Assignment 2 LASA 1Business Unit AnalysisDirections Create a.docx
- 1. Assignment 2: LASA 1 Business Unit Analysis Directions: Create a Feasibility Study for Harley-Davidson using the following outline: Part I: Differentiation Strategies The analysis of current strategy and competitor analysis you conducted last module impressed the senior vice president. She now needs you to delve into the brands and analyze them by conducting a business unit analysis and presenting your findings in a three-part PowerPoint presentation. Research the Harley-Davidson (H-D) Web site for each brand, and review the annual report for relevant details of the size, scope, target market, services and amenities, and other salient points of differentiation. Include these details in Part I of your PowerPoint presentation. From the research and analysis of the business units, identify: · A description of each brand that provides a clear picture of the brand and its place in the overall portfolio of Harley-Davidson. · The target market of each brand. · How the brands are alike and how they differ. · A preliminary analysis of any gaps that exist in the portfolio that might lead to opportunities to add to the brands. · Your analysis of possible merger/acquisition/joint venture possibilities and what would be achieved or accomplished through the merger/acquisition/joint venture. Part II: SWOT Analysis Perform a SWOT analysis for Harley-Davidson and include this information in Part II of your PowerPoint presentation. · Based on the internal analyses of the SWOT analysis, assess the functional areas, resources, capabilities, and strengths H-D
- 2. possesses. Please be sure to cover the following functional areas in your assessment: · Marketing: New product development, integrated marketing planning, marketing communications, and building customer loyalty. · Operations: Quality, service, and consistent execution. · Human Resources: Hiring, training, developing talent, and performance planning. Avoided lawsuits and bad PR due to its hiring practices. Is ethical in its HR practices. · Executive Leadership: Industry knowledge and experience, vision about where the industry is heading, and strategy execution. · Supply Chain Optimization: Strategic sourcing of input, vendor management, integrated IS, and joint forecasting with suppliers. · Corporate Responsibility and Ethics: Concern for corporate citizenship and the environment. Present any potential ethical concerns as well. · Safety and Quality: How the motorcycle industry is dealing with safety and quality issues. Part III: Growth and Profitability Strategies In addition, the executive board is interested in your ideas about bold strategies for the future. The strategies you recommend will have to contribute to growth and profitability, as outlined in the Annual Report. You will want to pay special attention to exploring vertical integration, strategic alliances, and the internal growth of new brands entering new geographic markets, and/or additional acquisitions.
- 3. Consider the following: · Is Harley-Davidson, Inc., (H-D) competing in the right businesses, given the opportunities and threats present in the external environment? If not, how can H-D realign its diversification strategy to achieve a competitive advantage? This may include additional diversification to take advantage of opportunities such as further vertical integration. · Is the corporation managing its portfolio in a way that creates synergy among its businesses? If so, what additional businesses should it consider adding to its portfolio? After you have reviewed the growth and profitability strategies, create a list of possible strategies to present a full range of ideas. Part III of your presentation should include your complete list— all potential ideas—for the senior vice president. This is your chance to be creative. Next, rank your ideas from best to worst. To do this, keep in mind several things such as fit with current strategy, resources and capabilities, and difficulty of execution. For each of your top five ideas, add the following: · Briefly describe the strategy. · Why you picked it as one of the top five. Think about such things as: · Does the strategy build on current competencies and foster horizontal relationships among brands? In other words, what can be leveraged or shared? What are the pros and cons of this strategy? Your PowerPoint Feasibility Study presentation will also include slides pertaining to the following assessments: · Part I: Identification of size, scope, target market, services, amenities, and points of differentiation. · Part II: SWOT analysis that includes marketing, operations, human resources, executive leadership, supply chain
- 4. optimization, corporate responsibility, ethics, safety, and quality. · Part III: Growth and profitability strategies, including your top five strategic ideas and support. Submit the PowerPoint Feasibility Study presentation to the senior vice president so that she can review the alternatives and provide you with feedback about your ideas. Assignment 2 Grading Criteria Maximum Points Assignment Components Describe Harley-Davidson’s brand, including its target market, how the brands differ, business units, and its place in the overall portfolio of H-D. 16 Identify opportunities to add to the brands based on current gaps in the portfolio. 20 Assuming H-D participates in a merger, select a strategy and discuss the benefits of the strategy for H-D. 24 Provide a SWOT analysis on H-D’s functional areas: Marketing, Operations, HR, and Executive Leadership. 32 Provide a SWOT analysis on H-D’s functional areas: Supply Chain Optimization, Corporate Responsibility & Ethics, and Safety & Quality. 32 Recommend growth and profitability strategies for H-D. Rank and describe your top five options for the Sr. VP. Include a justification. 32 Presentation Standards Organization (12) Usage and Mechanics (12) APA Elements (16)
- 5. Style (4) 44 Total: 200 9 - 8 0 6 - 0 9 2 R E V : J U L Y 3 1 , 2 0 0 7 _____________________________________________________ _____________________________________________________ ______ Professor Richard Hamermesh, Dr. Ron Laufer, and Global Research Group Senior Researcher David Lane prepared this case. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2006, 2007 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 means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.
