Biotechnology and the Economics of Discovery in the Pharmaceutical Industry

BIOTECHNOLOGY AND THE ECONOMICS OF DISCOVERY IN THE PHARMACEUTICAL INDUSTRY HELEN SIMPSON Office of Health Economics 12 Whitehall London SWlA 2DY ©October 1998. Office of Health Economics. Price £7.50 ISBN 1 899040 60 9 Printed by BSC Print Ltd, London. About the Author Helen Simpson is currently a researc~ economist at the Institute for Fiscal Studies and was formerly an economist at the Department of Trade and Industry. However, the opinions expressed here are her own and do not necessarily reflect the views of the IFS or of DTI officials or ministers. Acknowledgements This paper has been developed from my MPhil Economics thesis Scientist Entrepreneurs and the Finance of Biotech Companies. I would like to thank Margaret Meyer, Paul David and Gervas Huxley for their valuable suggestions. I am particularly grateful to Hannah Kettler and Jon Sussex for their advice and editorial inputs to the paper. My thanks also go to Adrian Towse and members of the OHE Editorial Board for their comments, and to the following individuals who gave me their insights into the pharmaceutical industry: Dr Trevor Jones, Director General, ABPI; Dr Janet Dewdney, Chairman, Adprotech; Dr Clive Halliday, Head of Global External Scientific Affairs, Glaxo Wellcome; Mr Alan Galloway, Head of Research Administration, Dr Nick Scott-Ram, Director of Corporate Affairs, and Dr Philip Huxley, all of British Biotech; Christine Soden, Finance Director, Chiroscience; Ian Smith, Lehman Brothers Pharmaceutical Research; and Paul Murray, 31. The Office of Health Economics Terms of Reference The Office of Health Economics (OHE) was founded in 1962. 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CONTENTS 1 Introduction 7 2 The emergence of biotechnology firms 13 2.1 Technological change 15 2.2 The demand for research outcomes 15 2.3 Scientist entrepreneurs 16 3 The finance of biotechnology firms 22 3.1 The role of venture capital 22 3.2 Stock market flotation 28 4 Collaborations and the structure of the pharmaceutical industry 32 4.1 The size of innovative firms 33 4.2 The boundaries of the firm: are we moving towards a more efficient organisation of R&D in the industry? 35 4.3 Collaborations 38 4.4 The structure of the pharmaceutical industry 46 5 Conclusions 48 References 50 1 INTRODUCTION This paper examines the economic aspects of the forces driving the emergence of biotechnology firms, and the implications of this for the organisation of research and development (R&D) and industrial structure in the pharmaceutical industry. In the early 1970s, two molecular biology breakthroughs - the discovery of a mechanism by which part of a foreign gene could be inserted into another and thereby change its characteristics (recombinant DNA, or rDNA) and techniques for fusing and multiplying cells (hybridomas) - heralded the coming of genetic engineering.l 'Biotechnology is used in three different ways in the pharmaceutical industry: i) to produce drugs and vaccines using rDNA technology; ii) to make intelligent screens for new compounds; iii) to apply techniques for rational drug design by understanding molecular structure.'2 For the purposes of this paper, the term 'biotechnology firms' is taken to refer to small, research intensive firms that specialise in the drug discovery process. These firms do not necessarily only employ biotechnology methods nor focus exclusively on biopharmaceutical products. Biotechnology start-ups entered the pharmaceutical industry in the US in the early 1980s. By the mid 1990s, some US biotechnology companies such as Genentech and Amgen were integrated pharmaceutical firms, capable of competing, at least in some therapeutic areas, with large established pharmaceutical firms. The development of the biotechnology industry in Europe lagged some years behind the US.3 The UK' s most mature biotechnology company, British Biotech, was formed in 1986 and floated on the stock market in 1992. Although there are large numbers of European biotechnology start-ups entering the pharmaceutical industry, their combined scale remains small compared to that of the established pharmaceutical sector. At the end of 1997, the combined market capitalisation of the largest 10 European biotechnology companies was $5.7 billion, compared with the market capitalisation ot for example, $83 billion for Glaxo Wellcome alone at that time.4 1 Sharp and Patel (1996) p40. 2 Casper and Matraves (1997) p7. 3 For a detailed discussion of the development of biotechnology in the European pharmaceutical industry, see Sharp and Patel (1996). 4 Ernst & Young International Ltd (1998a). 7 Figure 1.1 Growth of the US biotechnology industry, 1986-1997 1997 1986 Revenues ($b) 17.4 2.2 R&D spend ($b) 9.0 1.7 Number of companies 1,274 850 Number of employees 140,000 40,000 Sources: Evans (1996); Ernst & Young (1998a). Figure 1.2 Biotechnology in the US and Europe Public 1997 1996 1995 %change companies 1995-1997 Financial Europe us Europe us Europe us Europe us Revenues 648 12,862 433 10,565 297 6,960 118 85 (Ecu m) R&D expense 534 5,145 243 4,226 158 3,440 238 50 (Ecu m) 347 1,654 73 2,021 73 1,840 375 -10 61 317 49 294 28 260 118 22 companies Employees 8,418 94,000 5,315 73,000 2,958 60,000 185 57 Industry 1997 1996 1995 %change total 1995-1997 Financial Europe US Europe US Europe US Europe us Revenues 2,725 15,985 1,721 13,413 l 1,471 10,160 85 57 (Ecu m) R&D expense 1,910 8,268 1,508 7,258 1,252 6,160 53 34 (Ecu m) Net loss 2,020 3,767 1,113 4,134 1,206 3,680 67 2 (Ecu m) Industry Number of 1,036 1,274 716 1,287 584 1,308 77 -3 companies Employees 39,045 140,000 27,500 118,000 17,200 108,000 127 30 Sources: Ernst & Young (1998a); Ernst & Young BioBusiness reported in Financial 8 Times 26 November 1996. The biotechnology industry as a whole is growing fast. Between 1986 and 1997 the industry's revenues and R&D expenditures increased dramatically, as Figure 1.1 shows for the US. In recent years, growth in Europe has just started to outpace that in the US. Figure 1.2 shows that between 1995 and 1997 the number of public biotechnology companies in Europe rose 118 percent from 28 to 61, while employment there rose 185 percent. (Their losses also rose, however). Growth rates in the US, while significant, were much less rapid than this. Figure 1.3 shows the geographic structure of the European biotechnology industry. The UK leads Europe with approximately 180 firms. Germany comes second with approximately 100, but cannot compete with the UK in terms of firm size. The European industry as a whole is still dwarfed by the US, which has around 1,300 biotechnology companies. Biotechnology companies' contribution to R&D in the pharma ceutical industry is also growing, as is illustrated by Figure 1.4. Technological changes can be considered the catalyst for the emergence of biotechnology firms. The major breakthroughs in molecular biology referred to above meant that the traditional method used to discover drugs, where thousands of chemical compounds were screened for efficacy, could be replaced by a more focused drug design method, where the design of molecules is targeted to particular cells or particular biological interactions.S Practically this has meant a decline in the minimum scale required for a firm to be efficient in drug discovery and a new opportunity for small firms to enter an industry previously closed to them by prohibitively high set-up costs. Technological change has made small discovery firms potentially viable. But technological change is only part of the story.

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