The Foundations of the Pharmaceutical Industry

On this day in economic and business history...

Merck (NYSE: MRK  ) took its first steps toward pharmaceutical dominance on April 30, 1953, when it merged with Sharp & Dohme, a pharmaceutical manufacturer. Until that time, Merck had been primarily a chemical manufacturer, despite its role in producing the earliest doses of penicillin. Together, the two companies combined for $156 million in sales and $12 million in net income for the 1952 fiscal year, but the new Merck's growth was just beginning -- as was its role in modern pharmaceuticals.

Four years after the merger, Maurice Hilleman joined Merck as its head of virus and cell biology research. In this role, Hilleman would develop so many life-saving vaccines that he was later called "the most successful vaccinologist in history" and was credited with potentially saving more lives than any other scientist of the 20th century. Two of Hilleman's critical vaccine developments while at Merck included one for mumps (now part of the standard MMR vaccine) and one for hepatitis B, the latter of which has reduced the disease's incidence in American children by more than 95%.

In 1979 Merck became the first drugmaker ever inducted into the Dow Jones Industrial Average (DJINDICES: ^DJI  ) . By then its annual net income had grown to $291 million, representing an annualized growth rate of 13.1% from its merger with Sharp & Dohme. From that year until 2005, the year of Hilleman's death, net income grew to $4.6 billion, representing an annualized growth rate of 10.8%. Small wonder, then, that an investment in Merck shares has been so profitable for so long.

Old school patent medicines
A strong system of patent protection is a critical part of the reason why pharmaceutical companies have been so successful. Patented pills are not, however, a recent development. It was on April 30, 1796, not long after the founding of America, that Samuel Lee, Jr. of Connecticut gained the first patent ever issued for pills of any kind in the United States. His "Bilious Pills" were purportedly made of gamboge, aloes, soap, and nitrate of potassa -- hardly the result of an intensive scientific research program. Despite the odd ingredients, Lee Jr.'s Bilious Pills became a hit in the young nation, to such a degree that a patent battle soon erupted, as retold in James Harvey Young's The Medical Messiahs:

Three years after [Lee Jr.] had begun selling his Bilious Pills, another Samuel Lee began to trespass on his preserve.

Samuel H. P. Lee was a physician who also lived in Connecticut. In 1799 this New London doctor secured a patent, and the name of his medical invention was also "Bilious Pills." The coincidence seemed too great. The original Samuel, obviously angry, addressed the public on the subject of his upstart rival. After the launching of his own pills, he wrote, "the demand soon became so great and benefits ... so amply demonstrated" that the New London scoundrel, thinking to "take advantage of the similarity of names and of the credit of my Pills," obtained a patent. The public needed a warning. "If people incautiously purchase his pills for mine," Lee Jr. cautioned, "I shall not be answerable for their effects."

The national appetite for Bilious Pills was obviously enormous. Drug catalogues listed both varieties, and the Connecticut rivals fought each other from nearby newspaper columns with an acerbity worthy of their English ancestors. The vigor of the competition may have boosted the sale of both brands. When 14 years had expired, each patent was renewed, and on the contest raged. Nor was it limited to Connecticut and surrounding states. Early in the 19th century Bilious Pills were being sold in Georgia to the south and in the newly acquired territory west of the Mississippi River. And numerous other aspiring promoters throughout the nation had entered the battle against biliousness.

As there was no FDA in those days to regulate any wild claims of efficacy, both Lees would go to great lengths to proclaim their ability to cure all manner of ills. H. P. Lee, in one 1803 advertisement, claimed that his New-London Bilious Pills ("Interesting to all sea-faring People") had "extraordinary virtues in preventing and removing all those complaints which arise from bilious redundancies in the stomach and bowels." The advertisement goes into more than half a page of detail on the various ailments the Bilious Pills could purportedly cure. If the people of those days had known of disco fever or boogie-woogie flu, these pills probably would have claimed to cure those, too.

Today, the pharmaceutical industry is a bit more discerning in its claims, a fact reflected in the industry's rather small share of total patents obtained in the U.S. Between 2004 and 2008, pharmaceutical companies obtained roughly 13,600 patents, or 47 patents for every 1,000 people employed in the industry. This total significantly lags the patents obtained by many high-tech industries, which combined for more than 206,000 patents across a variety of enterprises. This discrepancy is reflected by the Intellectual Property Owners Association's list of the top 300 patent-receiving organizations: in 2011, Abbot Laboratories (NYSE: ABT  ) was the top pharmaceutical company on the list, ranking 76th out of 300 with 419 patents. Merck came in at 96th with 302 patents, and no other pharmaceutical company managed to crack the top 100.

Can Merck beat the patent cliff?
This titan of the pharmaceutical industry stumbled into 2013 and continues to battle patent expirations and pipeline problems. Is Merck still a solid dividend play, or should investors be looking elsewhere? In a new premium research report on Merck, the Fool tackles all of the company's moving parts, its major market opportunities, and reasons both to buy and to sell. To find out more click here to claim your copy today.


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