- 6. R I C H A R D H A M E R M E S H R O N L A U F E R D A V I D L A N E Corporate Venture Capital at Eli Lilly In October 2005, Darren Carroll was completing his second month as senior managing director of New Ventures at Eli Lilly and Company (Lilly). In this role, Carroll was in charge of two distinct groups within the corporation. One was Lilly’s corporate venture capital (CVC) group, Lilly Ventures, an evergreen fund with a capital pool of $175 million that had been investing since 2001 in biotechnology, healthcare IT, and medical device start-up companies. The other was Lilly Accelerators, which since 2000 had been incubating business ideas developed by Lilly employees that had the potential to transform various elements of the pharmaceutical industry. Carroll had been assessing the overall effectiveness of Lilly Ventures to date, whether it was sufficiently aligned with Lilly’s overall strategy, and any changes needed to make Lilly Ventures more effective. At the same time, Carroll was reviewing a particularly interesting, and potentially problematic, Series A investment that was being proposed by Lilly Ventures. The possible investment, in an early- stage chemistry-engine technology company called Protagonist, located in Brisbane, Australia,
- 7. represented a major opportunity, but would be unusual in many respects. Carroll explained: One of the great advantages of being a corporate venture capital fund is that we are able to make investments that are earlier stage than regular VCs would be willing to make. In this case, the company is probably three years away from starting its first clinical trial. That, plus its location, is a turnoff for U.S. VC firms. As a matter of policy, we only invest as part of a syndicate. Since we have begun to take the lead in this investment, several Australian VC firms have signed up. But so far we have been unable to get a top-tier U.S. VC firm to invest. Should we really continue to pursue a deal that can’t attract a U.S. investor? Corporate Venture Capital In the United States, corporate venturing historically showed strong cyclicality. Between the late 1960s until the oil shock of 1973, over 25% of Fortune 500 firms set up divisions that mimicked independent venture capital firms. However, poor returns and the belt tightening induced by the oil crisis sharply curtailed most corporate venture investing. A second wave of corporate venturing arose during the 1980s. By 1986, corporate funds managed $2 billion (12%) of the total pool of venture For the exclusive use of P. Sun, 2017. This document is authorized for use only by Pang Sun in Competing in Technology Industries taught by H. Dennis Park,
- 8. Drexel University from January 2017 to June 2017. 806-092 Corporate Venture Capital at Eli Lilly 2 capital. At this time, high-tech and pharmaceutical firms were the leading corporate investors, though the 1987 stock market crash dried up the demand for IPOs. The third wave of corporate venturing rode the high-tech bubble and equities bull market of the late 1990s.1 One conservative estimate put corporate venture capital at $8 billion in 1999, a 20-fold increase over 16 years.2 Much of this evaporated in the technology and equities slump of 2001– 2002, as Accenture, Dell, Level3, and Oracle, among others, sold off their venture arms.3 Of the $21.7 billion in venture capital invested in 2005,4 corporate venturing accounted for $3.1 billion (14%), and corporate venture investments in the life sciences amounted to $1.1 billion.5 While cyclicality typified corporate venture investing in general—robust when the parent was healthy, curtailed when the parent ailed—the pharmaceutical industry resisted the temptation to enter and exit the venture business as a pack. Instead, different pharmaceutical firms at different times reached the point at which external and internal environments supported the launch of a venture fund. The oldest active corporate venture fund in life sciences was the Johnson & Johnson Development Corporation (JJDC), established in 1973. The second-oldest active investment group,
- 9. S.R.One, was over a decade younger. Launched in 1985 after several years of fund-of-funds investing, this investment arm of SmithKline Beecham gained early success with its investment in Amgen and became a model that other corporate funds emulated. At the same time, CVCs in the pharmaceutical industry still relied for their existence on support from senior corporate management, which could wax and wane with corporate priorities, earnings prospects, and personnel changes at the top. In addition, the reporting relationships of CVC arms varied greatly—reporting to the offices of the CEO, CFO, or Business Development, for example. Elaine Jones, a former vice president at S.R.One, asserted that having a champion who is very high in the organization was a key success factor for any CVC: Someone must be willing to invest in corporate venturing for years, because it takes several years to see results. This person needs to have a long view, not come to check in by the quarter. It starts with senior leaders who see this as a different facet of business development which makes money for the corporation. As your management changes, people and needs change, and you need to continue demonstrating that you add value. There will always be people that see CVC as an unnecessary end of the tail of the dog. Unlike stand-alone venture capital (VC) firms, which funded start-ups purely in the expectation of financial gain through their eventual sale or IPO, corporations set up venture capital arms primarily to nurture and develop start-up businesses for their parent company.6 In general, the payoff to the
- 10. parent was strategic and typically involved either access to innovation or support for the viability of the parent’s business objectives. Among technology companies in particular, corporate venture investments helped create an “ecosystem” that helped broaden and deepen the market for the parent’s products. Chemical and pharmaceutical companies used venture investments primarily to 1 Paul A. Gompers, “Corporations and the Financing of Innovation: The Corporate Venturing Experience,” Economic Review— The Federal Reserve Bank of Atlanta, 87:4 (2002): 1–6. 2 Asset alternatives data cited in Paul A. Gompers, “Corporations and the Financing of Innovation: The Corporate Venturing Experience,” Economic Review—The Federal Reserve Bank of Atlanta, 87:4 (2002): 6–7. 3 Felda Hardymon and Ann Leamon, “SAIF: May 2004,” HBS Case No. 805-091 (Boston: Harvard Business School Publishing, 2005), p. 5. 4 www.nvca.org/pdf/Moneytree05Q4FinalRelease.pdf, accessed February 1, 2006. 5 Casewriter calculation from Thomson Venture Expert data. 6 See Julian Birkinshaw, “The Secret Diary of Corporate Venturing,” Business Strategy Review, 16: 2 (Summer 2005): 1–24. For the exclusive use of P. Sun, 2017.
