Hi Will,
We're in luck... found an article on Judy Lewent's work with R&D models. (The article I originally read might have gone into more detail, but this one gets the point across.)
Fortune, 11-13-1995, pp 160+.
MANAGING: SUPER CFOS: THEY CAN'T JUMP..(but...)
A new group of CFOs are pushing the envelope by employing academic
models to weigh investments. Call them the super-number
crunchers. One of the best is Judy Lewent of Merck. Athletically
slim in gray pinstriped suits, Lewent, 46, absorbed option
theory as an MBA student at MIT in the early 1970s. Even then,
she sensed that such breakthroughs would revolutionize thinking
not just on campuses but in boardrooms. "My ambition was to use
the theory to help run companies," she says. "For me, financial
models are the key tools in a CFO's kit." Lewent surrounds
herself not with dealmakers but with quants who scour journals
and hobnob with professors.
Lewent first displayed her talent as a CFO in the early 1980s.
At that time Merck was questioning if new drugs really made
money. Its formula for measuring return on investment couldn't
project future earnings more than five years after a product's
launch. It showed that new drugs barely earned the cost of
capital. As a result, Merck pondered diversifying into fields
like medical devices. Lewent convinced management to measure the
value of projects in the pipeline using a technique called Monte
Carlo analysis. The scientists, who used probability theory in
their research, liked the idea. Monte Carlo totally contradicted
the old model. It showed that Merck held a fabulously profitable
portfolio of drugs in development. The answer, Monte Carlo
showed, was more R&D, not less.
Instead of producing a single estimate on a drug's future
profits, Monte Carlo assigns the probability of every possible
outcome 20 years out. The drug, for example, could fail in
clinical trials, prove a moderate success, or become a
blockbuster. Monte Carlo gives the odds on all three, and all
the outcomes in between. Lewent understood that Monte Carlo is
perfectly attuned to the drug industry, where one hit has to pay
the development costs of dozens of drugs that die in
development. "It's like movies or records," says Lewent.
"Everyone remembers the Batman Forevers and forgets the Heaven's
Gates."
So to raise the probability of discovering the big hits, you
have to invest in a greater number of promising new drugs.
Starting in 1985, Lewent prodded Merck to lift its annual
research budget from $426 million to $1.2 billion today. The
results are pleasing. In the past three years Merck has launched
a spate of original products, including Fosamax, the first
treatment for osteoporosis. Over that period Merck's stock rose
39% to $59, and analysts estimate that next year's earnings will
increase 14%.
Lewent's projections also help flag short-term problems. When
Monte Carlo estimates show a product is poised just to break
even, she recommends using less expensive packaging or
retrofitting an existing plant instead of building a new one.
That tinkering can turn a lackluster performer that might have
been killed into a profit maker. Says she: "Financial types are
often accused of being too shortsighted. In our case, the
reality is just the opposite."
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Complete article can be obtained at Electric Library, search criteria: Merck CFO.
Laura |
