External Innovation: Force Multiplier For R&D
External models of R&D innovation are the rage in Pharma today, as they should be – the future of our industry depends on a great deal more rather than less collaboration.
In a very healthy way, lots of experiments are being done across the ecosystem and the final scorecard for what worked and what didn’t is years from being tallied up; however, the early biomarkers are positive and it’s a widely-held belief that a critical element of exceptional R&D organizations in the future will be creative BD engagement. In short, great BD and R&D are becoming synonymous with each other.
For much of the past decade, most of Big BioPharma has focused on extracting value from the conventional workhorses of partnering: licensing, M&A (including use of risk-sharing biobucks), and R&D collaborations. Over 75% of the most exciting late stage assets in Pharma’s pipelines came via these traditional external sourcing routes (here). These are valuable tools, and are certainly very important for pipeline-building, but they only scratch the surface of what external R&D models can deliver for Pharma.
Beyond the obvious and direct value of accessing new assets or platform technologies, the much more compelling strategic imperative of external innovation initiatives is as a force multiplier for the R&D organization.
Taken seriously enough – as both a percentage of an R&D leadership team’s time and budgetary resourcing – these creative external strategies have the potential to be meaningful culture-change agents to invert the periphery and the core of corporate R&D; they also greatly enhance the breadth and quality of an organization’s exposure to new innovation without smothering it inside the internal bureaucracy; lastly, they provide great leverage to the financial model of R&D via access to different capital sources, the benefits of fractional ownership, and operational flexibility and efficiency. All of these benefits, which are detailed below, aid in the tighter integration of internal R&D efforts with BD. But these can really only be achieved by overcoming a range of established value-destroying mental models, also described below, that are pervasive in R&D today.
Before going through those value-enabling elements of external R&D, it’s worth summarizing and exemplifying the range of models being explored today.
External R&D Toolbox
Conventional BD deal-making around licenses and acquisitions make up a good deal of the external activity for most companies, and that’s likely to continue to be the case; here, though, I’ll focus on the other tools of the craft that are in some ways more intriguing and more explicitly focused on early stage innovation. There are at least three broad types of these creative “external R&D” strategies: direct company engagements, fund-related portfolio approaches, and open innovation models.
Direct external innovation models involve partnering specifically around a single company or concept with the principle purpose being to advance the innovation in a startup environment and to play a role (of varying degrees) in shaping it. Very often these have pre-specified rights to products or rights to acquire the company itself.
- Venture co-creation efforts, like Sanofi’s “Sunrise” initiative with WARP Drive and Myokardia, or Novartis’ role in helping us found with Intellia Therapeutics, provide opportunities where bigger companies participate with venture capital firms in the early moments of launching a company. Venture formation involves identifying the concept, encoding the corporate DNA, bringing the right ingredients to bear, and launching the new enterprise. It’s a sleeves-rolled-up endearvor, and only a handful of venture firms do it well on a systematic basis. That said, a number of large companies have also been attempting to do this on their own, without venture involvement at last initially; as far as I can tell, these have had limited “success” to date. GSK’s experiment with Tempero Pharmaceuticals is a good example: founded around great science, the idea was to create a standalone biotech with its own governance that GSK could leverage for Th17 projects in the future. Unfortunately, although the research programs advanced, the company appears to have been unable to escape the gravitational pull of the GSK organization – accessing internal research infrastructure led to conformity, financial costs were all consolidated leading to compliance and internalization, and its employees were eventually just integrated back into GSK. The science advanced (or so I’ve heard), but whether the venture formation experiment was a success is debatable.
- Built-to-buy deals are a flavor of this direct model as well, as exemplified by Arteaus and Annovation with Lilly and the Medicines Company, respectively, as well as Celgene and Versant with Quanticel, Astellas with Mitokyne, etc… GSK’s co-creation efforts with Avalon around asset-centric drug discovery startups, with pre-defined acquisition rights at Development Candidate nomination, are a good example of this model done via a portfolio approach. We and others have demonstrated these “B2B” models can create significant value for both venture firms and corporate partners, especially around specific assets.
