Solved: Homework #3-Pharmaceuticals industry until 1980

Most commercial drug companies were large enterprises, fully integrated from drug discovery through clinical development, regulatory affairs, manufacturing, and marketing. Drug discovery was conducted in house and, at least in the early part of this period, was dominated by large-scale “random screening” programs with limited requirements for deep knowledge about fundamental physiological processes. Licensing activity was driven largely by downstream concerns: Rights to sell drugs that were already approved (or in the late stages of clinical development) would be acquired to maintain efficient levels of use of manufacturing or marketing assets or, in the international context, to take advantage of local knowledge and access to regulators and distribution channels. Upstream technology was largely acquired either “for free” by reading journals and attending conferences or by purchasing tangible inputs and services, such as scientific instruments or highly skilled graduates. Pharmaceutical companies appropriated returns from R&D through a combination of extensive patenting, proprietary know-how, brands, regulatory barriers to entry, and favorable product market conditions. Most of these firms were long-lived, mature organizations, tracing their roots back many decades, often to the nineteenth century chemical industry. Their large and sustained investments in R&D, marketing assets, and human and organizational capital were largely financed from internal cash flow. Competitive advantage was driven by firms’ ability to effectively manage product market interactions with regulators and end users and to “fill the pipeline” with internally developed blockbuster drugs. In turn, the productivity of internal R&D appears to have been driven by economies of scale and scope in conducting research, efficient allocation of resources in internal capital markets, and the ability to capture internally and externally generated knowledge spillovers. In the upstream not-for-profit sector, taxpayers (and to some extent philanthropists) supported curiosity-driven research conducted at cottage industry scale inside government labs, universities, research institutes, and teaching hospitals. Legal constraints and a strong set of social norms limited commercial or contractual contacts between drug companies and the world of “open science.” Resource allocation in the not-for-profit sector was driven by peer-reviewed competition for grants on the basis of scientific merit and the reputation of individual researchers. The importance of establishing priority and reputation drove early and extensive publication of results, and social norms (and requirements of granting agencies) promoted routine sharing of research materials. Not-for-profit researchers concentrated largely on basic science and filed few patents. 1980 and beyond: After decades of stability and consolidation, in the 1980s the for-profit side of the industry experienced significant entry from biotechnology companies, many of which positioned themselves as an intermediate sector between academic research institutions and Big Pharma. By the mid-1990s several thousand biotech ventures had been launched, and several hundred had reached sufficient scale to be an important force in the industry. Existing vertical relationships were disrupted and reformed, with the new companies straddling (and blurring) the divide between for-profit and not-for-profit research. Although most were overtly profit oriented, they also had much tighter personal, geographical, cultural, and contractual links to nonprofit research institutions. Academic scientists played a particularly important role in the founding of these companies, either moving out of academic employment or participating actively in both worlds. While some of the new companies sought to be fully integrated horizontal competitors with Big Pharma, and a handful succeeded in doing so, most assumed the role of specialist suppliers of leading-edge technology to downstream firms. Several developments were responsible for such changes. First, revolutionary scientific discoveries in the 1970s, such as gene splicing and the ability to create monoclonal antibodies, opened up new areas of research, and the pace of discovery in basic biomedical science accelerated dramatically in subsequent decades, raising the importance of close contact with university science. At the same time, developments in patent law brought much of molecular biology and the life sciences within the ambit of the patent system. Without patent rights in inventions in areas such as isolation and purification of proteins, DNA sequences, monoclonal antibodies, knockout and transgenic organisms, gene expression systems, and so on (or at least the prospect of obtaining and enforcing them), many biotech companies would never have been founded. The passage of the Bayh-Dole Act also relaxed barriers to licensing of government-sponsored research. Before Bayh-Dole, government had invested large sums in U.S. research in academia but had also retained property rights in the innovations. Increasingly dissatisfied with the paucity of commercial successes derived from this investment, government (through Bayh-Dole) assigned property rights (patents) to universities and forced universities to establish technology transfer offices. Such offices were notified of all innovations by university researchers and were charged with finding outlets for these inventions. Finally, changes in tax and financial regulations brought about a venture capital industry (and ultimately a stock market) that was willing to support inexperienced companies entering a market with a seven-to-ten-year product development cycle. At least in the U.S. equity markets, tolerance for risk has risen, and after a few well-hyped early successes, investors became comfortable with the idea of “high science for profit,” developed a shared language and conceptual framework for valuing these new ventures, and—periodically—have been willing to support the new sector with substantial injections of capital. The revolution in life sciences also affected organizational and managerial aspects of drug research. As drug discovery became more science-intensive, with increased emphasis on “deep” understanding of physiology at the molecular level, it became not just more expensive but also more difficult to manage. As “rational drug design” took center stage, changes in the nature of research activity were accompanied by complementary changes in the internal structure of commercial R&D organizations. Drug companies began to look and behave more like universities, with increasing emphasis on collaboration, publication, and exchange of (precompetitive) information. This was accompanied by increased willingness to exploit external sources of technology, through in-licensing or strategic partnerships. In this environment, specialist research firms could expect at least to survive, if not to prosper. At the same time, the growing cost and complexity of academic research projects forced successful scientists to acquire managerial and organizational skills—leaving them better equipped to run business ventures and looking much more like entrepreneurs and managers to outside investors or business partners. As rising costs and growing societal pressure to justify their budgets pushed universities and other publicly funded institutions to become more tolerant of “just-off-campus” commercial activity, or even to actively encourage it, this cadre of scientist-entrepreneurs was well positioned to take advantage of the commercial opportunities their research created. By 1990 it was clear that biotechnology was here to stay. Although investors’ interest waxes and wanes, fresh waves of entrants have been able to take advantage of periodic opening of the financing window, and the pharmaceutical industry has developed a new vertical structure, with biotech “tool” companies as a specialized layer between Big Pharma and the nonprofit sector. Big Pharma now increasingly relies on the research tools and product leads provided by biotechs, and 25–40 percent of its sales are reported to come from drugs that originated in the biotech sector. The orderly world of the “waterfall model” has been replaced by one in which information and materials circulate rapidly between not-for-profits, Big Pharma, and the biotechs, supported by a complex set of contractual agreements and collaborative arrangements. Adapted from Cockburn I.M. The changing structure of the pharmaceutical industry. Q1: Utilizing Figure 3.1 and Table 3.1 in your book, identify and categorize the changes in the macro-environment which enabled the entry of biotechnology companies into the industry.