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4 Japan's Growing Presence in the United States STRATEGIES ()F JAPANESE COMPANIES Difficulties faced by small U.S. companies in securing capital are seen by some as a limiting factor in the growth of U.S. commercial biotechnology. Through 1990 roughly $6 billion had been raised by the industry in its history, the bulk of that in equity.52 In the wake of the stock market crash of 1987 it became more difficult for firms to raise money through equity offerings. Though the "top-tier" companies benefit from their visibility and are obvious choices when investors need exposure to the sector, many of the smaller companies that are continually being launched through venture capital found their access limited. The situation has improved more recently. During the first half of 1991, biotechnology was one of the sectors that benefited from the bull market that followed the Persian Gulf war. The stock prices of top tier companies rose significantly, and a number of smaller firms rushed initial public offerings to the market. Still, there is more product in the R&D pipeline than capital to bring it to market.53 52Stelios Papadopoulos, op. cit. The $6 billion figure does not include the in-house efforts of the major chemical and pharmaceutical firms, which are difficult to estimate. s3Ibid. 24

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25 Amount of Capital T. 1me FIGURE 4 The Biotechnology Industry: The Funding Gap for Product Development. Source: PaineWebberlncorporated Capital Requirements Capital Inflow At the same time, the large Japanese pharmaceutical companies have a critical need for growth, and opportunities in their own domestic market are limited. Domestic competition is fierce, and marketing to physicians who dispense ethical drugs in Japan is more intense than in the United States, where the prescription and dispensing of drugs are separated. Also, for over a decade the Japanese govern- ment has targeted drug reimbursement as an area to cut costs in the national health insurance system.s4 The U.S. pharmaceutical market is especially attractive to Japanese companies because of its size and because there are fewer restraints on pricing at this time. But there are several major obstacles to Japanese firms seeking to enter the U.S. market. Some assert that as a rule of thumb a billion dollar annual sales level is necessary to sustain an independent, broad-based, R&D driven organization in the U.S. pharmaceutical market, unless the company is a well-designed niche player.Ss Acquisition would seem to be a logical route for Japanese firms to enter the U.S. s4Drugs make up approximately 30% of Japanese health care costs, as compared to 7% in the United States. G.D. Laubach, personal communication to the National Research Council, Office of Japan Affairs, August, 1991. 55Stelios Papadopoulos, op. cit.

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26 market. Indeed, with currency factors favorable, and U.S. accounting rules that may discourage acquisitions of U.S. companies by other American firms, it would seem an ideal time for Japanese pharmaceutical companies to enter the U.S. market via acquisition.56 But contrary to what one might expect from the consolidation in the U.S. ethical drug industry over the past several years and the increase in Japanese acquisitions of U.S. companies in other industries, Japanese firms have not pursued this strategy. This may be due to the smaller size of some Japanese pharmaceutical companies and a shortage of experienced managers in international pharmaceutical operations.s7 For the time being, Japanese companies appear to be developing alternatives to acquisition for entering the U.S. market. Otsuka Pharmaceuticals has operated R&D facilities in Maryland and Seattle since the mid-1980s. The Maryland lab is focused on biotechnology and operates as a part of the U.S. research community rather than a facility that focuses exclusively on technology monitoring. Yamanouchi, which may be the most internationally minded of the Japanese pharmaceutical firms, appears to be focusing on Europe at this point. A number of relatively small European acquisitions could be linked in conjunction with the EC '92 market unification and then used as a platform to enter the U.S. market.59 Chugai has a broad U.S. strategy, which includes a joint venture with Upjohn, its acquisition of Gen-Probe and participation in several joint development projects with small U.S. companies. Some of these joint development projects have fairly long time horizons. One example is Chugai's relationship with Vertex, a start-up in the relatively new non-biotech field of rational drug design. The pharmaceutical companies are not the only Japanese fines seeking access to U.S. biotechnology. Cosmetics maker Shiseido is contributing $85 million toward the establishment of the Cutaneous Biology Research Center at Massachu- setts General Hospital, an arrangement that we will discuss in more detail below. Kinn Brewery, Amgen's Japanese licensee for EPO and G-CSF, also established 56U.S. firms making an acquisition must account for the "good will," or the premium they pay above the book value of the acquired firm. European and Japanese firms do not. This is widely believed to be one of the reasons why Genentech made its deal with Roche and not an American company. See Burrill and Lee, op. cit., p. 101. 57Some Japanese pharmaceutical companies are quite large, albeit smaller than the largest U.S. and European drug companies, and a number of the non-pharmaceutical companies diversifying into this field are even larger. 58Stelios Papadopoulos, op. cit. 59See "Yamanouchi: M&A 0 Kappatsuka, Oshu de Chiho-Tsugi wa Beikoku ni Shojun" (Yamanouchi: Activity Through M&A, Standing in Europe Next Aiming at America), Nihon Keizai Shimbun, March 4, 1991, p. 43.

