Alza Breaks out of the Ivory Tower

Alza recognized that it had become overly dependent on projects owned by its drug-delivery clients; not only was Alza receiving just a small percentage of its products' value, but its fate was subject to the development and marketing delays and decisions of clients.

For years, Alza has harbored visions of itself as a fully integrated company, looking to gain greater control over its products. After a series of false starts, a new management is giving this client- and technology-oriented business a marketplace focus.

by Roger Longman

• Alza recognized that it had become overly dependent on projects owned by its drug delivery clients; not only was the company receiving just a small percentage of its products’ value, but its fate was subject to the development and marketing delays and decisions of clients.

• Alza stumbled in early attempts to develop a more fully integrated business. While fostering technical innovation, its client-focused culture and history left it without the necessary commercial infrastructure or business planning systems to be able to fully capitalize on its scientific creativity.

• A new management team, under former Glaxo chief Ernest Mario, has reshaped Alza’s product selection system, grafting onto the company’s innovative but insular culture new market-focused systems. In particular, the company is trying to choose practical and high-value development projects.

• While the new business systems look positive, Alza still hasn’t revealed more details of its development program, making it difficult to judge the magnitude of Alza’s change or its chances for success.

Alza Corp., the grand old man of the now crowded drug delivery industry, sits squarely on the central problem of successful drug companies: what to do for an encore.

An estimated 45% of Alza’s royalties come from one product: Pfizer Inc. ’s Procardia XL(63% including Alza’s other once-a-day nifedipine, Bayer AG ’s Adalat CC)—and Alza has no obvious replacement in sight. Its Nicoderm anti-smoking patch, which Alza developed and makes for Marion Merrell Dow (now Hoechst Marion Roussel Inc.), looked like such a replacement, but its sales quickly topped out at $216 million and the next year plunged to $91 million as smokers who wanted to quit found that the nicotine patches offered no easy solutions. Meanwhile, Pfizer is doing what it can to switch patients from Procardia XL, whose growth has stopped, to its newer calcium channel blocker Norvasc, which lists for less than Procardia XL but isn’t vulnerable to generic competition and doesn’t carry the 6-7% royalty burden.

Alza’s proposed solution to the problem has been a program to take greater control over its commercial destiny: rather than simply working for contract fees and royalties on products which may or may not be worth pursuing, Alza is looking to create its own pipeline. It aims to uncover drug-delivery driven solutions to big medical problems and do most of the development, manufacturing and sometimes marketing work—thereby controlling how quickly the project moves forward and keeping a greater share of the end sales of the product, whoever sells it. Says Ernest Mario, PhD, Alza’s co-chairman and CEO since August 1993: “I want to be master of the process all the way to the revenue stage. If Bill Steere [CEO of Pfizer] decides one day that he wants to shift Pfizer’s emphasis from Procardia XLto Norvasc, he can. It’s not our product.” But, adds the former Glaxo Holdings PLC chief executive: “I would like to be the owner of the next XL, whatever that product is. And then I can decide who Alza should partner with or whether to partner at all.”

Alza’s program to take control of its destiny—outlined in 1990 in its Target 2000initiative—is now in full swing. Under Mario’s direction, the company has built, for the first time, important capabilities in drug development and what it calls product discovery, Alza-speak for the selection of projects to pursue. It also has hired experienced marketers to oversee its small sales force and provide input into project selection.

To fund its new initiative, and create a barrier of sorts between its client work and its own projects, Alza in June 1993 put $250 million into a newly created company, Therapeutic Discovery Corp., which it then spun off to shareholders. Alza proposes projects to TDC which, through its boards of directors and advisors and Gary Neil, PhD, TDC’s CEO and its only full-time executive, then accepts or rejects them for funding. Alza has commercialization rights on all the TDC work—currently 20-plus projects—and a buyback option on the company.

But Alza is late to the party. Arch-rival Elan Corp. PLC has seen its market cap grow tenfold—its valuation now equals Alza’s—since it pioneered the more fully integrated approach in the late 1980s. And despite the fact that Elan’s biggest revenue-producing drugs, Cardizem SR and Cardizem CD, are both at the end of their growth cycles, Elan’s stock trades near its historic high while Alza’s trades at a 50% discount.

The reason: given Elan’s much lower cost structure and its historic success in signing deals in which it keeps 25-35% of the products’ net sales, Elan looks as if it will benefit more richly from its near-term drug approvals than will Alza.

Alza’s nearest-term earnings boost will come from Sandoz-developed and -marketed Dynacirc CR, for which Alza will get an estimated 7% royalty, according to H&Q analyst Alex Zisson. Moreover, while the FDA approved Dynacirc CRin mid-1994, Sandoz hasn’t yet launched it, to Alza’s intense frustration. In short, where Elan exercises greater control over and will get a bigger share of its near-term pipeline, Alza takes smaller royalties and must await its partners’ decisions.

