For the past decade biotechnology start-ups have existed in a world of their own: brimming over with capital, infrastructure, and expectations. Now the smart ones are joining the rest of us

In the new economy, knowledge displaces labor, capital moves at the speed of electrons, and few assets remain fixed for very long. Vertical integration yields to virtual integration in a world where everything is outsourced. It gets harder each passing day to find those old touchstones of the mass economy, in which the gathering of capital, labor, and equipment confers a competitive advantage. The old model breaks down in even the most unlikely of places.

Look at biotechnology.

It's an industry in which big money traditionally has pooled inside big companies. The conventional strategy involved lots of capital, legions of scientists, and a blockbuster mind-set. Each company hoped that before the money ran out, it would create a wonder drug, on whose testing, manufacturing, and marketing it would then lavish millions more.

But in the past couple of years that strategy has exhausted itself. Biotechnology, once thought so immune, is now prey to the rigors of the new economy. And there is a simple reason for that. Many biotech companies -- like so many other institutions of the mass economy -- no longer make economic sense.

What exactly is happening in biotech? And what do the changes tell us about changes occurring throughout the economy?

Capital is growing scarcer in the 1990s. Biotech, meanwhile, has been a 1980s-style spendthrift. Running a credible research effort can require up to 100 scientists and $20 million a year. And that's just for research. There isn't necessarily a potful of product at the end of that rainbow.

Chastened investors know they can no longer keep throwing such large sums at such elusive dreams. Mark Edwards, managing director at Recombinant Capital, in San Francisco, which helps biotech start-ups with their business planning, has calculated that some 100 major biotech companies have burned through about $10 billion in research and development and overhead in the past 10 years. Edwards guesses that every year now about 30 biotech companies get merged out of existence, and the spectacular crashes keep on coming.

Last year Synergen stock lost $715 million of its value in a single day when its sepsis drug, Antril, failed in clinical trials. Centocor stock swooned from $60 to $10 in a few weeks, after its big drug, Centoxin, similarly tanked. (Waggish observers subsequently dubbed the drug Centoxic.) Cetus went through $500 million in 10 years before finally merging with Chiron, after Interleukin 2 proved less than a blockbuster. Most recently, Biogen pulled the plug on one of its major drugs, Hirulog, and the organization shuddered.

The above are all big names, erstwhile "first-tier" biotech companies. But the failure and bloodletting have also occurred further down the ranks among lesser-known names such as Procyte, Telios, and Gensia. In biotechnology, it seems that big cash has often translated into big crash.

Knowledge, unlike capital, is more available than ever. With the decline of many traditional organizations -- from the Soviet Empire to the downsizing U.S. corporation -- knowledge has become freer, more available. Some $8 billion worth of government-backed health-care-related research is conducted annually in the United States. He who adds value is no longer the one with a big bankroll to throw at a given scientific problem. What counts is the insight to differentiate unique research from the humdrum and the ability to commercialize it. That's the strategy behind a biotech company like Neurobiological Technologies Inc. (NTI), in Richmond, Calif. And NTI, I think, embodies the shape of things to come -- not just in biotech but throughout industries in which knowledge, applied, creates the edge.

NTI was founded in 1987. To date, the company has spent more than $8 million; it has three drugs for seven conditions already in human clinical trials. In fact, NTI had only one employee and had spent a mere $120,000 when it licensed its first two drugs from the Salk Institute, in La Jolla, Calif. NTI, unlike most other biotech companies, is not an integrated research-and-development company (like companies in the first generation of biotech), nor is it a drug-discovery company (like companies in the second generation). It is part of the new wave: a drug- development company.

NTI looks for specific drugs that have broad applications -- but unique properties -- already discovered by researchers. It looks for drugs that are easy to manufacture and whose effectiveness can easily be proved, thus avoiding lengthy and costly clinical trials. Says chairman Jeffrey Price: "When I license in a product, part of my decision is based on a vision of exactly what the label is going to say and look like. What do we hope to claim for its efficacy, and what will it take to prove that over the next several years?"

Organizations no longer unite people; shared interests create a stronger bond. NTI has a skeletal corporate staff of 20 people. Its core asset is a network of 25 scientists, not clustered in-house or salaried by the company but dispersed in research labs around the country. All are substantial shareholders in the company, and all share a kinship through their overlapping research disciplines. All serve as "scouts" for the company, bringing promising research to NTI for evaluation.

Chairman Price and chief operating officer Michael Ostrach are the gatekeepers at NTI. Their job is to rigorously screen the research to filter out the projects with the best chance of commercial success. Says Price, "I think most biopharmaceutical companies have been formed by groups of scientists, and what they wanted to do was to get funding to pursue a particular research approach." He says that of the roughly 1,300 U.S. biotech companies, "very few have drug-development people. They have research teams. Our research people are connected with us, but they exist independently in academia."

The company is thus not a hotbed of research but a conduit through which to bring the most promising research to market as fast as possible. Having so little invested in infrastructure allows NTI to move freely to identify and lay claim to knowledge-based assets, another strategy that increasingly drives prosperity and creates value in the new economy.

In a virtual world there are more resources to leverage. Mark Edwards of Recombinant Capital notes that the biopharmaceutical industry is starting to look like a lot of industries did before they went through downsizing. It is beset by overcapacity and a proliferation of "me too" drugs. That throws a surplus of collaborators, marketers, and manufacturers into the market, from which companies like NTI can freely choose. NTI develops novel drugs with broad applications, putting itself into a "seller's market" among would-be strategic partners looking for products that can be differentiated. Price says that what keeps him awake at night is not that a competitor might copy his strategy, because his core asset, his shareholder-scientist network, is already in place. What worries him is finding the right strategic partners to maximize the potential of NTI's products.

Edwards says the virtually integrated biotech company "is a model with enormous leverage." He explains, "In biotech there are three major business risks: clinical failure, clinical success but market failure, and delay." NTI's approach greatly reduces the first two risks because it focuses on finding a handful of drugs with a high likelihood of clinical and market success. Meanwhile, it offloads the third risk onto its partners. In the new economy, risk rises for all companies. The smart ones find ways to out-source it.

Virtual biotech companies like NTI still form a distinct minority within the industry, "way less than 10%," says Edwards. The breakdown of the raise-a-lot-of-money-and-build-a-huge-organization mind-set is really just beginning. The industry, barely two decades old, is still relatively flush with early -- and nave -- investment capital. "The industry has created these capital sponges. They are Wall Street driven," says Jack Stuppin, an early investor in NTI who is seeking to break the mold. "These new companies will be science driven. They will be technology platforms."

As the big biotech disappointments keep on coming, as the cash dries up, and as capital-hungry companies proliferate, biotech will come to look increasingly like other industries: lean, flexible, rational, and economic. Today the industry still values the big cash hoard, the impressive state-of-the-art infrastructure, and all the in-house scientists. Appearances still matter; a sense of plenty is preferable.

Says Edwards, "There's a prejudice against these small virtual companies. In this industry the mind-set is, 'If you aren't fully funded, you don't exist, no matter how good you may be.' In other words, 'Is the skinny guy dieting, or is he just plain poor?' "

Someday soon the skinny guy will be seen differently. Remember, you can never be too thin or too rich.

Edward O. Welles is a senior writer at Inc .

Published on: Jan 1, 1995