Anne Evans: assessment of a biotechnology market opportunity.

This case describes Anne Evans' search for a market opportunity in the biotechnology industry, and examines the feasibility of establishing a new venture to exploit this opportunity. The drug development process in the biopharmaceutical industry spans three critical phases: pharmaceutical discovery,

pharmaceutical development, and product marketing. The drug development process is a very capital-intensive process with expenditures averaging $800 million per drug and with very high failure rates--only one out of 5,000 compounds that emerge from discovery and preclinical testing will make it into the market. The drug development process therefore contributes to very high cash burn rates and corporate failures in the biotechnology industry.

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Being intimately aware of the reality and economics of drug development, Anne was intrigued and excited by the possibility of establishing an intermediary in the pharmaceutical discovery phase of the drug development process. Such an intermediary designated as a biotechnology services investment firm (BSIF) would bring together providers of discovery testing capabilities and biotechs that would be key users of such critically needed capabilities. Anne believed that the BSIF would succeed by enabling biotechs-and subsequently the much larger pharmaceutical organizations--to significantly enhance the efficiency of the drug development process. Her MBA thesis examined the feasibility of establishing a BSIF. While Anne was confident about the conceptual analysis underlying the feasibility of establishing a BSIF, she pondered what action(s) to pursue at this juncture. Was she passionate about the venture to overcome the entrepreneurial struggles that she anticipated would inevitably follow the launch of her venture?

Introduction

It was November of 2000 and Anne Evans had just been informed, in confidence, that the small biotechnology organization (biotech) she had joined less than six months prior was unlikely to remain as a going concern, in its current form, beyond first quarter 2001. She was advised that fixed costs would have to be drastically reduced and that it would be wise to initiate a search for a new position. The news was not unexpected, since the MBA she had completed that same year had enabled her to read the "writing on the walls" in the corporate financials. The situation was certainly not unique to the industry, since few biotechs had positive cash flow from operations, so when cash from external sources dried up, the organizations generally withered and died. She knew this all too well--not just from reading business periodicals or comforting laid off industry colleagues, but from personal experience--having been laid off roughly two years prior.

The question she kept asking herself was simply, "so now what?" Join the management team of yet another biotech and watch it burn through its cash as it tried to beat the odds and bring a product to market? At least her husband and family would know better than to suggest that she simply abandon her ten years experience in the biotech and pharmaceutical industry, fall back on her doctorate in veterinary medicine, and retreat to the fiscal stability that a practice in veterinary medicine would offer. The latter was as safe an out to her current predicament as it was dull and entirely out of keeping with the interests that had driven her back, midlife, to participate in the executive MBA program at San Diego State University.

Anne found herself contemplating the thesis that had culminated in her MBA program. Her business experience spanned the critical phases of drug development: pharmaceutical discovery, pharmaceutical development, and product marketing. Being intimately acquainted with the process, Anne was intrigued by the possibility of establishing an intermediary in the discovery phase of the pharmaceutical development process. Such an intermediary designated, a biotechnology services investment firm (BSIF) would bring together providers of discovery testing capabilities and biotechs that critically needed such capabilities. Anne believed that a BSIF could succeed by enabling biotechs--and potentially the much larger pharmaceutical organizations--to significantly enhance the efficiency of drug development. Her MBA thesis examined the feasibility of establishing a BSIE As she recalled and reflected on her thesis Anne said to herself, "this may represent my opportunity--my opportunity to succeed as an entrepreneur and to reinvent the business of biotechnology!"

Anne Evans' Background

Anne G. Evans had earned a doctorate in veterinary medicine in her early twenties, seeking that goal because of her love for animals and passion for science. The latter drove her to advance that degree with post-doctoral training in comparative veterinary-human medicine and with a focus on dermatology, allergy, and immunology. She obtained specialty board certification in veterinary dermatology in the mid '80s and opened a referral practice devoted exclusively to the treatment of dermatologic and immunologic diseases of large and small animals. The practice was sold in the late '80s at a profit so that she could accept what she envisioned as a more challenging academic position as an assistant professor of veterinary dermatology at a prestigious veterinary school, being involved with teaching, clinics, and research. Still, the position failed to bring her career satisfaction, with the focus on veterinary medicine preventing her from using the full scope of her training. She turned to human pharmaceutical development.

For most of the '90s Anne held positions of increasing responsibility that dealt with business strategy, multinational licensing, development of drugs, biologics, and medical devices that were intended for diagnosis and treatment of human disease. Subsequent to joining the management team of a San Diego biotech startup in 1997, she became acutely aware that her skills in business management were lacking and that obtaining an MBA while continuing her work was the most efficient solution. In August of 1998 she began an executive MBA program. However, by late 1998 the biotech's cash was running low, a third round of financing fell short of corporate and product development needs, and the CEO resigned. Anne left shortly thereafter to embark on a career as an independent consultant predominantly serving the local biotech community, although also addressing alternative health and fitness products and services in the scope of her work. Through the remainder of the '90s and into 2000 she watched as biotech after biotech burned through their cash, experienced product failures well into clinical development, fell out of favor with the investment community, laid off double digit percentages of their personnel, and ultimately failed as going concerns. The biotech industry's corporate and product failures drove her to look for answers and were the springboard for the topic of her MBA thesis.

Nearing the completion of her MBA, she accepted a full time position as executive director of corporate business development for another San Diego biotech. She knew that the organization's potential for long-term profitability was tenuous, at best, however the position offered some new and interesting challenges that were worth the risk. Shrinking market capitalization, declining cash flow, and investor dissatisfaction led to the situation she faced on this day. Once again, it was time to move on in her career.

The Biotechnology and Pharmaceuticals Industries

Collectively, the biotechnology and pharmaceutical industries are generally referred to as the biopharmaceutical industry. Their products include drugs, pharmaceuticals, and biopharmaceuticals with these terms frequently used interchangeably.

Unlike the pharmaceutical industry that has been in existence since the late nineteenth century, creating multinational corporate giants such as Merck, Johnson & Johnson, and Pfizer, the biotechnology industry is a fledgling that only began to gain recognition in the '80s. Although the two industries generate products that target similar markets (i.e., diagnosis and treatment of disease) the differences and relationships between them merit discussion in order to understand why one exhibits substantial cash reserves and profitability, while the other struggles with negative cash flows and layoffs.

