Research setting

In this Chapter, I outline the rationale for choosing the biotechnology industry as the empirical setting for my research. I require a model industry in which I can observe sensemaking in entrepreneurial ventures and as stated in Chapter 1, my research objectives and main motivation lie around how entrepreneurial ventures can effectively respond to partial failure, in the form of adverse deviations from the business plan. The model industry needs to satisfy the requirement of being an entrepreneurial venture; as well as a suitable environment to observe sensemaking from a trigger or cue of partial failure evidenced by an adverse deviation from the business plan. I initially consider whether the biotechnology industry contains entrepreneurial ventures.

3.1.1 Entrepreneurial ventures

Biotechnology products need to be innovative to have the potential to take globally leading positions required by a purchaser of the product – the larger pharmaceutical industry. Risk needs to be taken and this environment inherently attracts entrepreneurs, often frustrated in the larger pharmaceutical industry which is risk averse. The biotechnology industry has gone through much change over the last few decades. Much of this change has been driven by the challenges faced by the larger pharmaceutical companies, which have become hungry for new biotechnology products to boost flagging product pipelines. This can be demonstrated by examining 2004, which was a difficult year for the pharmaceutical industry. There were heavier demands for fuller disclosure of clinical trial data by the FDA, accusations of collusions between regulatory agencies and companies compromising drug safety and recalls for major products, namely Vioxx and Celebrex: “These challenges are further compounded in large pharmaceutical

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eating away at price on products that have come off patent” (PricewaterhouseCoopers 2004). Despite these problems, there are huge unmet medical problems, increasing age demographic and emerging geographical markets (particularly China and India) which all lead to an increased and sustainable need for new proprietary product. This is clearly demonstrated by the extent to which US pharmaceuticals come off patent from 2004 – 2011 on the top ten selling drugs in 2004, shown in Figure 3.1.

Figure 3.1: The top ten pharmaceuticals (by sales) coming off patent between 2004 and 2011

Gassmann & Reepmeyer (2005) suggest innovation is a key success factor in the pharmaceutical industry (of which the biotechnology industry is a subclass), which aligns with the need for entrepreneurship. They state that: “Few other industries are as driven

by science, research and development as much as the pharmaceutical industry, however we are still a long way from solid guidelines for the manageability of pharmaceutical innovation” (233). This is evidenced by the fact that in 2003, the major US and European pharmaceutical companies invested more than US$33 billion in research and

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development, at a higher R & D to sales ratio than virtually any other industry including electronics, aerospace and computers (PhRMA 2004). This aligns the key success factor (innovation) to one of the required attributes of an entrepreneur (the ability to identify and exploit opportunities).Hence it is reasonable to conclude entrepreneurial ventures would be commonplace in the biotechnology industry. I next consider whether such a model may be suitable to observe sensemaking episodes.

3.1.2 Biotechnology ventures and sensemaking

Movements in the share price in the biotechnology industry suggest that it is highly volatile and hence a setting where adverse deviations from plans are more likely. Figure 3.2 following shows the volatility of share price from the major European biotechnology companies during 2008. Share price volatility occurs due to the uncertainty of the business plan which often is out of date within weeks of being written. I have invested more than three decades in the biotechnology industry, resulting in the acquisition of in- depth knowledge and access to data, which is beneficial in both planning and interpreting this study; and never been involved in a venture that has held to the business plan for more than three months. As such the business plan represents an idealized journey that can resemble a work of fiction; seldom does a business plan fully hold when put into practice. Deviations from the business plan signal that something has gone wrong, however, such deviations represent equivocal outcomes that are open to multiple interpretations and lend themselves to sensemaking (Maitlis, 2005). Hence it is reasonable to assume this model industry may be a sensible choice to observe sensemaking.

