Switzerland healthcare: Where biotechnology is the drug

FROM FINANCIAL TIMES

By Andrew Jack

Franz Humer may only have a narrow view from his office across the river Rhine in Basel, but the chief executive of Roche is being eyed back with some envy around the world.

At a time when many pharmaceutical companies are struggling against investor pessimism, Roche has received a far more positive assessment from the markets. After a period of difficulty just a few years ago, it seems to be on strident form, in the short term at least.

Its new medicines are helping to replenish the corporate “pipeline” and stave off concerns about patent expirations. The “differentiated” nature of its drugs has enabled it to seek premium prices – and avoid criticism of the industry that it is developing “me-too” drugs of only marginal benefit.

Roche’s choice of speciality treatments such as cancer medicines also means that it needs a relatively small, low-cost sales staff to market to hospital doctors. This frees it from the more aggressive consumer advertising tactics that have dominated the US in the past decade and damaged the industry’s reputation.

For Mr Humer, the reason for all of these approaches comes down to strategic management choices. “In the past, anyone could make a decent return,” he says. “Today, there is a clear differentiation of strategies, between winners and losers.”

This has been reflected in its share price, with its most commonly traded form of equity breaking through SFr150 ($121) this week, the highest level in more than three years.

Others debate whether Roche’s current success is a question of skill and judgment, or has more to do with luck, legacy and a more positive phase in the erratic cycle of drug development. Critics add to that the support of its unusual core shareholder group, and a fair amount of rationalisation after the fact.

Whatever the explanation, Roche certainly looks well positioned. The most important reason for this is Genentech, the California-based biotechnology company, in which it acquired a majority stake in 1990, and which furnishes many of its most important drugs.

Since buying into Genentech, Roche has also cleaned up its cupboard. The group has spun off peripheral activities, such as Givaudan, its flavours, fragrances, vitamins and consumer drugs division. Meanwhile, it has reinforced its core pharma business by forming a close alliance in 2001 with Chugai, one of Japan’s leading biotech-based pharmaceuticals groups.

It has also invested in a large diagnostics arm. Diagnostics, which accounts for about one quarter of group sales, produces equipment designed to identify patients’ propensity to disease and suitability to treatments.

The Genentech and Chugai acquisitions explain why Roche has surpassed its traditional “big pharma” rivals in riding the biotechnology wave, shifting from a chemical “small molecules” base towards biological “large molecules”. Biotechnology now accounts for almost half of group revenues.

Genentech’s success also causes rivals to sneer that Roche’s innovation record has little to do with its own in-house research. Peter Hug, responsible for pharma partnering, is indifferent to such criticism.

“I don’t give a damn,” he says. “So what, as long as we have differentiated products? You can’t do it all in-house. If you can’t refuel with new innovative drugs [internally], you go outside.”

Ed Holdener, head of global pharma development, argues that “humble sensitivity” has been the key to boosting innovation. “We have been alert and sensitive enough to respond.”

Mr Hug estimates that half of the pipeline of future products will come from outside Roche’s own laboratories. “That is within the normal distribution.” In total, the company has 75 alliances, ranging from control at Genentech to minority participations and licensing agreements in small biotech businesses.

And there is no sign of expansion slowing down. “We screen more than 1,600 companies a year, draw up 100 business cases, send 30 to a committee, and carry out due diligence on 15-20, leading to 5-10 deals,” he says. “There are lots of ideas around.”

Filtering the most promising alliances requires powerful scientific acumen. But Mr Hug also concedes that luck has played a role. “Research has to do with strong beliefs and luck. There is a high attrition. You invest in something and you don’t know if in 10 years it will succeed.”

The key, he argues, is managing these agreements well. “Most of our partnerships are based on autonomy,” he says.

“The traditional approach is to absorb. We have a hub and spoke model instead. It makes things more complex. You have to respond to the individual needs of each partner. But it gives far more creativity.”

Roche’s fluctuating stake in Genentech illustrates how the model works. Roche first raised its stake to 90 per cent, and then floated off a minority share, reducing its holding to 56 per cent. Mr Humer says the decision was taken to remove the temptation to absorb the company.

For a long time, the returns were modest. “Genentech would probably not have survived [on its own],” says Mr Hug.

“The initial products were not successful. Their capacity was mixed with our financial strength.”

Ironically, that same protection to downturns in the innovation cycle by a deep-pocketed parent shareholder has also helped Roche over the years. The majority of the group’s voting shares are still controlled by a trust of the descendants of the original owners.

Mr Humer says this dominant ownership structure – unsuccessfully challenged by its Basel rival Novartis, which holds a minority stake – has shielded Roche from short-term speculative pressures.

In any case, Roche today has a range of medicines that make it stand out. Most important has been its portfolio of cancer drugs. With Herceptin, a monoclonal antibody to treat breast cancer, it has been able to point the way towards “personalised” medicine responsive to genetic variations between patients.

Herceptin has proved highly effective in treating a sub-group of patients who are “HER2-positive”, having a particularly aggressive type of tumour.

This success strengthens its commercial case for charging premium prices. “With rising healthcare costs and pressure on expenses around the world, the only way through is your degree of clinical differentiation,” says Bill Burns, head of Roche’s pharma division.

