Roche Diagnostics' New Marker Mandate

Roche Diagnostics is the best performing asset at Roche. As the troubled Swiss pharma company suffers through its worst pipeline drought in a decade, Roche Diagnostics is delivering a stellar performance. It is strong across all business segments, from laboratory systems to diabetes to molecular testing. Its challenge: to pull far enough ahead in its traditional businesses to maintain a comfortable lead. Its bigger hurdle, however, is to position itself as a leader in adoption of new genomic and proteomic diagnostic technologies, which is where the industry's future growth lies.

The best-performing business at troubled Roche is its diagnostics unit—the number one player in its industry. But can it stay on top in a new era of diagnostics?

By Wendy Diller

• Now that it has integrated Boehringer Mannheim and installed a new president, Roche Diagnostics is delivering stellar performance. It is strong across all business segments, from Laboratory Systems to Diabetes to Molecular Diagnostics.

• Its success stems partly from competitors' weaknesses, but it has core competencies, too, demonstrated by its abilities to roll out new products and by the breadth of its product portfolio.

• In its traditional businesses, Roche's challenge is to pull far enough ahead to maintain a comfortable lead. Its bigger hurdle, however, will be to position itself as a leader in adoption of new genomic and proteomic diagnostic technologies, which is where the industry's future growth lies.

• Roche Molecular Diagnostics is better positioned than other major diagnostics companies to look for high-value markers. But it will be competing against a new set of players—biotechs and large non-in vitrodiagnostics companies especially—bringing with them biological expertise, significant financing, and the ability to operate, without stock market penalty, at a loss.

When Roche bought Corange, the holding company of diagnostics powerhouse Boehringer Mannheim, in 1997, few investors were happy [See Deal]. At the time, Roche's drug unit was a bright spot in the drug industry and a favorite with investors, who were enthusiastic about prospects for orlistat (Xenical) and a series of Phase III products. Paying $11 billion to boost the position of Roche Diagnostics , which had lower margins and slower growth prospects than the much larger pharma unit, didn't make sense. Moreover, Roche's rationale—the attractive commercial prospects for linking diagnostics and therapeutics—wasn't convincing. Such a link had never worked historically (few drugs could be prescribed on the basis of specific diagnostics, and none of the diagnostics were particularly proprietary).

What a difference three years can make. Today, even as Roche Pharmastruggles through its worst pipeline drought in more than a decade, Roche Diagnostics is booming across all segments. With new management in place for slightly more than a year, a revised organizational structure, and some high-profile marketplace successes, Roche Diagnostics sales grew 18% in Swiss francs in the first quarter of 2001, well above the industry average. All of its five business segments are doing well and Roche has even picked up market share in areas in which it has been weak, like immunoassays.

Roche Diagnostics' triumph is built in part on the misfortunes of others. In diabetes, it gained the number one position when its chief rival LifeScan Inc. , an operating company of Johnson & Johnson , stumbled with product recalls and couldn't deliver new technology. (See"Two Rising Stars In Glucose Testing," IN VIVO, February 2001 [A#2001800028.) In lab systems, Roche took business from market leader Abbott Laboratories Inc. , which had fallen foul of the FDA. In molecular systems, it stays ahead partly because no one has been able to come up with a truly viable alternative to its polymerase chain reaction (PCR) technology, which remains the gold standard for amplification a decade after its introduction. And these gains are all the brighter in comparison to Roche's pharma division's performance.

But its competitors' failings don't explain most of the story: Roche has also done things right. Since 1991, it has built a $400 million molecular diagnostics business out of a market that didn't previously exist. It gambled on buying Boehringer Mannheim, which has since more than paid for itself, gave the company greater market clout, a broader product portfolio, and entrée into new, highly profitable businesses, like diabetes. Its aggressive, consumer-oriented strategy in diabetes, which it honed by watching LifeScan at work, has made its Accu-Chekdiabetes glucose monitoring system the best selling brand in all of Roche.

All of this has given it the cash and profit margins to pursue the next steps of its strategy: solidifying its lead over existing rivals and positioning itself for a new era in diagnostics, one in which high-margin, high therapeutic value tests based on discoveries in genomics and proteomics will drive growth. To this end, it is rolling out new products in nearly every major category of its portfolio in order to gain distance between itself and its competitors. In diabetes alone, where it expects a major battle with a potentially reinvigorated LifeScan this year, it is introducing three glucose-monitoring systems. (See"No Surprise: LifeScan is Probably Buying Inverness," [A#2001800105)

But its future might well rest on a long-term effort to discover or otherwise access high-margin markers, which it can turn into clinical diagnostics. The diagnostics world has been trying to figure out how to find high-value content for years. Yet most of the major diagnostics players, under pricing pressure for the better part of two decades, don't have resources to invest heavily in the biological research necessary to make such discoveries or buy them from others on an exclusive basis.

Roche, because of its success, and the link to its large parent, can do more than others. It has a series of internal research programs, some jointly with its sister pharma division, some entirely focused on diagnostics. It plans to hire more than 100 scientists to work at Roche Molecular Diagnostics (RMD) in the next year, and it is actively looking for partners to enhance its molecular and proteomics programs. Roche Diagnostics head Heino von Prondzynski wants to boost operating margins to the low 20s from the current 13%, while also boosting R&D productivity. At the same time, he wants to get rid of the last vestiges of Roche's not-invented-here syndrome, which permeated the company and other diagnostics firms for much of the 1990s, as it aggressively seeks partnerships and in-licensing agreements.

None of this will be easy. Roche can't rely on in-licensing new proprietary markers if it doesn't also discover some of its own: Without an overwhelming market dominance on the system side—which is unlikely—Roche can't demand the exclusive licenses which will allow it to maximize pricing. Instead, it will have to create a de factoproprietary position by bundling non-exclusive access to proprietary markers with its own patented tests. It's also likely that in pharmacogenetics and pharmacogenomics—the testing of patients to determine appropriate drug therapy, an area Roche sees as important to its growth—it will have significant competition from biotechs and large companies that haven't previously been involved in in vitro diagnostics. And while Roche has certain financial advantages, many of these companies also have substantial monetary support. Moreover, other drug companies are more likely to be willing to work with biotechs, providing them, in the interest of more efficient clinical trial programs, with tissue samples and biological information about the specific drugs they're developing. There is at least a question of whether they'd provide the same information to a diagnostic company affiliated with one of their major pharmaceutical competitors.

