Genzyme Corp

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________________________________________________________________________________________________________________ Research Associate Sharon Rossi prepared this case under the supervision of Professor Elizabeth Olmsted Teisberg as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Copyright 1993 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any meanselectronic, mechanical, photocopying, recording, or otherwisewithout the permission of Harvard Business School.

E L I Z A B E T H O L M S T E D T E I S B E R G

Genzyme Corporation

Strategic Challenges with Ceredase

Henri Termeer did not believe in strategic planning. As CEO of Genzyme Corporation, he stressed to his managers the importance of strategic thinking, instead. Under Termeer's direction, the Cambridge, Massachusetts, company had grown to become one of the biggest and one of the few profitable biotechnology companies in the world. The biotechnology industry association had awarded the company with three biotech "Oscars," crystal statues shaped like giant strands of DNA. One of these awards honored Termeer as top chief executive in the industry. The other two prizes recognized Genzyme for introducing the industry's most important new diagnostic product and completing the best new financing. Genzyme's management attributed the company's good fortune to its diverse range of businesses, which included biotherapeutics, fine chemicals, diagnostic products, and diagnostic testing services, and to managing opportunities with a nontraditional approach.

The company's single biggest product success was Ceredase, a treatment for a rare genetic disease. Genzyme had developed, commercialized, and marketed the product on its own. Following Henri Termeer's call to "innovate the marketplace," the company developed a unique approach to promote and sell Ceredase. Revenues at Genzyme doubled each year following the product's launch in 1991. But while Ceredase had enhanced Genzyme's success through 1992, its future was obscured by uncertainties. In 1993, as the company was finishing construction of a new plant for the manufacture of Ceredase, it was time to reassess the conditions of the market. Putting strategic thinking into action, Termeer was looking for a way to manage, mitigate, or capitalize on the uncertainties surrounding Ceredase.

The Ethical Pharmaceutical Industry in 1992

Ethical pharmaceuticals (also called therapeutics) were drugs for treating disease or disability which were made available to patients through a physician prescription or hospital order. Depending on what ailment they were prescribed for, therapeutics could prevent or treat a disorder, ease discomfort, or reduce or eliminate the need for surgery or hospitalization. Most of these therapeutics were developed and sold by pharmaceutical companies.

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There were hundreds of pharmaceutical companies worldwide, including several very large health-care conglomerates.1 Biotechnology companies were also developing and selling therapeutics, referred to as "biotherapeutics" because they were created using biotechnology, rather than chemical synthesis. In the United States, there were 375 biotech companies developing biotherapeutics. Relative to pharmaceutical companies, biotech firms were highly focused organizations with low revenues and few personnel. (Appendix A describes the biotechnology sector.) Worldwide, sales of ethical pharmaceuticals were $157 billion in 1991. Of this total, $3 billion were sales of biotherapeutics.2 A major therapeutic could generate more than $1 billion in sales annually. In 1990, Glaxo's peptic ulcer treatment Zantac had sales of $2.9 billion, the highest of any drug. A minor market drug could generate $50 million to $100 million in annual sales. Average gross margins ranged from 70% to 85% in the United States and 60% to 70% in Europe.

Research and Development

To discover new drugs, pharmaceutical companies typically screened thousands of compounds in search of ones that had potential for treating or curing disease. Chemical compounds were initially screened using chemical and structural analysis to identify those with possible biological effect. Researchers typically spent 1 to 2 years screening compounds for a specific medical condition. In contrast, biotechnology companies often knew in advance which biological substances they wanted to produce. Instead of screening compounds, they had to "clone" the desired molecule by manipulating the DNA of a host cell. When researchers produced enough of the substance, they tested it for biological activity. Cloning the right molecule and producing enough material for initial testing could take one or more years.

A widely cited study from Tufts University showed that the process of developing and commercializing a chemical drug took 8 to 12 years to complete, at an average cost of $231 million.3 Comparable cost data for biotechnology drugs had not been studied, but these products were generally developed and commercialized in less time than traditional chemical drugs. Products were usually patent-protected for the first 17 years in the United States and 20 years in most European countries. (Appendix B discusses the approval process for both chemically based and biotechnology-based drugs.)

Drug Regulation in the United States and Abroad

In the United States, therapeutics were strictly regulated by the Food and Drug Administration (FDA). The FDA dictated standards for Good Laboratory Practice (GLP) and required all new products to be channeled through a rigorous approval process prior to sale, a process which usually required six years. The process began with preclinical testing, in which the product was tested in animals to assess its safety and efficacy. If the drug proved safe and demonstrated the desired biological effects, the company filed an Investigational New Drug (IND) application with the FDA. The product was then subject to three phases of human clinical trials conducted by the manufacturer, usually in conjunction with a university hospital, the National Institutes of Health (NIH), or a contract clinical testing company. If a drug proved safe and effective in all trials, a New Drug

1 Worldwide, sales of the four largest pharmaceutical firmsGlaxo, Merck, Bristol Meyers Squibb, and Hoechstmade up 16% of total industry volume in 1991. In the U.S., sales of Merck, Bristol-Meyers Squibb, Eli Lilly, and American Home Products represented about one-third of industry volume.

2 Medical and Healthcare Marketplace Guide (MLR Biomedical Information Services, 1992), p.33.

3 P. Roy Vagelos, "Are Prescription Drug Prices High?" Science, May 24, 1991, p.1080.



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Application (NDA) was prepared and filed with the FDA for review. The average waiting time from NDA submission to final approval was three years. Only one out of 20 drugs that entered clinical trials was approved by the FDA.4 The cost of this process usually represented about 40% of the total cost to research, develop, and commercialize a new product.

Because the development process was so long, costly, and risky, the U.S. government offered special incentives to encourage companies to work on treatments for rare diseases (those affecting fewer than 200,000 people in the United States). A company working on a treatment for a designated "orphan disease" could receive tax breaks and government assistance in the development of the clinical testing program. The first drug to receive FDA marketing approval for a particular orphan disease received orphan drug status. With this status, the product was granted a seven-year exclusive marketing period in the United States, during which no other company could sell the same compound. In addition, an orphan drug might be patent protected.

In Europe and Japan, prices charged for ethical pharmaceuticals were subject to government approval. In the United States, prices were not regulated, but the government was threatening action in 1993. Prescription drugs accounted for only 7% of the U.S. health care bill, but due to the combination of price increases for existing drugs and the introduction of new drugs at high prices, the cost of prescription drugs was increasing faster than any other medical expense. High drug prices were particularly problematic for elderly people who lived on fixed incomes and had many prescriptions because Medicare (the federal health insurance program for the elderly) and some other insurance programs did not cover costs of most prescription drug purchases.5 On the other hand, some people argued that new drugs were lowering the overall cost of health care by improving treatment and diagnosis, by replacing expensive, invasive surgeries, or by allowing a patient's return to work.

Buyers

Ethical pharmaceuticals were typically sold to hospitals, health maintenance organizations (HMOs), retail pharmacies, and physicians, each of which resold the prescribed drugs to patients. In hospital sales, the hospital's pharmacy and therapeutics committee (including the hospital pharmacist, and select doctors and administrators) decided what products the hospital pharmacy would stock. The accepted products were compiled in a list, called the hospital's formulary. Doctors could then choose drugs to prescribe for their patients from the formulary. For HMOs, the buying decisions were similar, but these organizations were usually more cost-conscious; they preferred fewer suppliers and obtained discounts by buying in larger volumes. Unlike indemnity insurance plans, health care coverage by HMOs often included most of the cost of all prescription drug purchases by their members. For sales to independent pharmacies and physicians, the pharmacists and doctors decided which drugs to buy according to their own criteria.

