Political and regulatory risks and opportunities
As a global corporate group, we face political and regulatory changes in a large number of countries and markets.
Risk of more restrictive regulatory requirements regarding drug pricing and reimbursement as well as pricing-related opportunities
Our business is affected by numerous regulations that are continuously changing – and could even become more stringent. For example, in the Healthcare business sector, the known trend towards increasingly restrictive requirements in terms of drug pricing, reimbursement, and the expansion of rebate groups is continuing. With globally rising healthcare expenditures, both in absolute amounts and relative to GDP, healthcare budgets around the globe face increasing pressure. Specifically, in the United States, a pricing reform on prescription drugs is part of the agenda of the current administration. These requirements can negatively influence the profitability of our products, as can market referencing between countries, and the success of market launches. Foreseeable effects are considered as far as possible in the business sector’s plans. Close communication with health and regulatory authorities serves as a preventive measure to avert such risks. The remaining risks beyond the current plans resulting from restrictive regulatory requirements are possible to likely with a moderate to significant impact. While we consider the possibility of resulting price cuts in our forecasts, there is also an opportunity that price pressure from healthcare systems worldwide is less pronounced than expected or materializes at a later point in time versus the base assumption. Additionally, as a global specialty innovator that pursues a focused leadership approach in attractive therapeutic areas, we are positioned to benefit from attractive pricing schemes for demonstrated major therapeutic improvements.
Risk of stricter regulations for the manufacturing, testing, and marketing of products
We must adhere to a multitude of regulatory requirements regarding the manufacturing, testing and marketing of many of our products. Specifically, in the European Union, we are subject to the EU chemicals regulation REACH. Similar regulations are emerging globally in relevant markets, particularly in Asia. These regulations demand comprehensive tests for chemicals. Moreover, the use of chemicals, such as per- and polyfluorinated alkyl substances (PFAS), in production and final products could be restricted, which would negatively impact the ability to manufacture and market certain products. With the EU Chemicals Strategy for Sustainability, an initiative of the European Green Deal, we expect increasing demands concerning the substitution of specific hazardous substances. We are constantly pursuing research and development (R&D) in substance characterization and the possible substitution of critical substances so as to mitigate this risk. Nevertheless, risks of stricter regulations are classified as possible to likely with moderate to significant impacts.
Risk of negative political and macroeconomic developments
The current political and macroeconomic situation, characterized by high uncertainty and volatile global developments, is a strategic factor for us as potential negative developments can also impact our businesses. The ongoing general trend of bloc building and reshoring of critical supplies and processes is leading to a further increase in the establishment of trade barriers and the general weaponization of trade to assert interests. While the global economy continues to gradually recover from the aftermath of the Covid-19 pandemic and Russia’s invasion of Ukraine, the increased threat from armed conflicts including the resurgent conflict in the Middle East as well as the tensions between the United States and China could lead to further sanctions and economic measures that harm global trade and affect bilateral and multilateral relationships. For example, multiple countries have already implemented measures to restrict the export and transfer of technology to China, particularly in relation to advanced chips that could be utilized for AI, quantum computing and military applications.
These risks can have a negative impact on our supply chains and sales in our key countries and regions. Such risks are considered as fully as possible in the business plans of the affected countries and regions, and are mitigated through product, industry and regional diversification as well as measures to ensure resilience of supply chains and networks. For instance, in the Electronics business sector, a strong local presence in China enables us to remain competitive in the country while our global footprint could provide opportunities to capture the demand shifting from Asia to other geographies (i.e. the United States and Europe). Also, given the considerable investments of several countries in the domestic chip industry (e.g. the U.S. Chips Act, EU Chips acts) to establish local supply of this critical component. Besides that, strategic geopolitical risk management is in place at the Group and business sector levels to continuously monitor and assess the global developments and to prepare Merck holistically for foreseeable risks.
