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...