The Kauffman Foundation who a few years ago awarded my co-author, Scott Stern, a medal for for excellence in entrepreneurship research, have established a research portal. You can access it here. Lots of good material for those interested in all aspects of entrepreneurship.
In today’s Age, I respond to Mike Vitalie’s suggestion that there be a HECS scheme for biotechnology firms in Victoria. I argue that while the intentions may be good, it may be ‘solving the wrong problem’ when it comes to VC funding.
Youtube has just posted Steve Job’s introduction to the very first iPod; almost 5 years ago now. When you watch it, the first thing that hits you is the small room this was done in and all the empty seats. Hardly the introduction you would expect from what became a killer appliance in the music industry.
The initial iPod was only for Mac (Windows would have to wait another year), ultraportable with firewire and with a 10 hour battery life. Apart from a neat design and great performance, there was nothing to suggest here that this would be more than another gadget with another name — iMac, iBook, iPod, iEverything. Indeed, it was not until the opening of the iTunes Music Store (two years later) that anything special looked like coming from this. Just goes to show: who can predict?
Another interesting bit in the video is a comparison of alternative devices. Here is the table put up:
A CD player costs $75 and has 15 songs equating to $5 per song.
A Flash player costs $150 and has 15 songs equating to $15 per song.
A MP3 CD costs $150 and has 150 songs equating to $1 per song.
A hard drive costs $300 and has 1000 songs equating to $0.30 per song.
Notice the problem here? It assumes that once you put a CD in a CD player you can’t change it. I hope that wasn’t on the business plan. Hardly a good description of consumer decision-making.
In today’s Age, Mike Vitalie argues for a HECS scheme for biotechs …
A “HECS for Biotechs” program, that is loans for fledgling companies, to be repaid if and when a company’s earnings reach a certain level – should be implemented. More should be done to encourage overseas biotechs to establish operations in Australia. In biotechnology as in education, our neighbours are steadily becoming our competitors – Singapore used the occasion of BIO to announce $US8 billion ($A11 billion) in biotechnology funding over the next five years, and Malaysia announced it was creating a biotech hub. The Australian tax system is not friendly to overseas companies or executives. Global biotechs certainly need to be in the Asia Pacific region, but they do not need to be in Australia, and for the most part they aren’t.
The scheme would be the equivalent of a loan provided by the government. It would only be repaid if the biotechnology was successful.
Of course, that is pretty much what venture capitalists do now except that they do this by taking equity in the biotech start-up. For there to be a government provided substitute for this, it would have to be that venture capital is suffering from some sort of market failure. Certainly, as Vitalie points out, less VC funding goes to Australian biotechs than those in other countries but that does not mean there is a market failure in terms of capital market constraints.
The constraint could be on the demand for capital side. Not enough funding is going to Australian biotechs because their potential to earn profits may be lower than elsewhere. Indeed, this appears to be the constraint on start-ups even in the US. A few years ago, Scott Stern (Kellogg) and I studied whether the demand or supply side of the capital market constrained start-up funding. By comparing privately funded start-ups with those seeded by government we could distill this. Our conclusion: that it was the demand-side that constrained funding. The implication: it is better to improve the prospects for start-ups to appropriate more of the returns from their intellectual property than to provide them with more capital per se.
All this means that biotechs in Australia likely don’t need a HECS-type scheme. Instead, they need assistance in accessing commercialisation resources and overseas networks. This suggests that core infrastructure might be a better way to spend Victorian government dollars.
[By the way, Scott Stern was lurking around and presenting at the Chicago biotech gathering this week. I heard he made off with a boomerang from the Australian exhibits.]
In new research, Alan Garber, Chad Jones and Paul Romer show how the system of co-payments for health insurance may encourage socially desirable use of pharmaceutical drugs. Drugs that are under patent are priced in a monopolistic way. This usually means that their use will be much lower than would be socially desirable: put simply, there may be consumers out there who are willing to pay for drugs more than the marginal cost of producing them but monopoly pricing is rationing them out of the system.
Garber, Jones and Romer point out that when patients are covered by health insurance, they do not pay the full price for drugs. They share the cost with their insurers through a co-payment. This means that a consumer is more likely to purchase a drug than if they had to bear the full price. This over-purchase tendency will counteract the under-purchase tendency that is coming from monopoly pricing of drugs. The end result could be socially optimal drug consumption.
