Case Challenge: Pharmaceutical Company, R&D Pipeline Value, Successful Rate

Question

Hi Experts,

I found this pharmaceutical case quite interesting but need some help on one of its questions. For me, the whole logic of the solution (I highlighted in yellow) to calculate the breakeven rate is really strange.

In my opinion, if we have an extra $150m invested in phase 2, then the result is that we will have a bigger tolerance for the failure rate of phase 2. This is why I struggle to understand why the success rate for phase 2 has to be improved by a certain percentage to ensure a breakeven?

Thanks in advance!

Best,

Jing

Answer 1

Hello Jing,

This is a nice example of how you can use the "Expected value" theory. Let me try to clarify the solution:

The value of a successfull candidate drug is 1.2 B$
What is the expected value of a drug starts the process? We can calculate it as following:
- Probability of success = % success Phase I x % success Phase II x % success Phase III x % success Filing = 70% x 40% x 50% x 90% = 12.6%
- Expected value of a drug starting the process= Value of a successfull drug x Probability of success = 1.2 B$ x 12.6% = 151.2 M$
In order to justify an investment of 150M$, this expected values has to increase by (at least) 150M$. The interviewer is asking us how much we should increase the probability of second step success. We can proceed as following:
- First of all, we calculate the overall success probabilty that we need. New expected value of a drug starting the process= Value of a successfull drug x desired probability of success ---> Desired probability of success = New expected value of a drug starting the process / Value of a successfull drug = (151.2 M$ + 150 M$) /1200 M$ = 25.1%
- In order to achieve that probability, we need a specific probability of success for second step: Desired probability of success= % success Phase I x Desired % success Phase II x % success Phase III x % success Filing --> Desired % success Phase II = Desired probability of success / (% success Phase I x % success Phase III x % success Filing ) = 25.1% / (70% x 50% x 90% ) = 80%

Let me know if something is still not clear.

Best,
Luca

Answer 2

Hi Jing,

This is the practice case that they have on the McKinsey site.

Your question states - if we have an extra $150m invested in phase 2, then the result is that we will have a bigger tolerance for the failure rate of phase 2.

That is not what is said in the actual question - it says that if they invest in phase 2, there is a higher likelihood of success (which is not the same as bigger tolerance for failure rate). Hence the next step is to calculate how much the success rate has to improve by for it to make sense to invest 150M in phase 2

Hope that helps,

Udayan

Answer 3

Hi Jing,

Very important in your statement is a lack of understanding of sunk cost!

Past decisions should never affect your acceptance of failure/success for future decisions!

Answer 4

Hello Jing, could you share the link to this case?