R&D Licensing in the Biopharmaceutical Industry: How to Structure a Good Deal

Objectives. How to best structure an IP licensing agreement taking account of embedded optionalities and other terms negotiated between licensor and licensee via a case study involving a prototypical options-based business model (biotech industry). Methodology. Binomial lattice simulation. Findings. It shows how IP management practices would change depending on who pays for the development costs, controls the continuation/development or abandonment option and thereby appropriates more of the embedded option’s value. It presents alternative (iso-value) menu licensing term choices (different combinations of royalty vs. fixed upfront fee or milestone payments) that are fair and optimal in properly accounting for optionality embedded in the R&D development and related licensing structures. Research limits. An extension of our study lies in the collection of a dataset of remuneration structures of (market-based) licensing transactions in the biotech-pharmaceutical industry so as to empirically validate our pricing technique. Practical implications. Real options thinking leads to different perspectives on how patent licensing agreements should be structured properly accounting for which party controls the embedded optionality. Originality of the study. It proposes a comprehensive real options approach to: (a) appraise the IP asset capturing the value of optionality embedded in the underlying drug R&D program; (b) consider the licensor and licensee perspectives in negotiating the terms of the IP licensing agreement providing guidelines on how to determine its optimal remuneration structure reflecting a fair sharing of project value and embedded optionality among the parties; (c) offer a tool for IP portfolio management that helps a licensor prioritize internal R&D projects accounting for managerial flexibility and optimal licensing design under uncertainty.