Biotech is reliant on pharma – it needs commercial funding.

Although the drug was never approved in the United States, the existing regulatory review process was incredibly lax, with no clear methodology for evaluating supporting evidence. To remedy this situation, Congress passed the Kefauver-Harris Amendment in 1962, which included such common-sense measures as a “proof of efficacy” requirement that is still the basis of the drug approval process today.

The immediate effect of this regulatory change was industry consolidation. With the massive investments and long lead times required to bring new drugs to market, only larger firms such as Pfizer, Merck, and Johnson & Johnson had the necessary capabilities to compete.

Concurrently to industry consolidation, the seeds of the biotech industry were sowed. Biotechnology, at least in pharmaceuticals, is distinguished by its reliance on the use of genetic engineering to produce new compounds. A series of breakthroughs throughout the 1970s culminated in the first genetically engineered human insulin in 1982, the fruit of collaboration between Caltech and the first biotech firm, Genentech. This paved the way for the emergence of other small start-up biotech firms in the 1980s, typically only composed of a few successful scientists.4

While the number of pharmaceutical companies remained constant during the 1970s, the 1980s was a period of rapid growth driven by the emerging biotech field.5 Though the industry itself was evolving, little changed in terms of output, not only because drug development takes a long time, but also because biotech research was still a relatively small part of total pharmaceutical R&D. Roughly 20 new molecular entities (NMEs) are approved each year (though year-to-year variation is large),6 and by 1988, only 5 had actually come out of biotech research.7 By the end of the 1990s, however, the FDA had approved more than 125 biotech drugs.8

As biotech grew, the dominance of the largest pharmaceutical firms fell. From 1950 until the early 1980s, the 15 largest pharmaceutical companies were responsible for roughly 75% of NMEs per year; today, their share has stabilized around 35%.9 Generally, large pharma has been good at generating successful follow-on approaches (70% of follow-on approaches come from large pharmaceutical firms) but much less successful in novel treatment options. Biotech has taken up much of this slack. From 1998 to 2008, biotech companies have been responsible for nearly half of new drugs with novel mechanisms (a subset of “especially innovative” NMEs) and 70% of orphan drugs in the pharmaceutical industry.10 Biotech had also increased its share of blockbusters—drugs whose annual sales exceed $1 billion—from 8% to 22% by 2007.

The biotech-pharma networked model suggests that smaller firms can play a key role in industry innovation.

For the last few years, anywhere between 5 and 10 biotech drugs have been approved,11 and perhaps more significantly, biotech has been growing at roughly twice the speed of the pharmaceutical industry as a whole (roughly 10% per year since 2009 versus 6%).12

The emergence of biotech also led to a steady increase in inter-firm collaboration, whether in the form of joint research projects, strategic alliances (where one firm does one part of the process, and the other another), or mergers and acquisitions. By 2000, roughly 25% of corporate-financed pharmaceutical R&D came out of joint ventures, 3 times as much as in 1990 and 20 times as much as in 1980.13 From 1990 to 2010, mergers and acquisitions deals increased fivefold. As a subset of the industry, biotech is especially reliant on external forms of collaboration, with nearly half of biotech R&D funding coming in the form of partnerships (since 2009 at least).14

Since most biotech firms are small and rarely have the means to take their drugs all the way from preclinical trials to commercialization, collaboration is a necessity for them. For larger pharmaceutical companies, the growing interest in external collaboration can be traced back to a paradigm shift in research methodology.

With the tremendous advancements in genetic engineering, chemistry, and computational biology, the 1980s opened up the possibility of rationalizing the drug development process.15 Prior to that period, companies principally relied on “random screening” to identify promising compounds for drug development.16 This process involved testing a large number of chemicals to determine how they interacted with the targeted disease. By the 1980s, this process had run into diminishing returns, and the industry switched to a “guided search” model,17 thanks to the advances in computation and genetics. As a consequence of this shift, large research labs and capital were no longer as important to drug research, and the value of genetic expertise increased, bolstering the comparative advantage of highly specialized biotech firms.

According to Gottinger and Umali (2011), this paradigm shift wasn’t in itself sufficient to push large pharma toward more collaboration. Initially at least, pharmaceutical companies were convinced they could do much of this guided research themselves.18 But the early and remarkable success of Genentech changed this perception. Its first two blockbuster drugs, Humulin and hGH, were developed and commercialized in close partnership with larger pharmaceutical companies. Genentech started working with Eli Lilly in 1978 and jointly created Humulin, approved in 1982 and a blockbuster a few years later.19 Genentech also worked with the giant Japanese firm Kabi starting in 1977 on hGH, which was approved in 1985. Genentech’s success helped shake up the pharmaceutical industry and encouraged other big players to seek out partnerships with biotech firms, which they did in much larger numbers from the early 1990s onwards.

While there is no set model for how these partnerships work, some broad trends can be observed. One common pattern is for biotech to focus on the early stages of new drug development, especially preclinical trials. If the early signs are promising, they will enter a licensing agreement with a larger firm. Another option is for the larger firm to simply acquire the start-up, a pattern that is very common. Just last year, large pharmaceutical firms spent a few billion dollars buying the rights to biotech drugs or the companies themselves.20 At this stage, it is rare for any single company to have invented, tested, and commercialized an NME solely internally.

Though again the setup varies from one case to the next, many biotech firms preserve much of their independence even once they have been bought. They maintain their separate offices, research direction, and internal structure, taking on the role of “centers of excellence.”21 Generally, biotech firms boast human capital better equipped to harness the cutting edge of research, as the majority of their employees have PhDs and strong ties to leading research universities.22

The nuclear industry needs more support in turning new technologies into start-up companies.

From the perspective of biotech firms, there is little doubt that this collaboration has been beneficial. Apart from Genentech and a few others, very few biotech firms have actually succeeded in bringing their inventions to market. Reviewing the evidence from the 1990s, Owen-Smith and Powell (2004) find that network ties are a significant predictor of performance in biotech.23 More recently, Munos (2009) finds that acquisitions lead to a 120% increase in NME output for small companies.24 Interestingly, increased collaboration or consolidation between large firms isn’t as strongly associated with increases in NME output.

Since the approval of NMEs is actually relatively rare, most partnerships and external collaborations don’t actually lead to a new drug approval. In most cases, they are formed in the hope of achieving the next milestone on the long road toward drug approval. Indeed, the average R&D alliance in biotech lasts less than 4 years, whereas the drug development process takes closer to 10–12 years.25 The fact that large pharma has been willing to bet substantial sums on biotech ventures still far away from commercialization has played a key role in driving the growth of the latter, and has allowed smaller firms to secure funding (often from VCs) despite having a product that is still many years from commercialization.26