Why Not Test a Supply Chain Model? What We’ve Got Isn’t Working
I find myself siding more with Flagship’s Noubar Afeyan than with Katrine Bosley in the intriguing conversation emerging in Xconomy in recent weeks over the supply chain model for early stage biotech.
Today neither biotech nor pharma are producing a sufficient supply of new products. If we can’t figure out a way to profitably finance early development, this industry will implode. I believe the supply chain model is an important advance, and needs careful, thoughtful consideration.
Ms. Bosley makes the point that many independent groups pursuing their own ideas within the life sciences community can be more creative than a few large corporations dictating the direction and details of exploration for the industry. She warns that the supply chain model, which enables a biotech to “prewire” its program with a future acquirer, limits the creativity and initiative of the smaller partner and subjects it to the conventional prejudices of big pharma, which are valid concerns.
Unfortunately, her market-based model of totally independent bio-venture companies that relies on a buy-sell interface (what we have today) is not sustainable from a commercial point of view. Neither side is making returns in discovery and early development sufficient to sustain investment in the space.
People like Flagship Ventures’ Noubar Afeyan and Avalon Ventures’ Jay Lichter are exploring alternative strategies like the supply chain model precisely because the market-based model is not working. The institutional investors upon whom venture depends have largely turned their backs on the industry; both pharma and venture have shifted resources and capital out of research and early development to lower risk and improve returns. Investment in innovation is declining at a time when science-driven opportunity, demand by pharma, and patient needs are exploding.
Biotech-Big Pharma: The Problem
The problem lies in the market-driven relationship between biotech and pharma. The best way to explore outside the established frontier of knowledge is to run many small experiments, rather than pharma’s traditional approach of a few gold-plated studies designed not to end someone’s career. Small biotech is good at doing small projects. But, no matter how efficient their virtual managers, investors cannot chase creative ideas unless they can count on selling the products of successful experiments for an adequate return.
The earlier the stage of development that investors target, the less efficient the market becomes, because the quality of information diminishes the further we move upstream, away from the end-user. Buyer and seller don’t have reliable feedback, like revenues and profits, on which to value the asset. So one sees risk; the other sees potential. Transactions are hard to get done. Without a deal, the early stage investor is forced to carry on until his biotech venture exhausts its resources. The timeframes are so long and the failure rates so high in early R&D, that investors cannot justify supporting multiple projects for only a few successes. The costs are overwhelming any potential gains in the creativity our industry achieves from a competitive biotech-phama market.
Biotech has done well on innovation, but fallen short on realizing value for its investors. Pharma and late-stage venture have enjoyed a windfall of cheap new products from companies started in the first half of the last decade. But the innovation pipeline will run dry unless the industry can devise models that enable the sector to attract sufficient capital—and that is a far bigger threat to creativity than a lack of independent thinking.
The Supply-Chain Solution
Instead of a buyer-seller relationship, the supply-chain model creates a partnership to bring the two sides into closer alignment and maximize LargeCo-SmallCo efficiencies. Each side can specialize in its particular strengths. By cooperating rather than competing during development, they can use their resources more efficiently than in a market-driven relationship.
Pharma’s principal problem with innovation is not so much what to do but how to do it. Pharma has plenty of bright creative people; venture capitalists often recruit them. In a true partnership both sides contribute energy and ideas. Together the partners can take on more risk and push deeper into discovery than they could independently. The greater the time and cost to product sales, the greater the need for both sides to share the burden.
Biotech investors make money through timely, efficient exits. Pharma will pay for a work-in-progress, but a half-completed product has to fit not only an acquirer’s strategic goals but detailed requirements like patent protection and data configuration. It is a tremendous advantage to biotech if planning for an efficient hand-off can begin at the starting point of a project, rather than the conclusion. Trying to negotiate terms after the money has been spent may be great for pharma, which gains advantage by seeing the data, but it often eliminates any “walk-away” leverage the biotech investors might have had before committing their capital.
Pre-negotiated deals can’t guarantee a sale—pharma always has the option to step back if the strategy or market conditions change. However, they can improve the probability of an efficient exit. On the other hand, if both sides can’t agree on a deal up-front, the bio-venture managers had better walk away if they expect to live to see another deal, or another day.
Alignment may reduce innovation relative to what biotech could do unconstrained by the realities of the capital markets, but it will increase the creativity of pharma alone. Even if aligning the two sides does reduce the innovation factor, the long-term gains from a sustainable early stage sector would far outweigh the cost to creativity. Over time the partners can learn to move the risk/reward equilibrium further in the direction of innovation. The threat that Ms. Bosely sees in the supply chain model is not nearly as great as that of the failed business model we have now.
The supply-chain model will not be the only approach to early stage investment. The investors who choose to pursue a partnered approach should not diminish the number of traditionalists. The very clever (or lucky) VCs who can make the market-driven model work will continue to use it. However, a supply chain approach can broaden the range of options and offer an alternative should the industry need more new products than market-based model can provide.