But public equity was never designed for an R&D enterprise, because the markets don’t know how to value R&D. Standard accounting and financial methodologies don’t really address the value of intangible assets like R&D, and the generally accepted accounting principles (GAAP) don’t require disclosure of R&D portfolios. Also, although pharma and biotech companies must disclose information on their development pipelines, the amount of detail they reveal varies widely from one company to the next. As an investor, you really need somebody on the inside who understands the science; public equity isn’t set up to do that.
S+B: Given VC’s shorter time horizons, how do the investors get their money back in a business where it takes a decade to go from blackboard to market?
PISANO: That gets us to the third troubling dynamic: the drive to monetize intellectual property (IP). Again, it’s worked very well elsewhere, but it’s problematic in biotech. Start with the understanding that it’s nearly impossible for a firm to get a billion dollars in funding for the decade-long process of developing a drug for market. So early in the life of this industry, entrepreneurs and venture capitalists came up with the idea of monetizing IP by selling it off. You come up with a concept, get it rolling, find a corporate partner, and capitalize via an alliance, a licensing fee, or future royalties, among other options. Monetizing IP occurs all over the place — in the book business, music, software, electronics. In those industries, the market for know-how is vigorous, and the system functions well.
But in biotech, knowledge is not easily tradable. Monetization of intellectual property works really well when you have modularized ideas contained clearly in formats — for example, written code — that are easily transferable and that can work like puzzle pieces or links in a chain. But biotech involves plenty of tacit knowledge that’s interwoven with other elements of the system. There is a lot of science in biotech, but also a lot of art. Drug development is a messy process and involves judgments based on both hard scientific data and the researchers’ individual experience. It’s very difficult to transfer this type of knowledge from one organization to another because researchers have different skills and different experiences. The market for know-how is not an efficient way to get lots of different players together in biotech.
Many have suggested that this business should work like the movie industry, but it can’t. For a movie, the studio hires the needed inputs — producers, directors, actors, costumers, camera operators, and so forth — to come together and produce the film. Why can’t you do that here? Because there’s a well-understood technology for making films. If I’m a cameraperson, I know exactly what I have to do. And if I’m a cameraperson for your movie today, I can be a cameraperson on someone else’s movie tomorrow. It always works the same way.
But knowledge in biotech is not fungible. It’s highly specific. The monetization of intellectual property assumes that we can buy and sell knowledge as if it’s a commodity and find different partners. Biotech is too complex a system for monetization of IP to work. And monetizing IP this way cuts directly against the impetus toward integration. If firms truly believe they can profit by focusing on just one piece of the puzzle, they become myopic. They will build their own island of expertise, and fail to consider how their approach links with others.
S+B: You’ve identified a disconnect between the paths of innovation in business and science. What does that reveal about the biotech sector?
PISANO: There are two types of innovation required here. One is scientific innovation, which we see all over the place. The second is innovation in business models and approaches. That’s what Alfred Chandler, the great business historian, was getting at when he noted that the railroads would not have been possible without the creation of the modern corporation. Before railroads, there weren’t corporations. But then railroads required a large amount of capital, and that meant raising money from other sources. That in turn required separating ownership from management. Venture capital moved along a similar path, evolving in the 1940s and ’50s and ’60s as an institutional innovation to enable the funding of small companies.