Search

site map

IP Handbook Blog

Your source for expert commentary on IP management issues.
Go to the blog

About

MIHR

PIPRA

Fiocruz, Brazil

bioDevelopments-   Institute

Home > IP Topics Index > Evaluation and Valuation of Technologies > Valuation of Bioprospecting Samples: Approaches, Calculations, and Implications for Policy-Makers

Valuation of Bioprospecting Samples: Approaches, Calculations, and Implications for Policy-Makers

Editor's Summary, Implications and Best Practices

Abstract

In this chapter, the revenue consequences of varying collection fees and royalties with regard to germplasm prospecting contracts are demonstrated. Principal factors are the uncertainty of finding marketable products and the value of these products. Negotiation factors are finding a good balance between collection (initial) fees as opposed to royalty (delayed) payments. Emphasizing collection fees reduces total payments except when national interest rates are very high. Reducing the risk of failure through in-country screening, including the use of indigenous knowledge, is a potentially valuable activity. Issues for contract negotiators are outlined and the implications for biodiversity conservation discussed. Conceptually, the highest valuation approach, royalties, will most encourage conservation, but as the future is typically heavily discounted, collection payments may get more attention and be most effective. Policy considerations for national governments, nongovernmental organization (NGOs), and development agencies are reviewed and it is concluded that grants/loans and training/equipment for in-country screening should be given a high priority as a potentially viable activity in the long term.

It should be noted that the figures and calculations in this chapter are merely for illustration. The valuation of samples, and by extension a country’s biodiversity, is a negotiation and will depend on many factors, including alternative investment options by a company, alternative technologies that could be used for lead compounds, interest rates, and a range of risk factors, such as the political situation in a given country surrounding the national debate on bioprospecting. The latter point is a key factor: valuation is always a calculation that has important political consequences. Another complicating factor is the need for confidentiality with which a country and company will hold its overall business estimates. Neither a company nor a country will be likely to share their valuation basis purely for negotiation purposes and because neither want to tip off other entities about the opportunity. It is therefore concluded that, from a practical perspective, the proper valuation is the one that (1) provides the country with compensation and other benefits such that it does not feel taken advantage of and can withstand criticism from its constituents and (2) provides the licensee (typically a company) with a reasonable cost of obtaining the crucial raw or semifinished goods it requires as an input to its business.

1. Introduction

Since the adoption of the Convention on Biological Diversity (CBD) in 1992, the legal status of traditional knowledge is in the focus of international debate. Concurrent with CBD, Merck & Co. and INBio, the National Biodiversity Institute of Costa Rica, made a deal, which was widely publicized, for the payment of fees and royalties for germplasm collected inside Costa Rican conservation areas. Importantly, the agreement was renewed in 1994, 1996, and 1998 in similar terms and by 2004 has led to the filing of more than 27 patents based on the collaboration. Studies to determine the potential use of a limited number of extracts of plants, insects, and environmental samples have been completed, and the agreement has given INBio access to technology, teams, and training. It marked the first of a series of deals made by INBio (Table 1).

Such collection activities, so-called bio-prospecting, have received considerable attention in the literature and have precipitated discussions on payments for collected samples and chemical extracts from samples. But the subject is generally treated in generalities, focusing on research needs, basic rights, and moral obligations. CBD itself is famous for broad language with multiple interpretations possible. On the subject of payments, CBD proposes “sharing in a fair and equitable way the results of research and development and the benefits arising from commercial and other utilization of genetic resources … upon mutually agreed terms” (Article 15(7)). There is no attempt to identify appropriate payment approaches or a system for valuing germplasm for specific uses. Even a full decade after the entering into force of CBD, the topic still receives attention, and 15 years since its passing has not been resolved. Evidently, there cannot be resolution on actual terms and payments, since these will be a function of market conditions, alternative technologies (such as recombinatorial chemistry, to name one), and other factors. We hope to shed light on the approaches that could be used to calculate royalty rates and collection fees.

The purpose of this chapter is also the provision of information on the revenue consequences of alternative payment arrangements for collected germplasm. We do not attempt to present actual market values for the material, although approximate figures are used for illustrative purposes. Commonly, germplasm-rich countries charge for samples in the form of a fixed initial payment (collection fee), a delayed payment based on sales of the resultant commercial product (a percent royalty, that is, a form of sharing of benefits), or combination of the two. Here it is demonstrated that when the likelihood of finding a commercializable product is small (the risk of failure great), emphasizing initial payments can be done only at the expense of a significant reduction in the royalty rate and, hence, in the expected overall revenues. The importance of the failure risk is such that reducing it through preliminary in-country screening can improve the revenue prospects greatly. Whether that is a viable approach depends on in-country skills, facilities and costs, which are not evaluated here. Use of indigenous knowledge of plants is another means of reducing the failure rate and can add value to the samples that might be used in determining an appropriate payment to indigenous groups for sharing their knowledge.

