Perform a VRIO analysis. What is Genentech’s competitive advantage, if any?

Perform a VRIO analysis. What is Genentech’s competitive advantage, if any?

QUESTIONS

1 Perform a VRIO analysis. What is Genentech’s competitive advantage, if any?

(VRIO table: must produce a table for the case, must evaluate a minimum of 8 resources/capabilities)

2 What is the major dilemma that Mr. Scheller faces in the case? What should he do?

MARNE L. ARTHAUD-DAY FRANK T. ROTHAERMEL WEI ZHANG

Perform a VRIO analysis. What is Genentech’s competitive advantage, if any?

Genentech (in 2011): After the Acquisition by Roche

IT WAS ALMOST MIDNIGHT. Dr. Richard Scheller, Executive Vice President of Research and Early Development of Genentech, was sitting at his desk in the Grand Hotel Les Trois Rois, Basel, Switzerland. He had arrived in Switzerland earlier that afternoon, and spent the rest of the day fin- ishing up the slides for his presentation to the Roche Executive Committee the next morning. Severin Schwan, CEO of Roche Group, was expecting Dr. Scheller to present his strategic plan on how to man- age Genentech’s R&D process and clinical pipeline. Roche had completed its acquisition of all remain- ing publicly held Genentech shares in 2009, cementing a corporate partnership that dated back to the 1980s. Roche believed that Genentech’s legendary expertise in biotechnology could help propel the company to the forefront of personalized medicine.

Dr. Scheller’s last meeting at Roche headquarters had not gone well. Many questions were raised regarding the recently failed clinical trial for the use of Avastin in early-stage colon cancer. Avastin was first approved for advanced colon cancer in 2004, and had since been approved for several other types of metastatic cancer. An antiangiogenesis agent, Avastin worked by blocking a protein called VEGF that tumors needed to form blood vessels and gain access to nutrients in order to grow.1 One of Roche’s main motivations for acquiring Genentech had been to obtain the rights to Avastin, and Roche was counting on extending its applications as a major part of its growth strategy. If positive, the clinical trial results could have led to billions more in Avastin sales, as well as primed the way for multiple other early-stage cancer indications. Instead, the negative results were a major setback, sending Roche shares down by 10 percent.

Severin Schwan’s words from the last meeting at headquarters were still ringing in Scheller’s head: “We need more efficiency in drug development, only an approved drug is a good drug.” A failed Phase III clinical trial was a major “inefficiency” that Roche’s executives did not want to see repeated. Phase III trials involved testing the effectiveness and safety of a new drug compared to existing treatments in any- where from 1,000 to 3,000 patients, with costs exceeding $26,000 per patient.2, 3 To make matters worse, a

U.S. advisory panel had recently voted to revoke Avastin’s approval for the treatment of advanced breast cancer, after two large Phase III trials revealed that Avastin provided no significant benefit in terms of survival. Patients and doctors were fighting to keep the product on the market, but the FDA rarely devi- ated from an advisory panel’s recommendation, especially when the vote was 12 to 1.4

Despite this string of recent failures, Dr. Scheller continued to feel pressure from Roche to focus on the development of Phase III projects in order to bring more products to market. Things were different now that Roche owned Genentech outright and was not just a well-invested partner. Scheller missed some of his previous autonomy. He was not sure that reducing the resources dedicated to early drug

Professors Marne Arthaud-Day, Frank T. Rothaermel, and Wei Zhang (PhD in Bioengineering) prepared this case from public sources. It was developed for the purpose of class discussion. We thank IMS Health for making various data reports available to us, and Dr. Christopher Boerner (formerly Director Avastin Franchise Strategy, Avastin Marketing, Genentech) for helpful comments and suggestions as well as for his presentation in the “Competing in the Health Sciences” course, Georgia Institute of Technology, April 9, 2010. This case is not intended to be used for any kind of endorsement, source of data, or depiction of efficient or inefficient management. © Arthaud-Day, Rothaermel, and Zhang, 2013.

Perform a VRIO analysis. What is Genentech’s competitive advantage, if any?

Genentech: After the Acquisition by Roche

discovery and reallocating them to the development of current Phase II and Phase III projects repre- sented the best use of Genentech’s talent. He believed strongly that early drug discovery research was the key to keeping the company’s future product pipeline well stocked, and he feared the long-term implications of neglecting this core capability to pursue more immediate returns. Finding the optimal strategic balance between generating novel therapies and pursuing further commercial applications of the discoveries already made was one of Scheller’s most challenging tasks.

