HIGH FLYERS THINK TANK
National Research Priorities Strategic Forum
The Shine Dome, Canberra, 26-27 June 2002
National research priorities: Science, innovation and industry
by Denis Wade
Denis Wade has been Managing Director of Johnson & Johnson Research Pty Ltd since 1988 and Chairman since 1989. For the last 10 years, he has been a member of the US-based Corporate Office of Science and Technology (COSAT) and the Business Development Council. He has been very active in pursuing the commercial opportunities related to gene therapy and is a former Chairman of Gene Shears Pty Ltd. His major focus has been to develop significant research-based health care products in Australia and to bring these to international markets in a competitive way. He was Foundation Professor of Clinical Pharmacology, and is currently a Visiting Professor at the University of New South Wales.
Chairman, ladies and gentlemen, firstly thank you very much for the invitation to sit through this discussion. I have enjoyed it enormously and, as I think you will gather from what I am about to say, it reminds me very much of the process that I have been going through over the last seven or eight years. I want to talk specifically about a major process, similar to this, that took place in the industry about that time ago, to let you know why it happened and what has happened in the last 10 to 15 years in industrial research that has changed the whole climate and made us think much more carefully about the way we establish research priorities.
To do that I will walk you through some of the background in the particular company I work for, which is a major multinational. But I can also make some observations about a quite different world in so-called start-up companies, where I occasionally have some fun. I at one period of my life invested everything, including the family house, in one of those. Priority setting is very, very different in that environment, I can assure you.
Let me walk you through the J&J experience and tell you why we are concerned about this issue of setting priorities in our research. J&J is the world's largest integrated health care company. It is made up of 150 companies, acting in a group, with remarkable autonomy existing in the individual companies. We employ about 100,000 people.
If you look at our published figures for sales and profits a very interesting thing becomes immediately obvious. That is, about a third of our income comes from products that were introduced less than five years ago. But if you look at our profit, and this the key point, 100 per cent in the growth in profit comes from products that are less than five years old. In other words, you must innovate, you must provide products that the community wants, if you are to grow. Indeed, it is getting to the state now where you must do this if you are going to survive. Otherwise you simply are another casualty of the stock market, or featuring in the financial pages in some sort of takeover.
I am going to drill down a little bit further, to try and show why it is that this setting of priorities is different – why it has become a quite different exercise today compared with, say, 15 years ago. This particular company has sales of about $US35 billion a year, an enormous amount of money, and we invest something of the order of $3.5 billion in R&D. But there are some features of this investment that you have to understand, to try and follow why we have problems setting research priorities.
The first is that in the health care industry we are essentially investing long term. At the profitable end of the business, which is biotechnology and pharmaceuticals, we have lead times that are in excess of 15 years between early-phase science and the possibility of reaching the market at all. On the other hand, we report to the stock market every 12 weeks. So you have got long-term investment, with public scrutiny over very short periods of time, where considerations other than the success of the science are often dictating people's attitudes.
The second issue is that with investments as long as this in research and development, not only do you have to anticipate what the market will be, what the economy will be like – whether people can afford it – but you have got to anticipate demographic changes, political changes, quite different issues, longer-term issues which would test anyone.
The other point about the R&D spend that we are managing is that although it sounds like a big sum of money, very little of that expenditure in any particular year, in the sort of industry we are operating in, is discretionary. Taking compounds through clinical testing and the regulatory path now costs many hundreds of millions of dollars. So the amount of money left each year to make discretionary decisions about some exciting new area of science, and becoming committed to it, is quite small. You could picture the development pipeline in this industry as a pyramid. For about $800 million expenditure you can sustain about four compounds in clinical development. So if you want another compound to come out of the big pool of research that you are managing and get into the developmental pipeline, something has to come out of the top of the pyramid – a product to market – or you have got to displace something that is already there. It is extremely competitive at that point, in taking good science through to clinical development. In fact, there is an excess of good ideas competing very, very fiercely for a place in that pipeline.
