Glaxo Italia S.p.A. is introducing the new drug, Zinnat, into the market. Glaxo has the option to directly sell or co-market the pharmaceutical. If the company were to sell the product directly, Glaxo’s sales force would be the sole distributors of the drug. Using co-marketing, Glaxo would allow another company to sell the same product under a different brand name for a fee. We have compared the two options to determine which marketing strategy would be in the best interest of Glaxo Italia in terms of net present value, rather than the IRR or payback period used previously. We have decided that co-marketing with another company would be the best option for Glaxo Italia as it has the higher net present value.
Forecasting and Analysis
We have decided to extend the forecasts to 2010 because although it is difficult to predict beyond 6 years, the typical life cycle of a drug lasts between 10 to 20 years. Looking at the forecasts made by CFO Emilio Rottoli, we have decided to change several of the original assumptions. The first change we made was to include the expected Italian lira inflation rate of 4%, previously listed incorrectly at 0%. We have reflected this rate of inflation change in the transfer price of ingredients. A 20% cost for production and bottling and a 4% fee for customs and transportation were not previously taken into account in the transfer price, and have now been added.
We have assumed a constant total market demand from years 1997 to 2010, using the average from 1991 to 1996. We have also applied this method to the percent of Zinnat sold by Glaxo if they were to choose a co-marketing strategy. We assumed that the market share for Zinnat will decline by 5% per year after the seventh year, as predicted by Rottoli. Gross margin of direct sales to Glaxo Italia and gross margin of ingredient sales to Glaxo Holdings are assumed to stay the same. We agree that the amount of samples given out will quickly decrease after the initial introduction of Zinnat. By 1999, samples will remain constant.
The costs for medical promotions, seminars, congresses, etc. have been based upon historical data. These marketing expenses are vital only to the introduction of a new drug. Thus, after year 6 these costs are unnecessary. The sales force was also increased to 440 representatives by the third year and remained constant after the increase. As stated in the case, the cost per salesperson will increase by 12% until year 6, where it will then increase by the Italian lira inflation rate of 4%. Sales force training expenses were kept at 1.6% of revenues based on 1996, the last forecasted year. Compensation for the sales force was forecasted by taking the percent of time spent on Zinnat for each marketing strategy multiplied by the cost per salesperson and the number of salespeople. All other forecasted assumptions are assumed to be correct.
Glaxo Italia currently uses a payback evaluation to decide whether or not to undertake a project. Glaxo Italia deems any project with a payback of three years of less acceptable. This method is favorable due to its level of simplicity and cost effectiveness, because of the ease of calculation and time saved. The main advantage of this method is that it allows Glaxo to see how soon they will be able to reinvest cash flows into new research and development.
The main problem with using the payback method as a means of project evaluation is that it is not based on any sort of financial practicality. Time value of money is not taken into consideration, with equal weights being placed on cash flows over different time periods. The payback method only considers the time up to the breakeven point, so cash flows past this time are not reflected. These future cash flows could change the internal rate of return and net present value, resulting in an inaccurate projection. In addition to being a poor quantitative measure, there is no basis to determine an...
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