In this section, we analyze the development of the biotechnology industry from scientific, organizational, and financial perspectives. These perspectives reveal the need for a strategic consolidation in the biotechnology industry.
7.2.1 The Development of the Biotechnology Industry from a Scientific Perspective
Broadly considered, biotechnology includes techniques as old as Western civiliza- tion itself: e.g., the cultivation of microorganisms for brewing and the intentional cross-breeding of plants and animals. Thus, the roots of modern biotechnology, the so-called first generation of biotechnology, lie in the fermentation of foods and drinks, industries spanning almost every society and evolving over centuries (Sharp 1991; Kenney 1986).
“Second-generation biotechnology” developed as an outgrowth of traditional fermentation in the late nineteenth and early twentieth centuries and depicted the greater understanding about microorganisms. The discovery of penicillin by the British bacteriologist Alexander Fleming in 1928 and the subsequent development of the antibiotic industry is one of the major milestones of the twentieth century.
“Third-generation biotechnology,” also called “new” or “modern” biotech- nology, resulted from the discovery in the early 1970s of the method by which genes could be cut and spliced. It includes the use of recombinant DNA and cell fusion techniques as well as bioprocessing technology to make or modify products.
The development of “new biotechnology” has been characterized by Wirth (1994) in four phases; however, in this chapter we are adding a fifth phase. The first phase, the so-called research phase, lasted from 1970 to 1980 and was dominated by two path-breaking discoveries that revolutionized molecular biology. First, in 1973, Herbert Boyer of Stanford University and Stanley Cohen of the University of California at San Francisco reported the discovery of recombinant DNA. Second, in 1975, Cesar Milstein and Georges Kohler of the British Medical Research Council discovered monoclonal antibodies by fusing cells from a mouse myeloma with cells derived from mouse B lymphocytes to create a “hybridoma.” In this phase, universities and research institutes played a critical role in biotech’s emergence, not only as the places where young scientists were educated, but, particularly, as the sources of breakthrough discoveries and techniques that fostered scientific and technological innovations (Powell 1996).
Hence, most biotechnology firms have been started by scientists with the help of venture capitalists, specialized law firms, or ex-pharmaceutical executives, while pharmaceutical companies have applied a “wait-and-see approach” and remained on the sideline.
The second phase, from 1980 to 1985, is considered as being the pioneering phase. The first product of a biotechnology company made by recombinant DNA, human insulin, was launched in 1982 and was soon gaining significant market penetration. In 1983, first experiments with genetically modified microorganisms were allowed to be carried out in the USA, and in 1985 the first genetically produced hepatitis B viral antigens were introduced.
The third phase, from 1984 to 1990, is regarded as being the first prosperous phase of biotechnology, because there had been strong indications that the real
“take-off” point for the large corporations came in the years 1984–1985. Big-firm investment in commercial biotechnology in the USA increased markedly (Office of Technology Assessment 1988).
The fourth phase, from 1990 to 1996, is perceived as the real prosperous phase of biotechnology leading to new opportunities. In 1990, the first experiment to treat ADA deficiency genetically took place, and in 1992 the US Trade Office had worked out new rules for biotechnology as well as genetic engineering according to which genetically developed products are to be treated equally as conventional products. In this same period, the market share of drugs and diagnostic methods based on biotechnology increased steadily. By the end of 1994, more than two dozen biotech drugs and vaccines had been approved by the FDA, more than 200 medicines were in various stages of clinical testing, and approximately two dozen drugs awaited FDA approval (Powell 1996).
The fifth phase, which began in 1997 and continues to the time of publication of this chapter, is characterized by the discussion about necessary consolidation activities and the future “dream” about the never-ending benefits of biotech- nology. On the one hand, biotechnology companies are considered as being the
“innovative engine” for the pharmaceutical and biotechnology industry. On the other, however, institutional investors are not motivated by biotechnology’s past performance and are looking for new areas to invest (Purcell 1998). Moreover, with the launch of the Human Genome Project in 1990, there was a growing perception that drug discovery was to undergo radical changes. First, the number of possible targets relevant to diseases was about to rocket. Second, new technologies such as high-throughput screening and new bioinformatics tools related to combinatorial chemistry made it possible to test a large number of potential drug targets against an even larger number of chemical entities. Third, the growing awareness of the innovation deficit at pharmaceutical companies makes them look for alternatives: biotechnology. Overall, the convergence of genomics and informatics not only heralds a new era of biomedical research, but will also foster M&A activities in the biotechnology sector.
7.2.2 The Development of the Biotechnology Industry from an Organizational Perspective
University laboratories have played a critical role in developing the scientific fundamentals of biotechnology during the first phase of the development of the new biotechnology. However, it was the dedicated biotechnology firms that
commercially exploited the results of the research. The scientific breakthroughs of biotechnology constituted a radical change from previously dominant technologies in the pharmaceutical sector. Hence, “biotechnology is a dramatic case of a competence-destroying innovation” (Powell and Brantley 1992: 368). This parti- cular radical technological change builds on a scientific basis (immunology and molecular biology) that differs significantly from the knowledge base (organic chemistry and its clinical application) of the established pharmaceutical industry (Powell 1993).
