The lengthy timeframe for drug development serves as a strong and subtle influence on the biotech industry. Certainly its relatively slower pace has caused traditional biotech to adopt a unique culture distinct from its Med Device, Diagnostic, & Tools cousins. Below are three ways time causes the biotech model to diverge from most other industries.
1) IRR (Time-weighted return)
Many VCs and the biotech media will measure multiple return on cash investment as an indication of success (e.g. 5X return). However, this ignores an important variable in finance, time. IRR, a time-weighted return, is the more important measure. A 10X return achieved over 100 years is not so impressive. Because biotech takes so long before a product is cash flow positive (10+ years), returns on an IRR basis take a hit. Even if an early-stage biotech sells to big Pharma after say Phase IIa proof-of-concept, its purchase price will be heavily influenced by the Pharma’s timeframe to cash flow breakeven. Cost of capital becomes a real issue over ten years, as does any loss in patent life. Contrast this to the faster paced Med Device or Diagnostic world, and you can see why a lot of Healthcare VC dollars are migrating in those directions. Furthermore, the pressure for a biotech to partner or sell after five years to satisfy VC’s timeframe puts unnatural pressures on a program that is meant to take much longer. When a biotech rushes development to partner early, when the focus is not on a successful product launch but solely Phase II exit, shortcuts are taken, know-how, focus and momentum are lost, and drugs often fail as a result.
2) Crystal Ball
In many ways running a biotech is like steering an ocean-liner. It is hard to be nimble and you have to predict what macro and microeconomic conditions will look like ten years from now. Will regulatory rules and reimbursement mechanisms have changed? Will there be an IPO market or interested acquirers? Will a new diagnostic tool identify more patients to treat? Will the emerging markets have a sustainable health care system and honor IP? What about competition? It is very difficult for biotech companies to predict any of these variables. Unlike most industries, the long R&D time-cycle means you can’t necessarily tailor your business model to the fluctuations of the marketplace.
3) Personalities
The relatively slower pace of drug development and its focus on major innovations vs incremental improvements attracts a different personality than most other industries. Many start-up biotech companies are at least initially run by MDs or PhDs, not traditional business people. These individuals are intellectually curious, passionate about their field, and interested in advancing science and medicine. However, many were raised in academia and have little inclination to focus on the end market. They often base their companies around innovative capital-intensive solutions looking for problems to solve. This “hammer-looking-for-a-nail approach” can create a challenging dynamic for a for-profit, VC-backed start-up with little cash or time to spare and high demands for exits.
Because the healthcare commercial marketplace is constantly evolving, biotech companies should avoid relying on stale business model heuristics that were only relevant to the healthcare landscape of the past. No one has a crystal ball, so the best you can do is research current market conditions, take a reasonable and thoughtful guess as to the future, narrow your focus on a specific set of product opportunities, and generate a tactical game plan. Then do it all over again in six months.
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