More than twenty years ago, the first private biotechnology industry emerged in the USA. The new companies were founded by scientist with strong ties with university biotechnology. For their survival, these new companies functioned as R&D contractors of established companies. However, from the mid 1980s onwards, the vertical division of labour between the different companies has  been replaced by an ongoing vertical integration of the biotechnology sector in the USA.

In no country has the number of companies and the amount of capital they have invested been so large as in the USA. The main US biotechnology trade organization, Biotechnology Industry Organization (BIO), using a broad definition of biotechnology, states that in 1994 there were a total of 1,311 biotechnology firms in the US
The twenty years of US biotechnology industry can be seen as a two­phased development. The first phase has been characterized by the establishment of new biotechnology firms (NBFs) and a strong division of labour between the new NBFs and established firms. During the second phase, starting in the mid 1980s, NBFs and established firms were involved in an integration process.

Emergence of new firms
The first phase occurred approximately between the mid 1970s and 1987, in which NBFs were established. The NBFs generally started as research organizations, selling scientific and technological knowledge but no products. They did not undertake R&D on the broad range on which established companies were active. Instead they focused on specific technologies and niche markets.
Two discoveries really triggered the development of biotechnology and NBFs. Firstly, the discovery of a technique to transfer specific genes from one organism to another by the US scientists Boyer and Cohen in 1973. Secondly, the invention of the cell fusion or 'hybridoma' technique by the British scientists Milstein and Kohler in 1975. Recognizing the commercial potential of these discoveries, many NBFs were founded by university scientists in collaboration with entrepreneurs and suppliers of venture capital.
A strong industry­university relationship is one of the remarkable aspects of the development of the US biotechnology industry. In the 1970s most of the expertise in genetic engineering was found at the universities. Many of the NBFs were started by university faculties interested in retaining simultaneously their professorship and participating in the development of a company. In the close vicinity of universities, special science parks were newly established, where high­tech firms could build or rent facilities under beneficial conditions. Most of the biotechnology companies are now located in the states California and New England, near universities such as Harvard, MIT, Stanford and UC Davis.
In the beginning these companies had to fund the costs of infrastructural development, without the benefit of internally generating revenues. The NBFs, therefore, had to depend on venture capital, stock offerings, and relationship with established companies for their financing. Although venture capital and stock offerings were an important source of funds for the NBFs, contract research for established firms has always been the most important. Between 1977 and 1985 established enterprises, mostly in the pharmaceutical and chemical industry, provided 56 per cent of the total funds invested in NBFs.
Apart from the need for capital, NBFs benefited from their R&D supply/demand relationship with established firms to get access to downstream capabilities in manufacturing, clinical testing, regulatory processes, and distribution. A last reason was the scope economics in basic biotechnology R&D. Because different commercial products were based on similar basic technologies, the costs (and risks) of developing these technologies could be shared by clients with different commercial interests.
For established firms, buying biotechnology R&D from the outside and directing the main focus at commercialization had advantages. Control over manufacturing, testing and distribution facilities could be used to acquire access to the technology on attractive terms, without the large and risky investment in an in­house biotechnology unit. In addition, collaboration allows established firms to tap the specialized expertise of the NBFs.

Facts on US biotechnology industry Company size There are 1,311 biotechnology companies in the biotechnology industry, 265 of those being public companies. The biotechnology industry is an industry of small business. Of the public companies, 37 per cent have fewer than 50 employees, 18 per cent have between 51 and 135 employees and 12 per cent have between 135 and 299 employees. Total employment in the American biotechnology industry is 103,000 people in the US.  R&D In 1994, the biotechnology industry spent an overall US$ 7 billion on research and development. For the public companies, R&D spending accounted for 43 per cent of total costs and expenses. R&D expenditures per employee were US$ 68,000 in 1994, compared to US$ 39,000 per employee in the pharmaceutical industry. 15 Agrobiotechnology companies surveyed by the journal Bio/Technology together spent US$ 85 million on R&D, i.e. an average of US$ 5.6 million per firm. The 1993 R&D spending was 43.6 percent higher than spending in 1992, that was already 40 percent up from the year before. As many agrobiotechnology firms are getting very close to the marketing of their products, there is a need for increased R&D spending for regulatory approval, field testing, and product introduction.  Financial results In 1994, the biotechnology industry had sales of US$ 7.7 billion. Overall, the US biotechnology industry is still operating at a loss. In 1994 the main 152 biopharmaceutical firms reported a loss of US$ 1.3 billion, or an average loss of US$ 8.7 million per firm. Only 20 out of the 152 firms generated a net profit in 1994. The agrobiotechnology companies reported a total net loss of US$ 140 million in 1993. For the 15 agrobiotechnology companies, the average R&D/revenues ratio is 106 percent. The reason for this high percentage is the low or absent revenues for most of the companies in combination with the large and still growing investment in R&D. This situation of negative business results is one of the reasons behind the decrease in the value of biotechnology stocks since the peak of 1991. Recently, however, the value of the stocks have started to increase. Market segments (1994, in %) Therapeutic 42 % Diagnostic 26 % Supplier 15 % Chemical, environmental and services 9 % Agrobiotechnology 8 % Total sales US$ 7.7 billion Sources: BIO (1995), The US Biotechnology Industry: Facts and figures. 1994/1995 Edition. Washington: Biotechnology Industry Organization, p.7. Bio/Technology (1994), "Agbiotech firms increase R&D spending 43.6%". Bio/Technology, vol.12 August 1994, pp.755-756.