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Figure 3.2: Volatility in share price in the biotechnology industry (Europe 2008)

Source: Datastream

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3.1.3 Failure within the biotechnology industry

The extant literature describes the extent of failures in the biotechnology industry. Biotechnology organisations are highly dependent upon the creation of new drugs (Rothaermel & Deeds, 2004), “while a typical R and D process lasts up to thirteen years,

only one out of ten thousand substances become a marketable product” (Gassmann & Reepmeyer, 2005 233). The percentage of new chemical entities that fail along the drug development pathway are the highest in the preclinical phase (60.2%), and this reduces as the drug candidate moves into the human clinical phase. Once a new drug candidate has been submitted to the appropriate regulatory authority, the attrition rate is noted to decrease to 10% (Buchanan, 2002). Cannon & Edmondson (2005) give examples of failure in the biotechnology industry. They conclude :

90% of newly developed drugs fail in the experimental stage, and thus drug companies have plenty of opportunities to analyze failures. Firms that are creative in analyzing failure benefit in two ways. First analyzing a failed drug sometimes reveals that the drug may have a viable alternate use. For example, Pfizer’s Viagra was originally designed to be a treatment for angina, or Eli Lilly discovering a failed contraceptive drug could treat osteoporosis and a failed antidepressant could be an effective treatment for ADD (attention deficit disorder). Second, probing analysis can sometimes save a failed drug, a good example being Eli Lilly’s Alimta which failed in clinical trials, and after a thorough investigation of the reason for failure by investigating patient notes, it was discovered that the patients who suffered negative effects from Alimta had a deficiency in folic acid. By combining folic acid with Alimta, the treatment worked! (308).

So partial or total failure is commonplace within the biotechnology industry, due to engagement in developing risky products, involving innovation and change. Shepherd

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(2003) comments that a vast array of exploratory and inventive organisational activities, which includes drug development, involve high base rates of failure and they call for highly resilient entrepreneurs who must valiantly persevere for eventual success.

The potential for failure is also heightened in the biotechnology industry because of the risk of being unable to sustain the cash burn requirements; effectively running out of cash and failing to raise the next round of finance. The Ernst & Young survival index (Table 3.1) shows that in both the US and Europe in both 2011 and 2012, around one third of biotechnology companies held less than twelve months of cash reserves, and this was substantially more in Canada.

Years of cash left US Europe Canada

2012 2011 2012 2011 2012 2011 % % % % % % >5 YEARS 22 24 36 27 16 13 3-5 YEARS 8 8 6 10 5 7 2-3 YEARS 15 11 11 10 8 9 1-2 YEARS 21 20 16 20 18 22 <1 YEAR 33 37 31 33 53 48

Source: Ernst & Young beyond borders 2013

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Figure 3.3: The biotechnology venture life cycle

The venture life cycle, as depicted by Figure 3.3, shows the diversity and change the venture must progress through as the venture progresses. The entrepreneur builds the business in the earlier days until value reflection points and enterprise value becomes firmly expected. Missing some time points of projected value inflection may be considered as “small failures” whereas missing significant value reflection points may be considered as moving more towards the catastrophic scenario. When significant value reflection points are missed in entrepreneurial ventures, if venture capital backed, often this triggers an adverse deviation which may form a trigger for the commencement of the sensemaking process.

3.1.4 The role of venture capitalists in biotechnology

I place emphasis on funders, notably venture capitalists, as they form a significant element in the financing of biotechnology companies and their founders (entrepreneurial managers). A broader thesis considering further stakeholders would require substantive work and the primary aim of the research is to consider sensemaking within

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entrepreneurial ventures, which often take investment in the form of venture capital, hence I now consider the venture capital investment in the biotechnology industry.

Venture capitalists

Because true venture capitalists who invest in early stage risky investments, distinguished from the leveraged buy-out investors who invest in later stage less riskier investments, expect failure as part of their business model, such failure is priced into the cost of the equity at entry and there is acknowledgement that failure is endemic: “Such a

playing field is littered with the remains of failed companies” (Gorman & Sahlman,1989 237). Although there appears to be dispute over the exact failure rate of venture capital funded ventures, several studies have reported that over 40% of venture capital investments either become living dead losers or mega-losers (Ruhnka, Feldman & Dean 1992; Smart, 1999).