- 11. This document is authorized for use only by Pang Sun in Competing in Technology Industries taught by H. Dennis Park, Drexel University from January 2017 to June 2017. Corporate Venture Capital at Eli Lilly 806-092 3 learn about, license, or acquire innovative new compounds, processes, and intellectual property (IP). Their investments could take the form of pure equity investments or equity plus additional rights such as licensing agreements. Alternatively, corporate venture investing could be part of collaboration agreements between firms to cooperate in the development, marketing, and sale of products that neither partner could produce alone.7 As a result, CVC differed in several ways from the stereotypical VC investment. CVC investors normally offered start-ups more complementary assets— physical, knowledge based, and intangible—than a VC could. Theoretically, CVCs could invest in companies regardless of their development stage, whereas a VC would try to time its exits around the life cycle of its fund or the raising of a new fund.8 Not purely motivated by financial returns, CVCs were less constrained by issues of valuation. For the same reason, corporations were often less emphatic than VCs about maximizing a start-up’s financial discipline. More critically, a CVC’s investing interests could be viewed as less aligned with its start-up’s and more focused on information gathering, hedging the
- 12. parent company’s bets, and even as strategic denial of an opportunity to a rival. As one account put it, CVCs were “historically regarded as at best, fickle, and at worst, misguided.”9 Recruiting and retention were additional challenges for CVCs. Few VCs were eager to forgo a share of investing returns for the rigidity of lower corporate pay scales, and the most successful corporate investors often left for private VC.10 For start-up companies, corporate venturing offered the backing of a large company, backing that potentially extended beyond an injection of capital to include access to experienced management and sectoral expertise, as well as access to R&D, marketing, and distribution channels. Moreover, CVC recipients were well placed to receive subsequent funding from third parties, often on the basis of the validation created by the earlier corporate investment—the halo effect. In addition, a corporate investor usually created a clear exit path for start-up companies.11 However, start-ups feared the potential loss of management control that even a light corporate embrace could bring. They also worried that any IP sharing could create a formidable competitor. Another key concern was that having one corporate investor on board could scare other corporations away from business development, collaboration, or M&A deals with the start-up. As one expert put it: Entrepreneurs were limited by this structure because . . . they were forced to sacrifice breadth of available resources. In addition, early-stage entrepreneurs were often concerned about protecting their intellectual property and wanted to avoid
- 13. alliances that could threaten their position. For example, a small high-technology company in a precarious financial situation might be reluctant to approach IBM or Sony directly for funding. Therefore, the very companies in which these corporations wanted to invest were usually the ones that never made it to their doorsteps.12 7 See Lisa Bushrod, “Corporate Venturing: Different Models and Their Applications,” European Venture Capital & Private Equity Journal, September 1, 2005, p. 1. Available from ProQuest, ABI/Inform, www.proquest.com, accessed December 15, 2005. 8 Henry Chesbrough, “Designing Corporate Ventures in the Shadow of Private Venture Capital,” California Management Review, 42:3 (Spring 2000): 38–41. 9 Hardymon and Leamon, p. 5. 10 Hardymon and Leamon, p. 6. 11 See Edward Cartin, “Corporate Venturing: A Financing Cinderella,” Accountancy Ireland, 37: 3 (June 2005): 30–31. 12 Paul A. Gompers, “Corporations and the Financing of Innovation: The Corporate Venturing Experience,” Economic Review— The Federal Reserve Bank of Atlanta, 87:4 (2002): 2. For the exclusive use of P. Sun, 2017. This document is authorized for use only by Pang Sun in Competing in Technology Industries taught by H. Dennis Park,
- 14. Drexel University from January 2017 to June 2017. 806-092 Corporate Venture Capital at Eli Lilly 4 Eli Lilly and Company Eli Lilly and Company was founded in 1876 by its namesake, a colonel in the Union Army and pharmaceutical chemist by training. Driven by a frustration with the poorly prepared and often ineffective medicines of his time, Colonel Lilly committed himself to basing his new company on the best science of the day, developing only medicines that would be dispensed at the suggestion of a physician and manufacturing products of the highest possible quality. With a staff of three, including a drug compounder, a bottler and finisher, and his 14-year-old son Josiah, he set up the company in downtown Indianapolis, only a few blocks away from the present-day location of the company’s global headquarters. Over the next 129 years, Eli Lilly and Company played a key role in improving human longevity and quality of life around the world. In 1923, Lilly introduced Iletin, the first commercially available insulin product for the treatment of insulin-dependent diabetes mellitus (IDDM). Prior to the Lilly collaboration with Banting and Best, the discoverers of insulin, the only effective method to prolong the life of children diagnosed with IDDM was a caloric-negative diet, effectively starving the children