The Birth of Biotechnology

Medical biotechnology involves the use of cellular and biomolecular processes to develop new products with health care applications.5 These so-called biologics differ from traditional, chemistry- based medicines (new chemical entities) in that they are derived from living cells and therefore have more complex structures. They may be composed of a variety of organic molecules, including sugars, proteins, or nucleic acids, or may be actual living cells or tissues derived from humans, animals, or microorganisms. Because of their biological nature, such products are more sensitive to heat and are susceptible to microbial contamination, making them more difficult to produce.6 However, the specific- ity of DNA and the cellular processes upon which biologics are based means that they can be designed to address specific medical needs with fewer unintended side-effects, compared to traditional pharma- ceuticals. (See Exhibit 1 for a comparison of biologics versus pharmaceuticals.)7

The theoretical groundwork for the emergence of the biotechnology industry dates back to Watson and Crick’s discovery of the double helical structure of DNA in 1953. Twenty years later, a team led by Stanford University professor Stanley Cohen and University of California, San Francisco (UCSF) Professor Herbert Boyer (one of the eventual founders of Genentech) published its breakthrough research on recombinant DNA in the Proceedings of the National Academy of Sciences.8 The develop- ment of recombinant DNA technology provided scientists with a simple but powerful method for iso- lating and amplifying any gene or DNA segment and moving it with controlled precision. This process allowed for the analysis of gene structure and function in simple and complex organisms, information that scientists then used to develop procedures for producing proteins, such as human insulin, in cell cultures under controlled conditions.9

On December 2, 1980, the U.S. Patent and Trademark Office issued the first major patent in the new bio- technology sector (U.S. Patent 4,237,224), one of the three patents subsequently known as the Cohen-Boyer recombinant DNA cloning patents. For his contribution, Cohen was entitled to one-third of Stanford’s licensing royalties on the three patents, but he decided to donate his share to the university. Boyer did not relinquish his personal share of patent royalties until he experienced strong pressure from UCSF. The university even threatened to conduct a detailed investigation of all sponsored research taking place on campus, making Boyer a target for personal hostility by his colleagues.10 The three rDNA pat- ents generated more than $250 million in licensing fees for Stanford University and UCSF before their expiration in 1997.

Recombinant DNA, along with several other biological breakthroughs (such as the discovery of monoclonal antibodies in 1975 by George Köhler and Caesar Milstein), revolutionized scientific approaches to drug development. Advances in fields like rational drug design, genomics, proteomics, RNA inference, and systems biology led to a host of new biologically based therapies, including vac- cines, blood products, allergenics, somatic cells, gene therapy, tissues, and recombinant therapeu- tic proteins.11 Consequently, treatment options have improved for more than 200 different diseases, including Alzheimer’s, cancer, diabetes, multiple sclerosis, and AIDS.

Perform a VRIO analysis. What is Genentech’s competitive advantage, if any?

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Genentech: After the Acquisition by Roche

Evolution of the Biotechnology Industry

Along with a host of new therapies, the birth of biotechnology led to the emergence of a powerful new business model for the commercialization of scientific intellectual property.12 This model was based on three interrelated components: development of new technologies, venture capital and public equity markets, and a market for know-how. New biotechnology breakthroughs tended to be discov- ered in universities and other research institutes, which lacked the resources and knowledge needed to bring their innovations to market. Researchers therefore partnered with venture capital and private equity markets to provide the “fuel” to commercialize their new technologies. Development and mar- keting know-how was contributed to by large incumbent pharmaceutical firms in return for partial ownership of the new technology. Such partnerships provided the new ventures with a ready supply of financial capital to support ongoing research and development.

In a classical Schumpeterian swarm of new entry, the number of biotech startups exploded, reaching over 1,400. (See Exhibits 2 and 3 for the leading global biotech corporations.) Between 1994 and 2006, industry R&D expenditures tripled to $22.9 billion while revenues increased five-fold to $53.5 billion.13 (See Exhibit 4 for U.S. biotech industry statistics.) In 2007, global prescription sales of biotech drugs increased 12.5 percent to more than $75 billion, nearly double the 6.4 percent growth rate of the global pharmaceutical market.14 (See Exhibit 5 for global pharmaceutical sales from 2002 to 2009.) The range of biotech products and their therapeutic applications also steadily increased. By 2008, more than 200 new biologics had been approved for therapeutic use, with 400 more at various stages of clinical develop- ment.15 Twenty-two biotech products generated sales exceeding $1 billion (the threshold to be considered a “blockbuster drug”) in 2007, compared with just six products in 2002.16 (See Exhibit 6 for a list of the leading global biotech products.)