Scholars have noted that venture capitalists recognise the valuable learning that may accrue from failure (Cardon & McGarth, 1999). It is recognised that the failure stems from both internal and external factors (Zacharakis, Meyer & Decastro 1999). There are several reasons for such failure (Ruhnka, Feldman & Dean 1992). Such reasons include consequential uncertainties and the limited resources typical in venture capital backed businesses which means unexpected snags can be extremely damaging, along with market problems, and the quality of the management may not be up to the demands of the marketplace (Ruhnka, Feldman & Dean 1992).

3.1.5 Differences in venture capital in the USA and UK

There is an important contrast to the view taken in the USA and the UK. Cope, Cave & Eccles (2004) report the following observations. American venture capitalists are more tolerant and pragmatic about failure and expect entrepreneurs to have two or three failures before they succeed, and they have a better understanding of the entrepreneurial process, making them more supportive and sympathetic of entrepreneurs and

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entrepreneurial activity in general. In contrast, British venture capitalists work on the presumption of guilt that the management team are always deficient, and hence they rarely invest in the failed entrepreneur a second or subsequent time, and they tend to adhere to stereotypical cultural differences to failure. This is important as this research will use the European biotechnology sector and its entrepreneurs to gain further insight into sensemaking, and venture capitalists and their representatives on the board of directors (investor directors) are invariably an important influential stakeholder in these ventures. I believe it difficult to research this topic without consideration of the influence of this group of stakeholders on the entrepreneur. US venture capitalists are often interested in entrepreneurs who have a range of experiences, rather than merely investing in people who have a history of success. Venture capitalists may not necessarily fixate on the entrepreneurs’ past successes. Zacharakis & Meyer (1998) consider that the US venture capitalists’ decision to invest is not negatively affected to any significant degree by a previous experience of failure. Although this may be affected if the entrepreneur has experienced multiple failures with very little success then this seriously brings into question the entrepreneur’s ability. The context of the failure is also of importance, e.g. if the entrepreneur had achieved an exit in times of market decline, then although the investors may have recorded a book loss, this may be indeed an achievement of which both the entrepreneur and investor can celebrate.

Cope, Cave & Eccles (2004) reported the views of a small number of venture capitalists towards venture failure. They concluded the following:

There are other factors, other than failure that shape the investment decision and the quality of the concept or opportunity has a strong impact on the decision to impact, along with the ability of the entrepreneur to step out of the CEO position; when the business has reached a certain stage, and maybe step away from management

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absolutely. An important aspect of venture capital investment is the previous start-up experience, whether good or bad, and failure combined with success is most favourable, if the entrepreneur has not continually experienced failure. The nature of the failure itself and the perceived level of personal culpability of the entrepreneur affects the investment decision along with a recognition that failure has an element of both luck and timing.

There are opposing views to the conclusions drawn above. Rea (1989) argues that entrepreneurs or management teams perceived as potentially marginal are considered as a recipe for failure even in strong market conditions, and the quality of the entrepreneurial managers is of paramount importance in the venture capitalists’ decision to invest (Goslin & Barge, 1986; Roberts, 1991; Sapienza, 1992; Shepherd, Douglas & Shanley 2000). Zecharakis & Meyer (1998) take a middle position and argue that when venture capitalists are uncertain about a certain market, then the entrepreneur becomes a more critical factor in the due diligence.

3.1.6 Overall use of the biotechnology industry model

The debate in this Chapter leads to the conclusion that the use of the biotechnology industry should be a good model to show that adverse deviations from plans are likely and these outcomes are likely to be equivocal leading to the promotion of sensemaking. The presence of investor directors on the board, representing the investor; and the entrepreneurial managers, representing the founders and staff makes this an ideal setting to study the social aspects of sensemaking.