Indeed, Roche's drug business could be a handicap in more ways than one. Faced with flat sales in its pharma sector, the company's future is cloudy. Roche CEO Franz Humer has said the company isn't looking for a buyer and, given its odd corporate structure, (the Oeri-Hoffmann and Hoffmann families control 50.1% of the company's voting shares) a hostile buyer can't make a play for it within the existing structure.

Still, nothing is impossible. (See"Novaroche: Novartis' Very Swiss Bid for Roche," [A#2001800100) In early May, Novartis AG , Roche's neighbor in Basel, said it had bought 20% of the voting shares in Roche from a dissident Roche shareholder, and the next day Roche's CFO was fired. The once unthinkable scenario—the acquisition of Roche—is far from unthinkable, particularly at its very depressed share price.

Top Roche Diagnostics executives insist that these events aren't likely to change the course of their strategy. On the contrary, they say, Roche recently approved a significant increase in research funding for RMD, despite the fact that it is cutting expenses and jobs in the pharma sector. But diagnostics, no matter how well it does, isn't big or profitable enough to drive Roche's stock—Roche derives roughly 64% of its revenues from its pharmaceuticals division—and could fall victim to plans to bolster that much larger, ultimately more important division. (See Exhibit 1)

Getting to Number One

When Roche acquired Boehringer Mannheim several years ago, few people outside of the company could see the value of it. (See"The Grand Vision of Roche Diagnostics," IN VIVO, October 1998 [A#1998800200.) Why would a company that derived more than 50% of its revenues from high-margin pharmaceuticals want to spend $11 billion on a diagnostics behemoth like Boehringer Mannheim? Yet Roche, as a mid-sized diagnostics company sandwiched within a much larger pharmaceutical business, lacked critical mass both internally and in the marketplace. It needed to make an acquisition—or exit diagnostics. But as Roche leadership saw it, diagnostics could play an integral role in pharmaceutical development and marketing.

Roche and Boehringer Mannheim were, in many respects, a good culture fit; both companies were European-based and family-controlled, with headquarters a two hour distance from each other. Their assets were complementary, rather than duplicative, and each had strengths that could address many of the other's weaknesses. Roche brought Swiss financial skills to Boehringer's far-flung, wayward, but more creative operations; Boehringer Mannheim had marketing and engineering prowess. It was a powerhouse in clinical chemistry, diabetes, and biochemical reagents; Roche had cutting-edge technology in molecular probes, mid-volume chemistry, and drugs-of-abuse testing.

Jean-Luc Belingard, head of Roche Diagnostics at the time, was instrumental in putting the deal together but didn't stay to start building the new entity. For personal reasons, he left Basel to head Pierre Fabre SA, a French family-owned pharmaceutical company, where he was part of a team that last fall merged the firm with bioMerieux SA [See Deal], creating another company with the opportunity to integrate pharmaceutical and diagnostics businesses. (See"bioMerieux's and Pierre Fabre's Surprise," IN VIVO, October 2000 [A#2000800180.)

Otto Meile, a long-time Roche executive and former head of Roche Pharma in Germany, replaced Belingard on a temporary basis. By many accounts a tough manager, he focused on integration and getting the company into financial shape. When he retired a little more than a year ago, von Prondzynski, the former head of Bayer Diagnostics Inc. in Germany, a subsidiary of Bayer AG , and, more recently, president of Chiron Corp. 's vaccine business, took his place.

His mandate: to take Roche-Boehringer Mannheim from a good beginning and solidify its lead. Von Prondzynski, to that end, has spent the last year combing through management ranks, creating more opportunities for younger executives. He pushed to settle Roche's critical patent dispute over its hepatitis C diagnostic with his former employer, Chiron [See Deal] and to expand a cross-license agreement with Perkin Elmer, now Applera Corp. , which allows both partners to sell PCR-based systems to both research and clinical markets. (See"Surely You Joust," IN VIVO, September 2000 [A#2000800153; "Chiron and Roche Bury the Hatchet—for Now," IN VIVO, November 2000 [A#2000800207.) That deal opens doors for Roche in the research arena, though it also positions Applera as a rival in molecular diagnostics.

As of this spring, von Prondzynski has streamlined the company's management and revamped its organizational structure to better reflect the diverse needs of its differing customer bases. He divided the division's four business units—biochemical supplies, molecular systems, patient care (diabetes and point-of care), and laboratory systems—into five customer-based groups— Applied Science, Molecular Diagnostics, Diabetes Care, Centralized Diagnostics, and a new area, Near-Patient Testing.

And following the resignation of two of four key business unit leaders, he has a new management team in place. Manfred Baier, PhD, the longtime president of Roche Biochemicals, this spring became head of a new coordinating entity, Laboratory Networks, which in turn incorporates Centralized Diagnostics (formerly Laboratory Systems), Near-Patient Testing, and Molecular Diagnostics. Werner Schaefer, who had been head of Laboratory Systems, left at the end of his contract, now that the Boehringer integration is complete. Heiner Dreismann, PhD, a veteran Roche executive, succeeded Kathy Ordonez as head of RMD, after she resigned last fall to head Applera's new clinical diagnostics effort, taking with her several key R&D executives. (See"PE's Diagnostic Start-Up," START-UP November 2000 [A#2000900204.) And Roche has just named Susanne Raehs, PhD, a former consultant with Arthur D. Little, to replace Baier as head of Applied Science.