The double-digit growth in biotech revenues was only one side of the story, however. Only a small percentage of companies, like Amgen and Genentech, achieved commercial success. Many more bio- technology firms burned through significant amounts of capital (see Exhibit 7) without producing prof- its.17 Moreover, while the industry as a whole continued to grow, growth rates appeared to be leveling off (see Exhibit 8). During the 2008–2009 recession, even the large biotech companies felt the pinch, while smaller firms struggled to survive. These numbers reflected the fact that the discovery and devel- opment of a new biologic was a long and costly process. Medical biotechnology was among the most research-intensive industries in the world; publicly traded U.S. biotech companies spent $27.1 billion in R&D in 2006.18 The average drug development time increased from 12 to 15 years,19 while mean devel- opment costs (excluding product launch and marketing expenses) nearly doubled from $800 million in 2000 to $1.5 billion in 2010.20 Thus, biotechnology did not turn out to be quite the panacea for the bottom line that pharmaceutical companies once hoped.21

Facing empty product-development pipelines, expiring patents on their blockbuster drugs, and strong generic competition, the pharmaceutical industry as a whole was expected to lose as much as

$65 billion from patent expiration by 2012 (see Exhibit 9). Given the more positive prognosis for bio- technology, big pharma firms readily established strategic alliances with biotech companies, hoping to share in their future profits. The first pharma-biotech agreement was formed between Eli Lilly and Genentech in 1978 to commercialize the new drug Humulin, a biotech-based human insulin. According to BioWorld, pharmaceutical and biotech companies formed 417 new partnerships in 2007 alone.22

Still other pharmaceutical firms sought to acquire their biotech partners in order to bring their inno- vative capabilities and new-product pipelines in-house. Novartis bought Chiron for $5.4 billion in 2006, AstraZeneca bought MedImmune for $15.6 billion in 2007, and Roche finalized its acquisition of

Perform a VRIO analysis. What is Genentech’s competitive advantage, if any?

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Genentech: After the Acquisition by Roche

Genentech in 2009. This flurry of biotech acquisitions formed part of a larger trend toward pharma- ceutical industry consolidation, as companies vied for greater market power. Critics, however, were concerned that these mega-mergers would have a negative effect on R&D productivity and innova- tion in general. Increasing the amount of R&D did not necessarily make such research more produc- tive. “On the contrary, it is very hard to manage science when you have huge teams of people,” said Joseph Schlessinger, chairman of the department of pharmacology at Yale’s School of Medicine and the founder of three biotechnology companies.23

Biotech Wunderkind: Genentech

Genentech was founded in 1976 by the late venture capitalist Robert Swanson (MBA from MIT Sloan) and Herbert Boyer, a professor of biochemistry and biophysics at UCSF. After Boyer and Cohen published their breakthrough research on recombinant DNA in 1973, Swanson instantly recognized the new technology’s commercial potential. He called Boyer to request a short meeting, which turned out to be three hours long. Swanson’s enthusiasm and belief in the new technology was so persuasive that by the end of their conversation, Genentech was born. A few years after the company was founded, Genentech’s scientists successfully produced the first therapeutic proteins by splicing human genes into fast-growing bacteria.24

Considered the creator of the biotechnology industry, Genentech’s aim was to leverage the newly discovered rDNA technology to develop a new generation of therapeutics. Genentech’s mission was to discover, develop, manufacture, and commercialize biotherapeutics using genetic engineering and other advanced technologies, with a focus on critical medical conditions in the areas of oncology, immunology, and tissue growth and repair. Prior to its acquisition by Roche in 2009, the company had built one of the leading product portfolios in the biotech industry, and had led in U.S. oncology sales since 2006. In 2008 (the company’s last full year of independent operations), Genentech had revenues of $13.4 billion, more than double the amount ($6.6 billion) it had in 2005, and a net income of $3.4 billion. (See Exhibits 10 and 11 for Genentech financials.) Net U.S. product sales totaled $9.2 billion, an 11 percent increase from 2007. Product sales represented 78 percent of revenues, with royalties and contracts making up the remainder.