Global economic growth is projected to slow down with growing regional divergences. Weak economic growth or even a recession could lead to less government spending or other cost-containment policies. Global inflation declined gradually in 2023, but remained significantly above target levels, keeping costs at an elevated level which could negatively impact our business. Persistently high inflation could increase our operating expenses (e.g. raw materials, operating costs and logistics) as well as capital expenditures. It could also prompt central banks to increase interest rates further and curb fiscal policy for some economies. In the course of 2022 and 2023, the European Central Bank as well as the U.S. Federal Reserve increased key interest rates significantly, which may affect our refinancing costs. Financial markets remain volatile, which could have numerous potential impacts.
The net risks of negative geopolitical and macroeconomic developments are seen as possible and might have significant to critical effects. However, our assumptions on geopolitical developments exclude extreme scenarios with severe escalation of tensions. The materialization of such scenarios would jeopardize entire industries and the balance of geopolitical and economic structures, posing a substantial challenge for us, as for any other company.
Further details on the macroeconomic development can be found under “Macroeconomic and Sector-Specific Environment”.
Market risks and opportunities
We compete with numerous companies in the pharmaceutical, chemical, and life science sectors. Rising competitive pressure can have a significant impact on the quantities that can be sold and prices attainable for our products.
Risks and Opportunities in Life Science
The portfolio of our Process Solutions business unit encompasses a broad range of pharmaceutical development and manufacturing solutions, including filtration devices, chromatography resins, single-use assemblies and systems as well as processing chemicals and excipients. We have strategically positioned ourselves to capture numerous opportunities from the industry’s shift towards biologics, coupled with the growing demand for bioproduction driven by many drug candidates and more regulatory approvals. In addition, we are well-prepared to benefit from our customers’ investments in expanding bioreactor capacity. Our commitment to innovation and our customer-focused approach positions us to advance the field of biomanufacturing.
The growing use of biologics is creating a need for more efficient and higher-yield manufacturing processes. This represents an opportunity for us to enable continuous and intensified processing through our ongoing innovation in single-use technologies and advancements in bioproduction.
Consequently, faster market growth driven by the aforementioned industry shifts can lead to a more positive development compared with our latest plan.
Our Life Science Services business unit fully integrates Contract Testing, Development, and Manufacturing Organization (CTDMO) services to meet the evolving needs of our global customers across all stages of drug development, from preclinical to commercialization. Our CTDMO services cover a wide range of modalities, including monoclonal antibodies (mAbs), high-potency active pharmaceutical ingredients (HP-APIs), antibody-drug conjugates (ADCs), viral and gene therapies (VGTs), and end-to-end mRNA offerings. We continually invest in expanding our portfolio and production capabilities to offer specialized solutions for both traditional and innovative therapies. This positions us to capitilize on the potential of the growing biopharmaceutical market by providing leading CTDMO services to our customers. Through quicker establishment of model modalities on the market in combination with our broad and integrated portfolio, we can increase the potential beyond the assumptions reflected in our plan.
Our Science & Lab Solutions business unit serves customers in the pharmaceutical and biotech industries and other industries in production, testing and research, as well as public authorities and research institutions. Despite current headwinds – a complex macroeconomic environment, and softer market demand, especially in the United States and China – the business unit is well-positioned to deliver long-term, profitable growth. We aim to offer our customers a streamlined experience and a comprehensive portfolio of offerings to facilitate their research and analytical processes. This includes several customer solutions in the area of innovative digitalization and automation. A faster recovery from the aforementioned macroeconomic adverse development as well as greater commercial success of our innovative digital and automation solutions could imply an increased potential compared to our latest plans.
Further details on the industry, market developments and associated risks, such as the challenging market environment in the life science industry, can be found under “Risks due to increased competition and customer technology changes as well as related opportunities” and “Macroeconomic and Sector-Specific Environment”.
Risks and opportunities in the semiconductor industry
Our Semiconductor Solutions business unit leverages a broad portfolio of independent technologies. This enables us to supply products for all essential production steps of wafer processing, helping our customers to achieve their technology roadmaps.
