My last post talked about broad classes of technological innovation – novel research methods and tools, novel mechanisms of action or targets, novel compound types and novel treatment modalities – and the common business models associated with them. The type of technology a company has influences the choice of business model, since the technology bears on the need for specialised assets, such as manufacturing and distribution that may or may not be readily available, and on the ease of transferring knowledge about the technology to collaborators, licensees or acquirers. Some technologies are readily written down in standard operating procedures or lab reports, whilst others may be more art than science and their implementation may require extensive personal expertise. However, technology type is not the only factor driving a firm’s choices.

The hard reality is that drug development is an expensive process and access to capital is a massive constraint. The high costs are largely driven by the high quality standards inherent in clinical trials and manufacturing in order to pass stringent regulatory hurdles that stand between our innovations and commercialising a product. And for the most part, we need access to assets that are outside of our companies – such as clinical and regulatory capabilities, manufacturing, sales and marketing infrastructure and the like. Financial constraint often impairs our ability to build these assets internally, some of which may be needed to deal with regulatory burden.

The environment is tough. How do biotechs choose the best strategy? Which business models work best? There are no easy answers or good data to help make these decisions. The knowledge and data are simply not available because the biotechnology sector is too early in its life cycle to provide stable patterns of performance. Even the early successful biotechs have significant differences in strategies – Amgen commercialised a few blockbuster drugs, Genentech focused on smaller markets (e.g. specific cancer therapeutics) and Genzyme focused on very rare diseases.

However, I have made several observations (during my doctoral research) about strategies for biotech start-ups. Firstly, companies often endeavour to progress as far along the value chain as possible – capital and capabilities permitting. Certainly this is the trend that has emerged in the wake of the platform company era. There is a strong tendency for start-ups to plug in to the value chain at the point where they either run out of capital or they require complementary assets (such as sales and distribution) that they cannot easily access.

That is to say, biotech start-ups often enter into a partnering transaction when they can no longer raise enough capital to continue along the value chain independently or when they reach some kind of obstacle that they do not have the skills or resources internally to overcome.

Secondly, it is not uncommon for companies to pursue therapeutic indications where there are lower regulatory barriers, such as orphan diseases or acute uses for a drug rather than chronic, thus lowering cost and risk. Many companies focus on reformulations of existing drugs to minimise cost and risk.

Thirdly, in the absence of sufficient capital to bring their innovations to market, biotech companies pursue a number of supporting strategies:

• Leveraging strategies
• Survival strategies
• Alliances
• Strategies for building credibility

Leveraging strategies

All companies that I studied faced significant cash constraints. This caused companies to add value to, or to de-risk, more than one asset, and also to use assets in more than one way. For example, preclinical and phase 1 safety data may be applicable to more than one product based on a single molecule or technology. Similarly, proof-of-concept in a first indication may strongly suggest that proof of concept will be likely in other indications. Companies typically have a pipeline of projects that they intend to develop, and leveraging strategies are used to ensure that money spent enhances the value of several projects. (See also Taylor and Ramsey’s post for more ideas on leveraging strategies.)

Survival strategies

Survival strategies are often tangential. Examples include the provision of contract research or contract manufacturing services to third parties in order to generate surplus cash flow. Survival strategies are aimed at ensuring that the company lives until it earns a return on its core business. Sacrificing the first-born project through an early stage deal provides cash flow that will improve the firm’s chances of survival. Sometimes survival strategies are incorporated up-front as part of a business plan, whilst other times they are developed in response to financial pressure.

Alliances

Alliances are key for pursuing development and commercialisation in the face of capital constraint. Alliances can provide cash-strapped start-ups with access to complementary assets that they cannot afford to develop in house. Furthermore, alliances often provide the third-party validation and credibility, which may support further raising of capital.

Strategies for building credibility

Credibility for biotech start-ups may come from several sources – the reputation of the team, the science, or key investors and alliance partners. Biotechs can pursue credibility by ensuring that their scientists participate in conferences and by publishing in peer reviewed journals. Firms can also win credibility through cornerstone investors such as large pharmaceutical or biotech companies and respected venture capital firms.

The key strategic issues (capital constraint, regulatory burden and the need for complementary assets and credibility) faced by biotech firms are inter-related. Combine those with project-specific factors, such as market opportunity and competition, and the decisions about ‘what’, ‘when’, and ‘how’ to plug into the value chain are shaped. Over my next few posts I am going to explore the implications and trade-offs that surround each of these strategic decisions, beginning with ‘what.’

Janette Dixon

In an earlier post I discussed how biotech companies can earn a return on a technology either in the product market or the market for ideas. Although this appears to be a dyadic decision, it is more helpful to think of a continuum of choices, between plugging into the value chain early and full vertical integration, with many different ways in which a firm can interact with its value chain. The best strategy will depend on how well the market for ideas works. Important factors include the degree of information asymmetry between the seller and the buyer, the need for investments in specialized assets, how easily knowledge can be transferred between parties, and how strong the intellectual property protection is.

