1976 was a seminal year for innovation. Itwas the year when Apple was founded, starting the propulsive growth ofcomputer-driven business. After just 30 years, the results have saturated oureconomy and culture, changing the way we live and producing giant companieslike Microsoft, Intel, Amazon, Google and Bloomberg. Microsoft alone has bredmillionaires like rabbits.
That same year Genentech became the pioneer of the biotechindustry, and the company (now partially owned by Roche) is still around andhighly successful. Overall, however, as even Genentech CEO Arthur Levinson hasbluntly said, biotechnology has been “one of the biggest money-losingindustries in the history of mankind” (see sidebar, page 58). Money aside, thebiotech promise has not changed the healthcare landscape the way Apple’s seedshave sprouted. The cures for cancer, multiple sclerosis, and Parkinson’s arestill around the corner.
What went wrong? Despite the stark difference in the twoindustries’ fates, they followed essentially the same business model—aninspired innovator, sometimes partnered with an equally venturesomeentrepreneur, forms a company and attracts smart investors. It worked not onlyfor Genentech but for Amgen, Biogen Idec, Celgene, Genzyme and GileadScience…but they are the exceptions. Other startups, however, are either stillstruggling, extinct or have sold out. But the promise remains, and venturecapital is still chasing the pot of gold. Whether this confidence is justifieddepends, as so often, on whom you talk to.
Since BIO is the industry’s trade association, it is itsmission to be optimistic. Alan Eisenberg, EVP for emerging companies andbusiness development, told MM&M in an exclusive interview that the industry“has been extraordinarily successful in terms of addressing medical needs,developing new therapies for patients that had no hope previously.”Financially, “some companies have been very successful and others less so.” Hepointed out—and this was the theme of everyone we talked to—that since “theindustry is fundamentally about trying to commercialize new and innovativescience, it’s a high-risk business.”
A look at the data
For hard numbers, we turned to Glen Giovannetti,biotechnology leader of Ernst & Young. The firm is in its 22nd year oftracking the biotech market and its reports present annual snapshots of what’shappening industry-wide.
Citing the latest report, which covers the first half of2007, Giovannetti said it reflects “a symbolic milestone”—for the first time inbiotech’s history, the industry is on track to achieve aggregate profitabilityfor this fiscal year. In fact, according to Giovannetti, this milestone mighthave been achieved during 2006, except for charges related to the many dealscompleted then, which depressed the bottom lines.
The basis for this hopeful profit picture is that revenuesfor US publicly traded biotech companies were up 18% as compared with the firsthalf of 2006, a performance that outpaced the industry’s historical averagerate of growth. It was a record led by Amgen, Celgene, Genentech, Genzyme, andGilead Sciences—what the report refers to as the industry’s stalwarts. “Thisgrowth rate is all the more impressive,” the report adds, “because it includesthe impact of the acquisition of MedImmune by AstraZeneca,” one of dozens ofsuch acquisitions by pharma companies over the years (Alza, Chiron, etc.),which keeps their revenue statements out of the public record. MeanwhileR&D expenses kept pace with revenue growth.
Growth in revenues is nice, but the bottom line is whathappens to profits. Says Giovannetti: “If you track the financial reports ofall the publicly traded companies since we’ve been tracking it, the industryhas never shown profitability, but last year we were right on the cusp ofprofitability. And this year (i.e., 2007) through mid-year it was clearly goingto be profitable, and I have no reason to believe that the full year will notbe profitable.” (The full year’s data for 2007 are due out in this month.)Those are composite figures, of course, and as he points out, the profits arecoming primarily from a handful of companies—the Genentechs and Amgens—while80% to 90% of the public companies are still in the R&D stage which, “bydefinition means losing money.”
The private sector
Financial reports for publicly traded companies are easy totrack, but when private companies lose money they do it, well, privately. EvenErnst & Young finds their financial data hard to get at. “The way youmeasure how private companies are doing, at least on a broad level,”Giovannetti explains, “is by how successful they are in attracting capital.”Since they have little if any revenue on the sales front, infusions of capitalplus partnership agreements with pharma are what keep them afloat. And from aventure capital point of view, 2007 was also a very successful year, the secondhighest in the industry’s history according to BIO’s Eisenberg.