Going forward Roche faces at least two challenges.The first is to sustain the momentum of new drug innovation in the coming years, when – as Mr Humer argues – it could be a decade before advances in genetics translate into new drugs. Meanwhile, Mr Hug says, as more pharmaceutical groups seek external partners, the price of alliances is rising.

The second issue is tackling the damaged reputation of the entire industry, and the negative effect that is having on politicians’ attitudes.

It is an issue that concerns Mr Humer, who is also president of the European Federation of Pharmaceutical Industries and Associations.

But beyond recent initiatives such as greater transparency surrounding clinical trials, he expresses more exasperation than solutions. That is one thing he does have in common with his corporate rivals.

An innovative solution to curing disease

A small image of Rodin’s “The Thinker” sits on computer screens in Roche’s newest chemistry laboratory in Basel and across terminals in the offices of the group’s affiliates all around the world.

It symbolises one aspect of the company that Jonathan Knowles, a British scientist who runs Roche’s global research, believes will help keep Roche at the forefront of medical advances.

Just as he tried to persuade the architects of the latest Basel chemistry research laboratory to rip down the internal walls to get scientists to talk to each other, so has he attempted to stimulate discussion and the exchange of ideas across the company while preserving a “hub and spoke” model.

“You can only be successful in drug development if you bring together all the disciplines you need across the journey,” he says. “The problem is that in science you can measure the same thing in different ways and then you can’t compare data. Our scientists agreed voluntarily to run their experiments in the same way. We have developed a uniform data architecture.”

The result is Roche’s Rodin system, developed at the end of the 1990s. Several times a day, the results of thousands of tests carried out in the laboratories of its subsidiaries and partners in Europe, Japan, the US and beyond are fed into the system and “pushed” out to its researchers.

Mr Knowles argues that there are strong synergies in a large pharmaceutical group. The skill is to stimulate innovation by sharing ideas and expertise, while keeping its separate units autonomous so that researchers are not crushed by a single set of decision-making rules.

“Innovation by definition is non-obvious, and will therefore not be accepted by most experts in the field,” he says. “You have to create an environment to study the non-obvious and the erroneous in the face of conventional wisdom.”

That means keeping Roche’s alliance partners autonomous in many ways, ideally in units of no less than 200 and no more than 1,000 staff on a single geographical site. “Any smaller and you don’t have the expertise to do anything.

“It is an extraordinary management challenge,” he concedes. “It would be much easier to take a top-down approach with our partners and say ‘we bought you, do what we tell you’. Increasingly it has been demonstrated that that approach isn’t working. You have to invest in promising people, and not enforce your decisions on them.”

If the integration of ideas across autonomous units is one aspect of his approach to innovation, another is a philosophy that reflects Roche’s embrace of diagnostics. “Where we are distinctive is that most companies have a strong weighting to one or other biological or small molecule. We are much more driven by patients and disease.”

He says that has resulted in carrying out many studies on patients that do not even involve drugs, in an effort to understand disease mechanisms. “You need two things to advance medicine: new therapeutic agents and understanding of the molecular pathology of disease.”

One result, he suggests, has been to shift from a more traditional research approach of asking questions in series, to instead doing so in parallel. Laboratory and computer simulations take place alongside human testing. Combined with information-sharing, he says the timetables for research have shrunk in some cases from months to hours.

Mr Knowles acknowledges that Roche has had some difficult times in launching innovative medicines but expresses confidence in the future, reflecting the promise of both scientific advances and his company’s approach to exploiting them. At a time when Roche at least is doing well, he sees no need to change the current patent regime: “The deal is you get patent exclusivity, and then you give it to society afterwards.”

Mr Knowles is now trying to apply aspects of his approach externally. He sits on a working party advising the European Commission on its framework document on research, which has identified pharmaceuticals as a key area for competitiveness in the European Union.

While he concedes that some elements of drug company research are proprietary, he believes that many efforts can be pooled between the big groups. The key “bottlenecks” include better prediction of safety of drugs and their efficacy in particular patients.

Combined with information-sharing – such as that potentially available through the British National Health Service’s patient data bases – he suggests that the prospects for medical innovation across the continent look bright. “Europe may have an edge,” he says.

Why Roche remains in safe hands

Roche may be the world’s eighth largest pharmaceuticals group, with sales last year of SFr29.5bn ($23bn) and net profits of SFr6.6bn, but it is unique in big pharma in still being controlled by its founding families.

Some 50.1 per cent of Roche’s voting shares are held by the Oeri and Hoffmann families, descendants of the founders, through a special pooling agreement.

Although ranked by a leading magazine as Switzerland’s second richest clan, with assets of SFr12-SFr13bn (and probably significantly more now after the latest share price rises) family members are notoriously press-shy, even by Switzerland's reticent standards.

Two family representatives, André Hoffmann and Andreas Oeri – both from the fourth generation – sit on Roche’s board of directors and Gigi Oeri, Andreas’s wife, has attracted considerable publicity as vice-president of the local Basel soccer club, but most family members avoid the limelight.

The families’ long-term commitment to the company has helped to guarantee Roche’s independence in a consolidating industry. Although Novartis, Roche’s cross-town rival, has built up a 33.3 per cent stake, its chances of gaining control are marginal as long as the families stand by.