The problem isn’t merely a short-term earnings issue. Alza’s client business has grown more demanding, as have the client businesses of all Alza competitors. Clients looking for drug delivery services now have dozens of suppliers from which to choose. Some of these players have technologies Alza doesn’t; others have similar technologies and charge lower prices for them. Moreover, Alza and its competitors are fighting over a shrinking client base as mergers remove drug companies from the field. Finally, these potential clients have tougher drug delivery problems to solve; instead of bringing Alza established products whose patents they are looking to extend by creating a once-a-day version, the new projects often involve innovative but problematic NCEs which haven’t yet proven themselves in clinical trials.

The earnings winners in such an environment will be those companies that can develop the right products—those with significant clinical advantages over competitors, particularly generic competitors—and keep big percentages of the products’ end sales. Up to now, Alza has had trouble doing both at the same time.

Alza’s Cultural Challenge

The challenge may be a cultural one. Founded by pharmaceutical industry visionary Alejandro Zaffaroni, PhD, Alza has traditionally pursued innovative science but has not always done so with a strong sense of its end products’ commercial potential or how to maximize it. Alza’s focus on the development side has made it a preferred contractor for its clients, who choose the drug projects and historically have done most of the clinical and commercial work themselves; but the front-end focus has handicapped Alza’s efforts towards building a fully integrated business.

Mario and his team insist that Alza is now a different company, a message he wants to stress both internally and to potential partners whose drugs Alza wants to sell or develop in different delivery formats. Alza executives argue that its historical technological leadership will allow it to create highly differentiated, high-margin products that its drug delivery competitors won’t be able to match. And it wants to couple this old technological advantage with a new commercial focus.

But so far no one has seen either the numbers to prove Alza’s commercial capabilities or evidence that its superior drug delivery technology really makes a big difference in product revenues. Analysts complain that the company still hasn’t gotten a handle on expenses. “Just look at their facilities,” says one, noting the sprawling California campuses. And Alza spends 30% of sales on R&D—twice Elan’s rate. Mario insists the R&D spending is more market focused than it ever was, and just as innovative. But outside observers have no way of assessing the claim, because Alza hasn’t made its TDC portfolio public.

Alza executives believe the company’s reserve is necessary. Despite Alza’s extensive patenting of its methods and technologies, some of its executives worry that competitors can steal its ideas, especially since most TDC products incorporate generics. Nor do Alza executives feel they have to reveal their pipeline to tease up their company’s share price. Alza appears to have enough cash to fund itself without going to the stock market.

But the corporate preference for secrecy may also be a corporate habit learned from the client business and now too ingrained to break. As such it may also be symbolic of the challenges Alza will have to surmount in its transition from contractor to owner.

Fully Integrated, Once Again

No one questions Alza’s opportunity in drug delivery. As managed care tightens the screws on health care spending, drugs need to prove economic value. Theoretically, drug delivery technologies can give existing and new drugs powerful arguments for economic efficiency, improving efficacy, side-effect profiles, and compliance—and thereby saving a host of related medical costs.

For investors in the pharmaceutical industry, drug delivery is seen as a relatively low-risk opportunity. When a drug company creates a new program around a new chemical entity, it must spend tens of millions of dollars to find out whether it works at all in human beings. New drug delivery projects can get to the same level of clinical insight for far less money since in general the programs are started with drugs of known efficacy.

The higher cost of NCE development doesn’t reveal itself only in longer timelines and higher risk. Says Mario: “With an NCE you get people who are wedded to projects. They start a project; you tell them it’s not working; they say they will stop working on it—but they don’t. You have all this underground stuff which keeps using up your dollars. If during development we don’t manage to get over these hurdles, we can be absolutely ruthless, because there’s no emotion tied to it like ‘This is my little molecule that I discovered. How could you not continue this investigation? If it only sells $10 worth when it’s done, it’s still wonderful science.’ Maybe Glaxo would be willing to continue that project, but Alza can’t.”

Alza understood these economic rules from the beginning. Indeed, its new, more integrated approach isn’t far from the original plan for the company. In the 1970s it developed and began to sell two products, Ocusert, for glaucoma, and Progestasert, a contraceptive. Both solved difficult technical problems: Ocusert, for example, made a once-a-day product out of the leading anti-glaucoma drug, pilocarpine, a generic eyedrop which had to be applied 4-6 times a day.

But both products were marketplace failures: Ocusertwas introduced shortly before Merck & Co. Inc. introduced its beta blocker, Timoptic, which soon became the drug of choice. Progestasert, though not, strictly speaking, an intrauterine device, nonetheless fell victim to the anti-IUD furor following the Dalkon Shield product liability law suits.