With the integration officially complete, and the modest reorganization underway, Roche has ramped up its roll-out of new products throughout all business units. In Centralized Diagnostics, for example, it is launching both a clinical chemistry system that can run homogenous immunoassays and a modular immunoassay system that attaches to other Roche immunoassay and chemistry systems for greater throughput; in other divisions it has on its plate an automated PCR sample prep system, a protein generator, and three diabetes monitoring devices. (see Exhibit 2 and 3)

Laying the Ground Work

Roche executives hope that by steadily achieving pre-determined goals, as they have done with integration and product roll-outs, they will put further distance between themselves and competitors. This in turn not only helps them grow existing businesses, but gives them the stability, resources, and time to devote to development of innovative markers and systems.

Of all the businesses, the merger had the least impact on patient care diagnostics, which until recently consisted largely of diabetes testing. Its top executive, Staffan Ek, head of the business for nearly a decade, exerted razor-sharp focus on executing a strategy broadly envisioned years ago, when Boehringer Mannheim was independent. Last year, Roche bought Austrian POC company AVL Medical Instruments AG and put it under his jurisdiction [See Deal]. When he reportedly balked at incorporating it into patient care because of its entirely different business model and customer base, Roche this spring created a fifth business unit, Near-Patient Testing, for non-diabetes-related POC diagnostics.

Ek kept pace with new technology, seized the offensive in a highly competitive, marketing-driven environment (such as flooding pharmacies with new Roche glucose testing instruments), and cultivated the consumer, who, in contrast to other areas of diagnostics, has the major role in purchasing decisions in this field. He carefully and slowly transformed Accu-Chekglucose level monitors into a global brand for all Roche diabetes products worldwide; Accu-Chek is now Roche's number one selling brand throughout its divisions, with sales of nearly $2 billion a year. As a result, Roche's patient care revenues are growing above the market average of 12-14%, a pace Roche executives expect to continue, even if LifeScan's attempted comeback succeeds.

The Diabetes Care business unit's contribution to Roche's future lies less in its technological prowess—although it knows how to get new POC systems on the market—than in its marketing savvy and financial performance. Simply put, it throws off cash, which can be used to fund research endeavors in other areas. Also significant is its familiarity with the forces of consumerism; techniques for educating diabetics, who don't consider themselves sick, may come in handy as Roche launches programs to educate people about the value of genetic tests, particularly those focusing on predisposition to disease and genotyping. Ek is fully aware of how to keep users informed and satisfied in an environment which requires winning their loyalty again and again, and one in which comprehensive, complex information must be distributed in a user-friendly format.

Locking In Hospital Customers

If diabetes provides cash for new ventures, Applied Science contributes a strategic window on new laboratory technologies. The group designs and sells reagents and systems to the research community. For years, as part of Boehringer Mannheim, it was a sleepy, commodity-like niche business. With the Roche merger, the division's managers placed more emphasis on Roche's PCR technology for genetic analysis. They began reorganizing its product line to sell into hot research areas as they occurred, achieving 18% year-on-year growth, substantially above the market average, says Manfred Baier; his expanding duties into other business areas demonstrates just how intertwined they are becoming.

If its fastest-growing products in the past four years involved PCR and functional genomics, Applied Science's interest is shifting to newer areas like SNPs, proteomics, and gene and protein expression analysis, says Baier. He (and now his successor) is focused on developing analytical tools that identify proteins and genes, all of which may be used by Roche Diagnostics and its partners in their search for new content. A number of pioneering technologies and diagnostics assays, in fact, got started in this group, he notes, notably the RTS 500(rapid translation system), which Roche introduced in the third quarter of last year to simplify and automate the process of expressing proteins. So far demand is strong; Roche has placed about 400 systems in six months.

The LightCycler, too, a popular research tool for automating PCR amplification and detection, is being sold through Applied Science. It is used with new research assays and, unexpectedly, increasingly in clinical laboratories, which like some of its customization features.

Applied Science also serves as a testing ground for new assays that might be useful in humans. Until the most recent reorganization, it was responsible for developing and selling analyte specific reagents (ASRs), a category of tests the FDA created several years ago to bridge the gap between research and FDA-approved assays. ASRs are semi-complete test kits for human clinical use that haven't gone through the regulatory approval process and, as a result, have marketing restrictions. They are an increasingly popular format for commercializing genetic tests, which manufacturers are interested in getting on the market but which may not generate returns big enough to warrant trying for full FDA approval. Applied Science sells about five genetic ASRs; Roche plans to introduce 25 more genetic ones in the next two years, but through Roche Molecular, which, following the reorganization, handles all products aimed at human clinical testing.

Roche Molecular is looking at a number of ASRs to determine if they are worth taking through the FDA; in this respect, Applied Science's ability to convince researchers to accept ASRs is important to Roche Molecular's decisions about whether to position those tests for the broader clinical markets. And while most ASRs currently don't have much patent protection, they might in the future provide a fast route to market for a proprietary product that has yet to get FDA approval.

Applied Science has another aspect to its business that is likely to help Roche's quest for new markers. While researchers tend to rapidly accept genetic tests, they are increasingly interested in content-driven results and context, and less interested in the generation of basic, pure data. Satisfying this desire will be key to success in clinical markets, says Baier. Simply put, as the industry offers more complex tests, users will need a better explanation of what results say about a particular disease state, not just whether the marker levels are high, low or normal, or whether the risk factor is 10% or 20%. They will want to know, for example, how particular risk categories relate to a patient's predisposition to a disease and implications of the results. Such information in context will be important and difficult to pull together with new markers, particularly those based on patterns stemming from analysis of their groupings and levels. These tests will require software-generated explanations of their meaning, based on data gleaned from huge databases.

Getting this information, however, is a challenge because the context continually changes with the addition of new knowledge. Because Applied Science works so closely with the research community, it may help Roche Molecular figure out how to present the information gleaned from novel tests to clinicians.

Because it forges links with new technologies, Applied Science is integral to the success of Roche Molecular, Baier says. Even though the reorganization gives authority over all human tests to Roche Molecular, Applied Science will continue to provide a first look at where research, both on systems and reagents, is headed.

