Objetivo General de Mediano Plazo 3.2: Garantizar una efectiva capacidad de

A small biotech company has come up with a revolutionary new seed for sugar beets which are exactly the same as regular beets but yield twice as much sugar. The company wishes to sell the patent (which is valid for twenty years) so that the inventors can pay off their venture capitalist and retire to an island with lots of sun and palm trees. What is the value of the patent?

The price of a product is determined by the market. Let's assume that there are no inputs for the new seed technology (it's already produced and can simply be cloned), and that agricultural goods are commodities sold to a dispersed market of buyers who individually can exercise little power over the price. The price, then, will be based on the value of the product to the buyer, and by competition from similar and substitute good. To start out with the competition from similar goods: since this is a patent there are no similar goods, and therefore no competition. Substitute goods are regular seeds and possibly seeds for sugar cane.

Sugar cane is grown in entirely different climates and is not considered to be a competing product in this market.

That rules out one possibility and makes the solution easier. The only possible competition, then, is from regular sugar beet seeds. The value of that product should be compared to the value of our new seeds. Seeds need to be grown into beets, which require land and labor. The farmer using our new seeds has two possibilities: he can grow twice as much sugar with the same amount of land and labor or he can grow the same amount of sugar with half the land and labor. (Let's look just at land for simplicity here.)

Do you believe the farmer can sell twice as much sugar?

One individual farmer in a commodities market should be able to sell all his increased output at the market price, but if every farmer uses the new technology and doubles his output, the price will have to fall. The question then becomes whether the demand for sugar is elastic. Using common

sense, would you expect anyone to consume more sugar (bake more cookies or make more lemonade) when the price of sugar drops? Probably not, because sugar is already a pretty cheap staple product and rarely the most expensive ingredient in something. You might want to think about other uses for sugar such as making alcohol to use as a substitute for gasoline. This market's demand would probably be elastic.

That is a good point but let us assume demand for sugar is fixed for now.

This is an example of a clue where the interviewer does not want you to pursue this any further. Having established these facts, get back to the original line of the argument and continue. If demand for sugar is fixes, then the only possibility for the farmer is to use only half the land to grow the same amount of sugar. You need to determine the value of the land saved. This could be determined by the market price of agricultural land times the area saved.

That's a bit of a problem. There is a glut of land available, and it is unlikely that the farmers will be able to sell their land at all within a period of a few years.

Oops! Now what? Another possibility is to see if the farmer may have other uses for the land. Maybe he can grow a different crop?

It is possible to grow other crops on that type of soil. For instance, cabbage grows well in those types of climates. The problem is that the profit margins on cabbage are only 20% of those on sugar beets.

Sugar beets are produced by the farmer, and then shipped to the sugar refinery by truck. The sugar refinery makes sugar crystals from the beets and packages them. The packaged sugar is then shipped to retailers where it is distributed to the end consumer.

The sugar that reaches the end consumer is the same sugar and the same amount that would be shipped if old seeds were used. Therefore, there are no cost savings there. From the farmer to the refinery, however, the amount of beets shipped would be only half the traditional amount.

Trucking expenses should drop by 50%. The question is whether the refinery also realizes any production benefits from the reduced number of beets.

As it turns out, the processing cost of the new beets will be 25%

higher per beet than the old ones.

If the number of beets is reduced by 50% and the cost per beet is only 25% higher, there will be a 25% production cost savings to the refinery.

The refinery should be willing to pay the farmer a higher price for the new beets. The total savings from the new seeds can be summed up as follows:

farmers gain 10% on their profit margins from the opportunity to grow cabbage on half their land (100% is original profit. 20% of this 100% on 50% of the land equals 10%.); trucking expenses from the farmer to the refinery are cut by 50%; and production costs are reduced by 25%. Next you need to find out how much each step contributes to the final price of sugar.

Growing the sugar is 40% of the cost, trucking 10%, refining 30%, and distribution 20%.

The savings are 10% x 40% = 4% in growing; 50% x 10% = 5% in trucking; and 25% x 30% = 7.5% in refining. This adds up to a total savings of 16.5%. Multiply this number by the annual sugar demand and you get a dollar value of annual savings.

How would you estimate the annual demand for sugar?

At this point you drop your head in exhaustion for you will have to do an estimation case within a business case. See some of the examples above on how to do this. Assume that the resulting figure is $2 billion. Next you have to take the net present value of twenty years (the length of the patent) of 16.5% x $2 billion. Don't worry, they won't expect you to actually calculate this off the top of your head, as long as you tell the interviewer that this is the approach you would take.