The buyers considered both price and effectiveness of a product. In most cases, product effectiveness was more important than price, particularly with regard to patented drugs for life-threatening needs. With increased concern over high-priced health care, however, an increasing number of buyers were weighing cost against effectiveness. A higher-priced therapeutic needed to be justified by speeding a patient's recovery or as an alternative to riskier procedures. The hospital, HMO, pharmacy, or physician's decision depended heavily on whether third parties such as

4 Standard & Poor's Industry Surveys, August 20, 1992, p. H23.

5 Medicare did not cover most prescriptions, but it did pay for injectable drugs approved by the FDA which were administered as part of a physician's professional services. Many insurance companies had similar rules.




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Medicare and insurance companies or HMOs would reimburse a patient for the treatment. If a lower-priced substitute or generic equivalent existed, or if a treatment was viewed as experimental or not medically necessary, payers sometimes refused reimbursement.6 Third-party payers were increasingly challenging prices charged for medical products and services; firms were being asked to justify pricing decisions and offer deeper discounts and rebates to customers. In December 1990, the U.S. government passed a law requiring pharmaceutical companies to offer discountsto Medicaid and other federal agencies matching their deepest discountssometimes as much as 60%for other large customers.7 Some pharmaceutical companies responded by eliminating discounts altogether. In 1991, several of the largest drug companies agreed to keep average price increases below the rate of inflation. At the end of 1992, there was debate about whether this promise had been kept, but the rate of growth of drug company profits had slowed to 10% from 15% in the previous year.

Marketing and Distribution

Three-fourths of the sales volume of ethical pharmaceuticals were sold through wholesale distributors. For the most part, these were products which had been on the market for a relatively long time (both branded and generic) and did not require explanation or promotion. The remaining one-fourth of volume was sold directly by pharmaceutical salespeople to the hospitals, HMOs, retail pharmacies, and physicians.8

Much of marketing activity involved educating medical professionals about products and their use. New therapies and medical technologies were advancing rapidly, and pharmaceutical marketing efforts helped keep practicing physicians abreast of developments. In direct sales, a salesperson visited individual physicians' offices, offering for sale the company's entire line of drugs. The salesperson explained and promoted new productssome of which were not yet available for saleand provided the doctor with product brochures as well as free samples of approved drugs that could be passed on to patients. Products were also marketed to physicians through symposia arranged by the drug companies, usually in conjunction with academic researchers. Marketing to large customers such as hospitals and HMOs was similar, but involved selling to administrators as well as doctors and required fewer sales calls. Pharmaceutical companies also marketed in medical journals by publishing studies on products or placing advertisements.

An effective sales force for U.S. hospitals usually required a minimum of 50 people and cost $5 million to $10 million; sales to pharmacies or physicians required many more individual sales calls and a sales force of about 1,500 people. Merck, the world's largest pharmaceutical firm with 1991 sales of about $7.2 billion, had a sales force of 2,700. For the largest companies, selling and administrative expense represented about 30% to 40% of sales revenue.9 Some companies licensed their products for sale through other pharmaceutical companies to avoid the cost of supporting their own sales force.

6 A branded pharmaceutical was one that was marketed with a trade name from a company. Such products were usually patented. After the patent expired, a drug could be produced by many companies as a generic pharmaceutical. These off-patent products required no marketing and were sold more cheaply than the original branded product.

7 Previously, the government mandated only that pharmaceutical companies provide a 12% discount. With the new law, firms had to provide this discount, at least, or their deepest discount, whichever was greater. In 1992, the federal minimum discount rose to 15.7%.

8 Standard & Poor's Industry Surveys, August 20, 1992, p. H18.

9 Marjorie Shaffer, "Changing the Prescription," Financial Times, January 28, 1993, p. 12.




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In a few cases, more consumer-oriented ethical pharmaceuticals were marketed directly to patients. Products such as Upjohn's Rogaine (a treatment for baldness) and Ciba-Geigy's Habitrol (a treatment to help patients quit smoking) were advertised on television, radio, and in magazines.

Production

Methods of manufacturing pharmaceutical products differed, depending on whether a product was chemically based or biotechnology-based. Production of a chemical pharmaceutical involved multiple chemical synthesis steps to produce the active ingredient; the active ingredient was then formulated into a pill, liquid, or other dosing variation. Biotechnology drugs, in contrast, involved culturing genetically engineered cells in tanks, then purifying their "broth" to obtain the active ingredient. Biotech drugs could only be formulated into injectable fluid because the material was too unstable for other forms. Manufacturing environments, particularly for biotech pharmaceuticals, had to be totally sterile and processes had to be extremely precise. To ensure this, plants in most countries had to follow government guidelines for equipment, cleanliness, batch purity, and record-keeping. For biotherapeutics, U.S. regulation also dictated that the plant be licensed and ready for commercial manufacture when the product reached the final phase of clinical trials.

As firms became more cost-conscious, manufacturing was targeted as an area for improvement in both chemical and biotechnology production. Manufacturing costs represented about 20% of sales, up from 10% in the early 1980s.10 This increase was attributed partly to more stringent regulations, more complex biotech manufacturing, and underutilization of facilities. Since plants had to be approved prior to product approval, facilities sometimes sat idle for years ahead of commercial production. In a few cases, companies built plants for products which were subsequently never approved.

Genzyme Corporation

Genzyme's Four Businesses

Genzyme Corporation of Cambridge, Massachusetts, was a biotechnology company which researched, developed, manufactured, and marketed products for human health care. In 1992, Genzyme had revenues of $220 million, the third-highest revenues of any biotechnology company (after Amgen and Genentech), based on sales of its one proprietary therapeutic and a range of other products including generic pharmaceuticals and diagnostic enzymes and substrates. Management's stated goal was to become a diversified health care company. In 1993, Genzyme operated four divisionsbiotherapeutics, fine chemicals, diagnostics, and diagnostic servicesall of which relied on the company's expertise in carbohydrate chemistry, enzymology, and molecular biology, with particular emphasis in the area of genetic diseases. (Exhibit 3 shows an overview of products and Exhibit 4 shows sales projections by line of business.) In addition, Genzyme earned revenues from research which it conducted on a contract basis with Neozyme and the Surgical Aids Partnership (two of Genzyme's funding vehicles), a joint venture, and the government; this contract R&D generated 18% of the company's revenues in 1992.

Blotherapeutics The biotherapeutics division produced Ceredase (a treatment for a rare genetic disease) and was researching several other ethical pharmaceuticals using biotechnology. The development pipeline included a recombinant (genetically engineered) form of Ceredase, as well as

10 "A Modem Smokestack Industry," The Economist, November 1992.




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treatments for thyroid cancer, cystic fibrosis, and Fabry's disease. All of these were designated for orphan drug protection. Researchers were also working on a treatment for the removal of burned tissue (Vianain) and four other products for reducing the formation of scar tissue following surgery (HAL products). Genzyme had a gene therapy research program which was working to develop a cure for cystic fibrosis. In the opinion of many investors and analysts, the biotherapeutics division was the company's "gem"; with one therapeutic already approved and with other important products in the development pipeline, Genzyme showed promise to investors. In this division, Genzyme often pursued drugs for small, non-competitive markets, a practice which the press had dubbed Genzyme's "Orphan Drug Strategy." Analysts considered the cystic fibrosis research a potential "blockbuster" with a product market of $500 million annually. In 1992, the biotherapeutics division generated 45% of Genzyme's total revenues.