The result: Alza couldn’t afford its infrastructure and went looking for an acquiror. It found Ciba-Geigy AG, which in 1978 acquired 80% control of the company through preferred stock—an early version of the now widely copied acquisition of Genentech Inc. by Roche Holding Ltd. Financially, the deal was an excellent one for Ciba—it bought into a sudden stream of Alza product successes like the transdermal patches Transderm Nitro (which, 13 years after its 1982 introduction, still provides about 12% of Alza’s royalties), Transderm Scop, Estraderm and the first use of Alza’s OROS oral delivery, in its diet pill Acutrim.

But the Alza and Ciba cultures clashed, and not merely because of the inherent differences between a California startup and a large Swiss firm. To take full advantage of its technology, Alza argued that it needed to work on more than Ciba’s projects. But when Ciba allowed Alza to sell its services to outsiders, Alza couldn’t find enough clients. With the threat of Ciba always looking over Alza’s shoulder, other drug companies simply didn’t want to provide Alza with sensitive information on their products.

Eventually Alza bought back Ciba’s stake for a mix of lower royalties on a few products and a royalty-free license for all others it had developed for its former parent.

But the experience clearly made Alza shy of betting too heavily on a strategy for making it into a fully integrated company. Independent of Ciba, Alza focused on developing its drug delivery technology and acquiring an extensive list of clients. The deals were like consulting projects with success fees attached: clients reimbursed Alza’s development expenses, then took over clinical trials and commercialization. If the products made it to market, Alza got royalties, generally 5-10%, according to analyst reports.

One Step Forward, One Backward

Accordingly, Alza’s culture became a client-driven culture—focused on solving particular drug delivery problems for companies which brought it projects, not on the ultimate value of the end product. Says Gary Neil, who until May 1993 had led worldwide drug R&D for American Home Products Corp. ’s Wyeth-AyerstLaboratories’ research unit and who had overseen Alza’s work for Wyeth: “In the past, Alza’s motivation was to make a proposal and get its client to buy in. But once that was done, Alza’s goal was primarily to keep the project going. If it hit a technological hitch, Alza’s motivation was to propose a fix because the risk was totally assumed by the client.” In short, Alza wasn't primarily concerned with a product’s ultimate commercial value. Says Neil: “The way things used to happen at Alza was like a Field of Dreams syndrome: They said: ‘We can make it. Therefore somebody will buy it.’”

ALZA AT A GLANCE$ millions; Alza’s fiscal year ends December 31 so 1995 figures are estimates 1994 1995(e)$ Royalties & Fees 123.7 143.4$ Net Sales 68.5 76.0$ Product Development 68.7 96.2Other Revenue 17.8 24.0Total Revenues 278.8 339.7R&D 76.1 97.3Cost of Goods Sold 56.6 67.0G&A, Marketing 33.3 33.5Interest 19.4 23.5Pre-tax Income/% of Sales 93.3/33.5 118.4/34.9After-tax Income/% of Sales 58.1/20.8 73.4/21.6SOURCE: Alza company reports, Alex Zisson (Hambrecht & Quist), Richard Vietor (Merrill Lynch)

But Alza soon recognized that for its long-term health and growth, its business needed more than royalty-based client deals. In the first place, Alza had done very little to proactively develop its drug delivery capabilities and therefore a pipeline of projects. Says Mario: “The company did not put money into their own technology. They relied on clients exclusively.” And since Alza was relying on funding from clients, which paid Alza to develop drug delivery solutions for their own proprietary products, Alza was rarely able to explore drug delivery’s potential in other areas—particularly in improving the value of generics.

Alza's answer to the problem was its Target 2000strategy, designed to make it into a more fully integrated company, one capable of directing its own business destiny. But Alza didn’t believe it had the infrastructure to quickly ramp up an extensive set of drug programs for its own account. It lacked the medical, regulatory and marketplace expertise to evaluate projects; its strength was in engineering and physics, not biology and medicine. Nor did it believe it had the money to buy what it needed—the oil well of Procardia XL had barely begun to sputter when Target 2000 was unveiled.

Thus, even as Alza was creating its Target 2000strategy, it took a clear step backwards, signing an alliance with Wyeth-Ayerst in 1991 which gave Wyeth substantial commercial rights to a variety of products in return for funding that would help develop a broad range of Alza’s technologies. In effect, the deal was a precursor to the 1993 TDC strategy. Like TDC, the Wyeth deal was designed to develop Alza’s technologies and give it greater commercial experience—but it removed the financial risk.

