Table 4 - Compound Success Rates by Stage
Discovery Preclinical Testing Phase I Phase II Phase III FDA Post-marketing Testing
Years 2 to 10 4 2 2 3 2
Test Population Laboratory and animal testing 20-80 healthy volunteers 100-300 patient volunteers 1000-5000 patient volunteers
Purpose Assess safety and biological activity Determine safety and dosage Look for efficacy and side effects Monitor adverse reactions to long-term use Additional post-marketing testing
Success Rate 5000-10000 screened 250 enter preclinical testing 5 Enter clinical testing 1 approved
Once the drug is approved by FDA, it will commercialize and be protected by patent for another ten years. Even though it is very time consuming and costly to successfully develop and launch a new drug into the market, the revenue generated by a patented drug is significant. Pharmaceutical companies will have excusive rights to produce and sell the drug with low costs. After the patent expires, the drug becomes generic, which can be legally produced by generic drug manufacturers. The expiration of a patent removes the monopoly of the patent holder on drug sales licensing, which will have huge impact in the patent holder's sales. Pharmaceutical companies' revenue and profit will decline, which causes stock price to drop.
Merck had an opportunity to bid on licensing Davanrik, which might generate revenue if the drug successfully gets approval from the FDA. It is a long-term investment with high uncertainty and high failure risk. It is also a high competitive industry that a company will land itself in a passive position once it losses its most patent rights, which was exactly the situation Merck had been facing to. Should Merck bid to license to Davanrik? What is the maximum bid they would be willing to pay?
To evaluate this investment, Merck must look at outcomes from each phase, and their possibilities of success and failure. The bidding strategy should be based on the expected value of all possible outcomes. Also keep in mind that the FDA approval has a relative low passing rate 0.02% or lower, which means there are high chances that the tests will fail at any phase with a substantial loss.