Fine Chemicals Division The fine chemicals division supplied generic chemical pharmaceuticals, pharmaceutical "intermediates," and fine chemicals to pharmaceutical, biotechnology, and cosmetics companies. This business had many global competitors, but Genzyme had established a position as a high quality supplier. Many of its products were proprietary and the company was developing new product and manufacturing technologies which management hoped would improve profitability. Genzyme's gross margins were below the fine chemical industry average of 35% to 40%, but management expected its margins would increase to 50% to 55% as the company introduced more proprietary and high-technology products. In 1992, this division's sales represented 6% of Genzyme's total revenues.

Diagnostic Products Division The diagnostic products division supplied assays, reagents, enzymes, and complete diagnostic kits to companies that performed clinical tests. This division also produced and sold immunobiologicals, which were products used by academic and clinical researchers, as well as pharmaceutical and biotech companies. Like fine chemicals, the diagnostic products industry had many competitors. Genzyme tried to distinguish itself from competitors by building relationships with its customers with the goal of becoming their primary supplier. Genzyme was also working on developing more innovative products. One of these products was a test kit for direct testing of HDL and LDL levels of cholesterol that would be launched in 1993. With this and other new cholesterol-testing products, Genzyme would sell 50 million cholesterol tests annually by 1995, giving Genzyme a 30% share of the existing market. Fetal Cell Separation (FCS) was another of Genzyme's innovations; this proprietary diagnostic for identifying genetic disorders in fetuses could potentially replace amniocentesis, a test performed on 8% of all pregnant women in the United States. Unlike amniocentesis, FCS posed no risk to the fetus, so analysts predicted it had sales potential of $500 million annually. This division was also using biotechnology in manufacturing, which allowed them to produce more efficiently and to higher quality specifications. Gross margins on some of Genzyme's products were 10% to 15% higher than the diagnostic products industry average of 30% to 35%. Some of this division's products were also supplied to Genzyme's diagnostic services division. In 1992, the diagnostic products division generated 13% of Genzyme's total revenues.

Diagnostic Services Division Genzyme's diagnostic services business included IG Labs, a separate company which was 30% publicly owned and 70% owned by Genzyme. IG Labs provided genetic testing services to hospitals, clinical laboratories, physicians, and HMOs. Biochemical and cytogenetic tests screened for and detected genetic abnormalities in fetuses, while DNA tests determined whether a fetus or person has or is a carrier for a specific genetic disorder. There were hundreds of academic labs and several commercial labs offering these services, but IG tried to distinguish itself by offering faster service, regional presence, and a wider range of services. Though many academic labs were researching new technologies for genetic testing, IG was the only commercial testing company that conducted research; the company believed its research would lead to new types of tests, improved efficiency, and greater profitability. Vivigen, Inc., a commercial




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testing laboratory in New Mexico, had been IG's closest competitor until Genzyme acquired it in 1992. In 1992, diagnostic services represented 18% of Genzyme's total revenues.

Company History

Genzyme had started out as an enzyme manufacturing company in 1981, founded by Henry Blair, a Tufts University scientist whose vision was to develop enzymes for use in diagnostics. Blair began the business by purchasing a small enzyme manufacturing facility in the United Kingdom with the help of U.S. venture capitalists. In 1983, the investors recruited Henri Termeer for the position of president. Termeer, a native of the Netherlands, had 10 years of experience at Baxter International where he had headed the company's German subsidiary, and later served as an executive vice president of the Hyland Division, one of Baxter's four major product divisions. Termeer had studied economics at the University of Rotterdam and earned an MBA from the University of Virginia.

When Henri Termeer joined Genzyme, he was eager to see the company generate revenue in the near term and urged the company's scientists to find an application for enzymes that had not been done before. Termeer scheduled weekly brainstorm sessions with Genzyme's management and a group of eight scientists from MIT and Harvard University to find product ideas and to design a successful direction for the company. As a result of these meetings, the company set its sights on creating products immediately, rather than on long-term applications of research. In the early years, the company produced a variety of diagnostic intermediates (enzymes, assays, and reagents used in diagnostic tests) and fine chemicals. None of these products were genetically engineered, but Genzyme was working on applications of biotechnology. In the mid-1980s, management saw applications of its research in other health-care related areas, based on the company's developing expertise in enzymes and carbohydrate chemistry. Its first opportunity to turn enzyme expertise into a new therapeutic came with Ceredase, a treatment for Gaucher's disease.

Gaucher's Disease

Gaucher's disease (pronounced gau-shay) was a rare genetic disease that affected only 20,000 to 30,000 people worldwide. The disease occurred throughout the general population, but was most prevalent in the East European (Ashkenazi) Jewish population. Within this group, incidence of the genetic defect was 1 in every 400 births.11 The U.S. National Gaucher's Foundation was established in 1984 to encourage the development of a cure or treatment for Gaucher's disease. In addition to conducting research, the Foundation provided patient support and was working to raise awareness of the disease.

People with Gaucher's disease lacked the normal form of the enzyme glucocerebrosidase (GCR) which is responsible for breaking down lipids (fats) in the body. Without this enzyme, lipids accumulate in tissues such as the spleen, liver, and bone marrow, often causing spleen and liver enlargement, bone deterioration, and fatigue. The type and severity of symptoms and the age of onset varied among people with the disease. Some people experienced no symptoms at all and were unaware that they even had the disease; others were unable to work or take care of themselves because of weakened bones that were chronically painful and easily broken. The most severe cases led to early death. Genzyme estimated that 5,000 to 6,000 people worldwide had severe enough symptoms to require treatment; the U.S. Office of Technology Assessment (OTA) estimated that

11 Horizons, Quarterly Newsletter for Gaucher Patients (published by Genzyme Corporation), February 1992, p. 5.




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between 2,000 and 11,000 people in the United States might need therapy.12 Before the development of Ceredase, the only treatment for people with Gaucher's disease was bone marrow transplantation, but 10% of patients died from this high-risk procedure, and the $200,000 transplant surgery might not permanently cure the disease. To ameliorate symptoms of the disease, physicians sometimes treated patients with blood transfusions or performed surgery to remove the spleen or replace bones. Some patients underwent multiple hip-bone replacement surgeries.

The Development of Ceredase

Gaucher's disease was first described in 1882 by French physician Charles Ernest Gaucher. Further progress in identifying the disease was made by other French and German physicians in the 1900s. In 1965, the United States National Institutes of Health (NIH) made a breakthrough by identifying the missing enzyme (GCR) and began pioneering research on enzyme replacement therapy. In 1981, Genzyme became involved with the Gaucher's treatment effort by supplying the NIH with the natural GCR enzyme. The enzyme was very difficult to produce and did not seem effective at first; when NIH researchers infused 8 patients with GCR, the enzyme only improved the condition of one of them.

In 1985, the U.S. government designated Gaucher's an orphan disease and Genzyme began working to develop a new form of GCR as a treatment which would be effective in enzyme replacement therapy and which the company could produce commercially. Some of Genzyme's scientists were initially opposed to the effort. They were concerned that gene therapy, a potential cure for Gaucher's disease, would be developed before Genzyme could develop enzyme replacement therapy. Gene therapy was then only in early stages of research, mostly at academic institutions. Henri Termeer insisted that they continue the project. "It was a gamble," Termeer admitted.

By 1988, Genzyme had developed a process for purifying and modifying the enzyme which was extracted from human placental tissue. Genzyme could not patent its process since the NIH had already patented an earlier version. Genzyme named its product Ceredase and filed with the FDA to initiate clinical studies. In 1989, clinical studies were performed involving 12 patients which showed safety and efficacy of Ceredase. The FDA approved the treatment protocol so that Ceredase could immediately be made available to severely ill Gaucher patients, prior to full regulatory approval.