The examples used herein apply to pharmaceutical prospecting for medicinal products, the basis of the Merck/INBio agreement. Pharmaceuticals are typically high-value products so the revenue is potentially greatest. The approach developed here, however, is general and can be used as well for other products, such as crop varieties and cosmetics. The variable likelihood of finding useful germplasm and values with respect to the resultant products could lead to somewhat different conclusions. For example, the long standing (but possibly evolving) practice of placing plant varieties in publicly accessible germplasm collections limits the market value of that material.

This chapter does not attempt to identify a specific market value for germplasm. Most efforts to do so, thus far, date back well over a decade and have been conceptually general or relevant only to specific examples from developed countries. It is, nevertheless, well established that biodiversity provides two types of values. These are:

1. direct value

   consumptive-use value (that which derives from such activities as sport fishing, subsistence hunting, gathering)

   productive-use value (that which derives from such activities as logging)

2. indirect values

   - nonconsumptive-use value (that which derives from such activities as tourism)

   - option value (that which derives from the delaying of destructive use until the use and value are better understood)

   - existence value (bequest value; that which derives from leaving a resource for consumption by future generations)

Valuation is complicated because, with the exception of productive-use value, none of these forms of use involves a marketed product from which value can be ascertained directly. Rather, indirect measures, such as travel expenditures, are used or, in cases of option and existence values, quite esoteric measures, the interpretation of which is not fully clear. Yet valuation is important because it indicates a potential economic justification for preservation or, more precisely, in the case of germplasm prospecting, for substituting sustainable use for destructive uses like logging.

Further complicating valuation is the discussion of appropriateness of adding opportunity cost, the value option foregone when another mutually exclusive use is selected (an opportunity cost of clear cutting is germplasm prospecting, for example). Opportunity costs are sometimes calculated (companies making mutually exclusive investment choices do this routinely) but, traditionally, never are subtracted from the value of the selected use as it is sometimes argued they should be. Conceptually, there is no reason to limit opportunity cost to a single alternative use where many likely exist, nor is there a reason indirect benefits (for instance, those derived from logging open land for farming or grazing) should not be added to the use value. There is the further issue of discount rate for future income—the reduction akin to an interest rate—in the value of delayed consumption compared to present consumption. Typically, private (personal and corporate) discount rates are greater than social rates, although the determination of the social rate is open to different interpretations. Yet, as anyone who has paid off a loan over a ten- or 20-year period recognizes, small changes in the interest rate have major implications on the outcome. Indeed, the use of opportunity cost is a complex matter yet to be resolved.

2. Pricing Choices

The Merck/INBio agreement of the early 1990s utilized a combination of the two principal payment alternatives: collection fees and royalties. Merck paid to INBio a fee of US$1.1 million and an undisclosed royalty rate for resulting product sales. A collection payment can be (and in the Merck/INBio case was) paid in total, or in part, in services, such as providing training to national scientists in screening procedures, or as equipment. The purpose here is to demonstrate how total revenues are affected by an emphasis on initial, as opposed to delayed, payments.

Delayed (royalty) payments are preferred by the contracting company, which, for the purposes of this article, we shall assume is a multinational pharmaceutical company. Delaying payments means the company has no interest costs, which are required if payments are made before the product is marketed and revenues flow. Pharmaceutical products can take up to 12 years to bring to the market in the United States, so the interest cost could be considerable. As important, making initial payments shifts the risk of failure to the company, which will have expended the collection and screening costs as well as development charges. With a successful product found in only one of some 12,000 tries and average product development costs of US$230 million including the costs of failures, the risks are indeed large. Because of these risk and interest factors, along with tight budgets and scarce foreign exchange, contracting countries prefer initial payments to subsequent and uncertain royalties. However, the contracting companies will seek compensation in the form of lower overall payments for accepting additional risk. Here we explore how much that compensation is likely to be.

For the purposes of this article a base agreement is computed on a per-sample basis (in U.S. dollars). This agreement is intended to represent the outcome of careful negotiations, with both sides reaching a minimal acceptable position from which they are unwilling to move without concessions from the other party.