- 15. to death. From the 1940s, Lilly built a name for itself in the anti- infective area. Starting with the mass production of penicillin, the company moved to introduce products such as Vancomycin, Erythromycin, Keflex®, and Ceclor®, the world’s top-selling oral antibiotic in the 1970s. In the 1980s and 1990s, Lilly became a neuroscience powerhouse, introducing a new class of antidepression treatment with Prozac®, as well as Zyprexa® for the treatment of schizophrenia. Prozac was a particularly important drug to Lilly and became a cultural totem, effectively marking the first time prescription drugs could safely and effectively be used to improve mood. The impact of Prozac was both positive and negative: the drug had brought the company about $2 billion annually and helped quadruple the company’s stock between 1993 and 1998, but it also created a strategic crisis when it went off patent in 2001. While Prozac and its relatives continued to generate over $500 million in 2004 sales for Lilly, its going off patent forced Lilly to roll out drugs and strategies that could sustain the company through the earnings trough that followed the onset of competition from generics. Over the years, Lilly added medical devices, diagnostics, animal health, even cosmetics businesses but during the 1990s refocused on its pharmaceutical core, spinning off many of its medical device assets to form Guidant in 1994, selling other noncore business units, and retaining as a separate division only its animal health business unit, Elanco. By the end
- 16. of 2004, Lilly had sales in over 140 countries, amounting to a record $14 billion (see Exhibit 1). Its lead product, Zyprexa®, reached blockbuster status with worldwide sales of close to $4.5 billion, followed by significant products in the areas of oncology, endocrinology, and women’s health. Keeping Colonel Lilly’s commitment to “the best science of the day,” the company reinvested over 19% of its sales in R&D through a network of science facilities in nine countries, with clinical research conducted in over 60 countries. Forming the e.Lilly and Lilly BioVentures Funds In the 1980s and early 1990s, Lilly began making equity investments in start-up companies as part of its business development transactions. Some of those investments—initially conceived of as just a minor component of a larger scientific collaboration between Lilly and small biotech companies— turned into significant moneymakers. Ron Henriksen, the architect of most of these deals, described how Lilly developed its initial interest in biotechnology partnerships: “Ever since the late 1970s, Lilly For the exclusive use of P. Sun, 2017. This document is authorized for use only by Pang Sun in Competing in Technology Industries taught by H. Dennis Park, Drexel University from January 2017 to June 2017. Corporate Venture Capital at Eli Lilly 806-092 5
- 17. was concerned that there would not be enough animal-derived insulin to supply the growing number of diabetic patients. That led to the first significant business development deal between a large pharmaceutical firm and a small biotech—the licensing of the technology for human recombinant insulin from Genentech.” By the late 1980s, Henriksen was Lilly’s director of business development, reporting directly to the CFO. In this role, he started making equity investments in start-up companies as part of licensing deals with them. As Henriksen recalled: The drivers were twofold. Getting access to technologies was key. If it was a really good company in an area Lilly was interested in, I wanted to get in first. Lilly was held in high esteem; companies wanted Lilly’s validation as an investor. We also wanted to make money. The concept was to run an evergreen fund of a sort, so we would not have to go back to the corporation for every new deal, but the key driver was to get a product or technology into Lilly. Generally we invested alone, sometimes paying a premium, but always as part of a business development deal. Sometimes the collaboration would fail, but we still made money. For example, we invested in Athena Neurosciences, but the science was too early and Lilly did not get a product out of it. But we made over 35% IRR. Twenty-six of Henriksen’s 50 deals included an equity investment component. At the time, Lilly also invested as a limited partner in two venture funds, one on each U.S. coast. Said Henriksen, “It
- 18. was a way to watch how venture capitalists worked, to sit at their meetings and become a member of the club. We did learn stuff from these guys. In the end we were as good, and we concluded that remaining an LP would be a distraction.” But such successes did not lead Lilly toward more intense corporate venture investing, nor did it raise the firm’s appetite to invest in private venture capital funds. In fact, Lilly repeatedly declined invitations to invest as a limited partner in life science venture funds during the late 1990s. According to Chuck Schalliol, who headed Lilly’s corporate finance and investment banking department during the mid-1990s: “VCs often approached Lilly, asking us to invest as a limited partner in their funds. The Lilly name would lend their funds credibility and prestige, while we were promised access to their deal flow. But our policy was that Lilly should only invest for strategic advantage, not purely for financial return. We didn’t need access to VCs and the financial world, and we could get access to the biotech companies ourselves if that were important to us.” In 2000, however, Lilly launched an internal corporate experiment. In response to the growing importance of the Internet and wireless technologies, the company established a small new division dubbed e.Lilly. The charter of e.Lilly was to experiment with new technologies, new business models, and new practices that might ultimately have a significant impact on the pharmaceutical industry. The division’s objectives were broad, ranging from influencing the discovery and development of new drugs on the one hand, to new ways to market and sell them on the other. To this end, e.Lilly
