Healthcare connects on defence

This week’s ezine editorial and Big Deal analysis combined is from a speech given Thursday at bank SVB’s healthcare-focused corporate venturing retreat in Napa Valley, California. To see the slides please follow this link.

At bank SVB’s healthcare-focused corporate venturing retreat in Napa Valley, California, a straw poll found a two-thirds majority of the 40 attendees regarded their industry was primarily about acting as a gatekeeper to entrepreneurs inside and outside the company wanting its help to succeed, where corporate venture capital (CVC) was part of the innovation toolkit.

A minority said it was about CVC, the direct or indirect taking of minority equity stakes in entrepreneurial third-parties.

There are no right answers as the war itself has been won: just about all companies agree that they don’t retain a monopoly of smart people and ideas in their organisation.

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In a study by Boston Consulting Group analysing Global Corporate Venturing data, the management consultants focused on the 30 largest corporations in each of 17 industries and found healthcare (63%, up 13 percentage points since 2007) was second only to IT for the penetration of CVC as an industry and the longevity of these units had increased by more than 50% between 2002 to 2012.

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(The BCG chart is quite small so a more visually stimulating way to represent this is to take the logos from the corporations attending our Symposium in May this year – kindly sponsored by SVB, among others, for which thank you. These attendees represented corporations with aggregate revenues of more than $3.5 trillion, dominated by oil producers and healthcare firms.)

Interestingly, during this period 2007-11, healthcare and IT research and development (R&D) fell as a proportion of sales from 16.5% to 15% and from 11.5% to 11%, respectively, while CVC increased, BCG’s analysis found.

Why? It is hard to find effective drugs – 15 years and $1bn – and so only one in 10,000 science discoveries get to market; the proverbial needle in the haystack.

Or as one head of R&D at a large pharma put it at the recent Tech Transfer Summit: “Over the past decade, there has been an unprecedented attrition in compounds in phase II & III trials. Alongside the patent cliff and gap in early-stage research investment, we are having to find ways to collaborate with the outside, such as academia and entrepreneurs.”

Previously, if big pharma wanted to tackle a new market it would hire university researchers. Now, they are starting to look at how partnerships could scout specific projects where the drugs companies have set the framework and collaborations with academics could potentially repurpose their in-house compounds (for more on how the Global 1000 are meeting university interest see this week’s ezine editorial here).

Sanofi has a target for 50% of its early-stage pipeline to come from external sources by 2015; for Roche this target is 30%. But tensions still remain from corporate antibodies as, fundamentally, entrepreneurs are paid to take risks, while big pharma employees are not. The scary numbers of peer-reviewed research that cannot be replicated and manipulation of clinical trials data to fit expected outcomes point to the pressures these different outlooks can bring.

Corporate venturing, by contrast to R&D, is remarkably cost effective; it delivers positive financial returns rather than acts as a cost centre. And given Wall Street’s pressure on public companies to deliver stead or rising total shareholder return through rising stock prices and dividends it could be expected that internal R&D in pharma as an industry could continue to fall with money potentially reallocated to open innovation projects, ie those sourced or involving third parties.

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As BCG concluded: “Considering the benefits that venture investing offers when best practices are employed, the real questions is whether corporations can afford not to join the game” – hence the continuing number of new programs and launches Global Corporate Venturing tracks. But naturally, other sectors are in more of a catch-up mode.

It is always worth remembering the research by Gary Dushnitsky at London Business School found CVCs on average outperform independent VCs and also those parent corporations which are effective at CVC gain in their stock price.

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This is perhaps not surprising given how important growth is to total shareholder returns (TSR). Research by BCG showed between 1991 and 2012 growth was THE essential driver of TSR – about 75% over a 10-year period.

An interesting healthcare trend noted by Toby Lewis, editor of Global Corporate Venturing, from his chats with the industry is whether pharmaceutical companies should do venture seeking largely strategic returns. A financial orientation in the sector, such as professed by groups such as Novartis and AstraZeneca’s MedImmune, in some ways makes limited sense because even top quartile returns are generally not very impressive when set against the overall revenues of the parent businesses. On the other hand, Toby said you could argue financial CVCs can be well embedded in the sector because of their financial focus, and indirect benefits for a large pharma corporate parent would disappear if it tried to be strategic. Nevertheless, overall, most insiders reckon that a strategic focus is sensible to pursue. 

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And this strategy is essentially defensive: to stay in the sector rather than necessarily look for opportunities beyond.

Analysing GCV’s deals data from 2010 to 2012, BCG found fully 96% of the top 30 healthcare companies’s CVC deals were in their own sector, far ahead of any other sector, including the oil majors.

BCG explained this focus as due to “the rapid pace of change in the industry, spurred by new legislation and strong pressure from payers and government to control costs, capture efficiencies and improve patient outcomes”.

It also partly reflects the past growth of the healthcare industry in the economy.

As Albert Einstein reputedly said: “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”

And while “Healthcare inflation is slowest in 50 years,” at 1% in the 12 months to July, according to a Wall Street Journal headline Wednesday, it had outpaced general price increases for the three decades to the latest recession. The industry now makes up 18% of the US economy and could rise to 20% by 2050 even as the American population doubles.

Everyone has their own favourite anecdote about the local healthcare industry gouging them on their treatments but we are beginning the genius of the system has been divorcing patients from having to immediately pick up the bills through the use of insurance and government schemes. For example, when my aunt moved to California from the UK 40 years ago there was no health insurance – people paid for services at use and costs were carefully watched.

