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Entrepreneurship and Innovation: Biotechnology ROBERT A. SWANSON The United States is at the port of risking significant export of jobs and technology to Japan and Europe zf the regulatory costs and delays associated with marketing biotechnology ir: the United States become prohibitive. This potentiality reflects a pattern. The United States develops, finances, and builds a new technology only to have the profits skimmed offbyforeign competitors who spend their money on manufacturing development and marketing. The history of biotechnology, or genetic engineenng, is short, because it was only 1973 when Herbert Boyer (my cofounder at Genentech) and his colleague Stanley Cohen of Stanford University inserted DNA into a host bacteria that reproduced the foreign DNA. It was in 1976 that Dr. Boyer and I formed Genentech. In the following year, 1977, Genentech scientists expressed in bacteria the brain hormone somatostatin, which was the first useful protein to be produced by recom- binant DNA technology. The president of the National Academy of Sciences described the production of somatostatin as a '~scientific triumph of the first order." ~ It then took one more year to produce human insulin and another five to move it to the market. Today, human insulin is He only recombinant DNA product available at He phannacy. The indus~y's gestation period took a bit longer, because the basic research on which recombinant DNA technology is founded had gone back a number of years. For example, He federal government had been partially funding Statement by Philip Handler, President, National Academy of Sciences, at hearings on Recom- 5~t DNA before the Subcommittee on Science, Technology, "d Space of the U.S. Senate Committee on Commerce, Science, and Transportation, November 2, 1917. 429

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430 ROBERTA. SWANSON -Dr. Boyer's research in microbiology at the University of California at San Francisco for 15 years. Or as he likes to put it, "Who would have dreamed that my work on how bacteria have sex could combine with other pieces of basic research to help fob a new industry?" With enough basic research to choose from, American business can continue to spawn new industnes. OPPORTUNITIES AND RISKS The United States is the world's leader in both the basic science and the commercial development of biotechnology because of enormous sums in- vested by the government dating back to World War II. For example, in 1983 expenditures by the U.S. government on basic research in biotechnology were the largest in the world over $500 million. This basic research has provided industry with a smorgasbord of knowledge from which to choose in order to produce solutions to major world problems such as disease and malnutrition. Basic research funding has also provided the training ground for the scientists who are staffing today's companies. In the United States, there are now more than 200 biotechnology com- panies. These are divided into two distinct categories: small entrepreneurial firms, like Genentech, and large established companies, such as Eli Lilly, Monsanto, and Du Pont. Most small fins have been founded since 1976. These ventures were started specifically to corrunercialize the applications of biotechnology. Many were foxed around a nucleus of university-based research scientists. During the industry's early development period, the competition among biotechnology firms was in the areas of cloning and expressing desired prod- ucts. The focus is now shifting. The cutting edge of the technology is now in scaleup and downstream processing. And the emphasis is on getting prod- ucts to market. Bringing a product (especially a human health care product) from the laboratory to the marketplace demands an enormous front-end investment in human and capital resources. It has been largely for this reason that a major pharmaceutical firm has not been formed in this country since Syntex in 1957. While the biotechnology industry has already spent hundreds of mil- lions of dollars on research and development, it is just entering the stage of product manufacturing and sales. This is exactly the stage at which fledgling industries are most vulnerable and in need of a positive environment—the stage at which government needs to provide positive incentives. However, historically, our government has not offered its support at this development stage, and this has allowed foreign competition to close the gaps. Federal funding of generic applied research, which focuses on process development and bioprocess engineering, is small less than 10 percent of the funding for basic research. There is little focus on international manu-