- 19. would husband ideas originating within the Lilly organization or elsewhere, initiate collaborations between Lilly business units and external partners, and manage its own venture capital fund. Schalliol argued that e.Lilly needed to function as much as a pure VC as possible. At the same time, he stated, “We said that we’d only invest if it gave us access to technology we viewed as interesting to Lilly Research Labs or our business units. In effect, we expanded business development activities.” With an allocation of $50 million and an internally recruited staff, the e.Lilly venture fund was launched in January 2001 with a mandate to focus its investments in four areas: “open-source innovation”—the use of Internet-based networks to foster scientific innovation from around the world; e-Clinical Trials and Development—leveraging sponsor/investigator/patient networks to reduce the time and cost of clinical trials; “Physician Connectivity”—multichannel, patient-physician relationships; and “the e-Patient”—delivering patient information at the point of care. For the exclusive use of P. Sun, 2017. This document is authorized for use only by Pang Sun in Competing in Technology Industries taught by H. Dennis Park, Drexel University from January 2017 to June 2017. 806-092 Corporate Venture Capital at Eli Lilly 6
- 20. At roughly the same time, another venture fund concept emerged from Lilly’s corporate strategy and business development group. This was also in response to a technological revolution, only of a different nature. Over the course of the late 1990s, many technologies that were tightly connected to the drug discovery and development process helped foment a “genomic revolution.” Backed by venture capital, many new companies were formed to take advantage of the abundance of newly discovered biological data and groundbreaking platforms and capabilities. Many of these companies looked up to leaders of the biotech industry such as Amgen and Millennium Pharmaceuticals, which had started as venture-backed start-up companies and were now on their way to becoming fully integrated pharmaceutical companies. As the number and importance of these biotech start-ups grew significantly, different people within the Lilly organization argued that perhaps it was time for large pharmaceutical companies to be more engaged with them, not just as collaborators or as the potential acquirer of an end product, but as a constructive influence in their early days. As Lilly employees watched the trajectories of such firms, it often seemed that small biotechs could benefit greatly if they had access to the organizational memory, discipline, and deep commercial understanding resident in large, mature pharmaceutical companies. A corporate venture capital fund, run out of Lilly’s corporate strategy and business development group, was seen as an appropriate vehicle to provide that access. Schalliol proposed that if Lilly chose to do corporate venturing, “Let’s get competitive advantage out of it by going it
- 21. alone, not as a limited partner in the same funds as our major competitors.” Launched in September 2001, Lilly BioVentures was allocated $75 million and was staffed initially with internal recruits, primarily from Lilly’s M&A department. Later on, junior staff were recruited from outside Lilly. The team was responsible for the generation of deal flow, due diligence, closing of deals, and portfolio management. Its investment focus was broadly around two key areas: “enabling technologies”—tools and platforms that could enhance the drug discovery and development process; and “horizon therapies”—emerging and novel therapies that lay beyond the boundaries of products currently being tested and marketed by the biopharmaceutical industry. The mission of Lilly BioVentures was to make early-stage to expansion-stage investments as part of a syndicate of venture investors in return for an equity stake as well as board or observer seats. The team also worked to leverage the large corporate organization behind them. Lilly Ventures expected this leverage to create value in three ways—as an additional source for deal flow through the network of thousands of Lilly scientists and businesspeople, as a source of expertise for the purpose of due diligence, and finally, as a resource for the benefit of portfolio companies. The BioVentures fund had an investment committee of three, including Schalliol, who headed the BioVentures fund, Lilly’s head of research strategy, and the CFO of Lilly’s research labs. Any two members could commit to a venture investment of up to $5 million without further approvals.
