A Biotech Innovation Supply Chain: Reality or Fantasy?

4/22/13Follow @xconomy

Biotech has always been a bit like an open-air market bazaar. Now the industry needs to become a little more stable, more predictable. It ought to be part of something you could call an “innovation supply chain.”

At least, that’s the view of Noubar Afeyan, the managing partner of Cambridge, MA-based Flagship Ventures.

Biotech is like a souk, Afeyan says. It’s the Arabic term for an open-air marketplace. For centuries, merchants went there to hawk their wares for the highest price possible, and buyers sought to haggle for deals. It’s capitalism in its most raw form. It happens in rural American flea markets, and it happens in Istanbul.

Buyer beware.

This is basically how biotech works: It starts when an entrepreneur or researcher is inspired to create a new drug or medical technology. It’s immensely daunting and risky to create. So, he or she goes on a quest to raise money from adventurous investors to develop the widget over many years.

Once the idea passes a tough series of tests, the little biotech company, usually running low on cash and energy, heads to the souk. There, it finds Big Pharma companies, and hopes to entice them to pay the highest price possible for whatever it’s selling.

Ideally, the entrepreneur and VC can get rewarded for the risk they took, and the value they will provide to patients. Pharma companies, despite the ineptitude of their own R&D labs, know they can always head over to the souk and find good new products to keep their businesses humming.

Noubar Afeyan, managing partner, Flagship Ventures

But cracks have emerged in this system for life science innovation. Biotech VCs are reeling after a decade of investments that sounded good at the time, but which nobody in Big Pharma wanted to buy, or pay much for. Returns for most firms are nowhere near high enough to justify the risk, and so they are struggling to convince pensions and endowments to keep backing their wild biotech ideas.

Big Pharma companies, for their part, often feel like they’ve been snookered a few too many times by overpaying for biotech companies that didn’t deliver on their promise. (Ask Merck about San Francisco-based Sirna Therapeutics, or Bristol-Myers Squibb about Alpharetta, GA-based Inhibitex).

The result is that very few VCs are still strong enough to invest in early stage biotech innovation. Many Big Pharma companies have grown wary of the souk, or have noticed that there aren’t as many things to buy there anymore. Pharma has been scrambling to figure out how to keep the entrepreneurial ecosystem strong enough—cutting deals with academic institutions for example—in the hope that it will still have some good drugs to buy 10 years from today.

This is where Afeyan enters the picture, with his idea of the “innovation supply chain.” Flagship, a firm he co-founded in 2000, is one of the few still investing in truly disruptive biotech ideas. Like every firm, it has made its share of bad bets. But it has had a few hits lately, with companies like Agios Pharmaceuticals, Moderna Therapeutics, and Tetraphase Pharmaceuticals.

But instead of just dreaming up companies, building them, and hoping for the best, Afeyan says there has to be a more orderly handoff. There has to be a way to create an industrial conveyer belt of innovative new products for pharma acquirers.

The innovators should be working closely with the acquirers from the early days, getting regular feedback. The pharma company can provide what Afeyan calls “Darwinian pressure” to force the startup to run the key experiments needed to prove the value of their idea, rather than simply guessing what the pharma companies want to see.

Flagship is doing something like this with Merck, which is an investor in its fund, and a strategic advisor to its portfolio companies.

In an “innovation supply chain” venture capitalists will know that if their company passes a certain experiment, or gets to a certain stage with, say, a Parkinson’s drug, it will be able to find a willing buyer who will pay an amount that rewards the early investors. For the Big Pharma company’s part, it will know that it can count on a steady supply of new drugs that will keep its profits going up when the patents on the blockbusters of the past run out.

“The difference between what we have now and a supply chain is (like) when car companies used to have to figure out where to buy rubber, and where to buy metal,” Afeyan says. “They’d source from wherever they could get bits and pieces. Now they have a whole supply chain, with supplier companies that are specialized in making the best subcomponents they can. Each of the sides took care of each other. They’d project demand, and make sure that everybody makes money in the supply chain, so people aren’t going out of business.”

When industries mature, they develop supply chains, Afeyan says. When Boeing needs jet engines for its planes, it can draw up contracts with the folks at GE or Rolls Royce to get those engines. Ford knows what it’s going to get with an AC Delco automotive battery or air filter. It’s orderly, predictable.