Table 2 shows the estimates of the variables required for a bioprospecting agreement. As we are developing different variations, we call this the “base” agreement.

From Table 2, the expected return per sample collected can be computed as shown in Table 3 (figures are rounded for convenience). Total value for a 12,000-sample contract is also included.

Of course, most samples would pay $50 with, on average, the 1/12,000 paying off $25 million. In other words:

This is a general average with the likelihood of a hit² having a wide latitude. Thus, countries selecting this approach would be operating in a “boom or bust” mode. The collection fee covers costs so that no real revenue comes in until and unless a hit is scored. No attempt was made here to determine the range (frequency distribution) with regard to the estimated 1/12,000 hit figure. The present value of the $25 million figure is only $6 million because of the high interest rate used (15%) and the ten-year delay involved. Figure 1 gives an indication of how these values are affected by royalty rates and product value.

3. Emphasizing Collection Fees Over Royalties

What would be the ramifications of shifting fees forward, emphasizing current collection payments at the expense of longer term royalties? Suppose for our example the collection fee was increased by $150, to $200 per sample. What would change? We shall assume that the basic revenue situation remains unchanged and that only the schedule is altered. Since there are just two payment parameters (collection fee and royalty rate), increasing one necessitates reducing the other.

The point about raising collection fees necessitating a reduction in the royalty rate has several components. First, there is a direct transfer of dollars. Second, the company, which, in this example, is making payments today instead of ten years in the future, will add an implicit interest charge (technically, a discount) to those payments. The third component, and the most complex to calculate, is the change in the risk undertaken by the company. Under the base agreement, the selling country accepts most of the risk; if no marketable product is forthcoming no royalty payments are made. The 1/12,000 hit-rate figure used here is an average and an approximation. It is possible that 12,000 samples will yield no marketable products or ones with low values. Shifting royalty payments to collection fees means, in effect, that some of the royalty has been “prepaid” so that the failure of a product to materialize is a loss for the company. That is, the company is taking on an additional risk of a loss. In this regard, the contracting company will act like a banker, and indeed like any private corporation, which is a risk/reward managing entity, by demanding to be compensated financially for accepting additional risk. That required compensation can be estimated.

Raising the collection fee by $150 would increase the expected costs for the company by $1.8 million. In other words:

Moreover, the payments would be made today as opposed to 10 years hence so that the company would have total (including interest) costs of $3.5 million, that is:

The company is then willing to pay only $21.5 million (25 - 3.5) in royalties (from Table 3) so that the effective royalty rate becomes:

But the company accepts additional risk ($1.8 million worth) and will want to be compensated. The amount can be computed using the following the equation:

Thus the company is willing to offer a royalty rate 30% lower, that is:

The new royalty rate is now 3.0%, that is:

This is a reduction of 40% of the original value. The new present value of the expected payment per sample can now be computed as:

Hence, the country is giving up $50 ($550 - $500) or 9% per sample to ensure timeliness of the payment.

An important insight can be derived from this example. The penalty for the germplasm-providing country declines as its interest rate increases, or more correctly, as the gap between its interest rate and the corporate rate of the contracting company (7% in this example) increases. This penalty is shown in Table 4 where, using the figures described above, the penalty declines to zero at a country rate near 20 percent; at higher rates the country is actually better off. The company is borrowing money at a preferential rate and lending it to the country at the same rate, plus risk premium. This approach might be an efficient way for the selling country to finance itself, but several additional factors must be considered.

First, the contracting company must be agreeable to such an arrangement (not all will be). Second, a 15% figure is quite a high discount rate and involves a significant discounting of the future. Note that the country is paying the company 7%, along with discounting the future by 15% for a total discounting of 22%, which reduces any future royalty payment by a factor of 7 that is (from Table 4, Equation [2]):

Third and finally, the country is effectively borrowing against the future; should a hit come, less additional revenue will be collected. While that may be undesirable for future generations, this approach does increase the awareness of the value of germplasm resources. Referring again to the Merck/INBio agreement, the more than US$1 million collection fee (a rather insignificant amount) received all the public attention while the level of the royalty figure has never been made public and potentially could represent a much greater figure.

It should be noted that it is very difficult to come up with an appropriate discount rate without knowing specific country circumstances. It may also not be an objective figure. The concept of personal discount rate, that is, what the person on the other side of the table has internalized about risk, as well as political and economic instability and immediate need for money could all play major roles in the choice between collection payments and royalties.