The pharmaceutical industry and its organizations (Large Pharma) are mature and could be characterized as an oligopoly. The industry leaders are multinationals currently undergoing consolidation and with heavy reliance on "cash cow" products with revenues exceeding $1 billion in annual sales and with high margins to sustain their profitability. As an example, Schering-Plough's allergy medication, Claritin, generates $3 billion in annual sales. Large Pharma employ hundreds of thousands of people worldwide and are vertically integrated with operations spanning the stages from discovery research through development to global marketing and sales. The corporate weaknesses inherent and pervasive in the pharmaceutical industry are in discovery research; because of its size and associated bureaucracy, it is slow to foresee market needs, adapt to market change, and exercise innovation. (1)

In contrast, the biotech industry comprised numerous, mostly small organizations. Each one typically employed fewer than 100 people and a staff of fewer than than employees was not uncommon. Most biotechs had not brought a product to market; positive cash flows from operations were rare. Instead biotechs generated cash from their investors (angels, then venture capitalists), licensing fees from large pharmaceutical organizations, and proceeds of IPOs (initial public offerings). Some biotechs eventually were acquired by Large Pharma (e.g., Agouron Corporation's acquisition by Warner Lambert, itself later acquired by Pfizer) or faded into oblivion along with their dwindling cash flow; the latter outcome was by far the more common. The corporate strengths of biotechs ere in sharp contrast to those of Large Pharrna. Biotechs offered innovation--that is, discovery research but consistently failed to make it profitable owing to their heavy investment in personnel and laboratory facilities prior to generating revenue. Anne considered the biotech industry in her locale--San Diego, California--and could recall only one biotech over the past five years that had attained profitability through successful product commercialization. (2) She searched the literature to validate this rather cynical perspective on the biotech industry and found that " ... biotech [had] one of the lowest success rates of any area of pharmaceutical R&D, according to data analyzed from Pharmaprojects and its sister publication, R&D Time-Lines.... A biotech drug entering development historically has had only a 7 percent chance of reaching the market. (3)"

The Drug Development Process

Figure 1 provides an overview of the drug development process. Bringing a pharmaceutical product to market began with a discovery phase, typified by the research arm of research and development (R&D) that generated and screened hundreds to thousands of compounds for potential therapeutic activity. Those compounds with potential advanced into a development phase, typified by (1) optimization of the structure of the active ingredient (i.e., drug substance) and formulation (i.e., drug product), (2) preclinical (i.e., in vitro (4) and animal) testing, and (3) clinical (i.e., human) testing. (5)

[FIGURE 1 OMITTED]

According to the Tufts Center for the Study of Drug Development, it takes on average 15 years for a new drug to move from the discovery phase, into preclinical testing, through clinical trials, through approval by the U.S. regulatory authority, the Food and Drug Administration (FDA), and into the market. A November 2001 Tufts Center for the Study of Drug Development report indicated that the average cost of developing a single new drug exceeded $800 million. Of the average $800 million estimated cost of developing a new drug, about two-thirds is expended in the post-discovery phase, and one-third is expended in the discovery phase. (6) Exhibit 1 describes the stages and timeline corresponding to the key milestones of the drug development process in the United States. The search for the next (blockbuster) drug is fraught with substantial risk. Retrospective data analysis performed by Tufts suggests that for every 5,000 compounds that emerge from discovery and preclinical testing, only about five compounds perform well enough to advance into human clinical testing--and only one of these five will make it into the market.

Discovery Stage. In the past drugs targeted treatment of symptoms rather than cures of diseases (e.g., the pain, inflammation, and swelling of arthritis). The advent of modern biotechnology brought forth new research methods (e.g., molecular biology, cell biology, assay development, and combinatorial chemistry) that probed the cellular function and deciphered the causes of diseases. These new tools enabled researchers to discover specific disease-causing "targets" for drug treatment. In fact, biotech researchers have become so adept at the discovery stage that most Large Pharmas devote up to 50 percent of their R&D budgets to partnering with and supporting the research of selected biotechs.

Preclinical Testing. This stage involves a sequence of in vitro and animal studies intended to demonstrate sufficient safety and efficacy with the drug to initiate and support human testing. Three to four years of preclinical study may be necessary to obtain the information required by regulatory authorities, such as the FDA. Preclinical testing continues in parallel with human testing for much of the development phase.

Phase I Clinical Trials. Studies here are designed primarily to look at safety in normal human subjects, and to study how the drug is taken and metabolized by the human body. The objective is to ensure that the drug is safe, and to design the most rational dosing regimen (e.g., once or twice daily; oral or injectable administration) for the trials to follow.

Phase II Clinical Trials. Studies here are designed to provide more information about how the drug is processed in humans, to begin providing information about effectiveness in patients, and to continue to gather data on its safety. These studies allow companies to understand more thoroughly how their drug works with respect to dose, treatment regimen, and target patient population. Generally, Phase II trials involve a larger population of subjects and a lengthier test period than Phase I.

Phase III Clinical Trials. The role of these trials (also called pivotal trials) is to generate information that will lead the FDA and/or non-U.S, regulatory agencies to permit the company to market its new drug. The FDA has estimated that out of every 20 drugs entering clinical testing, on average, 13 or 14 will successfully complete Phase I with only one or two surviving the rigor of Phase III trials.

As noted previously the cost and time incurred to complete regulatory requirements associated with drug development are substantial despite the recent FDA Guidance for Fast Track Drug Development Programs. The latter addresses expedited development and review for only those drugs intended to treat serious or life-threatening conditions and that demonstrate the potential to address unmet medical needs. Consistent with this FDA Guidance, in early 1996 several new breakthrough protease inhibitors for the treatment of HIV and AIDS were approved only a few months after their applications were filed. However, the majority of drugs offering tremendous market potential (e.g., treatments of obesity, hypercholesterolemia, and behavioral disorders) fail to meet "fast track" criteria.

The Market Opportunity

"The single largest challenge facing drug developers--both [Large Pharma] and [biotechs]--is to contain R&D costs and reduce development times without compromising clinical test design. It's a tall order". (7) Anne's experience convinced her that increasing the efficiency of the drug development process could significantly enhance the growth and profitability of biotechs. She believed that to do so biotechs must (1) emphasize the use of pharmaceutical discovery phase screening tests to identify and eliminate flawed products prior to investing in their development, and (2) reduce the cost of operations by outsourcing (i.e., contracting) these discovery activities, thereby converting fixed to variable costs.

Anne thus envisioned the BSIF to be a firm that would be the preemptive service provider in the discovery phase testing market segment with a mission to reduce product failure and financial burn rates. This firm would serve as a third party intermediary linking biotechs--and potentially Large Pharmas--to outsourced discovery testing capabilities. For a fee, the BSIF--as an agent rather than the discovery testing service provider--would receive, source, negotiate, execute, and manage a biotech's "order" to contract with an existing laboratory or scientist(s) to perform the desired testing.

Size of Potential Market

The size of the discovery phase product testing market segment depends on

1. the magnitude of total R&D expenditures by biotechs on both discovery and development testing phases, and

2. the proportion of total R&D expenditures that are directed toward discovery phase testing.