In 1990, Genzyme completed clinical studies on Ceredase and submitted a New Drug Application (NDA) to the FDA. In 1991, the company received approval for the marketing of Ceredase, making it Genzyme's first marketable proprietary therapeutic. Since it was the first treatment for Gaucher's disease, Ceredase was awarded Orphan Drug status by the U.S. government. As such, it would be the only treatment for Gaucher's disease allowed for sale in the country for a seven-year period, assuming that no other company developed a different treatment during that time. After receiving approval from the FDA, Genzyme filed for approval to sell Ceredase in a number of other countries. By 1993, Genzyme had received approval in Israel and was awaiting approval in Europe, Australia, Canada, and South Africa.

By 1993, Genzyme reported that it had spent a total of $70 million exclusively for Ceredase, including $40 million for R&D and $30 million for capital equipment. Though many pharmaceutical companies have difficulty sorting out the costs for individual products (the cost of failed product research often gets added to the cost to develop a single successful product), Genzyme had funded the research on Ceredase primarily through a separate limited partnership, which kept Ceredase costs

12 "Federal and Private Roles in the Development and Provision of Alglucerase Therapy for Gaucher's Disease," U.S. Office of Technology Assessment, 1992, p.5.




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apart from Genzyme's other product R&D. Separately, the NIH contributed a great deal to develop the product by discovering the enzyme, performing initial research, and conducting the clinical trials, but the NIH could not quantify the cost of its efforts. In addition to conducting ongoing research on Ceredase, Genzyme was also developing a recombinant form of the enzyme. The recombinant form would be subject to clinical testing and regulatory scrutiny before it could be marketed.

Treatment of Gaucher's Patients

Ceredase was approved in the United States in March 1991 for people with moderate to severe symptoms of Gaucher's disease, a patient market of some 3,000 people, according to Genzyme's statistical estimations. Immediately upon receiving approval, Genzyme's first target market was patients who were seriously afflicted with Gaucher's disease. These patients would initially receive high doses of Ceredase every two weeks (typically 60 units of enzyme per kilogram of body weight)13 to eliminate lipids which had built up over a lifetime of Gaucher's disease. Every six to twelve months, the dosage could be reduced somewhat, easing patients down to maintenance treatment doses, typically 10-15 units/kg. After these neediest patients were receiving treatment, Genzyme targeted patients with moderate symptoms. These patients were able to start on lower doses of Ceredase, typically 30 units/kg. Ceredase had not been approved for patients with mild symptoms of Gaucher's disease; since the enzyme was a human biological (derived from natural sources), there was a very slight risk of viral contamination which could not be justified for people with only mild symptoms.

Genzyme was working closely with the National Gaucher Foundation to collect data on Gaucher's patients, particularly to assess the progress of those using Ceredase. Optimal treatment dosing was still being determined and different physicians had tried different treatment regimens. In Europe, for example, the starting dose levels were sometimes much lower than in the United States.

Since Gaucher's disease was so rare, there were few physicians who knew much about the disease. Gaucher's disease was often misdiagnosed as leukemia, since symptoms of chronic fatigue and low blood count were common to both diseases. To positively diagnose Gaucher's disease, a physician had to order a special enzyme test which was performed at only a few clinical laboratories. Physicians who did know of Gaucher's disease and could diagnose it properly often did not know there was a treatment available. Consequently, their patients did not know either. In some cases, people who had Gaucher's disease denied that they had any ailment in spite of the symptoms they experienced. Denial was common among patients with untreatable illnesses.

Cost of Treatment

Initial treatments of the enzyme at a high dosage could cost upwards of $200,000 annually for a single patient. Maintenance treatments and treatments for moderately symptomatic patients cost between $20,000 and $60,000 per year. The total cost varied depending on a patient's weight, age, and severity of illness, although on a per unit basis the price of Ceredase was the same worldwide for all Genzyme's customers. Unlike many drug companies that offered discounts and rebates to different customers, Genzyme offered no discounts on Ceredase other than the 15.7% rebate to the U.S. government for treatments covered by Medicaid, as required by law. (Exhibit 5 shows a cost breakdown for Ceredase. Exhibit 6 shows average pharmaceutical company costs estimated as a percentage of sales.)

13 The average patient using Ceredase weighs 50 kilograms (110 pounds).




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Over 95% of the patients received coverage from an insurance plan and 90% of patients were paying less than $2,500 per year out-of-pocket for Ceredase. For patients in the United States who had no insurance or had exhausted their lifetime maximum coverage and could not pay for treatments, Genzyme offered Ceredase for free. Genzyme had allocated $5 million for this expense in 1992.14 That year, the company reported that the cost of uncollectibles and the Medicaid rebate represented 16% of sales or $15 million. In addition to paying for the enzyme, Gaucher's patients also faced ancillary costs of treatment, such as doctors' fees for administering the treatment and the costs of tests to monitor their condition. These costs could range from $5,000 to $13,200 annually, but were expected to decrease after a patient's condition had stabilized. These ancillary costs were largely covered by insurance.

Although Medicare, Medicaid, and private insurance companies all covered Ceredase treatment for Gaucher's disease, there were questions about what dose would be covered. For example, after one medical center published results on three patients (all children) whose condition improved at lower dosing, some insurance companies used this study as evidence to allow them to refuse payment on treatment costs above the low doses suggested in the study. Genzyme and some other doctors disputed the study, explaining that every patient's condition was unique, and that the sample of three children was not conclusive for other patients.

In 1992, the U.S. Office of Technology Assessment reviewed Genzyme's facilities, records, and pricing practices involving Ceredase. Henri Termeer had invited the reviewers into the company, making Genzyme the first pharmaceutical company to "open its books" to the OTA. Termeer explained, "We're looking at the government as a customer. A customer has a right to question the cost." After conducting its studyincluding six months of research inside Genzymethe OTA published a report detailing the government's role in the research and development of Ceredase. The report acknowledged that Genzyme's product was very effective and very costly to manufacture, and estimated that before-tax profit margins on Ceredase were 33% and 46% in 1991 and 1992, respectively. The OTA's calculation excluded the cost of research on Gaucher's disease not directly related to natural Ceredase and the cost of free goods and uncollectible accounts. The OTA report ultimately questioned whether the government should consider the potential cost of therapies in areas where it supports research, especially if the government eventually pays for such therapies through its own health insurance programs.15 Termeer believed that research on incurable diseases should be pursued even if the resulting cures or therapies would be costly; he was considering allowing the OTA to examine Genzyme's expenses for cystic fibrosis research even before a product had been developed.

Production of Ceredase

Ceredase was made from the human enzyme GCR which was derived from human placental tissue. The single supplier of this tissue was Imedex, a subsidiary of Institut Merieux in France, which had an exclusive contract with Genzyme. Imedex collected the tissue from normal full-term deliveries and performed the initial preparation and purification steps to extract the enzyme. Even though Imedex collected and processed placental tissue in huge volumes, there was not enough enzyme to treat all cases of Gaucher's disease. Ceredase treatments for one adult patient for one year required 22,000 placentas. Even with the exclusive contract, Genzyme only had enough enzyme to treat

14 Horizons, Quarterly Newsletter for Gaucher Patients, published by Genzyme Corporation, February 1992, p. 10.

15 "Federal and Private Roles in the Development and Provision of Alglucerase Therapy for Gaucher Disease," Office of Technology Assessment, 1992, p. 28-29.




