Big Pharma’s Hardball Tactics Won’t Kill Biotech, But They Could Kill Off Some Pharmas

Xconomy National — 

Few people in biotech have the guts to stir the pot the way Kevin Kinsella did in an interview with Xconomy’s Bruce Bigelow earlier this month.

Kinsella, a venture capitalist with a 30-year track record of biotech investing, delivered a blistering analysis of what he sees as the pharmaceutical industry’s bad-faith negotiating habits, predatory behavior, and short-term, brass knuckle business tactics when dealing with smaller biotech firms. Big Pharma, basically, risks killing the golden goose of biotech innovation it needs to survive, he contends.

Big Pharma, of course, is branded as the bad guy every day of the week. It gets attacked for gouging Grandmas on fixed incomes with excessive drug prices. It takes heat for paying “key opinion leader” physicians who then influence peers to prescribe expensive brand-name drugs. It gets ripped for donating to Congressmen who then protect the industry’s profits through legislation like the new healthcare reform law, or the Medicare drug benefit.

But Kinsella’s charge is different: This comes from an insider within the biomedical/financial complex—someone who would normally be considered an ally of Big Pharma. Biotech and Big Pharma, after all, are supposed to have a symbiotic relationship. Big Pharma has money, manufacturing, and marketing horsepower, but needs a steady supply of innovative new drugs to keep the machine moving forward. Biotech has inventive people with ideas to create new drugs, and the entrepreneurial spirit to navigate the risky early days of R&D, but it often lacks the money and manpower to take a new drug all the way to the marketplace. At some point, the Big Pharma operation strikes a deal to scoop up the little biotech and its drugs to replenish the pipeline, rewarding the shareholders and employees of the biotech company.

That’s the way it’s supposed to work, anyway, but not in the dysfunctional situation Kinsella describes.

Big Pharma companies of today, which are still raking in profits by the billions, sense they have the upper hand in the wake of the Lehman Brothers/Merrill Lynch/Fannie/Freddie-driven financial crisis of 2008. Economists might say the recession is over, but the financial crisis still has a huge impact on early-stage biotech companies today.

Here’s why: Many venture capital firms are slowly, quietly dying off. By and large, they haven’t been able to produce lucrative returns, via IPOs or acquisitions, in the past few years. That means they don’t have the leverage to raise new funds from the pensions, endowments, and other institutions that only consider venture capital as one of many asset classes—a way to get a little better return than, say, a T-bill. Since VCs are struggling to justify their existence, many of the biotech companies that rely on venture capital are also slowly, quietly, running out of the cash they need to sustain this enterprise. Many biotech companies—especially the ones with minimal evidence to suggest their drug works in people—have no choice but to genuflect at the feet of Big Pharma.

So Big Pharma—which has been consolidating through mega-mergers into what amounts to an oligopoly—has sized up a situation it can exploit, Kinsella says. It has been offering up stingy terms to biotech companies that provide practically zero return to the people who shouldered all the risk from the biotech company’s early days. This kind of hardball negotiating has potential to push the whole biotech industry to the brink of extinction, Kinsella argues. After a while, it becomes like commercial overfishing, he says.

The story has been generating chatter all over the web for more than a week. Derek Lowe, the author of the terrific blog “In the Pipeline,” generated a lot of commentary with his own post on Kinsella’s charges. Last I checked, The Atlantic‘s take on this had 154 comments.

Kinsella ran the risk of burning some bridges in pharmaland, or otherwise ticking off lots of people with this kind of commentary. He tells me he was warned by one of his VC friends to keep his mouth shut. But since the Xconomy story ran on February 17, he says he has gotten dozens of “attaboys,” along with quite a few critiques. Often, biotech entepreneurs feel that it’s the VCs, not Big Pharma, who usually victimize biotech entrepreneurs with predatory tactics.

I made some calls on Friday to people with experience in Big Pharma/biotech dealmaking to check for reaction to Kinsella’s charges. Not everyone sees this phenomenon the same way as Kinsella, but he clearly has put his finger on something that’s been bothering people in biotech for a long time.