- Another version of this direct external model would be broad company-accelerating R&D collaborations – where large bear-hug style deals without buyout rights can transform the trajectory of the young startup while retaining its ability to grow and thrive. Agios-Celgene’s 2010 deal is the poster-child of this type of collaboration: $130M upfront for a multi-year collaboration with a aspiring drug discovery stage platform company in exchange for pre-specified product rights.
All of these company-directed external R&D investments are beyond typical conventional scope of BD, and should be tightly linked into overall R&D strategy.
Fund-related portfolio approaches represent a second type of external R&D investment. By creating or working closely with an fund structure, Pharma can expand its reach and exposure to innovation, as well as minimize the internal bandwidth and infrastructure dedicated to these efforts. It’s also a highly leveraged way of seeding innovation in the biopharma ecosystem.
- Most biopharma firms today have in-house corporate venture capital funds; these firms have become syndicate partners of choice for many in the early stage arena, especially a few years ago when there were almost no other co-investors around. I’ve written about the myths of corporate venture capital (here), their unappreciated scale in our business (here), and the data around what appear to be improved returns to startups that have CVC’s involved (here). Of the Top 20 pharmaceutical companies, only a small subset do not have their own CVC arm. While the benefits directly back to the parent company have been questioned, the benefits to the broader ecosystem of CVC efforts are certainly significant.
- Another version of fund-related investment involves open market Limited Partner (LP) commitments to established venture funds. Atlas has a multi-fund relationship with Amgen and Novartis, our Corporate Strategic Partners (here). They both have additional relationships in the venture community (e.g., Amgen with VenBio and OrbiMed Israel, Novartis with MPM). GSK has a broad range of LP relationships (e.g., Index, Hatteras, Sanderling, Longwood), as does J&J (e.g., Index, MPM) and Merck (e.g., Flagship, Lumira). The primary reason for most LP investments is “strategic proximity” (as we called it) or an “awareness advantage” (as Flagship recently called it with Bayer and AZ joining their recent fund) – the idea that even in a purely “open market” relationship Pharma gains an advantage by being proximate and exposed to early stage innovation and company formation. Some are aimed at regional engagement, such as those in Canada, but most LP relationships are geared to innovation more generally.
- Option Funds are another flavor of fund-related investment. These are either in-house funds with product rights as part of the deal, or are LP-relationships where Pharma gains direct rights to option-in or access the underlying investments in the portfolio. Lilly’s Mirror Funds concept entails some of these rights (with HCV and TVM). Novartis has had both an internal “Novartis Option Fund” (which isn’t still active as far as I can tell), and an ongoing relationship with MPM on an sidecar option fund that runs parallel to MPM’s main fund. The goal of this type of relationship is to secure direct company or product rights via a venture-like investment.
Open Innovation models are a third bucket of external R&D strategies around academic partnerships, consortia-based pre-competitive approaches, and the sharing of internal capabilities. These include Pfizer’s Centers for Therapeutic Innovation (CTI), Lilly’s Phenotypc and Target Drug Discovery initiatives, UCB’s multi-pronged partnership with Harvard, GSK’s academic Fast Track relationships, and many others. I won’t cover these, but many good reviews exist on the subject (here). The more interesting versions of these models aren’t simply funding mechanisms of academic work in exchange for rights to internalize, but are ones that bring the capabilities and technology platforms from the core of Pharma into frame for external groups (academics and small biotechs) to access. This is particularly useful in areas where Pharma may have excess internal discovery capacity and underleveraged technology platforms (e.g., deals to access novel mAb technologies, High Throughput Screening, or compound libraries). These are often challenging to negotiate (around the rights downstream), but if created in a non-cumbersome manner they could be catalytic.
Although not technically “external”, it’s worth noting a number of Pharma experiments involve pushing teams and groups out towards the periphery in order to “free them up” from the internal R&D bureaucracy. AZ’s neuroscience unit in Cambridge is an attempt at creating a more autonomous unit with the agility to move and engage the external R&D environment. Several internal units are even adopting their own “branded” names in an attempt to distance their culture from those of the mothership, like GSK’s EpiNova DPU and Pfizer’s Neusentis pain organization (check out its own website here). It will be interesting to evaluate the success (or not) of these long-standing efforts at liberating smaller units in the hopes of establishing new cultural “biotech-like” R&D dynamics, as there are few if any examples of truly doing it successfully inside of a large company.
