Tuesday, November 29, 2011

Big pharma hasn't solved commoditization

Cross posted from Bio Business Blog.

Many reporters, analysts and other observers over the past decade have remarked on how the traditional big pharma business model has been running out of steam. Proposed solutions have included buying biotech companies (as Roche did) and forming generic divisions (as has Sanofi). Still, from outside, the (in)actions of big pharma resemble the controlled flight into terrain of other IP companies.

Last week, two consultants from Booz & Company published their own analysis of the problems in the Booz house journal, strategy+business.

Alex Kandybin and Vessela Genova deduced the strategic choices of 10 major pharma companies (Abbott, AstraZeneca, Bayer, GlaxoSmithKline, Johnson & Johnson, Merck, Novartis, Pfizer, Roche, Sanofi) through their acquisitions and divestitures from 2004-2010. Nine of the 10 have bet on biologics, five on OTC, four on generics and one (Sanofi) on animal health.

They draw an analogy to the choices of the computer industry:

Most industries go through periods of both deterministic and stochastic development. For instance, the computer industry in the 1960s and ’70s had all the characteristics of a deterministic process. IBM, Burroughs, Cray, and others pursued similar strategies, selling giant data processing machines known as main- frames. The personal computer changed the dynamics of the industry, triggering a turbulent stochastic period. It became impossible to predict where the computer industry was going, and in the early 1980s the incumbent players’ strategies diverged significantly.
This is, alas, an inaccurate revisionist view of the industry: in the 1980s, it was quite clear that the PC was democratizing computers and that standardized microprocessors enabled market entry and reduced margins.

More importantly, the computer industry of the 1970s has significant a priori heterogeneity: it was not for nothing that people referred to IBM and the Seven Dwarfs (or IBM and the BUNCH). Cray was in a very narrow and dangerous niche diametrically opposed to commoditization trends and desperately dependent on Cold War spending.

One place where the authors clearly have it right is that big pharma is fleeing from the highest margins in the life sciences (and among the highest margins anywhere) towards average or sub-average margins. The operating margins of pharmaceuticals is 29%, vs. 12% for generics, 8% for services and 2% for drug wholesaling.

This is utterly consistent with the 15-year-old observations of Clay Christensen: lower cost solutions eventually supplant higher cost solutions, destroying margins. Or, as my former colleagues Jason Dedrick and Ken Kraemer showed in their 1998 book, IBM’s shift from hardware to services dramatically grew revenues but cut margins.

What to do? The authors offer fairly generic (i.e. undifferentiated) advice: firms should embrace change, consider multiple scenarios, and assess the firm’s unique capabilities.

In the end, the old model of one-size-fits-all drug is breaking down. What will replace it? One prediction is personalized, genomic-based medicine. But even if that’s true, many uncertainties remain, including how quickly that future will get here and which part of the value chain will be the most unique and thus valuable.

Friday, November 11, 2011

Are firms serious about open innovation?

Cross posted from the Open Innovation Blog.

Given the popularity of open innovation, it was inevitable that companies — and researchers — would seek to wrap themselves in the term to leverage its cachet to legitimate their otherwise unremarkable efforts.

One way that I’ve seen this is through a Google news watch on “open innovation” that lands in my inbox every night around midnight ET (9pm Pacific.) Every day there are 1-5 stories about companies (and increasingly the government) trumpeting their latest “open innovation” breakthrough. I am convinced that half the PR people (or execs sponsoring the underlying initiatives) couldn’t articulate a recognizable definition of open innovation.

In talking about this in conjunction with the creation of the Open Innovation Community, I found that Henry Chesbrough has a similar news watch. I’m concerned that faux open innovation will muddy the waters and confuse the market; also, from a research standpoint, a theory of everything is a theory of nothing. However, Henry is more inclined to give them the benefit of the doubt, perhaps because he is a more optimistic person.

The issue came up earlier this year in a press interview. Orange Silicon Valley (a branch of the French mobile phone company) hired a former WSJ technology writer to prepare a 48-page report on the future of Silicon Valley. This included interviews with 10 Silicon Valley experts, including California’s second most famous open innovation researcher. Here is an excerpt:
Do you think the phrase is being overused?

We don’t have a term for it, but there is an Open Innovation equivalent of “greenwashing.” Greenwashing is where people wrap themselves in claims of environmental-friendliness, but don’t change their actual practices to make their products more marketable.

When I use Google to see how corporations use “Open Innovation,” I’d say only about a third of it is really legitimate; the rest of it is just people want a buzzword to make themselves seem more innovative and more trendy.

In many cases, when they appoint a VP for Open Innovation, there is an attitude change and they really are being more collaborative. At other times, it’s just a new name for something they’ve always done, and they’re just calling it something else.
I was thinking of a particular example three years ago when one of Silicon Valley’s most respected companies renamed their university relations office to be their open innovation office.