If something like this system could be set up—and be even partially successful—it would change the economics of the industry, Afeyan says. No longer would VC firms feel intense pressure to milk a tenfold return from their one half-decent portfolio company left standing, when it’s worth less. Pharma companies would feel like they are getting a decent product at a fair price—what any Costco customer could tell you is the concept of “value.”

“The reason we try to get as much money as we can for any one of our sales is that there are a whole bunch of things that fail,” Afeyan says. “It’s the same argument that pharma uses to price a drug at $50,000 even though the cost of goods is $5,000. They do that because they’ve got so many drugs that fail, and they have to pay for them.

“Guess what, when we [venture capitalists] sell a company for whatever the exit price might be, we are essentially doing that same thing because we built a bunch of things and took them to market, and either nobody wanted it, or nobody wanted to pay for it. We’re pricing that in. That’s not how a material supply chain works. People don’t say, ‘I’m going to sell you this brake pad for $5,000 because my last six didn’t sell.’ Instead, you say ‘this is what it costs. I know you need 10,000 of them, so I’m going to make 10,000 of them for this price.’”

Flagship isn’t the only venture firm trying to figure out a more orderly way to hand off the fruits of its innovation to Big Pharma acquirers. Third Rock Ventures did a deal with Sanofi in which the Big Pharma company has the right to acquire Cambridge, MA-based Warp Drive Bio at a predetermined price, if the startup hits certain technical goals. Johnson & Johnson has nuzzled up close to Polaris Venture Partners, as each side has looked to co-invest in startups, and sought to better understand each other’s needs.

Pharma companies can be good at developing single assets, Afeyan says. But you need entrepreneurs for platform technologies that can enable all kinds of discovery, or create many new products. “It’s the hyper-adaptive mindset you get into when you’re resource-constrained. It’s very hard for a pharma company to reproduce.”

Many VC firms are brainstorming different ways to create orderly handoffs to pharma, when the time is right.  “I think you will see more and more of these early pharma-biotech-VC relationships, where the pharma is part of the VC investment thesis right from the get-go,” says Mike Powell, a general partner with Sofinnova Ventures in Menlo Park, CA. “We have worked on a few of these already (latest is a vaccine play with one of the top Japanese pharma companies), but they are still far and few between.”

Personally, I like the analogy of an innovation supply chain as something to aspire to. But I don’t think it quite fits in today’s biotech, because biotech is still one of the technically most challenging fields of human endeavor. Putting a man on the moon was easy compared to coming up with a targeted cancer drug. Until we come up with some enabling technology that really makes drug discovery and development more predictable, this is the system we’re stuck with.

Pharma companies and VCs should work better together, and form healthy long-term business relationships that reduce the risk and improve the overall returns for each side. But I don’t see how it will ever create a system where you just start popping out new cancer drugs on time and on budget, like producing a new brake pad for GM.

I’d love to hear your thoughts on how biotech and pharma can work better together in the comment section below, so I can think about how to incorporate them into covering this ongoing story.

By posting a comment, you agree to our terms and conditions.

  • http://twitter.com/Nanostring Nanostring Founder

    Honest account, but somewhat troubling.
    “VC firms feel intense pressure to milk a tenfold return from their one half-decent portfolio company left standing, when it’s worth less.”
    This sounds bad; volatilization of the sale of a “half-decent” company for a fair price – in order to get the fund above water – carries asymmetrical risks to the LPs relative to the GPs. If they are not in “carry-land”, the GPs do not care if the fund returns 0.9x or 0.2x, but they still have fiduciary duty to return max value to LPs. Flagship LPs who read this may want to discuss the fund practices with the GP.

    Unfortunately, these incentives for volatilisation (“if WE win, I win; if WE lose, I still win my mgmt fees) permeate the financial management industry. Credit Mr.Afeyan for at least being upfront about it.

  • Stefano Picone

    I imagine that pharma LPs would negotiate a right of first refusal/negotiation with the portfolio companies as part of their investment, resulting in a trade-off between more exits and lower exit multiples. Personally, I think the long-term sustainability of the industry depends on “solid singles” as opposed to “hacking for home runs.”

  • http://twitter.com/JAggERnauTs juSTin

    I like that you mentioned that “maturity” of the business brings out a stable supply chain. One thing to remember is that for a SC to be truly efficient, there must be a level of trust and information sharing taking place. When dealing with VC’s and the “next big thing”, secrecy tends to be paramount to ensure payoff of investment. Good article!