Vertical integration
This vertical division of labour between NBFs and established companies as described above has not proved stable. During the second phase, from 1987 onwards, there has been a trend in the biotechnology production chain towards (a) a forward movement by NBFs into manufacturing, and (b) a backward movement into biotechnology R&D by established firms.
The main reason for forward or backward movements is the avoidance of (excessive) transaction costs. Transaction costs are costs that firms face in doing business with other firms in for example obtaining information about markets and about the (prospective) behaviour of the partner, in designing and enforcing a contract, or in preventing opportunistic behaviour by the partner.
In biotechnology, transaction costs in the market for manufacturing arise from the complexity of process development and scale­up, and the problems of protecting intellectual property rights. Close interaction between the scientists, who develop a microbial process for the production of a specific protein, and the bioengineers, who design industrial­scale processing, generates significant advantages. Trial­and­error and learning­by­doing are still important activities in the scale­up process. Vertical integration allows the accumulation of firm­specific experience with scale­up in repeated projects. Such experience represents a valuable asset because it allows new projects to proceed from a base of shared knowledge and provides a common frame of reference for communication and problem solving.
The intensive collaboration between product developers and process engineers of different firms cannot be effectively protected by patents, although highly proprietary information is generated in this process. By the vertical integration of R&D and manufacturing the protection problem is solved, and boundaries which could impede the flow of sensitive information can be removed.
For the established firms that sponsor R&D contracts transaction costs increase as generic research projects result in concrete product development. With product development, much more of the know­how generated is product and firm specific. Such idiosyncratic knowledge can be difficult to transfer to a new R&D supplier. Thus, the sponsor becomes more and more dependent on the R&D supplier, which can use the advantage of its accumulated knowledge continuously.
This dependence of established firms may even increase in second generation biotechnology projects: firms that buy R&D from a particular contractor today may be forced, for example, to buy additional R&D services from this same contractor in the future.

