Thinking about Life Sciences: So Far, Venture Capital Relatively Unsucce... http://blog.aesisgroup.com//2006/11/14/so-far-venture-capital-relatively-...

Thinking about Life Sciences

http://blog.aesisgroup.com

Wednesday, November 15, 2006

So Far, Venture Capital Relatively Unsuccessful in Biopharma Market

There has been increasing concern that current models for financing innovation in biopharma – and by
extension medical technology in general – are “broken”. A recent Economist article (“From bench to bedside”
on Nov. 4, 2006) summarizes some of these difficulties and highlights a new book - Science Business coming
out on Tuesday by Harvard Business School professor Gary Pisano. This is a hot topic and one that this
column has referenced several times in recent postings.
In summary, there are two models – based on either large or small companies - that drive innovation in the
life sciences industry.
The large-company model
Large pharmaceutical companies have traditionally developed and financed sizeable, in-house research
labs. However, the paucity of new drugs in the pipeline have not generated sufficient fruit from these
efforts and a number of factors (generic drugs, extensive red tape, inertia and a focus on blockbusters)
have been blamed for this innovation drought. To an extent, this is not unexpected as it has long been
understood that there is generally an inverse relationship between the size of an organization and its
capacity for innovation. The public certainly seems to have realized this as pharmaceutical share prices
grossly underperformed over the past five years. The Dow Jones U.S. pharmaceutical index has gone down
approximately 20 percent while during the same period the overall Dow Jones index has gone up about 25
percent.
Industrial behemoth IBM realized this during the late 1970s, and in order to break out of the mainframe
mode, the company implemented a radical innovation: a new business model. Big Blue sent 12 engineers
to Boca Raton, gave them near-complete independence, and within a year, they created the first personal
computer using entirely off-the-shelf components. From this, the modern PC was born. While nothing
new was invented, it was a radical innovation that nearly brought down its parent company. New business
models or their consequences can be as disruptive (and even more so) than individual technologies.
The small-company model and its challenges
In general terms, the other model for innovation revolves around venture capital firms and smaller biotech
companies. While on the surface the creation of small and nimble biotech firms would seem to solve the
problem of size, there are two major problems that have stymied real business development around this
model.
The first – identified in the Economist article – is that venture capital has “shriveled up” in America. That
begs this question: How could venture funding be so sparse in a capital market that is relatively awash in
capital? In reality, most of that capital is going to private equity and hedge funds that have “exit windows”
substantially shorter than most venture capital expectations for the life sciences. To put money down and
not expect an exit for at least five years is not a game that most investors – even far-thinking venture
capitalists – are willing to play. To be fair, the venture capital model works extraordinarily well in the
software and IT markets. Silicon Valley is rightly envied and envied models are often emulated.
Time to market (Microsoft’s new Vista operating system notwithstanding) for software products is nearly

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an order of magnitude faster than most conventional drug development. It is therefore unfair to assume
that the VC model will work for biopharma. In my mind, there is a second reason – especially recently –
why venture capital has been relatively unsuccessful in the biopharma market. Companies that successfully
raise money are ones that have a very simple and focused business model that fits well with the three-
minute elevator pitch. For example: “Here’s drug ‘X’ that cures ‘Y’ disease.” Enough said.
Venture Capital bias
Moreover, to make their venture patrons happy, these companies do not deviate from that focus. “Focus,
focus, focus” is the mantra. I remember being at a private equity conference where a company had a great
new drug formulation. I commented to their CEO that there were other applications of their technology
that could be brought to market even faster and to even larger markets. The CEO told me that they need
to “focus” and their venture backers would not look kindly upon any “diversions”.
So much for “nimble” biotech companies.
While these are, of course, generalizations, I suspect this paradigm is not uncommon especially since the
concept of investment diversification takes place at the level of the VC firm rather than the level of the
portfolio company. That is a shame as it imposes a dangerous level of bureaucracy on small firms.
So what are the business models of the future? The Economist article points out a few trends. There is a
new crop of venture firms that “focus” on new areas.
Some potential new business models
As well, the Milken Institute has also entered the fray and disease-focused charities (such as the Cure
Alzheimer’s Fund) are bringing to bear their resources to finance innovation. In previous columns, I have
highlighted some important trends that lend insight into what may be some of the business models of the
future. In particular:
1. The importance of partnerships.
2. The ascendancy of innovation over invention.
3. The rise of convergent medical technologies.
In this regard, the example of the IBM PC is quite relevant. Partnerships (for example with Microsoft and
other providers) helped to break out of the Big Blue box. The IBM team did not invent. It innovated. The
PC revolution was a completely disruptive development that came out of a convergence of technologies
rather than something entirely new. It all happened very fast (in less than a year).
Given these trends (for the traditionalists out there, there is the powerful example of the IBM PC from the
early 1980s), new business models in biopharma will need to accommodate partnerships, innovation and
convergence. The inability for big box pharma or little box venture capital to integrate these elements into
the very core of their development is what I believe ails the industry. Though I have some ideas for business
models that may cut through this impasse, we’ll leave that for a later column.
Ogan Gurel, MD MPhil
gurel@aesisgroup.com
http://blog.aesisgroup.com/

Convergent Medical Technology Innovation Venture capital biotechnology partnerships Aesis Research Group Ogan Gurel MD

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