Selection of preferred commercialisation routes for life science start-ups
Master thesis Business Administration at the University of Groningen Specialisation Small Business & Entrepreneurship
Author: R.O. van Merkerk
Selection of preferred commercialisation routes for life science start-ups
Groningen, March 2003
Master thesis Business Administration at the University of Groningen Specialisation Small Business & Entrepreneurship
Author: R.O. van Merkerk
Supervisor University of Groningen: prof. dr. mr. N.M. Wijnberg 2
ndSupervisor University of Groningen: dr. W. Westerman Supervisor Applied NanoSystems B.V.: J-J de Jaegher
Abstract
The topic of this study is choosing preferred commercialisation routes for intellectual property of life science start-ups. A theoretical framework is developed which is used as a guide to make these kinds of choices. In this framework different methods are proposed to guide a selection process among seven different business options, namely spin-off, start-up, producing, licensing, patent selling, strategic alliance and joint venture. The first method is a strategic selection model. In this model, the company, the intellectual property and the environment are linked to the risk/uncertainty and attractiveness/value of the specific business options.
Concerning practical methods, two selection rounds are proposed. In a preliminary selection round the seven business options are compared to general conditions. This leads to a quick selection of a few business options, which are analysed in detail in the final selection round.
In this selection round the pre-selected business options are analysed using the strategic selection model, decision tree analysis and real options valuation. By applying these methods a company with proprietary applications is able to make a sound choice in favour of a preferred business option.
Face-to-face meetings were used to verify the determinable variables as proposed in the strategic selection model and to compare the theoretical framework to the practical situation.
A case study, using a proprietary application of Applied NanoSystems B.V., is used to test the workability of the theoretical framework. This case study showed workability of the strategic selection model and the two selection rounds as proposed in the theoretical framework.
The analysis in the case study showed that the most preferable business option for the Protein
Anchor technique from Applied NanoSystems B.V. applied on mucosally administered
vaccines is the following. It is preferred to in-license the antigen (e.g., from a university) and
to combine this with the Protein Anchor technology, to create value by developing Proof of
Concept for mucosally administered vaccines. Consequently, a clinical product can be
licensed to pharmaceutical companies, which is likely to create the highest revenues for
Applied NanoSystems B.V.
Table of contents
Introduction 1
Chapter 1 – Research scope 3
§1.1 Nanotechnology, life sciences industry and drug delivery
§1.2 From idea to commercialisation
§1.3 Business Options
§1.4 The ‘patent world’
§1.5 Venture Capital
§1.6 Commercialise it yourself vs. contract out
§1.7 General remarks to keep in mind
§1.8 Conclusion
Chapter 2 – Theoretical framework 11
§2.1 Strategic Selection Model
§2.2 Preliminary selection round
§2.3 Final selection round
§2.4 Conclusion
Chapter 3 – Case: Proprietary application of Applied NanoSystems B.V. 27
§3.1 The company
§3.2 The proprietary application §3.3 The environment
§3.4 Preliminary selection round
§3.5 Final selection round
§3.6 Conclusion
Discussion 49
Conclusions and recommendations 52
Acknowledgements 53
List of abbreviations 54
References 55
Appendix A – List of interviewees 59
Introduction
In this report a study is presented dealing with choosing a commercialisation route for intellectual property (IP). This study is focused on Dutch companies, active in the life sciences industry, which make these kinds of choices. The intellectual property is focused on drug delivery systems based on nanotechnology. This study was performed at Applied NanoSystems B.V. (ANS). ANS was lately (and will be more in the near future) confronted with these choices. Therefore this study is relevant to the company where I did my internship.
Nanotechnology is an emerging technology field, which will penetrate more and more into our daily lives. From the hype of the nineties, it now starts to create a substantial influence on today’s business. Due to its wide applicability, this field bears the potential to influence most of the products we know in today’s world. In principal, nanotechnology encompasses every technique that deals with the ability to control processes at the nanoscale (10
-9meters), which determine the characteristics of the application. A nanometer can be compared with 1/80.000 of a human hair.
Applied NanoSystems B.V. is a start-up in the life sciences industry that translates basic technologies in the field of molecular biotechnology into market based solutions. Molecular biotechnology is part of the complete nanotechnology field. The contract research to develop these solutions is carried out by the Biomade Technology Foundation (BTF). ANS and BTF are both located in Groningen (The Netherlands). The proprietary applications, which results from innovative research performed by BTF, are filed into patents. The proprietary applications are subsequently commercialised by ANS. This generates revenues, which enables further product development at BTF.
To guide the research process the following theoretical and practical research questions were posed.
Theoretical research question: “What are the characteristics of the possible business options for Dutch companies, active in the life sciences industry, to commercialize proprietary applications and how can the most preferable business option(s) be selected?”
Practical research question (case study): “What will be the most preferable business option(s) for a proprietary application of Applied NanoSystems B.V. in financial and organisational terms?”
An important term in both research questions is ‘preferable’. In this study preferable means that two conditions have to be met. Firstly, at least the business option should be realistic.
Secondly, preferable means, that the business option generates the highest revenues (present value) for the company which owns the intellectual property.
To answer the two research questions, appropriate data had to be collected. To develop a
theoretical framework, mostly recent literature was used. The life sciences industry typically
differs from ‘traditional’ industries in the amount of risk, uncertainty and non-linearity
involved (Fisken & Rutherford, 2002 and Müller, 2002). It is assumed that recent literature
addresses these rapid changes by presenting ‘new’ methods (like real option analysis) and
To perform the case study, different types of information needed to be gathered. Information about the organisation, the application and the environment was provided by ANS, recent printed and electronic literature and field visits (Appendix A). To get the best estimates for financial data, historical benchmarks and industry rules of thumb were used. Again ANS, recent printed and electronic literature and field visits were the sources of information. By using multiple data sources the consistency of the data is secured.
Practically this study was divided in three steps. The first step was a recent literature search to develop an updated theoretical framework (chapter 2). This framework was necessary to develop methods to guide the selection process between the different business options (commercialisation routes). Seven business options were distinguished, namely spin-off, start-up, producing, licensing, patent selling, strategic alliance and joint venture (chapter 1).
The second step in this study consisted of performing field visits in the life science industry.