Monsanto and Calgene On June 28, 1995, the US private company Monsanto announced the signing of a letter of intent to acquire 49.9 per cent of equity stakes in Calgene, USA. Monsanto will provide to Calgene US$ 30 million, certain research on fresh produce and oilseeds, and its current equity interests and options in Gargiulo, one the major US firms in tomato breeding, production and marketing. Monsanto will also provide long­ term credit facilities for the general business needs of Calgene and Gargiulo.  Monsanto expects that the transaction announced will be closed at the end of 1995. Although the deal initially covers only a partly ownership, it is expected that eventually Calgene will become fully integrated into Monsanto.  The main reason for this rather unexpected step in the US agrobiotechnology world is money. Calgene, like most of the other biotechnology firms, was in desperate need of additional capital. The main gain for Monsanto is access to Calgene's expertise in developing and commercializing genetically engineered tomato, cotton and canola varieties. As these crops are also important for Monsanto, benefits can be obtained by creating synergy.  Calgene Calgene, a leading agricultural biotechnology firm in the USA, is well known for its Flavr Savr tomato. Calgene also has genetically engineered cotton and canola (oilseed rape). For cotton production, Calgene has developed a variety that is resistant to the herbicide bromoxynil (marketed as Buctril by the French agrochemical company Rhone­Poulenc). For both transgenic cotton and canola Calgene has full approval in the USA and is currently in the process of commercializing its varieties.  Calgene is following a vertical integration strategy for its tomato and canola varieties. Besides the actual tomato production, which is done under contract by farmers, Calgene itself carries out all other activities in the production and marketing chain. For canola production and processing Calgene has its own subsidiaries: Ameri­Can Seed for canola seed production and Calgene Chemical for processing oilseeds.  Monsanto Monsanto has a long tradition as a chemical company, going back to 1902. In the 1980s it decided to become one of the key players in the worldwide agricultural biotechnology market. In 1994 its total revenues were US$ 8.3 billion. Worldwide the company employs almost 30,000 people. Monsanto consists of four business groups:  The Agricultural Group (net sales: US$ 2.2 billion). It develops, produces and markets crop protection products and     lawn­and­garden products. Its main product is Roundup herbicide. Another well known product of the agricultural group     is Posilac bovine somatotropin (bST). The Chemical Group (net sales: US$ 3.7 billion). This group produces and sells plastics, nylon and acrylic fibres, rubber     chemicals, etc. Searle (net sales: US$ 1.6 billion). It develops, produces and markets prescription pharmaceuticals. The NutraSweet Company (net sales: US$ 0.6 billion). It produces sweeteners and other food ingredients. In the field of plant biotechnology Monsanto is mainly focusing on two applications: herbicide­resistant and insect­resistant crops. Monsanto has full approval in the USA for soya beans resistant to the herbicide Roundup. The resistant variety is sold under the brand name Roundup Ready, and will be widely available in the USA in 1996. Monsanto is also developing Roundup Ready varieties of canola (to be marketed in Canada), cotton, maize, sugar beets (to be marketed in Europe), and oilseed rape (to be marketed in Europe).  The insect resistance is obtained by inserting the Bacillus Thuringiensis (Bt) gene into various crops. The first insect resistant crop that has received full approval in the USA is Monsanto's NewLeaf insect­resistant potato. Monsanto is also developing insect­resistant varieties of cotton and maize.  Vertical integration? The commercialization of the NewLeaf potato variety will be done by Monsanto itself, through its potato breeding company NatureMark. There are, however, no plans for vertical integration in the potato industry. Potato production and marketing is a small­scale and regionally divided business. The tomato business is rather different: Monsanto's subsidiary in the tomato industry, Gargiulo, is a vertically integrated company, with its own breeding programme, production and marketing of tomatoes.  For the other major crops, soya beans, cotton and maize, the herbicide resistance and insect resistance technologies will be commercialized in collaboration with existing seed companies. For cotton, for example, Monsanto has a long­standing relationship with Delta and Pine Land, the main cotton seed producer in the USA.  Sources: Monsanto 1994 Annual Report; Monsanto Press Release, June 28, 1995; Personal communication with Monsanto employees.

Impact of vertical integration
Although mature NBFs have started downstream activities like manufacturing and distribution and established enterprises have started conducting biotechnology R&D on their own, it is unlikely that vertical integration will completely replace all alternative organization forms. There are two major reasons for this. Firstly, there are limits on the rate at which NBFs and established enterprises can expand their boundaries. These limits include financial restrictions, but also the risks inherent to mergers or acquisitions. Secondly, vertical integration is likely to predominate where the innovation chain is characterized by uncertain property rights, transaction­specific assets, and complex technologies. Where these conditions are absent, such as in research products, functionally specialized firms will deal with each other through contractual relations.
Given that the extent of transaction costs will differ across applications of biotechnology, firms are adopting hybrid organizational structures to get access to or to commercialize technology. Thus, a single NBF may use vertical integration, strategic alliances, and licensing to commercialize different technologies in different application segments.

Strategic alliances
In building a strategic technology alliance, both NBFs and established companies can choose between two broad categories of governing structures: joint ventures and contractual alliances. Joint ventures involve equity sharing and direct investment. Contractual partnerships involve joint development agreements, joint research pacts, cross licensing, second sourcing agreements, R&D contracts, etc.
Given the high uncertainty about both the outcome of the process of technological innovation and the structural consequences for the market as a result of the innovations, US firms operating in the biotechnology sector prefer contractual strategic technology alliances. These alliances are usually R&D or innovation driven, are one­dimensional and their usual duration is relatively short.
The factors driving corporate alliances are the access to capital, access to technology or development skills of a partner, reduction of the time and/or costs to market entry, and validation of a technology. Not surprisingly, most of the alliances focus on technology in its concept or feasibility stage, when uncertainty is still very high on many levels, such as the validity of technology, development of time frames and regulatory approval.
Once a technology has successfully been converted into a new product or process, biotechnology companies look for access to manufacturing capacity and (global) markets. In return for this access, companies trade in exclusive intellectual property rights and marketing rights. Often NBFs give up technology rights for specified markets and applications, and international and/or US manufacturing and commercialization rights. But increasingly, biotechnology companies only give up exclusive rights to technologies in exchange for future revenue participation with their alliance partner.
Although the traditional model for strategic alliances involves a NBF and an established pharmaceutical or chemical company, increasingly biotechnology companies establish alliances among themselves. Ernst & Young noted the establishment of 196 strategic alliances in the US biotechnology industry in 1992/1993. 51 per cent of these alliances were within the pharmaceutical industry. Alliances in the agrochemical industry only accounted for 7 per cent of the total number. Two­thirds of all alliances were with North American partners. Alliances with European partners accounted for 24 per cent, while US­Japan alliances only covered 11 per cent of the total.
 

