To the editor

In their recent article “Deals that make sense,” Moscho et al.1 propose a model for valuing the respective contributions of licensor and licensee for biotechnology product deals. They seem to move from their model based on industry average valuations (which are themselves problematic) to the specifics of the Biochem Pharma–Glaxo example as if they are interchangeable. Are the averages, in fact, appropriate for the cited Biochem Pharma–Glaxo example? An important question, as “applying pharmaceutical average numbers” and their “formula for determining the value of financial investments” leads directly to their assertion that Biochem Pharma “would have more than doubled its royalty rate” had Biochem Pharma used the proposed model. The problems with their “industry average” assumptions do not stop there:

For marketing and sales contributions, an “average”of 25% of sales for marketing and sales costs is perhaps reasonable for a product at 3 to 10 or more years post-launch. While they acknowledged that the “marketing and sales costs can vary a lot throughout the different life cycle stages,” the use of the 25% average for a major new product probably understates the high cost of a successful product launch (of long-term importance to both licensor and licensee). Depending upon the product, the market segment or segments to be addressed (which largely determine the size of the required sales force and marketing expenses), and the level of competition, the actual required marketing and sales investment may be much greater. Perhaps the use of 25% for the licensee's know-how contribution (cited as the “reported industry maximum”) added to the 25% for costs is meant as an offset. However, for a new biotechnology product with significant potential, the licensor would want to “buy” the best know-how they can get, so 25% is probably the right number rather than the maximum.

For the manufacturing contribution, a provision of 10% of sales for manufacturing costs and know-how, in most cases, substantially understates the value of manufacturing. Let us suppose, for the sake of argument, that the fully loaded cost of manufacturing a particular product is 10% of sales. This would not be an unusual cost-of-goods for a “high-tech” product. However, a provision of 10% for manufacturing completely ignores the value of an established and approved GMP facility, support infrastructure, and the licensee's manufacturing know-how, all of which would cost the licensor dearly in time and money.

For the R&D contribution, as Moscho et al. state, the roles and contributions of the licensor and licensee vary considerably. In the biotechnology arena, however, the “R” is usually contributed by the licensor or continues as a collaborative effort by the licensor and licensee, and, while the “D” is occasionally a collaborative effort by the licensor and licensee, most often it is contributed by the licensee. The “D” includes scaleup of manufacturing, equipment, and process validation, the development of the required quality assurance/quality control parameters and tests for product characterization and lot release, coordination with clinical testing, and, very importantly, the required regulatory interface all along the way. All of these activities are possible due to the licensee's extensive infrastructure, which again would cost the licensor a great deal in time and money. Moscho et al., however, assign no value to this licensor contribution, as “in nearly all cases, this percentage (the 26.7% of sales example) would go to the biotechnology company, which normally has developed the compound at least up to clinical phase I.” This ignores the fact that usually a great deal of additional product development is required (as described above) between the start of phase I clinical trials and the submission of a BLA or PLA, most of which is carried out by the licensee.

Net-net, given that these factors have been ignored or undervalued in the cited Biochem Pharma–Glaxo example, it would seem that Biochem Pharma's 13% royalty rate is quite appropriate and perhaps even a bit rich, especially when combined with the millions of dollars in fees and milestones also received. Had Biochem Pharma used the model (as presented) in negotiating a deal with Glaxo and in the process insisted upon a 26.7% royalty, I suspect there may have been no deal at all.

See “Reply to 'Making or breaking a deal' “ by Moscho et al.