Biotech Clusters in Practice

A few days ago I met an old friend of mine who is the CEO of a small (40 people) biotech company in Boston. The company is privately held, runs losses, and is sustained by millions of dollars from the venture capital (VC) industry. My friend is a very smart guy (he has a PhD in biology from Harvard) and has a small team of highly competent guys around him. He is no economist and has no special liking for free markets. However, he has learnt some economics by running his business and being in the industry over the years. He now understands the limits of government regulation better and the adverse consequences of government interference with his industry. Here are a few ideas that we discussed.

• The biotech industry is a very small and very risky industry. It is mostly concentrated in Boston with a bit in San Francisco. There is some in Europe and Asia too, but most of it takes place in the US. It doesn’t generate many jobs (the pharmaceutical industry does but this is not the same story) and it needs to outsource more and more, as human trials are very expensive.
• The economics of most biotech firms is pretty dire: it takes between 10 and 15 years to develop a drug. In most cases the drug will not work and the firm will go under. Because of the number of trials necessary, biotech is very capital intensive: firms can eat up between $20 and $30 million per year (without making any money).
• As a result, the number of investors in the field is limited. There are less than 100 VC and hedge funds that are willing to invest in biotech companies. The overall majority of these funds are located in New York City. There are some in Boston and San Francisco as well. The industry is so risky, that many hedge funds like to be short on biotech stocks.
• Because success in biotech is a matter of decades, the brightest graduates prefer to go somewhere else where their human capital will be more rewarded. The CEO of a biotech start up makes 10 times less than if he were in the IT industry or if he was working on Wall Street (even though his IQ is just as good if not better). People in the biotech industry are passionate about their work and willing to forgo monetary rewards.
• The impact of regulating the prices of drugs would be enormous. The complex set of relationships that exist between biotech entrepreneurs and financial markets depends entirely on the probabilities of success of future drugs. When regulators talk about controlling prices, they send a signal that goes all the way back to financial markets, and this tends to reduce the main source of equity for biotech entrepreneurs.
• Considering (a) the size of the industry world-wide, (b) the ties among the actors in the industry (in Boston the industry revolves mostly around graduates from Harvard and MIT and their connections), (c) the role of financial markets (with their specialized funds), and (d) the quality of human capital necessary in biotech, it is highly unlikely that governments could ever create a successful biotech cluster anywhere. Markets allocate resources towards the best biotech entrepreneurs, and most of them already are in Boston or San Francisco.
• Many biotech firms cannot obtain capital from financial markets. As a result, they turn to the government to obtain grants. If one considers that the most promising projects attract the attention of super-specialized VC funds (considering that if a successful drug is developed, it can be financially very rewarding), it tells a lot about the quality of the investments the government makes in biotech.

Comments

[Matt C.]

Forgive me for being daft here, but what are VC funds?

[Josh]

"Considering (a) the size of the industry world-wide, (b) the ties among the actors in the industry (in Boston the industry revolves mostly around graduates from Harvard and MIT and their connections), (c) the role of financial markets (with their specialized funds), and (d) the quality of human capital necessary in biotech, it is highly unlikely that governments could ever create a successful biotech cluster anywhere. Markets allocate resources towards the best biotech entrepreneurs, and most of them already are in Boston or San Francisco."

Biotech is one of those things that every Massachusetts politician takes credit for. If Al Gore invented the internet then the Democrats of the state invented biotech.

[Nick]

Venture Capital Funds

[js]

memphis will be a biotech center in 5 years

[Matt C.]

Thanks! Should have known that considering I work in financial services.