The underlying semiconductor industry is cyclical by nature. The current downturn has been exacerbated by a post-Covid-19 pandemic recession. The economic weakening has led to a temporary weakness of the traditional industry growth drivers such as PCs, smartphones and traditional data centers, while the new growth drivers such as AI and automotive are still too small to compensate for these effects. The multi-layered macro-economic effects and poor transparency throughout the supply chain cause a certain degree of uncertainty when estimating the timing and shape of the industry recovery. However, it may also imply upsides compared with our plan if the industry recovers faster and stronger than expected. The semiconductor cyclical correction risk is considered as likely with a significant impact.
Irrespective of the current turbulent macroeconomic situation, the positive medium- and long-term growth prospects of our markets remain unchanged. We see long-term growth opportunities in the semiconductor market due to the significantly accelerating global demand for innovative semiconductor materials with potential growth upside beyond the assumptions reflected in our plan, driven by a faster market adaptation and penetration. This demand is driven by exponential data growth and highly impactful technology trends such as autonomous driving, electric vehicles, Internet of Things (IoT) and 5G. We will benefit from the high material requirement of these AI chips and are working with our customers on almost all of these groundbreaking technological innovations in the semiconductor sector. That is why we are investing in our highly attractive growth markets and purposefully expanding production capacities with a smart localization of our footprint to further boost customer proximity and ensure supply stability. Having the right capacity in the right place to bring new products and higher volumes to our customers enables us to stay flexible about the timing of the market upswing and can serve as a competitive advantage.
The aforementioned trends and the continued announcements of major capacity expansions in the industry in the coming years also benefit our DS&S business. With this portfolio of gas and chemical cabinets and the potential to provide our largest customers with turnkey solutions for the delivery of bulk gases in the manufacturing process, we are well positioned to capture upcoming opportunities.
Risks due to increased competition and customer technology changes as well as related opportunities
In the Healthcare business sector, both our biopharmaceutical products and classic pharmaceutical business are exposed to increased competition from other rival products, especially in the form of biosimilars and generics but also in innovative R&D. We compete with other pharmaceutical companies in various therapeutic indications and rely on high quality data to successfully market our products. For this reason, we closely observe our competitive landscape and make assumptions with regard to future competitor entries that pose competition to our products. Due to the uncertainty that is inherent to clinical trials, there is the possibility that competitor trials fail to meet primary endpoints in their studies or deliver inferior data than we initially anticipated. If there are no new competing products or if our competitors deliver less promising data, this could represent opportunities for us in therapeutic areas in which we are active.
In the Life Science and Electronics business sectors, risks are posed by not only cyclical business fluctuations but also changes in the technologies used or customer sourcing strategies. We use close customer relationships and in-house further developments as well as market proximity, including precise market analyses, as mitigating measures. Overall, the occurrence of these risks is possible to likely and could have a significant impact.
Further details on the industry and market development can be found under “Macroeconomic and Sector-Specific Environment”, e.g. on the market challenging environment in the life science industry.
Risks and opportunities of research and development
Innovation driven by R&D is a major element of the Group strategy – including fostering innovation at the intersection of our business sectors – and is particularly important in the Healthcare business sector. In regular portfolio management reviews, we continually evaluate and, if necessary, realign research areas and R&D pipeline projects to focus our investments in areas where patient needs are served best. Nevertheless, R&D projects can experience delays, expected budgets can be exceeded, or targets can remain unmet. Sometimes, development projects are discontinued after high levels of investment at a late phase of clinical development. Decisions – such as those relating to the transition to the next clinical phase – are taken with a view to balance risks and opportunities.
In addition to in-house R&D efforts, strategic alliances with external partners and the in- and out-licensing of programs also form part of the catalog of measures to develop innovative medicine and ensure the efficient allocation of resources. Strategic alliances with partners as well as in- and out-licensing transactions always follow a stringent selection process along clear strategic and financial decision criteria. An example of such in-licensing deals is the recently announced partnership with Jiangsu Hengrui Pharmaceuticals Co. Ltd. for a next-generation selective PARP1 (poly (ADP-ribose) polymerase 1) inhibitor and ADC (antibody drug conjugate) which represents a strong strategic fit leveraging our internal DNA damage response expertise and in-house ADC capabilities. This agreement provides the opportunity to advance more therapeutic options for patients with difficult-to-treat cancers. However, in general, there is a possibility that we may not be able to identify a sufficient number of in-licensing assets on financially acceptable terms.
