In the first article in this series (Under Pressure, PME February 2016), I described the six fundamental market shifts that are shaping our industry’s evolution. The last time so many powerful changes converged was in the late 19th century, a period that saw the extinction of apothecaries and the birth of modern life science companies. So today, we should expect a flowering of business models as dramatic as that seen by our great-great-grandparents, marked by the survival of those who anticipated the change and the extinction of those who did not. But how might we gain such vital foresight? The answer lies in the application of Darwinian evolutionary theory to the realities of our sector.
Darwin’s concept, displaced
Our modern understanding of Darwin’s brilliant idea is elegantly simple. Variation occurs within populations of reproducible, information-storing replicators, which in biology we call genes. This leads to variation in the traits of their host interactors, which biologists label organisms. These variations are selected for or against by environmental selection pressures, and reproduction leads to the emergence of new populations sharing the same, new replicators. Biological scientists refer to these new, differentiated populations as species.
Exactly the same mechanism drives industry evolution. Variation occurs in populations of reproducible, information-storing replicators, now called organisational routines. This leads to variations in the traits of their host interactors, now called organisations. These variations are selected for or against by market selection pressures and imitation leads to the emergence of new populations sharing the same, new replicators, which we now call business models. Importantly, the comparison is an analogy, not a metaphor: what is happening in our industry is not like evolution, it is evolution.
This shared mechanism provides powerful insight. Biological evolution makes ‘choices’ in order to optimise reproductive success; our ancestors ‘chose’ to have cell nuclei, spines and mammary glands because the costs and risks involved were outweighed by the reproductive returns. Similarly, evolution in industry makes ‘choices’ to optimise risk-adjusted returns on investment; firms chose markets, strategies and structures that optimise commercial success.
This Darwinian explanation of industry evolution has been used by management scientists for decades. Its application is incredibly powerful but practically difficult because complex, adaptive systems, such as industries, are immune to extrapolation or mathematical modelling. Instead, we must gather thousands of examples of industry change, from investments and divestments to launches and restructures, and look for emerging patterns. My research group at the University of Hertfordshire is the only one in the world to apply this approach specifically to the life science sector. When we do, a fascinating picture emerges.
The net result of this series of evolutionary choices is a complex family tree of business models in the life science sector
Primary choices
This first evolutionary choice to emerge concerns which part of the value chain with which to compete, a choice that shapes our industry as fundamentally as the prokaryote/eukaryote split shapes biology. Increasingly, firms chose to be either technologically innovative, operationally excellent or customer intimate. Selection pressures disfavour firms that are adequate but not distinctive in one of these value-chain steps. For example, Roche, Sun Pharma and Fresenius each succeed by virtue of excellent new product development, supply chain management and customer relationship management respectively.
The next evolutionary split between business models is based on which customers to focus upon, a choice as salient as that between vertebrates and invertebrates in biology. As governments are financially overwhelmed and patients become more responsible for their own health, the payer focus of business models is polarising between patient payers (both mass market and affluent) and governments. We see this when we compare, for example, generic Paracetamol with Allergan’s Botox and Bayer’s Xarelto. The success of each arises from very different evolutionary choices.
These two primary choices – how to create value and who to create value for – shape our industry’s landscape and define its nine main principal habitats. As in biology, species (that is, business models) that are well adapted for one habitat (for example, the operationally excellent/mass market patient payer habitat) are necessarily poorly adapted for another (for example, the technologically innovative/government payer habitat). But evolution, in its ceaseless drive for superior fitness does not stop there. Additional evolutionary choices lead to further branching and speciation of business models.
Orgel’s Second Law
Within the nine habitats defined by the primary evolutionary choices, further differentiation occurs between business models. This is an example of Orgel’s Second Law, which states, slightly flippantly, that ‘Evolution is cleverer than you are’. In other words, market selection pressures force business models to make every possible choice to optimise evolutionary fitness. In practice what emerges is a series of choices that trade off risk and return. For example, firms that choose discontinuous innovation are taking higher risks that are justified by higher returns. Incremental innovators, by contrast, accept lower returns in exchange for more tolerable risk. We see this choice most obviously in the split between small molecules and, for example, advanced immune-oncology therapies.