These field visits supported the formulation of the theoretical framework and provided a better insight in the business options and the life sciences industry.
The third step consisted of a case study (chapter 3). In this study the theoretical framework was applied to a proprietary application from Applied NanoSystems B.V. This resulted into advice on how to address the commercialisation process in this situation.
This report is divided in three chapters. In chapter 1 the research scope is sketched. Topics like commercialisation of intellectual property, nanotechnology, business options, the ‘patent world’ and venture capitalists are discussed. These topics are a basis for the following chapters.
In chapter 2 the theoretical framework is proposed. In this chapter, firstly general selection criteria for seven business options are explained. Secondly, a strategic selection model is proposed as a method to select the most preferable business option.
In chapter 3 a proprietary application of Applied NanoSystems B.V. is the subject of a case study. The two selection rounds and methods as proposed throughout chapter 2 were applied.
This leads to recommendations about the most preferable business option in this situation.
After the three chapters, a discussion reflects the methods (from the theoretical framework)
used in the case. This report ends with conclusions.
Chapter 1 – Research scope
In this chapter several topics are discussed which relate to the scope of this research. These topics are a basis for chapter 2 (theoretical) and chapter 3 (practical).
This chapter starts with a short introduction to nanotechnology and drug delivery. This part is necessary to understand the part of the life sciences industry where Applied NanoSystems B.V. is active in.
In paragraph 2 the process from an idea to full commercialisation proposed by SalomonSmithBarney (1998) is discussed. The theoretical framework presented in chapter 2 only deals with the last part of this process. By knowing the full path to commercialisation, this can be seen in the right perspective.
In this study seven business options to commercialise intellectual property (IP) are distinguished. These business options play a central role throughout this study and are described in paragraph 3.
The life sciences industry is one of the industries where patents have a great value and work as a protection mechanism. It is therefore important to describe how the ‘patent world’ works.
Paragraph 4 describes this topic.
Venture capital influences the different business options. Paragraph 5 describes this influence.
Also corporate venture capital, a relatively ‘new’ type of venture capital, is discussed.
Paragraph 6 discusses some basic reasoning behind the choice of doing the commercialisation yourself vs. contract out. Also the changes between business options are discussed here.
The final topic of this chapter briefly points out general remarks to keep in mind. These are topics, which are important in choosing a commercialisation route, but fall outside the context of this study.
§1.1 Nanotechnology, life sciences industry and drug delivery
Nanotechnology is a ‘new’ scientific area, which has gained a lot of interest from the business world. One can even say that a nanotechnological era has commenced. The ability of nanotechnology to change the world is enormous due to the fact that the basics of nanotechnology encompass the ordering of the building blocks of matter itself. Therefore the applicability has the potential of affecting everything that humans produce. In this way nanotechnology offers the technological roadmaps to continue the trend towards miniaturization to which the world has become accustomed.
Nanotechnology has an extremely wide applicability and technological development is recognized as a significant driving force for growth. Therefore, the economical influence of nanotechnology on the world’s economy on the medium to long term will be considerable.
This fact is also recognized by governments. Especially over the last 5 years, governments have increased their interest in nanotechnology funding. Governments more and more accepted that investing in the nanotechnology field is necessary to be capable of participating successfully in the worldwide marketplace.
Nanotechnology can be found in the life sciences industry. Life science companies can be defined as those companies that apply the possibilities of organisms, cell cultures, parts of cells or parts of organisms, in an innovative way for the purpose of industrial production.
They also may supply related services, hardware and software (Hu & Buitelaar, 2002).
Various subdivisions of life sciences can be found, but in this study the subdivision of
Drug delivery is part of the life sciences industry and categorised in the subdivision human health. Drug delivery technology, which includes oral sustained release, transdermal and inhalation delivery, attempts to improve an existing formulation by modulating the release characteristics of a drug or changing its route of administration (SalomonSmithBarney, 1998).
A large range of technologies and drug delivery applications has been developed so far.
However, nanotechnology can bring drug delivery to a higher level, enabling ‘intelligent’
drug delivery systems to bring the drugs exactly to the right place in the human body.
Therefore, having large advantages over ‘conventional’ drug delivery systems, like precision treatment, less side-effects, less drug needed and new treatments.
As in any research field, numerous ideas are proposed on a regular basis. How these ideas finally lead to commercialisation is discussed in the next paragraph.
§1.2 From idea to commercialisation
When the full path from an idea to full commercialisation of a ‘pharmaceutical’ product is considered, four stages (Fig. 1.1) are distinguished by SalomonSmithBarney (1998). These stages are Entrepreneurial management, Preliminary idea development, Proof of Concept and Commercialisation.
It should be stated clearly that this study is restricted from the moment that specific intellectual property (patents) are filed and have a certain commercial value. Depending on the proprietary application this can be after the Preliminary idea development or after the Proof of Concept phase.
Entrepreneurial Management Preliminary Idea Development Proof of Concept Commercialisation
Academic Grants Government Grants
Private Investment
Seed Capital Venture Capital Financing
Further Financing
• Private
• Public o Equity
Partnerships Strategic Alliances Joint Ventures
• Licensing Agreements o Milestone Payments o Royalties
Further Financing
• Private
• Public o Equity o Debt
Figure 1.1: Specialty pharmaceutical path to commercialisation.
Source: SalomonSmithBarney, 1998.
A first comment that can be made to Fig. 1.1 is about the venture capital that finances the
Proof of Concept phase. Besides venture capital, among other types of finance, innovation
funds or government grants can be used (also see §1.5).
After the Proof of Concept phase, two ingredients are needed to launch a successful commercialisation. A suitable business option has to be chosen and financing has to be raised to enable the commercialisation process. In Fig. 1.1 three different business options are distinguished, namely Partnership, Strategic alliance and Joint venture. In the next paragraph the business options used in this study will be proposed.
Nevertheless, there is something that is not taken into account in Fig. 1.1. After (or just before) the Proof of Concept phase, a decision has to be made about the fact if the commercialisation will be done by yourself or by someone else (contract out). This directly influences the route to commercialisation that can be chosen. For example, when the company does not have access to the market, the commercialisation process is better done by somebody that does have this access. Therefore, in this case, licensing will be an option. Further exploration on this subject will be done in the next paragraph and chapter 2.