Creating Market Dominance

If Applied Science is rooted in research and futuristic applications of diagnostic technologies, the Centralized Diagnostics business unit concentrates on the mundane, but critical, traditional diagnostics customer base: hospital and reference labs. The largest business unit of Roche Diagnostics—its broad product line and leadership position in key laboratory segments—helps the company maintain a strong presence among centralized laboratory customers and hone its skills in systems design and engineering. This systems expertise and extensive customer network will aid widespread acceptance and adoption of novel markers. It gives Roche's new tests a natural distribution system and credibility with customers. (see Exhibit 4)

Roche will thus have some advantages in negotiating licensing deals with innovators who hold rights to technology it wants. A distribution deal with Digene Corp. [See Deal], announced in May, to sell Digene's patented human papillomavirus (HPV) probe tests in Europe came about in part because Digene was impressed with Roche's strong worldwide market presence. And the test, even though Roche has to pay royalties on it, could be quite profitable, says von Prondzynski, who estimates that HPV, which is used to clarify ambiguous PAP smear results, could be a $500 million market in a few years. Roche doesn't get exclusive rights to the markers, but, to Roche's advantage, Digene doesn't have other distribution partners. It has just terminated an exclusive distribution arrangement with Abbott, because it didn't think the larger company was giving the test enough attention.

While the Boehringer Mannheim integration affected all Roche businesses—pharma included—nowhere did it have a greater impact than in Laboratory Systems, partly because this was one area with some product overlap and partly because the unit operates under tight margins. Other diagnostics businesses saw little shift in head count, but by the end of the integration, Laboratory Systems had closed six manufacturing sites and cut staff. For example, unit leader Werner Schaefer, PhD, had to figure out how to combine two similar although not identical chemistry systems, Roche's Cobasand Boehringer's Hitachi instruments. Roche ultimately kept both, aiming them at different-sized laboratories and is on the verge of introducing a new chemistry/immunoassay analyzer that it claims incorporates the best features of both product lines.

Schaefer achieved his goals: substantial financial savings from integrating the two businesses with minimal disruption to the customer. Roche now has the world's largest laboratory systems business, with a broad portfolio of products, an increasingly strong US presence, including growing visibility with group purchasing organizations and the ability to roll out a steady stream of new products. The integration complete, Schaefer resigned just before this article went to press and his position has been filled by Manfred Baier.

In one other measure of success, Roche gained market share last year in immunoassays, a large segment in which it and Boehringer Mannheim were relatively weak, partly because of the regulatory problems of market leader Abbott Diagnostics . In late 1999, the FDA forced Abbott to pay a $100 million fine and suspend production at its major immunoassay manufacturing facility. (See"Abbott Gets into Hot Water," IN VIVO, November 1999 [A#1999800228.) Abbott's woes helped all its competitors, and although everyone expects its setback to be temporary, its troubles are making laboratories cautious about being too dependent on one manufacturer, as some were with Abbott. This means that Abbott, even after it makes a comeback, may not have quite as strong a grip on the market as it did before its troubles began.

While Roche plans to take market share away from existing players, it faces a long-term problem: the centralized testing market overall isn't growing. That central fact in Roche's biggest diagnostic operation underscores the problem facing the diagnostics industry overall and indicates just why Roche needs new proprietary markers and technology platforms. Indeed, Roche Centralized Diagnostics is spearheading much of Roche's diagnostics-oriented research in proteomics—and for good reason. Early new markers stemming from proteomics research are likely to run on basic immunoassay analyzers, according to Schaefer and others, since the initial results are likely to be single protein analytes. Roche's number one share of the laboratory market, theoretically, should therefore also provide it with the leading share of the new tests.

Proteomics: A Key to New Markers

Only further down the road, Roche executives argue, will more specific and predictive, if also more complex, multi-protein panels be available—panels which will require new formats, like protein chips, which Roche today doesn't provide. To this end, the lab systems group has three major proteomics initiatives, both internal and through alliances. And it continues to look for partnerships with academia and start-up biotech companies.

Roche Diagnostics began its proteomics initiative last November, when the parent company expanded an ongoing research effort, committing $57 million (CHF100 million) over the next five years to a program, which will be concentrated in Penzberg, Germany, and Basel. About 60 scientists in multiple disciplines will work together to find targets for both diagnostics and pharmaceuticals. These targets would be linked to selected diseases—cardiovascular, cancer, inflammatory, and metabolic disorders—and on the diagnostics side, would allow patient-specific diagnosis and prognosis of disease, leading possibly to customized treatments. Diagnostics tests could be ready for commercialization in three to four years, much earlier than the drugs, says von Prondzynski. The first tests are likely to be simple, either running on single-analyte formats or low-density arrays because of the prohibitive cost and complexity of high-density arrays, he says.

But CHF100 million in internal spending is hardly enough to achieve the results Roche is looking for. To this end, it is also looking to external partners. In January, the diagnostics group announced a three-year deal with Millennium Pharmaceuticals Inc. and its subsidiary Millennium Predictive Medicine Inc. , focusing on rheumatoid arthritis [See Deal].

The narrow scope of this collaboration provides a glimpse into Roche's approach to finding new markers and the extent of its ambitions. Markers to come out of it will enable individualized programs of care and medical intervention, according to Roche executives, and include early detection, prognosis and monitoring. While Millennium will hold patents to products resulting from its research, Roche gets exclusive rights to those products, as well as the opportunity to obtain patents for its contributions.

Roche chose rheumatoid arthritis because the disease affects a large number of people and yet doesn't have good diagnostic tests. Traditional diagnosis is made from X-rays of the joint but doesn't distinguish different variants of the problem or indicate progression. These distinctions can influence therapeutic decision-making, perhaps preventing or delaying cartilage damage, says Helmut Koehler, PhD, SVP, Centralized Diagnostics R&D, who is supervising the diagnostics portion of the proteomics efforts. In addition, Roche Pharma has several rheumatoid arthritis drugs in preclinical stages of development, which might benefit from diagnostic markers resulting from the Roche-Millennium collaboration. The markers might help determine, for example, which patient groups should be getting the drugs, or they might allow monitoring of the drugs' efficacy.

