Biotech’s current funding crisis is unlike any previous funding challenge the sector has faced. In the past, funding droughts were largely driven by investor sentiment toward the biotech industry. When investors were bullish about the sector’s prospects — for instance, because of product approvals in the industry’s formative years or media excitement over the sequencing of the human genome around the turn of the millennium — money rushed into the sector, and companies rushed out to conduct IPOs. Unfortunately, the boom was inevitably followed by a bust a few years later, when investors realized that the path to commercialization was considerably longer than they had initially assumed or when business models failed to live up to their promises.
The current funding crisis is different. The bubble that burst was not in biotech, but fueled by real estate and an environment of easy credit. And so, while biotech’s past financing droughts were localized and industry-specific, the present downturn is global and systemic. This has implications for the length of the drought and the path to recovery. In the past, conditions improved when investor sentiment recovered, but this time the global economy is undergoing a significant deleveraging which could constrain the flow of money into equity markets for an extended period. Things will only get better when the overall pie — the global economy — grows. And that, by all accounts, will take time.
As funding options have dried up, many companies with little cash are running out of options, and we are likely to see a sizeable number of entities declare bankruptcy or cease operations. Facing a sustained funding drought, many firms are taking urgent measures, including restructuring operations, laying off employees and focusing on one clinical candidate to reduce cash burn and advance to the next value-creating milestone.
The current environment is placing the biotech business model under unprecedented strain. To understand this impact, we need to remember that necessity is the mother of all models. The models that companies and investors adopt are, in other words, not developed in a vacuum. They are instead compromises shaped by a number of constraints — resources, funding options, bargaining power and the inescapable reality that it takes US$1–2 billion and upwards of a decade for a biotech company to become a mature, financially sustainable enterprise. Few investors have the means and patience to endure such a journey — after all, they face constraints of their own on investment horizons and rates of return. Consequently, the business model that has evolved in the biotech industry is akin to a marathon relay race, in which biotech companies work with a series of investors and partners to raise capital and share risk before passing the baton to the next runner.
The biotech business model’s key inputs (funding) and outputs (innovation) face increased risks. On the funding side, the relay runners that biotech companies have come to rely on are facing constraints. For VCs, exits have become ever more difficult, and raising capital from limited partners is becoming more challenging as LPs see their portfolios shrink. Meanwhile, public funding — which accounts for the majority of the recent decline in biotech funding — is likely to remain at lower levels for some time as the global financial system deleverages. Lastly, many pharma firms will likely find their ability to invest in biotech increasingly constrained, both because of the need to focus on integrating mega-mergers and because the pharma industry will spend less on R&D as its revenues decline.
On the innovation side, the ultra-lean business models that companies are adopting in the wake of the financial crisis could lead to some slowing of innovation. While companies’ efforts to focus on fewer drug targets are logical survival measures to reduce cash burn, drug development is still dependent on a good deal of serendipity, the culling of large numbers of “less promising” R&D programs raises the very real prospect that we might be killing the next big thing.
The path ahead: beyond business
models as usual
However, there is hope ahead, because times of tremendous change can also reshape landscapes and create new opportunities. In particular, four sweeping changes that are on the horizon could dramatically shift existing paradigms and generate opportunities to build sustainable business models:
A coming wave of generics based on some of the world’s most successful drugs could lower pricing pressure as payors’ budgetary constraints are loosened — sustaining returns and keeping runners in the race.
Fundamental healthcare reform in the US — the world’s largest drug market — is likely to usher in pay-for-performance. This could help sustain returns for investors if the metrics adopted by payors truly reward innovation.
Personalized medicine will increase the importance of research and early development — biotech’s traditional strengths — boosting biotech valuations and returns. More efficient drug development could shorten the race altogether.
Globalization. Increasingly valuable ex-US rights create the potential for new “win-win” distribution of rights in deals. Partnerships with Asian companies could provide new sources of capital and new ways to overcome the constraints facing Western companies.
To seize the opportunities latent in these trends, biotech executives will need to understand the potential impact of these changes, prepare for them, and wherever possible, help shape them. The industry’s representatives will need to be actively involved in the policy debate on healthcare reform, to ensure that the pay-for-performance metrics developed align incentives with the needs of innovation. And its scientists will need to focus their R&D efforts to embrace personalized medicine, since its adoption offers some of the best hope for quicker R&D and better returns on investment.
Necessity is the mother of all models, and if history is any guide, today’s tremendous challenges will unleash tremendous creativity. As the industry’s creativity is applied to the issue of sustaining the biotech relay race, and as several paradigm-shifting trends unfold, we could see the emergence of more durable models that will carry biotech through the next 30 years. The sooner we can get there, the better.
Adapted from Beyond Borders: Global Biotechnology Report 2009, published by Ernst & Young Global Biotechnology Center, Boston, MA.
> ABOUT THE AUTHORS
Glenn Giovannetti (left) is Global Biotechnology Leader at the Global Biotechnology Center of Ernst & Young. Gautam Jaggi is Senior Manager and Managing Editor, Beyond Borders Report, at the Global Biotechnology Center.