ASSESSING RISKS, REWARDS, AND REQUIREMENTS
Because the differences in risks and rewards between the idea factory and the fully integrated firm are so vast, it is essential
to make a well-timed, unambiguous decision that will guide implementation of the strategy and sharply focus the efforts of
the company on the ultimate goal. Those efforts include getting the type of management team in place that is appropriate for
the strategy. For the idea factory, that usually means a small team that is adept at research, early development, alliances,
and outlicensing. For the fully integrated firm, it means strong executive leadership in critical commercial areas like manufacturing,
marketing, and sales. (For a discussion of how business processes and infrastructure should be created and measured for each
strategic alternative, see BioPharm International's March 2008 Compliance Notes column, "How to Avoid Becoming a Biotech Zombie—Part 3".)
The risks for the idea factory are far lower than the risks for the fully integrated firm. The products that the idea factory
produces need only show some therapeutic promise. They do not have to be herded all the way through regulatory approval and
use in humans.
Not surprisingly, lower risk means lower rewards. Nevertheless, for the idea factory that can generate a continual stream
of ideas and then turn them over to another company for commercialization, those rewards can be reasonably consistent and
substantial. Moreover, with big pharmaceutical companies facing thin pipelines and patent expirations, the market for ideas
The fully integrated company stands to reap even more substantial rewards, but the risks are concomitantly far greater than
the risks for the idea factory. The fully integrated firm must make enormous investments in human and infrastructure resources.
Further, for every drug that doesn't make it to full commercialization or that fails to win sufficient market share, those
investments are wasted. And the odds of successful commercialization are long. For example, it is estimated that an IND has
a 10–15% chance of reaching the market, and an alarming number of new drugs (50% by FDA estimates) are failing trials in late
stages. The fully integrated company must therefore have enough promising products in the laboratory and the clinic as a hedge
against products that fail.
Deciding between these two risk profiles is not a simple matter. Certainly, different companies, their boards, and their executives
will have different appetites for risk, often depending on who among those stakeholders is ultimately making the decision.
But regardless of who makes the decision, it should be made at a much greater level of granularity than a simple macrochoice
between low risk or low return and high risk or high return.
With an understanding of the differing requirements for the two business models, you can clearly and comprehensively define
your risks, both external and internal: competitor actions, patent protection, gaps in core competencies and management, product
development, regulatory hurdles, and other risks that could delay reaching the ultimate goal under each model. You can then
consider what potential effect these risks are likely to have on cash flow and model the cash flow under different scenarios.
Unfortunately, many organizations treat risk and uncertainty in a highly unsystematic fashion. They may have a general, qualitative
discussion of potential setbacks and pitfalls, but they fail to try to quantitatively calculate the chances that particular
problems will occur. Instead, they simply increase the discount rate to compensate for a vaguely conceived notion of risk.
But this fails to account for the specific risks of a chosen strategy. Those specific risks must be quantified in terms of
their contribution to uncertainty in cash flow. Although most biotech companies lack the ability to conduct this kind of probabilistic
analysis, it is nevertheless worthwhile to seek assistance with it to understand the total risk exposure of any given business
plan. Then it is possible to make a fully informed decision about which business model to pursue.
Regardless of which path you choose, you will then face another crucial set of decisions that turn on risks and rewards—whether
to build or buy such capabilities as:
- clinical or commercial drug supply;
- quality control laboratory testing capability for drug release and stability testing;
- internal versus CRO clinical study capabilities; and
- sales force.
It is this build-or-buy analysis that is the subject of the next article in this series.
Joseph J. Villafranca, PhD, is a senior vice president, Conrad J. Heilman, Jr., PhD, is a senior vice president, and Siddharth J. Advant, PhD, is a principal, all at Tunnell Consulting, King of Prussia, PA, 610.337.0820, firstname.lastname@example.org