Specifically, Roche is looking for markers that differentiate faster from slower-progressing disease. To do this, the collaborators are looking for all proteins in synovial fluid, a clear liquid which builds up in joints of those affected with rheumatoid arthritis but isn't found in large enough quantities to extract from healthy people. Since scientists, therefore, can't compare synovial fluid of healthy and sick people, they are comparing differences in proteins and protein levels in patients at various stages of disease. Once they know the proteins, they can measure which ones leak into the blood stream, then compare protein content in the serum of sick and normal people. If they find proteins in sick subjects that aren't in healthy ones, they have a candidate for a disease marker.

Using high-throughput mass spectrometry and other technologies, including bioinformatics, the group expects to find multiple relevant proteins, but can't predict how many, says Brad Guild, PhD, Millennium's director of protein biochemistry. The partners hope to find large numbers of proteins, which they can whittle down to a limited number of informative markers. Roche then will convert those markers into immunological tests by developing antibodies for them, validating them, and formatting them into ELISA assays.

A New Horizon

If Centralized Diagnostics is driving the proteomics effort, Roche Molecular Diagnostics, is leading the way in genomics. A relatively new operation, it nonetheless has more experience than the other business units in researching complex biological assay development and formatting those tests for clinical applications. It's also got more at stake, since its PCR technology forms the basis of a lot of the world's genomics work. If it can't meet the challenge, competitors are likely to try to step in with their own amplification technologies.

RMD's lock on PCR shows at once the opportunities and challenges facing genomics players. Roche patents covering PCR give it a tremendous advantage over other genomics players in technological expertise, relationships with customers and scientists, and proven ability to bring products to market. But its expensive royalty rates and sheer dominance of nucleic acid testing have created a backlash, spurring potential competitors to develop their own amplification methods or even license in PCR and use it as a foundation to aim for clinical applications.

Although most of these companies haven't succeeded, some have developed other kinds of innovative genomics technologies and even gotten clinical products to the market. Gen-Probe Inc. (a division of Chugai Pharmaceutical Co. Ltd. ) is probably the most successful of these. But Third Wave Technologies Inc. (TWT), for example, sells three genetic tests based on its Invader technology, which eliminates the need for PCR, to clinical and hospital laboratories. The tests help in determining predisposition to certain cardiovascular diseases. Third Wave is also developing genetic mutation panels for pharmaceutical companies like Novartis to help them associate selected genes with diseases. Another company, Molecular Staging Inc. has developed an amplification system which is an alternative to PCR, called Rolling Circle Amplification Technology (RCAT) and is partnering with larger companies to bring assays to the research field and eventually to the clinic. Other small companies, like Cepheid Inc. have their sights on the clinical market, and some large ones do too—witness the recent joint venture between two divisions of Applera—Celera Genomics Group and Applied Biosystems Group —to set up Celera Diagnostics, focused on clinical diagnostics. And while none of these efforts are very big yet, some, like the Celera start-up, have deep-pocketed investors backing their efforts.

And while it has built a $400 million business out of PCR, some question why Roche hasn't done more, given the breadth of its resources. While it has slightly more than a dozen FDA approved nucleic acid tests on the market, most of its revenues and profits come from only three of those. Last year, the FDA approved only one nucleic acid probe, and none from Roche, a surprisingly low number given the scientific world's interest in genomic assay development The test, Digene's combined assay for chlamydia and gonorrhea, was at best an incremental improvement over existing ones.

The business unit has seen a number of changes since last fall, when Ordonez left with some of her team. Heiner Dreismann, PhD, a Roche veteran executive, who was previously head of business development and licensing for Roche Diagnostics, and leader of the Roche-Boehringer Mannheim integration team, took her place. Vowing to end the "pause" in new technology introductions—both systems and assays—that has enveloped Roche and the rest of the industry, he has pushed through a business plan with a core goal of developing new parameters for testing.

While Ordonez had instigated the plan, Dreismann asked for and is receiving a much greater amount of R&D funding than originally proposed. Roche is putting "triple digit millions" into molecular R&D programs in infectious diseases and human genomics and expects to hire more than 60 scientists in the next year in California alone, Dreismann says. In infectious diseases, it is focusing on virology and bacteriology, the latter of which it had somewhat neglected. In human genomics, it plans to emphasize work on complex genetic diseases, although it still sees some opportunity in the already heavily explored monogenetic diseases. RMD's research efforts are far greater than any one else's in diagnostics and have been for years, he says.

Dreismann, a microbiologist by training, was instrumental in building the PCR business and has already made some changes. Under his leadership, for example, the unit has set up a new sales force to call on public health labs, which are big buyers of probe tests for infectious diseases. And since the recent business unit reorganization, RMD has responsibility for all human molecular testing, including ASRs previously sold through Applied Science.

Evidence of Roche Diagnostics' deal-oriented R&D strategy is already manifest at RMD. If von Prondzynski wants to jettison Roche's not-invented-here syndrome (the diagnostics group did about a half dozen, mostly small deals in the past six years, apart from the acquisition of Boehringer Mannheim in 1997), RMD is the right place to start. It has the tools in place to conduct deal-making and there is a lot of interest in its technologies. Its ownership of PCR should give it a bargaining chip when it looks to in-license discoveries patented by others, something it will have to do given that the vast majority of important genetic markers will be patented by others. To that end, RMD has already formed several key genomics collaborations and is looking for more, says Thomas Metcalfe, VP, business development at RMD.

Finding Salvation in Iceland

At the heart of RMD's effort to find new genetic markers is its alliance (one of several for Roche) with deCode genetics Inc. , the Icelandic population-based genomics company, which is studying Icelandic patients in order to identify disease genes and, from them, drugs and diagnostic targets [See Deal]. (See"Roche and deCode Turn to Diagnostics," IN VIVO, April 2001 [A#2001800085; "The Population Genetics Equation: Data+Product Focus=Funding," START-UP, April 2001 [A#2001900066.) While Roche has several smaller research collaborations with genetics companies, including ones with Incyte Genomics Inc. [See Deal], which it won't say much about, and another, brand-new deal with Partners HealthCare System Inc. in Massachusetts, its relationship with deCode is by far its largest, both in amount of money devoted to it as well as manpower and scope of interest.