§1.3 Business Options
In this paragraph the different characteristics of seven business options are described, namely Spin-off (SO), Start-up (SU), Producing (P), Licensing (L), Patent Selling (PS), Strategic Alliance (SA) and Joint Venture (JV). These business options play a central role in this study, because they are the distinguished options from which the choice can be made.
These business options were selected during the literature study. The different aspects of the business options are discussed in §1.3.1-1.3.7. In §1.3.8 a classification is applied to these business options.
In all these business options, patents play an important role. Therefore the ‘patent world’ is discussed in the next paragraph. Another influence on the business options is financing.
Implications of venture capital financing to the business options is discussed in §1.5.
§1.3.1 Spin-off
A spin-off is defined as an individual or a group of individuals leaving a ‘parent’ firm to start a new, independent business. The spin-off occurs on the basis of specific knowledge and competence built up within the parent firm. The parent firm supports the spin-off by allowing the transfer of knowledge, competence and/or direct means (Bernardt et. al., 2002). The transfer of knowledge can consist of customers, access to the parent’s network and/or orders.
The competences that can be transferred are tacit knowledge (people that worked for the parent take this with them), advice in doing business and/or loosely licensing the intellectual property on which the new venture is built. This last point often means that the parent only gains revenues when the spin-off is actually successful. Direct means can consist of financing, equipment and/or people. The parent is very important for the spin-off to gain success in the first phases of the new venture. The chance that the spin-off will be successful, increases with the quantity and the quality of the support (Bernardt et. al., 2002).
The main advantages for a spin-off are parent support (among other things the Proof of Concept is finished), possible growth on further developments and entrepreneurial motive. As stated above, due to the parent support the spin-off has a good chance of being successful.
Together with the entrepreneurial motive of the owners, this is a strong combination. As for
disadvantages, one can think of the fact that a new venture has to be built. Therefore, for
example, money has to be raised to invest in resources and management issues like hiring
personnel, etc.
§1.3.2 Start-up
A start-up mainly differs from a spin-off on the fact that the new venture is built earlier in the commercialisation process (Proof of Concept phase still has to be performed). The support from the parent to the start-up is less intensive. The technical and commercial risks are much higher compared with a spin-off (see chapter 2 for details). For example the patents have just been filed and no precise definition of the end product and customers exists.
Roughly the same advantages and disadvantages, which were discussed for a spin-off, hold for a start-up, although to a lesser degree.
§1.3.3 Producing
Producing means that a product (build on intellectual property) is manufactured by the company which owns the intellectual property. This means that the company, which does not have production capacity, should invest in housing, machinery and people to enable the production (and distribution) of the product.
The main advantage of producing is full revenue ownership. As for disadvantages, one can think of the fact that production capacity has to be built. Therefore, money has to be raised to invest in resources and management issues like hiring skilled personnel, etc.
§1.3.4 Licensing
In licensing, a right is given from the licensor to the licensee to use a certain part of intellectual property that the licensor owns. To gain this right, the licensee has to pay a fee to the licensor. This fee can have different forms like milestone payments, royalties, etc.
Important to notice is that the value of intellectual property is related to the economic benefits it brings, not the cost of development or reproduction (Gruetzmacher et. al., 2000). When determining the fee this has to be taken into account. According to Gruetzmacher et. al.
(2000) the license price is influenced by seven general categories, namely Technology, Anticipated economic benefit to licensee, Markets served, Complementary assets, Legal position, Risk and Other license terms. Within these categories different factors exist. The licensee can, for example, be an established company, a spin-off or a start-up. Therefore licensing involves most of the other business options.
Three types of licensing exist, namely in-licensing, out-licensing and cross-licensing. With in-licensing your company is the licensee, with out-licensing your company is the licensor.
Cross-licensing means that your company is the licensor as well as the licensee. For example, two companies both have intellectual property which together can generate a product with Freedom to Operate (FTO, see §1.4). Then they can enter into a cross-licensing contract. This means they can both make the product, but for example in another area of the world or in another industry sector.
§1.3.5 Patent Selling
Patent selling, in general, is less attractive in comparison with the other business options, due to the fact that the effort put into the development of the intellectual property is lost and no further developments can be conducted to gain additional revenues in the future.
An advantage of patent selling is that revenue is owned on a very short term. But patent
selling mainly has disadvantages, like the fact that intellectual property is lost, no further
development is possible and by loosing the intellectual property, the company ceases to exist.
§1.3.6 Strategic Alliance
A strategic alliance is a collaborating process where two or more companies engage in a partnership. This partnership is set up for a certain purpose (for example, development or manufacturing of a product). All partners invest people, knowledge, money and/or equipment into the alliance. Strategic alliance is a business option that can adopt a large range of possible purposes and combinations. The strategic alliance mostly deals with multiple contracts. One of these contracts is generally a license agreement, where one of the participating companies provides the knowledge (IP, patents) to make the common purpose possible.
A strategic alliance is very flexible. This flexibility enables opportunities for the company which owns the intellectual property which otherwise would not be able to get access to.
Disadvantages are complex deal structures, revenue split among the partners and cultural differences between the partners.
§1.3.7 Joint Venture
A joint venture is defined as a collaborating process of two parties, consorting to engage in and to carry out a specific business activity (for example, development or manufacturing of a product) for joint profit. Both parties combine their efforts, intellectual property, money, skills and/or knowledge. From this definition certain aspects can be subtracted. First of all, engaging in a joint venture means that a new venture is created. This new venture is created for a certain common purpose, for a fixed lifespan, where both parties invest people, knowledge, money and/or equipment. Both parties own an equal share of the new venture.
The joint venture is enforced by formulating a set of contracts. One of the contracts is usually a license agreement with the company that provides the knowledge (IP, patents) where the joint venture is build on.
A joint venture enables a penetration of markets which the company holding the intellectual property would otherwise not be able to penetrate. Disadvantages are complex deal structures, revenue split among the partners, long preparation, a certain lifespan and cultural differences between the partners (Ernst & Halevy, 2001). The room for cultural differences is greater for joint ventures than for strategic alliances, due to the fact that with a joint venture a new venture is created and therefore people work more closely together.