Internally, biotechnology firms are organized flexibly in overlapping interdis- ciplinary project teams with minimal hierarchy in order to create a lean and effective organization for drug discovery and commercial development (Powell 1996). Small biotechnology firms require large financial support and regulatory knowledge, while larger pharmaceutical companies desire access to the research capabilities of smaller companies. It is usually the case that the full range of relevant skills needed to develop therapeutic drugs is not readily available under a single roof. The necessary basic and research skills to create a new product are found in universities, research institutes, or small biotechnology companies, whereas the cash needed for product development, clinical trials, and worldwide marketing is located in large pharmaceutical companies. Hence, the players in this field have turned to numerous forms of collaboration such as joint ventures, research agreements, or licensing agreements. Overall, the biotechnology industry is placed in an extremely challenging, hypercompetitive environment, compound- ded by appropriation problems, high levels of uncertainty, and critical resource immobility (Liebeskind et al. 1996).
The biotechnology industry is characterized by a social network structure that ensures the reliability of scientific information due to well defined and socially enforced norms, reciprocity, respect for individuals’ intellectual property rights, and honesty in research (Blau 1973; Crane 1972; Merton 1973). A better environment for efficient organizational learning and enhanced flexibility for responding to unpredictable changes is provided by firms that organize themselves to maximize the benefits of this social network structure. A prerequisite for success is a shift from coordinating the internal activities of the firm through a command and control structure to providing organizational support for internal as well as external exchanges.
The pattern of interfirm collaboration in biotechnology is probably more extensive than in any other industry (Arora and Gambardella 1990; Barley and Freeman 1992; Powell 1993; Powell and Brantley 1992). Greis et al. (1995) distinguish four different types of partnership agreements: (1) research contracts or minority investments for the purpose of gaining a window on new technologies, (2) licensing and marketing agreements to obtain the use of a particular techno- logy, (3) corporate alliances such as joint ventures with or without the transfer of equity, and (4) mergers and acquisitions. Interestingly, M&As are referred to as types of “partnership” agreements reflecting the specific context of the biotechnology industry and its social network structure.
7.2.3 The Development of the Biotechnology Industry from a Financial Perspective
Financing a biotechnology company or venture is the result of interactions between entrepreneurs, venture capitalists, management teams, investment bankers, research analysts, and institutional investors (Hurwitz 1999). The role and influence of each player depend on which stage the company is in. The biotechnology industry has enjoyed more funding by governments, pharmaceutical companies, the equity capital markets, and the venture capital community than has virtually any other high-growth sector in the worldwide economy.
Teitelman (1989) describes Wall Street’s initial attitude toward biotechnology as “biomania.” In 1980/1981 biotechnology investments in the USA were attracting nearly $100 million of venture capital. However, Wall Street’s overall relationship with biotechnology has been extremely variable, being hot and cold on a number of occasions. In its early enthusiasm for the technology, Wall Street ensured that many new biotechnology firms enjoyed substantial funding. Large, established pharmaceutical companies have generally been slow to become involved in biotechnology, but, over time, have been devoting considerable resources to it and many also have acquired biotechnology firms.
The restructuring and reorganization within the two primary sources of biotech- nology funding − pharmaceutical companies and the institutional investment community − now pose a threat for the continued growth of the industry. On the one hand, the short-term earnings pressure on pharmaceutical companies to maintain their valuations will probably result in a reduction of discretionary dollars traditionally used for biotechnology funding. On the other, the bull markets that institutional investors have enjoyed, combined with the inconsistent market performance of biotechnology investments, have reduced their interests in future investments. From the point of view of the institutional investor, Coyler (1999) stresses that investors’ caution in the biotechnology sector is rooted in its historical return, which means that the additional risk assumed by biotechnology investors has not been rewarded within a reasonable time. Investors in the average biotech IPO in 1993 have enjoyed on average only an 8% return through 1998, whereas the return to investors in the average US pharmaceutical company over the same period averages 36%.
The restructuring of pharmaceutical industry and the institutional investment community will ultimately provide a dilemma for biotechnology companies. For example, Saviotti et al. (2005) described how Hoechst and Rhône-Poulenc attemp- ted to transform themselves into life sciences companies during the 1990s before their merger to form Aventis. The drug companies who still believe in the promise of biotechnology no longer have excess discretionary dollars to spend, and the institutional investors with discretionary dollars to spend are not “true believers.”
The short-term strategic answer is to find ways to give both kinds of investors what they need. First, biotechnology companies have to become as financially innovative in their interactions with pharmaceutical partners as they are scientifically innovative by using creative financing structures such as off-balance sheet or product debenture financing. Second, they have to develop a critical mass − through organic growth,
consolidation, or collaborative agreements − in order to meet the needs of the pharmaceutical industry as well as the institutional investment community. This may lead to an increase in M&A activities between biotechnology companies, on the one hand, as well as more acquisitions of biotechnology firms by pharma- ceutical companies, on the other.
The development of the biotechnology industry has been described from three different perspectives: (1) scientific, (2) organizational, and (3) financial. We can conclude that a strategic consolidation resulting in fewer but stronger, larger, more market capitalized, and, thus, more financeable biotechnology companies is only a question of time because most biotechnology companies desperately need money in order to ensure their future growth and survival. Basically, biotechnology companies can choose between two approaches in order to solve this problem: a biotech-to-biotech deal or a pharma-to-biotech solution.