The Market for Inventions: August 19, 2018 Snippets
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This week’s theme: how pharmaceutical companies like Merck helped establish and perfect the “Market for innovation”. Plus welcoming SFOX to the Social Capital family with their Series A announcement.
In last week’s Snippets, we explored one similarity between Silicon Valley tech companies today and their German chemical industry predecessors a century ago: their mastery of data-driven, iterative product design. Unlike in other industries, where R&D was kept separate from most profit centers of the firm and treated as a cost to be tolerated but isolated, continuous iteration was (and is) a core part of product development, testing, shipping and sales. This approach proved to very successful: industry leading firms, like Bayer and BASF at the time or Google and Amazon today, are routinely able to out-innovate even their smaller, nimbler peers.
But not all innovative ideas necessarily come from inside a firm’s four walls. Innovation is also something that can be bought, sold, traded and priced. The biggest breakthroughs often come from other entrepreneurs, with completely different skill sets and points of view, and a healthy market for those ideas proved to be another accelerant to the innovation economy a century ago, as it still does today.
This week, we’re going to look at another set of German companies from 100 years ago, close cousins to the chemical giants we heard from last week, who mastered this practice: pharmaceutical companies. One of the most famous, Merck, is perhaps the most extreme example of a firm that placed nearly their entire exploratory R&D pipeline in the hands of outsiders: independent researchers, scientists, and others who were independently motivated to discover, patent, and license out their inventions to the large giants who were uniquely able to bring their newly discovered compounds to market.
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Merck was founded in 1668 by Friedrich Jacob Merck, and its German entity remains the oldest continually operating drug company in the world. (Its American spinoff, on the other hand, was seized during World War 1 and remade into the “American Merck” entity with which most of us are familiar today, which has since dwarfed its German ancestor “Merck Darmstadt” in size.) 100 years ago, the German Merck was a hotbed of innovation and profit: in addition to its growing new product line of antibiotics, it held monopolies on two of the most powerful consumer products in history: morphine and cocaine.
Merck by no means suffered from a phenomenon we sometimes know today as “Not invented here syndrome”: their management aggressively sought to acquire the rights to new promising drugs, regardless of who invented them or where. German patent law at the time was highly conducive to scientists and universities licensing out their IP to large firms in steady streams: one rule, for instance, required that all novel IP be commercialized within three years or else forfeited. So academic researchers, without the resources to further develop drugs themselves nor to wait for best offers, often had to negotiate with whoever was there and ready first.
As Burhop writes in his case review of Merck’s outsourced research, one of the most important dynamics in the relationships between outside inventors who discovered new compounds and the large acquirers that could bring them to market is the two-way information asymmetry between the two. Clever ways had to be arranged and perfected in order to resolve these potential conflicts. “Asymmetric information is critical in relations between outside researchers and a firm. Ex ante, the inventor of a new drug has substantially more information about its properties; ex post, the firm has more information about the market outcome. At Merck, the former problem was mitigated by drawing up long-term research contracts and by screening outside inventions before acquiring them. A solution for the latter problem was for the outside inventor to obtain audit rights.”
This two-way information asymmetry is reminiscent of the exact same dynamic today between large, tech giants and the smaller, nimbler startups they look to acquire. Google’s acquisitions of Youtube and Android, or Facebook’s acquisitions of Instagram and Whatsapp, have turned out to be absolute game-changers for both companies. In any of these cases, a startup has much more information than the potential acquirer about what is actually going on: it knows its users, it understands its product, and it knows its value proposition likely better than anyone. But the acquirer more likely than not has more information about the state of the broader market overall, and about what to do with the startup post acquisition. Youtube may have understood its product best, but Google knew what to do with Youtube best.
Merck did have an in-house research team to compliment its external patent-hunting. But it wasn’t actually all that influential in the research and development of important new products. It was much more fine-tuned to implementation and execution around the product lines they already had. Burhop writes: “The central research unit was treated as a profit center, like the other departments of the firm. Thus, the fixed costs of the laboratory were kept to a minimum. Product development was, by and large, outsourced through long-term research contracts with university professors. … All of Merck’s top products were invented by outsiders. No other firm relied as strongly on the market for technology.” Their internal R&D, in other words, was not innovating so much as it was continually engineering for little improvements everywhere. They did not seek to find new molecules or value propositions, but to reinforce the areas where Merck was already winning.
A century later, although we’ve made numerous improvements and adjustments to the way that we innovate our way into the unknown future, many of these themes are still visible. The idea that a “market for innovation” could have many different participants, big and small, all with different points of view and skill sets that collectively drive a process that’s greater than the sum of its parts, is familiar to any observer of today’s tech industry. 100 years from now, what will be different? It’s hard to know. But looking back in history is a good place gain an appreciation for how sometimes, the more things change, the more they stay the same.
As you likely heard, Aretha Franklin passed away this week.
Aretha Franklin’s American Soul (2016) | David Remnick, The New Yorker
Amidst a flood of touching, heartfelt pieces about her presence, her talent, her power, and her presence as a singer and civil rights icon, one piece stood out for me which we’d like to share: Rembert Browne’s reflections on the impact of her singing one song in particular: Amazing Grace.
