Financial returns on an innovation may be earned through the “product market” or the “market for ideas.” The product market we are all familiar with – it describes the way in which we buy and sell physical products (medicines or diagnostic kits, for example) or services (laboratory tests or surgery).
The market for ideas, on the other hand, is a notional market in which innovations are sold or licensed before they are a final product (or service). In essence the innovation is still an idea, or intellectual property – it is a collection of intangibles. Choosing between these two options is a key element in commercialisation strategy. The innovator can try and take a product to market themselves (including manufacturing, marketing and distribution) or they can sell the idea to another firm – one with the appropriate infrastructure to launch the innovation.
In the first instance, the innovator will use or pioneer its own value chain, meaning the firm integrates internally or contracts for the value-added activities. (For more on value chains, read my last post.) In the second, the innovator will use an already-existent value chain. The majority of biotech firms commercialise their innovations in the market for ideas – after all, manufacturing, marketing and distribution all bring additional costs – but there are times when this may not be the best strategy.
How do we know which is best, and what are the drivers for this decision?
Intellectual property protection and access to complementary assets (regulatory knowledge, manufacturing ability, sales and distribution teams) both play a part. Strong intellectual property protection and a lack of in-house complementary assets usually means a company commercialises in the market for ideas – selling or licensing to a party with the skills and infrastructure to bring it to market. This is typical for small biotech firms.
However, when a firm does not have strong intellectual property protection, then it’s at risk of having a larger partner appropriate (steal) its ideas, or take a much greater share of the value than the smaller firm thinks is fair. In this case, that firm might be better off keeping its intellectual property protected as a trade secret, which means it takes the innovation to market itself. If resource constraints means self-commercialization is not possible, then a small firm will need to rely on the reputation of the larger company to not be taken advantage of. If this occurs, it’s best to use a trusted intermediary (such as a prominent venture capitalist or licensing lawyer) to act as a go between in negotiations that will not include full disclosure of the trade secrets until after deal completion.
A second situation is when there is no existing full value chain for a product, and the biotech start-up is forced to pioneer the development of new complementary assets. An example would be the xenotransplantation of alginate encapsulated neonatal porcine islet cells to produce insulin in the host. That’s what "Living Cell Technologies ":http://www.lctglobal.com/ (LCT), a New Zealand based biotech firm, is doing, and it has had to develop its own specialised manufacturing facilities. To bring the firm’s products to market it may eventually pioneer the development of specialised clinics that can handle the transplants in large numbers. LCT has no choice but to commercialise its technology in the product market.
Sometimes an evaluation of the risks and rewards of using an existing value chain vs. building one will show the latter to be more rewarding, though building one requires access to sufficient capital. Products targeted at high-paying and/or highly centralised or niche market opportunities may lead to the development of downstream infrastructure for manufacturing, sales and marketing and distribution, even though existing channels could be used (e.g. orphan drugs, products sold to specialists or hospitals).
Once a startup has made the decision to commercialise in the market for ideas, the next questions are “when” and “how” to plug into the value chain. Cooperation might occur via research partnerships, arms-length licensing agreements or cozy joint ventures among other alternatives. Further, a company might find help at many points along the value chain, from discovery to preclinical testing or clinical testing to marketing. Still, a bioentrepreneur might not know how to make these types of decisions, and I’ll explore that in future posts. First, though, we’ll look at typical business models in the biotech sector (that’s coming up next).