The other consideration that influences the setting of priorities is the way in which the R&D spend is divided amongst different activities of a large company. For example, of the 150 companies in our group, 40 develop new products. That is, they have an R&D facility. But those 40 companies include a lot of companies operating in very narrow franchise areas – for example, an orthopaedic company or a company that specialises in neurosurgical instruments or computerised axial tomography or something like that. Their research focus is necessarily very narrow. A consequence of this is that, firstly, the sum of money available tends to be more or less all used up with existing products in development, and the ability to make new decisions is limited from that point of view. But, importantly, the people managing these individual units are very reluctant to consider any other, perhaps very exciting, bit of science if they cannot see an application for it in their own franchise area.
So there are two problems. Firstly, an exciting bit of science might come along which would, if you like, slip through the cracks between the areas of interest in existing businesses. Secondly, people are reluctant to take long-term positions as managers of these subsidiary companies, because by the time anything could happen they would be long gone in some other job and the only effect it will have on the business at this point in time is that it is the blot on the bottom line. It costs money.
Twenty-five years ago we realised this situation and did some things about it that I will tell you about in a moment. But let me digress a bit about this issue of sums of money and price of shares, and what it all means. When I joined this industry, the average price of the Dow – that means the price of a share of a company that made up the Dow index, relative to its current earnings – was a factor of about 12/14. That is, you paid 14 times the current earnings that year for the share, to buy it. You would recover your money in 14 years. We are now dealing with price-to-earnings multiples of technology-based shares that absolutely frighten those of us in the business. The P/E for my company at the moment is about 30. That is, people are paying 30 times what the share can earn, to buy a share.
I have told you earlier that the growth of the company is dependent entirely on new technology, new products. If you look at how much of the price of a share is represented by solid equity, assets that you can measure, it is a very small amount. The vast majority of that share price is blue-sky; it is people paying because they expect that the rate of earnings will increase by that amount. And from what I have said earlier, that rate of increase is entirely due to new technology – innovation.
So research managers in my position are feeling very threatened. And if I am threatened when I have a P/E of 30, how should, say, someone running research in CSL or Cochlear, or ResMed a few months ago – companies that have been mentioned here yesterday – feel when they are selling on a P/E of 50? That is absolutely ridiculous when you consider the assumptions that you are making to justify that as an investment. So the issue of how we spend our R&D money over the last 10 to 15 years is something that weighs heavily on our mind.
How do we go about it? Let me refer to three things that our company is doing, and these three things may have some relevance to the exercise that you are embarking on now. The first is that we tried to address this business of difficulty investing long term, or this application may not be obvious now – it might fall through the cracks – by establishing two bodies, the Development Corporation and the Corporate Office of Science and Technology. I don't have time to go into exactly what those bodies do, but for 25 years they have operated very successfully in trying to integrate new and exciting leading-edge science into the business, or being able to invest in those areas of science and technology without frightening the shareholders – that is, keeping it off the balance sheet or keeping it out of the annual report.
The Development Corporation does this by investing in venture capital, and it in fact ran its own venture funds. In other words, it uses business instruments to access and to keep us with a toehold in what we think are exciting new developments in science and technology. Some of them may have no immediate relevance to the health care industry, but we think they are exciting bits of science and technology, and something that we should keep some sort of interest in. The second body is the Corporate Office of Science and Technology, which acts slightly differently but interacts with universities, institutes, and runs granting programs et cetera, the aim again being, from our point of view, to keep tabs, to keep some interest, some involvement in something that might be cutting-edge science and technology. In this part of the world, my company here represents both those bodies and we do those two things, apart from our own research programs here.
About six to seven years ago, when we started to become really concerned about this issue of the extent to which share valuations, equity valuations, were dependent upon the outcomes of science and technology, and the anticipated growth being so high, we addressed the very issue that you are now addressing: how could we establish research priorities to increase the odds that we could latch on to the best bits of science and technology and secure any position they might have that related to the health care industry?
