Why start-ups can become mega companies in the pharma sector

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In a previous BioVox article, we analyzed the steps needed for a life sciences start-up to turn into a fully integrated, commercial stage biotech company. For this to happen, the hurdles that need to be overcome include: the development of a first-in-class disruptive medicinal product (preferably backed up by a pipeline of runner up products), the ability to gather ample financial means, and savvy tactics for avoiding acquisition along the journey. We now ask the question: why does the pharmaceutical sector – in comparison to many other industries – provide such fertile ground for start-up companies to succeed.

In many industries it is extremely rare for start-up companies to make it to the top of the food chain. Although the automotive sector has seen the rise of Tesla, very few other new companies manage to compete with established brands. Even for Tesla, the jury is still out on their success: despite 15 years in business, the iconic electric car company is now teetering at the brink of profitability. Similarly, in the food industry, small companies can occasionally become successful in specific niches or within local market boundaries, but most eventually end up as just another brand of one of the food giants.

In clear juxtaposition to these examples, the list of Top-25 pharmaceutical companies includes four companies created less than 40 years ago (Gilead, Amgen, Celgene and Biogen), with other up-and-coming enterprises steadily climbing the ranks. These relatively new companies are currently generating several billion dollars of free cash flow and are unlikely to be dethroned any time soon. So, let’s have a look at the key extrinsic factors that enable this upward mobility for newcomers in the pharmaceutical industry.

Ring-fencing early R&D assets

The discovery process in the pharmaceutical industry typically results in drug candidates with novel chemical compositions. A novel molecular entity is highly amenable to a ‘composition of matter’ patent claim, which provides the highest tier of protection in patent world. In other industries, patented inventions tend to rely on ‘method claims’ or ‘use claims’, which are much easier to circumvent. As the method and use claims are harder to monitor and enforce, they leave small innovative players vulnerable to copycats with deeper pockets. Composition of matter claims provide pharmaceutical start-ups with better control over their assets than small companies in other industries.

In the pharma business, a small company with a well-protected drug candidate stands a good chance to keep large companies at bay. Additionally, the notoriously high costs and long timelines of drug development actually work to the advantage of small innovative companies: other companies are reluctant to spend billions of euros to develop a drug if they run the risk of coming too late in the race to commercialization.

With a little help from the service providers

A young biotech company can often stay lean and capital efficient, throughout the process of bringing a first-in-class drug to the market, by outsourcing certain tasks to sophisticated fee-for-service providers. What’s more: the drug developer often stays in control of subsequent commercialization of a new product, despite the involvement of other larger players along the road. This is because, in the pharma business, the protected innovation itself, i.e. the novel drug substance, determines the final manufactured product.

In many other industries this is not the case; a disruptive invention in any given car component, for example, rarely results in anything more than an incremental improvement of the car itself. It therefore does not provide strong leverage for a small innovative company against established car manufacturers.

First-mover advantage

A small biotech company that gets market approval for its first-in-class transformative drug, can reap the benefit of the first-mover advantage. This situation occurs in many industries, but it is particularly striking in the pharma business. First-in-class drugs build the largest dataset of documented efficacy, which builds trust at the doctor’s office.

Additionally, the time between market introduction of a first-in-class drug and expiry of the corresponding patent usually lasts no longer than ten years. Expiry of the key patent often coincides with a dramatic price drop, as generic drugs move onto the scene. Because of this, the ‘first-mover’ company can take advantage of the longest high-margin commercialization period, while the secondary players have less time and smaller market shares to recover their high development costs.

Juicy gross margins

An ambitious runner-up biotech company, wishing to control the commercialization of its transformative drug, will get tailwind from the extraordinarily high gross margins common in the pharmaceutical sector. These margins, typically in the 70-90% range due to premium pricing, is possible when the innovative drug brings life-changing value to the patient in need. The high margins allow a midsize company to set up its own salesforce and generate significant cash flow, even if the company initially sells only one product. That ultimate step is a hugely challenging feat, yet not impossible in the pharmaceutical sector; in other, lower margin, industries it is often an insurmountable obstacle.

Willem Broekaert, managing partner at V-Bio Ventures, concludes: “Recent history has taught us that once-small companies can become mega-companies in the pharmaceutical sector, due to a combination of industry-specific factors. These extrinsic factors allow for high fences at the R&D stage (strong patents, lengthy and costly R&D process), as well as relatively low barriers to market entry at the commercial stage (first mover advantage, high gross margins, outsourced manufacturing). In more traditional industries, the reverse situation is more typically the case, hampering upward mobility of newcomers.”