In addition to looking to Wyeth to take on the clinical and marketing duties, Alza also largely depended on Wyeth to pick the right projects, medically and commercially. Besides its breadth, the deal marked a new direction for Alza’s client projects, since it envisioned incorporating widely available generics in new drug delivery systems. Most Alza clients wanted Alza to work with drugs in which they had a strong scientific or marketing investment.

The deal itself was a commercial failure. By the third quarter of 1995, the last remaining activities of the partnership had been cancelled. Once representing a big chunk of Alza’s pipeline, it now represents nothing (Wyeth-Ayerst still has a number of specific projects ongoing with Alza, but none relate to the 1991 deal).

Alza officials contend that it was a useful failure. While the partnership was partly designed to allow Alza to investigate the possibility of improving generic drugs through better delivery, it quickly became clear that Wyeth-Ayerst’s research group had no vested interest in developing generics. They wanted to work on Wyeth’s proprietary drugs. Says Bruce Cozadd, Alza’s CFO, “It makes sense that a research group would feel that they can do better with their own compounds than with generics—but it also makes these deals difficult.” In short, if Alza wanted to explore the possibility of developing generics in new drug delivery mechanisms, it would likely have to do it alone.

At the time, contend Alza executives, the deal looked like the right way to pay for developing Alza’s technologies. They say they couldn’t have paid the development bills on their own since the company hadn’t yet begun to receive the dramatic proceeds from Procardia XLor the short-lived earnings boost from Nicoderm. Moreover, Alza didn’t have the medical or commercial executives that would have allowed it to make the right product choices.

Alza University

But still-disgruntled analysts argue that the deal represented bad planning and evidence of deeper problems at Alza—an academic culture that blinded it to commercial opportunities. Says one sell-side analyst: “Alza was a university masquerading as a company. You’d go to analyst meetings and [former CEO] Marty Gerstel would say: ‘We have 2000 patents.’ Hallelujah! ‘We have this technology and we have that technology.’ And [this focus on technology for its own sake] was the problem.” Says another: Alza “would be a great place if it were a not-for-profit think tank.”

As evidence of Alza’s academic attitudes, a number of analysts point to the company’s experience with Testoderm, one of the earliest products of Alza’s Target 2000initiative. The product, a testosterone patch for hypogonadism, was clearly innovative, but has also been a commercial disappointment. Zaffaroni sees the product, says Cozadd, as part of his vision that hormone replacement can be as important a therapy for aging men as it is for women. Much as women’s estrogen production falls with menopause, men’s testosterone levels drop with age, precipitating a host of changes in mood, energy, libido and sexual function.

But Alza had set itself a commercially daunting task. Many doctors don’t consider treating many of the hypogonadism cases they see. They often look at it simply as an inevitable part of aging.

Nor is the product particularly consumer-friendly. To get the hormone through the skin, Alza developed a patch for the scrotum, where the skin is highly permeable. But because of the sensitivity of the area, Alza couldn’t use an adhesive on its patch, which sticks instead with body heat. The problem is that it falls off frequently.

While sales continue to grow, analysts haven’t been impressed. Testodermremains unlaunched in Europe; total sales have reached about $10 million and it now faces an improved non-scrotal testosterone patch, developed by Salt Lake City-based TheraTech Inc. and being marketed in the US by 550 detail reps from SmithKline Beecham PLC.

TDC: Alza’s Ideal Client

Perceptions that it is unfocused still follow Alza. But company executives argue that it is a different company today from the one that created and gave up most commercial rights to Procardia XL, that misread the challenge of Testoderm, or that signed the 1991 Wyeth-Ayerst deal.

The first and most obvious change was the creation of TDC. Like other off-balance sheet financing vehicles, TDC pays Alza to develop products it owns. But unlike SWORDs and R&D limited partnerships, TDC was created entirely with Alza’s own cash, and then spun off to Alza’s shareholders.

The second major difference is that most off-balance sheet financing vehicles fund pre-selected research programs; TDC funds a constantly changing portfolio of drug development projects—in effect, funds nearly all of Alza’s research done on its own account.

As such, TDC seemed to be Alza’s own recognition of its vulnerability to making poorly conceived commercial decisions and its tendency to focus on technological innovation at the expense of realistic development or marketplace considerations. TDC enforces a practical mentality, providing Alza’s product development with a truly independent decision-making process.

To evaluate which Alza programs it will fund, TDC calls on outside experts, including its own board of directors, none of whom are affiliated with Alza and all of whom have extensive health care business or clinical experience. It also has a clinical pharmacology advisory board, again made up of non-Alza affiliated clinical scientists. The idea is to at least assure development projects of objective, market- and science-tested evaluation. The internal politicking that can keep marginal projects alive can thus be effectively neutralized.

