Merck Case Study

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Second result, due to a higher research cost of 140 million, provides smaller positive returns with 60 and 15 percent probability for gains of 295million and 215 million correspondingly. However, losses associated with this option are also great: 10 percent chance of losing 165Million and 15 percent chance of negative $215 million.

The risk of this ventures is also great. Only three out of the ten possible outcomes are positive and substantial in profits. Initial testing in Phase 1 grants a 60 percent chance of success and accounts to overall 18 percent chance of obtaining a return after all 3 Phases of testing and approval are completed. Profitable investment is possible only if KL- 798 tests positive as a drug for obesity or obesity and high cholesterol simultaneously.

Furthermore, according to Merck’s historical track record, in the pharmaceutical industry, only 5 out of 16 new products would become a success (Citation Needed). Therefore, EMV and Pay Off calculations could become subject to adjustment for this coefficient of market return.

‍Expected Value of Perfect Information

Research offered by Foresight Consulting can predict the outcome of Phase I and Phase II effectively eliminating the uncertainties Phase I and Phase II and thus reducing risk risk. However the questions becomes, how much should Merck be willing to pay for this service. To determine the maximum amount Merck will pay, Expected Value of Perfect Information (EVPI) is calculated. Given perfect information, there are four possible results to Foresights Consulting research and the corresponding probability is the joint probability of result in Phase I and result in Phase II. For example

Pr[Pass Phase I and Phase II (Obesity)] = Pr[Pass Phase I]* Pr[Phase II (Obesity)]

If Merck contracts the research by foresight consulting, Merck will know the result of Phase I and Phase II before it makes the decision of purchasing the rights to KL-798. Therefore it will know if it wants to buy Kl-798 and conduct Phase I and Phase II simultaneously. The criterion for making decision is to choose the path with higher EMV. Using the calculation listed in methodology, the perfect information one has an expected value of 40.72 million. The EMV without perfect information is -0.26 million. So EVPI equals the difference of the two number 41Million (40.72-(-0.26)) , which is the maximum amount that is worth paying for any information about the results of Phase I and Phase II. If Foresight Consulting charges a cost higher than that, Merck should refuse to conduct the research.

‍Sensitivity Analysis (I need to fix the pictures, which I will do tomorrow.)

A sensitivity analysis is a great way to determine the robustness of the analytical decision. For our investigation we performed a Monte Carlo Simulation using Crystal Ball 7. Essentially Crystal Ball allowed us to select which variables we want to fluctuate according to certain statistical rules. We ran this simulation a total of ten thousand times under three different conditions. For the first condition, we wanted to see what the effect of varying costs of completing each phase and the payoff for a successful marketing of the drug. Each variable was assumed to be normally distributed with a mean equal to the number stated in the case, and the standard deviation to be equal to 10% of the mean. (For examples the lump sum payment would have a mean of -30Million and standard deviation of 3Million). We found, that under these assumptions, the mean expected monetary return for purchasing the drug to be -0.18Million. However, this number comes at a high variability, with the standard deviation equal to 7.51. Therefore we can be 95% confident that if we purchase the drug, we will have an EMV between -14.81 and 14.45. Furthermore, as shown Figure 1, the Payoff for curing both diseases has the greatest affect on the overall EMV accounting for 54.1% of the variation. [[image:file:C:%5CDOCUME%7E1%5CGAITHS%7E1%5CLOCALS%7E1%5CTemp%5Cmsohtmlclip1%5C01%5Cclip_image002.gif width="60" height="19" align="center" caption="tmp9.tmp"]] Figure 1: Sensitivity Analysis of Varying Cost

[[#_msocom_1|[GS1]]]

[[image:file:C:%5CDOCUME%7E1%5CGAITHS%7E1%5CLOCALS%7E1%5CTemp%5Cmsohtmlclip1%5C01%5Cclip_image004.jpg width="468" height="354" align="center" caption="tmp9.tmp"]] Figure 2 Expected Monetary Value of Buying while varying the Probabilities The last simulation we conducted combined the last two situations. Essentially we assumed that all the variables (costs, payoffs and probabilities) will have a normal distribution, with a mean equal to the numbers stated in the case and the standard deviation equal to the 10% of the mean. We found the mean EMV to be -0.43Million with a standard deviation of 8.72Million. Additionally we can conclude that 95% confident that the result will be within -16.78Million and 17.07Million. According to Figure 3, we found that the payoff for curing both and probability of passing phase I to have the greatest effect on the total EMV with a sensitivity of 38.9% and 16.1% respectively. [[image:file:C:%5CDOCUME%7E1%5CGAITHS%7E1%5CLOCALS%7E1%5CTemp%5Cmsohtmlclip1%5C01%5Cclip_image006.gif width="468" height="354" align="center" caption="tmp9.tmp"]] Figure 3 Sensitivity Analysis of EMV

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[[#_msoanchor_1|[GS1]]]Going to have to re do this section and change the probabilities to be normally distributed

‍Conclusion (I was thinking that maybe we should change this title to Recommendations) Findings of this report utilized Tree Diagram as a decision making tool and abbreviated on the Expected Monetary Value criterion. Given the limitations of the information and techniques, Merck & Co is expected to lose 260Million dollars if it proceeds with the purchase of the KL- 798. However, assuming the fact that the vision statement of the founders of the company would guide a decision making process, Merck& Co will complete a purchase of the patent. Estimated probabilities of success in three different phases of the testing provide that the highest return should be expected if KL-798 proves its efficacy in treatment of obesity solely. Profits are expected to reach 305Million dollars for an investment of 125 million. Second highest number in sales would be generated upon success in treatment of high cholesterol level and obesity simultaneously, 295Million with the 60 percent chance upon success in Phase 2 followed by identical findings in Phase with joint probability