New coalition of US religious groups appeals patenting genes and animals In the USA, a coalition of 175 Christian, Jewish, American Muslim, Hindu and Buddhist groups has published an appeal to stop the patenting of animals, human genes, cell lines, embryos, and body parts. The statement, which received ample attention in the US press in May 1995, does not oppose genetic engineering or the biotechnology industry as such, but the appropriation of what they consider rightfully belongs to humanity. Their main concern is the "commodification of life," or the reduction of life to its commercial value and marketability. Patents on the techniques of genetic engineering are not challenged in the statement.  The coalition was mainly initiated by the Methodist Church and Jeremy Rifkin, the latter being a well­known opponent of genetic engineering from the start. After publication of the statement, the coalition has been broadened, and now also includes scientists, activists, representatives of agriculture, native Americans and health advocacy groups. The initiators succeeded to bring together a politically influential group of organizations around the issue of genetic patenting in spite of the many other issues, such as abortion, which often divide these groups. The coalition aims at a broad public debate in the USA about the moral and ethical aspects of genetic patenting.  Representatives of biotechnology industry consider patents to be essential for the development of, for example, modern medicines. Many companies, they say, will not survive on process patents alone. Additionally, in reaction to the coalition's appeal against appropriation of life, they emphasize that patent protection should be differentiated from actual ownership. Members of the Council for Responsible Genetics, part of the coalition, however, counter that patents may impede medical progress by effective appropriation by private industry of the results of publicly funded research and restrictions on the free exchange of scientific information.  The statement comes 15 years after the first US patent for a genetically engineered microbe, and 6 years after the first US patent on an animal. Nevertheless, biotechnology industry is concerned that it could lead to new discussions in Congress about patent laws, introducing religious and moral arguments into what they see as a legal matter. The Republican majority in Congress might find it difficult to choose between the interest of biotechnology industry, and the interests of the religious groups, with which it traditionally has a strong relationship.  Sources: Sally Lehrman (1995), "Coalition Plans Challenge to Genetic Patenting in the US." Nature, vol. 375, 25 May 1995, p. 268; Richard Stone (1995), "Religious Leaders Oppose Patenting Genes and Animals." Science, vol. 268, 26 May 1995. p.1126; "Mainstream Religions Oppose Human and Animal Patenting." The Gene Exchange, July 1995, p.1/12.

International alliances
Given its strong basis in technology development, the US biotechnology industry uses international alliances to get access to foreign markets and additional capital. European and Japanese companies alliances with US biotechnology firms have the objective to get access to technology with the intention to renew and expand product ranges in the home market.
All major European pharmaceutical companies have alliances with one or more US biotechnology firms. These alliances can involve equity sharing or R&D collaboration. The best­known example of equity sharing is the purchase by Hoffmann­La Roche, Switzerland, of a 60 per cent share in Genentech (USA), covering the sharing of development costs, sales and marketing efforts and profits.
Also in the agrobiotechnology market US biotechnology companies have alliances with European and Japanese agrochemical companies. For example, Calgene has an alliance with Ferruzzi, Italy; Ecogen with Roussel Uclaf, France; and Mycogen with Shell, UK/the Netherlands, with Ciba Geigy, Switzerland, and Japan Tobacco. It is expected that international strategic alliances will increase in the near future.
Jos Bijman

LEI­DLO, P.O. Box 29703, 2502 LS The Hague, the Netherlands. Phone (+31) 70 3308218; Fax (+31) 20 3615624; E­mail w.j.j.bijman@lei.agro.nl

Sources
BIO (1995), The US Biotechnology Industry: Facts and figures. 1994/1995 Edition. Washington: Biotechnology Industry Organization.

Ernst & Young (1993), Biotech 94: Long­term value, short­term hurdles. Eighth annual report on the biotechnology industry. San Francisco, CA: Ernst & Young.

Gary P. Pisano (1991), "The Governance of Innovation: Vertical integration and collaborative arrangements in the biotechnology industry". Research Policy, Vol. 20, pp. 237­249.

D. Teece (1986), "Profiting from Technological Innovation: Implications for integration, collaboration, licensing, and public policy". Research Policy, Vol. 15, pp. 285­305.