For more on the toolkit of external R&D models, check out these recent high quality papers reviewing the topic of external innovation and related approaches (here, here, here, here). In addition, Deloitte’s recent report on their approach to “Open Innovation”, or OI as they call it, is worth reviewing (here). The plethora of writing on the subject is a reasonable, albeit lagging, indicator that the wheels have been in motion for sometime regarding these external models of innovation.
Most of the commentary, though, focuses on the use of these models for sourcing new assets, securing new innovations, and feeding pipelines; while this is very important and tangible benefit of these approaches, they miss what I think are the broader intangible benefits of a deliberate expansion of an R&D externalization strategy.
Broad Intangible Benefits Of External R&D
Beyond pipeline enhancement, embracing and turbocharging the external R&D models described above can drive significant value to internal R&D efforts and the corporation at large across a number of fronts – culture change, talent development, financial leverage, and capital efficiency.
Infusing entrepreneurial culture into R&D. As I’ve written multiple times in the past, the internal bureaucratic and sclerotic culture of today’s Big BioPharma R&D organization is a cause of much of the industry’s malaise (see blog on culture here, and some possible strategic, operational, and governance solutions here). By bringing high doses of innovative creativity from the “periphery” – via the above-mentioned biotech experiments enabled by external innovation – a leadership team can inoculate their R&D organization’s culture with different strains of thinking, different intellectual antigens to prime new ways of doing things. Simple strategic proximity and openness can afford real opportunities for this interaction if done at significant scale, where the “periphery” achieves a meaningful mindshare (and budgetary support) of the organization.
There are many culture-changing concepts that emerge from this: for example, exposure to more nimble governance, burn-rate centric resource allocation, and decision-making autonomy by lean management teams; being able to follow the science in a startup rather than getting locked into an “in” and “out” list of commercially-valid indications or a market assessment group’s NPV calculations; focusing on multi-year R&D milestone-based rather than annual budget review driven funding and incentive models; creating distributed RFP-driven project management with external market-based partners rather than captive internal groups; thinking about corporate R&D like a well-run venture portfolio of fully enabled “startup teams” held accountable but unencumbered; leveraging virtual R&D groups to tackle high risk projects isolated from committee-debate paralysis, inappropriate portfolio benchmarking (“that’s too risky”), and HR constraints; acceptance of fractional ownership models and arms-length governance to share risk and marry new capabilities; use of equity as the ultimate currency of entrepreneurship and nimble project governance; different views of the real risks in drug R&D (here); balancing CYA-driven and gold-plated “Cadillac” programs with leaner risk-reducing Fast-to-PoC concepts (i.e., derisively called “cutting corners” by most Pharma, it’s frequently the best use of high cost-of-capital dollars to discharge the biggest risks to a novel mechanism before spending on all the other bells and whistles). Many other examples come to mind. Further, this cultural infusion also creates the wonderful competitive tension of “if they can achieve this much on that little, maybe we ought to rethink our project’s plan…” Inoculating the organization with new culture has big benefits.
Exposure to and retention of great talent. Many of these external R&D initiatives are exciting career development opportunities. The cultural exchange described above is ultimately enabled by people. I’ve previously written about secondments/sabbaticals of emerging leaders from Pharma into biotechs where there’s an “external R&D” linkage (here). This concept has still not been tried at any meaningful scale – largely due to fear of losing talent – but I think it could provide huge talent development and retention benefits. Think of it like this: “Go join one of our external R&D startups for a year, add value, and come back to the Mothership afterward to share your learning.” Use the powerful gravity of future equity vesting to encourage their return and incentivize retention. This could be done for venture co-creation deals to help get liftoff, or built-to-buy structures where the executive returns when the startup is acquired. Many versions of this “core-to-periphery-back-to-core” talent development model could exist. Even the opposite could work and have broader benefits: younger scientists from biotech startups coming to do a “tour of duty” inside of a large company, knowing they will go back to the startup in 6-12-18 months after learning inside a more well-capitalized R&D group. Post-doc opportunities already exist like this from academia, why not from an external R&D partner’s bench as well? Given the diversity of approaches being explored in these external R&D models, there’s a huge range of talent development opportunities.