Rembert writes: “More than any sermon, any text, or any life moment, it’s Aretha that keeps me a believer, in something. On Amazing Grace, the belief that Aretha exudes about her God is all the convincing I need that she’s right. And it’s not any specific word or phrase she says; it’s that she feels so much — it makes you want to go through it with her, and feel that, too.
Over the years, it was her voice on this album that provided a light. That assurance you need in your life, that things will eventually be OK. When people in my life passed away, the first thing I would do is turn on Amazing Grace. When dark moments of depression would take over, the light feeling extinguished, the first thing I’d do is turn on Amazing Grace. And when I’d come out on the other side, I’d go back to Aretha and turn it back on. Aretha and I, we were a team.
I never considered what I’d listen to should Aretha die. But even today, amidst all the sadness of her passing, it’s Aretha who is still there for me, reminding me that this, too, shall pass, that I’ll never walk alone, and that I’ll always have a friend.”
Another story worth highlighting this week is Erin Griffith’s piece in the New York Times about the rise of “Mega-rounds”: $100M+ financing rounds fuelled by immense sources of capital that are changing the dynamic of later-stage funding in private tech companies.
The practice, along with this piece specifically, is quite controversial: it more than does its job of bringing this recent, uneasy change in private tech financing further into the public limelight.
Elsewhere in the world:
Facebook is losing the war on hate speech in Myanmar | Steve Stecklow, Reuters
The world is cracking down on Bitcoin — except Japan | Yuji Nakamura & Aki Ito, Bloomberg
Alibaba founder Jack Ma to launch $10M African entrepreneurial prize | Toby Shapstak, Forbes
The future of media is a continually moving target:
The future of HBO: Why HBO has to grow (part 1) | Matthew Ball, Redef
The future of HBO: a six-point plan | Matthew Ball, Redef
Amazon has YouTube envy, and Twitch is a part of it | Lucas Shaw, Bloomberg Businessweek
Podcast episodes for your listening enjoyment:
Glassdoor CEO Robert Hohman | Recode Decode with Kara Swisher
Leon Cooperman on finding the overlooked investment | Masters in Business with Barry Ritholtz
Other reading around the Internet:
Meet Nick Millington, who’s building Sonos’ audio internet | Jeffrey Van Camp, Wired
Best Buy acquires aging in place tech company GreatCall for $800M | Jonah Comstock, MobiHealthNews
Cheap natural gas and renewables could close half of US coal fleet by 2030 | Jeff St. John, GTM
Farmers Business Network is launching its own brand of seed and R&D program | Sara Schafer, AgPro
Gene-silencing therapy gets first drug approval after 20-year wait | Heidi Ledford, Nature
And a goodbye:
In this week’s news and notes from the Social Capital family, we have a new member of the portfolio family to announce: SFOX.
Why we decided to raise $22.7 million | SFOX
SFOX raises $23 million to make crypto trades faster and stealthier | Jeff Kauflin, Forbes
SFOX is a cryptocurrency market maker built to give larger entities, like institutional investors and accredited investors, access to liquid, functional and healthy cryptocurrency trading across exchanges anyway. SFOX brings to the cryptocurrency world what broker-dealers have been doing in the traditional financial world for years: acting both on behalf of their clients as well as putting in their own principal to help make markets. In a blog post marking their Series A financing, SFOX founders George and Akbar write:
“We founded SFOX in 2014 as a way to solve the problems that were preventing institutional investors and high net worth individuals from investing in Bitcoin. We saw an asset class that had tremendous long-term potential, yet was too volatile and illiquid for these types of investors to enter. We developed two tools to lower these barriers to entry:
- A single point of access to liquidity from a wide range of exchanges, OTC desks, and market makers.
- A suite of smart-routing algorithms that empower traders to buy and sell large amounts of crypto efficiently, without moving the market in the process.
“Our goal is to develop SFOX into the single-point solution for all your cryptoasset management needs. That means that every aspect of your asset management experience needs to meet the standards of our order book and algorithms. Our next step towards this goal is to build industry-leading solutions to other aspects of cryptoasset management — starting with the foundations of fund security and risk management, and building upwards to help our customers accomplish increasingly more in the crypto space.”
With $9B USD in transactions processed to date, we’re thrilled to see customers everywhere quickly adopting SFOX as the best liquidity provider, asset manager and smart trader in the cryptocurrency business. To help build towards this goal, SFOX is currently hiring for many different positions: High frequency trading systems, SRE and security software engineers, compliance analysts, accounting and operations analysts, client services, and a social media marketing manager. Welcome on board to everyone on the SFOX team!
And finally, congratulations to Remind for celebrating another anniversary of #81010 day (on August 10th, naturally). Why 81010? Because back in the very beginning of Remind, when founders Brett and David Kopf were brainstorming to see how they could help families and educators remain in better contact with one another, there was one common denominator that every stakeholder knew they shared: texting. Texting 81010 became the first shared way that anyone could join a class, and Remind has taken off ever since. Case in point: as the school year starts up, Remind has taken back its usual annual spot at the top of the App store — yes, the entire App store.
That’s pretty good company!
Have a great week,
Alex & the team from Social Capital
