Portfolio Management in New Drug Development - Innovation and Marketing in the Pharmaceutical Industry - page 95

We now examine other approaches in the literature for project valuation. Girotra
et al. ( 2007 ) measure the value of a project to the firm with the impact of its failure
in Phase III. Their rationale was to use the natural experiment of a product develop-
ment failure to determine the interaction effects from other projects in the portfolio.
Using a combination of new drug portfolio data and stock market data, Girotra et al.
( 2007 ) show that the impact of a project's failure in Phase III is lessened when other
projects targeting the same market are still being pursued by the firm. Further, the
impact of a failure is also smaller if resources used in the failed project have syner-
gies with other projects. This approach provides an ex post measure of a project's
market value and can be a useful benchmarking exercise to compare internal valua-
tion with that of the stock market.
Market research is one approach to developing an ex ante measure of project
value. Conjoint analysis is a popular approach to estimate the market value of
improving product attributes. Ofek and Srinivasan ( 2002 ) show that when determin-
ing the market value of attribute improvement, customers who exhibit a very high
or very low probability of choosing the product should be weighted less. In addi-
tion, customers whose utility functions consist of a larger random component should
be given less weight in determining market value because there is more uncertainty
about their choices. We suggest that customers in this context can be interpreted
broadly as stakeholders of pharmaceutical firms including physicians, health insur-
ance firms, and patients.
We observe that the extant literature focuses either on an external measure of
value (such as from the stock market, real options pricing) or internal measure of
value (NPV, IRR, expected utility). An interesting research question may be to
evaluate how correlated the internal and external measures are. Posed another
way, does the firm or the market do a better job of valuing a new drug? Clearly,
managers within a firm would have detailed insights about a project's prospects.
However, due to federal regulations, data from clinical trials is publicly available
information (Grewal et al. 2008 ) which allows the market to weigh in on the per-
ceived value of the project. Of course, the challenging of separating a causal effect
from noise in financial data is considerable and may pose a barrier that has to be
overcome. Yet, since some of the key decisions for a pharmaceutical firm may
involve strategic choices of therapeutic areas and preclinical resource allocations,
further research can explore feasible valuation procedures that go beyond current
state-of-the-art.

3.2.2 Valuation of Portfolios

While the valuation of individual projects can be useful, pharmaceutical firms also
need to understand the total value potential of their portfolios. A common approach
is to roll-up individual project valuations into an aggregate valuation.