Leveraging alternative internal sources of capital. In the quarterly EPS-driven world of Wall Street, most Big BioPharma companies are acutely sensitized to P&L pressures and making sure R&D stays below a certain percentage of sales. Managing to an EPS target means that even small blips in consolidation around deal-making can raise ire of bean-counter analysts and therefore Pharma’s armies of R&D finance and accounting folks. But many external R&D models offer the possibility of accessing one of the largest resources in Big BioPharma – their cash-rich balance sheets. Over $130B in cash sits on the aggregate balance sheets of the largest pharma companies – 20x the amount invested into all VC-backed biotechs annually, 10x the amount invested into all the IPOs since the start of 2013 (here). It’s a huge resource that’s largely unable to be tapped; if even 5% of this industry war-chest was put towards external R&D it would transform the resourcing of the sector (and drive better returns than cash sitting near zero interest rates). By using equity-based investments, fractional ownership, less controlling governance models and the like, and fund-oriented commitments, these external R&D vehicles are able to deploy balance sheet capital to advance innovation more broadly. Celgene has been exceptionally effective at this strategy, and has been able to outmaneuver many of its peers on deals. In addition, because of inefficient US tax policy, huge reserves of “off-shore” cash exist in the industry, which drove the “tax inversion” craze of last year. Better tax structures have created BD advantages for foreign-based “inverted” companies, requiring US-domiciled companies to become even more creative in order to win deals. Creative ex-US deal-making surrounding different types of external R&D approaches can tap into these pools of capital in a tax-efficient manner. At a philosophical level, I think it’s a shame that accounting issues and quarterly EPS-centric myopia shape innovation strategy, but at the same time it’s the world we live in so finding ways to optimally deploy capital into value-creating investments which can advance new medicines feels like the right thing to do. Many of the models in the external R&D toolbox open up paths to accessing these enormous untapped resources.
Elevating the investment efficiency in R&D. Just turning the lights on inside large Pharma companies is a huge bill, and legacy infrastructure is tough to maintain. BMS was the latest Pharma to shut down more big R&D sites (like Wallingford, CT here). Fixed cost infrastructure creates a big drag on resource efficiency. External R&D models move resources towards being more flexible and variable, and enable titration of expenditures up and down in a more fluid real-time manner. Further, because of the contribution of “other people’s money” in most external R&D models, there’s significant financial leverage to R&D resources put towards projects on the outside. Lastly, many biotechs are able to conduct leaner R&D operations on a project-basis because of their infrastructure-lite, nimble governance, and fast-to-PoC models. This is not to say that all biotechs are intrinsically more efficient or faster/better/cheaper than Pharma R&D; in fact, when the full power of the huge resources in Pharma are put to a specific project, it’s incredibly hard for startups to compete. Take Novartis’ efforts in I/O following the CoStim acquisition – they powered up those antibody projects to get them into the clinic far faster than we could have as a small startup company. But the broader point that external R&D models have some intrinsic efficiency benefits remains valid and provides a great comparative benchmark as part of a broader R&D strategy for large BioPharma.
To achieve the above benefits, however, requires a real commitment. Spending a few percentage points of R&D on them isn’t going to move the needle; it needs to a significant component of the overall portfolio strategy and expenditure in order to capture the mindshare of the organization required to catalyze change.
Further, improved integration of R&D and BD around these strategies creates a cognitive consonance in the organization and a shared alignment that advancing innovation, no matter where it comes from, is the principle goal. This leads me to a final set of concepts around the obstacles to successful external R&D.
Overcoming Biased Mental Models
In order to capture the tangible and intangible value from external R&D models, organizations have to overcome a set of established, pervasive, and frequently corrosive mental models that prevent successful engagement in the ecosystem. These are challenging to unwind and impair many organizations today.
