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Darwin's Medicine blog

Professor Brian D Smith is an authority on the pharmaceutical industry and works at SDA Bocconi University and Hertfordshire Business School.

Choices, choices...

Not all innovative business models are equal

Although much of what we read in the industry media concerns radically new, embryonic business models, it is equally informative to observe the evolution and divergence of some of the industry’s oldest companies. So, for example, recent news from both AstraZeneca and Bayer points to interesting trends in the industry. As usual, let me build a foundation in the evolutionary science before returning to the practical implications of what we are seeing.

In biological evolution, the imperative is to optimise reproduction. When humans ‘decide’ to have a handful of babies while some species of turtle have hundreds each year, we are seeing different choices about how to sustain the species. You and I choose to invest heavily in a small number of offspring in the hope that almost all will give us grandchildren. Our turtle cousins choose to make much less investment in each child, knowing that most will be eaten in the short journey from the beach to the ocean. Both choices are essentially risk and return trade-offs that have developed over vast periods of evolutionary development.

Look carefully and you can see the same mechanism in business model evolution. In this case, the imperative is to optimise risk-adjusted rate of return. And just as different biological species make different choices, then different business models are characterised by the risk and return trade-offs they make. So for example, Bayer’s excellent results (see page 12) can be attributed, in large part, to Xarelto, its novel anticoagulant. AstraZeneca’s share price bounces up and down with each piece of trial data that emerges. Both firms are generally categorised as innovative, as opposed to generic, pharmaceutical companies but one can see that they are making very different risk and return choices. When a firm chooses to take an incrementally innovative approach to developing a small molecule, particularly one in a well-known therapeutic area, it is generally making the choice to accept relatively limited returns when compared to those that might be available to a radically innovative biologic in a much less understood therapeutic area. On the other hand, the incrementally innovative firm is also choosing a relatively low risk approach compared to the biologic company. I stress the word relatively here of course. Taken overall, both choices may have similar risk return ratios but with very different numerators and denominators. Metaphorically speaking, one is behaving like a human, the other more like a turtle.

The point is that while 30 years ago it may have made sense to categorise firms as generic or research-based, it is now a less useful distinction. Within the broad category of research-based business models, which Bayer and AstraZeneca obviously are, now many subspecies are emerging that are differentiated by their different choices about how much risk to take and what returns to expect. This is true not just between companies but also between different business models within companies. This has important practical implications. The capabilities needed to succeed with an incrementally innovative small molecule in primary-care, for example, are quite different from those needed to succeed with a discontinuously innovative large molecule in specialty care. Companies that depend upon fixed processes for the efficiency find it very difficult to be effective and efficient with both of these business models managed by the same people. The differences between the capabilities, organisational routines and micro-foundations (such as skills, team structures, etc) are just too great to be housed in one unified team. In my research, I see firms struggling with this problem all the time. It is part of the reason that we see many companies splitting the activities into innovative and mature products. Although we think of this as referring to the age of the product, it more usually refers to whether the product is incrementally or discontinuously innovative. And sometimes of course the division aligns neatly to therapeutic area, such as when we see oncology split off as a separate company.

Whatever the approach a company takes to structuring itself, what we’re seeing is a form of speciation. Just as six million years ago evolution decided that two different species of hominid were needed to fit the two very different environments of jungle and savannah, it now seems that the evolution of the life science industry is deciding that different species of business model are required to fit very different parts of the healthcare market environment. The result is a kind of mass speciation event in our industry that we must understand because evolution, in biology and in business, is an unstoppable process. We can’t change the direction of evolution. The best we can do is work out where it’s going and get in front.

27th March 2017

From: Sales

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