4. Payment for Screening

One of the emphases on germplasm prospecting in the CBD, and elsewhere, is the performance of the maximum number of services in country (value added) as opposed to the export of raw germplasm materials. That emphasis not only increases payments but also enhances national scientific expertise while moving away from dependency on commodity-type exports. Here we examine the revenue ramifications of such an approach. No attempt is made to determine the practicality of such a step that depends on the country of origin having adequately trained staff and adequate facilities to be able to complete screenings in an accurate, timely, and cost-efficient manner. Screening near the source of origin has some advantages due to the cost of packaging and transport and the volatility of some compounds. On the other hand, some screening procedures are technically complex or, for infectious diseases, involve high standards for isolation facilities. Those screenings would not be feasible away from a major company’s laboratories, at least for the present.

The development of a marketable pharmaceutical product passes through several stages beginning with a primary screening and, if successful, progressing through secondary screening (including isolation and preliminary toxicological evaluations) and proceeding to the several stages of drug development. For purposes here, assume in-country collection with primary screening costs of $200 per sample. Prescreened samples in this example have a 1/3,000 chance of being a hit (four times the unscreened rate) because the least promising samples have been eliminated. The rate depends on several factors, including the stringency of the screens. This rate presumes relatively nonstringent tests that would be most appropriate for a range of developing countries.

Of course, screening does not change the underlying probability of finding a commercializable product. Screening merely increases the value of the retained samples, because they have a higher probability of viability than the collected samples. There is a cost for this: every retained sample represents four screened samples, so the per-sample-retained cost is $800. It is assumed the country will collect the out-of-pocket costs, or $200 per sample, but because these represent actual costs, the country does not make a profit as in the earlier second example. Payments can be computed following the royalty-rate calculation method shown earlier, using the hit rate of 1/3,000 and a collection and screening fee of $800 (figures are rounded):

The total expected value per sample is now more than five times the base payment.

It should be noted that both the royalty rate and the risk factor remain unchanged. The additional “collection” fees are merely a transfer of expenses from the company’s in-house screening cost to the developing country, and this does not change the basic value of the contract. The calculations assume, however, that the quality of cost screening in the developing country is identical to that of the company. If the quality in the developing country is inferior, the value of the screenings is questionable, and the pharmaceutical company is likely to reject this option. Especially in the case of false negative results (improperly rejecting a potentially viable compound), inaccurate or inconsistent results must be repeated. If the total cost of screening in developing countries is less than that of the pharmaceutical company (a plausible situation due to lower wages and shipping costs), then the selling country can take the difference as profit. For the example just mentioned, imagine further that a screening by the pharmaceutical company costs $150, while in the country of origin it is $100. Total costs including the $50 collection fee are then $200 versus $150. The company should, in theory, be willing to pay the full $200 cost to the developing country, which would yield it a “profit” of $50 per sample ($200 payment - $150 costs). As discussed in the preceding example neither the royalty rate nor the risk factor would change.

Now, however, imagine the costs are reversed, $100 for the pharmaceutical company and $150 for the selling country. This could happen for a number of reasons, such as a high cost of maintaining specialized equipment or simple inexperience and/or inefficiency. If the country still covered costs by negotiating a $200 collection plus screening fee, the company would treat $50 of it ($200 payment - $150 costs) as a higher fee, along the lines of the second example. Rather than repeating those calculations, note that the fee increase here is one-third ($50/$150) of the amount shown in the second example. The royalty-rate reduction would likewise be one-third of that amount, or:

This gives a final rate of:

While the amount is not huge, it represents a penalty and would likely not represent a viable option in the long term.

These calculations, of course, are only illustrations and say nothing about the practicality of screening in-country. Actual cost and result figures will be required for such computations. The exercise does suggest that economical in-country screening is a potentially valuable value-added activity. Screenings in countries, following this strategy must, as noted, be less costly than contracting-company screenings, and less accurate. Indeed, to the extent screening in-country is less expensive due to lower salary levels, savings on shipping costs, and other factors, all parties may benefit. However, countries must invest in training and equipment/infrastructure before offering this service. Several sources of funds are possible, including the use of collection fees (as is provided to a small degree in the Merck/INBio agreement) or through a grant or loan from a bilateral or multilateral agency.