TDC, Alza executives argue, is the ideal client. To an extent, it represents the managerial fruits of the Wyeth-Ayerst experience, and not only because it was able to hire its collaborator’s research chief, Gary Neil. The failure of the Wyeth-Ayerst deal taught Alza the necessity of close collaboration between the scientific, medical and commercial departments on the one hand and the drug delivery and formulation scientists on the other. Looking back at the Wyeth-Ayerst deal from the vantage point of Alza’s TDC collaboration, Cozadd says, with the TDC arrangement “we’ve had the opportunity to structure our development activities any way we wanted—which is notto meet with a partner only once a quarter, and that was at best. We meet with Gary Neil at 10, 12, 2 and 4.”

TDC’s independence also helps allay any fears that Alza will steal its clients’ ideas for its own account. Neil says that he doesn’t know, and never asks, what non-TDC projects Alza is working on, or for whom.

Nor are any unintentional conflicts likely to arise, says Samuel Saks, MD, Alza’s SVP medical affairs, because TDC focuses largely on generic drugs, while clients increasingly come to Alza with development-stage proprietary drugs facing big formulation problems. Says Saks: “The days when somebody would ask us to create a once-a-day dosage form simply to extend the drug’s patent life are gone.” Companies now look to Alza to help them solve, for example, the problem of an innovative therapeutic’s unacceptable half-life. Alza gives its clients a drug development choice, he says: they can give the project back to their chemists to create a new set of analogs or put it into an Alza delivery system that solves the half-life problem without throwing away all the work done on the project up to that point.

New Management, New Attitudes

The changes manifested by TDC are aspects of broader changes implemented by Alza’s new managers. Martin Gerstel and Jane Shaw, who as CEO and COO helped shape and run the company almost from the beginning, have both left Alza, replaced by Ernest Mario. Mario brought in Glaxo Inc.’s former sales and marketing chief, Jim Butler, who arrived in September 1993, to run Alza’s nascent sales and marketing efforts. Neil joined TDC in June 1993. Sam Saks, a former medical executive with Genentech, Xoma and Schering-Plough, arrived in August 1992 to take over medical and regulatory affairs. James Young, PhD, a refugee from another Zaffaroni startup, Affymax NV, joined the company in June 1995, eventually to run an ambitious business development program as SVP, commercial development. Meanwhile, Phyllis Gardner, MD, a Stanford medical professor who had been on sabbatical at Alza for a year, joined the company full time at the end of 1995 to run the Alza Technology Institute, its technology development arm.

The new managers brought with them, says Mario, a more commercial attitude about product development. While the basic idea for Alza’s transformation into a more fully integrated company had been created by 1990-91, says Mario, the new management team has been responsible for “the acceleration of the process and the selection of the projects.”

In keeping with Alza’s cultural predilection for innovative technology, the company apparently targets tough therapeutic problems (“apparently” because only a few of its drug development projects have been revealed). But to ensure that each one is commercially viable—that Alza isn’t spending all its time pursuing a series of Testoderms—it puts its concepts through a gauntlet of medical and economic challenges.

Fundamental to its development program has been the creation of the company’s new product discovery group. Working with a medical and scientific advisory board and a diverse set of consultants, says Saks, Alza’s discovery group looks to identify unmet medical needs and then for the technology/drug combinations that will address them. Each new product idea that passes a first inspection is given a formal “challenge statement”—specific clinical or economic hurdles the product must satisfy before it goes further into development.

For example, one of the few programs Alza has disclosed publicly is its urge incontinence product, now in early development, which incorporates oxybutynin—Hoechst Marion Roussel’s Ditropan—into a transdermal patch system. The incidence of the condition increases with age and is one big reason for the growth of the adult diaper market. It’s also, says Saks, a key “driver of institutionalization, which drives up health care costs tremendously.”

Drugs like oxybutinin work pretty well for the condition, says Saks, but have toxicities unacceptable for elderly patients: blurred vision, dry mouth, dizziness and sedation. Most of these drugs are given three-four times a day; Alza scientists figured that if they could create a sustained-release product that kept blood levels low but consistent, they could dramatically cut the drug’s side effects while preserving its efficacy.

Eventually, the company created a challenge statement for its product: equivalent efficacy with a 50% reduction in side effects. Says Saks: “The magnitude of the hurdle is large, but it makes a compelling argument from a medical standpoint.”

Keeping Failure’s Costs Down

The hurdle rate wasn’t arbitrarily arrived at, Saks says, but based on discussions with Alza’s cadre of medical consultants, its regulatory and medical scientific advisory boards (which meet regularly and are studded with significant names in the field), and TDC’s pharmacology board. As another check on the true value of the hurdle rate, Alza also established a mock formulary review committee, staffed by pharmacists and others who decide on formularies for managed care organizations such as Kaiser. Says Saks: “They have some insight into the drugs” that Alza is putting into new drug delivery systems because Alza often uses older, well characterized products. “We can simply ask them: ‘what would it take for you to put this on your formulary, to have a positive view of this product?’”