Current Status of Biopharmaceutical Product Discovery and Development Testing

The cost of bringing a biopharmaceutical product to market is high and continues to grow. In 1989, the average cost per product was $125 million, climbing to $231 million in 1993. Pre-tax estimates for 1999 ranged from $500 to $600 million--and increased to over $800 million by 2001. These figures include the cost of research failures occurring in various stages of discovery and development that are judged to be at least as high as $440 million. Development phase delays have been estimated to cost $10 million per week and a 1994 study found that only 30 percent of drugs introduced to market from 1980 to 1984 provided returns exceeding their average after-tax R&D costs. (8) Premarketing product failure rates are high and have a tremendous impact on R&D expenditures. Product failures occur at all stages throughout both the discovery and development phases. During early-stage discovery activities only one out of every 1,000 to 10,000 compounds advances further into R&D. Of these, 50 percent fail during preclinical studies and, of the remainder, 80 percent fail during clinical trials.

Not only are nearly two-thirds of R&D costs associated with the second phase of development, costs are highest for the later of the development phase activities. For example, preapproval clinical development accounts for roughly 33 percent of total product R&D expenditures, whereas initial discovery phase evaluations for activities account for only 10 percent. Thus, the cost of product failure is disproportionately higher for late-stage failures. Even those products eliminated during preclinical evaluation have expended upward of $100 million of R&D funds.

Estimated R&D Expenditures for the Biopharmaceutical Industry: 2000-2005

Global R&D spending by Large Pharma was over $40 billion in 1998, and industry analysts estimated R&D spending to be $50 billion by 2000, implying an annual growth rate of 12 percent, which they expected to continue for at least the next three to five years. Global R&D spending by biotechs was $9 billion in 1998 and expected to grow at the same rate forecast as that for Large Pharma. Whereas the pharmaceutical industry devoted 10 percent to 20 percent of annual sales to R&D, biotechs typically committed over 50 percent of annual sales to R&D xpenditures. This reflects in part the large number of biotechs with no product sales.

With discovery phase expenditures averaging 35 percent of all R&D expenditures, industry analysts estimated global discovery phase expenditures at $21.5 billion in the year 2000; Exhibit 2 provides these estimates for the period 2000-2005. Industry analysts expected that by 2000, 11 percent of global R&D expenditures would be outsourced.

This shift from in-house to outsourced R&D was expected to continue; the percentage of R&D expenditures outsourced was expected to grow at an annual rate of 20 to 30 percent for the period 2000-2005.

Anne Evans estimated that outsourced global discovery phase expenditures would grow from a base of $2.4 billion in 2000 to $12.7 billion in 2005 if outsourced discovery phase expenditures comprised 35 percent of outsourced R&D expenditures. These estimates were uncertain, of course, and could be higher if more drug candidates resulted from new discovery research technologies emanating from the Human Genome Project and other aspects of genomics, combinatorial chemistry, high throughput screening, and bioinformatics.

Proposed BSIF

The BSIF Anne Evans had in mind would comprise specialists with requisite skills in assisting clients to outsource their discovery phase activities. Initially, the BSIF would identify and link biotechs with capable discovery phase testing service providers--and generally assist with agreement negotiation and execution. Other services would include outsourced research management and outsourced activity analysis or consulting. Services could be bundled or offered separately as needed. The BSIF would charge fees for identifying discovery phase test capabilities needed by clients, negotiating agreements with, and executing resulting contracts with discovery phase testing services. Factors that would influence BSIF fees were likely to be size of offering/contract, difficulty associated with linking the buyer and seller, the BSIF's competitive environment, due diligence effort required, current market demand and conditions, anticipated expenses or concessions, and client-specific demands.

Based on Anne Evans' experience, discovery phase testing capabilities that could be outsourced by biotechs would range in cost from $10,000 to $5 million per contract. A fee of 10 percent to 15 percent of a contract's value was proposed as appropriate compensation for BSIF services requiring identification, negotiation, and execution of contract discovery phase testing capabilities on behalf of a biotech. The percentage quoted to the client would, however, be dependent on whether all of the services listed above were included, as well as other relevant factors. In addition to the fees tied to identifying discovery phase testing services, the BSIF would provide a variety of management and consulting services. As most of these projects were not expected to have clearly limited needs, clients would be billed a fixed rate fee per hour. Biotech experts' fees generally ranged from $200-$400 per hour.

To assess the demand for BSIF services and acceptability of the proposed fee structure, six biotech executives and consultants to biotechs were interviewed by Anne ton determine concept acceptance. The respondents were asked whether they would use this service and, if so, what they judged as appropriate costs for services. Anne solicited further comments from the respondents regarding attributes that might be critical to their use and cost acceptance of BSIF services. A summary of the information provided to the respondents and their replies are given in Exhibit 3; the replies from the respondents were a combination of verbal and written quotes.

Anne believed that these quotations reflected factors that would be crucial to the success of her venture. She knew that the BSIF needed to provide high-quality, reliable service and be responsive to its customers. She also realized that competitors would enter the market, and was concerned about the possibility of biotechs bypassing her BSIF after the initial use of its services.

Competitive Analysis of BSIF Target Market

Anne Evans' research failed to identify organizations serving the market segment targeted by the proposed BSIF. She, therefore reasoned that a preemptive first-mover entry by targeting biotechs as initial customers could yield sustainable competitive advantages (see Exhibit 4). Following BSIF market entry Anne had identified two groups of potential entrants based on their assets and competencies: biopharmaceutical contract research organizations (CROs) and business management consulting firms (BMCFs). The former understood biotechs' technical needs and the latter, their management needs.

CROs perform contract research testing services with the vast majority offering development phase testing services. However, some CROs that have provided standardized discovery testing and development management and consulting services were likely to be more direct competitors of the BSIF. If these CROs elected to develop customized discovery testing they would reduce biotechs' need to utilize the BSIF to identify and link them to such services. Alternatively, CROs that decided to expand into discovery management and consulting could become formidable competitors of the BSIF CROs judged as the greatest potential threat to the BSIF were Discovery Partners International, MDS Panlabs, Phoenix International Life Sciences, and Quintiles Transnational. Exhibit 5 summarizes Anne's assessment of the competitive strengths and weaknesses of these potential competitors.

BMCFs as potential entrants into the BSIF's market segment were likely to be a less significant threat than CROs. BMCFs generally offered corporate finance, process management, strategy, and technology application services spanning multiple product, resource, and service industries including biotechnology. Several large BMCFs provided biotechnology R&D consulting services including process, strategy, and productivity improvement. Further expansion into the research (i.e., discovery) consulting component of their existing R&D services would put BMCFs into direct competition with the BSIF. However, such a move would require significant investment in additional, highly skilled personnel to provide these services. BMCFs Anne recognized as potential threats included Ernst & Young, Deloitte Consulting, and McKinsey & Co. Exhibit 5 provides this strategic group's competitive strengths and weaknesses.