However, I was a little more encouraged in looking through the news articles that Google emailed to me in November (thus far) — perhaps more encouraging than when I started the news watch four years ago.

Two sorts of articles have been there consistently throughout. One is for the crowdsourcing companies that are seeking to match firms with external suppliers of ideas — certainly a form of open innovation, but (as I’ve found in my research) tending to be narrowly focused on just the sourcing aspect.

The other common thread are stories that treat “open source” as synonymous with “open innovation.” The two terms are not synonymous: there’s an overlap in some cases but they are disjoint in other cases. This is the sort of misuse of the term I’m trying to discourage.

And yes, I saw a certain amount of greenwashing-type usages, using the buzzword for PR purposes. Alas, some of this is being done by the US government: small high-visibility innovation efforts don’t make a $3.5 trillion/year bureaucracy innovative — any more than banning iPad purchases make it efficient.

Still, what I found in this month’s data was more encouraging than I expected to find. One example was this news item from last week:
XYZ Corporation has announced a new Web portal to support its existing Open Innovation program. The new Web portal will increase the pace of innovation, in targeted areas, by improving XYZ Corporation's ability to leverage outside resources.
At the one level, this is the same as hiring Innocentive or Nine Sigma to find new technologies. On the other hand, the effort of setting up a portal demonstrates a greater level of commitment to OI — and perhaps to act upon these ideas — than a few experiments with outsourced crowdsourcing vendors.

Overall, I think the trend line is encouraging. There’s more real open innovation happening in practice, and perhaps even a higher proportion of it is real.

Thursday, November 10, 2011

Bill still wants to be Steve

Bill Gates still wants to be Steve Jobs — even though Steve is dead.

How else can we explain why Chairman Bill (or rather, his trusty sidekick and CEO, Steve Ballmer) is opening a new Microsoft store today in Valley Fair, the same Silicon Valley mall as one of the earliest Apple stores — the store where the media go to take photos of people lining up to buy an iPhone.

Today’s opening marks the 12th Microsoft store. (With a decade-long head start, Apple now has more than 300.) In 2009, Microsoft bragged it would open up retail stores “right next to Apple,” and 6 miles away from Apple HQ certainly counts.

However, Microsoft is bribing people (or rather celebrities) to generate traffic at both ends of the age spectrum. On Thursday, the QB of the first decent 49er team, 55-year-old Joe Montana, is making a 5pm appearance. On Friday, the 30-something duo The Black Keys is performing a free concert (free to customers, not to Microsoft) while on Saturday one of the teen heartthrob Jonas Brothers is doing the same.

I don’t see the point, but then I’ve never seen a Microsoft store and (other than an office suite) haven’t used their products for a decade. However, after visiting the LA store, Greg Sandoval of CNET wrote:

Offering techies a stage to show off power points isn't a bad way to get people in the store.

Still, Microsoft has a long way to go before challenging Apple. Not only does Apple dominate in the number of stores, but some doubt whether Microsoft possesses Apple's sense of style or can create the same first-class shopping experience—even with all the mimicking. There's also this: consumers shop at Apple because for decades now they have loved Apple products.

Microsoft hasn't been anywhere near so successful at duplicating that kind of customer loyalty.
Some “experts” claim we should want our kids to emulate Bill and not Steve. I think Steve did a better job of understanding — and more importantly, anticipating — what excited people, while Bill produced credible incremental improvements funded by monopoly rents. Now Bill is semi-retired to count his money and (ala Carnegie and Rockefeller) burnish his reputation for posterity.

Apple sans Steve Jobs will eventually lose that élan. That’s little consolation to shareholders of Microsoft, who’ve watched Steve Ballmer (charitably) lead the company sideways since taking over as CEO.

The retail strategy that worked for Steve Jobs is not going to work for Steve Ballmer. Apple store’s worked because (as Elaine Misonzhnik put it) “The stores are experiential rather than simply a machine for moving goods.”

Sony failed at retail stores because their products failed to excite people. With the important exception of Kinect, Microsoft has also failed to excite people as customers slowly defect from its platform to the Mac, tablets, Android, the iPhone and other non-Windows platforms. Among the 4Ps, Microsoft needs to focus on product, not place.

Wednesday, November 9, 2011

Steve was right and so was I

Danny Winokur, Adobe vice president of interactive development, posting at blogs.adobe.com, Wednesday 6am:

Over the past two years, we’ve delivered Flash Player for mobile browsers and brought the full expressiveness of the web to many mobile devices.
However, HTML5 is now universally supported on major mobile devices, in some cases exclusively. This makes HTML5 the best solution for creating and deploying content in the browser across mobile platforms.

