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NUCLEON
The date is December 1990
Nucleon is a small biotechnological
company specialized in R&D, nomanufacturing capabilities
Potential products CRP (cell regulatingprotein) and 2 other products
In order to get to the market the drug mustbe approved by FDA->successful clinicaltrials
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Vertically integrate downstream into
(pilot) production or “buy” theproduction on the market
DILLEMA
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Bio techno logy
Biotechnology a relatively new field
Nucleon one of over 200 companies, mostof them specialized in R&D.
Companies racing to be first to clone agene (proprietary position)
CRP attractive niche
Burn wound treatment Kidney failure
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Bio techno logy
Strategies of BT companies -> most R&D,some integrated into manufacturing, somealso into marketing
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Legal framework
Competition was mostly in R&Destablishing a strong proprietary positionwas crucial
Risks of establishing a strong proprietaryposition New legislation (difficult to predict court
rulings)
Time demanding to obtain a patent Most companies could not wait until patent
was granted (time lag)
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Drug development
process
Drug development process was verycomplex (growing genetically alteredbacteria was very much an „art‟)
Nucleon currently produced quantitieswell below those needed for clinicaltrials (scale up 10x)
Due to complexity of process scalingup was unpredictable
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Human clinical trials
To get FDA approval drug had toundergo three phases of clinical trials
Phase 1 trials assessed basicsafety -adverse reaction (6-12months)
Phase 2 (determining appropriate
dosages on a small sample->1-2years)
Phase 3 trials assessed product’sefficacy (multiple hospitals and
large number of patients, 2-5 years)
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Financial environment
Poor capital availability (“buyers‟market”)
Venture capitalists expected returns of30%
Nucleon just about to receive another 6mil $ from its venture capitalist
With additional infusion (6 mil $) and
cash on hand, Nucleon had about 6,5 mil$.
Market analysts expected that situation
on capital market would improve in 1992
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Manu factur ing op t ions for
c l in ical tr ials
Three different options for Phase I and II
The new pilot plant
Contract manufacturing Licensing product to another company
Two options for Phase III
V. I. into commercial manufacturing
Licensing out manufacturing and marketingrights at Phase III
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Phase I and II – three options
Licensing out
in Phase I
Pilot production inthe new pilot plant
Contract
manufacturing
outside the firm
Phase I and II
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The new p i lo t plan t
Pilot plant capacity (~600 m2) wouldmeet Nucleon‟s requirements for Phase I
and II
Investment outlay can be found in exhibit3
The pilot facility could however not be
used for Phase III (stricter requirements) It was beyond Nucleon‟s financial
capability to build such a plant at this
time
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Contract manu factu r ing
Biggest advantage no major capitalinvestment (if CRP failed contract could beeasily terminated)
Companies offering contract manufacturinghad facilities and their personnel in place
Contract manufacturing not inexpensive(see exhibit 4)
Industry experts believed that excesscapacity would accumulate in the future
Much time needed to transfer process dueto high complexity
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L icens ing ou t-Phase I
Nucleon could license the productimmediately (before human clinical trials)
Get 3 mio $ cash on hand (immediately)and royalties equivalent to 5% of grosssales (upon FDA approval)
Gross sales estimates (exhibit 5)
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Phase III – two opt ions
Licensing out in
Phase III
Phase III
Vertical integration
into manufacturing
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Vert ical in teg rat ion into
commerc ial manu factur ing
Before Phase III Nucleon could V.Iinto manufacturing
21 Mio $ required to perform scale up(provided by venture capitalist ifintermediary results promising)
If FDA approved the drug Nucleonreceived 5 mio $ upon FDA approvaland royalties equal to 40 % of thepartner‟s gross sales
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L icens ing ou t in Phase III
Under this option Nucleon couldexpect to receive 7 mio $ upon FDA
approval of the drug and royaltiesequivalent to 10% of the partner‟s
gross sales
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Back to the case:
Methodo logy
Use decision tree for determining possiblescenarios
Number of factors has to be considered:
Qualitative arguments (pros and cons ofevery alternative)
• Organizational change• Technology transfer costs and risks
• Long term strategic options• Other
Quantitative arguments (Financial returns-NPV)
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Study quest ion 1
(work in groups o f 4)
Develop a proper decision tree
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license
license
license
license
contract
production
production
pilot
Phase I&II Phase III
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Study quest ion 2
(work in groups o f 4)
Develop a table with pros. and
cons. for Phase I&II and
Phase III
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Pros and cons (Phase I and II)
Alternative
Pros Cons
Build pilot plant - Future options (other products)- Higher profits- Learning economies- Possibilities for economies ofscope (Kidney failure treatment)-More control over process
-high asset specificity
- Organizational change- Large investment (capitalavailability)- Process uncertainty (scale up)- time consuming
Contractmanufacturing
- Requires no capital investments- Little risk (terminate contract)- Contracting companies havefacilities and personnel in place
- Focus on core competencies- Strategic flexibility
- Big risk of confidentialinformation disclosure- Still time consuming because ofthe complexity of process
- V.I at Phase III questionable-Asset specificity
License theproduct
-Obtain cash immediately- No further investments arenecessary-Company can concentrate on
R&D
- Lost ownership of CPR-1- Much lower potential income- “Mortgaging company’s future”
in eyes of its employees
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Pros and Cons (Phase III)
Option Pros Cons
Vertical
integrationofproduction
-Lower risk
-Good possibilities ofraising needed funds- Possibilities otherproducts- Large potentialincome
- Large investment of
$21 million-Organizational change-Could get lost inproduction
Licensingout
- no furtherinvestments- No organizationalchange- Could focus on R&D
-Significantly lowerincome-Smaller risk-Lower possibilities ofV.I in the long term
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Study quest ion 3
(work in groups o f 4)
Based on the NPV makerecommendations
Calculating NPV: Estimate operating CF
(exhibit)
Discount factor (30 %)
General approach (usedifferent discountfactors according torisk of each CF)
Assumptions:•Discount factor 30 %•Gross sales represent after taxcash flows•Sales after 2002 grow constantlyat 5%•Depreciation tax shield CF andPhase III cost are approximatelyequal
•How do you feel about theseassumptions?
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NPV calculation
First calculate pilot manufacturing + V.I.
Based on NPV calculation makerecommendations
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Example of NPV calculation –
pilot manufacturing + V.I.Costs of pilotprotuctionand testing
Additional:costs of plant
21 mio
40% salesrevenue
Additional:payment $ 5mio
Additonal: PVof future sales
Sales
revenue Cash flow
Present value
(1991)
1991 -3350 -3350
1992 -1840 -14151993 -23204 -13730
1994 0 0
1995 0 0
1996 0 0
1997 0 0
1998 53700 26480 42201999 99500 39800 4879
2000 125000 50000 4715
2001 130000 52000 3772
2002 780000 312000 13392
NPV 12483
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FCF analysis
Alternativa P/P P/L C/P C/L L/L 1991 -3350 -3350 -250 -250 3000 1992 -1840 -1840 -1995 -1995 0 1993 -23240 -2204 -23550 -2550 0
1994 0 0 0 0 0 1995 0 0 0 0 0 1996 0 0 0 0 0 1997 0 0 0 0 0 1998 26480 12370 26480 12370 2685 1999 39800 9950 39800 9950 4975 2000 50000 12500 50000 12500 6250 2001 52000 13000 52000 13000 6500 2002 312000 78000 312000 78000 39000 NPV 16478 3596 19276 6372 7275
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NPV of “branches” on the decision
tree
license
license
license
license
contract
production
production
pilot
Phase I&II Phase III
16.487
3.596
19.276
6.372
7.275