The recommendation is that, Merck should license the new drug Davanrik. The company is facing serious situation that most of their drug patents are going to expire soon. For maintaining company’s value and profit, it is vital to invest into new drug development. In the other part of the report, a preamble of Merck and Davanrik, decision support data and the answers of important questions are provided in detail.
Merck
The Company is discovering new innovative products and developing new indications for existing products – the result of its continuing commitment to research (Annual Report, 2000). Several products face expiration of product patents in the near term. U.S. product patents expired in 2000 for Vasotec and Pepcid and will expire in 2001 for Prilosec, which is supplied
exclusively to AZLP, Prinivil and Prinzide, for which co-marketing rights have been licensed to a third party, Mevacor and Vaseretic. In the aggregate, domestic sales of these products represented 19% of Merck human health sales for 2000 (Annual Report, 2000). The patent expiration can cause deeper drop in overall sales. (Merck’s Consolidate Balance Sheet: See Appendix A)
Davanrik
Davanrik originally developed by Lab Pharmaceutical Company to treat depression. Lab Pharmaceutical offered Merck to license her new developing drug. Lab Pharmaceutical is only 15 years old company. FDA has recently denied to approval one of their drug which completed all three phases. In response to this decision, Lab lost 30% of her overall sales. As a result, LAB was hesitant to issue additional equity to finance the testing of Davanrik and was seeking a larger pharmaceutical company to license the drug and provided the following facilities:
Needed Cash
Fund for clinical testing
Manufacturing and Marketing
Royalty on the eventual sales of Davanrik
Decision Support Data
Merck
The patent of Merck’s most popular drug is going to expire by 2002
Expiration of Patent can cause a deeper drop in overall sales.
Merck needs new drug development to maintain its values and refresh portfolio.
The company sales reflect continuous growth in earnings.
The success of Davanrik would keep Merck &Company in the black for the following seven years, while the failure of Davanrik would ultimately force Merck &Company to quickly develop other profit producing drugs.
Davanrik and Merck
Davanrik is drug compound for treatment of depression and neurological disorders.
Its need 7 years or more to approve form FDA in three phases.
Phase I would take 2 years. It was expected to cost $30 million, including an initial $5 million fee to Lab for licensing the drug.
There was 60% chance that Davanrik would successfully complete Phase I
Phase II would take 2 years. It was expected to cost $40 million, including $2.5 million fee to Lab.
Phase III trial would cost $200 million including a $20 million payment to lab.
Merck & Co. should analyze the following different types of factors to make a decision to license Davanrik:
Expected revenue
Expect royalty fees to lab
License fees for each phase
Success probability at each phase
Marketing cost
Merck responsibility at each phase
Phase I
Testing would cost $30 million including $5 million to lab
Total duration of phase 2 years
Probability of Success 60%
Phase II
Testing would cost $40 million including $2.5 million to lab
Total duration 2 years
Probability of success for depression only 10%, for weight loss 15% and for both 5%
Phase III
Cost and success probability are depend on the result of phase II
Testing would cost for depression only $200 million including $20 million to Lab and probability is 85%
Testing would cost for weight loss only $150 million including $10 million to Lab and probability is 75%
Testing would cost for both (Depression and Weight loss) $500 million including $40 million to Lab and probability is 70%
Depression only cost $250 million to launch with a PV of $1.2 billion
Weight loss only cost $100 million to launch with a PV of $345 million
Both depression and weight loss would cost $400 million to launch with a PV of $2.25 billion
Overall Failure Risk
Questions and Answers
Should Merck bid to license Davanrik? How much should they pay? 
There is an extreme risk of failure in taking Davanrik. However, pharmaceutical drug producing industry does have to be risk seeking, because no any drug can get an approval. It is recommended that Merck & Co. should accept Lab pharmaceutical offer for Davanrik. The expected value of Davanrik is around $14 millions.
What is the expected value of the licensing arrangement to LAB? Assume a 5% royalty fee on any cash flows that Merck receives from Davanrik after a successful launch. 
LAB would also receive a 5% royalty fee on any from future sales of Davanrik separate from the milestone payments and regardless of the costs associated with getting the drug to market.
Expected value of the licensing arrangement to Lab:
Phase I (100% chance of success): $5 million
Phase II (60%): 2.5 million
Phase III depression (10%): $20 million
Phase III weight loss (15%): $10 million
Phase III both (5%): $40 million
Depression Success (85%): $1.2 billion * 0.05
Weight Loss Success (75%): $345 million * 0.05
Depression Success [Lower path] (15%): $1.2 billion * 0.05
Weight Loss Success [Lower path] (5%): $345 million * 0.05
Both Success (70%): $2.25 million * 0.05
How would your analysis change if the costs of launching Davanrik for weight loss were $225 million instead of $100 million as given in the case? 
Analysis is depending on the success probabilities and failure risks. At phase III, there is only 5% chance of success on weight loss. BY using decision tools the values will be calculating again.
What other issues should Merck consider in taking this decision? 
Merck & Co. should consider the cost of marketing, administration and overall sensitivity of each testing phase. The royalty, cost and overall failure risk is also vital factors to be considered for the decision. Merck should also consider that their drugs’ patents are going to expire and their many other drugs are not approved by the FDA.
How has Merck been able to achieve substantial returns on capital given the large costs and lengthy time to develop a drug? 
Merck & Co. is a big and economically stable company which can afford large costs and lengthy time to develop a drug. In other hand Lab pharmaceutical is a small company which is not very flexible to handle such type of task. Research and Development is the strength of Merck. Once the drug approve, Merck can produce it for long time period.
Appendix A
Source: Merck’s Annual Report 2000
Appendix B
Source: Unknown