Empirical evidence from studies suggested that the BBSIF as a first mover into it market segment would gain, at least, a short-term advantage in market share. One study (of mature industrial goods businesses) reported that first movers into markets averaged 29 percent of market share; early followers 21 percent; and late entrants 15 percent. (9)

However, other studies Anne reviewed reported that the failure rate among first movers into markets is 47 percent, with the five factors identified as critical to success being vision, persistence, commitment, innovation, and asset leverage, (10) These same studies suggested that the mean market share of surviving pioneers is 10 percent. Exhibits 6 through 8 reflect the results of Anne Evans' financial analysis to assess her proposed BSIF's operating profitability for the years 2000-2005. The long-term BSIF market share and profitability (i.e., after the fifth year of operations going forward) depended on whether both CROs and BMCFs are expected to be early followers into the BSIF's market segment.

Estimates of Long-Term Profitability for Proposed BSIF

The BSIF's startup costs, which Anne projected at $510,000, included cash outflows for personnel, offices, information technology and communication, business travel, and promotion of services. Successful entry and gain of market share could be dependent on investing in top professionals and in prime quality office space with high visibility and in close proximity to customers (see Exhibit 6).

Anne's vision was that the BSIF's growth strategy would be to compete by differentiating competencies that provided sustainable competitive advantages, resulting in continued gain of market share subsequent to entry of followers into its market segment. These differentiating competencies would include premium quality customer service, management that combined biotechnical and business expertise, and market research capabilities. Anne was confident that the BSIF's sources of revenue would be renewable. Instead of bypassing her BSIF, after initial use as an identifier of outsourced services, biotechs would become repeat BSIF customers because of the cost savings recognized from its contract management services. The first set of customers Anne would target were biotechs, segmenting them into (1) newly funded startups, and (2) established firms with restricted cash flows, due to high bum rates. As the BSIF established a proven record in reducing pharmaceutical discovery costs, a second set of customers would be targeted. This set comprised Large Pharma that although unhampered by cash flow restrictions, faced huge outlays for discovery phase testing and were under constant pressure (from the capital markets) to enhance profitability.

Anne intended to retain all earnings for the first five years of operations and use them to grow the initial office as well as open new offices in geographic hotbeds of the biotechnology industry. She estimated the cost of each new office at the cost of the first ($510,000) plus 4 percent annual inflation. Existing offices would be allocated the cost of new office capacity from preceding years plus 4 percent annnual inflation for expansion. The BSIF's profit margin was estimated from data Anne obtained on publicly held CROs that she judged as significant potential competitors (MDS, Phoenix International Life Sciences, and Quintiles Transnational). For 1999 the after-tax profit margins for these CROs ranged from 5.3 to 7.8 percent. However, Anne knew from her industry experience that each also provided contract testing and therefore was committed to significant laboratory and associated personnel fixed costs far in excess of what she expected the BSIF to incur. Therefore, she estimated the BSIF's profit margin at 10 percent. Anne's forecasts suggested that during the BSIF's first five years of operation sufficient net income would be generated to open 12 offices. The growth strategy is detailed in Exhibit 7.

Estimated incremental free cash flows are provided in Exhibit 8. Anne based them on the following: she would start with $0.25 million for working capital and outlays for the initial office, and maintain future working capital at 20 percent of the difference between the current and preceding year's total revenues. Anne estimated the BSIF's earnings before interest and taxes (EBIT) from the financials of the CROs noted above. For 1999, their EBITs ranged from 7 to 13 percent, with the former figure associated with an organization that subsequently restructured to cut costs. Due to the BSIF's anticipated lower cost of operations, Anne assumed an EBIT rate of 20 percent. The BSIF's tax rate of 30 percent was selected based on the reported tax rates for these same CROs. Her BSIF's preliminary valuation based on these revenue and profit projections is provided in Exhibit 9.

Decision Time for Anne Evans

In the course of the last few years Anne had attended numerous presentations in which venture capitalists and founders of technology startups addressed the requirements for success of entrepreneurial ventures. All agreed that the success of any venture depended on its ability to generate attractive long-run growth and profitability. The latter in turn depended on the attractiveness of the venture's market opportunity, and the competitive position created by the management team to exploit the venture's market opportunity.

As Anne reviewed her options after learning she would soon be once--again--without a job in the biotech industry, she was well aware that she did not want to return to either veterinary practice or to academia. She realized, as well, that she harbored a twinge of bitterness toward the biotech industry that had now laid her off twice and dealt similar blows to valued colleagues. She was extremely confident about her assessment of the BSIF's potential as a going concern as well as the possibilities it held to generate personal wealth. However, while Anne had no doubts regarding her business analysis underlying the feasibility of establishing a BSIE she pondered what action to pursue at this juncture. She asked herself, "Is the BSIF what I truly want to dedicate myself to?" Anne recalled some of the comments offered by the executives she had interviewed to identify BSIF attributes that would be critical to its success (i.e., the BSIF "must be a high-quality, reliable service ..."; it must provide "prompt response to a biotech's needs"; it must have a "strong commitment to confidentiality"). Wasn't it interesting, Anne thought to herself, that none of these executives had identified as a critical success factor whether Anne had a passionate, unrelenting commitment to make this entrepreneurial venture succeed. She knew that the latter was absolutely essential to the BSIF's success or failure. So there Anne sat. She looked in the mirror and asked herself, "Am I excited by the prospects of launching this venture and do I have the passion to see it through to success that will sustain me through the entrepreneurial struggles that will inevitably follow?"

Appendix

Methodology Used to Prepare Case

This case is based on a thesis project required in the Executive MBA Program at San Diego State University (SDSU). For most of the '90s Anne Evans held positions of increasing responsibility in the biopharmaceutical industry dealing with various aspects of the drug development process. Anne has identified a potential market opportunity associated with the drug development process that she hopes to exploit via an entrepreneurial venture. Her MBA project completed in August 2000 examined the feasibility of establishing this venture. Anne Evans' co-author is Nikhil Varaiya, a professor in the EMBA Program at SDSU and was Anne's faculty advisor on her project. Anne Evans is very keen to have her "process of discovery of an entrepreneurial opportunity" become an integral part of an instructional case study.

In the fall of 2000 a first draft of the case study was distributed to students in Professor Varaiya's graduate entrepreneurial finance course to seek input about the case and its viability for classroom use. Thereafter, a revised version of the case was used in the spring of 2001 in his financial management course in the EMBA Program at SDSU. Additionally, CFOs of two well-known biotechnology firms (which are subsidiaries of publicly traded pharmaceutical firms) in San Diego also reviewed the case and provided insight into the complexity of the drug development process. The present version of the case reflects graduate student input and Professor Varaiya's experience from continuing use of the case with EMBA participants.