DISCOVERY RESEARCH AND DRUG DEVELOPMENT

From its inception, Genentech’s R&D activities focused on applying leading-edge scientific knowl- edge to discover and develop first- or best-in-class medicines. The company’s research reputation attracted some of the best scientists in the world, who were encouraged not only to commit to projects associated with the company’s strategic goals, but also to pursue projects of their own interest. The company viewed “individual creativity and initiative” as the driving force behind its numerous sci- entific breakthroughs. In total, there were approximately 1,100 researchers, scientists, and post-docs at Genentech, consistently publishing high-quality research papers in the top peer-reviewed scientific journals. Genentech’s scientists held approximately 7,400 current patents and had about 6,250 patent applications pending worldwide.25

The Founders Research Center, a 275,000-square-foot facility, was opened in 1992 solely for biotech- nology research in honor of the company’s two founders, Swanson and Boyer. In 2001, the company expanded the Founders Research Center by 280,000 square feet to celebrate Genentech’s 25th anniver-

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Genentech: After the Acquisition by Roche

sary. The 230,000-square-foot southern campus extension opened in 2007.26 These facilities provided Genentech scientists a stimulating environment in an attractive setting, with numerous specialized laboratories and state-of-the-science equipment.

Genentech had a sophisticated set of selection criteria to move projects from discovery research into development, including scientific rationale, critical medical need, significant market opportunity, adequate market protection, and reasonable manufacturing economics. Once a new molecule entered the development phase, the process followed the guidelines prescribed by regulatory authorities (see Exhibit 12). Before testing a new medicine in humans, researchers conducted extensive preclinical investigations in cell lines and laboratory animals to determine its potential therapeutic targets, safety profile, and recommended starting dose. Phase I clinical trials served to examine the safety of a drug and to determine appropriate dosage levels in humans. Phase II clinical trials provided a further assess- ment of safety and efficacy in humans over the short term, as well as helped establish parameters (e.g., dosage) for the longer-term Phase III trials. Phase III trials were designed to prove the efficacy and confirm the safety of the drug compared to the current standard of care. Once all phases of clinical testing were completed, Genentech applied to the Food and Drug Administration (FDA) for regulatory approval to market the medicine in the United States. Market approval in other countries followed a similar process.

GENENTECH’S PRODUCT PIPELINE

By 2008, Genentech’s development pipeline included more than 100 projects across multiple thera- peutic focus areas (see Exhibit 13). Oncology medicines were the main source of Genentech’s revenue (around 70 percent of 2008 product sales). Genentech’s best-selling product was Avastin (for multiple forms of advanced cancer), with $2.7 billion in annual sales. Its next-largest products were Rituxan (used to treat non-Hodgkin’s lymphoma) and Herceptin (for certain types of breast cancer) with sales of $2.6 billion and $1.4 billion, respectively. (See Exhibit 14 for 2006–2008 product information.) Genentech’s fourth cancer product, Tarceva (for advanced non-small-cell lung and pancreatic cancers) had sales of $457 million in 2008.27

The market for cancer treatments was one of the largest and fastest-growing areas in the pharmaceu- tical industry. (See Exhibit 15 for leading global biotech therapy classes in 2007.) IMS Health forecasted that global sales of cancer drugs would grow at a compounded annual rate of 12 to 15 percent, reaching

$75 to $80 billion by 2012.28 This robust growth projection was due to numerous factors, including an aging population, the availability of new treatments, the unraveling of the genetics behind cancer, and the fact that cancer was a significant disease with many variations. The increased demand for oncology drugs represented a tremendous opportunity for Genentech to further increase revenues for its estab- lished cancer products. At the same time, Genentech scientists continued to perform basic research in identifying antigens that could serve as markers for novel therapeutic agents. Other areas of research aimed at new cancer drug discovery included the Human Epidermal Growth Factor Receptor (HER) pathway, angiogenesis, and apoptosis.

In immunology, Genentech had three products: Raptiva, Rituxan, and Xolair. Its tissue growth and repair products consisted of Activase, Cathflo Activase, Lucentis, Nutropin AQ, and Pulmozyme. Both the immunology and tissue repair and growth markets were likewise growing rapidly, representing additional opportunities for Genentech’s current product line. Leveraging their resources in immunol- ogy, Genentech researchers were also researching new mechanisms of innate and adaptive immunity. They hoped to translate their discoveries into new therapies for the treatment of a broad range of dis- eases involving immune and inflammatory cells.

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Genentech: After the Acquisition by Roche

Despite Genentech’s current market leadership and promising growth figures for the company’s key market segments, Dr. Scheller recognized that the company was vulnerable in two main respects. First, both Avastin and Tarceva were brought to market in 2003. Since then, only two new products had received FDA approval: Lucentis, for the treatment of neovascular (wet) age-related macular degen- eration (AMD) in 2006; and Actemra, for rheumatoid arthritis, in 2010. (See Exhibit 16 for Genentech’s medicine-approval timeline.) As evidenced by the time lag between recent product introductions, Genentech suffered from a lack of original drugs in its pipeline; the quality of the new therapies was excellent, but the firm needed to be producing more of them. Otherwise, a major problem with any of their flagship products could send Genentech’s finances into a tailspin. Second, the company was reliant on the cancer market for a majority of its revenues, and high-priced cancer treatments were a prime target of health care reform. The degree to which the current positive growth rates for oncology products could be maintained was therefore quite uncertain.

