to high-quality biologics to more patients all over the globe. The unit is developing a biosimilars portfolio focused on oncology and inflammatory disorders, through both in-house research and development expertise in biologics, and partnerships with other biosimilar players. The initiation of Phase III trials is planned for 2015 / 2016 onwards. Biosimilars is an attractive market in which Merck is well-positioned as it can build on existing strengths and capabilities across the biosimilars value chain. This includes the ability to leverage internal assets or source capabilities from suppliers to ensure compliance with regulatory requirements, secure market access across key markets such as the Emerging Markets region, leverage commercial manufacturing capabilities and flexibility, as well as adopt a tailored go-to-market approach. Merck has also established strategic alliances with Dr. Reddy’s in India to co-develop several oncology compounds and with Bionovis in Brazil to supply the Brazilian market with biological products under the Product Development Partnership (PDP) policy of the Brazilian Ministry of Health.

This is to be expanded by another, as yet undisclosed in-licensing agreement for a late-stage biosimilar.

Allergopharma

The market for causal allergy therapies is a global growth market. On the one hand, the global market growth expected by market researchers will be generated by an increasing number of people with allergies, and on the other hand it is based on the growing use of specific immunotherapy (SIT) in many emerging markets. Allergopharma is a manufacturer of diagnostics and prescription drugs for allergen immunotherapy (AIT). AIT (hyposensitization, desensitization, allergy immunization) is the only causal therapy for treating allergies to unavoidable allergens. AIT is primarily carried out by physicians who specialize in allergies, such as ENT doctors, dermatologists, pediatricians and pulmonologists. With its own research department and in cooperation with research institutes and other partners, Merck is helping develop a better understanding of the immunological mechanism that underlies the development of allergies and is actively working on the next generation of drugs for allergen immunotherapy. Plans to expand production in Reinbek near Hamburg in 2016, thus expanding capacity, will advance global expansion and will also help to meet the increasingly high manufacturing standards. As was previously the case, products to diagnose and treat type 1 allergies such as hay fever or allergic asthma will be manufactured here under ultrapure, sterile conditions.

Consumer Health

In 2012 and 2013, Consumer Health undertook steps to strategically realign the internal organization while sharpening its focus on core brands and particularly attractive key markets. In 2014, Consumer Health forged ahead with its growth agenda, particularly in the emerging markets of Latin America and Southeast Asia. As a result, Consumer Health achieved organic sales growth of 5.4 %, clearly exceeding general market growth. To this end, the company is pursuing a clear strategy: The aim is for Consumer Health to achieve a market share of at least 3 % by 2021 in each of its top 20 markets (including France, Mexico, Brazil, Germany, Indonesia, India, and the United Kingdom), with at least three brands in leading positions.

An important milestone within the framework of this strategy was the transfer of the Neurobion® and Floratil® brands from Merck Serono to Consumer Health in 2014. Neurobion® is a leading global brand in the vitamin B segment and Floratil® is a leading brand in the probiotic antidiarrheal segment in Brazil. Following their transfer to Consumer Health in 2014, both brands clearly demonstrated potential to focus more closely on consumer wishes and needs in core markets. For instance, the growth of Floratil® in the key market of Brazil increased more than tenfold. Further important components of implementing the “3 x 3” strategy are geographic expansion of existing brands into new markets, such as the recent market launch of the Bion® brand in Brazil, as well as possible inorganic growth through tactical takeovers and product acquisitions, as long as these are in line with the strategic direction.

Life Science business sector

Merck Millipore

Merck Millipore is one of the leading players in the attractive global life science tools industry. The business has a global presence across the laboratory and process markets – two broad customer sub-segments with differing needs. The strategy in laboratory markets is based on three success factors: a broad and attractive portfolio, a simple customer interface and an organization able to deal with complexity, for example more than 70,000 products serving over 1 million customers. The three key success factors for the process markets strategy are a deeply technical field force, product depth in developed markets as well as portfolio breadth in emerging markets.