5. Indigenous Knowledge

Indigenous knowledge of plants can be an alternative to preliminary screening. Plants that can be identified as free from insect damage, for example, likely contain potent alkaloids, called the most important group of medical chemicals. If plants identified by indigenous peoples as having particular attributes are collected, the probability of a hit is increased. Here, for simplicity, we will assume the increase is to 1/6,000. Some argue that the success of screening could double or triple if information based on traditional knowledge was utilized. Further, it is assumed that the cost of a single specimen collection is $100 because of the additional difficulty of finding selected plants. Payments are then (again rounded):

The royalty level in this example is the same as the base situation because:

So there is no change in the timing of payments. Similarly, the risk factor is unchanged:

Again, while only hypothetical, this example does indicate the potential value of indigenous knowledge, at least for plants (it is less indicative for microbes and insects with which indigenous cultures are typically less familiar). The additional amount of $500 per sample (Equation [11]), can be paid to indigenous groups for the value of their knowledge, but a suitable transfer mechanism must be developed.

6. Conclusions

The negotiating of terms for germplasm collection is a complex matter, made more so by the absence of a generally accepted value of the material in its raw form. This article is directed to a related issue: how any payments should be divided between current (collection) fees and future royalties. The two are different because of the ramifications of who accepts the risk of finding a usable product and the capital cost/value of sales to be made ten or more years into the future. The examples shown here suggest, but do not guarantee, that increasing collection rates is costly in terms of overall expected payments. However, for countries short on foreign exchange and, hence, with high interest rates, raising collection fees is an economical means of “borrowing” from the contracting company. Seemingly more favorable is in-country screening, but costs, feasibility, and acceptability of results must be considered carefully before choosing this option. Utilizing indigenous knowledge is, according to the example used here, also remunerative along with the prospect of providing equity payments to numerous groups otherwise far removed from market systems. However, to be utilized by companies, indigenous knowledge must be less costly than mass screening.

Overall, the aggregate payments for collected germplasm, given the current state of knowledge, appear limited. Similarly, the payments to indigenous groups will likely be fairly modest compared to the needs of those groups. These issues make careful valuation and contractual negotiation all the more critical.

Negotiators need to consider, at least, two additional factors, which have not been discussed here. First is the granting of exclusivity for the samples. Companies, of course, will be hesitant to invest in a product when the possibility exists of a competitor bringing the technology to market first or obtaining the patent. Therefore, companies will seek exclusivity. Countries, however, will wish to find additional markets; certainly, the possibility of multiple products from the samples is there. Thus, countries will opt against exclusivity. As a compromise, countries should (1) charge more for granting exclusivity and (2) set a time limit (it is four years in the Merck/INBio agreement).

Second, negotiators must evaluate their level of trust in the opposite party. One way to consider contracts is as a means of reducing the need for trust by specifying obligations in a way that can be adjudicated. However, it is not feasible to specify all aspects, so some level of trust is required. With germplasm prospecting perhaps the most critical issue is identifying whether the material used in developing a product was derived directly or indirectly from a sample provided under the agreement. Unscreened samples, with the myriad compounds they could provide, and the numerous analogs to them, will be virtually impossible to track thoroughly. Preliminarily screened samples are described in more detail and hence easier to track, but documenting a claim in court could still be difficult and expensive. Thus, considerable trust in the integrity of the contracting company would seem to be critical, but perhaps some checks should be included in the agreement.

In a broader context, this analysis suggests several policy considerations for national governments, nongovernmental organizations (NGOs), and international donors, such as foundations and bilateral and multilateral agencies. These considerations involve both the allocation of payments between collection fees and royalties and in-country screening. If the examples used herein are substantiated at all by actual cost figures, in-country screening is attractive financially as well as for its effects on development and skills improvement. However, considerable investment will be required before such efforts are possible. With adequate in-country funds lacking, international donors should seriously consider loans or grants for training and equipment purchases since in-country screening will be economically rewarding in the long term. Unlike numerous potential projects, there appears to be a ready market for the product, a preliminary-screening service. More, broader conclusions from INBio on their experiences are given in Box 1.

The allocation of funds between collection fees and royalties can affect conservation incentives. While a thorough treatment of that issue is outside of the scope of this article, it does warrant mentioning. Conceptually, the highest valuation approach—payment of royalties—will encourage conservation the most in the long term. However, people typically discount the future heavily so that up-front (collection fee) payments may get more attention and, in the long run, do most to encourage conservation. This is a matter of perception and not of business or economics, which needs exploration through other methodologies.