Genentech had taken some important steps to address these issues. In March 2007, Genentech announced an internal stretch goal of advancing a total of 30 new molecular entities into clinical devel- opment by the end of 2010. According to its 2008 Annual Report, the company had eight new thera- pies in clinical trials by the end of the first year, though most were still in the area of oncology. Then in 2008, Genentech initiated early efforts in two new therapeutic areas—neuroscience and infectious diseases—as a first step toward greater diversification. Dr. Scheller wondered how well Genentech’s biotech capabilities would transfer to these new indications and at what point his scientists might start to feel that they were being spread too thin.

Buyout by Roche

Roche Holding Ltd. (headquartered in Basel, Switzerland) was one of the world’s leading research- focused health care groups (see Exhibit 17 for Roche financials). Famous for discovering the blockbuster drug Valium, Roche operated in two segments, pharmaceutical and diagnostics, selling its products in more than 150 countries. As an innovator of products and services for the early detection, prevention, diagnosis, and treatment of diseases, Roche aimed at improving health and quality of life. Prior to the Genentech acquisition, the group’s focused therapeutic areas included autoimmune diseases, inflam- matory and metabolic disorders, and diseases of the central nervous system.

The Roche–Genentech relationship dated back to 1980 when Roche licensed the patents and know- how for interferon alpha-2a (Roferon-A) from its American partner. (See Exhibit 18 for the complete Roche–Genentech timeline.) Six years later, Roferon-A was one of the first biologics to receive FDA approval for the treatment of hairy cell leukemia, a cancer of the blood or bone marrow. Roche subse- quently purchased 60 percent of Genentech in 1990, investing $2.1 billion in the new startup.29 The deal was advantageous for both Roche and Genentech because it assured continued collaboration between the two companies. The companies agreed that Genentech would market its products domestically, while Roche would have the first option to market Genentech products internationally.

Almost 20 years later, on March 12, 2009, Roche and Genentech announced a final merger agreement under which Roche would acquire the remainder of Genentech’s outstanding shares (44 percent) for

$95.00 per share in cash, at a total valuation of $46.8 billion.30 This 2009 purchase price amounted to a multiple of 22 times more than it paid for Genentech shares in 1990. The merger allowed Roche access to Genentech’s top-selling drugs, including the blockbusters Avastin, MabThera, and Herceptin, all of which were outselling Roche’s own drugs.31 More importantly, Roche viewed the Genentech acquisi- tion as central to its strategy of pursuing personalized medicine, which involved the use of molecu-

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Genentech: After the Acquisition by Roche

lar information to tailor medicines for specific patient populations. According to Roche CEO Severin Schwan, “personalized medicine means that we can develop drugs which are more effective, safer, and ultimately also more cost-effective.”32

The combined company became the seventh-largest U.S. pharmaceutical company by market share, with expected annual revenues of $17 billion. Jointly, the companies employed approximately 17,500 workers in the United States, with a combined sales force of 3,000 people spanning several specialty areas.33

STRUCTURAL AND ORGANIZATIONAL CHANGES

After the merger, Roche’s top executives decided to maintain Genentech as a wholly-owned subsid- iary, which meant that it would continue operations as an independent research and early-development center within the larger Roche Group. Genentech also served as the new name and headquarters of the companies’ combined U.S. commercial operations, including support functions such as informatics and finance. Roche closed down its Palo Alto site, moving the virology unit to Genentech’s campus in South San Francisco and relocating its inflammation group to Nutley, New Jersey. Genentech’s late- stage development and manufacturing operations were combined with the global operations of Roche, in anticipation of significant scale benefits and operational synergies.34

Considerable leadership changes were made as well. Genentech’s chairman and CEO Arthur Levinson and product development chief Susan Desmond-Hellmann left day-to-day operations but continued to function in an advisory capacity. David Ebersman, executive vice president and chief financial officer, and Steve Juelsgaard, executive vice president and chief compliance officer, also left Genentech. Pascal Soriot, previously responsible for commercial operations for Roche’s pharma divi- sion, became the new CEO of Genentech. Richard Scheller continued to serve as executive vice presi- dent of Genentech research and early development, reporting directly to Roche Group CEO Severin Schwan.

CULTURAL CHANGES?