Now, while Obamacare (aka Affordable Care Act) has seen cost controls weakened it does limit some growth in Medicare reimbursements and taxes some corporate plans. Individuals through deductibles and co-pay are also picking up at least some of the burden if they use the system and through the internet and mobile apps can start to better compare prices for drugs and services.

So corporate venturers are primarily tasked with finding the next drug, product, service or business model that could replace or build on existing strengths and skills.

That is not to say it is not looking for highly disruptive technologies and models but mainly ones impacting the core business. As BCG said: “By investing in broadly disruptive technologies, such as biotech, pharmaceutical giants such as GSK, Novartis and Pfizer, have spotted emerging trends that are reshaping their industry.”

[In the discussion under Chatham House rules after this speech, only a handful of companies said they had invested outside of healthcare, for example in batteries, to gain financial diversification and/or technological insights but none said they were proactively trying to help their parents move into other sectors.]

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Unsurprisingly, it is the groups that combine longer-term visions and approaches with financial and strategic successes, including how they think about M&A – to which SVB’s Jon Norris has some data and analysis – that are regarded as the most influential in the sector.

The question about open innovation becomes how to engage effectively and reap the benefits for the organisation in healthcare as the industry undergoes change.

But this strategy is also one that could leave incumbents vulnerable to disruption by outsiders. It is perhaps no surprise that the big chemical companies would continue to look at healthcare given how many big pharma companies, such as what is now GlaxoSmithKline from what was then ICI, were spun out from them last century. Other industries are also looking, such as consumer goods businesses, such as Reckitt Benckiser (RB) and Nestle, as well as the tech giants, including Google, IBM, Qualcomm and Samsung.

As BCG described it: “Venturing can yield important information that companies can use to prepare or facilitate the entry into new businesses…. Samsung Ventures is following this path to gain early insight into trends [through backing clean-tech and medical technology start-ups in MRI Imaging] that could reshape value chains in its various business lines.”

Google has this week backed Calico, run by Genentech’s former CEO and current chairman, Art Levinsohn. Interestingly, Google’s investment came from its corporate department rather than financial-focused Ventures team, which I think indicates the deal has strategic angles for the search engine provider into how information can be stored and processed on grown chips, something that Intel and chip makers have been preparing for for years. But what could the impact be for pharma – as Dan Primack, columnist at Fortune, said: “I’ve also reached out to several other top life sciences VCs, none of whom had heard about Calico before yesterday’s announcement. Same goes for some healthcare industry headhunters. In other words, this has legitimately taken folks by surprise.“

(The straw poll of SVB attendees confirmed this as no one there had expected the Calico deal either.)

For consideration: Google gets processing power, analytics, personalisation and they know just about everyone and Sergey Brin’s ex-wife runs genetics company 23andMe, and Levinsohn has the pulling power to build a team of just about anyone he wants.

I also think interesting strategic battles could be fought between incumbents and the FMCG companies, such as RB, Unilever and even chocolate companies such as Nestle.

As we wrote exactly three years ago: “Nestlé uses venture investments to spark drugs war”

Nestlé planned to invest SFr500m ($510m) over the next decade in health science division, targeting obesity and chronic disease, and to “pioneer a new industry between food and pharma” after committing nearly $1bn to its corporate venturing funds in the sector over the prior decade.

FMCG’s marketing skills and distribution against the incumbent industry’s regulatory knowledge and existing distribution is an interesting area for venturing approaches to be played out. But whereas you might see Google compete with Amazon on each other’s territories, pharma, device and clinical providers and insurers seem content to play defense.

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And it is these incumbent and new-entrant corporate venturing units that are helping dealflow hold up. We are tracking more than 1,000 CVC deals per year, with the US the biggest region and healthcare the second-biggest sector and rebounding.

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Part of the challenge for dealmaking has been building a syndicate.

There are an estimated 12 VC funds investing in early-stage healthcare, a third of the number of 10 years ago as returns not great (until the present wave of flotations comes through in distributions back to limited partner). Plenty of people are looking for new models to tap into academic research, build on government grants through the SBIR and STTR programmes (and the EC’s SBIR-type scheme that will start with Horizon 2020 next year and make up about 7.7% of the €69bn budget), force start-ups to be more parsimonious and lean on corporations, which are more active especially at the early stage.

As Eugene Kleiner, co-founder of KPCB that backed perhaps the first real biotech, Genentech, used to put it: “Real value comes when you remove real risk.”

Syndicates now are forming with deep pockets and funding tranched rounds where the money is released when these risk inflection points are passed. The lesson learned by those remaining has been: “Avoid being dependent on market whims or having to raise outside capital.”

But with some many types of syndicate investors, from VCs to CVCs to governments, foundations and philanthropists to clinical research offices and academia trying to get alignment on aims and know how people will respond when the pressure is on is remarkably hard.

In conclusion, healthcare is changing and the response from incumbents has been essentially to try and build a Maginot line rather than many scouting outside and understanding the implications of, say the amplituhedron, the so-called jewel at the heart of quantum physics.

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I also want to mentioned that our ponsored report on the industry changes at the end of the first quarter next year – very keen to learn more and sponsorship and feedback very helpful. We’ll do a roundtable to publicise it – our one on media is out next week so if you are in NYC and fancy a coffee let me know, and also our inaugural Global University Venturing Summit is in London next month on the 16^th for those reaching out to an earlier-stage.