- 22. Lilly BioVentures allowed Lilly representatives to get a first look at companies earlier than Lilly might otherwise see them as potential business development partners. According to one manager, the early opportunity to enter a relationship with a start-up also gave Lilly a way of identifying possible technical snags before they became too significant for the start- up to fix later. The goodwill that resulted from such assistance helped position Lilly as a relationship-based investor and, it was hoped, provided Lilly with an advantage in case of a bidding war among top pharmaceutical firms, a situation that frequently developed over desirable acquisition targets or collaboration partners. Yet Lilly BioVentures was not simply an extension of the business development office, Schalliol emphasized: “Our goal was to make money, to beat the corporate hurdle rate. We described ourselves as financial investors in areas of strategic interest. We decided to be as much like a real venture fund as possible. Even if a company had good technology, we’d refer it to our licensing and business development people if it didn’t look like it would make money for us.” For the exclusive use of P. Sun, 2017. This document is authorized for use only by Pang Sun in Competing in Technology Industries taught by H. Dennis Park, Drexel University from January 2017 to June 2017. Corporate Venture Capital at Eli Lilly 806-092
- 23. 7 The First Four Years Lilly BioVentures invested in 10 companies in its first four years through 2005 (see Exhibit 2). All Lilly BioVentures investments were for equity in the form of preferred shares; there were no tie-in or licensing components to its deals. Lilly BioVentures always invested as part of a syndicate, never as sole investor. There were several reasons for this. First, it allowed Lilly BioVentures to benefit from the funds of other investors. Second, it brought additional expertise to the start-up and to the deal. Third, syndicate participation tended to enhance deal flow, as Lilly would sometimes be invited to invest with a syndicate member in one or more of its deals. Syndicate members were usually top-tier firms, preferably in the United States, where the liquidity event was most likely to occur. Lilly BioVentures also took board or observer seats in each of its companies. Though one principal noted that portfolio companies sometimes initially objected, fearing that they could not thereafter collaborate with or sell to a Lilly competitor, “In response, we’d explain that the board seats will be occupied by our investment professional or investment committee members.” That is, Lilly BioVentures would establish a clear “Chinese wall” between the portfolio company and the rest of Lilly. Unusually for a CVC, Lilly Ventures was not averse to leading an investment round and in fact had done so for four of its 10 companies. Through this process, Schalliol noted, “We found that our
- 24. analysis was often more thorough than that of our co-investors. We were proud when a venture capitalist told us, ‘We don’t like corporate venture funds, but we’ll work with you.’ I’m proud of our investment process and that we run it like a real venture fund.” Between 2002 and 2004, the e.Lilly venture fund was merged into Lilly BioVentures, with the joint group operating under the name Lilly Ventures. In addition, the group was allocated an additional $50 million for investments in medical devices. By 2005, Lilly Ventures had $175 million under management, with 17 portfolio companies and a team consisting of its managing director, four principals, and two associates. However, with its growth, and especially with the entry into the medical devices area, the group had to resolve internal questions regarding its fit with the rest of the Lilly organization. Mike Gutch, a Lilly Ventures associate, elaborated in conceptual terms how the group fit internally within Lilly: Corporate venture capital can be seen as exclusively strategic, as a front end for future business development—to acquire technologies that the parent company needs. Elsewhere, corporate venture capital can help the company as an agent of product commercialization or can act as an internal service organization for the parent company. Lilly Ventures is not like this. We have a different mandate. We explore emergent technologies and those that in some cases are contrarian to Lilly’s current business mix. It might be
- 25. too early a technology, or simply a hedge or a different approach from what the corporation is doing. My perspective is that we should focus primarily on the areas Lilly works on, including neurological diseases, metabolic diseases, and cancer, but be open to looking at other therapeutics spaces and technologies on a selective basis. Schalliol put it more pragmatically: I felt we needed to have a higher standard than typical corporate venturing required. Deals will fail early and succeed late. I wanted to avoid early failures to validate our model, because there was pressure within the firm. We had to resist the desire of some senior people to make us a direct arm of business development or transfer the dollars to the R&D budget. A lot of it For the exclusive use of P. Sun, 2017. This document is authorized for use only by Pang Sun in Competing in Technology Industries taught by H. Dennis Park, Drexel University from January 2017 to June 2017. 806-092 Corporate Venture Capital at Eli Lilly 8 amounted to researchers saying that they could use the money allocated to us more effectively if it was part of their own R&D budget, misunderstanding that we were a balance sheet item,
- 26. not a cost on the income statement like R&D. Our position was that Lilly Ventures will get our scientists more access and leverage than they could on their own given that they could not get the same dollars for direct operating expense. The compensation system was another chronic challenge, said Schalliol: We had the choice of being separate from Lilly or part of Lilly’s system. We chose the latter, but that created incentive problems. Unlike venture capital partnerships, we couldn’t give people a piece of the traditional carry. We purchased a survey that found that we paid competitively only at the level of a VC associate or vice president level, below the equivalent of VC partner. On the other hand, Lilly offered some things a VC couldn’t offer, like immediate bonuses at the end of a year and stock options, whereas VCs had to wait for their deals to come to fruition. The overall package was not hugely disadvantageous especially at the more junior levels, and we did recruit excellent younger people from outside Lilly. By mid-2005, Lilly Ventures experienced several departures from its small team. Schalliol left to head a local initiative to promote the development of the life science industry in central Indiana and later was asked by Indiana’s governor to serve as the head of the state Office of Management and Budget. His successor as managing director, Dominic Colangelo, left for a senior management role with a public biotechnology company, and Ed Seguine, one of the fund’s principals, left to become