Not only is the company funding R&D at deCode, but it is setting up a separate internal group to work with the firm, and hiring experts in areas such as biostatistics. Unlike the narrowly-focused agreement with Millennium supervised by Roche's Centralized Diagnostics unit, the RMD-led deCode alliance is broad ranging, covering development of DNA-based diagnostics in as yet undefined areas, but likely to include inflammatory diseases, diabetes, and cardiovascular disease. And while Millennium will hold most of the patents resulting from its collaboration with Roche, both Roche and deCode will divide the patents more evenly, in part because they are sharing more of the basic research.

Roche picked deCode largely because of its approach to genetic analysis, as well as its expertise in biostatistics, research, and generation of contextual information, says von Prondzynski. DeCode is applying population genomics to locate disease genes and then resorting to functional genomics to more specifically define the molecular pathways of selected genes.

Its researchers use the company's genealogy database of 620,000 entries covering twelve centuries of Icelandic families to cluster patients with a particular disease into large, extended families. Through large-scale genotyping, they can find common genetic fingerprints in every chromosome and determine which ones are shared by victims of a particular disease. They can then map the region of the gene, zero in on it, and screen it for mutations that might be the cause of the disease.

In addition to its own database, deCode has certain rights to the Icelandic Healthcare Database, which contains medical records from Iceland's single-payer national health care system. Large numbers of Icelandic patients can be linked together for study using deCode's computerized geneology database. In this way, deCode and Roche can look for new drug targets and better markers for predicting which patients can be treated effectively with existing drugs.

Roche executives also figured they knew what they were getting. A three-year-old relationship between Roche Pharma and deCode was progressing well and has resulted in the discovery of several genetic targets, some of which may ultimately be useful to Roche Diagnostics. DeCode's approach is faster and cheaper than standard methods of understanding genetic function, which involve gene expression and clinical trials, says Heiner Dreismann.

Tests resulting from this joint endeavor may or may not be multianalyte—it is too soon to predict—and the first ones aren't expected to be available for three to four years. But they are sure to be more complex than existing tests and will require new ways of providing results to physicians and patients. Moreover, they may not accord with Roche's current systems.

Obtaining such a system—either buying or licensing it—won't be the biggest problem for Roche—there are lots of people working on microarrays and Roche and deCode already have separate relationships with Affymetrix Inc. , the chip-maker, which has its own detection system [See Deal], [See Deal], [See Deal]. Moreover, Roche is working on a high-throughput system using the Affymetrix chip. Nor will developing software to support the test results be unduly difficult, the partners believe; deCode is working on a computer-based system to put genetic information in context, so that it has comprehensible state-of-the-art information.

The bigger challenge is coming up with the tests in the first place. While Roche is highly enthusiastic about deCode, some wonder if it is placing too much emphasis on a company that is controversial, both ethically and scientifically. DeCode's deal with the Icelandic government is the subject of much debate worldwide concerning the violation of privacy and whether a for-profit company should be gaining from public property. Scientifically, some argue that deCode's approach is limited partly because the Icelandic population is too small and homogenous to take into account genetic variations that might be more prevalent.

Roche executives dismiss these attacks. Dreismann notes that deCode combines excellent medical data with historical information, well-characterized sample banks, and sophisticated bioinformatics in a way that few other companies do and which is of immense value in speeding up both discovery work and retrospective trials. Roche executives point to studies showing that Iceland's population is as heterogeneous as other populations. And Kari Stefansson, MD, PhD, deCode's founder and CEO, is convinced that the predictive tests on which Roche is focusing initially will be a basic part of medicine in the next decade. Some genetic predisposition tests are on the market—such as BRCA 1 and 2, he notes, which already have a big impact on a small subsegment of patients.

But the implications for new tests, which he believes will start coming out in greater volume in the next two years, are powerful, he predicts. For example, a predisposition to elevated blood lipids could affect a person's behavior and the medication he or she is taking. And these tests will force the diagnostics industry and its customers to look at the information it provides differently than merely identifying a patient's particular disease.

Moreover, the large investment may actually be a bargain for Roche. While the company isn't disclosing the numbers involved in the alliance, it gets, to some extent, two for the price of one. That's because it gets the diagnostic benefits of the Roche Pharma work, thereby leveraging the investment far beyond what most diagnostics companies can do. In contrast, in its two-year-old cancer-oriented deal with Millennium, Becton Dickinson & Co. [See Deal] has to pay the full ticket price to get a diagnostic marker. For Roche, a marker might come for free through the pharma collaboration and then the diagnostics division would only have to pay for further validation work.

A Pharmacogenomics Opportunity

But, for obvious reasons, Roche doesn't want to leave all eggs in the deCode and Millennium baskets—it wants to in-license other technologies, too. While it has made large investments in a few companies, it is pursuing more deals, albeit on a smaller scale, with both proteomics and genomics companies working on tools and content. In addition to Affymetrix, for example, it is looking at more microarray technologies. While the Pharma side can rely on Affymetrix for most of its microarray needs, the diagnostics business needs both high-density chips, which Affymetrix can provide, and low-density chips, which Affymetrix does not make. Roche therefore is in the midst of negotiating with companies, and, if successful, expects to have a chip-based product for the life sciences market in a year or two.

Meanwhile, the deal with Affymetrix provides Roche's entrée into an area of genetic testing it is eager to develop, pharmacogenomics. Pharmacogenomics is enticing because it has direct implications for therapeutic decision-making. At the simplest level, it refers to pharmacogenetics, the identification of single mutations or groups of mutations that might affect people's responses to a drug. At a more complex stage, it revolves around the search for larger patterns of gene and protein expression, distinguishing more finely among stages of disease or kinds of diseases or people likely to respond to particular medicines.

