A lab technician at Novo Nordisk conducts in vitro research in Malov, Denmark. John Mcconnico | Bloomberg | Getty Images

Novo Holdings' recent launch of a $165 million venture fund focused on tackling "superbugs" resistant to modern antibiotics demonstrates the paradigm shift occurring in Big Pharma. Novo's Repair Impact Fund — Repair stands for Replenishing and Enabling the Pipeline for Anti-Infective Resistance — will invest $20 million to $40 million in start-ups and early stage companies in the United States and Europe that have new approaches to combat bacteria that pose the greatest threat to human health. New approaches to combat antimicrobial resistance urgently need to be developed. Already, more than 700,000 people die each year from infections resistant to most or all antibiotics, and the number is increasing by the day. Antimicrobial resistance is projected to kill more people than cancer by 2050, which would reduce global economic output by between 2 percent and 3.5 percent and severely cripple modern medical and surgical advances. Despite growing recognition of this threat, there is an early stage funding gap for new treatments. To date, Big Pharma companies have not successfully developed a new generation of antibiotics, although last year they set up AMR Industry Alliance, a coalition to monitor the industry's progress in this field.

A magnified image of the MRSA bacteria. The "superbug" is poised to kill 30,000 Americans per year by 2050. DTKUTOO | iStock / 360 | Getty Images

"This is a huge global problem in need of R&D funding," said Aleks Engel, partner at Novo Holdings. "But many Big Pharma companies have pulled out of the area in the last 10 to 15 years because they see a challenging ROI." As he explains, antibiotics are a fraction of sales of drugs in other classes. They would rather wait as upstart biotechs take the risk out of development. The economic challenge the industry faces is undeniable. That's because the average cost to develop and win marketing and FDA approval for a new prescription drug in the United States is about $2.6 billion, reports the Tufts Center for the Study of Drug Development. Despite high development costs, the majority of drug launches achieve modest sales in the first five years on the market. Only 19 drugs have reached $1 billion in annual sales within five years of launch over the past 20 years, the QuintilesIMS Institute revealed. In response, industry giants like Novo Holdings — which has big stakes in Danish drugmaker Novo Nordisk — Merck, Johnson & Johnson, Sanofi and others are looking to become more entrepreneurial. Increasingly, these big players are setting up venture capital funds and investing in start-ups and licensing technology to fuel their own drug pipelines. Many are also outsourcing R&D, while reducing product development efforts internally. The trend is accelerating at a rapid pace. Behind the scenes, pint-size ventures are driving pharma innovation. The majority of drugs approved in recent years originated at smaller outfits— 63 percent of them over the last five years, according to HBM Partners, a health-care investing firm. The allure is multifaceted. Small biotech start-ups are more nimble, and many can do research and product development faster. By investing in a broad portfolio of young ventures, a big drug company can leverage outside scientific talent and cast a wide net in order to gain access to breakthrough discoveries in areas of the company's strategic interest. For investors the sheer market size of the industry cannot be ignored. It's a global market growing at 6.5 percent compounded annually that is expected to reach $1.06 trillion by 2022, HBM forecasts. "If you look at the money going into R&D in health care, it is a drop in the bucket," said Tom Heyman, president of Johnson & Johnson Innovation — JJDC, the oldest corporate venture fund in the life sciences industry, launched 45 years ago. "In today's world, trying to get access to external innovation is extremely important to stay competitive."

J&J provides scientists with shared lab work space at its JLAB facility in San Francisco. Source: Johnson & Johnson

That's because so many revolutions are going on in so many sectors of the industry, he noted. The rate of innovation keeps accelerating, making it so hard for one company to capture all the innovation itself. While Johnson & Johnson invests $10 billion to $12 billion on R&D annually across the company's different sectors — medical devices, consumer health, prescription drugs — it also invests $250 million to $300 million a year in everything from seed investments to PIPE transactions.

If you look at the money going into R&D in health care, it is a drop in the bucket. Tom Heyman president, J&J Development

Often the payoff for J&J can be huge. For example, 22 years ago it invested in Biosense Webster, a company that makes a 3-D mapping system that discovers, interprets and treats cardiac rhythm disorders. Two years later it acquired the company, and today it is part of its medical device business and a leader in the worldwide $4.4 billion electrophysiology market. Its sales last year were around $2 billion. Making early bets on behemoths that fill overlooked niches in the health-care market is key to J&J's strategy. Last year, for example, it acquired a venture capital-backed Portland-based start-up called Sightbox and then folded it into its vision-care business. The three-year-old company sells contact lenses with a membership model that charges users $39 each month for an annual eye appointment and contact lens fitting, along with a 12-month supply of contact lenses of their choice.

How innovators stack up

The Pharmaceutical Innovation Index 2017 released in March provides a snapshot of innovation leaders in the industry, most of whom have reinvented the value chain for discovery and development. Companies leading the league are those developing creative approaches to the R&D productivity crisis with all kinds of early stage collaborations. At J&J the company is building a network of incubators known as JLABS to get a window on early stage breakthroughs. It operates shared workspaces and labs with chemistry, biotechnology and prototyping equipment for local scientists and entrepreneurs to use. Launched in 2012, it has eight incubators, in cities such as San Francisco, Boston, San Diego, Houston, Toronto and Beerse, Belgium. It plans to open two more — one in New York in June, and another in Shanghai next year. "Every start-up in the JLabs workspace gets a J&J mentor that helps them focus on ideas that have potential," said Melinda Richter, global head of J&J Innovation JLABS.

They also have access to a J&J business service team that helps manage their start-up's operations and navigate the regulatory and product development pathway, helping them get permits and licenses and funding they need to grow. "The idea is to catalyze great ideas and build business around them," Richter points out. "There is magic in tapping the black box of entrepreneurs located anywhere around the world," she said. France's Sanofi has taken a different tact. It runs Sanofi-Sunrise, a company creation vehicle that works to invest in seed ideas or co-invest with venture capitalists on promising new technologies. Leading the effort is a team of scientists with Sanofi's global R&D department who have ties to venture capitalists and academic networks. It's run by Sanofi's vice president of global R&D, Kathy Bowdish, Ph.D., a former serial entrepreneur.

Creating new models

Sanofi-Sunrise is a unit in the company's R&D group that collaborates with outside scientists in R&D. "The idea is to access science early and co-create a company that we can later invest in and partner with," said Bowdish. "It helps us bring in new products in Sanofi's pipeline. The benefit for entrepreneurs is that they get to work with our senior scientists and scale up production quickly. We often invest and license their technology as well." Companies can be in the process of being formed, or be one or two years old after seed financing, Bowdish said. Typically, Sanofi-Sunrise invests in those areas the company targets, such as rare disease, oncology, neuroscience, diabetes, multiple sclerosis and immunology. To date its biggest win has been investing with Third Rock Ventures in MyoKardia, a company focused on precision therapies for genetic heart diseases that lead to heart failure. After plowing more than $150 million in equity financing in MyoKardia and $45 million in Sanofi resources, the company went public in 2015. It now has a market cap over $1.8 billion.

Myokardia scientist working on new precision medicine for genetic heart disease. Source: Sanofi