“There are record levels of capital pouring into biotech,”Giovanettti concurs, despite the difficulties in the stock market. It is,however, hard to generalize. “The dollars are not spread evenly, so thecompanies that have an interesting research platform are attractive toinvestors, while others are in a part of their development cycle where they arenot as attractive. There are so many different stories, but if you look at howmuch money is flowing to private companies as a surrogate of their success,it’s a pretty healthy picture.” (This conversation took place before the BearStearns meltdown.)
Nonetheless Eisenberg cautions that a good number ofcompanies have less than three years of financing, and if they need to raisemoney this year, the financial situation might make it more difficult. Someobservers we spoke to (who preferred to remain anonymous) went further,expressing concern that if the current credit crunch leads to, if not a dryingup, at least to a shrinking of the capital market, that might bankrupt the morevulnerable players.
Asked to comment on the Levinson quote, Giovannetti says, “Youhave to be careful about what’s being measured. In terms of true operatinglosses as shown on companies’ income statements, he’s quite right. But if youlook at value creation for investors, it’s a different story.” His point isthat hundreds of billions of dollars have been invested in start-up ventures,and while not many have become profitable, many others developed somethingsufficiently valuable to lead to buy-outs by pharma companies—a good deal forinvestors. So some people have made money but “everybody agrees that this is ahigh-risk area, not for the faint of heart, and companies do lose a lot ofmoney before they ever return a dollar.” Single product companies areparticularly vulnerable, especially now that an increasingly risk-averse FDA seemto be giving new product applications ever closer scrutiny.
Looking ahead, Giovannetti summed up: “Six months ago Iwould have said that the near future for the industry’s overall picture wasvery positive.” Now, due to the ripple effects of the problems in the mortgagemarkets, “the capital market will be tighter and might even shut down for alittle bit. But we’ve come off a couple of very good years that permittedcompanies to stock up their cash reserves. These cycles come and go.” Anexample cited by him as well as others is the genomic bubble of 1999 and 2000;the fallout when it burst was quickly overcome. By the time this appears inprint we may know whether the current market bubble will prove equally benign.
Overseas trends, by the way, are similar. European companieshad their best results in years in 2005, with revenue growth of 17% compared toa five percent decrease the year before. Also in that year, for the first timeever, Europeans raised more money through IPOs than their US colleagues.Meanwhile, the Asia-Pacific region, Ernst &Young reports, “recorded ascorching 46% increase in revenues” in 2006. Australia alone scored a 60% boostin biotech revenues, helping to propel Australia’s biotech sector toprofitability ahead of either Europe’s or ours.
Cyclical or endemic?
If, after 30 years, the biotech industry is only now on thecusp of becoming profitable, it may be, of course, that it has basic, systemicproblems. That, at least, is the conclusion of Gary Pisano, a professor atHarvard Business School and author of Science Business, widely regarded as themost definitive study of the industry. Published in 2006 (and he confirmed in apersonal interview that the essential facts haven’t changed), the book sums uphis 20 years of analyzing the industry’s technology strategy and management ofinnovation. Having also served as an advisor to top execs of bothpharmaceutical and biotech companies, Pisano asked himself: “Can science be abusiness?”
“The scientists and executives I met and worked with…wereamong the smartest, most dedicated and most imaginative people I had everknown,” he reflects. Not only that, but “everything we knew about business andindustry performance suggested a very promising future for biotechnology, notjust commercially but also for its ability to transform drug therapy,” and atindustry conferences he kept hearing consistently “sunny prognostications.” Sowhy, he began to wonder, “was the great promise of biotech going largelyunrealized?” Conducting a productivity analysis, he concluded that despite thebasic premise of biotech there was in fact no discernable difference in R&Dproductivity between biotech firms in the aggregate and that of large,traditional pharma companies. So he began to look for explanations.
He came to believe that the scientific and commercial promiseof biotech has been hampered by the way the business is structured andoperated. Specifically:
- Effective development and application of the technology requires integration, but the founder-driven biotech business is characterized by specialization and fragmentation.
- “The uncertainty and novelty of the science requires rapid diffusion of ‘high fidelity’ information,” while each company jealously guards its trade secrets.