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roughly 3,000 patients per year, capping Ceredase revenues at $125 million per year.16 At Genzyme's facilities in Cambridge and Framingham, Massachusetts, the material was purified further, modified, and converted into an injectable formula. The final sterilization, bottling, and packaging steps were performed at other locations by an independent contractor.

Distribution

Ceredase was distributed to physicians offices and hospital and HMO pharmacies. To receive Ceredase treatments, a patient went to a physicians' office, hospital, or clinic. The enzyme was administered intravenously by a doctor or nurse. In a few instances, physicians were reluctant to purchase and stock the drug because of its high cost. These physicians referred their patients to hospital outpatient clinics to receive their infusions. Some hospitals were reluctant to administer the drug to Medicare patients because the hospital sometimes had to wait up to a year for full reimbursement from the government.

Sales and Marketing of Ceredase

After Ceredase was approved in April 1991, product sales generated $40 million in revenues that year. In 1992, Ceredase revenues totaled $95 million. In 1993, Genzyme was selling the product in 20 countries around the world, although some countries only had one patient. Worldwide, the company had three sales groups: United States, Europe, and Japan and The Rest of the World. In the United States, Genzyme had a sales force of 14 (expanded from 8 in 1992); in Europe, it had 6 salespeople; in Japan, it had 2, and elsewhere, it had 3. Many of these salespeople had been recruited from other biotechnology companies which had successfully launched their own high-priced products.17

At the time of product launch, Genzyme had only 70 patients, but in 1993, the company was selling to 1,000. Seventy-five percent of these patients were in the United States; twenty-five percent were in other countries. Ceredase was approved for sale only in the United States and Israel, so it could be sold only on a "named patient" or "compassionate" basis elsewhere. This meant that a patient could receive the product only upon permission of the local health authorities in the patient's principality or town. Products sold for compassionate use could not be directly promoted by Genzyme. The issue of who paid for Ceredase in countries where it had not been approved was complicated (see Exhibit 7).

Genzyme's field organization faced the multiple challenges of creating product awareness among patients and physicians, educating them about the product, and assisting patients with receiving reimbursement, all of which were time-intensive efforts. Because of the rarity of the disease and the previous lack of effective therapy, no treatment infrastructure or communications channels existed through which Genzyme could bring Ceredase to market. As a result, Genzyme chose to direct its awareness and educational marketing programs to patients as well as physicians. Although salespeople working directly with patients was a somewhat controversial departure from tradition, the company believed it was necessary in order to assist patients with their insurance issues.

Genzyme's programs involved radio and television spots which described the symptoms of Gaucher's disease, explained availability of the new treatment, and provided phone numbers for treatment centers and the National Gaucher Foundation. Genzyme's salespeople also requested 16 Peter F. Drake, PhD, Vector Securities International, Inc., September 9, 1992 report.

17 Genentech's tPA (treatment for blood clots) sold for $2,200 per dose. Its Protropin (growth hormone for children) sold for $25,000 to $30,000 for a year of treatment.




12

hospitals to search their discharge records for patients with Gaucher-like symptoms in order to identify physician contacts. Doctor-patient confidentiality was carefully respected by the small and specialized sales force, so although this practice sounded controversial, it had been well received. Greg Phelps, vice president of corporate development, explained, "Normally, doctors would be angry if a company became involved directly with patients. In this case, however, they are quite accepting, even encouraging it. The typical situation here is that the doctor has only one Gaucher patient and so has little incentive to invest the time to become an expert. We, therefore, play a very valuable role for the physician by working with the patient."

Service

Genzyme set up its own reimbursement organization to assist patients in obtaining payment from insurance companies and government agencies such as Medicare. Genzyme's reimbursement staff worked with patients, physicians, and insurance companies to educate them about Ceredase therapy and facilitated the exchange of information among them to ensure patient coverage. Each Ceredase patient was assigned a Case Management Specialist who took care of the necessary paperwork and inevitable problems associated with reimbursement. A Case Management Specialist completed insurance forms for individual patients and provided patients with pre-formulated letters (customized letters, when necessary) for patients to send to their insurance companies when difficulties and questions arose. The Case Management Specialists also offered one-on-one counseling to patients and potential patients.

Outside the United States, where Ceredase could be sold only on a compassionate basis, Genzyme's salespeople handled politics in addition to a tremendous amount of paperwork required by regulatory authorities. The salespeople helped many of these customers obtain reimbursement through their governments, insurance companies, or private institutions.

Research on Recombinant Ceredase

Genzyme was creating a recombinant form of Ceredase which would be produced by mammalian cells and would not involve the use of placental tissue. Unlike the human biological form of Ceredase, recombinant Ceredase (rGCR) had no chance of viral contamination. Genzyme expected that the FDA would approve the product for treatment of mild symptoms, as well as moderate and severe cases. Geoffrey Cox, vice president of operations, believed that recombinant Ceredase would not be less expensive to produce than the natural form.

In 1993, the recombinant product was undergoing Phase III clinical trials in the United States. Genzyme anticipated filing its NDA by mid-year and hoped to receive FDA approval in 1994. If Ceredase was the first recombinant treatment for Gaucher's disease, it would receive Orphan Drug protection extending seven years beyond its market launch. Genzyme planned to have this product tested and approved for sale in Europe and Japan as well. By the time of its approval, Genzyme estimated that its R&D investment in recombinant Ceredase would total $30 million. In addition, the company was investing $100 million to build a plant to manufacture recombinant Ceredase, as well as other products. In 1993, the 160,000-square-foot facility was under construction in Boston, Massachusetts, next to the Harvard Business School. The facility was expected to be completed in 1994.




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Competition for Ceredase

Enzon Corporation, a Plainfield, New Jersey biotechnology company with $2.4 million in revenues, was working on its own treatment for Gaucher's disease. In 1992, Enzon had not yet indicated when its product might be ready for clinical trials. Like Ceredase, Enzon's product was an enzyme replacement therapy and it would be produced using recombinant techniques, but it would be designed to break down circulating lipids rather than those stored in tissues. Scientists within Genzyme believed that Enzon's scientific approach to treatment would not work.

Gene therapy was a scientifically and potentially medically superior alternative which might cure Gaucher's disease, but it was still undergoing basic research. To cure Gaucher's disease, gene therapy would involve replacing some of a patient's bone marrow with cells that carried "genetically correct" DNA. These cells would multiply and produce the missing enzyme, effectively curing Gaucher's disease. No firm was seriously pursuing gene therapy for Gaucher's disease, although Genzyme was conducting a small amount of research in this area as part of its gene therapy program. Henri Termeer believed it was important that Genzyme pursue research in this area. "We'd rather make our own products obsolete than have a competitor do it for us," he said.

Corporate Research and Development

Each of Genzyme's divisions and facilities conducted its own research, in addition to research performed by a corporate group. Henri Termeer explained that this decentralized approach was not typical for a science-based company. "In a traditional research organization, companies usually have a large campus with geese and ducks swimming in ponds," he said. Genzyme had no such campus, explained Termeer: "Our research organizations are really quite independent." He believed that this arrangement gave the company a better chance at succeeding with innovative technologies and he purposely avoided limiting the scope of the various research groups. "We make no attempts to make sure everyone is communicating nor to make sure there are no duplications. We don't mind some duplications," he said.