The most well-known negative mental model in Pharma R&D is the NIH syndrome of “Not Invented Here”. This once-powerful bias is well on its way to being beaten out of today’s large R&D organizations, having reached its apex in the 1990s in many large companies.
But a large number of other internal mental models still remain and prevent organizations from fully embracing a portfolio of external R&D models successfully.
- “Protecting our interests”. This is one of the most pernicious of mental models that renders many Pharma groups incapable of creative external R&D, and is based in the paranoia that everyone is out to screw you. Lawyers are paid to be conservative, think about every scenario, extract every protection possible, and create piles of paperwork. I’m convinced that Pharma’s corporate deal lawyers suffocate more creative deals than they are able close – they are the ultimate “Deal Prevention Officer” inside of many companies. They also drag processes into the quagmire, stalling momentum that makes deals happen. Further, given the importance of IP in our field, protecting internal projects from external “contamination” is a frequent battle cry of Pharma’s deal-lawyers. Sure, it can be a legit concern but like many things its blown way out of proportion in my opinion. This mindset also prevents the collaborative, pooling of insights approach that is so vital to successful external (and internal) R&D efforts. Making sure the lawyers aren’t running the process, and focusing on real business partnerships, is critical.
- “Heads I win, Tails you lose”. Every negotiation point doesn’t have to involve winners and losers. Great deals create two winners, and expand the size of the pie for all parties. Sadly, fighting each point in the minutiae of deal terms is a very common mindset as mid-level BD folks look to “earn their chops” as tough deal-makers. Add this dynamic to the overly protective lawyers above and it not a prescription for widespread success.
- “The World is Not Enough”. While a number of large companies are open to doing ex-US or regional deals with biotechs, many still remain narrowly focused on the “we’ve got to have global rights” mindset. Letting a biotech keep US rights creates huge optionality for them to grow and successfully resource their R&D enterprise, while giving the partner Pharma an intimate perch to watch the progress and a huge future BD advantage to acquire the rest of the story in the future if they desire.
- “Control, control, control”. The majority of external R&D models don’t involve control or overly assertive participation; in fact, the vast majority involve fractional ownership, devolved governance, and deferred control. But the bias in many Pharma companies is to control everything, prescribe the exact stage gates, imprint their own processes and terminology on the collaboration, etc… By bending the relationship to their approach, these control-freak manifestation of this caps the broader value of the deal. This is a related variant to the one above, but mental models of needing to “own it” and control it often hinder the creation and successful execution of these models.
- “This is a one-way street”. An essential part of sellside BD efforts involves sharing a biotech’s scientific basis, details of their ongoing R&D efforts, and their insights into the disease or program. But this sharing is almost always unidirectional. Rarely does a prospective pharma partner, sitting on the buyside of the table, share any deeply insightful programmatic learnings with young biotechs. It happens, but it’s unusual. CDAs themselves are almost always one-way, counter to the idea of “working together” and “sharing”. External R&D models are only successful with two-way sharing of information; if real value is desired, they have to go way beyond arms length licensing deals. For instance, we meet with senior R&D executives of our LP’s Amgen and Novartis frequently to engage on scientific topics; we exchange privileged insights about specific targets, disease areas, clinical approaches. It helps with diligence and execution. In contrast, I’ve been in meetings where Pharma had a program die for a certain tox liability but were unwilling or unable culturally to share that insight, or even a sanitized version of it, with us or our biotechs working in the field; hard to think that’s in the spirit of collaborative external R&D. Mental models geared to more two-way sharing of information are important enablers of successful external R&D.
Overcoming these and other pervasive corporate mental models is essential for successfully exploiting the value of the broad toolbox of external R&D approaches.
The future of innovation in the life sciences will be defined by a converging R&D ecosystem that brings larger BioPharma companies, young biotechs, VCs, and academia together in new collaborative models. Lots of BD and organizational experimentation is happening around this convergence, and I’m confident many of these external R&D approaches will transform the companies that embrace them and accelerate the progress of innovative new medicines.