- 27. the CEO of one of the healthcare IT portfolio companies. Following Colangelo’s departure, Darren Carroll took over as head of Lilly Ventures, reporting to the Lilly vice president of business development. Following service as Lilly’s U.S. attorney for Prozac, Carroll had built several businesses, each of which used the Internet to innovate in the life sciences. These included InnoCentive, an online research community that was also Lilly’s first e-business. In his new role, Carroll moved quickly to survey the corporate view of Lilly’s venture activities. The feedback he received was that, despite strong support from the top for corporate venturing, Lilly’s CVC would need to communicate more frequently and more effectively with the Lilly community, much of which believed that Lilly Ventures overly emphasized its external face and was not sufficiently in touch with the strategic needs of the company. In addition, it was obvious to Carroll that the compensation system was not going to change in order to mimic the private VC model. He noted: “While some view departures as inherently destabilizing, in my opinion it creates an opportunity for change.” With the added responsibility for Lilly Accelerators, Carroll chose to continue Schalliol’s distinction between acting with the discipline of a venture firm versus serving as an agent of Lilly business development. “We’re not here to get an option on a firm,” Carroll stated. “Both Lilly Accelerators and Lilly Ventures are expected to be protecting our flank, since others are focused on Lilly’s bottom line.” As another principal put it, “We need
- 28. strategic alignment—but not identity— with Lilly’s strategic development and research strategy. Any potential investment must be a strategic fit with Lilly first.” Carroll agreed: “If we had financial returns but no alignment with Lilly strategic goals, we’d be shut down. There are two currencies to our success, cash and alignment. One way to repay alignment currency is with communication. You’ve got to tell your corporation what you are doing.” For the exclusive use of P. Sun, 2017. This document is authorized for use only by Pang Sun in Competing in Technology Industries taught by H. Dennis Park, Drexel University from January 2017 to June 2017. Corporate Venture Capital at Eli Lilly 806-092 9 The Protagonist Decision The Lilly Ventures team had noticed that VCs since the mid- 1990s often were forced to carry their early-stage U.S. biotech investments longer, prior to IPO or sale. In some instances, VCs were expected to buy additional shares at the IPO stage in support of their portfolio company. At the same time, the market seemed to no longer reward longer-term investments. Explained Gutch: The buy side has simply gotten smarter about biotechnology. They are no longer buying
- 29. into firms in the first or second phase of pharmaceutical development, where significant risk remains. Nowadays, every buy-side firm uses professionals who are medical doctors and Ph.D. scientists to evaluate companies and their products. They want firms already in Phase 3 of development, since this limits their risk. Yet pre-IPO values for companies at this stage of development have declined from previous years. The question becomes how to make money investing in early- stage biotech start-ups. The answer is to be capital efficient, and we can do that in two ways: first, by finding companies where labor and facilities costs are lower than Boston and California, and second, by finding companies and technologies that are more advanced prior to the Series A investment. While on sabbatical at an Australian business school in late 2004, one Lilly Ventures principal took the time to learn about the local VC and biotechnology markets. Through those efforts, he was introduced to a local firm called Protagonist. Established by Mark Smythe in 2002 in Brisbane, Protagonist had developed a platform for “rational drug design.” Drug Design and Discovery During the late 1990s, the pharmaceutical industry devoted much of its drug discovery efforts and resources to combinatorial chemistry that generated millions of synthetic molecules for later screening for efficacy against well-defined targets using “high- throughput screening” (HTS) tools. While the industry warmed to this notion that drug discovery
- 30. was, in essence, a numbers game, it was apparent by the early 2000s that this approach suffered from two critical challenges. Despite the declining cost of chemical synthesis and screening, the burden on R&D budgets of making and testing millions of molecules was substantial. Further, the speed with which HTS identified new molecules with potential far outstripped the speed at which laboratories could assess them, creating both a large backlog and few ways to identify the most promising molecules. In addition, the discovery that a synthetic molecule had some positive effect in the laboratory did not necessarily make it a prospective drug: the molecule still needed to be nontoxic, with a chemical profile that would allow it to be absorbed in the digestive tract, distributed in the body, metabolized at an appropriate rate, and then excreted, all while maintaining its desired effects. Imbuing molecules with these drug-like properties required substantial additional effort beyond the discovery process. In response to growing disappointment with combinatorial chemistry and HTS, “rational drug design” reemerged as a new approach. Featuring greater selectivity, rational drug design focused first on better understanding the effects required of a given drug before synthesizing a limited number of molecules likely to have those effects as well as drug-like properties. Protagonist Using proprietary software, the Protagonist platform allowed the company to isolate and focus on the most effective ways a molecule could switch cellular
- 31. responses on or off in order to create For the exclusive use of P. Sun, 2017. This document is authorized for use only by Pang Sun in Competing in Technology Industries taught by H. Dennis Park, Drexel University from January 2017 to June 2017. 806-092 Corporate Venture Capital at Eli Lilly 10 reactions with therapeutic effects. Protagonist’s software could then match the company’s proprietary library of molecules with the most effective reactions. Only the handful of molecules that company algorithms identified as promising were then synthesized and taken into the laboratory. Uniquely, Protagonist’s library contained molecules that already had drug- like properties. This not only significantly reduced the cost of drug discovery but also increased the probability of success for any molecule built upon this platform that made it into the laboratory. With seed funding of $3 million from Start-Up Australia, a Sydney-based venture fund, Protagonist completed the development of its platform, performed “proof-of-concept” work, and held contract discussions with several large pharmaceutical companies. But Smythe and Stephen Robinson, an executive director with Start-Up Australia and Protagonist’s interim CEO, had no intention of making the company a fee-for-service provider.