Human Resource Management

In 1993, Genzyme employed 1,500 people worldwide, with offices and manufacturing facilities in Cambridge and Framingham, Massachusetts, two manufacturing sites in the United Kingdom, and sales offices in the Netherlands and in Japan. The company had grown so quickly that communication had become a concern. Alison Taunton-Rigby, vice president of the biotherapeutics division, explained: "What's beginning to happen at Genzyme is that we're dropping the ball in a few places. We never used to do that. When the company was smaller, we could rely on informal communicationthere were only 10 or 15 things going on and you could manage it. Now, it's hundreds of things going on." Managers faced the challenge of managing people and products, as well as navigating through regulatory requirements, as the company's portfolio of products in development multiplied and expanded throughout the divisions.

With the new Ceredase manufacturing plant under construction, Genzyme also faced challenge in hiring people with experience in biotechnology manufacturing. People with these skills were generally hard to come by. When Genzyme agreed to build the plant in Massachusetts (management had considered sites in several other states), it arranged for the state to establish biotechnology education and training in some schools which would help biotech companies find qualified candidates for staffing their manufacturing plants. Some of these programs were already in effect and would benefit Genzyme and other biotech companies in the long term.




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Unlike a pharmaceutical company with a big corporate campus, each of Genzyme's businesses was physically separated from the others, and management of each was given significant independence. Henri Termeer wanted to maintain a loosely structured organization, one which would preserve the entrepreneurial atmosphere necessary to motivate individuals, keep up with changing technology, and make work more fun.

Finance

In its earliest years, Genzyme was a manufacturing-oriented firm that generated income from sales of enzymes. In 1983, venture capitalists contributed $3 million to the business and refocused operations toward developing proprietary products and earning contract revenue. Three years later, as research on Ceredase proved promising, the company made its initial public offering (IPO) and raised $25 million.

Since the IPO, Genzyme used a variety of methods to fund specific research and development projects independently, without direct risk to the company. In early 1987, it sponsored Genzyme Clinical Partners, a limited partnership, which raised $10 million exclusively for the development of Ceredase. In 1989, the company sponsored the Surgical Aids Partnership which raised $37 million for the development of hyaluronic-acid (HAL) based products, treatments which reduce scar tissue following surgery. In October 1990, Genzyme created Neozyme Corporation, a separate public company, to use as a funding vehicle for the development of six other products. This IPO, the industry's first multi-product public financing vehicle, raised $47 million. In March 1992, Genzyme created Neozyme II, a second public company, which raised $85 million for cystic fibrosis research. These off-balance sheet financings all gave Genzyme the option to buy the research at a predetermined price if successful; if research proved unsuccessful, Genzyme lost credibility and time. These funding vehicles were unusual; most biotech companies typically used equity to fund research.

Separate from these "creative" financings, Genzyme Corporation made a second public offering of its stock in 1989, raising $36.3 million for general research and capital investments. In 1990, Genzyme offered 30% of its genetic testing business, IG Labs, as a separate public company, raising $14 million. In 1991, Genzyme attracted $143 million with another public stock offering and $100 million with a convertible debt offering. By 1993, Genzyme had completed eight financings. Henri Termeer now displayed eight clocks in his office which he had received as recognition, one for each financing. Capital markets for biotechnology fluctuated in extremes, making funding opportunities a hit-or-miss game, but Genzyme had had particular success in attracting funding throughout its history. Greg Phelps described financing as one of Genzyme's "core competencies."

Challenges Ahead

In 1993, the Clinton administration was working to reform the U.S. health care system with the aim of bringing down costs. Drug companies were attacked with criticism in the first months of the new presidency. The administration had not agreed on a plan for health care reform, but pharmaceutical and biotechnology executives worried that the plan might include price regulation or limit profits on pharmaceuticals and thus reduce incentives for investment in their industries. This was a particular concern for biotechnology companies since most raised all of their funds through equity investments. "Investors are losing their appetite for this industry," noted Termeer, who believed that investors were already becoming more selective. In the first two months of 1993, the marketwide indices rose about 2% while the drug industry index dropped 16%. The biotech industry index fell 31%its depression was due in part to news of one promising product which failed in research and another product which showed disappointing sales.




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Looking to the years ahead, the path to success was sown with uncertainties. Alison Taunton-Rigby summed it up: "There are incredible challenges, and they're ones we have to face successfully to continue to grow this company." Henri Termeer believed that the future of biotechnology companies would be shaped by the outcomes of capital market and political uncertainties. In the environment of the 1990s, he explained, good finance and good science were no longer sufficient for success.




16

Exhibit 1 Consolidated Income Statement, Years Ended December 31, 1987-1992 ($000s)

1992 1991 1990 1989 1988 1987

Revenues: Product sales 139,568 72,019 32,057 23,572 18,833 12,548 Service sales 40,400 21,503 13,941 9,261 5,812 Revenue from R&D contracts 39,111 28,394 15,551 9,021 5,774 4,207 Investment income 21,981 12,371 4,752 1,548 1,252 1,694 TOTAL REVENUES 241,060 134,287 66,301 43,402 31,671 18,449

Costs and Expenses: Cost of products sold 52,514 33,164 18,239 15,310 10,398 7,332 Cost of services sold 27,254 14,169 8,439 4,420 2,979 Selling, admin & general 59,704 39,118 23,615 14,848 9,579 7,448 Research & development 39,675 27,232 18,611 11,316 6,284 4,293 Purchase of in-process R&Da 51,100 0 20,783 3,653 Purchase options/Financing Exp.b 16,905 0 9,050 3,659 0 0 Interest expense 7,099 2,088 681 551 438 277 TOTAL EXPENSES 254,251 115,771 99,418 53,757 29,678 19,350

Income (loss) before unusual items (13,191) 18,516 (33,117) (10,355) 1,993 (901) Gain on sale of IG Labs stock 7,214 Gain on sale of GENE-TRAK 4,065 Provision for income taxes (19,275) (12,848) (730) (1,025) (729) (159) Credit from utilization of

operating loss carry-fwd

471

8,387

229

147 Other revenue (expense) 1,678 2,726 645 0 0 1,323 NET INCOME (LOSS) (30,317) 20,846 (25,988) (11,380) 1,493 410

a 1990 includes purchase of Ceredase Partnership in exchange for common stock. 1992 includes purchase of 4 research projects from Neozyme II. b 1990 includes warrants granted to Neozyme I investors. 1992 includes write-off of value of Neozyme II stock purchase option.

Source: Company Annual Reports. 1992 financials include the accounts of IG Laboratories and Genzyme's wholly owned subsidiaries.




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Exhibit 2 Consolidated Balance Sheets, Years Ended December 31, 1987-1992 ($000s)

1992 1991 1990 1989 1988 1987

Assets: Current Assets

Cash and equivalents 48,975 30,565 6,652 27,013 2,209 1,221 Short-term investments 67,416 79,642 36,290 25,712 8,760 18,511 Accounts receivable 52,635 34,104 11,289 7,822 5,745 3,785 Inventories 20,344 16,329 12,995 8,678 7,276 3,834 Prepaid expenses & other 13,577 8,535 1,690 1,771 697 416

Non-current Assets Net property, plant & equip 87,927 39,103 8,876 10,035 14,829 10,428 Other non-current assetsa 189,812 195,365 40,297 28,119 2,615 3,617 Total Assets 480,686 403,643 118,089 109,150 42,130 41,812

Liabilities and Stockholders' Equity: Current Liabilities

Accounts payable 11,614 4,725 2,028 1,646 2,347 1,422 Accrued expenses 20,996 11,284 4,558 5,616 1,690 1,452 Income taxes payable 1,058 2,513 Deferred revenue I 1,893 2,078 1,232 Current portion of LT debt - 1,062 1,568 2,625 2,651 1,257 1,235

Non-current Liabilities Long-term debt 104,906 103,499 300 2,160 2,700 49200 Capital lease obligations 463 1,110 1,743 2,897 63 Deferred investment grants 378 531 606 563 682 Other non-current liabilities 3,356 2,668 1,243 2,635 159 166 Total Liabilities 145,726 129,976 14,335 18,168 8,835 8,538 Minority interest in subsidy 12,347 5,334 7,566

Stockholders' Equity $ 322,613 268,333 96,188 90,982 33,295 33,274 $ 480,686 403,643 118,089 109,150 42,130 41,812

a 1990 includes $131 million in long-term investments.