The authors wish to thank Gregg Capella, Alex DeNoble, David Galanti, Larry Gitman, Kent Johnson, Dave Osborn, and Dennis Smith for their insightful comments on earlier versions of this case. We want to especially thank three anonymous reviewers and the case editor, William Sandberg of Entrepreneurship Theory and Practice for their comprehensive and insightful comments and suggestions.

Exhibit 1

The Drug Development Process: What Happens and When

            Early
            Research/
            Preclinical  Phase I     Phase II           Phase III
            Testing      Trials      Trials             Trials

Years       6.5          1.5         2                  3.5

Test        Test tube    20 to 80    100 to 300         1,000 to 3,000
population  and animal   healthy     patients           patients
            studies      volunteers

Purpose     Look for     Determine   Evaluate           Confirm
            safety,      safety and  effectiveness,     effectiveness,
            desired      dosage for  look for           look for side
            activity     the next    potential          effects from
                         phase       toxic side         long-temt use
                                     effects

Success     5,000        5
rate        evaluated    compounds
                         enter
                         clinical
                         trials

            FDA
            Review
            Process/     On
            Approval     Market      Phase IV

Years       1.5          Took 15
                         years to
                         get here
Test                                 Patients
population

Purpose                              (1) Postapproval
                                     surveillance
                                     to look for
                                     potential
                                     problems
                                     (2) Promotional/
                                     marketing
                                     studies
Success     1
rate        compound
            approved

Source: Pharmaceutical Research and Manufacturing Association.

Exhibit 2

R&D Expenditure Forecasts for the Biopharmaceutical
Industry (2000-2005) (1) (in Billions of U.S. $)

                    R&D Expenditures

            Global R&D            Global Discovery
           Expenditures          Phase Expenditures
            (12% Annual            35% of Global
Year     Rate of Increase)       R&D Expenditures)

2000           $61.3 (2)               $21.5
2001           $68.6                   $24.0
2002           $76.9                   $26.9
2003           $86.1                   $30.1
2004           $96.4                   $33.7
2005          $108.0                   $37.8

1. Engel, S. A time to outsource: Part 1 of 2. R&D Directions, 5(8),
September 1999.

2. Firn, D. Survey-Life Sciences: Temporary help stretches to long
term: Contract research organizations. Financial Times, July 15, 1999.

3. Maloff et al., (1997). Maximizing Return on Investment and
Minimizing Risk in Partnering with Preclinical CROs. Drug Information
Journal, 31, 857-863.

4. Pilling, D. (1999). Survey-FT Director: Revolution behind surge in
budgets: Pharmaceuticals, Financial Times, June 25.

(1) Developed from the following sources: Engel, 1999; Firn, 1999;
Maloff et al., 1997; Pilling, 1999.

(2) $50bn in expenditures by the pharmaceutical industry plus an
additional $11.3bn by the biotech industry.

Exhibit 3

BSIF Concept Testing--Information Provided to Respondents

To assess the demand for a BSIF's services and acceptability of the
proposed fee structure, six potential customers (i.e., Biotech
executives mad consultants to biotech executives) were questioned
regarding concept acceptance. The individuals selected received the
following information.

Background:

A feasibility study for a Biotechnology Services Investment Firm (BSIF)
is being performed and your input, as a potential customer, is
requested to assess the concept's viability and value. The concept is
based upon a perceived need to reduce product failure and financial
burn rates and that these objectives could be achieved as follows. (1)
Greater emphasis on the use of pharmaceutical discovery phase (i.e.,
early-stage research) screening tests to identify and eliminate flawed
products prior to investing in their development. (2) Reduction of the
cost of operations by outsourcing (i.e., contracting) these discovery
activities, thereby converting a biotech's fixed costs to variable
costs. The BS1F would be modeled after the financial industry's
investment banking firms, serving as a third party intermediary who
will link biotechs to pharmaceutical discovery testing outsource
capabilities. For a fee, the BSIF will--as an agent rather than as the
discovery testing service provider--receive, source, negotiate, execute
and manage a biotech's "order" to contract an existing laboratory or
appropriate scientist to perform the desired discovery phase research
testing.

Scenario:

Your organization has a new chemical entity (NCE). or several related
ones, that have the potential to become a blockbuster treatment for a
previously untreatable condition. However, significantly more
proof-of-concept discovery phase studies must be performed to identify
the optimal NCE and gain assurance of its potential before initiating
costly, standard regulatory-required development testing of the NCE's
structure, formulation, preclinical activity, and clinical performance.
One option is to obtain and spend the financial resources necessary to
build/expand the organization's (non-) existing laboratory capabilities
(i.e., fixed costs committed to plant, equipment, scientists, and
technicians) to perform the studies. An alternative is to employ the
BSIF's services to identify, negotiate, contract, and manage an
existing laboratory/scientist with the expertise to pursue the rather
unique and NCE-specific studies on an outsourced basis.

Questions:

(1) Would you seriously consider using the BS1F's services as an
alternative to performing the research in-house?

(2) If so, what is the most that you would be willing to pay the BSIF
for its services (e.g., 5 percent of the total cost of the outsourced
contract to the BSIF as a "finder's fee"? 10 percent? 20 percent?)

(3) Can you offer further comment regarding what attributes might be
critical to your decision to use the BSIF initially or on an ongoing
basis, as well as factors that might influence the amount that you
would be willing to pay for this service?

Responses were gathered either by e-mail response or telephone
conversation. A summary of the responses is provided in the table that
follows.

                                        Response to Questions (1)

Respondent/
Respondent's Background                 (1)         (2)

Respondent 1:                           Yes         25%
* VP with primary outsourcing respo-
  nsibility.
* Historically, has outsourced all
  development & some discovery phase
  testing.
* With a biotech employing -50 full-
  time personnel.
* Publicly held biotech. Current
  price per share < $3.
* No marketed products. One NDA
  awaiting approval.

Respondent 2:                           Yes         17-20%
* Ex executive (current consultant                  (A 10% fee is
  to CEOs).                                         usually well
* Executive for Large Pharma (> 1,000               tolerated for
  full-time personnel) and mid-size                 outsource
  Biotech (> 50 full-time personnel).               management.
  Consultant to small biotechs (< 10                Add 7-10%
  full-time personnel).                             for outsource
* While an executive, generally out-                identification
  sourced some-to-most development,                 and contract
  however little-to-no discovery                    negotiation.)
  testing.