- 32. Their vision was to make Protagonist an independent discovery company that would only partner out drug candidates at the clinical trial phase. Their hope was to raise capital in the United States and grow the company like other drug discovery companies in the Boston or the San Diego areas. Smythe shared this vision in a presentation to Lilly Ventures in the spring of 2005, in the process disclosing some of the therapeutic areas he planned to address with the Protagonist platform. He was confident that the platform supported the development of pills or inhalants to treat diseases that otherwise required injections of antibodies or other large molecules. Shortly after the presentation, a Lilly Ventures deal team was formed to perform due diligence on Protagonist. Unlike nearly all VCs, the team was quick to sign a confidentiality and disclosure agreement (CDA) with Protagonist to reassure the company that any information shared in the due- diligence process would not be used to benefit Lilly. Even with the CDA in place, however, the team had to be careful about which Lilly experts they would consult with on this project: Lilly would not want Lilly scientists who reviewed Protagonist’s technology to be involved in Lilly research projects that could potentially compromise protection of Protagonist’s confidential information. It was therefore important to seek an assessment of Protagonist from Lilly scientists who were knowledgeable about the relevant science but unlikely to be assigned to research similar areas. Eventually, the team chose to hire external consultants for some parts of the scientific due-diligence
- 33. process. The team also conducted traditional due diligence including financial and legal due diligence, a review of the company’s intellectual property, and employee references checks. Having reviewed this information, a Lilly team spent two days in Brisbane in mid-2005 “to kick the tires.” The visit gave them the opportunity to see Protagonist’s management in action as well as to inspect the company’s current location at the University of Queensland’s Institute of Molecular Sciences (IMB). Though a “state-of-the-art” research facility, it clearly focused on commercializing science, and IMB management indicated willingness to allow Protagonist to stay in its facility and benefit from its expensive infrastructure. This brought up a difficult question for the Lilly Ventures team. Initially the team’s thinking was to relocate the company to the United States, yet the virtues of the IMB infrastructure forced the team to consider the benefits of keeping Protagonist in Australia. Relocation would cost the company a precious six to nine months until the platform would be fully up and running again. It would also mean a future cash burn typical of U.S. biotech start-ups. At the same time, however, the team was doubtful it would be able to attract enough U.S.-based VCs willing to invest in an early-stage company located 15 hours’ flying time from the Bay Area. By late summer 2005, the deal team formed a proposal to lead a Series A financing for Protagonist of $10 million to $12 million. The team’s proposal called for the incorporation of a new parent company in the United States and the establishment of a
- 34. Protagonist corporate office on one of the For the exclusive use of P. Sun, 2017. This document is authorized for use only by Pang Sun in Competing in Technology Industries taught by H. Dennis Park, Drexel University from January 2017 to June 2017. Corporate Venture Capital at Eli Lilly 806-092 11 coasts. The company’s research and development activities would remain in Brisbane at the IMB and operate through a local subsidiary. To help support the Brisbane site, the team emphasized the importance of adding one or two top-tier Australian VCs to the future syndicate. This would also serve to mitigate concerns of potential U.S. investors. The team expected the Series A funding to last three years. A Lilly Ventures principal explained the terms of the deal and his team’s place in the syndicate: Series A milestones will include having one molecule ready for Phase 1 trials with one or two more behind it. Also, Protagonist should have a business development deal in place with an established pharmaceutical firm. Three years from now, the Series B milestones will be getting through Phase 2 trials with one or two molecules. Assuming that you have an A round, a B round, and potentially a C round before an exit,
- 35. you can’t give the company a high valuation in the first round, or you will end up with a down round along the way. You have to plan for the long haul. With a low valuation as well as the low labor and overhead costs in Australia, we begin to solve the problem of how to make money on early-stage investing. Lilly Ventures had taken the initiative in identifying several prominent Australian VC firms interested in participating in the syndicate and felt that additional Australian investors were waiting in the wings. However, the Lilly Ventures team also wanted a U.S. participant in the syndicate and began to gauge the interest among several U.S. VCs who were “friends of the firm.” Some rejected the potential deal because they wanted to be physically close to their early-stage companies. Others, while not opposed to Protagonist’s location in Brisbane, rejected the potential deal because they could not justify an investment that would not see liquidity for five to seven years. However, the team remained bullish about Protagonist’s platform and the outlined financing. A Lilly Ventures principal commented: Of all the deals our group has done to date, this is the most difficult deal to syndicate. A chemistry discovery engine, three years from the clinic, is pretty much contrarian to the current VC investment paradigm of clinical-stage companies. And the Australian location doesn’t help to syndicate the deal either. But I am still hopeful we can get this deal done. The Protagonist platform is too robust, and the financial upside is too great, for us to walk away from the
- 36. project at this point. As Carroll thought about the Protagonist deal, he found himself sympathetic yet concerned about some of the implications of such an investment: Protagonist is an exciting opportunity for us and in many ways is exactly what we should be doing at Lilly Ventures. Having founded companies myself, I can really appreciate the team’s excitement around building this one. But Protagonist is 16 time zones away. That takes a big commitment of time and energy to manage. It certainly makes it harder for us to bring U.S. VCs into the syndicate. In fact, what’s interesting is how Protagonist mirrors some of the larger issues we face as to what the role of corporate venturing should be here at Lilly. For the exclusive use of P. Sun, 2017. This document is authorized for use only by Pang Sun in Competing in Technology Industries taught by H. Dennis Park, Drexel University from January 2017 to June 2017. 80 6- 09 2 -
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