1991 includes $172 million in long-term investments, primarily municipal and U.S. Treasury notes.

Source: Company annual reports. 1992 financials include the accounts of IG Laboratories and Genzyme's wholly owned subsidiaries.




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Exhibit 3 Overview of Genzyme's Products and Services, 1992

PRODUCT APPLICATION STATUS

Biotherapeutics Ceredase (GCR) Treat Gaucher's disease product sales Ceredase (rGCR) Treat Gaucher's disease phase III trials Thyrogen Detect & treat thyroid cancer phase I/II trials CFTR-PR Treat cystic fibrosis (protein replacement) research CFTR-GT Treat cystic fibrosis (gene therapy) research CTH Treat Fabry's disease pre-clinical development Vianain Debride burned tissue pre-clinical development HAL-C/F/G Reduce post-operative adhesions initial studies HAL-S Tissue protectant for arthroscopic/orthopedic surgery phase II/III trials

Pharmaceuticals and Fine Chemicals Clindamycin phosphate Treat serious infections product sales Intermediates Production of bulk drug intermediates product sales Fine chemicals Pharmaceutical intermediates product sales Synthetic phospholipids; Drug delivery systems & pharmaceutical components product sales

Diagnostic Products Intermediates Use in manufacturing diagnostic kits for blood analysis product sales Immunobiologicals Use in research in immunology & cell biology product sales Direct cholesterol

testing products Clinical testing of HDL & LDL cholesterol levels

development

FCS product Prenatal testing research

Diagnostic Services (IG Laboratories) Biochemical testing Pre-screening for genetic abnormalities (prenatal) service sales Cytogenetic testing Screen/detect for genetic abnormalities (prenatal) service sales DNA testing Test for specific genetic disorder (prenatal & adult) service sales

Source: Company 10-K (1991)




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Exhibit 4 Genzyme Product Sales Projections, 1990-1996 ($000s)

1996(E) 1995(E) 1994(E) 1993(E) 1992(E) 1991 1990

Human Therapeutics

Ceredase (including rGCR) 150,561 141,506 130,070 119,976 94,040 39,600 5,897 HAL products 12,256 10,422 1,588 1,512 468 940 0 Thyrogen 22,500 5,000 0 0 0 0 0 Vianain 7,500 0 0 0 0 0 0 tPA (Japan) 0 0 0 0 0 553 0 Total $192,817 $156,928 $131,658 $121,488 $94,508 $41,093 $5,897 % growth 23% 19% 8% 29% 130% 597%

Diagnostics

Diagnostic enzymes 47,934 39,945 33,287 27,739 23,116 13,954 13,401 Immunobiologicals 18,102 15,085 12,571 10,476 8,730 7,040 6,100 Medix Biotech (acquired 6/92) 13,532 10,024 7,425 5,500 2,000 0 0 Cholesterol tests 130,000 100,000 60,000 10,000 2,000 0 0 Total $209,567 $165,053 $113,283 $53,715 $35,846 $20,994 $19,501 % growth 27% 46% 111% 50% 71% 8%

Fine Chemicals and Pharmaceuticals

Total $33,267 $27,230 $22,386 $18,477 $14,150 $9,932 $6,659 % growth 22% 22% 21% 31% 42% 49%

Diagnostic Services

Total $146,536 $114,345 $83,756 $60,591 $26,800 $9,073 $2,529 % growth 28% 37% 38% 126% 195% 259%

Total Sales $582,187 $463,556 $351,083 $254,272 $171,304 $81,092 $34,586

Source: Vector Securities International, Inc., September 9, 1992 report.

Notes: 1. (E) indicates estimated figures. 2. Revenues for 1990-1992 do not include recent acquisitions such as Vivigen, Inc. 3. Ceredase was sold on a compassionate basis in the United States prior to its approval in 1991. 4. Some figures do not add due to rounding; all figures taken from the Vector report.




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Exhibit 5 Cost Breakdown for Ceredase

Sales 100%

Cost of Goods Sold Materials 15 Production & Depreciation 11

Gross Margins 74 Selling & Administrative 12 R & D expensea 12 Uncollectiblesb 16

Profit before tax 34 Tax 12

Net Contribution 22%

a Includes ongoing R&D on both natural and recombinant Ceredase. b Includes Medicaid rebates, free goods, and uncollectible accounts.

Source: Company estimates

Exhibit 6 Pharmaceutical Company Costs Estimated as a Percentage of Sales

Sales 100%

Cost of Goods Sold 1530

Gross Margins 7085 Selling & Administrative 3040 R & D expense 1520 Depreciation 5 Profit before tax 1535 Tax 512

Net Income 1023%

Source: Compiled from company and analyst reports for leading pharmaceutical firms.



Exhibit 7 Boston Sunday Globe Article, April 11, 1993


21

Source: Boston Sunday Globe, April 11, 1993



Exhibit 7 (continued)


22




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Appendix A The Biotechnology Sector18

Biotechnology is the science and set of techniques for using living organisms such as bacteria, yeast, plant and animal cells to produce substances or perform a commercial purpose. Rudimentary techniques include fermenting ingredients with yeast (to produce beer or leavened bread, for example) or using the mold Penicillium to produce penicillin. Since the late 1970s, research breakthroughs have advanced the science so that biotechnology has now come to refer mainly to recombinant DNA ("genetic engineering") and hybridoma, techniques which allow scientists to produce proteins, antibodies, enzymes, and carbohydrates essential to biological functioning. These substances are impractical to extract from living organisms and are far too complex to synthesize with traditional chemical methods.

In 1992, there were 1,100 companies in the United States which were dedicated to using biotechnology for commercial applications. More than three-fourths of these companies were developing pharmaceuticals; 43% were primarily developing therapeutics (also called biotherapeutics) and 34% were developing diagnostics. The other one-fourth were developing applications for agriculture, energy, and the environment or specialized supplies for other biotech firms. In 1992, U.S. biotechnology companies generated $4 billion in product sales, most of which were pharmaceuticals.

Therapeutic Pharmaceuticals Therapeutics were vaccines, antibodies, and other medicines for treating disease or disability. The first modem biotherapeutic became available in 1982 (Eli Lilly's rDNA-produced humin insulin), but only 14 biotherapeutics were on the market in 1991. Some of these products were treatments which were not previously available. Others treated the same disorders as chemically produced drugs, but the biotech products were generally thought to be safer and more effective; because they were derived from human proteins, antibodies, enzymes, or carbohydrates, biotherapeutics generally caused fewer side effects in patients. In 1991, 132 biotherapeutics were in advanced stages of approval by federal regulatory authorities in the United States. Half of these drugs were being tested for cancer or cancer-related conditions and 17 were potential treatments for AIDS or human immunodeficiency virus (HIV)-related illness.