Despite Roche’s plan to maintain Genentech as an independent research and development center, there was some angst regarding the Genentech buyout. The biggest concern was whether or not Roche’s top management would respect and nurture Genentech’s informal and innovative culture.35 The campus in South San Francisco felt more like a research university than corporate America. Executives preferred jeans over suits, and even wore lederhosen in honor of Roche’s initial acquisition in 1990. In 2006, Genentech was voted as the best company to work for in the U.S. by Fortune magazine. This was not entirely surpris- ing, given Genentech’s history of providing generous employee perks such as day care for children and lavish employee get-togethers, the so-called “Ho-Hos.” Insiders described Genentech as a place of “casual intensity.”36

However, Roche Group CEO Severin Schwan was known for “being aggressive,” and many were concerned about whether he would “be sensitive to the Genentech cultural differences.”37 Scheller still remembered the conversation between David Mott, former CEO of the biotech company MedImmune (which was acquired by Astra Zeneca), and former Roche Chairman Franz Humer in 2007. Mott com- pared the independent structure of MedImmune under Astra Zeneca with that of Genentech under Roche: “He [Humer] laughed at me and said, ‘it will never work because if we owned all of Genentech we would kill it’; we wouldn’t be able to resist tinkering and playing with it . . . ,” Mott recalled.38

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Genentech: After the Acquisition by Roche

Multiple Challenges Ahead

Dr. Scheller recognized that the company faced multiple challenges ahead: the need to do compara- tive effectiveness research, increasing competition, and the threat of biogenerics.

COMPARATIVE EFFECTIVENESS RESEARCH

Another issue on Scheller’s agenda for tomorrow’s meeting was a discussion of the likely impact of the economic stimulus package approved by the U.S. Congress in 2009. The bill included $1.1 billion to perform Comparative Effectiveness Research (CER), which aimed to assess how various medical products and procedures compared with each other in terms of both effectiveness and cost.39 CER was part of a broader movement to make science-based evidence the basis for medical practice (so-called ”evidence-based medicine”). The bill’s supporters believed that conducting CER could avoid unneces- sary treatments and improve the quality of health care while lowering costs.

Passage of the stimulus package meant that the government would be involved in CER programs to a much greater extent. However, years of effort, both in the public and private sectors, had been invested in CER prior to the federal initiative. The Medicare Modernization Act of 2003 gave the federal Agency for Healthcare Research and Quality (AHRQ) a limited mandate to determine the clinical effective- ness and appropriateness of various medical products. The Blue Cross and Blue Shield Association’s Technology Evaluation Center (TEC) had been engaged in technology assessment since 1985. Another related initiative was the Drug Effectiveness Review Project (DERP), a collaboration between public and private organizations that was housed at the Oregon Health & Science University.40

Outside the United States, CER programs were more established. The National Institute for Health and Clinical Excellence (NICE) in the United Kingdom was the most prominent example. Funded by the government, NICE provided guidance to the National Health Service (NHS), Britain’s government- run health care system, about the effectiveness and cost of new therapies and diagnostic services. NHS determined coverage, while NICE played an advisory role. In 2008, NICE made a recommendation not to cover one of Genentech’s cancer drugs, Tarceva, forcing the company to lower Tarceva’s price significantly.41

This worried Scheller because Genentech’s current and potential product portfolio was heavily focused on oncology medicines. In 2008, close to 70 percent of Genentech’s sales came from its patent- protected, proprietary cancer drugs, which commanded premium prices. Avastin had sales of $2.7 billion in 2008 and cost $50,000 per year; Tarceva had sales of $457 million and cost $24,000 per year. However, several recent clinical trials had demonstrated little to no benefit in terms of survival time.42 This could raise a red flag concerning the comparative effectiveness of these drugs. Should more disap- pointing results from CER trials come in, Genentech could lose coverage and be forced to cut prices on its blockbuster products, even in the United States.

INCREASING COMPETITION

At the same time, Genentech was facing increasing competition from established pharmaceutical com- panies, who viewed investments in biotechnology as a means to offset stagnating pharmaceutical sales.43 (See Exhibits 19a and 19b for a list of the top 15 pharmaceutical companies and products by 2009 global sales.) GlaxoSmithKline produced Bexxar, which competed with Rituxan, and Tykerb (currently in clini- cal trials), which competed with Herceptin. Avastin’s competitors include Erbitux by ImClone/Bristol- Myers Squibb (2008 sales of $749 million); Nexavar (2008 sales of $667.8 million) by Bayer/Onyx; Sutent

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Genentech: After the Acquisition by Roche

(2008 sales of $847 million) by Pfizer; Gleevec (2008 sales of $950 million) by Novartis; and Vectibix (2008 sales of $153 million) by Amgen. Macugen by Pfizer and Visudyne (2008 sales of $141.9 million) by Novartis were challenging the market for Lucentis. Meanwhile, Xolair faced competition from numer- ous inhaled corticosteroids.

