Academic Ventures and Professional Service Companies

Over the past few decades, life science and pharma have been characterised by a series of radical changes that have been at the origin of an impressive transformation of R&D processes and have made them a favoured scenario for radical change in the innovation paradigm.

The main trigger for these changes was the decline in R&D productivity in the industry during the first decade of the 21st century. Investment in research and development has now increased substantially: they represent 16 per cent of sales in the period 2000-2010 with a 60 per cent increase in the previous decade. At the same time, the risk associated with the development process is increasing as a consequence of two main factors: the focus of investments in new and riskier therapeutic areas and the more restrictive regulation for drug approval.

In addition to this, the expiry date of patents between 2010 and 2014 have put at risk more than US$ 209 billion in annual drug sales, resulting in US$ 113 billion sales of unlabelled drugs.

All these challenges have generated two different results: a strategic effect on the pharmaceutical companies, and a structural effect on the pharmaceutical sector.

From a broader point-of-view, the challenges and radical change that characterise the sector require the pharma companies to adopt adequate strategies to manage these risks. Some of the major steps taken by big pharma companies are those of restructuring their innovation model. The traditional model of closed innovation, predominant in the past decade and in which the innovative activities were mainly carried out in-house, has been replaced by a new model called Open Innovation in which collaboration among different actors of the innovation process is the key element. In other words, the innovation model of the pharma industry has evolved from an integrated one to a more open and networked model.

As a consequence, pharmaceutical companies have radically modified the innovation strategies, adopting an approach that promotes relations with the different type of partners (such as biotech product firms) in order to acquire (inbound open innovation) or to commercially exploit (outbound open innovation) technologies and knowledge.

The growing openness of the innovation model of pharmaceutical companies is only one side of the coin, however. It has been accompanied, and at the same time favoured, by a radical change in the structure of the sector itself, with the emergence of new kinds of actors. The value chain of the pharma industry is now more disaggregated with the presence of different actors involved at different stages.

In particular, new kinds of players, that are small biotech start-ups, showed they were particularly able to capture the entrepreneurial potentials of these changes.

By deploying valuable technical expertise, lower costs, less cumbersome organisational structures and the ability to hyper-focus on one (or a few) specific areas that show promise, these companies have demonstrated the ability to make incredible scientific advances (Christy J. Wilson, in Pharma R&D, March 27th 2018) and they are playing a key role in the creation of new knowledge and technologies in the sector.

The growth rate of this eco-system of small biotech companies is very strong worldwide, and their development has conditioned the innovation strategy of big pharma companies and the organisation of the drug development process of the sector.

Incumbents, including big pharma, have progressively committed themselves over the final phases of new drugs’ clinical trials. They maintain their key role in the management of the more advanced and expensive phases of clinical development and commercialisation on the final market of these new targets.

Start-ups and new entrepreneurial research-based ventures have rapidly become key players in the drug discovery process and pre-clinical phases. Thanks to their previous scientific knowledge, sometimes with the support of financial professionals specialised in high-risk investment, these spin-offs have proved particularly effective in the operations of identification and preclinical validation of new therapeutic targets.

However, in an open model for innovation, the entrepreneurial opportunity for academic biotech startups is not at all (except few notable cases) than to try to dominate a market niche in the future, but to sell their technologies to a bigger company for further exploitation.

The business model of these small biotech companies, with few exceptions, normally consists of the sale of their technologies that have reached a certain stage of development, to big pharma. Therefore, to reach a successful drug discovery phase and/or a pre-clinical phase, that is the necessary level of development to be attractive to big pharma, for a new venture is a liveor-die question and at the same time a very challenging issue.

In fact, in addition to financial restrictions that generally this kind of firms have to face, there is a more ‘strategic’ aspect that needs to be considered concerning the choice of ‘key activities’ and processes on which to focus the attention and to direct efforts and resources during the initial stages of development. While clinical phases in the drug development process are quite well defined due to strict regulation rules that oversee the possibility to go forward, the pre-clinical phases are not. This means that judgement from the targeted buyers of the technology is the only benchmark against which pre-clinical projects struggle to demonstrate their proof of concept validity. In other words, due to the industry’s organisation, the validation process of a new therapeutical target takes shape inside an entrepreneurial body that don’t know ex-ante who will judge its robustness and according to which benchmark they will express his judgement.

Cognitive representation of (rugged) competitive landscapes of the pharma industry is, therefore, a key activity to better define the entrepreneurial opportunity and to represent a clear model of relationships between strategic choices and expected payoffs.

The problem is exacerbated by the team composition of the academic start up, that often miss management competencies. Integration of these competencies by the beginning in the founding team is quite complicated and notwithstanding some excellent experiences in the US and Europe about the so-called “founding angels”, this integration often remains a will.

To overcome these difficulties, “in most cases, what start-ups need most is something akin to “mentorship” from large pharma firms and industry organisations1”.

For those having onboard an external investor, an experienced mentor, having reached these steps means successful completion of a valuable milestone and could be the necessary condition for a new startup in order to reach the necessary development to intercept the interest of a big pharma company.