§1.3.8 Classification
The seven business options can be classified by characterising the business options with the fact that the commercialisation is done by yourself or contracted out. This subject was also mentioned in §1.2. In table 1.1 the classification is shown.
Table 1.1: Classification of business options.
Classification Business options
Do it yourself Spin-off, Start-up, Producing Contract out Licensing, Patent Selling
Combination Strategic Alliance, Joint Venture
Strategic alliances and joint ventures can have much different forms. However, mostly they
are a combination of the other two classifications.
§1.4 The ‘patent world’
Before a patent will be assigned to a company or institution, the patent has to be filed to the regional patent organisation (for example USA or Europe). The patent organisation will then investigate if the patent is not based on Prior Art. This means the investigation is concentrated on the fact if the idea behind the patent is original and not obvious. When these criteria hold, after a long period (approx. 5-7 years for the life sciences industry), the patent will be assigned to the company.
A second point, which is important in considering patents, is the Freedom to Operate (FTO).
This means that when a company wants to commercialize a certain product, it needs all the patents which are needed to commercialise the product. For example, a company wants to produce a product that has the technology stored in six patents. Five of these patents were developed by the company and one was developed by another company. Therefore the company has no FTO, due to the fact that it does not have the full right to produce the product. Therefore it needs to in-license or buy the missing part of intellectual property from the other company to gain the needed patent portfolio. FTO is also closely related to the region where a company wants to commercialise the product. All the patents covering the product need to be granted for this region. Therefore, for different regions, different in-licensing contracts have to be signed to gain the FTO for the specific regions.
For different business options the FTO can change. When for example, a spin-off has not the required set of patents, but with a strategic alliance the set of patents can be completed, the business option strategic alliance is more likely to be chosen. And therefore, the technical and commercial risks are reduced compared with a spin-off (see chapter 2 for details).
§1.5 Venture Capital
The Business Options Spin-off, Start-up, Strategic, Producing Alliance and Joint Venture can be influenced by financing. Therefore the role that Venture Capitalists play is important.
Venture Capitalists generally have a portfolio of investments in companies that work in high risk environments, but on the other hand have a high growth potential. This criterion holds for life science companies in general.
Venture Capitalists are driven by high returns. The returns are typically gained at exit points (Gilbert & Tobin, 2000). This means that they start by determining the next point in the development process of a business. Therefore, when venture capital is needed to make a certain step forward, the conditions to reach the next point should get the highest attention.
Two examples of final exit points are an Initial Public Offering (IPO) or a trade sale.
A rather ‘new’ phenomenon on the venture capital market is Corporate Venture Capital (CVC) (Paul et. al., 2002). This is typically venture capital funds originated by large companies (for example, pharmaceuticals). The reasons why these ‘new’ funds invest in new ventures is not simply a matter of seeking high returns. The possibilities that the funded company can bring to the CVC in the future is the main reason for the CVCs to invest (Chesbrough, 2002).
This category of venture capital should be considered seriously, due to the fact that it can have
great benefits to have an investor that knows the business well. Important to notice is that
CVCs use their funds to explore the future possibility to partner or acquire with the spin-off or
start-up they invest in. Therefore, using CVC influences the future options (JV, SA, L and PS)
for spin-offs and start-ups. When a CVC has the intention to acquire the spin-off later on, this
is called spin-in. For CVCs this is an additional exit option.
However, venture capital is the most important method to finance business options in the life sciences industry; other means should be evaluated when, for example, engaging in a spin-off.
Grants and innovation funds, for example, are two other possible ways to finance a business option. However, in practice, mostly multiple types of financing will be used to fulfil the total need for capital.
§1.6 Commercialise it yourself vs. contract out
The different business options are able to substitute each other over time. For example, as illustrated in Fig. 1.2., the first choice there is to make is, if you do the commercialisation yourself or if you contract it out. In the image, it is shown that after the Proof of Concept phase, there are three possible routes of commercialisation. The first route (1) is going on with creating value by scaling up the production. The second route (2) consists of licensing the improved intellectual property (Proof of Concept is finished) to another company. The third route (3) is starting a joint venture, which is actually a mixture, because often also licensing is involved. Other routes could also be identified, but for this example, these three were chosen.
Other initial business options can also be defined, see §1.3.8.
So, to conclude, in making the initial choice, the future alternatives should also be considered.
These alternatives can sometimes be typified as real options. Real options analysis is discussed in detail in §2.3.2.
choice
Do it yourself
Contract out
Start-up
Licensing
Proof of concept
Joint venture
Scale up
2
1
3
3
Figure 1.2: Changing the business option.
The factors which determine the initial choice are discussed in detail in the next chapter,
although in general three factors can be identified, namely market access, risk/uncertainty and
expected returns. Firstly, without access to the market you will never make any returns when
commercialising the intellectual property yourself. Secondly, when you do the
commercialisation yourself, you should be able to address the risks/uncertainties that are
involved in the business option you choose. Finally, the business option with the highest
expected returns is most likely to be chosen.
§1.7 General remarks to keep in mind
Intellectual property stored in patents has no value (only costs money) unless it is used in some way. Therefore the value is mainly dependent on the business option which is used to gain revenues from the intellectual property.
Tax and legal issues will influence the choice of one business option over another. These issues are rather complex and fall outside the context of this study.
For most business options (SO, SU, SA, JV & P) a management team is involved in creating the highest value. The quality of this management team therefore directly influences the value. However, in this study is assumed that the management team is equally skilled in all business options and therefore this has no effect on the selection of the preferred business option.
Important to keep in mind is the influence of the management team’s preference or bias towards a certain business option, when a choice has to be made. This subject falls outside the context of this study.
In making a decision the highest expected return is the important factor. One should notice that other types of returns will also contribute to the choice. The improvement of a reputation or the fact that you want to show yourself in the market will change between the business options and therefore influence the choice. This subject falls outside the context of this study.
Successful deal making is involved in all business options. Although not taken into account in this study, important characterises for successful deal making are pointed out here. The degree of trust is generally seen as one of the important variables. Myers (2001) gives three other factors, namely shared decision-making & control, complementary objectives and avoiding royalty stacking. Gruetzmacher et. al. (2000) points out that working to understand each other is important for a successful deal. This is especially important when a small and a large company or a university and a company work together. Speranza (2000) states that, when considering international deals, it is important to adhere to the specific country laws and guidelines.
