DISC 321 | Decision Analysis

MERCK AND CO.

Group 13

Introduction
Merck and Company is very unsure about licensing their KL-798 Drug. There are several
uncertainties involved in this decision. Firstly, the drug either is for obesity only, obesity and

cholesterol or only cholesterol. Moreover the other problem was the impact it would have on the
market as it could either be a breakthrough then it would gain significant price premium and
market share, or a me too, a smaller market share and gross margins and that in turn affects its
NPV, and this was all relied on the FDA approval of at least one of their competitors drug.AS it
already holds 37.5% of being approved and if that happens then KL-798 eventually becomes a
me too drug and in other case it would be a breakthrough. For cholesterol only, KL-798 would
remain a me-too as the market for this was already saturated. But in the case of both obesity only
and obesity-plus-cholesterol the prospective market growth was estimated to be 15% most likely,
as well as it could be as high as 35% and as low as 5%during the time period of 2001-2008. And
as from its launch in 2009 and onwards when the market would be mature then this would be
around 3%. For the obesity-only drug, gross margins would be 70% for breakthrough and 35%
for me-too. For obesity-plus-cholesterol, they would be 85% for breakthrough and 45% for metoo. Me-too would also require additional SG&A expense of around $350 million annually
whereas breakthrough will only require $50 million. The expert also, estimated that the market
penetration would be around 75% for breakthroughs for both the aforementioned drugs and 20%
for me-too. For cholesterol only the market was expected to grow by 7% annually with an
estimated value of $50 million. We assumed in our model that the probability of gaining
approval for any of the three drugs would be equal, thus taking it to be around 33.33% (as shown
in the precision tree in the appendix.1). According to Harlow, Merck was normally risk averse
but would be less inclined to this because of the opportunity to capture a new and growing
market. Their risk preference is represented by the following utility function:
U(x)=ln(x+700,000,000)
In the model we applied following functions
We created a risksimtable for transforming the categories into numbers that is Drug Quality of me too as
equal to 1, whereas breakthrough was equal to 0. The factors that were influenced by the drug quality
include market penetration, market growth, gross profit and SG&A expenses. In order to include the risk
in the given factors we used if statements, for example, in the case of Market penetration, we use the
formula =IF(DrugQuality=0,0.75,0.20) . This basically means that if the drug quality is breakthrough,
the market penetration would be 75%, otherwise it will be 20%.

For market growth, we used risktriang so that the initial market growth may include all three potentials
from 5%, 15% and 35%. Next, we defined NPV as our output cell and ran two simulations based on the
two types of drug qualities. Once the simulation was run, we used to formula =RiskMean(NPV,2), so as to
calculate the risk mean for each quality. These risk means were then incorporated into the decision tree to
calculate the payoffs.
Q1)

In risk neutral assumption, maximizing EMV is the same as maximizing the Expected Utility.
Therefore, we will go with obesity-plus-cholesterol EMV which is $658.56. However, taking
into account Mercks advice we will not give precedence to profits in making our decision, rather
we will consider the beneficial effect of the drug on the patients. Obesity-only would only treat
patients who have an obesity problem, but the obesity-plus-cholesterol would have a far more
significant impact as is would treat not only obesity but cholesterol as well. If Merck was to go
ahead with the cholesterol-only drug then only a few people will obtain its benefit due to the
availability of various other similar drugs. Thus, to treat as many patients as possible and not
giving priority to profits Merck should go ahead with the obesity-plus-cholesterol for a wider
social impact.
Q2)
We incorporate the risk aversion by adding risk tolerance into our calculations. The R value is assumed to
be 700, and using the precision tree software, we calculate the CE as 302.

Q3)
a) $658.56.
b) Using the decision tree Values the CE is -305 implying that decision maker is risk-loving.

EXHIBITS