Merck Millipore will focus on expanding its presence across laboratories in emerging geographies as well as gaining share of wallet in North America. Merck Millipore aims to continue to grow above market by accelerating growth in the process solutions and key laboratory businesses. This includes maintaining above-market R&D investments to remain on the innovation forefront, solving customer needs and delivering sustainable, profitable growth.

The planned acquisition of Sigma-Aldrich would establish one of the leading players in the life science industry, fostering key capabilities fully in line with Merck Millipore’s strategy.

Performance Materials business sector

Performance Materials

The demand for high-tech products in general and for innovative display solutions in particular has seen high global growth in recent years. This trend is not expected to weaken in the coming years. Instead, Merck assumes that increasing demand for these types of consumer goods will come from a growing middle class in emerging markets. Therefore Performance Materials will defend its position as the market and technology leader for liquid crystals and further expand it as far as possible.

Since the typical life cycle of LC mixtures is less than three years, innovation will remain the key success factor. The liquid crystals pipeline of Performance Materials is well-stocked with new technologies such as self-aligned vertical alignment (SA-VA), advanced fringe field switching (FFS), as well as projects with applications beyond displays.

Merck’s OLED business, which is part of the Advanced Technologies business unit, posted strong, above-average growth in 2014. Performance Materials wants to further position itself in the OLED market and play a leading role in this market segment in the medium to long term. Lower production costs for OLED displays are a precondition for this. External partnerships will also be used in the future to ensure the required exchange of technology and expertise.

The acquisition of AZ Electronic Materials has sustainably strengthened the portfolio and the market position of Performance Materials. All integration measures were successfully implemented in 2014, adding a further premium business to the existing profitable businesses. AZ is a manufacturer of ultrapure, innovative specialty chemicals and materials for use in integrated circuits (semiconductors) and equipment, in flat-panel displays, and for photolithographic printing. Both Performance Materials and AZ have very similar and attractive business models based on innovation, customer proximity, high market share and profitability in the growth areas of displays, semiconductors, organic electronics, and lighting.

Within its Pigments & Functional Materials business unit, Merck continues to focus on high-quality brands that add value for customers as well as on market segments with growth potential. These include effect pigments, e.g. for automotive coatings, and functional materials, e.g. for laser marking.

Strategic financial and dividend policy

For reasons of sustainability, Merck generally follows a conservative financial policy. Apart from a solid balance sheet with transparent and healthy structures, this policy is reflected by the selection of financing sources, liquidity management, key financial indicators, the dividend policy, and risk management. Merck generates high business free cash flow and its return on capital employed has been sustainably maintained at a high level.

In the context of the ongoing Group-wide efficiency program, in the past years cash was reserved with high priority to fund restructuring measures across all divisions and regions. In 2014, liquid funds were then used in particular for the acquisition of AZ Electronic Materials (Performance Materials).

One-time expenses in connection with restructuring measures as well as costs related to the integration of acquired businesses have also been assumed for 2015. With the planned acquisition of Sigma-Aldrich (Life Science) – subject to the successful closing of the transaction – in 2015 liquid funds would likewise again be used for inorganic growth. Accordingly, in the coming years, the repayment of the financial liabilities taken up in connection with this acquisition would be at the fore, along with the associated ongoing interest payments. In this case, initial one-time expenses for the integration could already be incurred then. However, smaller, so-called bolt-on acquisitions are still not ruled out. In addition, Merck will also invest in organic growth initiatives as part of its “Fit for 2018” transformation and growth program.

Merck is pursuing a sustainable dividend policy. Provided that the economic environment develops in a stable manner, the current dividend represents the minimum level for future dividend proposals. The dividend policy follows the business development and earnings increase of the coming years. However, dividend growth could deviate, e.g. within the scope of restructuring or in the event of significant global economic developments. Merck also aims for a target corridor of 20 – 25 % of EPS pre one-time items.

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