In Australia, the government enacts this system but in a way that makes it more likely that the social optimum can be reached. Drugs that are covered by Australia’s Pharmaceutical Benefits Scheme (a scheme that has been operating since the 1950s) are sold to patients at a price equivalent to marginal cost (taking into account the costs of manufacturing and distributing the drugs). Thus, Australian consumers face (near) socially optimal incentives to use medicines.
The difference between the government scheme and private co-payments is critical. Under the US system, the pharmaceutical company is still able to set their own price and with the co-payment demand is even greater than they would have under monopoly. The end result is much higher profits from drugs. Indeed, as Garber et.al. show this can mean that drug companies have socially excessive incentives to innovate. They recommend capping drug prices to improve the situation.
In Australia, that already happens. Moreover, the cap is set with reference to the profits of pharmaceutical companies who can always opt out of the system if they want. As such, they will always receive at least their monopoly profits. In this way, innovation incentives are not diminished by the Australian scheme and, moreover, do not generate excessive incentives either.
Last year, in a piece for The Age, I wrote about what appeared to be a change at the Lego company as to how they received user innovations.
That article talked about the Lego Factory concept that had users design new lego sets for a share of the royalties. This was a good example of user-based innovation as described by MIT’s Eric von Hippel in his book Democratizing Innovation.
It turns out that that was just the tip of the iceberg according to February’s Wired. User-based innovation has appeared to have infiltrated the whole innovation process at Lego.
Thanks to www.westwingtranscripts.com I was able to read the following exchange in the live (but fictional) debate episode between Republican Vinick and Democrat Santos in The West Wing. I love the show but this gaff regarding who invented ulcer treatments really irked me.
Here is the relevant bit:
SAWYER Senator, let me ask you about a related issue which is prescription drug prices and those prices have been going up at a rate more than double the inflation rate. So, would you favor re-importing American drugs from Canada where they are much cheaper?
VINICK You know why drugs are cheaper in Canada; because the government controls the price. Do you know how many life-saving drugs are invented in Canada? None, because the government controls the price.
SANTOS Well, Canadian laboratories have helped to create some very important drugs.
VINICK No, nothing like the miraculous drugs that the American pharmaceutical industry has given to the world.
SANTOS Given to the world? I guess you haven’t seen the price list lately, sir.
VINICK Not long ago, if you were HIV positive in this country you were marked for death. Not anymore. And that’s thanks to our pharmaceutical companies. You know, in the 1970s, the most common cause for surgery was ulcers. Now, you get an ulcer, you take a pill. Is it an expensive pill? Yes. A dollar does seem like a lot to pay for one pill. But how does a dollar a day sound compared to a $30,000 surgery bill? So, are prescription drugs expensive? Yes. Do they save us from getting hit with much more expensive hospital bills? Yes. Do they save lives? Yes. American pharmaceutical companies save us money and they save lives and the Democrats can not stop attacking them.
SANTOS Why should the pharmaceutical companies get protection that no other American industry gets? We can buy anything else from Canada; why not prescription drugs?
VINICK Because the Canadian price controls are unfair to American companies.
Now there is alot to think about here but the bit I didn’t like was the ulcer example (highlighted).
The Republican candidate was batting for protection of pharmaceutical company interests (the usual, the US people have to pay more than Canada so the companies will have an incentive to develop drugs). But he then cited as a prime example of this: the development of ulcer treatment which is now cured by a simple anti-biotic saving thousands in on-going treatment.
The problem with this example is that this treatment was discovered and developed in Australia using publicly funded research. To make matters worse, just two weeks before the live debate was aired (!), the Australians who discovered this won the Nobel prize (that is Marshall and Warren for “for their discovery of the bacterium Helicobacter pylori and its role in gastritis and peptic ulcer disease”) I am not even sure the treatment is IP protected. So this is hardly a good example of the need to protect US pharmaceutical companies against Canadian imports.
Actually, the Australian PBS system does it all — low prices and protection of innovative returns but that is a discussion for another time.
Richard Hayes (Research Fellow at MBS/IPRIA) and I have updated the Innovation Index. The index is a measure developed initially by Scott Stern and Michael Porter to measure a country’s capacity to innovate. Scott Stern and I did an update for Australia in 2003 and Richard and I produced an update in 2004.
This years Innovation Index is refined further. The bad news is that Australia’s potential has declined — mainly due to a loss in the perceived strength of IP protection. Nonetheless, our ranking with respect to other countries remains unchanged.