Challenge statements give Alza clear measures against which to cheaply and quickly test its ideas: one treatment for ulcerative colitis was knocked-out in animal tests because the local delivery technique didn’t reduce side-effects as much as the challenge statement required. Likewise, a program to deliver a particular protein by Alza’s transdermal electrotransport system failed in an early clinical trial to meet its challenge statement because, while the protein maintained its biological activity, it caused too much skin irritation. The cost of failures, Saks estimates: $3-5 million for the equivalent of Phase II information—far less than an NCE knocked out at the same level of testing.

To create this selection process, Alza needed expertise it didn’t have. Says Mario: “When I came here we had one or two MDs. These days we have close to 20. We had almost no molecular biology and very little skin chemistry. The reason was that we were dealing with clients’ money and doing specific tasks with our technology for them. I wanted to broaden that. I wanted to form a base of technology that was not just electrical engineers and physical chemists like myself, but people with a medical background, people who were familiar with biotechnology, who were looking for ways we could work with the biotech industry.”

Alza likes biotechnology because several of its drug delivery systems are well suited to delivering peptides and proteins, which so far have been injectable-only products. Its Chronsettechnology encloses proteins in a capsule, protecting them from the acidic environment of the stomach and delivering them directly to the colon. Its electrotransport technology uses electrical charges to drive biotech products across the skin. And its human implantable therapeutic system (HITS) houses peptides and proteins in an impermeable reservoir, surgically implanted in the patient, until the drug is ready to be pumped out through an osmotically driven process.

But Alza also likes biotech because its products are key strategic building blocks. Rather than basing its non-client business entirely on generics in patented delivery systems—drug/delivery system combinations which often carry limited exclusivity periods and must prove their value against other formulations selling at rock-bottom prices—Alza wants to buttress its portfolio with proprietary drugs.

The Not-Invented-Here Syndrome

The problem is how to gain business control over the products. Large drug firms certainly won’t give Alza shared ownership to products that join their NCEs with Alza drug delivery systems. But biotechs, theoretically, will. Says Mario: “They’re looking for partners and we’ve got [delivery] technology and can provide some funding. We share with them the product that comes out. Biotechs can’t do that with the big guys,” who will want the product in exchange for a royalty. “That’s just what Alza’s been doing,” says Mario. “But it’s not good enough.” Alza has signed its first such biotech deal, in which it is trying to deliver a recombinant protein in HITS.

Alza will need more than proteins to make a broad-based business: despite what it claims, and many observers agree, is its leadership position in the delivery of biotech products, Alza will also need new drug delivery technology, particularly given the hotter competition for clients.

But in accessing new biotech drug delivery systems, as with drug delivery technology in general, Alza has rarely ventured outside its own labs. And skeptics believe it never will. Typical is the comment of one drug delivery executive: “Alza believes they can do everything themselves.”

Alza executives acknowledge that, historically, the company has suffered from a scientific insularity, passing over potentially useful outside technology. Says Cozadd: “People here have been working on our OROSand transdermal systems for 15 years. To some extent an NIH syndrome is inevitable.”

But Cozadd also points out that Alza’s success has come from being able to exploit its technologies broadly—something drug delivery technology licensers aren’t often willing to let Alza do. “Any time Alza has had conversations with other drug delivery companies about a deal, they’ll tell us, ‘We’ll grant you a license only in a narrow field because we eventually want to be an Alza ourselves.’ But unless Alza can exploit a technology broadly, it’s not of much use to us.”

Still, Alza executives insist that the company has grown more pragmatic in its approach to other companies’ technologies. “We’re trying to change the Alza attitude toward in-licensing,” says Jim Young. He notes that one of his main tasks will be “filling in the gaps in Alza’s technology capabilities” through in-licensing or acquisition. “Our mission is to stay the leader in drug delivery with the broadest range of technologies. Our current technologies don’t address all the needs so we’re looking for complementary technologies.”

They’ve already found one such technology. In April 1995, Alza bought $1.88 million of Inhale Therapeutic Systems’ equity and agreed to support its work on a pulmonary drug delivery system for a peptide-based osteoporosis treatment. Alza gets worldwide clinical development, manufacturing and marketing rights to the product and will pay Inhale royalties on sales.

Marketing: Creating Commercial Options

Like its approach to business development, Alza’s sales strategy has also evolved. Until the arrival of Mario and Jim Butler, it looked unfocused—thanks largely to the odd combination of starting a sales effort with few products to sell. Detailing Testodermand co-promoting Duragesic with Janssen Pharmaceutica NV , a unit of Johnson & Johnson and Glucotrol XL with Pfizer, the company’s sales force has so far contributed very little to Alza’s bottom line.

