Executive Summary

Case Background
Merck & Co. is a global pharmaceutical company which is into drug research and production. Merck also markets its drugs on its own. It has launched several new products like Vioxx, Fosmax, Singulair etc for treating various diseases like osteoarthritis, asthma, osteoporosis etc. The company earned $5.9 billion on 1999 sales of $32.7 billion. This is a growth of 20% from 1998. LAB Pharmaceuticals is one such firm which is offering to license its drug Davanrik to Merck, on the condition that Merck would pay it an initial fee, take the drug through the entire FDA approval stage, manufacture the compound, market the drug and pay a royalty on all sales. Additional payments would be made by Merck as Davanrik completed each stage of the approval process. Merck maintains its steady supply of drugs and adds to its portfolio by placing utmost importance on R&D. Initiatives and joint ventures with other biotechnology companies are also a step in this regard. Davanrik is an antidepressant which was in pre-clinical development stage at the time of the offer. According to the offer Merck was to be responsible for getting the drug approved by the authority, its manufacture and marketing. Merck also has to pay LAB pharmaceutical an initial fee, royalty on the sales and additional payments at each phase of the approval process. There are three phases associated with the development of Davanrik which spans over the period of seven years. Each phase is associated with a certain cost and probability to complete that phase. Rich Kender needs to evaluate all the alternatives available with and without the launch of this drug. Problem Statement Rick Kender, the Vice President of Financial Evaluation and Analysis at Merck, with his team, needs to decide whether his company should license Davanrik or not. Qualitative findings There are several factors which contribute to Merck s high returns on capital. These are:

y y

A wide range of product portfolio might help Merck in offsetting the losses in some of the products. The company holds patents on the drugs developed and receives exclusive cash flows till the patent expires and it becomes a generic drug.

It has a competence in developing new products and can thus capitalize on its patents.

Apart from discovering and developing products, it also works jointly with other companies to the benefit of both the companies. It also acquires R&D work of other companies and saves on the amount spend on developing the same.

It sells of loss making portions of its business as is evident from the income statements for the years 1997 and 1998.

Quantitative findings The product is launched in different stages. Following table shows the probability of success in each phase given the result of previous. The expected cash flows and the cost associated in the launch of the given phase is also tabulated. As all the cash flows are expressed as after tax present values, we can calculate the effective output by multiplying probability with the NPV.

Launch in III

Success in previous phase Only Depression Only Weight loss Both

Success result in this phase Only Depression Only Weight loss Only Depression Only Weight loss Both

Probability

Revenue

Cost

NPV

Effective output

85% 75% 15% 5% 70%

1200 345 1200 345 2250

250 100 100 250 400

950 245 950 245 1850 Total

807.5 183.75 807.5 183.75 1295 1449.75 60.75 5.063 47.486 113.3 43.98 13.98

II

Only Depression Only Weight loss Both

Only Depression Only Weight loss Both

10% 15% 5%

807.5 183.75 1449.75

200 150 500

607.5 33.75 949.75 Total

I Initial

Successful

60% 100%

113.3 43.98

40 30

73.3 13.98

The criteria used here to calculate the net worth if the company invest in the research and development of Davanrik. We can use NPV method to make the decision. As the NPV of the company is positive, Merck can accept the offer of developing Davanrik from LAB pharmaceutical.

Detailed Case Analysis

Merck and Co., Inc. is a global research-driven pharmaceutical company that discovers, develops, manufactures and markets a broad range of human and health products, directly and through its joint ventures, and provides pharmaceutical benefit management services (PBM) through Merck-Medco Managed Care. The company earned $5.9 billion on 1999 sales of $32.7 billion about a 20% increase from 1998. The company, faced with the expiration of patents on its blockbuster drugs, needs to constantly refresh its portfolio by developing new compounds (primarily through internal research, but also through initiatives with biotechnology firms). Davanrik was originally developed only to treat depression. However, it seemed to stimulate not just the neural receptor that promotes anti-depression, but also to block the receptor that causes hunger. It was thus claimed to be able to help fight obesity as well. At the time Davanrik was offered to Merck, it was in the pre clinical development stage, ready to enter the three-phase clinical approval process required for pharmaceuticals in the US. There are three phases associated with the development of Davanrik. In Phase 1 of the clinical approval stage, the drug is given to a small number (20-80) of healthy volunteers to test for safety. This would take 2 years for Davanrik to complete. If Merck decided to go ahead with the first phase it would have to shell out $30 million including an initial $5 million fees to LAB for licensing the drug. There was a 60% chance that Davanrik would successfully complete Phase 1. In Phase 2, a larger number (100-300) of patient volunteers are tested to determine if the test is effective in treating a certain condition and to measure potential side effects. To complete the efficacy test Davanrik would have to demonstrate a statistically significant impact on patients suffering from depression, obesity or both. The Merck team estimated a 10% probability that Phase 2 would show that Davanrik would be efficacious for depression only, a 15% probability for weight loss only, and a 5% probability for both depression and weight loss at the same time. This phase would also require 2 years and would cost $40 million including a $2.5 million licensing milestone payment to LAB. In Phase 3, a large number (1000-5000) volunteers are tested for safety and efficacy in long term use. The cost and probabilities of success in this phase depended on the outcome from Phase 2. If Davanrik was effective for only depression, Phase 3 trials would cost $200 million including a $20 million payment to LAB, and have an 85% chance of success. If it were effective for weight loss only, it would cost $150 million (including a $10 million payment to LAB) and have a 75% chance of success. If however, it was efficacious for both weight loss and depression, more specialized trials would be required to determine efficacy for the dual indication. The total cost of the Phase 3 clinical tests for the two separate indications together with the dual indication was expected to be $500 million, including a $40 million licensing payment to LAB, and had a 70% chance of

successful outcome. Under this scenario, there was a 15% chance of a successful outcome for depression only, and a 5% chance of a successful outcome for weight loss only. The probability of complete failure of the dual indications or either separate indication was only 10%. This drug has substantial potential profits, when used for the treatment of both depression and weight loss. If the drug were approved only for the treatment of depression, it would cost $250 million to launch, and had a commercialization present value of $1.2 billion. If Davanrik were only approved for weight loss, it would cost $100 million to launch, and would have a present value of $345 million. If it were approved for both, it would cost $400 million to launch and have a present value of $2.25 billion. Problem StatementRick Kender, the Vice President of Financial Evaluation and Analysis at Merck, with his team, needs to decide whether his company should license Davanrik or not. He has to evaluate all the alternatives he has with the acceptance and rejection of this drug.

Decision Tree:
PHASE III PHASE I 2 years PHASE II 3 years 2 Years
C3
$200 million
Do Nothing

85% 950 million

15%
Do Nothing

Depression only

10%
$40 million

C2 15%

75% D3 C4
$150 million
Do Nothing

245 million

Invest D2 Success 60%

$30 million
Do Nothing

25% D4 5%
Do Nothing

70% 15%

C1
$500 million

C5

5% 10%

D1
Do Nothing

Do Nothing

D5 40%

Weight Loss only

Do Nothing

Do Nothing Do Nothing

Both Dep & Weight Loss 1850mn

70% 950mn

Depression only

245mn

Weight Loss only