Roche's first pharmacogenetics product is likely to be a chip assay based on the CYP 450 gene, done in collaboration with Affymetrix. Roche has had an alliance with Affymetrix since the mid-1990s to develop DNA probe-based chips that incorporate PCR (the companies have a series of deals that encompass a number of markers, such as mutations responsible for cystic fibrosis and p53). CYP 450 polymorphisms are well-known to be associated with variation in responses to many common drugs, such as anti-depressants, warfarin, and proton pump inhibitors. The drug industry tests for these mutations during the drug development process and regularly genotypes patients in clinical trials to obtain more information about pharmacokinetics and side effects. A number of companies, including Affymetrix, already sell CYP 450 tests in various formats for research and pharmaceutical development.

However, these tests have been too cumbersome, time-consuming and expensive to use in the clinical setting. The test is done sporadically for clinical use by a few specialized laboratories, which make it themselves, a category known as home brews. But physicians don't order it regularly and no one is selling it in a kit format that would be more suitable for hospital and clinical laboratories.

But Roche figures that the chip it's making with Affymetrix will go some way towards positioning a pharmacogenetic CYP 450 test as a regular clinical reality. In the past two years, Roche has done considerable development work to improve the speed, functionality, and ease-of-use of the product, doubling the number of alleles on it to more than 30. It has optimized chip layout and PCR-related functions and developed algorithms to analyze results. It has designed a format for the physician to receive information about the patient's variances and their meaning.

Roche expects to have the assay available in two years. But the road to the development of the CYP 450 tests has been slow, not just because of technology hurdles, but also because of patent issues. Roche has had to find out whether each of the mutations on the chip are patented, who holds the patents, whether they can be licensed economically, and then obtain licenses for those patents at terms that make economic sense. It has taken licenses for all but a few alleles on terms that allow it to "earn substantial money," says Metcalfe.

Therein lies a significant limitation of CYP 450. It isn't proprietary and thus may be offered by others. Roche insists that its work is protected anyway. Laboratories that do CYP 450 on a home brew basis don't have the regulatory and clinical acumen or skills necessary to develop clinical test kits and the associated information physicians need to make sense of them. Moreover, no other company can replicate what has taken Roche and Affymetrix years to develop. Finally, Roche believes that Affymetrix holds strong patents on the chips, despite ongoing legal challenges to their validity. And Roche is patenting some of the PCR technology users will need in the front-end of the analytical process.

If assay development is at the heart of many of its initiatives, RMD hasn't been neglecting instrumentation. It's started programs on new instrumentation for the central lab to handle more complex multi-analyte testing and it has also been working on a rapid point of care device which can run molecular tests in the physician's office. Such systems are likely to have tremendous value, particularly if pharmacogenomics becomes important in determining appropriate prescribing.

Still, while Roche has had an internal research group focused on pharmacogenetics for nearly two years, it is yet uncertain about the commercial potential of clinical tests. For example, it's not sure if it will take the CYP-450 test through the FDA—a signal that it doesn't yet believe fully in its broad economic viability. Indeed, it has yet to sort out whether many of the assays it hopes to develop in the field will remain niche products, sold as ASRs, or have substantial enough market potential to take through the FDA.

For now, the consensus in genomics circles seems to be that the big market for pharmacogenomics is likely to be pharmaceutical companies, who would like to use the tests for drug development. Many, even those skeptical of the size of the clinical diagnostic potential, believe this application offers significant commercial opportunities, and Metcalfe says that Roche intends to pursue this area.

But so far Roche hasn't signed up with any drug companies, which will be required partners in this area, supplying tissue and pharmaceutical samples necessary for finding diagnostic correlations between responders and non-responders. Indeed, one unanswered question for the company is whether other drug firms are leery of working with it given the potential for leakage between its diagnostic and pharmaceutical sides. Roche executives say that, given Roche's technology position, and lack of comparable competing approaches, they don't expect its affiliation with Roche Pharma to be problematic.

Blood Banking as a Bridge

As great as Roche's efforts are to find new technology, they are largely in the fledgling stage. CYP 450 won't be ready for at least two to three years, though a Factor V Leiden test to measure predisposition to deep vein thrombosis may be available sooner. And the truly innovative products that Roche is counting on in the longer term, won't be ready for sale for longer than that.

For at least the next year or two, therefore, blood banking will drive much of Roche Molecular's growth. Roche, which had never been involved in the field, became a key player several years ago, when governments began demanding gene-based testing of blood donations for HIV and HCV infections. Because it had sensitive, accurate HIV and HCV PCR based tests, Roche had an immediate advantage. It began working with regulatory authorities to modify existing PCR tests to meet blood screening requirements and started selling them to blood banks in the US and Europe. It didn't, however, have a license for HCV from Chiron, which holds the patent on HCV. But it claimed that its purchase of PCR from Cetus Corp. [See Deal], [See Deal] in 1991 included rights to develop PCR-based HCV tests (Chiron got rights to HCV when it bought Cetus at about the same time [See Deal]). Furthermore, in the interests of good medicine, Roche implied that it was the only company that could provide a highly sensitive, accurate NAT-based test for the disease and therefore should be allowed to sell it. Many laboratories agreed.

Chiron challenged Roche and other would-be blood bank players in court. And over the years, courts have, by and large, upheld Chiron's position, driving several would-be entrants from the market. Chiron, along with its partner in this area, Gen-Probe, remains Roche's only competitor in NAT blood bank screening.

The dispute with Chiron was partly settled this fall, when the companies reached a settlement covering not the blood banking market, but the clinical laboratory, in which Roche has to pay Chiron a hefty up-front fee and undisclosed royalty payments. The up-front figure is $85 million for a worldwide license to manufacture and sell HCV, of which most is back payments for royalties on past sales and at least $25 million is pre-payment on future royalties. Royalty rates are undisclosed, but believed to be high by diagnostics standards.

The status of Roche's rights to HCV in the blood banking relationship, however, remains unclear. Discussions between the companies are still ongoing because the blood banking industry's economics are different. In the meantime, Roche is operating under an interim agreement, says von Prondzynski, the former Chiron executive, giving temporary stability and legitimacy to Roche operations.