The same risk versus return trade-off is seen in the choice of market or therapy area. Large markets, such as diabetes or respiratory diseases, offer huge possible returns but to obtain them firms must choose the higher risk implied by the many strong competitors that such markets attract. Many firms, deterred by this risk, opt for smaller markets with less commercial risk, such as those firms that focus on rare diseases, such as Shire, or those that attempt to dominate specialities, such as Grünenthal in analgesia or Leo in parts of dermatology.
In operationally excellent habitats, different evolutionary choices drive the speciation of generic models. Foremost among these is the choice of how closely to follow the technological innovators. Fast followers, exemplified by the biosimilars, accept the risks involved in following close behind the innovators in return for the lucrative possible returns. Less daring companies, typified by the branded generics, mitigate that risk but only by accepting the more modest margins available to small molecules. Even within generics, we see the emergence of sub-species of business models based on some degree of differentiation or choice of condition severity.
In customer-intimate habitats, evolution forces choices such as how much to integrate into the customers’ value chain and whether to prevent or manage disease, again leading to a speciation of differentiated business models.
The net result of this series of evolutionary choices is a complex family tree of business models in the life science sector. In all, my work identified no less than 26 models at various stages of emergence. These various business models are shown in the accompanying figure and the parallels with biology’s ‘tree of life’ are obvious. To return to our biological analogy, the life science industry appears to be undergoing its own ‘Cambrian Explosion’, that burst of evolution 540 million years ago that led to almost all modern life forms. This parallel with biological evolution also helps us to understand the strategic implications of our industry’s equivalent of the Cambrian Explosion.
The only way that a firm meets this challenge is to evolve faster and more efficiently than the competition
Life on the tangled bank
At the end of ‘On the Origin of Species’, Darwin contemplated the complexity of the ‘tangled bank’ of an English hedgerow. He marvelled at the diversity of life forms and their exquisite, differentiated adaption to their environment. If we follow Darwin’s thought processes and apply them to the newly emerging picture of the life science industry shown in my diagram, it leads us to three very important lessons for those who lead our sector:
Your competition will be much more diverse. Life science companies have been used to competing with firms with similar business models to their own. In the future, every therapy area will include not only close peers but also competitors with diverse business models ranging from the innovative to the cheap to those that personalise their value propositions. We see ancestors of this trimorphic specialisation already with patented and generic products and the beginnings of value ‘beyond the pill’, but evolutionary forces will drive this trend much further. Within each habitat and disease area, many different models will evolve to complicate and intensify the competitive pressures.
Your competition will be much stronger. As we see in biology, evolution drives towards extremes. In our industry, it will drive technological innovators to create treatments that today are the stuff of science fiction, as we are seeing for example in gene and cell therapy. But it will also drive operationally excellent companies further so that generics – against which all other approaches will be benchmarked – will become unbelievably cheap. Equally, customer-intimate companies will find ways to release the 90% of value in healthcare that is not involved in the cost of medicines, diagnostics or other products. Most patients and payers, whatever their clinical and economic needs, will have many good and varied options to choose from, so most companies will have to compete against this plethora of strong, highly-evolved competitors.
You must direct your own evolution. The increasing diversity and intensity of the life science industry landscape, emerging from market selection pressures, has one overriding implication for those who lead pharma, med tech and related companies: your chances of survival are greatly reduced and the threat of extinction is much enhanced. The only way that a firm meets this challenge is to evolve faster and more efficiently than the competition. In biology, random, opportunistic and short-term approaches to survival are the norm but they are slow and hugely wasteful: many more biological species are extinct than are alive today. If life science firms want to out-evolve their rivals, they will need to direct their own evolution in an urgent and deliberate manner, thinking carefully about the direction of their own evolution and the steps involved.
In this article, I have built on my preceding article about the selection pressures shaping our industry and described a small part of my research into how life science business models are evolving. The picture I paint will, I hope, provoke thought and stimulate questions about how firms might direct and accelerate their own evolution. In the next two articles, I will answer those questions.