We set up a program where we deliberately mixed up different people from the company. We took up-and-coming young employees in their early 30s and deliberately mixed them up with senior management, and we formed a number of working groups to look at different areas that might constitute our priorities. We called them Frameworks for Growth. In each case we gave the chairmanship of that group to a junior member of the company. So the Chairman of the whole company was sitting as a member of a working party, but he was certainly not chairman and he certainly did not have an influence in those meetings, strangely enough, that was intimidatory.
We asked people to look very broadly over a long period of time – we took 18 months – and they did an enormous amount of background work. We asked them to try and identify those areas, within our own resources in the company, or those issues in the community – perhaps social issues, perhaps political, demographic issues – that were going to impinge on and influence our industry in the intermediate to long-term, 15 to 20 years, period of time.
To cut a long story short, that process led to the establishment of six or seven of what we called Frameworks for Growth, the same sort of thing as you are talking about now. These frameworks were interesting, because they were not based on existing structures that we had in the company; they were not based upon existing companies in the group. Allowing people to work in this way resulted in them reaching across company boundaries, reaching across to institutions outside the company, and defining totally new groupings, some of which we had not thought of before.
What was the consequence of having defined these frameworks? Well, it facilitated the decision process enormously in reaching a consensus. The way we operate in setting research priorities is that you have to have a champion. Someone has to be committed absolutely to doing something, and they have to risk their career and their reputation by maintaining a position. But the ultimate decision in this corporation doesn't depend upon someone signing an approval; it depends upon reaching consensus. It is staggering, the amount of work that you have to do in order to reach a consensus view amongst your own colleagues. So all the issues that I heard talked about yesterday – 'Oh, we have got to consider the social science issues,' 'We have got to consider the political issues, the changing demography,' and all those sorts of things – of course they are automatically part of the process when you have to reach a consensus in this way.
Let me give you some examples, and again they bear on comments that I heard yesterday. One of the so-called Frameworks for Growth was e-health, the effects of the new information technology on the provision of health care and how this might affect this industry. In the background to that, of course, there are all sorts of social issues going on. You are well aware that the time people spend in hospital is dramatically reduced. People are accepting a much greater responsibility for their own health. People are much better informed about illness and about treatments. And there are quite new ways of delivering health care – within the home, for example. You have got political change going on which has quietly, behind the scenes, in all Western countries, set a limit to what society is prepared to pay for health care. In the US that is capped off at 14 per cent of GDP; in this country it is a little bit less. So all these factors were impinging upon, perhaps, a totally new way of delivering health care, and if we had not structured ourselves to be able to cope with the inputs from all these sources, I fear that sadly we would have been caught right out.
So what general comments can I make in conclusion that might be helpful to you? The first is: if you are going to set these themes or frameworks for growth or investment in science and technology, give a lot of thought to it and put a lot of work into it. They are not things that you write down on a bit of paper by Friday. The background work, if they are going to be credible, sustainable and useful, is going to be a lot more than you anticipate. And certainly do involve all the disciplines and the sciences that you can bring to that coming together.
Secondly, I think they should be areas where Australia has some lead position, or some particular advantage. Thirdly, you should have the possibility of securing either some intellectual property position or some time advantage, if you are to maintain a leadership position in this branch of science.
Most importantly of all, you must identify strong leadership. These things don't happen unless you have got a charismatic person or two with a vision, a clear idea of what the end game is, who can recruit others to share that vision and share that view of the end game. And of course you have to train more leaders, because if we have to identify one area where Australia is a little behind, it is in this business of translating good ideas into something else.
And whatever you come up with as priority areas, they must excite the community. You must be able to take the community along with you – and I mean not only the political community but also the general community.
The final point I will make is that the most important of these is the one that I mentioned earlier, leadership. Look for things where you have some emerging leadership now, and build on that.