Alza’s recent in-licensing of US Bioscience Inc. ’s Ethyolexhibits, if nothing else, Alza executives’ understanding that they must pay for their sales efforts. Alza got rights to the anticancer drug, says Mario, because they were willing to give the product back to US Bioscience in six years, by which point TDC’s products should be ready for marketing. And Jim Young and his team are actively looking for other short-term marketing opportunities in the five therapeutic niches Alza has defined for itself and for which it has TDC products under development: endocrine disorders, urology, managed care, supportive therapy in oncology and AIDS, and pain management.

But Mario’s plan doesn’t ever envision the sales force as Alza’s major earnings engine. Alza isn’t planning to market everything by itself, says Mario; nor is it clear that Alza will take a major role in anymarketing effort. “Perhaps” in the US, says Mario, and then only in niche areas—but definitely not outside the US. Especially in contrast with the return on investment that manufacturing would bring to Alza, a sales and marketing infrastructure represents “the highest expense for what you get.”

Instead, Alza’s sales and marketing effort, even for niche products, is intended more as a positioning and monitoring tool for marketing partnerships. Says Mario, referring to the Ethyolmarketing program: “What we’ll have done is create a presence in the US oncology market, small but visible. When our TDC products arrive, we’ll have a better choice of options. We can decide to sell them ourselves because [our sales effort has shown us] who the [prescribing] decision makers are—or we can farm it out to somebody. But we have a choice.” A sales force, he continues, lets Alza keep in touch. “We don’t have to be in the market; we just have to understand [the market and Alza’s marketing partner]... and he has to know that we know....We don’t want to say [to a partner]: ‘Here’s the product. Go do what you want with it and let us know every month how things are going.’”

For Mario the key is flexibility: “I don’t need to create a distribution system. There’s plenty of those out there, running at less than full capacity—which is not good news for the companies that own them.” He wants to avoid building up sales infrastructure in what he sees as a cyclical industry—companies dependent on huge earnings from individual products, as Alza has been dependent on Procardia XL. On the other hand, he does want to create manufacturing facilities: along with the US, Mario plans to establish plants in Europe and Asia.

Alza vs. Elan

Alza doesn’t need a success the size of Procardia XLto maintain its growth rate. If it can take 25-35% of a product’s net sales, through a combination of a higher royalty rate and a manufacturing transfer price, then even a drug one-fifth the size of Procardia XL—with revenues of $200-300 million—will provide the same Procardia-sized earnings to Alza.

The irony is that Alza, the drug delivery pioneer, didn’t create this strategy: Elan did. And it is with Elan that Alza is most often compared, largely because the two represent such different kinds of companies.

If Alza is seen as a technology-focused business whose challenge is developing a marketplace orientation, Elan is viewed as pragmatic, market-oriented and thrifty. Alza looks primarily to new markets with the potential for high growth; Elan to existing large markets. If Elan’s products take even a small share, the impact on Elan will be great not only because it will recover 25-35% of end-proceeds but because its expenses are relatively low—in contrast to Alza, which is in what Mario characterizes as an “investment phase.”

Thus Elan’s ambitions for becoming a marketing organization stress cost-effectiveness: for example, it has fashioned a set of international sales joint ventures with local partners which will eventually allow it to fund the creation of its own international sales infrastructure, but for now don’t burden the company with a significant sales force expense. Alza has been more inclined to see its sales force as a positioning investment—not one which will immediately bring a major return. Likewise, while Alza set up manufacturing in high-cost California (total spending on its Vacaville facility: $103 million), Elan put its plants in low-cost Ireland and Georgia.

Elan has also historically been much more willing to take big financial risks. While Alza was reluctant to move precipitously towards a more fully integrated business once it had set its Target 2000strategy—mindful of the brush with disaster that led to the Ciba acquisition—Elan moved quickly to implement its Mind to Market strategy in 1987-88. Says Kenneth W. McVey, Elan’s EVP, corporate planning, “When we decided on our Mind to Market strategy it was a big risk. We didn’t have the money. But despite the fact that that year we lost money really for the first time, we recognized that it was necessary to do. We had to keep rights to our products and we were willing to withhold them from licensees until we got the deals we needed.”

By the same token, Elan has never seemed particularly insular in regard to other drug delivery technologies. Like Alza, it is targeting the biotech opportunity. Elan is working with Athena Neurosciences Inc. , for example, on a series of CNS products. And Elan, like Alza, is willing to co-invest—$12 million in a convertible debt deal with Athena.

