The not-so magic numbers

11 January 2007

Biotech businesses have made an aggregate loss over the past three decades, according to Harvard Professor Gary Pisano. He thinks it's time to try radically news ways of building businesses

Professor Gary Pisano has thrown open a rather large can of worms with his latest book. 'Science business: The promise, the reality and the future of biotech.' Arguing that biotech companies' business models are fundamentally flawed, he points out that the sector has lost money in aggregate over thirty years, and that R&D performance has not significantly improved. He also points to the ongoing tensions between science and business. What's needed, he argues, is better collaboration between businesses, fewer independent companies, and more partnerships where Big Pharma companies own large stakes in smaller biotechs.

You could argue that, having spent 20 years studying biotech companies, Pisano's arguments amount to biting the hand that feeds. And certainly, his views have provoked strong reactions. One respondent to a recent article on Pisano's book in Business Week headed 'Don't' wait around for the next Amgen' fumed: 'I don't think this guy understands how biotech companies operate (at least on the West Coast). Most are very aware of business considerations from their inception. The idea that biotechs should just become research arms for Big Pharma is absurd. In fact, Pharma companies are just becoming sales organizations for biotech.'

Bad business?

In person, however, Pisano is more measured than the reactions to his book might suggest. Speaking to g2i Insider, he hesitates to condemn the 4,000 publicly traded biotech companies, pointing out that they have made $40bn of revenues between them over the past three decades. And he's the first to recognise that his findings are based on an inexact science. For a start, he says, it's difficult to define what counts as a biotech firm, since the boundaries between traditional pharma and modern gene manipulation have blurred. Tracking all the privately held firms is equally hard - and as a result, most research is based on public companies, ignoring all the nascent ideas that haven't yet made it to IPO or companies that were sold in private deals.

But even taking into account these variables, Pisano argues that independent biotech firms have not returned significant returns to investors - and therefore in their current form are not a good business investment. 'I did some of my own research and I also used research from other academics and researchers,' he says. 'There are a range of numbers, but they all point to the same thing.'

There have been a few notable successes such as Genentech, of course, which is now the model for many other businesses. Countless biotechs have followed its lead in facilitating technology transfer by creating new businesses rather than selling it on, aided by VC funding. But in general, biotechs have failed to make profits, revolutionise R&D or mitigate risk, particularly since the genomics bubble burst in 2001.

Anatomy of a biotech

To explain his theory, Pisano uses the concept of 'anatomy' to describe how businesses are set up, building on the traditional idea of the 'structure' of a business sector. 'Structure is based purely on economic variables - the number of firms, their turnover and so on. Anatomy is a concept to characterise something different. It takes in the structure, but also institutional arrangements, the roles of different players, the capital and labour markets and the regulatory environment.'

With regard to biotechs, he says their business anatomy works against them in three ways. Firstly, there's the way they reward risk, shunning high levels of risk in favour of spreading it around - this dilutes potential investor returns. Secondly, the industry is fragmented by nature, with most collaborations surface-deep at best. Thirdly, intellectual property (IP) is effectively locked up in different concerns rather than being shared around. These approaches might have worked well for the hi-tech sector, but given biotech's unique characteristics - including its long R&D cycles - they're less effective.

Pisano argues that there's a need for more vertical integration with companies proving their expertise in a specific area and then collaborating widely, leading to 'fewer, closer, longer-term collaborations' and fewer independent biotech companies. He also favours a model where a biotech is publicly traded, but with a Big Pharma partner owning the majority of its shares. This is the Genentech model, which is 60% owned by Roche. Crucially, says Pisano, 'Roche did not exert a lot of control. It was a long-term partnership but not a controlling one. Not many have that.'

Selling out is also an option, of course, although in too many cases that results in founding entrepreneurs quitting after their lock-in period, taking away one of the company's key assets. An alternative, Pisano suggests, would be to go for a deeper alliance with a small set of firms.

Spinning out of control?

Finally, Pisano has concerns about university spinouts. While he says 'I'm all for universities moving technology to more of a commercial perspective', he believes universities shouldn't be so quick to spin out firms. Nor should their success be judged on the number of spinouts they establish. 'Sometimes there are other ways - lots of technology can be licensed to existing firms,' he says. 'At the very least you should think about the options. You should think about start-ups firms as the last resort, as opposed to the first.'

By David Longworth, Webster Buchanan Research

*'Science business: The promise, the reality and the future of biotech.' is available from Harvard Business Publishing. See www.hbsp.harvard.edu