Argyle Conversations

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1 by Argyle Executive Forum SM Argyle Conversation: Ted Torphy, Global Head of External Innovation and Business Models, Community of Research Excellence and Advanced Technologies (CREATe), Johnson & Johnson

2 Page 2 Argyle Conversation: Ted Torphy, Global Head of External Innovation and Business Models, Community of Research Excellence and Advanced Technologies (CREATe), Johnson & Johnson by AEF - Tuesday, Argyle Conversation: JACQUELYN NICHOLSON: How did your background in R&D lead to your current role as head of the external innovation group? TED TORPHY: My background is in drug discovery. I spent 20 years in the field starting in 1983, at SmithKline Beecham (now GSK) and then J&J, where I joined in After being with Centocor, the bio-pharmaceutical arm of Johnson & Johnson, for three-and-half years as head of the discovery and non-clinical development groups, I had the opportunity to join J&J s corporate staff in 2004 to head the corporate office of science and technology, also known by its abbreviation, COSAT. We re a very diverse healthcare company, so this position provided me with the opportunity to learn about all of J&J s businesses, especially those that were outside of pharmaceuticals, namely, medical devices and diagnostics, as well as consumer products. My time with COSAT also allowed me to peer over the trench line of the world of pharmaceutical R&D. It opened my eyes to the issues that we re facing in healthcare, not just in the U.S. but around the world. It took me a couple of months of being in that role to recognize that the pharmaceutical R&D business model was not a sustainable one. In fact, I even had some concerns about the future sustainability of the whole industry, particularly if we continued on the same path that we had been on. I began discussing the major issues facing pharmaceutical R&D with a diverse set of my like-minded colleagues, including Bob Zivin, Roy Cosan and Rich Christie, representing R&D, venture capital and finance, respectively. The issue that energized us the most was the falloff of innovation and productivity in the industry, and believed that new models of R&D should be tested and implemented. We put together a business proposal that was presented and approved by senior management. We formed a new group, a small agile group called external research and early development, or ered for short. The goal of the group was to test the viability of doing early-stage pharmaceutical R&D external to J&J. We wanted to build a portfolio of early-stage product opportunities that we could monitor over time and provide high level guidance on. All work was to be conducted outside of J&J, allowing external groups almost complete autonomy in terms of the way they would develop these opportunities. Then at the right time, when risk had been sufficiently reduced, we would have the opportunity to acquire the products and bring them into our own internal portfolio. In a sense, it could be looked at as prospective business development. We worked to form truly collaborative partnerships with academia and venture capitalists. During that time, I learned a lot about the frustrations and needs of academia and the frustrations and needs of the venture capital community. I learned to put myself in their shoes, understand their needs, and better align our expectations and capabilities with those needs. For the industry to thrive, all of the constituents within our ecosystem need to do well. The knowledge and experience that I gained from that experience led me to my current job, which I ve had for the last year and a half. Can you delve a little deeper into what you said about the pharmaceutical R&D model being broken? What do you attribute that to? From the R&D side, the most serious issue is that R&D productivity and innovation are not increasing, despite ever-increasing investment. Another issue that we face, patent expiration, is really nothing new. There isn t anything inherently wrong patent expiration. If patents didn t expire, there would be less incentive to innovate. Innovator companies must continue to innovate to replace the products that have gone off patent. Another issue we face is the ever-increasing requirements from the FDA, the EMEA and other regulatory agencies. In addition,