The aforementioned development opportunities are associated with different types of risks. There is the risk that regulatory authorities either do not grant or delay approval or grant only restricted approval. The risk that undesirable side effects of a pharmaceutical product could remain undetected until after approval or registration could result in a restriction of approval or withdrawal from the market. Furthermore, we cannot guarantee that all the assets we are currently developing will achieve the desired commercial success. The failure to meet targets in this area could have significant effects, for example due to lower net sales or the non-occurrence of milestone payments from collaboration agreements. These risks are evaluated with probabilities ranging from possible to likely.
Moreover, in Electronics, we will also continue to invest heavily in R&D in leading-edge material solutions. The aim is to seize growth opportunities arising from the increasing global demand for innovative semiconductors. Promising opportunities for innovation are constantly arising throughout our Semiconductor Solutions business. We work closely with our customers to exploit these. Technology inflection points bring opportunities to our material solutions and the chance to differentiate from competition. We are further developing new dielectric platforms in cooperation with our key customers for 3D NAND applications.
In addition, we see opportunities in organic light-emitting diode (OLED) materials in high-quality display applications. We have been conducting R&D in the area of OLED technology for more than 15 years and have grown into a well-positioned material supplier for OLEDs. Through our semiconductor and display knowledge, we will be able to contribute to the new display devices including foldable displays and Augmented Reality/ Virtual Reality applications, which require a broad set of materials.
More detailed descriptions on our R&D activities worldwide can be found under “Research and Development” in “Fundamental Information about the Group”.
Risks and opportunities related to the quality and availability of products
Opportunities arising from capacity expansion
We make targeted investments worldwide to expand our regional capacities and drive sustainable growth in all three of our business sectors.
During the Covid-19 pandemic, supply chains experienced unprecedented disruption, with customers placing greater emphasis on supply security. In Life Science, we responded to this trend by actively diversifying our global presence by moving to a production network in the region and for the region to increase resiliency and meet the local needs of customers in North America, Europe and Asia-Pacific.
In fiscal 2023, we announced several new investments to expand capacity and product capabilities at facilities around the world. These include investments in biosafety testing, the expansion of our production for highly purified reagents and expanded lab space and production capability to manufacture cell culture media. Having the right capacity in the right place to ensure supply security, to bring new products to the market and to serve higher customer demand offers us the opportunity to capture higher market shares and can serve as a competitive advantage. However, market dynamics naturally influence our expansion activities as well as utilization. We therefore regularly review our expansion plans and adapt them accordingly.
Risks arising from project execution
In today's dynamic business environment, we prioritize innovation and growth. Projects are essential for achieving our strategic objectives, driving expansion, and promoting sustainable development. To effectively support further business growth and enhance efficiency, we continuously invest in projects, such as IT systems, distribution centers, office buildings and other projects. However, project execution involves significant capital expenditures, making effective project management crucial to avoid delays and higher spending. Inadequate planning, execution errors, and ineffective change management can lead to inefficiencies and disruptions, resulting in increased costs and lower sales.
In a rapidly evolving market, there is also a risk of missing out on market growth and development by delaying or deferring investments. To mitigate this risk, we actively monitor industry trends, conduct market research, and maintain a flexible project portfolio. By aligning our investment decisions with market dynamics, we aim to capture opportunities and minimize the risk of being left behind. This is particularly important in industries like semiconductors, where market cycles present substantial risks.
To proactively address project execution risks, we apply well-established project planning and internal control practices, collaborate closely with stakeholders, and conduct regular project reviews through teams and steering committees. This approach enables us to detect risks early on and implement corrective actions or discontinue projects that are unlikely to succeed. Through comprehensive planning, accurate cost estimations and re-evaluations, we monitor costs and ensure efficient resource allocation. Effective project governance and prioritization further contribute to desired project outcomes.