- Science requires long-term, cumulative learning. Biotech firms, however, face market pressure to optimize short-term results.
These built-in inconsistencies are not amenable to easysolutions, Pisano feels. “The imperfect and often messy context in which thesefirms operate is taken as a given,” and therefore is not likely to changedramatically over the foreseeable future because “investors will be fickle andsometimes irrational. Academic entrepreneurs will continue to be motivated tostart their own firms, whether this strategy is rational or not. Venturecapitalists will still feel impelled to take companies public at the earliestopportunity.”
Since this outlook is not hopeful, Pisano concludes with aradical suggestion—abandon the current model and instead develop biotech drugsthe way movies are produced. Studios, he points out, do not generally developtheir own content. They get that from scriptwriters or independent producers.So let’s think of scientists as the outside idea people. Once proof of the concepthas been established, companies can then procure development rights. Call it“greenlighting” R&D. Finally, established pharma companies, assuming therole of the major studios, can take over, pursuing Phase III trials, securingregulatory approval, and applying their distribution and marketing skills. Thuseveryone, including medical care, will benefit.
Pisano concedes that this might not be the right model forthe most innovative drugs, since without strong internal scientificcapabilities it would be virtually impossible to differentiate the prospectivewinners from the lemons. Thus “vertical integration may actually be bettersuited to the most novel types of innovation.” But that brings up anotherhitch—the way traditional companies have tried to integrate both internallydeveloped and acquired biotech leads. “It does no good to be a verticallyintegrated enterprise and yet operate each major function or technicalspecialty as its own island of expertise,” he adds.
In other words, there is no one-size-fits-all solution. Eventhe fairly standard pharma/bio alliances often don’t work because they areusually arms-length relationships and not true collaborations.
Low-hanging fruit
In light of all that, you wonder how it happened that somecompanies did score signal successes, and what strikes you as you list them isthat most of them were early entrants into the biotech game. Then as you lookat their early winning products, it becomes clear that they mostly started withfar more attainable objectives than their successors. Genentech, for example,concentrated on its recombinant insulin program. Not only was this a specificproduct objective rather than trying to capitalize on basic sciencebreakthroughs, but it provided an opportunity to partner with an establishedcompany—their R& D agreement with Eli Lilly & Co.. It providedGenentech with development funding, while Lilly acquired the marketingexperience that gave it a head start among major pharma companies anxious tobranch out into biotech. Incidentally, Lilly had first tried to license Harvardscientist Walter Gilbert’s discovery, but Gilbert preferred to start his owncompany—a telling illustration of why pharma has largely been forced to rely onexpensive acquisitions to enter the biotech field. But that hasn’t stoppedacquisitions and partnerships. As recently as 2005 to 2007, according to anMM&M analysis, there were 17 big pharma/big biotech deals, involving suchmajor companies as Merck, Pfizer, GlaxoSmithKline, Lilly, Novartis, Roche, andAstraZeneca.
One conclusion all commentators agree on is that succeedingin or even entering the biotechnology business is fraught with hazards. Firstyou have to get the science right, turning promising leads into experimentalproducts. Then you face multiple R&D and regulatory hurdles, all the whilekeeping the money spigot open at one end as your funds pour out the other. AsPisano puts it in Science Business, “raising capital in biotech is like gettingan official number for the Boston Marathon. It can be really tough to do…but itonly gets you into the race. You still have to run the 26.2 miles!”
An interesting journey
But that won’t keep people from trying. As Glen Giovannettipoints out, the prospect of developing exciting technology that has a chance tomeet unmet medical needs will continue to attract investors, and when suchproducts are created, there will be a market for them—and they will get paidfor. His Ernst & Young colleague Gautam Jaggi, managing editor of the“Beyond Borders” report, concurs.
“While the issues change, the constant is that innovationdrives value in R&D, in deal structures, and in go-to-market strategies,”says Jaggi. “Yes, sometimes it feels like this industry is always at onecrossroad or another. That may well be so—it may just come with the territoryof being a high-risk, high-reward business. But we shouldn’t complain. Afterall, these challenges, and the biotech industry’s innovative responses to them,have always kept the journey interesting.”
From the May 01, 2008 Issue of MM+M - Medical Marketing and Media