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ENTREPRENEURSHIP AlID INNOVATION: BIOTECHNOLOGY 431 factoring competitiveness. International comparisons show that several com- petitor countries, such as Japan, Germany, and the United Kingdom, are already spending a significant amount on generic applied science In bio- technology. In Japan, the biggest share of every research dollar is funneled into bioprocess engineering rather than into basic research. The Japanes have relied on the United States and other countries to provide the break- throughs. Then, by rapidly applying considerable expertise in process de- velopment and scaleup, they can jump well ahead and capture a large share of the world market for biotechnology products. Highly skilled personnel for this stage of development is another area in which our competitive position is in jeopardy. Only a few programs are available in the United States for training personnel in the applied aspects of biotechnology, and there are few government programs, such as training grants, to support education in this field. Part of this lack can be made up by industry itself with the proper government incentives. For the larger companies, one alternative is tax credits. The 25 percent tax credit, which is due to expire on January 1, 1986, gives companies a reasonable incentive to increase spending, on R&D. It also allows industry needs to determine how R&D money is spent. Especially important to the smaller biotechnology companies is the avail- ability of capital. Without the equity funding to develop innovative ideas, most young, high technology companies would not exist today. This is es- pecially true for biotechnology. The availability of venture capital has been instrumental in the founding of new biotechnology Grins in the United States. The treatment of capital gains is particularly critical to the formation of venture capital. Fortunately, in 1978 Congress cut the capital gains tax rate from 40 percent to 28 percent. The results of reducing the tax rate were dramatic. Within 18 months, more than 51 billion of new venture capital flowed into funds for investment in new and growing companies. In 1983, aided by further cuts in the capital gains tax rate, to 20 percent, $4.1 billion of new venture capital was made available for investment. This is in stark contrast to the $50 million that was added annually, on average, to the venture capital pool during 1971-1977, when We tax rate was high. Although the Treasury Department had warned that the 1978 capital gains tax cut would reduce federal tax revenues, Dose losses never materialized. In fact, capital gains tax receipts increased markedly with We lower rates. It will be important to ensure that new tax legislation does not reverse this mend and thereby reduce the availability of capital needed by new innovative companies. Should all this sound a little self-serving, I would like to point out Mat it is the smaller companies that have in fact been We technology leaders and innovators. In 1967 a Commerce Department study found that more than half of all U.S. inventions and innovations were accounted for by small

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432 ROBERT A. SWANSON businesses and individual inventors. In 1976 an MIT study found that young technology companies far exceeded their larger, more established competitors in rates of sales growth, taxes paid, and, especially, number of jobs created. In the past 10 years, small innovative businesses have created 3 million jobs, while net employment in the 1,000 largest U.S. corporations has remained more or less level. The case of my own company, Genentech, Inc., illustrates many of the points ~ have been making. Our company is just 9 years old, but we have already created 700 new jobs and spent close to $146 million in research and development. We have also invested over $112 million in facilities for research, manufactunng, and administration, facilities Mat now exceed 350,000 square feet. And, most importantly, since Genentech's founding, our research has led to a number of important products for human and animal health care. These include t-PA, a blood-clot-dissolving substance used during hean at- tacks; gamma interferon, an anticancer and anti-infective agent; tumor ne- crosis factor, another exciting, new anticancer drug; human insulin for the treatment of diabetes; Factor VIII, an essential blood-clotting factor for the treatment of hemophilia; and human and animal growth hormones. This list of products illustrates the contribution that an entrepreneurial firm like Gen- entech can make in advancing the frontiers of biotechnology through ongoing technological innovation. It takes a long time, however, to bring a product to market, particularly in the pharmaceutical sector, where all products are subject to extensive clinical testing and regulatory review. For example, human insulin was de- veloped by Genentech and licensed for manufacturing and worldwide mar- keting to Eli Lilly. To bring this product to market required nearly five years of effort by Lilly and our company after the time the microorganisms had been engineered. Costs to build a production facility exceeded $80 million, and development expenses were well into the tens of millions of dollars. It required more than 1,000 man-years to bring Me product through the venous stages of development beginning win fermentation scaleup and punf~ca- t~on, through animal and human testing, and finally obtaining approval for marketing from the Food and Drug Administration (FDA). As my discussion has illustrated, the early risks and investment are great for biotechnology companies. Most small firms still have few or no products generating revenues, yet they are now faced win financing production scale- up. Consequently, many new firms have already had to obtain second- and th~rd-round financing, relying heavily on public stock issues, private place- ments, and R&D limited partnerships for additional funds. R&D partnerships are an ideal funding vehicle for small biotechnology companies having to raise money to complete the development of their prod- ucts particularly to fund clinical research, which is the most expensive phase of a development program. The risks of product development are shared ,,_ ~ ^~=

