Quantitative Techniques -III

MERCK & COMPANY: EVALUATING A DRUG LICENSING OPPURTUNITY

GROUP 13
CONTRIBUTED BY Karn Mehta Lakshmi Deboprio Dutta Priyansha Varun M V Trunal Tukaram Fulzele Krishna Moorthy M. ROLL NO. 2012PGP156 2012PGP183 2012PGP100 2012PGP278 2012PGP191 2012PGP408 2012PGP173

DATE OF SUBMISSION: 18th March, 2013

Brief Summary:
The case is about whether Merck & Co., Inc., a global-research driven company should license Davanrik, a new drug for depression and obesity. Since 1995, the company had launched 15 new products and the earnings of the company were $5.9 billion in 1999, about a 20% increase from 1998. Only few popular brands of Merck & Co. were responsible for a large chunk of the revenue. The patents of these drugs were about to expire in a few years. It estimated that soon after the expiration of the patents, there would be a decline in sales and revenue. Despite, they need to come up with new products so as to refresh the companys portfolio. So they started investing on research and development activities and sought help from biotechnology companies to ensure that Merck is on the leading edge. LAB Pharmaceuticals, a small pharmaceutical firm first developed Davanrik to treat depression. Later it found that it not only stimulated the receptor that promotes anti-depression, but also it blocked the receptor that causes hunger. Davanrik had to go through a three step approval process before it sold. But LAB lacked in resources to complete the approval process. So it approached Merck with an offer to license Davanrik. Under this agreement Merck would be responsible for the approval of Davanrik, its manufacture and its marketing. In return to that Merck would pay LAB Pharmaceuticals an initial fee, a royalty on all sales and make additional payments as Davanrik completes each stage of the approval process. At the time of LABs offer, Davanrik was in pre-clinical development, ready to enter the three-phase clinical approval process required for pharmaceuticals in United States. LAB had a few drugs in Phase II and Phase III testing, but none had successfully completed the FDA approval process. Recently, FDA had rejected one of its drugs which completed all the stages of the tests. This made the stock price to fall by 30%. As a result it sought the help of Merck & Co., to license the drug. Overall, the approval process was expected to consume about seven years. LAB had obtained a patent on the product, which is estimated to have a remaining life, including all possible extensions, of 17 years. Therefore, the product would have a 10-year period of exclusivity, in addition to the seven years for approval. Considering all these facts, Merck & Co. should decide on either going for licensing the product or not.

Solution:
The solution is based on the following assumptions: The cost that is incurred in the approval process includes the initial payment as well as the additional payments at every phase of the approval. It is also observed that Merck and Company should make royalty payments on the eventual sales of Davanrik.

The following is the decision tree that shows the cash flows and probabilities at all stages of the approval process.

Calculations: 1.Considering the decision to license, phase1-success, phase2 depression only, phase3 success Total probability to arrive at this situation = 0.6*0.1*0.85 = 5.1% Cash flow = $1200mn $(30+40+200+250)mn = $680mn Expected payoff = 0.051*$680 = $34.68mn 2.Considering the decision to license, phase1-success, phase2 depression only, phase3 failure Total probability to arrive at this situation = 0.6*0.1*0.15 = 0.90% Cash flow = - $(30+40+200) = -$270 Expected payoff = 0.9% of -$270mn = -$2.4million 3. Considering the decision to license, phase1-success, phase2 weight loss only, phase3 success Total probability to arrive at this situation = 0.6*0.15*0.75 = 6.75% Cash flow = $345 - $(30+40+150+100) = $25 Expected payoff = 6.75% of $25 = $1.6875million 4. Considering the decision to license, phase1-success, phase2 weight loss only, phase3 failure Total probability to arrive at this situation = 0.6*0.15*0.25 = 2.25% Cash flow = - $(30+40+150) = -$220 Expected payoff = 2.25% of -$220 = -$4.95million 5. Considering the decision to license, phase1-success, phase2 dual (D&WL), phase3 success dual claim Total probability to arrive at this situation = 0.6*0.05*0.7 = 2.1% Cash flow = $2250mn - $(30+40+500+400) = $1280 Expected payoff = 2.1% of $1280 = $26.88million 6. Considering the decision to license, phase1-success, phase2 dual (D&WL), phase3 success depression only Total probability to arrive at this situation = 0.6*0.05*0.15 = 0.45% Cash flow = $1200mn - $(30+40+500+250) = $380million Expected payoff = 0.45% of $380 = $1.71million

7. Considering the decision to license, phase1-success, phase2 dual (D&WL), phase3 success weight loss only Total probability to arrive at this situation = 0.6*0.05*0.05 = .15% Cash flow = $345mn - $(30+40+500+100) = -$325 Expected payoff = 0.15% of -$325 = -$0.4875million 8.Considering the decision to license, phase1-success, phase2 dual (D&WL), phase3 failure Total probability to arrive at this situation = 0.6*0.05*0.1 = .3% Cash flow = -$(30+40+500) = -$570 Expected payoff = 0.3% of -$570mn = -$1.71million 9.Considering the decision to license, phase1-success, phase2 failure Total probability to arrive at this situation = 0.6*0.7 = .42 Cash flow = -$(30+40) = -$70 Expected payoff = 0.42* -$70 = -$29.4million 10.Considering the decision to license, phase1- failure Total probability to arrive at this situation = 0.4 Cash flow = -$30mn = -$30 Expected payoff = 0.4* -$30 = -$12million Total Expected payoff when the decision is to license the drug, = $(34.68-2.4+1.6875-4.95+26.88+1.71-0.4875-1.71-29.4-12) = $14million

Conclusion :
The expected value for licensing the drug is positive and better than not licensing .So the optimal decision is to go for licensing the drug.