This is why growing numbers of professionals try to intercept the entrepreneurial teams in a more or less difficult step of their development process in order to help them in arranging their pathway to a potential deal for the technology.

Business developers, strategic consultants and so on can offer that “cognitive representation” and expertise in order to drive and manage the development of the young biotech start-up. However, if necessary, the match between these two kinds of subject, biotech start-ups and professional/external consultants, is not simple to realise.

Two separate kinds of a mismatches are the main sources of pitfalls in entrepreneurial/managerial cooperation in drug development:

1. Knowledge bases of both parties and absorptive capabilities
2. Distribution scheme of incentives and contracting forms.

The first one concerns the different backgrounds and knowledge bases of startups on one hand, and external consultants, on the other. The founders of an academic spin-off are typically university professors, research-centre faculty members, doctoral students, PhDs or research fellows, with a strong technical background and a full knowledge of the technology they develop. On the positive side, they own the intellectual capital related to the new technology and have the necessary scientific skills to develop further the technology on which the spin-off is based. On the negative side, they often suffer the so-called ‘technological myopia’, that is the inability to go further than the technical and technological aspects of the project to capture the market and economic implications.

On the contrary, the external subjects generally have significant experience in new ventures, competences, and networking in the business development of new ventures, necessary to drive the entrepreneurial development of the project; but they do not have the needed skills to address and to face the technological uncertainties arising in the early stages of development.

In this context, a problem of informational asymmetry emerges, making the match between the two subjects very complex. More specifically, we can observe two kinds of informational asymmetry (Parente et al., 2011).

The first one referred to as ‘hidden information’, occurs when one party to a transaction is aware of information that is not known to the other party. For example, a group of inventors being intimately involved with the creation of the technology and its development possesses more information than the external subjects –who might find it difficult to access the relevant information even through the process of due diligence. In some cases, researchers–inventors do not disclose the features of their invention because they do not have confidence in investors and fear to lose the economic benefits and rewards that could result from commercial exploitation.

The second type of informational asymmetry, described as ‘hidden action’, occurs when one party to the transaction is unable to observe actions taken by the other party. For instance, the work of a group of inventors might generate results that cannot be observed or verified by others and which are important to the development of the technology and the performance of the new venture; but, contrarily, by reducing such efforts, the inventors would reduce the probability of entrepreneurial success and the efficient use of the capital employed. The group of inventors might make certain decisions autonomously, and the costs resulting from these decisions would be borne by the investors or other external subjects involved in the project. This type of a problem can lead to moral dilemmas and agency conflicts — the ‘informed’ party has an incentive to act according to self-interest, even if such actions impose high costs and risks on the other party. That agency conflicts and costs may be especially important in high-tech startups, where potential investors are faced with the difficulty of assessing and developing the potential of the new technology. The agency conflicts and costs could discourage external subjects from participating in the spin-off.

With regard to the second problem, i.e. distribution scheme of incentives and contracting forms, generally an external consultant and/or business development manager, charge a fee for services mechanism of payment.

This system is very difficult to access for a young startup because they often lack the financial resources necessary to acquire external services in order to develop the project and to transform a promising technology into a successful business. Young startups, in general, suffer from a systematic lack of financial resources and face several difficulties in attracting them from external subjects, such as venture capital.

This is particularly true in the initial stages of development because of the technological and market risks they have to face. Technological uncertainties very often occur in new spin-offs based on the results of scientific research. In most cases, technologies developed introduce radical innovations, usually with a predominant component of tacit knowledge and general purpose type. The founders of an academic spin-off spend a great deal of time and effort on additional technical development in the early stages of a new company, focusing their activities on the proof of concept and prototypes. These characteristics create many difficulties in identifying a priori the possible technology developments and, consequently, the difficulty of determining the real value of the entrepreneurial idea. The market risk relates to the fact that academic spin-offs often propose new technologies for which there can be a high degree of uncertainty about being accepted by the market. This is why those technologies are invented as a product of academic research (science push) and, often, not as the result of efforts to meet specific customer needs (demand pull). A market application must be found for inventions, but this requires data collection and generation of information about customer needs and how these could be satisfied, as well as obtaining and incorporating customer feedback about the products that make use of new technologies.

The solution to these problems could be found in the definition of mechanisms of participation of inventors and investors in the company able to intercept the needs of both. More specifically, the prevision of a risk-sharing approach from external consultants could be a possible solution.

Aware of their difficulties in attracting external financial resources, academic startups in general are well disposed to integrate the entrepreneurial team, leaving an equity share of the company with the objective to acquire the necessary and missing competencies.On the other hand, for external consultants, the assumption of entrepreneurial risk should be balanced through a mechanism of allocation of decision-making powers and the introduction of monitoring and incentive systems in order to enforce the commitment of researchers– inventors in the academic spin-off.

Reference:

1. Christy J. Wilson, in Pharma R&D, March 27th 2018

--Issue 34--