We will no longer continue to develop Flash Player in the browser to work with new mobile device configurations (chipset, browser, OS version, etc.) following the upcoming release of Flash Player 11.1 for Android and BlackBerry PlayBook.

These changes will allow us to increase investment in HTML5 and innovate with Flash where it can have most impact for the industry, including advanced gaming and premium video. … Flash developers can take advantage of these features, and all that our Flash tooling has to offer, to reach more than a billion PCs through their browsers.
Steve Jobs, Apple CEO, April 29, 2010:
Flash was created during the PC era – for PCs and mice. Flash is a successful business for Adobe, and we can understand why they want to push it beyond PCs. But the mobile era is about low power devices, touch interfaces and open web standards – all areas where Flash falls short.

New open standards created in the mobile era, such as HTML5, will win on mobile devices (and PCs too). Perhaps Adobe should focus more on creating great HTML5 tools for the future, and less on criticizing Apple for leaving the past behind.
Back in February 2008, I wrote about how Apple was trying to discourage Flash on the iPhone and finding work-arounds to having it pre-installed: “Apple is gambling that Adobe needs the iPhone more than the iPhone needs Flash.”

Steve Jobs has won last battle. RIP.

Friday, November 4, 2011

What have we learned?

A decade ago, the dot-bomb era was ending, and with it the destruction of billions of dollar of investor wealth.

Three years ago, the financial markets were collapsing after the popping of a housing bubble fueled by subprime lending and liar loans.

Today, Groupon raised $700m in an IPO in “the largest IPO for a U.S. Internet-related firm since Google Inc. raised $1.66 billion in August 2004.”

The stock rose 30% in first day trading over its offering price, although it dropped 13% since its opening price of $30. The total shares traded Friday were 142% of those issued — meaning on average every share was sold once and 40% of shares were sold twice. Presumably some of that comes from the “greenshoe” of the offering bankers flipping their shares in addition to their $50 million in fees.

Today, Groupon has a market cap of over $16 billion.

In its S-1, Groupon claims competition is not an issue:

If there's a question I've received from Groupon skeptics more than any other, it's, "how will you fend off the competition—especially massive companies like Google and Facebook?" I could give a dozen reasons to bet on Groupon, but it's impossible to predict the future or the actions of others. Well, now the sleeping giants have woken up—and the numbers are showing that what was proven true with literally thousands of other competitors is just as true with the incumbents of the Internet: it's kind of hard to build a Groupon. And since anyone with an Internet connection can track the performance of our competitors, I can be more specific:
  • Google Offers is small and not growing. In the three markets where we compete, we are 450% of their size.
  • Yelp is small and not growing. In the 15 markets where we compete, our daily deals are 500% of their size.
  • Living Social's U.S. local business is about 1/3rd our size in revenue (and smaller in GP) and has shrunk relative to us in the last several months. This, in part, appears to be driving them toward short-sighted tactics to buy revenue, like buying gift certificates from national retailers at full price and then paying out of their own pocket to give the appearance of a 50% off deal. Our marketing team has tested this tactic enough to know that it's generally a bad idea, and not a profitable form of customer acquisition.
  • Facebook sales are harder to track, but are even less significant at present.
Normally, we’d wonder how much the shares will fall after the other 96% come out of lockup. However, insiders have already dumped $943 million in shares after capturing 84% of the VC proceeds. So perhaps the large insiders will be patient, holding out for a higher price in the long run.

Or maybe there is no long run. The company lost money for the last four quarters, and by some measures it was technically insolvency before the IPO. As Villanova business professor Anthony Catanach told CNBC:
The picture is even worse if you consider the significant intangible assets recorded by the company (goodwill, intangibles, deferred taxes, etc.).  We still don’t have any reported evidence of the cash generating ability of these “assets”, so future write-downs may be forthcoming.

If you deduct these assets, to get a tangible equity number, the insolvency picture is even clearer.

We still worry about all the red flags that are being ignored.  For example, with all the restatements (revenue, CSOI, etc.) and amendments, this delivers a powerful signal about the quality of internal controls over financial reporting, as well as the competence of the finance function at this company.

What else are we not seeing in the numbers?  Recent senior management turnover does not help, and the rapid growth adds more concern to the internal control issue.  And the working capital deficit (current liabilities greater than current assets) raises further concerns. 
Wikipedia tells us that 1637, a single tulip bulb sold for 10x average annual wages.

A century ago, philosopher George Santayana said: “Those who cannot remember the past are condemned to repeat it.” Nowadays, few philosophers make it to Wall Street, let alone invest in the market, which is why the “wisdom of crowds” is often the “madness of crowds.”