By employing these strategies, we mitigate project execution risks, ensuring successful project delivery, improved efficiency, and alignment with our strategic objectives. Overall, the possible risks could have a moderate to significant impact.
Risk of a temporary ban on products/production facilities or of non-registration of products due to non-compliance with quality standards
We are required to comply with the highest standards of quality in the manufacturing of pharmaceutical products (Good Manufacturing Practice or official pharmacopoeia). In this regard, we are subject to the supervision of the regulatory authorities. Conditions imposed by national regulatory authorities could result in a temporary ban on products/production facilities and possibly affect new registrations with the respective authority. We make the utmost effort to ensure compliance with regulations, regularly perform own internal audits, and carry out external inspections. Thanks to these quality assurance processes, the occurrence of a risk with a significant impact is improbable to possible; however, it cannot be entirely ruled out and depends on the product concerned and the severity of the objection.
Risks of production availability
Further risks include operational failures due to fire or force majeure, for example natural disasters such as floods, droughts or earthquakes, which could lead to a substantial interruption or restriction of business activities. As far as possible and economically viable, the Group limits its damage risks with insurance coverage, the nature and extent of which is constantly adapted to current requirements. Likewise, we are exposed to risks of production outages and the related supply bottlenecks that can be triggered by technical problems in production facilities with very high-capacity utilization. Furthermore, there are risks of supply bottlenecks due to a lack or disappearance of capacity. We work towards continual mitigation of such risks by making regular investments, setting up alternative sourcing options and maintaining sufficient inventory levels.
Although the occurrence of these risks is considered improbable, an individual event could have a critical negative effect.
Risks of dependency on suppliers and opportunities from supply reliability
Merck, like many other market players in other industries, has been exposed in the recent past to unprecedented events such as the Covid-19 pandemic and other geopolitical events. Throughout these challenging times, we have been able to avoid any major supply disruptions for our customers. A significant part of this success is rooted in our efforts to build resilient supply chains over the years with our strategic suppliers and reduce the probability of these risks. These strong and esteemed relationships have enabled Merck to respond to the changes in a difficult environment and adapt to the new circumstances quickly.
For example, the promise of our Healthcare business sector to reliably serve our patients is a top priority for us and requires a strong and resilient supply chain. In 2023, we proved that we could continue to reliably supply our patients with highly needed drugs while competitors in Fertility and Endocrinology ran out of stock. This stock-out situation faced by competitors could continue in the near future and would provide us with opportunities to gain additional market share by serving patient demand.
However, part of our supply chain remains vulnerable to certain events. Therefore, we continue to invest in the improvement of our supply chain, by for example, avoiding single-source situations wherever possible and economically sensible, and by increasing stock levels for essential materials in close collaboration with our suppliers. Through these measures we keep our dependencies on individual partnerships as low as possible within the highly regulatory environment we operate in. Overall, the likely risks might have a moderate to significant impact.
Risks due to product-related crime
As a leading global science and technology company and manufacturer of innovative products of the highest quality, we are exposed to various security- and crime-related risks. Due to the complexity of international trade and global supply chains, our products are at risk of being counterfeited, stolen, illegally diverted and misused. If left unaddressed, this would not only lead to financial loss, reputational damage and business disruption, but also compromise patient and customer safety. Consequently, we have implemented technical, operational and procedural measures aimed at protecting the integrity of our products and supply chains, while also ensuring that new threats are identified and managed appropriately.
Overall, the threat resulting from product-related crime is likely with a moderate impact.
Risks from the use of social media
We and our employees are active on numerous social media platforms. The consistent and legally compliant use of such platforms and their content is important in terms of increasing awareness of our brand, among other things. We take all necessary precautions and have implemented processes to ensure awareness regarding the proper handling of social media as well as actively manage and control our publications and communication.
Nevertheless, reputational risks could result, for instance through public dialogues on social media. On the qualitative rating scale, we thus rate this risk as significant.