3 Page 3 reimbursement is now being driven by medical and economic outcomes. In today s world, no one cares about the technology per se or how much the technology costs to develop; all that matters is the outcome, the benefit. We ve gone from an industry that sells pills a technology to an industry that gets reimbursed for the quality of the outcomes that we can bring to patients and payers. Another factor we deal with in our new world is the proliferation of healthcare outcomes and information. Payers, practitioners and the public know as much as we do about our products. That never used to be the case. The point is, we tend to view the changes in our environment as threats. Yet if our R&D productivity was high and innovation was great, these factors wouldn t be threats they would be opportunities. The problem is that innovation is not where it needs to be and the costs are just too great. So how do we create a solution to the problem? I am not concerned about the science. In my career, the science has never been as exciting as it is right now. The problem is not the science it s the business model. Most analysts agree that R&D productivity is decreasing and, if present trends continue, is not going to be sufficient to drive the future growth of the industry. At the same time, industry consolidation is leading to fewer large pharma R&D organizations, and the remaining R&D organizations are shedding infrastructure. In the 1990s, one of the rationales for merging was to amass economies of scale in R&D to build these powerful R&D engines. That approach didn t work; the rationale was faulty. Over the last 10 to 15 years, we have been acquiring a good share of our products from venture capital-backed biotech companies. The problem as I see it is that the traditional venture capital model of creating, funding, and monetizing biotech companies, is not as strong as it was. In some ways venture capitalists have become more risk averse than we are. So if our productivity is lagging and fewer biotechs are funded, where will our future products be generated? This question has ramifications not just for our industry, but for patients. Although venture capitalists in general have become more risk adverse, can corporate VCs still offer a solution? Many of the VC groups that are associated with corporations have a torn mission. On the one hand, they want to have their finger on the pulse of emerging business opportunities so that they can capture them when the time is right. On the other hand, they often are given a mandate to turn a profit, which can lead to behaviors that are at odds with the other goal of nurturing risky but potentially game-changing businesses. If you re an independent VC and you re working with a corporate VC, it is your responsibility to get your investors the very best financial return possible regardless of the objectives of the corporate VC. The interests of these groups are not necessarily aligned. It s very hard in reality for corporate-associated VC groups to invest in a way that gives their parent company that inside track, because the external investors have to make a fair return on that investment. Having said that, I think there are models that can work. J&J has formed an investment fund with MPM Capital, a venture firm that has a traditional venture capital approach, that I think is going to work well for all parties. It s paradoxical that the science has never been more exciting and yet we have never had lower productivity. Why is this happening and what s being done to fix it? There is actually enormous opportunity within the industry. The opportunities are not limited to science; they also encompass demographics and the emerging economies. But here s what I think happened: We, the industry as a whole, are becoming increasingly risk averse with respect to developing therapies for which there is not a fully established market. Years ago, when I began my career, science drove the selection of products that would be put into development. If you had great science to back you, and there was an identifiable unmet medical need, that was enough to launch a discovery effort even if the size of the market was unclear. Today it is the perceived market opportunity that drives the science that we do. Now, in all fairness, when I started in the industry, if you were a $3 billion pharma company, you were big. In this case a company could take a risk in developing a drug for which the commercial opportunity was unclear, because even a drug that sold $200 million a year would have a meaningful impact. Things have changed. Now we re talking about companies with annual sales of $30 billion. It s tough to grow at a reasonable rate year after year on a $30 billion base. With many of the breakthrough therapies from the past H2 blockers, erythropoietin, anti-tnf antibodies, for example the market opportunity was not clear. I ve challenged my colleagues to name a breakthrough product that has come from an established therapeutic franchise. On the contrary, typically it is the breakthrough products that build new therapeutic categories because they brought benefit that we couldn t even imagine. With the way