Looking at pharmaceutical development, there is a broad range of technologies and projects that span these factors, suggesting that different business models may be appropriate for various technological innovations. In Science Business, by Gary Pisano (published in 2006) the author provides a useful examination of four broad classes of technological innovation and the common business models associated with them:

• novel research methods and tools (such as high-throughput screening, combinatorial chemistry, bioinformatics)

• identification of novel mechanisms of action or targets (angiogenesis, RNAi)

• creation of novel compound types (rDNA, MAbs)

• identification of novel treatment modalities and therapeutic markets (gene therapy, xenotransplants, or drugs for rare genetic diseases).

There is broad variation within the technology categories described by Pisano, so we have to be cautious in generalization. The technology does not necessarily determine a firm’s business model, but rather influences it. Other factors, such as a firm’s ability to access capital, also influence the choice (and success) of a business model. Common business models across the four technology classes are discussed below, as is their popularity. This discussion draws heavily from Science Business.

Novel research methods and tools

Several business models are available to these companies, including simply licensing the use of the technique or tool to other drug companies that would then use them in their own discovery process. A second model would be to sell drug discovery services, while a third strategy would be to vertically integrate forward into drug R&D and develop proprietary molecules.

The market for ideas usually does not work efficiently in the first strategy, because the difficulty in fully sharing background information may make it difficult to convince potential licensees of the value of the technology or tool. Furthermore, the licensee would probably have to invest in specialized equipment (complementary assets), raising their risk. Difficulty may occur in transferring knowledge that is not easily codified, impeding the adoption of the new technology by licensees. If the intellectual property protection is not air-tight, the innovator could expose itself to imitation. Under the second business model all of these risks and issues are removed.

In the late 1990s this service model was followed by many platform technology companies. However, many of them, such as Millennium, Celera and Human Genome Services, abandoned this strategy to vertically integrate into the development of proprietary. Vertical integration (FIPCO/FIBCO) based on a platform technology is likely to be overkill and may even be suboptimal if the firm lacks downstream capabilities such as manufacturing, marketing and distribution. However, being a service or tool company offers a very different risk-reward profile than drug development. The problem that platform companies faced in the late 1990s was not their business models, but the environment created by the genomic bubble in which unrealistic valuations could not be sustained with a service or tool model.

Novel targets or mechanisms

Innovation here is concerned with the identification of new disease targets or mechanisms of action implicated in diseases. The market for ideas is not fully efficient is this situation. It is unlikely that intellectual property can be completely secured on a mechanism or class of targets. Often a lot of prior art exists and the intellectual property is based heavily on the kind of knowledge that cannot easily be transferred from one company to another, so it is unlikely that a firm in this innovation category can simply license its innovation. It is therefore more likely to pursue a drug discovery and development strategy. But how far down the drug development value chain should it integrate? This depends on the characteristics of the drug and the market. If it is a small-molecule drug candidate targeting a well established therapeutic market (hypertension, for example, or diabetes or depression) the rationale for full vertical integration is weak, assuming the innovator is able to secure IP protection on the molecule. A licensee would likely have the necessary complementary assets and capabilities required to take the drug candidate down the development pathway to market. Tacit knowledge (the knowledge that is difficult to write down and pass on) may be an issue in designing or interpreting clinical trials in some instances but can be overcome through close collaboration with the licensee. A long-term commitment would have to be made, and would probably be a more efficient solution than full vertical integration.

Novel compound types/novel treatment modality and novel markets

Biotechnology is bringing us new types of therapeutic molecules, such as rDNA, stems cells, monoclonal antibodies and new treatment modalities. Novel market opportunities are also being developed such as those for orphan disease for personalised medicine.

These types of innovations can be difficult to license due to lack of knowledge and capability on the part of would-be partners. Also, importantly, they typically require significant investments in downstream assets (development, manufacturing, distribution). Full vertical integration may be the logical strategy for these types of innovation. Collaborations have been seen with these opportunities, but the risks are high, disputes common and collaboration may be a second-best strategy. While vertical integration reduces the risks of operating in an inefficient market for ideas, it raises other risks. The level of capital required is huge, and may preclude R&D portfolio diversification. Younger firms pursing a FIPCO strategy may have everything resting on the success of a single (first) therapeutic candidate.

Pharmacogenomics is the branch of pharmacology behind ‘personalised medicine,’ in which drugs and combination therapies are optimised to an individual’s genetic makeup. Pharmacogenomics looks at the influence of genetic variation on drug response in patients by correlating gene expression or mutation with a drug’s efficacy or toxicity.

Whilst personalised medicine has been slow in making its mark on healthcare, it will probably be an important pillar in the future of drug therapy. The model for personalised medicine is evolving. It is likely to be more than one unique model, varying with the underlying technology, involving discovery companies, pharmaceutical company collaborators and clinical laboratories and may involve participation by healthcare providers.

It is clear from the preceding discussion that technology type has an important influence on business model by the bearing it has on the need for specialized assets and the difficulty in transferring underlying knowledge. Other factors influencing the choice of business model include how well the intellectual property can be protected and the firm’s ability to access capital.

In my next post I’ll talk about the strategic issues facing biotech start-ups and the kinds of strategies firms employ in response.

Janette Dixon

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 ":https://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).

Janette Dixon