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27 the La Jolla Allergy and Immunology Institute in 1988. Kirin's involvement in biotechnology is the result of a 1981 decision to diversify into pharmaceuticals. Biotechnology provided the perfect opportunity for this step because, in Kirin's view, the Japanese pharmaceutical companies did not have capabilities in the technology and Kirin had a background in fennentation.60 Where does IPR fit into Japanese corporate strategies for overseas expansion and diversification? Experts report that when Japanese companies, like all companies, discuss licensing arrangements with U.S. biotechnology firms the patent situation is one of their top concerns. Some also assert that, along with other factors, the overall situation created by the interaction between the American and Japanese IPR systems is favorable for the Japanese. The argument is that with relatively weaker protection in Japan they can often force foreign firms to license in, but they buy into a strongly protected position when they obtain rights abroad. Japanese firms are increasingly demanding U.S. and European rights as well as rights to the Japanese market in their deals with the emerging U.S. companies. IPR is crucially important to Japanese firms, as it is to all ethical drug companies, but it must be understood as just one aspect of their long-term strategies aimed at growth and full-fledged participation in the worldwide pharmaceutical industry. JAPANESE CORPORATE INVOLVEMENT IN U.S. ACADEMIC RESEARCH There is growing concern in the United States, in biotechnology and in other fields of science, that Japanese and other foreign-based companies are reaping "disproportionate" benefits from access to basic science and technology devel- oped at U.S. universities, often with government funding. The basic concern springs out of the perception that Japanese corporate support for U.S. university research is increasing, and that there may be a long-te~m danger of some research universities becoming the "advanced research labs" for Japanese companies. The perception that U.S. companies do not enjoy reciprocal access to Japanese basic research heightens the intensity of these concerns. Others assert that Japanese corporate support for U.S. basic research should be welcomed as an important contribution to the U.S. technology base at a time when academic institutions are experiencing difficulties securing other sources of funding. A lack of detailed data on the subject makes it difficult to draw film conclusions. In addition, discussion of the role of university research in U.S. industrial competitiveness and govern 60Noboru Miyadai, "Kirin Biru Beikoku Bencha Kigyo to no Goben ni Yoru lyakuhin Kenkyu Kaihatsu no Jissai" (Kirin Beer Realizing Pharmaceutical R&D Through Collaboration with a U.S. Venture Company), Business Research, March 1989, p. 25.

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28 ment funding for basic research is much broader and more complex than the "Japan aspect"-a comprehensive treatment of the foreign participation question as well as other important policy issues is beyond the scope of this discussion. Involvement by Japanese companies in U.S. academic research on biotechnol- ogy takes several forms, which parallel the mechanisms that American companies utilize. In biotechnology, "academic research" includes work done at research centers and hospitals as well as at universities. Increasing numbers of Japanese companies are endowing chairs at universities. This does not give the firms access to intellectual property rights, but helps build a relationship with the institution and individual scientists that can lead to more extensive collaboration down the roads A second mechanism is the dispatch of visiting professors and scientists from companies to American labs. These relationships are managed in various ways in terms of the host institution's degree of knowledge and control as well as intellectual property rights. At Massachusetts General Hospital, all visiting researchers agree to the IPR policy of the institution, and the hospital pays particular attention to visitors from corporations. If the visitor is accepted as part of a sponsored research agreement, then the institution can monitor the situation fairly closely. Many times companies will work out a sponsored research program and then offer an additional $100,000-$200,000 gift if the lab will accept a visiting scientist for one year. There are also cases in which corporate scientists are accepted as part of an outside gift mechanism. The company makes a direct grant to a professor, sometimes without the knowledge of the university. If the professor puts the gift into a sundry fund and uses it for legitimate purposes, then this arrangement would not contravene university policy in mostplaces. The danger exists that the visitors will bring in a program that the university and university scientists are not interested in.62 But this is a problem regardless of the nationality of the firm. At Massachusetts General, the terms for sponsored research agreements with Japanese firms are the same as they are for U.S. companies. The hospital's experience has been that Japanese sponsors are responsive and interested in building long-term relationships. While Massachusetts General is satisfied with its U.S. sponsors as well, there are indications that in the opinion of some institutions the quarterly profit focus and other factors make some U.S. firms capricious cooperators. In light of federal funding constraints, the willingness of Japanese firms to make a long-term commitment is very appealing to U.S. research institutions, some of which do not have relationships at this time but would like to develop them. 6'Marvin Guthrie, from his presentation on "Japan's Growing Presence in the U.S." at the Workshop on Intellectual Property Rights and U.S.-Japan Competition. 62Ibid.