Ironically, Genentech was also in danger of competing with itself. Scheller remembered how sales of Lucentis, a drug developed to treat an eye disease that causes blindness in the elderly, were threat- ened by off-label use of its older product, Avastin. Both Lucentis and Avastin had the effect of inhibit- ing a protein that initiates the growth of blood vessels, with applications in both cancer and macular degeneration. Some doctors believed that Avastin was “as effective, but less than one-tenth of the price of Lucentis.”44 The potential for cannibalization could pose a serious challenge for Genentech when developing new products based on the same biotechnology.

BIOGENERICS

Even more ominous was the specter of generic biologics looming on the horizon. Generics had long been the bane of pharmaceutical companies because generic companies would seek market approval for their copycat products as soon as the original period of patent exclusivity expired. Generic com- panies did not have to conduct clinical trials as long as they could establish that their product was “pharmaceutically equivalent” to the drug they wished to copy.45 This resulted in drastically reduced development costs, which permitted them to charge significantly lower prices and dominate the mar- ket. In 2003, generic drugs comprised 54 percent of the pharmaceutical market; that figure leaped to 72 percent of total pharmaceutical sales in 2008.46 By 2010, IMS Health forecasted that generics sales of pharmaceutical drugs would top $68 billion.47

However, the FDA had no parallel process for approving biogenerics, which were also called “bio- similars” or “follow-on biologics.” While lobbyists for the generics industry proposed allowing biolog- ics the same three- to five-year patent exclusivity as conventional drugs, biotechnology leaders argued that at least 14 years of protection were needed for them to recoup the high costs of development.48 Others expressed concern that biologically engineered molecules would be too difficult to replicate accurately, without access to the original molecular clones, cell banks, and manufacturing processes. They pointed out that even minute differences in impurities or breakdown products could create a serious health hazard.49

Despite these reservations, President Obama signed the Biologics Price Competition and Innovation Act into law on March 23, 2010, as part of his health care reform legislation. This effectively amended the Public Health Service Act of 1944, allowing for an abbreviated approval pathway for biosimilars, much as the 1984 Hatch-Waxman Act had done for pharmaceuticals. Under the BPCI Act, sponsors could seek approval for a “biosimilar” product if they provided scientific data that it was “highly similar” and there were no “clinically meaningful differences” between the two products “in terms of safety, purity, and potency.”50 While the FDA had yet to develop a full implementation plan, one major difference compared to the process for pharmaceutical generics was that biogeneric sponsors would have to provide data from analytical, animal, and clinical studies, unless otherwise deemed to be unnecessary.51

A study by the Congressional Budget Office indicated that the federal government could save

$6.6 billion over a 10-year period if biologics were granted 12 years of market exclusivity.52 Generics manufacturers and the insurance industry likewise stood to gain considerably from the availability of biogeneric products. Biotechnology innovators like Roche and Genentech, on the other hand, were understandably apprehensive about how and when the new provisions would take effect.

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Genentech: After the Acquisition by Roche

A Balancing Act

In the new-product development process, knowledge-generation (or exploration) activity refers to the uncertain activities of discovering something new, or the “R” in the research and development process. Knowledge-application (or exploitation) activity refers to less-uncertain activities of com- mercializing the new knowledge generated through research, or the “D” in R&D.53 Scheller and his counterparts at Roche were aware that research indicated firms needed to balance both knowledge- generation and knowledge-application activities in order to attain or sustain superior performance.54,

55, 56, 57

Scheller believed that Genentech’s strong commitment to research was the fuel that had kept the product pipeline full, propelling the company forward all these years. Meanwhile, without late-stage development, Genentech’s potential products could never mature over time and eventually reach their patients. Therefore, Scheller’s “goal in setting strategy for the research department [was] to strike the optimal balance between basic biomedical research and translational research aimed at developing therapies for unmet medical needs.”58 Genentech reinvested more than $2.8 billion into research and development in 2008, approximately 21 percent of its operating revenues,59 and significantly more than the pharmaceutical industry average.

Scheller had never faced more challenges when it came to allocating company resources to R&D. The answer was never as simple as a 50–50 split. Rather, it required ambidexterity, defined as the firm’s abil- ity to configure assets to compete in mature and emerging businesses, to find the optimal balance when engaging in both research and development.60 Scheller wondered what that meant for Genentech, and how to achieve it.

