Merck Company Analysis

To be able to generate substantial returns, it is necessary for Merck to be on the leading edge of drug developing technology. New drugs are primarily developed through internal research and also through initiatives with biotechnology companies. Davanrik is a drug originally developed by LAB Pharmaceuticals, intended to treat both depression and obesity, but the company suffered large losses after a few drugs completed the expensive and lengthy three phase testing process and were rejected by the FDA. If Merck were to license Davanrik and fund the clinical testing they would pay LAB an initial payment, as well as payments as it completes each phase, as well as royalties on the eventual sales of the drug.

Merck is continuously able to achieve substantial returns to capital, even with large costs and lengthy time to develop drugs, primarily through sales from patented drugs. Once the drug is developed, Merck will be able to exclusively sell the drug until the patent expires. It is necessary though for a global drug developer, manufacturer, and marketer to refresh their portfolio in order to maintain high revenue streams over long periods of time. While their most popular drugs generated over $5.7 billion in sales, their patents will expire in 2002, in which time it is essential for them to refresh their portfolio. Once the patents run out, generic drugs will be produced by competing companies and will substantially limit the profits to be made by Merck from those drugs. Merck also earns revenues by selling generic drugs that were once patented by other drug companies. Once other drug companies' patents expire, it opens the floor for Merck to produce those drugs without as high of cost and length of time it takes to develop the drugs themselves.

LAB patented the drugs at the start of the clinical testing for a period of seventeen years. Because the clinical tests take seven years to complete, Merck will be able to exclusively profit from Davarnik for ten years. Although they will be paying over $160 million to LAB, the eventual cash inflow from sales of Davarnik will cause the project to have a net present value of almost $14 million. Having the exclusivity in selling the drugs, with profitability such as Davanrik, is essential for Merck's continued revenue. Therefore it is imperative for Merck to lead the market in developing new drugs and obtaining the patents necessary to consistently replenish their portfolio.

To begin analysis of whether or not Merck should bid to license Davanrik, a decision tree needed to be constructed to properly evaluate all possible outcomes and their probabilities as well as the associated costs for each scenario in each stage of the FDA approval process. This decision tree can be found in appendix A. In the decision tree, there are symbols used to represent the decision alternatives or different possible outcomes. There are squares, circles, and triangles that can be