4 Page 4 we currently assess markets, we can only imagine getting a slice of the pie or making the pie slightly larger. We have trouble imagining the creation of an entirely new pie. My bet is that if you went to the 10 top pharma companies, and looked at our early stage portfolios, you would find enormous overlap. They re not identical, but they re very similar. All of us are going after the same therapies. To exploit more innovative, albeit risky drug targets we need to bridge the early stage valley of death between academic innovation and clinical proof of concept. The problem is that VCs typically are not investing in these opportunities unless there s a therapeutic platform technology underpinning them. They don t invest because it s not capital efficient to build a startup around a single product opportunity at a very early stage by definition, 95% of them are going to fail. I don t fault them for not investing. I believe we need to align the interests of all members of the pharma ecosystem, which is something large pharma has never done before. We need to embrace the fundamental concepts of open innovation, a term that is often used synonymously but erroneously with external innovation. When we speak of external innovation it is often interpreted as looking to see what we can buy from the outside. While critically important to our success, that strategy is not enough because there isn t enough to buy and what we buy is expensive. On the other hand, open innovation is sharing what we have our knowledge, our experience, our expertise, our capabilities, our networks of external technology providers with our external partners. We want to enable their success, because if they re successful it enhances the probability that we re going to be successful in acquiring attractive products from outside the company. From a historical standpoint, this is antithetical to what pharma has done. We ve been the paragon of closed innovation, desperately trying to protect our secrets, capabilities and expertise so that our competition doesn t benefit from them. Frankly, I am not overly concerned if Pfizer or Merck or GSK benefits, as long as we do too. Essentially, we need to teach the external community going from academia to VCs to biotechs to regional incubators about the kinds of products we need and help them be as efficient as possible in delivering them. Let s face it: nine times out of 10 or these days, even 99 times out of 100 it s not the public markets that are going to be the customer of what emerges from venture-backed entities; IPOs will be rare events. The customer is us, large pharma and established biotechs. We re the ones that are going to buy the products. We need to build an external ecosystem where we work hand in glove with partners to promote everyone s success. The line that s drawn between pre-competitive and post-competitive is changing rapidly. It s moving further downstream in the value creation process. We need new funding models in which seasoned pharma and biotech veterans can independently guide multiple product opportunities through the early stage of R&D with the full intent of selling the products not building companies, but building value into products. One thing that has happened over the last decade is that contract research organizations have gotten better and better at what they do. What we do inside the walls of pharma companies is no longer a secret, so much of the more commoditized work we did internally in the past can be done outside. You could create a virtual company, let s call it Acme Biotech Development Corp, and their mission is to take product opportunities coming out of academia or struggling biotechs and drive them through to clinical proof of concept, then sell them. Over time they might run 12, 15, even 20 projects, most of which are going to fail, but there s never an intent of making a fully integrated company. If there s a project that looks like it s going to be a loser, there s no incentive for them to put it on life support while continuing to invest. Instead, the incentive is to redeploy capital to more promising opportunities. This is in contrast to what we see now, where, sadly, there is an incentive for moribund biotech companies to keep themselves alive. Under this new model, there s no incentive to keep projects running that should be put out of their misery, so it s highly capital efficient. If product A looks like it s not going to make it but product F looks really exciting, you immediately cut the funding for product A. No one loses their job. You simply redeploy the capital and expertise toward the products that look promising. These organizations might have pharma at the table as an investor. The customers, pharma companies, would be there to give non-controlling advice. Moreover, if pharma is also an investor, it s in their best interest for the fund to succeed to gain a monetary return. Incidentally, there are places where economy of scale really makes sense in the discovery phase. Examples include certain platform technologies and where world class expertise is scarce. Late phase development is another area in which economies of scale are beneficial. It doesn t make sense for a biotech company to build its own phase III development group or to have global organizations for pricing, reimbursement, regulatory, sales and marketing and the like. Large pharma has all of these. A lot of what we re talking about would require a very big cultural shift within pharma. Are you

5 Powered by TCPDF ( Argyle Conversations Page 5 starting to see any of these changes either at J&J or across the industry in general? It s going much more slowly than I would like, but I think we re beginning to move the boulder uphill. We at least get it. We understand that we can t continue along the same way. I have always admired what Eli Lilly has done; they re actually doing something similar to the model we just talked about. Large pharma understands that we have to change in very fundamental ways, just like virtually every other industry has had to do. I see multiple companies doing much more with academic groups. I m not sure our industry is always making the moves that will give us the biggest return, but still, I am seeing that change. Within J&J, about a year and a half ago, we launched a very large organization-wide effort to make external innovation part of our day-to-day life. Increasingly, my colleagues speak about internal innovation and external innovation interchangeably. I think the message has gotten through. That s probably the biggest change that I ve seen, and it has taken place only in the last year or so. This cultural change is more unsettling to individuals as you move to layers below senior leadership. These are highly intelligent, skilled and motivated individuals who have spent their entire careers being compensated and recognized for what they do in their own laboratories. That s now changing. It s no longer solely about the scientist making an innovation in his or her own lab, prompted by the light bulb that pops on in the middle of the night. Pharmaceutical R&D is not an individual sport. Our ideas are fueled from many different sources. The scientists who will succeed and be the leaders of the future are those who can put together the pieces from both inside and outside their own company to identify solutions to the problems. They need to be able to drive that solution home regardless of where the innovation is coming from. Rather than being a lab head, the role of the pharmaceutical researcher has become more of what my colleague Ed Iwanowicz calls a scientific assembler. That is the unique value that our scientific staff can bring to pharma in the future. The timeframe to complete this shift is probably over the next three to five years. It s a very big change in our culture that we need to implement to ensure that we thrive in the future and continue to deliver high-value life-saving and life-changing products. Despite all of the challenges the industry faces, I remain optimistic. It is a very exciting time.