Recent challenges were forcing him to consider new resource configurations in order to find a new “optimal” balance. With the failed clinical trial of Avastin, the pressure would keep coming from Roche to focus more on late-stage development. Scheller planned to direct more resources into the develop- ment of Phase II and Phase III projects, but he did have some doubts. The push for drug comparison trials, together with Genentech’s major focus in oncology, also meant that Genentech needed to start focusing more on other therapeutic areas. Scheller was excited about the company’s recent expansion into neuroscience and infectious disease. He also knew there was a lot more that could be done to increase the level of Genentech’s product diversification: hire more talent in those other areas; give priority to those areas when picking projects to move forward in the pipeline; and favor them when it came to alliances and sourcing.

Scheller finished the last slide in his deck and glanced at the clock on his desk. It was five minutes past 2 a.m. He sat back in his chair and stretched his neck, thinking about the many challenges he faced in the board meeting that would commence in a few hours. He sincerely believed that it was the phi- losophy of deep commitment to excellent science that had made Genentech a success story. As a result, he feared that the most profound impact of the merger would come from whether or not the traditional Roche senior pharmaceutical management team could adapt to Genentech’s science-driven and indi- vidualistic culture. Scheller had been asked a lot by Genentech employees about Roche’s recent buyout, and whether this would mark the “end of Genentech as we know it.”

Would Roche unintentionally kill the goose that laid the golden eggs by insisting that Genentech adopt their standardized business processes? Would reallocation of resources to more advanced stages of development cause Genentech’s legendary scientists simply to walk away at their first opportuni- ties? Could Genentech grab a significant slice of the market in areas other than oncology? Scheller looked outside the window at the lights near the Rhine River and wondered. . . .

10

Genentech: After the Acquisition by Roche

Glossary of Terms

Genetic engineering refers to the direct manipulation of an organism’s gene. It is different than tra- ditional breeding, where the organism’s genes are manipulated indirectly. Genetic engineering uses the techniques of molecular cloning and transformation to alter the structure and characteristics of genes directly.

Genomics is the study of the genomes of organisms. The field includes intensive efforts to determine the entire DNA sequence of organisms and fine-scale genetic mapping efforts.

Monoclonal antibodies are monospecific antibodies that are identical because they are produced by one type of immune cell. The antibodies are all clones of a single parent cell. Given almost any substance, it is possible to create monoclonal antibodies that specifically bind to that substance; they can then serve to detect or purify that substance. This has become an important tool in biochemistry, molecular biology, and medicine.

Proteomics is the large-scale study of proteins, particularly their structures and functions. Proteins are vital parts of living organisms, as they are the main components of the physiological metabolic pathways of cells.

Rational drug design uses information about the structure of a drug receptor or one of its natu- ral ligands to identify or create candidate drugs. The three-dimensional structure of a protein can be determined using methods such as X-ray crystallography or nuclear magnetic resonance spectroscopy. Knowing the structure of the receptor, researchers can either use powerful computer programs to search through databases and identify compounds that are most likely to interact with the receptor, or build molecules that are likely to interact with the receptor. These molecules can then be tested in the laboratory.

Recombinant DNA is DNA from one organism that has been recombined with DNA from another organism to form a new organism. In biotechnology, individual human genes are often isolated and combined with a “DNA transporter,” such as a plasmid, and this recombinant plasmid is inserted into host cells so it can be cloned.

RNA interference (RNAi) is a system within living cells that helps control which genes are active and how active they are. Two types of small RNA molecules—microRNA (miRNA) and small interfer- ing RNA (siRNA)—are central to RNA interference. RNAs are the direct products of genes, and these small RNAs can bind to specific other RNAs and either increase or decrease their activity, for example by preventing a messenger RNA from producing a protein.

11

Genentech: After the Acquisition by Roche

ExhIBIT 1 Bio vs. Traditional: Advantages and Disadvantages of Biopharmaceuticals

Traditional Drugs Biopharmaceuticals

Unspecific binding Specific binding

Interactions with other drugs Interactions rare

Carcinogenic substances possible Not carcinogenic

Pharmacokinetics difficult Breakdown is predictable for the most part

Immune reactions rare Immunogenic effects possible

6% success rate in Phases I–III 25% success rate in Phases I–III

Development costs high, production costs low Development costs low, production costs high

Theoretically, any target molecule can be reached Target molecules limited, only outside the cell

Source: Modified from Roche Group (2006), Biotechnology–New Ways in Medicine (Basel, Switzerland), p. 36.

ExhIBIT 2 Top 10 Companies by Global Sales of Biotech Drugs ($ millions, 2007)

Amgen