Respondent 3:                           Yes         5% + equity
* Director with primary outsourcing
  responsibility.
* Historically, has outsourced all
  development testing.
* Existing laboratories (biotech's &
  founder's academic) perform disco-
  very testing.
* With a biotech employing [less than
  or equal to] 10 full-time personnel.
* Privately held biotech. High rate
  of cash burn.
* No marketed products and none near
  marketing.

Respondent 4:                           Yes         10-15%
* World-renowned consultant on                      15-20%
  bio/pharmaceutical development for
  biotech and Large Pharma executives.
* Has held senior management positi-
  ons with Large Pharma, however most
  of career has been in academics and
  as a consultant to bio/pharmaceu-
  tical executives and regulatory
  authorities.

Respondent 5:                           Non-        Not given.
* Ex CEO (current consultant to         committal   (Suggested
  CEOs), Resigned as CEO when unable                alternative
  to raise adequate capital.                        concept be
* While CEO, only approved outsourced               priced at
  development tests. Built lab and                  [less than or
  hired expertise to [up arrow] in-                 equal to] 50%
  ternal discovery and development                  return on
  capabilities.                                     product's
* From biotech employing [less than                 revenue.)
  or equal to] l0 full-time.
* Privately held. High rate of cash
  burn.
* No marketed products and none near
  marketing.

Respondent 6:                           Non-        Not given
* Ex CFO of biotech fully-owned by      committal
  Fortune 500 pharmaceutical firm.
* Prior experience as president and
  owner of company that marketed and
  distributed cosmetic products.

                                        Response to Questions (1)

Respondent/
Respondent's Background                 (3)

Respondent 1:                           * Must be a high-quality,
* VP with primary outsourcing respo-      reliable service that is
  nsibility.                              highly responsive (both
* Historically, has outsourced all        the BSIF & the outsource)
  development & some discovery phase      to the biotech's need for
  testing.                                frequent test-related in-
* With a biotech employing -50 full-      formation.
  time personnel.
* Publicly held biotech. Current        * Consider [down arrow] %
  price per share < $3.                   fee as contract cost [up
* No marketed products. One NDA           arrow] &/or
  awaiting approval.                    * Consider a fixed rate fee
                                          per hour for some of the
                                          BSIF's services.

Respondent 2:                           * A biotech's founder is
* Ex executive (current consultant        usually a scientist that
  to CEOs).                               wants to perform much of
* Executive for Large Pharma (> 1,000     the research. Even so,
  full-time personnel) and mid-size       considerable research must
  Biotech (> 50 full-time personnel).     still be outsourced, and
  Consultant to small biotechs (< 1O      the BSIF could add value
  full-time personnel).                   by [up arrow] outsource
* While an executive, generally           organization and focus.
  outsourced some-to-most developm-     * The concept is reasonable.
  ent, however little-to-no discovery     but there will be imita-
  testing.                                tors.
                                        * Need to start with several
                                          fixed-price service pac-
                                          kages.
                                        * After initial use of BSIF,
                                          biotechs may bypass it and
                                          try to contract directly
                                          with outsource service
                                          provider.
                                        * Fees will be based on sa-
                                          vings recognized by biot-
                                          echs (1) by having BSIF
                                          identify & negotiate con-
                                          tract and (2) manage exe-
                                          cution of outsourced ser-
                                          vices.
                                        * Prompt response to a bio-
                                          tech's needs (both the
                                          BSIF & the outsource) will
                                          be critical to success.

Respondent 3:                           * BSIF must have strong com-
* Director with primary outsourcing       mitment to confidentia-
  responsibility.                         lity.
* Historically, has outsourced all      * Biotech's provision of
  development testing.                    equity to BSIF (in addi-
* Existing laboratories (biotech's &      tion to percentage fee)
  founder's academic) perform disco-      suggested for the follo-
  very testing.                           wing reasons. (1) As an
* With a biotech employing [less than     incentive to [up arrow]
  or equal to] 10 full-time person-       the BSIF's commitment to
  nel.                                    perform in the biotech's
* Privately held biotech. High rate       best interests. (2) Decre-
  of cash burn.                           ase biotech's cash outflow
* No marketed products and none near      for services.
  marketing.

Respondent 4:                           * Fees biotechs will be wi-
* World-renowned consultant on            lling to pay will depend
  bio/pharmaceutical development for      on their source of funding.
  biotech and Large Pharma executi-     * Biotechs with large Pharma
  ves.                                    backing (e.g., agreements
* Has held senior management positi-      providing milestone paym-
  ons with Large Pharma, however most     ents) will only be willing
  of career has been in academics and     to bear relatively lower
  as a consultant to bio/pharmaceu-       BSIF fees.
  tical executives and regulatory       * Self-financed (i.e., An-
  authorities.                            gel, VC funding) will be
                                          willing to bear relatively
                                          higher fees.
                                        * Assumptions: fees do not
                                          include equity, and the
                                          service is efficient and
                                          controllable [by the bio-
                                          tech).
                                        * A biotech's commitment to
                                          future outsource services
                                          generally reduces initial
                                          contract costs by 20-30%.

Respondent 5:                           * Knew of three groups try-
* Ex CEO (current consultant to           ing to accomplish someth-
  CEOs), Resigned as CEO when unable      ing similar.
  to raise adequate capital.            * Consider, instead, having
* While CEO, only approved outsour-       the BSIF in license NCEs
  ced development tests. Built lab        from himechs, perform/out-
  and hired expertise to [up arrow]       source the R&D, and partner
  internal discovery and development      the more developed/promi-
  capabilities.                           sing NCEs to Large Pharma
* From biotech employing [less than       for final development,
  or equal to] l0 full-time.              marketing, y and sales.
* Privately held. High rate of cash
  burn.
* No marketed products and none near
  marketing.

Respondent 6:                           * My understanding of out-
* Ex CFO of biotech fully-owned by        sourcing, as well as prin-
  Fortune 500 pharmaceutical firm.        ciples I have used in my
* Prior experience as president and       own decision-making, is
  owner of company that marketed and      that you outsource non-
  distributed cosmetic products.          critical tasks. This allows
                                          you to focus on your core
                                          business. For biotech drug
                                          discovery, you find the
                                          smartest and most aggress-
                                          ive scientists and hire
                                          them to sweat out the new
                                          discoveries and eat and
                                          breathe this. This would be
                                          a scary thing to outsource.
                                        * The reason CROs (Contract
                                          Research Organizations)
                                          exist is that the compan-
                                          ies can lay out a very
                                          detailed and straightfor-
                                          ward program. Drug disco-
                                          very is not straightfor-
                                          ward in any sense of the
                                          word. It is inspired se-
                                          rendipity and luck. If
                                          this is farmed out, and
                                          the science doesn't work,
                                          the consultant gets bashed.
                                          If it does work, the
                                          consultant is so involved
                                          that he or she should be
                                          getting equity upside.