  • http://twitter.com/theraltweet Theral Timpson

    I thought Biopontis Alliance had a pretty good idea when they got going: one organization shepherds “assets” through the chain from early academic research on to a deal with Big Pharma. What is gained from focusing on “assets” rather than “companies” is the big question here, and I’m not sure how far they’ve come. I would think a lot of waste could be eliminated. However, are some soft factors (motivation, incentive, pride) lost in giving up on the idea of individual companies?

  • Kyle Serikawa

    I agree with the point that the technical difficulty of creating a drug is still too great to think about new drugs as amenable to a supply chain. Brake pads and jet engines are, ultimately, the expression of engineering while drugs are still somewhere between art and innovation. When we still can’t reliably predict what a drug will do the first time it’s put into humans, it’s premature to think about a supply chain analogy. Add to that the hurdles of creating better medicines, not just different medicines, and the bar is incredibly high for small biotechs to come up with a reliable stream of high-probability, high value targets.

    It may be that democratization and public acccess to large scale datasets a la what Sage Bionetworks wants to do will provide the bootstrapping to allow biotechs to start from a targeted/personalized medicine approach, which might give them a greater probability of success, even at the expense of some potential market–the “singles not home runs” analogy previously posted. Hard to say for sure.
    It might be that instead there needs to be a quiescent period of drug development, in which VCs don’t invest very much in startups, the large pharma consolidate and diversify to create reliable revenue streams rather than relying on large blockbusters, and the community waits for the next advances in basic biomedical research to turn the art of understanding drug effects to something more predictable. If Pharma and the VCs want to hurry that along, maybe they become a kind of NIH-lite, funding academic research centers that focus on understanding complexity.

  • http://twitter.com/haiping85 haiping choo

    Sounds like VCs and their start-ups themselves are also being more “lean” – to identify and focus on what is truly perceived to be of value/what actually matters; and to shorten the iterative cycle so as not to wander off too far on the wrong track…

  • Geoff Lawton

    We have argued (Nature Rev. Drug Discov. 8, 435 (2009)) that the complete process of drug discovery, development and commercialisation does not fit well into a single vertically integrated business but each phase is best handled in a
    different business structure. In this way each business can easily access
    multiple providers of inputs and multiple potential customers, and can flexibly
    tailor its portfolio and operational strategy to prevailing market conditions.
    The supply chain concept implies that there is a ‘controller’ of the system. There is now increasing recognition that partnerships between different stakeholders are essential in the new landscape of Biopharma 2.0. At present the partnerships are usually formed and controlled by large pharma companies. It is likely that the drivers of future partnerships will include a wider spectrum of stakeholders. These will include venture philanthropists, medical insurance companies and governments. We are already seeing the emergence of eg Bill and Melinda Gates Foundation, Michael J Fox, Cystic Fibrosis Foundation using their power to bring together the components of the supply chain. The members of the partnerships (supply chain) will be drawn from biopharma companies (pharma companies, biotechs, generic drug companies), academic institutes and their varied forms of technology transfer operations, other not-for-profit drug discovery units/consortia, contract research organisations, patient advocacy groups and other medical charities, various types of financial institution, and
    increasingly ‘the crowd’ (through a variety of crowd-sourcing engines).
    The presence of multiple stakeholder types within each of these partnerships will help to ensure that all of the value of all assets produced within the group will be effectively exploited. In Biopharma 1.0 it is commonplace to discard
    potentially valuable projects because they fail to fit the strategy (often newly defined) of the single current owner.

    • Roger Ramjet

      Interesting that the “members of the partnerships” does not include the entrepreneur, the one essential element.

  • http://carboxyl.com/ robertdesideri

    Luke, I agree there will be a new model. Supply-chain ain’t it, it’s not even a good interim measure. Clearly shows there’s too much money sloshing around. Sure everyone expected more value to be created, but that’s the nature of where we are along the knowledge curve. The good news is silicon is now essentially free, we’re nearing the threshold for handling big analytics. Good times are coming. These new knowledge companies will surprise, true value will be produced this time around. Skeptic VCs on the sidelines will miss it. Time to be raising a specialty fund. Several good paths to pursue the new discovery play. #excitingtimes

  • chcc

    Sounds like a middleman trying to validate his existence to me. that, and someone frustrated by his exit-ratio. if pharma is going to throw money at the Vc’s, they are really better served by doing these partnerships themselves. Not sure public pharma shareholders are signing up for this type of risk capital being deployed, but hey, r&d is risk-capital any way you slice it.