Genentech's 1800% solution

With stunning speed, Genentech is gobbling up big pharma’s lunch.

Perhaps no statistic testifies more eloquently to this than Genentech’s $83 billion stock market value – which exceeds Merck’s by $12 billion – a company with five times Genentech’s revenues. At 18 times revenues, Genentech is valued more highly than any leading publicly-traded health care company in the eight sectors I analyzed recently. Its stock is up 12-fold in the last decade; in the last five years its revenues have climbed an annual average of 21% and in the last 12 months it earned a 21% net profit margin on $4.2 billion in revenues.

How does Genentech accomplish this? Although I doubt Genentech is familiar with them, the company happens to follow closely the Four Sources of Advantage – introduced in my first book, The Technology Leaders: How America’s Most Profitable High Tech Companies Innovate Their Way to Success (Jossey-Bass, 1997).

The Technology Leaders’ key finding was that top performing technology companies share common organizational habits. The book selected 20 companies from 1,306 based on high R&D spending, superior return on investment, and a reputation for innovative products and services. These 20 companies grew six times faster, earned over twice the return on equity, were four times more productive, and increased shareholder value at four times the rate of their peers. They achieve superior return on innovation as a result of four sources of advantage:

• Entrepreneurial Leadership. Attracting and motivating entrepreneurs who combine technology and business expertise;
• Open Technology. Opposing the Not-Invented-Here (NIH) syndrome by obtaining the technology that customers want to buy regardless of source – whether through acquisition, licensing, or in-house development;
• Boundaryless Product Development. Engaging all relevant business functions, from purchasing to early-adopter customers, in the new product development process; and
• Disciplined Resource Allocation. Applying rigorous methods to deciding where to spend money on new product development and to spreading organizational learning.

Here’s how Genentech uses these four sources of advantage:

Entrepreneurial Leadership

• Hiring top scientists. Genentech’s CEO, Arthur Levinson, studied with Nobel Prize winning scientists and could have had a successful academic career. Levinson created a university-like environment that attracted other top scientists including Marc Tessier-Levigne, a former neurologist at Stanford University, and Andy Chan, a former immunologist at the University of Washington;
• Driving scientific initiative through self-selected projects. Genentech encourages its researchers to spend 25% of their time on projects of their choosing (compared to an industry average of 10%). In 1988, a Genentech scientist, Napoleone Ferrara, became interested in anti-angiogenesis, a process for choking off the blood supply to cancer tumors. His research led to Avastin which was approved as a colorectal cancer treatment in 2004 and is expected to reach $3 billion in peak sales;
• Using peer recognition to motivate innovation. Levinson believes peer recognition is a key motivator for researchers, and he gives them the opportunity to build a reputation for themselves. Genentech, unlike pharmaceutical companies, encourages employees to publish in-house research work in scientific journals. Pharmaceutical companies don’t want any of their findings to get out until they’ve got a patent. According to Levinson, by that time the work is no longer ground-breaking; no one cares about it any more; and
• Tapping into scientists’ desire to make the world better. Genentech creates a culture in which people believe they can make a big difference. There are 300,000 people who have been treated by Rituxan, a treatment for non-Hodgkin’s lymphoma. When someone comes up to a Genentech employee and says “you helped save my dad’s life” it creates a sense that Genentech has a higher purpose which further motivates Genentech scientists.

Open Technology

• Partnering to obtain technologies customers want. Genentech has forged over 100 partnerships in which it licenses technologies which form the basis of significant revenue-generating products. For example, Genentech worked with Idec Pharmaceuticals, before that company merged with Biogen in 2003, to develop Rituxan – a blockbuster which generated $1.6 billion in 2004 sales.

Boundaryless Product Development

• Using genomics to reengineer drug discovery. Genentech created the Secreted Protein Discovery Initiative -- that generated five exciting product leads, including a surprising antiviral molecule, and could spawn as many as 20 more within two years. The project -- called Speedy by company insiders – reengineered Genentech’s traditional approach to research, in which scientists worked alone or in tiny teams. Under the assembly-line-like Speedy process, 80 scientists -- a quarter of the Genetech’s research staff – search enormous gene-data warehouses. Traditionally, scientists chased drug leads, known proteins like insulin and growth hormone, by synthesizing them into marketable products. Today, drug prospects are more likely to lie within the human genome and are found with the help of computers. With Speedy, Genentech simplified the task by focusing on the 10% of all proteins that travel outside the cell, blocking or spreading disease. Those 10,000 proteins are identified by using high-tech screens called signal sequence traps (SSTs), and then run through tests to determine their therapeutic benefit.

Disciplined Resource Allocation

• Focusing on areas of therapeutic expertise. Levinson analyzed the drug industry and concluded that companies with a therapeutic focus earned higher shareholder returns than less focused competitors. After Levinson became CEO in 1995, he concluded that Genentech could best profit from this insight by focusing primarily on cancer treatment;
• Setting tight deadlines and beating them. In early 2005, Genentech was in a race against Novartis to complete Phase III trials for using Avastin to treat non-small cell lung cancer. Genentech worked so quickly that Avastin achieved its goals for the Phase III trials by March 2005 – effectively eliminating competition from Novartis which had moved much more slowly and ultimately found that its product was no more effective than chemotherapy. Genentech is not above using financial incentives to encourage workers to meet deadlines. In 1998, Levinson promised employees “Genenchecks” of $3,000 or more if they beat an FDA marketing application deadline for Herceptin, a breast cancer drug; and
• Killing development projects which lack tight scientific justification. Levinson can be brutal in killing projects he thinks are going nowhere. His presence at the Genentech’s weekly science meetings is as much feared as appreciated, because the CEO takes pleasure in asking tough questions. Genentech will not move compounds into clinical trials – which cost between $30 million and $100 million -- until scientific arguments for pursuing the drug are able to withstand Levinson’s intense scrutiny. And unlike some competitors, Genentech routinely designs drug trials to prove that its therapies extend the lives of patients, an exacting standard that is arduous and time-consuming, but which tends to convince even skeptics when the results are positive.

For companies like Merck, Genentech’s success may drive big pharma CEOs to lose sleep over the following issues:

• Why is Genentech doing better than us at getting new drugs to market?
• What could we be doing differently to attract top researchers in the biggest disease and science categories?
• How can we do a better job of building and motivating drug development teams to enhance our productivity?
• How could we make smarter decisions about which research projects to cut and which to initiate?
• Which technologies should we be licensing out to raise capital?
• Which should we be licensing in to cut time-to-market?

No doubt the stock market will mete out its rough justice depending on how well CEOs respond. In the meantime, look for Genentech’s stock to keep climbing steeply -- unless it has trouble in a drug trial or the FDA pulls one of its products -- then look out below.