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29 Japanese companies are interested in IPR, just as American companies are. That is one of the main benefits of sponsored research from the corporation's viewpoint.63 Massachusetts General currently has several projects with Japanese companies at the annual level of a half million to a million dollars, in addition to the Shiseido agreement, which will provide $85 million over ten years for a new Cutaneous Biology Research Center. The terms with Shiseido are the same as for other corporate sponsors: researchers at the center will publish almost immedi- ately; the rights of researchers to collaborate are protected; Massachusetts General will own the intellectual property; and Shiseido will have the option to buy an exclusive license.64 All of Massachusetts General's sponsored research programs with Japanese firms, including the Cutaneous Biology Research Center, were discussed with American companies first. The estimated costs were too high for the U.S. firms, and even Shiseido considered a dermatology center for several years before moving forward. Illustrating how Japanese firms build and utilize long-term relationships, the connection with Massachusetts General was established and maintained by a Shiseido researcher who had been a research fellow at the hospital in the 1970s. All indications are that Japanese firms will become more involved in U.S. academic research in biotechnology, through direct relationships with research universities and other institutions, as outlined above, and through the establish- ment of corporate laboratories near leading institutions. In biotechnology-a science-based field the potential benefits of this collaboration are clear. The ability to access U.S. academic research on the same basis as American firms means that, in this area at least, the competitive playing field is not tilted against them. JAPANESE CORPORATE EXPERIENCE WITH U.S. PATENT LITIGATION Tables 2 and 3 show that Japanese companies active in biotechnology have aggressively applied for U.S. patents. Just under half of the foreign origin patents in genetic engineering granted between 1985 and 1990 went to Japanese inventors. 63Corporate sponsors also get a general feel for the "state of science," contacts, intellectual stimulation, and other benefits. The importance of IPR also differs between different industries. It is particularly important in the pharmaceutical industry. 64Marvin Guthrie, op. cit.

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30 TABLE 2 U.S. Patents Granted for Genetic Engineering Inventions, 1985-1990 19851986 1987 1988 1989 1990*Total Total122149 261 312 376 1741394 U.S. Origin89113 198 241 288 1261055 (%)(73%)(76) (76) (77) (77) (72)(76%) Foreign Origin3336 63 71 88 48339 (%)(27%)( 24) (24) (23) (23) (28)(24%) Japanese Origin1919 25 30 38 25156 (%)(16%)(13) (10) (10) (10) (14)(11%) *Through June 1990 Source: U.S. Patent and Trademark Office TABLE 3 Organizations Receiving the Most U.S. Patents for Genetic Engineering Inventions, 1969-1990* Rank Organization (Nationality) Number of Patents 1 Eli Lilly and Company (U.S.) 63 2 University of California (U.S.) 60 3 Cetus Corporation (U.S.) 59 4 Genentech, Inc.(U.S)+ 56 5 U.S. Dept. of HAS (U.S.) 37 6 Ajinomoto Company Inc. (Japan) 36 7 Ortho Pharmaceutical (U.S.) 32 8 MIT (U.S.) 28 8 Sloan-Kettering Institute (U.S.) 28 10 Harvard College (U.S.) 23 10 Kyowa Hakko Kogyo, Ltd. (Japan) 23 22 Takeda Chemical Industries (Japan) 14 *Through June 1990 +60% of Genentech is now held by Roche Holdings of Switzerland Source: U.S. Patent and Trademark Office