None of this could have pleased Roche. The settlement puts it at a margin disadvantage since it, and not Chiron, has to pay royalties. Indeed, Roche's royalties provide a kind of pricing umbrella for Chiron—to make a profit, Roche has to charge more money than it might without the royalty bill, pushing the price of the tests up and giving Chiron some pricing flexibility it would otherwise not have had. Already, the fall-out has been a price increase disliked by customers but necessary to cover costs associated with the settlement, von Prondzynski adds.

Furthermore, blood banking won't provide Roche with long-term growth. In the short-term, Roche expects a large hike in blood test sales this year because several governments have recently mandated use of NAT testing of the blood supply, or are about to. France, for example, recently started requiring it and Japan is moving in that direction. In the US, NAT testing is not formally mandated, but all US blood is screened for HIV and HCV on an NAT basis, blood banking executives say. Moreover, governments are considering requiring HBV screening. Roche plans to launch an HBV test shortly for blood banks, a test it has been selling for the clinical market.

Also driving near-term growth is a trend towards using smaller pool sizes for testing. NAT testing is done on pools of donated blood, in which small samples from each donor are mixed together. If the sample is contaminated, all of the units of blood which were included in the pool have to be thrown away or retested separately. This is because the high-throughput automated systems needed to conduct NAT tests on each donor's blood separately aren't yet available and most likely won't be for several more years, despite Herculean efforts to meet this need.

The pool sizes vary from country to country but the trend is to make them smaller to increase the likelihood of catching viral positive donations. As the pools get smaller, the volume of testing expands. The pools, however, will eventually reach a minimum size, stalling market expansion. When instrumentation is available, governments are likely to switch to single unit donor samples, leading to a second growth spurt. But this isn't likely to happen in the near-term, says Dreismann.

The blood-banking opportunity is limited by its very nature: once a government mandates use of a test to screen donors, all blood banks must convert rapidly to that test, whether it is nucleic acid or immunoassay-based. The tests are bought through a few large contracts, rather than on a lab by lab basis. And since patents limit competition to two players in nucleic acid testing—Roche and the Chiron/ Gen-Probe partnership—the battle for market share in each country is fierce but short. Once all of the blood banks in a country have converted, the market stabilizes. With many governments of large countries already mandating NAT testing of HIV and HCV, or about to do so shortly, opportunities to break into a new country are decreasing. The introduction of a new test—for hepatitis B or mad cow disease, for example—could add zest to sales, but the only parameter which experts believe might be added to the menu in the near future is hepatitis B.

Building a Future

The blood banking scenario confirms Roche's argument that marketing muscle and diagnostics expertise can play a significant role in gaining a leading position in a business, even one filled with patent issues. At the same time, it also raises a red flag: royalties, particularly those involving genetic-related patents, can cut severely into margins. Surely Roche can't earn what it had hoped to from blood banking, now that it pays high royalties to Chiron.

In the best of all possible worlds, Roche wouldn't have to pay royalties because it would have its own proprietary tests to put on its instruments or be able to use as leverage in negotiating licensing agreements. Indeed, today, in molecular testing, where so much of the licensing activity is occurring, it has this clout, thanks in part to its ownership of PCR. Even when the initial patent on PCR expires in 2005, Roche is hoping the impact won't be so great because it will have an arsenal of additional patents around the technology making it next to impossible to use without getting a license from Roche.

But it needs to get beyond PCR, which will eventually be bypassed by other technologies. The advent of genomics and proteomics is sure to change diagnostics in major ways. Indeed, Roche is better equipped than any other major diagnostics company to take advantage of the certain upheaval genomics and proteomics will create, both because of its current position in molecular testing and in other laboratory segments and because of its deep pockets.

Roche has some breathing room. Last year, it experienced above-industry average growth in all of its major business segments. This year, judging by first quarter results, the company remains on track and expects the expansion to continue, thanks to a heavy program of product introductions and some new marketing programs. It can expect genomics and proteomics assays to contribute significantly to its financial position in four to five years.

Roche executives for now are willing to talk in broad terms about their programs and some of the new products they have in the works. But, they aren't, in reality, giving many cards away. Despite their talk, they still haven't said much about what they've got up their sleeves, particularly in terms of programs geared to finding proprietary markers. The molecular tests in development executives are willing to discuss are non-proprietary and already widely available, on an ASR or home brew basis. Moreover, they are hardly the novel proprietary content Roche is striving for. The deCode and Millennium deals were signed only a few months ago, so it is too early to say much about their performance. But the wisdom of counting so heavily on deCode has come under attack.

As for competitors, the traditional diagnostics companies are hedging: they don't have the resources to do much searching on their own for novel content, so they are looking to form partnerships and leveraging other strengths in assay formatting, regulatory skills, and marketing.

But the key to success, apart from finding their own proprietary markers, will be the quality of the technology they can swap for markers developed by others. The free PSA market may be a case in point. Free PSA is an adjunct test used to clarify ambiguous results from the total PSA test, which screens for prostate cancer. Abbott Diagnostics managed to obtain an exclusive license to free PSA, and has sublicensed it to Beckman and Roche because both Roche and Beckman had technology Abbott wanted. Bayer Diagnostics didn't have technology Abbott needed—and therefore didn't get a free PSA license. Not only will Bayer lose free PSA revenues, its customers won't be as interested in its total PSA test because they increasingly want to buy total and free PSA from the same manufacturer so that results can correlate.

Roche has technology other companies want, and it's rapidly trying to create new intellectual property as the competition to find high-value diagnostics heats up. There's no question that the game it's playing is risky—should other companies arrive at the important tests first, and should Roche not get any of its own, the margins in its business will dwindle to the unattractive industry average. But what separates Roche from nearly all other major diagnostic companies is that it has at least bought a number of tickets to the game. Granted the problems of Roche's parent and the pharmaceutical business don't affect the strategic and financial latitude the diagnostics division has been afforded, Roche has positioned itself to be, perhaps, the industry's power player—one with a commitment to developing new high-margin content which it can deliver to an established customer base on its own diagnostic systems.