But Elan has also moved more aggressively—or perhaps publicly—than Alza to sign up key drug delivery partners, including Emisphere Technologies Inc. , Ethical Holdings PLCand Dura Pharmaceuticals Inc. Notes McVey: “Our approach is pragmatic. We keep our eyes open and where we see compatible technology we construct one of these deals. In the area of oral delivery of peptides, Emisphere had access to things we didn’t—and we had money, which they needed.”

Where are the Drugs?

Nonetheless, both companies face people skeptical that either firm’s pipeline will produce revenues of the required magnitude. Many investors have grown tired of the apparent lack of productivity—at both Alza and Elan. “I just don’t see the products,” says Steven Gerber, an analyst with Oppenheimer & Co.

The knock on Elan is that its new products aren’t differentiated enough—an outcome of a business philosophy that stresses speed of product development and that targets large well-developed markets (as opposed to Alza, which looks to establish new markets).

Elan’s Ken McVey argues that Wyeth-Ayerst, with two other NSAIDs (Lodineand Oruvail), will be able to exploit marketing segmentation opportunities for Naprelan based on its improved side-effect profile. Wyeth-Ayerst, he says, is forecasting $150 million in annual revenues for the product—which would mean about $50 million in additional revenues to Elan.

But analysts note that the drug is late (Elan was held up by a number of FDA-related problems with manufacturing) and will be coming into a market totally dominated by generic naproxen. Elan could have a similar problem with Nifelan, its once-a-day nifedipine, which Bayer will market. But Nifelan, say analysts, doesn’t have many obvious advantages over its competition—which includes not only Procardia XLbut also Bayer’s own Adalat CC.

The knock on Alza is simply that no one can see the pipeline at all—and investors are being asked to take on faith Alza’s contention that its TDC pipeline is well stocked with innovative winners. No one doubts Alza’s technological competence but plenty of people are skeptical about Alza’s ability to turn its products into big marketplace successes. Says Jerry Treppel, who follows drug delivery companies for Dillon Read, “The stock market has basically concluded that Alza doesn’t have a systematic approach—that they got lucky once [with Procardia XL]. So far they haven’t gotten lucky again and there’s no way of knowing whether they ever will.”

Alza’s counter-argument is that Procardia XL’s success wasn’t based on luck but on a unique brand of drug delivery innovation that can make blockbuster products out of generics. Innovation, its executives argue, will create long-term, high-margin successes—in contrast with what it see as the quick-and-inexpensive solutions Elan generally provides.

As an example of what Alza believes its technology can do for generics, its executives cite its new version of verapamil, which will be marketed as Covera HSby GD Searle & Co. The Covera system releases the drug in accordance with the circadian rhythms of the body, potentially preventing more acute cardiovascular problems than even once-a-day versions of the drug, which simply release a steady amount of drug.

Covera HSwill in fact be an important test case for the company: is it simply an elegant technological solution that won’t repay the investment? The market has become extremely price sensitive since the deal was signed in 1990 (not only is generic immediate-release verapamil cheaply available, there are also several sustained-release versions, from Searle, Elan and now a generic from Ivax Inc.). Notes Jim Young: “If Covera doesn’t succeed, it would be disappointing to us, though it wouldn’t remove the strong argument” that Alza’s drug delivery technology can create big returns for investors and partners.

But it does point out that drug delivery, like the NCE segment of the industry, is a risky business, for a variety of reasons. Not only do markets change quickly, so do corporate prospects. At the time the Coveradeal was signed, Searle looked like a safe partner: it had been acquired only a few years earlier by Monsanto Co. , which was looking to create a major drug business. But the prospects of success look far different in 1996—and Searle’s fate is an open question.

In the meantime, Alza covers its bets with its client business—where again, it claims an advantage in its technology, by all accounts the broadest in the drug delivery industry. Says Sam Saks: “If you thought there was nothing unique about our technology, you could probably get it done cheaper [at other companies]. Some people have done that.”

Companies come to Alza to try out a range of solutions. With Warner-Lambert, for example, says Saks, “We looked at Cognexin multiple dosage forms to come up with the best one. That’s not going to happen at another, smaller drug-delivery company. They’re going to give you a patch whether its optimal or not.”

But other drug delivery companies are catching up with Alza on the technology front, creating stronger competition for clients and, potentially, fast-follower competition for Alza’s own innovative new products. Alza must thus run faster and smarter than it ever has.

The Mario regime has clearly focused Alza on the pursuit of big and practical opportunities within commercial structures which allow the company to keep the lion’s share of the profits. The question revolves, however, around the extra value brought by its simultaneous focus on innovation and dramatic product differentiation, a focus which makes its development programs more expensive and time-consuming than competitors whose overriding mandate is speed. In short: in the face of ever fiercer price competition, will Alza’s extraordinary investment in drug delivery bring extraordinary returns?