(1) Questions:

(1) Would you seriously consider using the BSIF's services as an
alternative to performing the research in-house?

(2) If so, what is the most that you would be willing to pay the BSIF
for its services (e.g., 5 percent of the total cost of the outsourced
contract to the BSIF as a "finder's fee"? 10 percent? 20 percent?)

(3) Can you offer further comment regarding what attributes might be
critical to your decision to use the BSIF initially or on an ongoing
basis, as well as factors that might influence the amount that you
would be willing to pay for this service?

Exhibit 4

BSIF Sources of Preemptive Competitive Advantage

Discovery Service Supply

* Secure access to discovery test providers.

* Dominate service supply logistics.

Linking and Consulting Service

* Secure superior service development personnel (i.e., business plus
biotechnical expertise).

* Preempt a position as the most reliable service.

* Become the industry service standard.

Service Systems

* Develop process effectively and efficiently linking biotechs with
discovery testing providers.

* Expand linking and consulting capabilities to discourage competitors
from market entry.

Biotech Customers

* Train biotechs in BSIF usage.

* Condition biotech in BSIF name recognition.

* Secure long-term commitments from customers.

* Gain specialized knowledge about targeted Biotech customer needs.

Service Distribution

* Occupy offices in prime biotechnology industry locations.

Exhibit 5

Key Strengths and Weaknesses of Potential Competitors

Competitor                                 Strengths

Biopharmaceutical Contract Research Organizations (CROs)
Discovery Partners             * Provider of discovery phase test-
International (1)                ing services performed in own labs
                                 by full time personnel.
                               * Ability/willingness to customize
                                 test offerings.
                               * Sensitivity to and focus on the
                                 needs of the BSIF's target custo-
                                 mers and market niche.
                               * Management team and technical per-
                                 sonnel.
                               * Culture (innovative, adaptive,
                                 motivated).

MDS Panlabs (2)                * Subsidiary of a major competitor
                                 in the CRO industry.
                               * Largest provider of standardized
                                 discovery phase testing.
                               * Significant access to capital.
                               * Multinational Corporation with name
                                 recognition.

Phoenix International          * Major competitor in CRO market.
Life Sciences (2)              * Significant provider of early-stage
                                 development phase tests, some sta-
                                 ndardized and some semi-customized
                                 discovery phase tests.
                               * Significant access to capital.
                               * Multinational Corporation with name
                                 recognition.

Quintiles                      * CRO industry leader.
Transnational (2)              * Largest provider of development
                                 phase testing services.
                               * Significant access to capital.
                               * Multinational Corporation with name
                                 recognition.

Business Management Consulting Firms (BMCFs) (3,4)
Ernst & Young                  * Significant access to capital.

Deloitte Consulting            * Business management expertise.
McKinsey &                     * Information technology systems
Company                          applicable to establishment of
                                 database of service providers.
                               * Multinational corporations with
                                 name recognition.

Competitor                                 Weaknesses

Biopharmaceutical Contract Research Organizations (CROs)
Discovery Partners             * Small CRO and early-stage venture.
International (1)              * Limited access to capital.
                               * Significant fixed costs.
                               * Limited scope of discovery testing
                                 capabilities.
                               * Limited name recognition.
                               * Relatively small customer base.
                               * Primarily a domestic (San Diego)
                                 corporation.

MDS Panlabs (2)                * High volume/low cost structure
                                 suggests limited or inability to
                                 customize discovery phase offerings.
                               * Corporate size and organizational
                                 structure consistent with inability
                                 to adapt to specific customer needs.

Phoenix International          * Corporate size and organizational
Life Sciences (2)                structure predisposing to inabili-
                                 ty to adapt to specific customer
                                 needs.

Quintiles                      * Image (development phase service
Transnational (2)                provider).
                               * Lack of commitment to providing
                                 discovery phase services.
                               * Historically inflexible (e.g., or-
                                 ganizational structure, to customer
                                 services) suggest inability to
                                 adapt to market needs.

Business Management Consulting Firms (BMCFs) (3,4)
Ernst & Young                  * Limited knowledge of sources of
                                 discovery phase testing.

Deloitte Consulting            * Current biopharmaceutical customer
McKinsey &                       base dominated by large bio/phar-
Company                          maceutical corporations; not small
                                 biotechs initially targeted by the
                                 BSIF.
                               * Questionable commitment to disco-
                                 very phase market niche.

(1) Discovery Partners International is privately held, thus strengths
and weakness are based on Anne Evans' consulting interactions with the
organization.

(2) Source: Evans, 1999.

(3) Sources: Developed from the following World Wide Web sites:
http//www.ey.com, http://www.dc.com and http://www.mckinsey.com.

(4) Strengths and weakness are provided for the BMCF strategic group
as a whole, rather than for individual organizations within that group.

Exhibit 6

Estimated Start-Up Costs (Year 0) (in US $)

Salaries & Benefits:
  Founder & Cofounder (each with Doctorate + MBA)         $200,000
  Office Manager                                           $80,000
  Executive Assistant                                       60,000

Office (1):
  1,000 sq. ft prime location in "Golden Triangle"          25,000
  (@$25/sq ft/yr)
  Furnishings, files, fax, photocopier                       7,500

  Parking                                                    1,500
Information Technology & Communication Set-Up & Support     25,000
Business Travel & Expenses                                  20,000
Promotion                                                    6,000

  Subtotal                                                 425,000
Safety Margin of 20%                                        85,000
Total:                                                    $510,000

(1) Source: D. Hearst of Cushman Realty, La Jolla, CA. (December 30,
1999).

Exhibit 7

BSIF Market Forecast and Growth Strategy, 2000-2005 (in Millions of
U.S. $)

                                          Year 0 (1)    Year 1
                                            2000         2001

Size of Market (2)                           $--         $495
Number of Offices                             1            2
Cost of New Office Capacity
  Expansion of Existing Office(s) (3)                    $.53
  Establishment of New Offices (4)          $0.51        $.53
  Total                                     $0.51       $1.06
Growth Strategy
  Projected Market Share (%) (5)                          10%
  Revenues (6)                                            $50
  Net Income (7)                                         $4.95
  g (annual % increase in revenues, net
  income)

                                           Year 2       Year 3
                                            2002         2003

Size of Market (2)                          4694         $971
Number of Offices                             6            8
Cost of New Office Capacity
  Expansion of Existing Office(s) (3)       $1.10        $3.44
  Establishment of New Offices (4)          $2.21        $1.15
  Total                                     $3.31        $4.59
Growth Strategy
  Projected Market Share (%) (5)             20%          19%
  Revenues (6)                              $139         $185
  Net Income (7)                           $13.87       $18.45
  g (annual % increase in revenues, net    $180.0%      $33.0%
  income)

                                           Year 4       Year 5
                                            2004         2005

Size of Market (2)                         $1,360       $1,903
Number of Offices                            10           12
Cost of New Office Capacity
  Expansion of Existing Office(s) (3)       $4.77        $6.20
  Establishment of New Offices (4)          $1.19        $1.24
  Total                                     $5.97        $7.45
Growth Strategy
  Projected Market Share (%) (5)             17%          16%
  Revenues (6)                              $231         $305
  Net Income (7)                           $23.11       $30.45
  g (annual % increase in revenues, net     25.3%        31.8%
  income)

(1) Year 0 devoted to set-up of initial office (see Exhibit 6 for
startup costs); no revenues expected to be generated.

