Biotechnology as a business burst on the scene in 1976 when Genentech was launched to commercialize the new discoveries of how to clone and express human genes in bacteria. This was soon followed by biotech companies commercializing monoclonal antibody technology, combinatorial chemistry and more recently “omics” technology (genomics, proteomics, metabalomics), high throughput screening and other continually emerging and commercializable technologies.
The lofty promise of all of this was that through improved technology and enhance understanding of biological activities, the process of drug R&D would become more efficient, faster, less risky and cheaper. This promise helped foster the perception that, compared to the pharmaceutical giants, smaller biotech companies are more agile, innovative and productive at R&D and, therefore, fill an important gap that the larger, ossified drug companies can not. It has been suggested by more than one industry observer that big pharma should focus on production, marketing and improving current products, leaving the innovative and cutting edge research to the more flexible and adaptable small biotech companies.
The biotech industry has certainly bought into this hope—it is rife with optimism that it can transform the pharmaceutical industry. The expectation has been that the biotech industry would follow a trajectory similar to that of the more mature semiconductor sector where the advent of solid-state technology stimulated fundamental product improvements and reshaped the whole electronics industry.
It is hard to dispute the notion that since genetic engineering technology first appeared in the early 70’s, we have seen the greatest scientific revolution in history. By all measures—publication rates, patent activity, growth of biological databases—biomedical information has exploded. This success has greatly increased the number of potential therapeutic targets and new molecular entities (NME) that represent potential new drugs. All of this has bred wide optimism by scientists, investors, Wall Street, policymakers, and others, that this life science revolution would lead to a trove of new drugs and ultimately to enormous financial rewards.
A further, related promise of the biotech revolution is that enhanced understanding of biological processes will allow more intelligent selection of new drug candidates and drug targets, thereby making drug R&D more efficient, less risky and less costly.
The Financial Reality
Indeed, there have been impressive biotech success stories, such as Amgen, Genentech, Genzyme and a handful of others, but, how has the sector as a whole lived up to this lofty promise? Thirty years after the launch of the biotech industry, Gary Pisano, a professor at the Harvard Business School, decided to empirically test how well the biotech sector has lived up to its potential. He collected and dissected financial and productivity data for 293 publicly held biotech companies and from 20 large pharmaceutical companies that existed between 1975 and 2004 and his results, published in the book, Science Business, are sobering.
Here is what he learned about investment returns on public equity: A hypothetical investor who purchased all 340 biotech IPOs between 1979 and 2000 and held those shares until January 2001, or until company acquisition, would have realized an average annual return of 15%. Not bad, but not stellar for such a high risk sector. If the same investor purchased a diversified biotech portfolio in 1981 and sold it at the end of 2003, he would enjoy an 8-fold return, or about a 10% compounded rate of return per year. Compare this to the more risk-adverse investor who invested in Treasury Bonds; he would have realized a 12-fold total profit and the same investment in the Dow Jones would be worth 21-times more. Clearly, the return on biotech investment is disappointing when compared to alternative and less risky investments. To be fair, this comparison pits the entire biotech industry against other investment vehicles. An individual investor who was more selective in the biotech companies he invested in, could have done much better (or worse) depending on his portfolio.
More revealing, however, was Pisano’s analysis of revenue and earnings for the whole biotech sector between 1975-2004. To measure this, he created a yearly aggregate income statement for the entire biotech industry. In other words, he combined the income statements of the 293 companies into one industry-wide income statement.
His analysis showed that over time, total sales for the sector increased exponentially, as one would expect. However, over the years, income has been flat, hovering close to zero until about 2000, when total sector income actually began to decline. By 2004, however, the industry showed its first positive income of about 7% of total sales. But, this is misleading since the most profitable firm, Amgen, heavily skews the results. Excluding Amgen from the analysis reveals that the remaining biotech sector sustained steady losses throughout its history and never has been profitable. Pisano points out that since this analysis does not include privately held companies, the situation for the biotech sector is even bleaker since almost all privately held biotech companies lose money.
Pisano also noted that positive economic performance is concentrated in only a very few biotech firms—the vast majority of biotech companies have never been profitable. When considering only those companies with positive cash flows, just fifteen firms account for 93% of the positive income for the sector and two, Amgen and Genentech, accounted for 53% of the total income of these profitable companies. Some firms have existed for close to 20 years without ever generating positive cash flows.
The Productivity Reality
In simple terms, the raison d’être of the biotech and pharma industries is to turn financial resources into drugs, which in turn should drive profitability. But, it is no secret that over the last few years, the big pharma R&D productivity has slipped dramatically. Even though R&D spending has increased, the rate at which NMEs are introduced has steadily decreased. Many industry observers argue that biotechnology will be the cure for this malaise and that big pharma companies ought to outsource its novel R&D to the leaner, meaner biotechs.
Pisano also investigated this promise that the biotech industry is the answer to the productivity crisis in the pharmaceutical industry. As a measure of productivity, he compared the inflation-adjusted cost per NME between the top 20 pharma companies in the world and the panel of 293 publicly held biotech companies. This analysis was complex with many confounding factors that needed to be accounted for, but these details are beyond the scope of this review. The important thing is that Pisano’s analysis showed no evidence that biotech companies are any more or less productive or innovative than pharmaceutical companies. Productivity and innovation between these two industries has been a dead heat almost since the beginning of the biotech industry.
In other words, evidence shows that, when it comes to R&D, biotech companies are not more productive or innovative than their larger brethren, which means that the biotech R&D productivity and novelty boom that has been expected has not happened. Pisano writes, “If big pharmaceutical companies are looking to biotech to help them fill their revenue gap, these data would not make one optimistic.”
The malaise of the pharmaceutical industry is no secret, but Pisano’s analysis suggests that, by both financial and operational measures, the biotech sector also has not been healthy during its entire 30 year life. Only very few companies have ever been profitable, and an even smaller number of biotech “elites” have achieved substantial profits. These include Amgen, Genentech, Genzyme, Biogen, Idec and others, which, interestingly, were also among the earliest entrants into the industry. Hence, one might argue that with time, additional companies will rise up to finally realize the biotech promise. But after 30 years, or about 2 product development life cycles according to Pisano, there is nothing to suggest that this will happen in the foreseeable future. In fact, projections that profitability is just around the corner have been made since the earliest days of the biotech industry and have been consistently wrong. The bottom line is that the biotech sector so far has failed to reach its enormous commercial and economic promise.
This begs the question—given this lackluster performance, how has the biotech sector been able to continually attract capital over such a sustained down period from market forces obsessed on quarterly performances? A more important question is whether the industry will continue to be able to attract such capital if it continues to operate in the red. An ominous history lesson might come from the dot-com bubble and burst. Pisano points out that once it became clear that the vast majority of these internet firms lacked a viable business model, the capital markets quickly pulled the plug. Pisano attributes the remarkable resiliency of the biotech sector to an “irrational exuberance” by investors who hope to invest in the next Amgen, and this is not unlike the exuberance that led to the dot-com bubble. But the sobering reality is that in 2006, only 20% of all publicly held biotechs had any products on the market or earned any royalties from products commercialized by partners.
Thus, the vast majority of biotechs are simply R&D entities that have nothing to sell, and are not much different than most of the dot-com companies that existed just before the bubble burst. Sobering indeed.
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