Traditional drug companies typically screened thousands of compounds in search of one that could cure disease. With this trial-and-error method, the cost to research, develop, and commercialize a traditional drug averaged $231 million. On average, the process of developing and commercializing a traditional drug took 8 to 12 years to complete. With biotechnology, trial-and-error methods were unnecessary, but identifying and synthesizing these products required a more thorough understanding of a particular disease. Biotech drugs could typically be researched, developed, and commercialized more quickly than chemical drugs, at an average cost of $100 million each. In the United States, both chemical and biotechnology medicines were regulated by the Food and Drug Administration (FDA). The FDA dictated standard for Good Laboratory Practice (GLP) and required all new products to be submitted to rigorous approval process before they could be marketed. See Appendix B.

Of the 43% of biotech firms involved in therapeutics in 1991, 48% of them had products sales and 9% of the companies were profitable. Most firms developing biotherapeutics were counting on one or two blockbuster products to build their success. A major therapeutic could generate $1 billion in product sales annually; a minor market drug could generate $50 million to $100 million. Biotherapeutics were sold to physicians, pharmacies, and hospitals, both directly and through wholesale distributors. These buyers considered both price and effectiveness of a product, though effectiveness was usually most important. Because it was expensive for a company to employ its own sales force, 60% of biotech firms formed marketing alliances with larger biotech or pharmaceutical companies to market their products.

Diagnostic Pharmaceuticals Diagnostics were tests to identify disease or genetic deficiency in humans. Biotech diagnostic products had been sold since the late 1970s. Most of the diagnostics introduced through the 1980s were replacements for existing products, but by the late 1980s, new products were developed, such as a test for detecting antibodies to HIV in human blood. Biotech diagnostics were considered superior to traditional diagnostics because they were typically faster, more reliable, and easier to use.

Of the 34% of U.S. biotechnology firms involved in diagnostics in 1991, 80% had product sales (many of which were non-biotech products) and 26% of the firms were profitable. Diagnostics did not have potential for sales as high as therapeutics, but had the advantage of lower research and development costs and a shorter product development cycle, averaging two to three years. The FDA regulated the approval and sale of diagnostics, but these products had fewer regulatory requirements than therapeutics. Diagnostics were typically approved much faster than therapeutics since they were generally not used in the human body. Diagnostics also faced more competitive products than therapeutics.

18 Summarized from "Biotechnology Strategies in 1992," HBS Case No. 792-082.




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Diagnostics were sold to medical laboratories, physicians, and medical centers. As in therapeutic sales, buyers considered both price and effectiveness. A higher priced diagnostic had to be significantly faster or more accurate. Products were typically licensed and sold through a marketing partner; in 1990, 73% of diagnostic firms had marketing alliances.

Patent Issues Biotechnology research was easy to imitate, but products (including animals, plants, and microbes) could be patented. U.S. patents granted companies 17 years free from competition. The U.S. Patent & Trademark Office granted patents to protect the process for making, method for using, or composition of a product. In the 1990s, the courts strictly enforced patents and harshly penalized anyone who infringed on an established patent. Consequently, litigation among companies over patent rights grew more common and more costly as companies aggressively defended their positions.

Research Most biotechnology companies licensed early stage research from universities, saving the firms years of exploratory research. Many companies maintained close relationships with academic researchers by collaborating on research. Other firms formed research alliances with other biotech firms or pharmaceutical firms to collaborate on specific projects; one partner funded a research program in return for a share of the profits. The largest biotech firms, with their greater number of people and projects, typically did not have to rely on collaborators, so more research could remain proprietary. A firm that had multiple projects and employed a number of scientists could share research results and discoveries within the company. This was possible because many areas of biotechnology were interrelated. The U.S. government offered increasing support for research in biotechnology. The proposed federal budget for fiscal 1993 called for $4.03 billion in biotechnology research, up from $3.76 billion in 1992. Government grants provided funds to independent companies for assigned topics, usually in innovative, high-risk areas of research.

Manufacturing Processes for large scale manufacturing of recombinant DNA and hybridoma technologies had to be extremely precise. Slight variation in temperature, pressure, or pH level could ruin an entire batch of active ingredient, a loss of hundreds of thousands of dollars in revenue. A firm became more efficient after scaling up production from small, lab-scale quantities to commercial manufacture, but commercial scale usually required a different process. Processes which worked at lab scale were ineffective or prohibitively expensive at commercial scale, so companies put great effort in to developing commercially feasible production methods. In extreme cases, companies had to abandon products which could not be manufactured at commercial scale. Typically, though, production accounted for roughly 10% of total product cost. As more products approached regulatory approval, more companies were preparing for commercial manufacture. Building a new facility cost a minimum of $25 million and took one to two years. If a firm did not want to manufacture, it could arrange for another company to produce the product in return for a share of the profits. In 1990, 80% of biotech firms were preparing to manufacture. Of these, 26% had manufacturing alliances.

Suppliers Biotech companies required general laboratory supplies (such as aprons and Pyrex glassware) and specialized supplies (such as reagents and assays, instrumentation, and equipment), most of which they purchased through distributors. Specialized lab equipment could cost tens of thousands of dollars. In most cases, technical product superiority and supplier reliability were more important purchase criteria than price.

Financing Financing was crucial because most companies had few tangible assets and little or no earnings. In 1991, industry losses totalled $2.9 billion, an increase of 45% over the prior year. That year, only 15% of companies had a net positive monthly cash flow. Start-ups were usually funded by a number of venture capital partnerships. Once established, many biotech companies raised money through public stock offerings. Since most biotech companies were venture-backed and had uncertain cash flows, debt financing was not a feasible source of funding. From the late 1980s into the early 1990s, the financing environment had changed dramatically. In the 1980s, investors were primarily attracted to firms with the most sophisticated science. In the 1990s, investors were concerned about the commercial potential for a company's products and the expertise of the company's management. But even as investors grew more sophisticated, their moods were changeable and the financial markets were extremely volatile. News of one product's FDA approval or rejection often triggered a reaction which affected the price of all biotech company stocks.




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Appendix B Overview of the Approval Process for New Drugs in the United States19

Pre-clinical Testing (2-3 years) A compound which showed potential was tested in the laboratory and in animals to assess its safety and to analyze its biological effects. If a compound proved safe and demonstrated the desired biological effects, the firm filed an Investigational New Drug (IND) notice with the FDA. If the FDA did not object within 30 days, the company could proceed to conduct clinical testing using the new compound.

Clinical Testing (6 years) Clinical trials involved the testing of the IND in human volunteers. This stage of the process was divided into three separate phases:

! Phase I Trials (1 year) The Phase I trials in humans were designed to determine the safety and pharmacological properties of a compound. Each drug was typically tested in 20 or more healthy volunteers. On average, 70% of all INDs moved on to the Phase II human trials.

! Phase II Trials (2 years) The Phase II trials were designed to evaluate the effectiveness of the drug and to isolate side effects. Tests were typically conducted with several hundred (volunteer) patients, some of whom received the IND and some of whom received a placebo. Only about one-third of all INDs survived both the first and second phases of clinical testing.

! Phase III Trials (3+ years) The Phase III trials measured the effect of the IND on a large sample of patients (typically thousands of patients) over several years. These trials helped ascertain long-term side effects and provided information of the effectiveness of a range of doses administered to a mix of patients.

FDA Review (2-3 years) Upon completion of the Phase III trials, firms were required to file a New Drug Application (NDA) or a Product License Application (PLA) with the FDA and submit documentation of all relevant data for review. The FDA created a special advisory committee for each NDA or PLA which made the final recommendation as to whether or not the drug should be released for commercial sale. Post-marketing safety monitoring continued even after approval. Only 20% of all INDs were ultimately approved by the FDA.

19 Exhibit adapted from Burroughs Wellcome and AZT, HBS Case No. 792-004.



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