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31 As is the case with American companies in Japan, the record of case law in determining the experience of Japanese firms with biotechnology patent litigation in the United States is quite limited. The most notable case to date, Amgen's dispute with Genetics Institute and its licensee Chugai over the anti-anemia drug EPO, is a U.S.-U.S. dispute with a strong U.S.-Japan component. It might be useful to ask whether any generalizations can be made about how Japanese high technology companies prosecute patent litigation and their degree of success. Though the data may not be complete, one can make several generalizations about how Japanese companies handle patent litigation in this country. First, Japanese companies are not afraid of litigation and have been fairly successful. They are suing for infringement more often. This could indicate growing familiarity with the U.S. legal system or recognition of the tendency of American courts to uphold patents in recent years. Second, Japanese companies are willing to retain and pay for quality representation. Finally, even though parties to infringement suits can demand a jury trial, there have been no cases of Japanese plaintiffs or defendants doing so.65 TABLE 4 Trends in U.S. Patent Litigation Involving Japanese Corporations as Parties Status of Japanese Corp. # Cases Success Rate Defendant 18 (78%) 67% (12 cases) Plaintiff 5 (22%) 40% (2 cases) Total Patent Cases: 23 Source: Norman Norris 6sNorman Norris, from his presentation on "Japan's Growing Presence in the U.S." at the Workshop on IPR and U.S.-Japan Competition in Biotechnology.

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32 EPO: AMGEN VS. GENETICS INSTITUTE AND CHUGAI Amgen's victory on March 5, 1991 at the Federal appeals court in Washington in its patent dispute with Genetics Institute over EPO was a major development in the four year legal battle surrounding the drug.66 The decision, which granted Amgen and its licensee Johnson and Johnson a U.S. monopoly on the manufacture and marketing of EPO, reversed an earlier ruling in a Massachusetts court that had found both companies infringing. The U.S. Supreme Court's refusal to hear Genetics Institute's appeal in October, 1991, seemed to resolve the case.67 EPO is a hormone secreted 'oy the kidneys that stimulates the production of red blood cells. The FDA approved the drug in 1989 and it currently generates over $300 million annually in U.S. sales, a figure that is expected to grow dramatically as it is approved for use in treating patients undergoing chemotherapy and for other indications. A series of court decisions prior to March 1991 seemed to establish that the Amgen patent covered the gene sequence for EPO and the host cell used to manufacture it, but that Genetics Institute had rights to the purified EPO itself. The March 1991 decision by the Federal Court of Appeals ruled the Genetics Institute patent invalid because the company "had not proved that it had isolated a protein with the biological characteristics described in the patent," and also dismissed charges that Amgen had committed procedural violations before the PTO.68 The U.S.-Japan aspect of the case revolved around the treatment of IPR in U.S. trade law. Amgen had filed suit with the International Trade Commission (ITC), which has the power to block the importation of products that infringe on U.S. patents. The suit was aimed at keeping Chugai from importing EPO that it had manufactured in Japan under its licensing agreement with Genetics Institute. The ITC ruled that it had no jurisdiction to block the imports because Amgen's patent on the host cell was a product patent and did not cover the use of host cells in the manufacture of EPO.69 Though the PTO granted Amgen a process patent on the 66Andrews, op. cit. Also see "EPO Battle Still Raging,'' BiolTechnology, August 1991, p. 684. 67Lawrence Ingrassia, "Genetics Institute's Patent Case Appeal Rejected by Court," The Wall Street Journal, October 8, 1991, p. B4. 68Andrews, op. cit. 69See In re Certain Recombinant Erythropoietin, 10 USPQ2d 1906 (U.S. ITC 1989).

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33 host cells in 1988, the patent had not issued pending the results of an interference proceeding before the PTO. Amgen appealed the ITC ruling, and the Federal Circuit ruled that the ITC was correct on that point but should have ruled on the merits of the case.70 The FDA granted Amgen a seven year monopoly on sales of EPO for the treatment of chronic renal failure associated with dialysis under the Orphan Drug Act. However, Chugai could have legally imported EPO had it received FDA approval for other indications.7' The Federal appeals court decision in the Amgen-Genetics Institute case was not expected to have a broad impact on the treatment of biotechnology IPR in the United States because it centered on the specifics of the Genetics Institute patent.72 The case, besides illustrating the importance of IPR for U.S. biotechnology firms and their Japanese competitors (and licensees), has focused policy attention on the implications of international trade law for this field. 70See Amgen Inc. v. U.S. ITC, 14 USPQ2d 1734 (CA FC 1990). 7' Summery Statement of Steven M. Odre, Vice President and Associate General Counsel, Amgen, Inc., Before the Subcommittee on Patents, Copyrights and Trademarks, Committee of the Judiciary, U.S. Senate, on S. 654, The "Biotechnology Patent Protection Act of 1991," Washington, D.C., June 12, 1991. 72Andrews, op. cit.