merck_execsummary
TRANSCRIPT
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:
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
Success in
previous phase
Success result in this
phase
Probability Revenue Cost NPV Effective
output
III Only Depression Only Depression 85% 1200 250 950 807.5
Only Weight loss Only Weight loss 75% 345 100 245 183.75
Both Only Depression 15% 1200 100 950 807.5
Only Weight loss 5% 345 250 245 183.75
Both 70% 2250 400 1850 1295
Total 1449.75
II Only Depression Only Depression 10% 807.5 200 607.5 60.75
Only Weight loss Only Weight loss 15% 183.75 150 33.75 5.063
Both Both 5% 1449.75 500 949.75 47.486
Total 113.3
I Successful 60% 113.3 40 73.3 43.98
Initial 100% 43.98 30 13.98 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,
D4
C4
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:
245 million
950 million
40%
Invest
70%
10%
5%
15%
70%
25%
15%
85%
5%
15%
10%
60%
$500 million
$150 million
$40 million
$200 million
$30 million
Do Nothing
Do NothingDo Nothing
Do Nothing
Do Nothing
Do Nothing
Do Nothing
Success
Do Nothing
Do Nothing
Do Nothing
C1
D1 D5
C5
75%
950mn
245mn
1850mn
Depression only
Weight Loss only
Both Dep & Weight Loss
Depression only
Weight Loss only
PHASE III
3 yearsPHASE IIPHASE I
D2
C2D3
C3