2.1 Alternate course of action ............................................................................................. 4 2.2 Decision Tree ..................................................................................................................5 2.3 Should Merck bid for the license? ................................................................................. 6 2.4 Expected value of licensing arrangement to LAB .......................................................... 6 2.5 Sensitivity analysis…………………………………………………………………….8 3.
Merck is a global research driven pharmaceutical company that discovers, develops, manufactures and markets a broad range of human and animal health products.
Merck earns most revenue from a handful of patented drugs. The company continuously refreshes its product portfolio by developing new drugs directly or through joint ventures. This is very important for the company to sustain high growth year after year.
LAB Pharmaceuticals has developed a drug, Davanrik, to treat both depression and obesity.
LAB had previously tried to get approval for one of its compounds but was unsuccessful. So it had decided to partner with an established Pharmaceutical company to conduct clinical trials.
The licensing agreement would require Merck to conduct the clinical trials, market the drug. Lab would earn via licensing fees - royalty on sales and milestone based payments.
After the approval, the patent protection will last for about 10 years.
1.2 OBJECTIVE Rich Kender, Vice President of Financial Evaluation & Analysis at Merck, was working with his team to decide whether Merck should license Davanrik.
1.3 PROBLEM STATEMENT Should Merck license the Davanrik? If yes, what should be the licensing fee? How sensitive is this decision on future cash flows associated with various costs?
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2. ANALYSIS
2.1
Alternate course of Action
License the drug
Do not license the drug
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2.2 Decision Tree 1 Launch
Revenue
0.85
680
Phase 3 success
-250
680
0
-270
1200
680
1 -200
680
0.1 Depression(Phase II) -40
-270
537.5 0.15 Phase 3 fail -270 -200
-270 1 Launch
Revenue
0.75
25
Phase III success
-100
25
345
25
1 -150
25
0.15
Don't launch
Weight loss
-220 0
-40
-220
-36.25 0.25 Phase III fail -220 -150
-220 1 Launch
Revenue
0.7
1280
Dual(Phase III success)
-400
1280
2250
1280
1 0.6
-500
1280 Don’t launch
Phase I Success
-570 -30
43.3
0
-570 1
Launch
Revenue
0.15
380
Depression(Phase III succes
-250
380
1200
380
1 -500
380 Don’t launch
0.05 Dual
-570 0 -40
-570
879.75 1 Launch
Revenue
0.05 License
-325
Weight loss(Phase III succe
-100
-325
345
-325
1 0
13.98
-500
-325 Don’t launch
-570 0
-570
0.1 Phase III fail -570 -500 1
-570
0.7
13.98
Fail -70 -40
-70
0.4 Phase I fail -30 -30
-30
Don’t License
0 0
0
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Since the EMV of the decision tree is positive, Merck should license Davanrik. From consolidated income statement, we could calculate the retained earnings as a percentage of income before taxes. Retained earnings as a percentage of PBT =
This should be maintained for this deal as well. Hence the most Merck could pay as licensing fee is = 37.84% of $ 13.98 million = $ 5.29 Million
2.3 Should Merck bid to license Davanrik? As the expected monetary value for licensing the drug is positive ($ 13.98 million), Merck should license Davanrik. Probability Failure Phase I
0.4
Phase II
0.42
Phase III
Depression
0.009
Weight Loss
0.0225
Dual
0.003 0.85
Money at stake
Expected value $ Million Phase I
12
Phase II
46.8
Phase III
71.8 3.375 1.5
Total
135.475
From the table above, we could see that expected value for failure is $ 135 million. Also, since the payments are to be made on basis of milestones, Merck would have the advantage of pulling out on later stages if progress is not made. The chances of failure reduce dramatically once the drug passes Phase II testing. So Merck will risk losing $ 70 million only. Once the drug passes Phase II, the chances of success are very high and it would only require additional investment of $ 65 million.
2.4 What is the expected value of licensing arrangement to LAB? (5% royalty assumed) The cash flows of LAB are : 1. $ 5 million initial licensing fee in Phase I ( irrespective of success of Phase 1) QT-3 Assignment
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2. $ 2.5 million in Phase II (Probability of occurrence 0.6) 3. Phase III a. $ 20 million if the drug cures only depression (Probability of occurrence 0.1) b. $ 10 million for weight loss only (Probability of occurrence 0.15) c. $ 40 million if drug cures both depression and weight loss (Probability of occurrence 0.05)
2.5 How would your analysis change if the cost of launching Davanrik for weight loss were $ 225 million instead of $ 100 million? Decision tree for the new scenario is: 1 Launch
Revenue
0.85
680
Phase 3 success
-250
680
0
-270
1200
680
1 -200
680
0.1 Depression(Phase II) -40
-270
537.5 0.15 Phase 3 fail -270 -200
-270 1 Launch
Revenue
0.75
-100
Phase III success
-225
-100
345
-100
1 -150
-100
0.15
Don't launch
Weight loss
-220 0
-40
-220
-130 0.25 Phase III fail -220 -150
-220 1 Launch
Revenue
0.7
1280
Dual(Phase III success)
-400
1280
2250
1280
1 0.6
-500
1280
Phase I Success
Don’t launch
-570 -30
28.925
0
-570 1
Launch
Revenue
0.15
380
Depression(Phase III succe
-250
380
1200
380
1 -500
380
0.05
Don’t launch
Dual
-570 0 -40
-570
873.5 1 Launch
Revenue
0.05 License
-450
Weight loss(Phase III succe
-225
-450
345
-450
1 0
5.355
-500
-450 Don’t launch
-570 0
-570
0.1 Phase III fail -570 -500 1
-570
0.7
5.355
Fail -70 -40
-70
0.4 Phase I fail -30 -30
-30
Don’t License
0 0
0
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From the tree, we could see that launching weight loss when the launching fee is $ 225 million would lead to losses. However, net EMV of the decision tree is still positive. Hence Merck should still license the drug. Case (i) If Merck finds out the Davanrik can cure only weight loss after Phase II, it should not proceed any further. Since the loss incurred ($ 70 million) will be less than the loss ($ 100 million) if the product is launched. Case (ii) If Phase II indicates dual efficacy and Phase III results in efficacy for only weight loss, then Merck should go still launch the product as it will result in lower losses ($ 450 million) than abandoning the product ($ 540 million)
3. LIST OF REFERENCES
Richard S.Ruback , “ Merck & Company: Evaluating a Drug Licensing Opportunity .” Harvard Business School Case 9-201-023 25 March, 2003.