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ENTREPRENEURSHIP AD INNOVATION: BIOTECHNOLOGY 433 with private investors and the government. R&D partnerships provide tax advantages to the investor, who looks to a percentage of product sales for his return. Such partnerships can be critical for a new company in the phar- maceutical industry, where product-development cycles of 5 to 7 years and front-end expenses of $50 million to $70 million are the norm. Patent Protection Opportunities in biotechnology also depend to a great degree on the pro- techon given research and innovation by patents. Without the means to prevent competitors from unfairly capitalizing on one's investment, most pioneering research projects would never be undertaken. Risk to investors would be prohibitive if the products of invention were likely to become freely accessible early on to others who had not incubated the same R&D costs. Not surprisingly, the number of biotechnology-related patent applications received by the U.S. Patent and Trademark Office has increased dramatically each year for the past several years, putting this agency to a severe test. Currently there is a backlog of 1,000 applications related to genetic engi- neering and a total of 2,600 related to biotechology in general. The critical issue is timing of issuance, and the average pendency has reached 28 months. Part of the bottleneck is due to lack of staff there are only 26 examiners in the biotechnology area. To ease the situation, the Patent Office is planning to streamline the review process and increase the staff (to 40 biotechnology examiners by He fall of 19851. This should help alleviate the problem. A final point pertains to patents and international competition. A large share of biotechnology-related patents issued by the U.S. Patent Office goes to foreign parties. This certainly is a good indication of the intent of overseas firms to stake a claim in the U.S. market. It is important that Americans get the same fair treatment when they file for patent protection in other countries. REGULATIONS So far, the United States has avoided He regulation of biotechnology. Guidelines sponsored by the National Institutes of Health and adhered to by academia and industry have provided a flexible and safe environment for the development of this technology. This is one reason why He United States is still ahead of Japan. Japanese research has been hindered by strict regulatory controls. However, Japan's restrictions have recently been relaxed, and bio- technology efforts are now progressing rapidly. FDA Regulations Pharmaceuticals are the prime commercial products of biotechnology, and they are subject to FDA approval. The FDA has taken a constructive attitude

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434 ROBERT A. - ARSON in making the first products of biotechnology quickly available to the public without lowering the agency's high standards for proof of safety and efficacy. However, the time it takes for a drug to go through the approval process is lengthy—an average of 40 months for drugs approved in 1984. And the FDA now faces a flood of applications for approval of biotechnology prod- ucts. European countries have a distinct advantage over the United States be- cause they are often not subject to the strict product-approval regulations deemed appropriate in this country. ~ have to agree with the Office of Tech- nology Assessment's statement that "~e regulatory environment favors He European companies, over those of Japan and He United States reaching their own domestic markets sooner for pharmaceuticals and animal drugs."2 If this happens, He European companies, fueled by profits from product sales in secure home markets, will be able to invest in further research and cost reduction with a view to exporting Heir products to the United States. The FDA's timing of approvals can have significant economic implica- tions. For example, in the last 20 years, more than 1,100 new pharmaceutical products have been approved for use in He United States, but only a little more than 100 of those will be approved first in the United States. While we do not want to change our high standards, it is clear that there needs to be better understanding of how regulatory delays can affect our country's international competitiveness. Export Policy One Anal regulatory consideration that ~ would like to address is the impact of U.S. pharmaceutical export regulations on biotechnology products. Export controls in this country are the most restrictive of any nation competing in the field, and they negatively affect our competitive position. U.S. export regulations state that new drugs not yet approved for sale In the United States cannot be exported for.sale outside the United States even if He regulatory agency in the recipient county has already approved the product for marketing. The United States is the only counoy in the world with such a law. This policy has several implications. Most large U.S. pharmaceutical com- panies have built manufacturing facilities in foreign counties. This results in the transfer of technology outside the United States, lost3Obs for the U.S. labor force, and lost opportunity to help the U.S. balance of payments. It also provides these large companies with an advantage over small U.S. biotechnology firms that cannot afford to establish manufac~g plants Office of Technology Assessment, Commercial Biotechnology: An Intern~zzzonal Analysis ~ash- mgton, D.C.: U.S. Government Printing Office, 1984), p. 21.

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ENTREPRENEURSHIP kD INNOVATION: BIOTECHNOLOGY 435 overseas. The biotechnology industry is working hard to change this law before the United States gives foreign competitors too much of a helping hand in biotechnology. SUMMARY The American biotechnology industry is at a critical stage in its devel- opment. Enormous R&D investments have been made, but the industry has not yet reached the manufact~g and marketing levels at which it can be self-sustaining. Many small biotechnology companies will fail altogether if they do not bring products to market in the near future. The larger companies will survive, but they may lose to overseas competition if they are forced to delay market entry. The United States is at the point of risking significant export of jobs and technology to Japan and Western Europe if the regulatory costs and delays associated with marketing products in the United States become prohibitive. The transfer of technology out of the United States is particularly worrisome given the enormous public funding that was largely responsible for the de- velopment of the basic biological sciences on which this technology is based. This has become a pattern. The United States develops, finances, and builds a new technology only to have the profits skimmed off by foreign competitors who spend their money on manufacturing development and marketing. The U.S. government has been a major contributor in establishing the leadership position of the United States In biotechnology. However, if we are to maintain our lead, we must act quickly to address a number of critical issues—continued tax incentives for research and capital formation, tamely review of patent and new drug applications, well-informed export policies, and increased funding for process technology and generic applied research. Win concerted, cooperative, and tamely efforts on the part of government, industry, and academia to address these critical issues, I am confident that the United States can maintain its lead in biotechnology.

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