(2) Figures derived as 15% fees on forecasts for outsourced global
discovery phase expenditures.

(3) Total cost of new capacity from preceding year plus 4% annual
inflation reinvested in expansion of existing offices.

(4) Exhibit 7 provides costs for set up of initial office. Cost of
additional offices projected at 075 million plus 4% annual inflation
x # of new offices.

(5) See narrative discussion under "Competitive Analysis" for market
share forecast justification.

(6) Revenues = Market Share x Size of Market.

(7) Net Income (after tax) derived from estimated 10% Profit Margin x
Revenues. See narrative discussion under "Estimates of Long Term
Profitability for Proposed BSIF" for profit margin forecast
justification.

Exhibit 8

Incrmental Free Cash Flows, 2000-2005 (in Millions of U.S. $)

                                      Year 0 (1)      Year 1
                                         2000          2001

Total Revenues (1)                                      $50
Pre-Tax Operating Expense (2)             --            $40
Rev-Total Expenditures (TTL EXP)          --           9.91
Taxe (3)                                  --           2.97
Rev-TTL EXP-TAXES                         --           6.94
Incremental Working Capital (4)         (0.25)         9.91
Cost of New Capacity                    (0.51)         1.06
Net Cash Flow                           (0.76)        (4.03)

                                        Year 2        Year 3
                                         2002          2003

Total Revenues (1)                       $139          $185
Pre-Tax Operating Expense (2)            $111          $148
Rev-Total Expenditures (TTL EXP)        27.75         36.90
Taxe (3)                                 8.32         11.07
Rev-TTL EXP-TAXES                       19.42         25.83
Incremental Working Capital (4)         17.84          9.16
Cost of New Capacity                     3.31          4.59
Net Cash Flow                           (1.72)        12.08

                                        Year 4        Year 5
                                         2004          2005

Total Revenues (1)                       $231          $305
Pre-Tax Operating Expense (2)            $185          $244
Rev-Total Expenditures (TTL EXP)        46.22         60.91
Taxe (3)                                13.87         18.27
Rev-TTL EXP-TAXES                       32.36         42.63
Incremental Working Capital (4)          9.32         14.68
Cost of New Capacity                     5.97          7.45
Net Cash Flow                           17.06         20.50

(1) Assume credit sales.

(2) Pretax operating expense includes depreciation allowances but
excludes interest expense and is estimated at 80% of total revenues.
See narrative discussion of EBIT under "Estimates of Long-Term
Profitability for proposed BSIF" for operating expense forecast
justification.

(3) Tax rate = 30%. See narrative discussion under "Estimates of Long-
Term Profitability for proposed BSIF" for operating expense forecast
justification.

(4) Incremental working capital of $.25 million in Year 0, & thereafter
maintained at 20% of the difference between the current and preceding
year's total revenues.

Exhibit 9

Valuation Projections

                                   Worst Case     Most Likely

Assumptions
Exit year                           7 (2007)        5 (2005)
Market growth rate (%)                40%             40%
Revenue (in millions)                 $274            $305
Profit Margin (%)                      5%             10%
P/E multiple (X)                       5               15
Total equity value in exit            $69             $457
  year (in millions)

                                   Best Case

Assumptions
Exit year                           3 (2003)
Market growth rate (%)                40%
Revenue (in millions)                 $335
Profit Margin (%)                     15%
P/E multiple (X)                       35
Total equity value in exit           $1,759
  year (in millions)

(1) Modeled from the following source:
Wetzel, W.E. "Venture Capital" (1997). In W.D. Bygrave (ed.),
The Portable MBA in Entrepreneurship, 2nd ed., 184-209. John
Wiley & Sons, New York.

(2) Obtained from growth in Size of Market in Exhibit 7 "Total
Revenues" assumed same for all three scenarios.

(3) "Most Likely" Revenue = Exhibit 7 "Total Revenues" for
2005. Best/Worse Case  =+/-%10.

(4) See narrative discussion of profit margins for related
businesses under "Long-Term Profitability."

(5) Most young growing companies have a P/E of 15 (Wetzel,
1997), which is used as "Most Likely."

(6) Total equity value = revenues x profit margin x P/E.

(1.) Harris, G. & Adams, C. (2001). Delayed Reaction: Drug Manufacturers Step Up Legal Attacks That Slow Generics--That's One Reason It Takes FDA Longer to Approve Knock-Offs Than Brands--The 'Metabolite Defense.' Wall Street Journal, July 12.

(2.) San Diego-based Agouron Corporation's launch of Viracept.

(3.) "Biotech Marches on Despite Low Success Rates and Faltering Investment." PR Newswire, June 10, 2002, Richmond, England.

(4.) In vitro testing is testing not performed on living organisms.

(5.) This section is based on (1) Robbins-Roth, C. (2000). From Alchemy to IPO: The Business of Biotechnology, Cambridge, MA: Perseus Publishing.; and (2) Standard & Poor's 2001 Industry Surveys for the Biotechnology and Pharmaceuticals sectors of the Healthcare Industry.

(6.) Mathieu, M.P. (ed.). (1999). R&D Spending: Pharmaceuticals. In M.P. Mathieu (ed.), Parexel's Pharmaceutical R&D Statistical Sourcebook 1999, 8.

(7.) Dr. Kenneth Kaitin, Director, Tufts Center for the Study of Drug Development, News Release, November 30, 2001.

(8.) Maloff et al. (1997). Maximizing Return on Investment and Minimizing Risk in Partnering with Preclinical CROs. Drug Information Journal, 31,857-863.

Anne Evans is a consultant/analyst.

Nikhil P. Varaiya is a professor and chairman of the Department of Finance at San Diego State University.

Please send all correspondence to: Nikhil Varaiya, Department of Finance, San Diego State University, 5500 Campanile Drive, San Diego, CA 92182-8236. email: Nikhil.Varaiya@sdsu.edu