Why Alliances Fail

Most biotech-pharma alliances fall short of expectations. But are they doomed -- or just difficult? In this second of two parts, experts say strategic partnerships offer acceptable odds, but only if you know what you're doing.
Jun 01, 2004

Our industry can succeed only by collaborations," a biotech CEO recently told Pharm Exec, "because no company has the whole of the jigsaw complete—only a piece." Clearly many of his pharma counterparts agree. The web of alliances formed by the top two dozen biotech and pharma companies from 1973 to 2001—at least the 12,500 contracts made public by these firms—is as tightly knit as a linen shirt.

Collaboration Continuum
Meanwhile the strategic significance, complexity, and cost of biotech–pharma alliances are, if anything, expected to rise. Everyone knows why: the "hunger for product candidates," in the phrase of editor Jennifer Van Brunt of biotech deal specialists Recombinant Capital (ReCap). It seems that "virtually all drug developers are raiding each other's shelves," she says. Jim Hall, president of life sciences at advisory firm Wood Mackenzie, says licensing, which accounted for about $65 billion of Big Pharma's revenues in 2002–2003, will probably top $100 billion in three years. As Van Brunt says, "Companies are in-licensing and out-licensing like crazy."

The pace of alliance formation generally should decelerate, Hall says, while the average deal size increases. "The days of the small, testing-the-waters deal worth tens of millions of dollars is going away and will be replaced by very large equity investments," he says. According to consultants at McKinsey & Co., up-front payments in therapeutic alliances increased more than sixfold from 1988 to 2002, and average milestone payments soared, from $6 million in the years 1988–1990 to $85 million in the 2000–2002 period. They also found that 65 percent of pharma executives anticipated that alliances would become more complex. As Hall says, the easy deals have been done: "Large Biotech and Big Pharma are looking for ones in real therapeutic areas rather than discovery and early technology."

Another trend is less frequent and more dedicated partnering. Fintan Walton, PhD, chief executive of PharmaVentures, a UK-based company that helps biotechs make deals, says some pharma companies are effectively saying, "We prefer to work with a few biotech companies we know well over the years rather than reinvent new alliances and new relationships."

These developments put a premium on alliance know-how for pharma companies and executives alike. Patricia Martin, executive director of alliance management at Eli Lilly, says: "I've heard the head of our US affiliate tell his leadership team that hands-on experience managing a collaboration will be necessary to be successful because that's the way the environment is going."

This article, the second of two parts (see "Dangerous Liaisons," Pharm Exec, May 2004), discusses the alliance phenomenon, examines failure rates and what they're based on, and suggests ways pharma can improve its results.

Lilly Promotes Alliance Spirit
On Their Toes "A dance between an elephant and a flea" is how Ed Saltzman, president of biopharmaceutical consultancy Defined Health, describes the typical biotech–pharma alliance. Size discrepancies aside, why would different species care to tango? Simple. Each has something the other wants. But instead of buying, they borrow. And rather than take control, they share.

Companies ally when certain conditions apply, says Professor Ben Gomes-Casseres of Brandeis University: (1) They have a capability their proposed partner values but does not have (and could not develop), and the partner has a capability they want but do not have (and could not develop). (2) It would cost more to buy these capabilities than to ally them. (3) It would cost more to merge the companies than create a series of alliances. (4) Combined, the capabilities are more valuable than apart.

Alliances can serve almost any purpose, from marketing to production and geographic expansion to R&D. However, the needs that prompt companies to seek partners are generally ones that can't be fully specified. The product or capability may not even exist. A complete contract can't be written.

Alliances manage this problem by operating under an an open-ended contract (also described as incomplete, relational, or evolving) that refrains from spelling out every aspect of the final objective and how it will be achieved. Rather than pin down each partner's behavior beforehand, it obligates them to coordinate and decide matters jointly as events unfold.

An incomplete contract need not be vague, Gomes-Casseres says. "You set down as much as you can about the various rights and responsibilities in the relationship. But you realize it will stand or fall on the partners' ability to come up with answers to questions they haven't thought about before." The heart of a relational contract is a commitment closer in spirit to what binds friends, family members, and spouses than typical business partners. The prevailing attitude is, as the song goes, "we can work it out."

Alliance Success Factors
One way to see how unusual alliances are is to compare them to acquisitions. According to Professor Mike Peng of Ohio State University,"Alliances work well when the ratio of soft to hard assets is relatively high, while acquisitions are preferable when such a ratio is low. Alliances create value primarily by combining complementary resources. Acquisitions derive most value by eliminating redundant resources." And, "consistent with real options thinking, alliances are more suitable under conditions of uncertainty, and acquisitions are more preferred when the level of uncertainty is low."

The various kinds of alliances—co-marketing programs, one-way licensing agreements, R&D contracts, strategic supplier relationships, cross-licensing, minority investments, cross-shareholding, joint ventures—can be arrayed along a continuum with nonalliance activities—with spot market transactions at one end and corporate mergers and acquisitions (M&A) at the other. (See "Collaboration Continuum.") The collaborative structures, moving from left to right, are characterized by increases in organizational interdependence, control, up-front costs, and time, and a decrease in flexibility.

Alliances fall into two classes, contract and equity-based, occupying opposite ends of the continuum. Contract-based alliances, like the one between Abbott Laboratories and Cambridge Antibody Technology (discussed in part one) are generally formed for a specific purpose for a limited time and entail a relatively low level of inter-firm involvement. Equity-based alliances (for example, the recently announced arrangement between GlaxoSmithKline and Theravance, also discussed in part one) tend to be more open-ended and usually inspire higher levels of interaction. (A contract-based alliance, despite the name, is still governed by an incomplete contract.)

Causes for Concern
The chief benefit of alliances is risk management. Firms deal with uncertainty in three ways, says Gomes-Casseres. They can postpone action, curb the cost of negative outcomes, or "influence the uncertainty itself." Alliances, he claims, accomplish all three: (1) They allow firms to hold off making premature bets by making "incremental commitments to an unfolding strategy," comparable to traversing a stream via stepping stones (the logic behind real option reasoning, exemplified by GSK–Theravance). (2) They let firms diversify risk by sharing it. (3) They create new responses to underlying uncertainties—technological, market-related, or competitive—by joining the collaborators' strengths.

But alliances also entail a tradeoff. You reduce performance risk in exchange for taking on a new kind: relationship risk. "You now have to manage something with an outside party," Gomes-Casseres explains. "You don't control them. You have some rights, some sharing of decision making. But clearly you don't have the full latitude you have when you control all the pieces."

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