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7 The New Biotechnology Firms Two DISTINCT TYPES OF FIRMS are pursuing the commercial appli- cations of genetic engineering in the United States: the small start-up companies founded primarily since 1976 to capitalize specifically on genetic engineering research, and the established multiproduct companies in such sectors as pharmaceuticals, chemicals, agriculture, energy, and food processing that have invested in the field. The interplay between the two and the complementary efforts of each have done much to give the United States its current lead in biotechnology. Between these two types of firms, considerable amounts of money have been invested in biotechnology. Since 1976, several billion dollars have been funneled into the start-up biotechnology firms, of which there are now more than 200. And since about 1981 many established firms have set up major in-house biotechnology programs. Although it is not always easy to characterize a specific industrial undertaking as "biotechnology" (which makes the "biotechnology industry" similarly hard to define), it is undeniable that substantial sums have been devoted to commercializing the techniques of genetic engineering. For the past several years, predictions of a shakeout among the This chapter includes material from the presentation by Hubert J. P. Schoemaker at the symposium. 84
THE NEW BIOTECHNOLOGY FIRMS 85 start-up firms have dogged the biotechnology industry, contributing to a wariness among investors after a surge of enthusiasm for the new firms in the early 1980s. Yet remarkably few of these firms have gone bankrupt or been acquired by other companies. Nevertheless, most observers agree that mergers, acquisitionsâeven failuresâcan still be expected as new challenges arise within the industry. For one thing, the new firms will face increasingly stiff competition from the estab- lished firms. Also, many of the small firms will eventually reach the stage where to survive they will have to engage in production and marketing as well as research and development. Their degree of success in making this transition will have an important effect on the future of the industry. Characteristics of the New Firms Historically, small firms have often established the prominence of the United States in emerging advanced technologies, and biotechnol- ogy seems to be no exception. Within just a few years of the first experiments with recombinant DNA, small firms were being estab- lished, often by distinguished academic scientists, to commercialize the new techniques. Since then, the expansion in the number of new bio- technology firms has far exceeded the expectations of the technologies' founders. The start-up firms have been working on projects that span the spectrum of biotechnology's potential applications. The most popular application to date has been the development of monoclonal antibodies for use in research, chemical separation and purification, diagnostic tests, and the treatment of disease. Many new biotechnology firms are also working to develop human and animal pharmaceuticals, which tend to have much higher costs associated with their development, regulatory approval, and production. Relatively fewer firms are work- ing on such applications as commodity chemicals production or waste management, generally because much more research is needed to demonstrate the commercial feasibility of these pursuits. To finance their research and development efforts, the new bio- technology firms have called on a wide array of funding mechanisms. Among the most important of these have been investments from venture capital firms and from established companies interested in biotechnology. The investments from the latter have generally taken two forms: equity investments and joint ventures. Equity investments, in which established companies buy portions of new biotechnology firms, have enabled the former to keep abreast of developments in the
86 BIOTECHNOLOGY field, perhaps to gauge the best time to enter the field themselves. Joint ventures, in contrast, usually involve a more active combination of R&D contracts and product licensing agreements. Under the terms of these agreements, an established firm often handles the regulatory approval, manufacturing, and marketing of a product after the small firm has done the initial development. The small firm receives royalties from the sale of the product and usually retains the patent on the product. In recent years, some new biotechnology firms have tried to lessen their reliance on R&D contracts and licensing agreements with large U.S. firms to retain more control over the uses and profits of their products. One way for them to do this has been to establish joint ventures with foreign companies. In these cases, the start-up firms often retain the rights to sell their products within the United States while selling the overseas sales rights to their foreign partners. In turn, the start-up firms supply either the products or the technology to make the products to the foreign companies. (As explained in Chapter 6, pharmaceuticals not approved in the United States can generally not be exported to another country for sale.) Many observers have ques- tioned the wisdom of this transfer of technology, claiming that in the long run the spread of know-how generated in the United States to other countries will enhance the competitiveness of foreign firms. But most of the new biotechnology companies have deemed the short-term benefits of such an arrangement to be more important than the long-term disadvantages. Another major source of funding for the new biotechnology firms has been the stock market. In the early 1980s several start-up biotechnol- ogy firms set Wall Street records when they first went public. Genentech's stock underwent the most rapid price increase in the market's history, climbing from $35 to $89 per share in its first 20 minutes of trading. A few months later, Cetus raised the largest amount of money that has ever been made with an initial public offeringâ$110 million. A couple years later the glow had faded from biotechnology stocks and they were trading for much less than their previous highs. But recently prices have rebounded, and the stock market remains a promising source of revenues for biotechnology firms. In fact, several firms have returned to the market two and three times to finance production scale-ups and clinical trials of their products. A source of financing that has rivaled the stock market in size is a type of investment known as an R&D limited partnership. This allows individuals or organizations to invest in a company's research and