—“It’s about time somebody lays out what’s going on,” says Jim Posada, a pharmaceutical business development consultant formerly of Eli Lilly and Lebanon, NH-based GlycoFi, who’s now the CEO of Seattle-based Resolve Therapeutics. “I’ve experienced everything he mentioned in that article.”

—“All parties involved here—VCs, pharma companies, and entrepreneurs—need to take more of a long-term perspective,” says Daphne Zohar, founder and managing partner of Boston-based Puretech Ventures, a firm backed by multiple pharma companies. “Because when you take a short-term perspective of always trying to optimize your best deal now, you will end up killing the ecosystem.”

—“It’s certainly true that Big Pharma is thought to have a lot of leverage, but it’s usually the case that in any deal, both parties have leverage on certain things. It’s not always so one-sided,” says Fran Heller, the executive vice president of business development for South San Francisco-based Exelixis (NASDAQ: EXEL), and a former dealmaker for pharma giant Novartis, She says Kinsella makes “some good points,” and while she says some pharma companies are better organized than others, she hasn’t personally seen the kind of bad-faith tactics that he described.

—One prominent Bay Area venture capitalist summed it up this way: “I don’t think I have the b*lls he has to say this stuff, but generally agree.”

While Kinsella didn’t name names, he didn’t really have to. Biotech is still a fairly small industry made up of specialists who spend their whole careers trying to create, and make money from, novel medicines. Short-term hardball tactics might help spiff up a Big Pharma company’s quarterly income statement, and might boost someone’s stock price for a few minutes one afternoon. But I have a feeling the bullies will get their comeuppance. The ones who act like thugs today will not get the phone call in 2020 from an entrepreneur seeking a partner to help market a new drug for cancer or Alzheimer’s. It will go to the company that behaved in 2011 as if it cares about being in business in 2020.

[Note: BioBeat is a new weekly column in which I will explore national issues in biotechnology. I welcome your comments below. ]

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10 responses to “Big Pharma’s Hardball Tactics Won’t Kill Biotech, But They Could Kill Off Some Pharmas”

  1. Bill says:

    Biotechs and their investors always have an alternative to partnering with Big Pharma, which is to fund a drug all the way through all trials and build a sales force. That is an extremely risky, expensive strategy that worked for Dendreon. Most biotechs do not or cannot take that risk and want to shift it to Big Pharma companies. Big Pharma doesn’t want the risk anymore or, more accurately, apparently doesn’t want to pay a huge premium to take an expensive risk anymore. Negotiating leverage is a function of having options and when biotechs do not have options, they get squeezed.

  2. Bill–good point about Dendreon. They kept 100 percent of the commercial rights to the drug, never relied on a partner, and now they are being rewarded with a rich valuation. There were certainly some harrowing risks along the way. Dendreon certainly benefited from good timing, in that it generated proof that its drug extends lives in April 2009—which boosted its stock and enabled it to raise cash right in the heart of the financial crisis.

  3. The equalizer in these negotiations is the public markets. If the public markets are available for new companies and money is available for existing companies, small biotech has leverage. If that option is not available, then big pharma holds the cards because they know their smaller target can’t simply walk away and advance the product themselves.

  4. Great analysis Luke, you present a well balanced angle without the personal bias. In the end a company, big pharma or not, will reap what it sews sooner or later. Dave has a good point — too bad the public markets are not in good shape to depend on.

  5. Krassen says:

    @JonathanInman: were you shooting for “reap what it sows”, or “rip what it sews”? Both work in context, but with different meaning.

  6. As someone who recently structured deals at a major biopharma and worked in its Corp Dev AND VC group, I feel what is being missed in this whole conversation is the increasing risk and expense of getting any drug approved as well as post-approval requirements. Return on invested capital is barely above cost of capital for major biopharma companies, if at all. The whole biopharma value chain (entrepreneurs, VCs, big Pharma) is getting squeezed by low reimbursement and high regulatory hurdles. Also, let’s face it, there has been a lot of capital thrown at a lot of failures industry-wide in the past decade. This is how it manifests.

  7. walt says:

    Can VCs go public?