§1.8 Conclusion
In this chapter the research scope was sketched. Seven different topics were discussed, namely nanotechnology, life sciences industry and drug delivery (1), the process from idea to commercialisation (2), the different business options as distinguished in this study (3), the
‘patent world’ (4), (Corporate) Venture Capital (5), doing the commercialisation by yourself vs. contract out (6) and the chapter ended with general remarks, which are not included in this study, but which should be kept in mind when dealing with commercialisation of intellectual property in the life sciences industry (7). By discussing the topics mentioned above an understanding is created about the research scope, which will be used as background knowledge for the following chapters.
In the next chapter a theoretical framework is presented. A strategic selection model is
proposed which relates important factors to make a choice for a preferred business option in
different situations. Then two selection rounds are proposed as practical methods to guide the
selection process.
Chapter 2 – Theoretical framework
In this chapter selection methods are presented and discussed to answer the theoretical research question as proposed in the introduction. First, a strategic selection model (SSM) is presented. This model is used as a guideline throughout chapter 2 and 3. Then two selection rounds will be discussed, which will enable a choice to be made in favour of for a certain business option (§1.3) in different situations.
In practice, the selection procedure should be done as follows. Before the two selection rounds can be performed, first the ‘fixed part’ (§2.1.1) of the SSM (Fig. 2.1) should be described. In the ‘fixed part’, the intellectual property, the company and the environment are described. By doing this, a necessary understanding of the situation is created.
Secondly, a preliminary selection (§2.2) can be made by comparing the situation as described in the ‘fixed part’ with general conditions when a certain business option is preferred (§2.2.1 & 2.2.2). After this preliminary selection round, a few business options are selected to be analysed further in the final selection round.
The final selection round (§2.3) consists of applying three methods to choose the preferred business option. The first method is a selection matrix (§2.1.2). On this matrix the business options can be situated by analysing the risk/uncertainty (§2.3.1) and the attractiveness/value (§2.3.2) (‘selection part’ in Fig. 2.1). The second method determines the amount of risk/uncertainty the business options face. This is done by a four-level framework from Courtney et. al. (2002). The third method determines the amount of attractiveness/value. This is done with a combination of decision tree analysis (DTA) and real options analysis (ROA).
§2.1 Strategic selection model
Müller’s (2002) thoughts and ideas were used as a basis for the theoretical framework. In his article about strategic management, he proposes a set of traditional instruments and concepts of strategic management. In this study, some of these instruments (Strategic planning process, SWOT-analysis and Portfolio analysis for strategic selection) are combined into the strategic selection model. This model (Fig. 2.1) relates the different variables, which are necessary to make a selection in favour of a preferred business option.
It is assumed that, by combining these instruments and adding additional theories to
determine the variables in the model, a sound model is constructed on which a preferred
selection can be made. The variables in the model, in combination with the additional
theories, will be discussed later in this chapter.
Resources &
Capabilities
Strengths &
Weaknesses
Fixed part Selection part
Opportunities
& Threats
IP Application
Technical Risk
Risk Uncertainty
Financial Risk
Commercial Risk
Width of Application
Development Potential
Attractiveness Value
Market Attractiveness Selection Matrix
Environment
Figure 2.1: Strategic selection model for choosing a preferred commercialisation route.
Based on Müller’s (2002) thoughts and ideas with additions.
The strategic selection model distinguishes two parts, called ‘fixed part’ and ‘selection part’.
These two parts are now discussed separately in §2.1.1 and §2.1.2.
§2.1.1 ‘Fixed part’ of the strategic selection model
The ‘fixed part’ of the model, in a practical situation (chapter 3), should be performed before the preliminary selection round (§2.2) and is used to create a necessary understanding of the situation. In the ‘fixed part’ of the strategic selection model (Fig. 2.1) the company, the intellectual property and the environment are described. This description is done by six variables (Fig. 2.1.), namely technical risk, financial risk, commercial risk, width of application, development potential and market attractiveness.
Resources and capabilities
In this study, the strengths & weaknesses are determined by internal parameters of the organisation (Fig. 2.1). According to Dollinger (1999) this can be described by the resources and capabilities. Six types of resources exist, namely physical, reputational, organisational, financial, intellectual & human and technological.
The management of the organisation generally impacts the capabilities. In the strategy of the organisation it is stated how the resources are used to achieve a set of goals. Although strategy has many definitions (Mintzberg, 1987), at this point strategy is seen as a consciously intended course of action, a set of guidelines to deal with the situation. Therefore, the strategy can be seen as a kind of expected capabilities.
Intellectual Property
Khoury et. al. (2001) state that there are different types of intellectual assets, like patents, copyrights etc. (Fig. 2.2). Secondly, there are different types of know-how assets, which together form a valuable combination. Know-how assets are characteristically different from legally protected intellectual property in that they are embodied and closely held by individuals/groups, and provide the positive enabling capability for producing a product or service. It is therefore important to notice, that the intellectual property, in this situation, is the key resource, from which the company can gain revenues.
The life sciences industry is one of the industries where patents have a great value and work as a protection mechanism. Therefore, in this study only intellectual property in the form of patents is under consideration.
Patents
Trade Secrets
TMs &
Domain Names Copyrights
Know-How
Designs Methods
Processes
Figure 2.2: Intellectual assets. Source: Khoury et. al. (2001).
Environment
The environment of any organisation can be described by two levels of hierarchy, where the company itself is situated in the centre (Dollinger, 1999). Firstly, the industry level, where competitors fight for the highest market share. This can historically be described by Porter’s five forces. A note of caution should be made here, due to the fact that the environment discussed in this study is highly uncertain by nature, this model will be less applicable (Courtney, 2000). Secondly, the macroenvironment, five main influences determine this level, namely Politics and government, Macroeconomy, Technology, Sociodemography and Ecology. From the environment, the opportunities and threats can be extracted.
Strengths, Weaknesses, Opportunities and Threats (SWOT)
To know the position of the company, the internal (SW) as well as the external (OT) situation is equally important (Müller, 2002). The strengths and weaknesses are determined by analysing the resources and capabilities of the organisation. In general, these should be compared with the resources and capabilities of the main competitor (Müller, 2002).