THE NEW BIOTECHNOLOGY FIRMS 87 development and to write off that money as expenses. The investors become limited partners and are entitled to receive royalty payments from future sales of products. Part of or all these royalties are in turn taxed as capital gains, offering an added attraction to this kind of investment. The new biotechnology firms also have a number of other sources of capital, including interest from funds previously raised, short-term loans, industrial revenue bonds, and equipment leasing. Through these and other funding mechanisms, the new biotechnology firms have generally been able to bring in enough revenue to remain viable, even though many of them have not yet generated actual products for the marketplace. Portrait of a Successful Firm One new biotechnology firm that has generated products for the marketplace through its work with monoclonal antibodies is Centocor, Inc., which was founded in 1979. According to the company's president, Hubert J. P. Schoemaker, Centocor's approach is based on a careful analysis of several key features of the health care business. First, it is very expensive to produce and market pharmaceutical products, but very few products are needed for the firm to be successful. Second, most health care companies have a relatively narrow product focus, since this optimizes the distribution of products and reduces risk. Third and most important, the health care industry worldwide currently has excess capacity in its manufacturing, distribution, and sales networks. As a result, "these companies are looking for products to feed into their investments," says Schoemaker. "There is a product shortage. This leads to a fairly aggressive acquisition strategy and to an aggressive licensing-in strategy. . . . Centocor, as a company, and, I believe, similar companies, were formed to capitalize on these features of the industry. Centocor bridges the gap between new innovations and the already existing product distribution networks." To find products to feed into these networks, Centocor's in-house technical groups keep close tabs on the research being done in univer- sities and in public and private research institutes. When the company uncovers work with commercial promise, it seeks to establish collabo- rative agreements with the investigators or research institutes that have done the work. Currently the company has initiated agreements with about 30 universities around the world to gather the results of research. Once Centocor has obtained the rights to a research development,
BIOTECHNOLOGY A researcher at Centocor prepares a monoclonal antibody assay. Many of Cento- cor's products are based on research done in universities that the company then develops for the marketplace. the project is brought into the company, where Centocor's own staff develops the product, performs any clinical tests needed to have it approved in world markets, establishes the market for the product, and introduces it for commercial sale. According to Schoemaker, the com- pany can usually ready a monoclonal antibody blood test for sale within four to six years of the antibody's development. "In our first six products the critical raw material, the antibody, was developed within a university, licensed, and brought into the company, the product was developed, and we now are delighted to pay royalties to these institu- tions," says Schoemaker. After Centocor has developed and introduced a product, the company often licenses it to pharmaceutical companies to supply a raw material like an antibody or sell an end product like a blood test. In this way, Centocor can take advantage of the unused capacity of existing production and distribution systems without having to overextend its own. The company has tried to stay away from exclusive arrangements with its partners, preferring to rely on territorial rights or a particular product format. "This goes a little against the culture of the health care industry, which likes worldwide and exclusive rights, but we believe
THE NEW BIOTECHNOLOGY FIRMS 89 we lose some control over our own destiny doing that," explains Schoemaker. Centocor also gives its partners the option of using the raw materials it provides in the partners' own product configurations. That extends the lifecycle of a product that Centocor has spent considerable effort developing. Centocor's initial products were in vitro monoclonal antibody tests for hepatitis B, ovarian cancer, gastrointestinal tract cancer, and breast cancer. Building on those successes, it has been developing similar tests for cancers of the colon, liver, and lung. Another product line involves monoclonal antibodies to be used inside the body for imaging both the location and extent of diseases such as cancer and atherosclerosis. A third product line involves the use of monoclonal antibodies for therapy. This wide range of pursuits has left Centocor with a problem that is unusual in the biotechnology industry. Says Schoemaker, "We have too many products for the size that we are. Most of these products are quite innovative and require significant market development to get them introduced worldwide." Half of Centocor's $3.2 million in sales during 1984 were in Japan, with the other half split between Europe and the United States. In addition, the company relies for its income on research contracts ($7.6 million in 1984) and on the interest ($2 million) from the remaining $18 million of $21 million raised in a public stock offering in 1982. With these three sources of income, the company earned its first profits in 1984. According to Schoemaker, Centocor intends to continue to act as a product development company that links academic research to health care distribution networks. "We believe that in biotechnology the innovations will still be made to a large extent within the academic realm. We have developed an organization that can capitalize on these developments. Centocor has built a company that can very quickly commercialize this technology and deliver it to the health care industry through the existing distribution channels. This strategy appears at this time to be successful." Challenges to the New Firms The young firms that are striving to make their mark in biotechnol- ogy will encounter a number of difficulties as the industry enters its second full decade. For one, the competition posed by established firms can be expected to heighten. Until about 1981 the large established firms generally stood on the sidelines in biotechnology, content to monitor developments in the field through various kinds of arrange-
90 BIOTECHNOLOGY ments with the new biotechnology firms and academic research cen- ters. But during the last few years they have moved into biotechnology in force. In 1984 both Monsanto and du Pont opened major life science research facilities representing a combined investment of more than $200 million. Such resources dwarf the amounts available to any new biotechnology firm. However, the established firms have continued to invest in the fledgling companies. Some new firms have also been protecting themselves by moving toward more limited product niches that would not interest larger firms. Perhaps a more serious problem lies in the nature of the biotechnol- ogy industry. To compete with the established companies and with other new biotechnology companies, the start-up firms will eventually have to become profitable through the sale of their products. In the early stages of the industry, firms have taken different approaches to this basic requirement. Some, like Centocor, have licensed part of the production and marketing of their products to established firms. Others are licensing all their technology to established companies in exchange for royalties. Still others, like Genentech and Cetus, are attempting to become fully integrated manufacturers and distributors. Fully integrated companies will continue to rely on the sources of revenue that have seen them through their formative years as they conduct clinical trials, set up production facilities, and organize mar- keting systems. In addition, as discussed in Chapter 10, the actions of the federal government could significantly influence the future courses of all new biotechnology firms. Additional Readings "Biotech Comes of Age." 1984. Business Week (January 23):84-94. Peter Hall. 1984. "The Business of Biotechnology." Financial World (March 21-April 3):8-14. Ralph W. F. Hardy and David J. Glass. 1985. "Our Investment: What Is at Stake?" Issues in Science and Technology 1(Spring):69-82. Arthur Klausner. 1985. "Corporate Strategies: And Then There Were Two." Bio/Technology 3(July):605-612. U.S. Department of Commerce, International Trade Administration. 1984. High Technology Industries: Profiles and OutlooksâBiotechnology. Washington, D.C.: U.S. Government Printing Office.