However, in an emergent market this is not always possible. Therefore, the judgement if something is a strength or a weakness, will mostly be determined by common sense. The opportunities and threats are determined by the analysis of the environment (Fig. 2.1).
Application
As can be seen in Fig. 2.1, intellectual property leads to certain applications. In this study it is assumed that the proprietary application is built on the technology described in the patents.
What should be noticed here is that, before commercialisation, it is necessary to secure if there is Freedom to Operate (FTO) (§1.4). The proprietary application is influenced by the opportunities and threats due to the fact that, an application lacking the opportunity to be commercialised, should not be considered any further.
§2.1.2 ‘Selection part’ of the strategic selection model
The Selection Matrix is the part of the strategic selection model (Fig. 2.1) that can be applied to all business options. This mainly consists of two parts, Risk/Uncertainty on one hand and Attractiveness/Value on the other. By analysing these two parameters, the business options will take their positions in the Selection Matrix (Fig. 2.3). Important to notice is, that in time, the position of a business option in the Selection Matrix is likely to change. How this can change, depends on the business option. This will be discussed in more detail later on. The two parameters will be briefly discussed in this paragraph. A detailed discussion will be done in §2.3.
increasing preferability
small small high
high
Attractiveness/
value
risk/uncertainty
1
2
Figure 2.3: Selection Matrix with examples (no. 1, 2).
Based on Müller (2002).
Risk/Uncertainty
Three types of risk are recognised in this study, namely technical, financial and commercial.
These are now discussed separately. How these variables can be measured, will be discussed in §2.3.1.
Technical risk
Technical risk includes factors dealing with the application itself. For example, when the application needs a Proof of Concept, there is a risk if this will succeed. The technical risk is dependent of the strengths and weaknesses of the company, due to the fact that these can increase or decrease the uncertainties of the technical aspects of the application. For example, when the company has a lot of experience in the Proof of Concept phase, it is more likely that this will succeed and the risk will be decreased. Or, if the application has already succeeded the Proof of Concept phase, the technical risk is decreased.
Financial risk
This risk factor deals with a broad range of uncertainties and differs a lot between the business options. It includes, among other things, uncertainty in financing, royalties and returns. The financial risk is influenced by the strengths and weaknesses as well as the opportunities and threats. For example, when the parent company is able to select a strong management team experienced in spin-offs (strength) (Rodgers et. al., 2002), a spin-off is more likely to gain financing and therefore reduces the financial risk for the parent company.
When the environment (market) has opportunities for high returns (e.g., for joint ventures) in the future, the financial risk decreases. The application itself will also impact the financial risk, due to the fact that the application holds a potential to gain revenues, which differs a lot between applications. Also the type of financing (§1.5) can change the amount of financial risk.
Commercial risk
Commercial risk is mainly influenced by the possibility of timely adoption (of the application) by the market. The commercial risk can be limited by an application that has the right fit with the market needs. This can be assumed by analysing the opportunities and threats. For example, when an application is technically very good and new, but there is not a good market fit, because customers want a much cheaper substitute, the commercial risk is high.
The Freedom to Operate is also an important factor (§1.4).
Attractiveness/Value
To measure the attractiveness of a business option, three variables are used, namely width of
application, development potential and market attractiveness. These variables are now
discussed separately. How value is related to attractiveness and how value can be determined,
will be discussed in §2.3.2.
Width of application
When the application can be used for a range of products or just one specific product, this will alter its attractiveness. For example, when a drug delivery system can be used for a range of drugs and therefore be licensed individually to a broad range of pharmaceutical companies, the system will be much more attractive than a system that can only deliver one drug from one company.
Development potential
Development potential actually measures the options the company has in the future for the application. For example, when future developments/innovations can change the application in a positive way (for example, enlarge the applicability) the attractiveness will increase. The development potential is influenced by the opportunities and threats in such a way that it is more likely to develop an application in a direction where opportunities exist. Another aspect of this variable is the question if the option to develop the application can be kept within the own company. Therefore the development can lead to extra future revenues.
Market attractiveness
Market attractiveness actually deals with the dynamics of the market where the application will be sold. When this market is large, has a high growth rate and has profitable companies investing in Research and Development, the attractiveness will also be high. Therefore the opportunities and threats will mainly determine the market attractiveness.
§2.2 Preliminary selection round
In the previous paragraph, the strategic selection model was explained and a general insight was gained in the variables that play a role in the selection process. This paragraph describes how a preliminary selection round should be performed. As mentioned before, in the practical performance of the selection process, first the ‘fixed part’ of the strategic selection model (Fig. 2.1) should be analysed.
The preliminary selection round consists of three considerations. Firstly, a general view on
how to deal with a patent portfolio is proposed. Secondly, for every business option a
description is made under which conditions the business option is preferred. This can be done
by comparing the proprietary application and the situation (‘fixed part’) with the description
made in §2.2.2. Thirdly, a brief consideration is proposed about the term on revenue and how
this affects the preliminary selection round of business options.
§2.2.1 General view
In Fig. 2.4 a general view is proposed how to deal with a patent portfolio.
IP, patent portfolio Patent,
divided in proprietary applications
Leftover of complete patent (PS or L)
Core business - Strengths SO, SU, SA, JV & P.
In other regions (L, JV)
Build technology standard (L) Application
leftovers (L)
Figure 2.4: A general view on how to deal with a patent portfolio.
Based on Torres (1999) with alterations.
Explanation: SO=Spin-off, SU=Start-up, P=Producing, L=Licensing, PS=Patent Selling, SA=Strategic Alliance and JV=Joint Venture.
The basis of this view consists of the intellectual property (patent portfolio) owned by a company. The patents can be divided into different applications. The idea behind this view is that every part of intellectual property should be used to gain revenues. The part of intellectual property that fits with the core business of the company (described in the
‘fixed part’) should be commercialised by SO, SU, JV or P (SO, SU and P most preferred), because these business options are likely to generate the highest value (§2.3.2). When a certain application falls completely outside the core business the most likely business options to gain revenue are PS and L. When only certain applications of a patent fall outside the core business, licensing is the best business option. Licensing can also be used for expanding the business to other regions (including cross-licensing) or to build a technology standard (e.g., Crucell with PER.C6
TM).
Of course, this is a rather generalised view on the situation. However, it is advisable to have a general view in mind as a starting point, when dealing with complex situations.
§2.2.2 General conditions
In this paragraph the general conditions are proposed as to when to apply which business
option. This can not be described in a precise manner, although a few general guidelines will
be given below. By comparing these conditions with the description of the ‘fixed part’ of
Fig. 2.1, a preliminary selection for the business option can be made. These general
conditions are mostly based on the face-to-face meetings (Appendix A).
Spin-off
Several conditions are preferred when to engage in spin-offs. Firstly, as will be stated in
§2.3.2, by doing a spin-off, the highest value can be created. Secondly, the product on which the company is built is ready (Proof of Concept phase succeeded, Fig. 1.1) and potential customers are present. Thirdly, a reason could be that by setting up a new venture, fewer risks (on failure) are bared by the parent company.
To be able to engage in a spin-off, a good capital market is an important factor, due to the fact that in the life sciences industry, financing is needed to start a new venture. For a spin-off the amount of financing is relatively high (compared with a start-up), because the company wants to get ready to market the product and therefore sufficient production capacity has to be built.
Start-up
A start-up begins with a high potential for not yet proven technology. This results in a development process with a high technical and commercial risk. The chance of success is therefore relatively low. With successive steps of financing a product is built and proven (Proof of Concept phase), markets are explored, customers found and technologies secured by patents. This process takes much longer than, for example, a spin-off. However, on succession, high revenues are likely to be gained.
To be able to engage in a start-up, a good capital market is an important factor, due to the fact that in the life sciences industry, financing is needed to start a new venture. For a start-up the amount of financing is relatively low (compared with a spin-off), because the Proof of Concept resource needs are low.
Producing
The conditions when producing is a preferable business option, mainly depends on the product itself. The product must require minimal expertise to be produced; otherwise it is not appropriate to manufacture the product yourself. Secondly, the product should be easily distributed and marketed. Still, the distribution and marketing can either be done by yourself or contracted out.
Licensing
Licensing is the preferred business option, when the company has no need or possibility to commercialise the proprietary application, however the application has value to other companies. As mentioned in §2.2.2, the proprietary application does not fit with the core business of the company. Another reason can be that the company holding the intellectual property is in need of short/medium term revenue (§2.2.3). Licensing can provide these revenues unlike most of the other business options, which generate medium/long term revenues.
Unlike for example a spin-off, a good capital market is not necessarily needed here, due to the fact that hardly any investment is needed to engage in licensing.
A disadvantage which should not be taken lightly, are the transaction costs to ensure the
license contract. This point is often overlooked and therefore revenues can be lower than
expected.
Patent Selling
There are mainly four conditions when patent selling is preferred. Firstly, when the company is in need of short revenue, patent selling can be an option. So, actually this is a method for the company to survive in difficult situations. However, if this encompasses the complete patent portfolio, the company will probably cease to exist. Secondly, when an opportunity has risen where a company puts a very high bid on the intellectual property, patent selling could be preferred. But still the fact holds that, when there is such a high bid, this indicates that there are other opportunities to gain revenues from the intellectual property. Thirdly, when the transaction costs to ensure the contract compared to the revenues gained from the license agreement are high, patent selling can be a preferred option in favour of licensing. Fourthly, when a certain part of intellectual property is not used by the company (no fit with the core business), it only costs money to maintain the intellectual property. Selling this piece can then be considered.
Strategic Alliance
The conditions when to engage in a strategic alliance can be multiple. Important to notice however is that the partners must complement each other. Due to this complementary character the strategic alliance can achieve goals the partners could never achieve themselves (Fisher, 1996). Secondly, a strategic alliance is a partnership that advances the strategic direction of both parties (Myers, 2001). This seems trivial but is often overlooked. Therefore the purpose of the strategic alliance should fit with the strategic goals of both parties.
Generally, the transaction costs to maintain a strategic alliance are high. Living up to the different contracts and securing the fulfilment of the contracts by the partner(s) are the reason for these transaction costs. These are factors which should not be overlooked.
Joint Venture
The conditions for engaging in a joint venture are usually threefold. Firstly, the joint venture enables a company to penetrate a market it otherwise would not be able to (for example Japan). Secondly, both parties should complement each other (Fisher, 1996). Thirdly, a joint venture is a partnership that advances the strategic direction of both parties (Myers, 2001).
In practise, a joint venture is often seen as a later stage business option, when (for example) a successful strategic alliance is turned into a separate organisation.
Generally, the transaction costs to maintain a joint venture are high. Living up to the different contracts and securing the fulfilment of the contracts by the partner are the reason for these transaction costs. These are factors which should not be overlooked.
§2.2.3 Term on revenue
For the different business options, there are different terms when revenues will start to be gained. These terms are divided in short (< 1 year), medium (1-5 years) and long (> 5 years).
In table 2.1 this is shown for every business option.
Table 2.1: Term on revenue for the business options.
Business Option Term on revenue
Spin-off Medium
Start-up Long
Strategic Alliance Medium / long
Joint Venture Medium
These terms can affect the selection of one business option above the other. For example, when the company that owns the intellectual property is in need of short term revenues, Licensing and Patent Selling are the preferable business options.
§2.3 Final selection round
At this point in the practical performance of the selection process, only a few business options are left to be analysed in detail. This will be done with four methods. The first method is the selection matrix. This method was described in §2.1.2. To measure risk/uncertainty, a four-level framework (Courtney et. al., 2002) is used (§2.3.1). To measure attractiveness/value, decision tree analysis and real options analysis will be used (§2.3.2). As a final remark of this paragraph, the timing in risk and attractiveness is discussed in §2.3.3.
§2.3.1 Measuring risk/uncertainty
Risk has a positive correlation to uncertainty. This means that when the uncertainty increases, risk also increases. The reason for this is that uncertainty is the source for risk (Goldschneider, 2002b). Therefore, by measuring the uncertainty (discussed below) an indication for the amount of risk is also gained.
To measure uncertainty, Courtney et. al. (2002) proposed a four-level framework. This framework is valid after all analysis, to reduce uncertainty, have been undertaken. The uncertainty that remains after the analysis (‘fixed part’ of Fig. 2.1) is called residual uncertainty. The four different levels form a continuous scale which is shown in Fig. 2.5.
Level one
A clear enough future
Level two
Alternative futures
Level three A range of futures
Level four True ambiguity A
B C
Figure 2.5: Continuous scale which distinguishes the four levels of uncertainty.
Based on Courtney, 2001.
Level one uncertainty means that the residual uncertainty is irrelevant to making strategic
decisions. This means a single forecast of the outcome is sufficient. At level two the future
can be described with a few discrete scenarios. Which outcome will actually come to pass can
not be identified; however probabilities can be addressed to the different scenarios. At level
three a range of potential futures can be identified. A limited number of key variables define
that range, but the actual outcome may lie anywhere within it. At level four a number of
dimensions of uncertainty interact to create an environment that is virtually impossible to
predict. It might not even be possible to identify all the relevant variables that will define the
future. Level four uncertainty is quite rare and when it exists, it tends to change quite rapidly
to level three uncertainty.
This four-level framework can be applied to the different types of risk/uncertainty as discussed in §2.1.2. To combine these measures a general measure can be made for the risk/uncertainty involved in a business option. The data necessary to measure the risk/uncertainty can be subtracted from the description of the ‘fixed part’ of Fig. 2.1.
§2.3.2 Measuring attractiveness/value
This paragraph starts with a discussion about the relation between attractiveness and value.
Secondly, an introduction is given to valuation techniques and revenues. Thirdly, the valuation methods, decision tree analysis and real options analysis are discussed.
The three variables that determine the attractiveness of a business option (§2.1.2) can directly be related to value. When, for example, the width of application is larger, the value will be higher due to the fact that a larger market segment can be reached. The value of a business option can also change when time carries on. A combined view of these two facts can be seen in Fig. 2.6. In this image it is clearly visible that value can directly be translated to attractiveness.
When, for example, a spin-off (SO) is considered, different distinct positions are present on the value-time curve. These are all ‘Exit’-points, for example a next investing round (scale-up) or an IPO. Between those distinct points, the spin-off is trying to reach the next point. During these processes, value increases and risk is reduced.
Time Risk
Value Attractiveness
SO
L PS
SO
L PS
Figure 2.6: Examples of the relation between value and attractiveness, and the development through time.
Value is largely dependent on the form in which the application is commercialised (hence the
different business options). This effect is shown in Fig. 2.7. In the upper area of the image,
three development stages (from idea to commercialisation) are shown. On completion of the
different stages the value is likely to increase by a large factor (also see Fig. 1.1 & 2.6). This
can even go up to ten times every stage. When going through these stages different options for
commercialisation arise (e.g., licensing, new venture). Although one should notice that in the
context of this study, the options proposed in Fig. 2.7 are rather limited.
Valu e
Options
New Venture Product
License R&D
100 x
1 x
10 x idea
innovation
market
invention
business finance
ideal
realistic
Figure 2.7: Commercial context for value extraction options.
Based on Khoury et. al. (2001) with small alterations.
However, this is an ideal view to the situation. In fact, three factors will influence the straight line (solid) and make it curved (dashed). These factors are management, strategy and newness to the market. How strong this effect is depends from case to case.
To valuate the business options, different methods can be used and different authors suggest different valuation methods. For example Remer et. al. (2001) propose three methods, namely Naive DCF, Advanced DCF and Real Options. As another example Luehrman (1997) proposes three complementary tools, namely Adjusted present value, Option pricing and Equity cash flows. However, this study focuses on the company that owns the intellectual property (patents), therefore the revenues granted by this company should be the main point of focus. Naturally the revenues should be different between the business options. It is therefore important to distinguish between the different sources of revenue and to which business option these sources belong. This is pointed out in Fig. 2.8.
Licensing fee Licensing fee
Licensing fee
Profit share
Profit share Profit share
Profit
One time payment
Licensing fee Spin-off (SO)
Start-up (SU)
Strategic Alliance (SA)
Joint Venture (JV)
Licensing (L)
Producing (P)
Patent Selling (PS)
100%
100%
100%
100%
100%
100%
100%
Licensing fee
Figure 2.8: Sources of revenue for the different business options shown from the viewpoint
of the company holding the intellectual property (patents). The scale of the bars is relative.
Four different sources of revenue are distinguished in Fig. 2.8, namely Licensing fee, Profit share, Profit and One time payment. There are different factors/circumstances that affect the revenue boundaries (100%) between the business options. Two tools are very helpful in determining the differences in revenue boundaries of the business options, namely Decision Tree Analysis (DTA) and Real Options Analysis (ROA). After the discussion of these two methods, it will be pointed out how the necessary financial data was measured during this study.
There are two reasons why the use of these methods is valid. Firstly, different levels of uncertainty need different valuation tools. In §2.3.1, to measure uncertainty, a four-level framework was proposed. As was stated in the introduction, the life sciences industry typically differs from ‘traditional’ industries in the amount of risk, uncertainty and non-linearity involved (Fisken & Rutherford, 2002 and Müller, 2002). Therefore, level one uncertainty will not likely be present in the commercialisation of intellectual property in the life sciences industry. On the other hand, situations with level four uncertainty are quite rare (Courtney et. al., 2002). Courtney et. al. (2002) also states that for level two and three uncertainty, decision tree analysis is a sound choice to analyse the scenarios. Secondly, the fact that the situations analysed with this theoretical framework face a certain level of uncertainty (Fisken & Rutherford, 2002 and Müller, 2002), legitimates the use of Real Options valuation (Remer et. al., 2001).
Decision Tree Analysis
With decision tree analysis (DTA) possible future scenarios are sketched into a tree-like structure. Every point has two or more branches (outcomes) and the estimated possibilities of these outcomes are written next to the branch. Also the estimated length (time) of the branch is pointed out. In Fig. 2.9 an example is given for a start-up.
Success
Failure 0.2
0.8
Success
Failure 0.6
0.4 Success
Failure 0.4
0.6 Start-up
1st round 2nd round IPO/exit
2-3 years 3 years 3 years
3rd round
Success
Failure 0.8
0.2
