GapSummit 2014_Keynote Speaker - Dr. Severin Schwan (31-03-2014)

Thank you, Christian. A pleasure to be here, and it's a particular pleasure to talk about innovation. It's a topic which is very close to my heart and it's at the very core of our company strategy. So what I'd like to do over the next 30 minutes or so is provide you with an external perspective around our business model, what I see as the key challenges around that business model as we go forward, and then really turn in a second part of my speech more to the internal perspective: what does it actually take to generate innovation, what kind of culture, what kind of leadership promotes innovation. And I'd like to share my personal view on that very point. So let me start with the business model. Fundamentally, our business model is a contract with society. We take the risk to invest into research and development, and in turn we get exclusivity, typically in the form of patents, for a defined period of time. That's what incentivizes, that's what keeps the business model going. And that is really the company view. If you look at it from a society point of view, the real benefits only kick in when the patents of the medicines actually expire, because this is the moment when generic companies come in, when they can offer the medicines at much lower cost. And to illustrate this, I'd like to refer to a list which is called the list of the most essential medicines. It has been developed by the WHO. It was originally really a guiding document for developing governments on which medicines to focus when they build up a healthcare delivery system. As a company, we are very proud that we have the most medicines on that very list. We have 21 medicines on this list, all of them today are generic, off-patent. And one of them, the third one here in infections, the trade name is called Bactrim, which is a broad-spectrum antibiotic which is still widely used, but it is today generic companies who distribute this product. And I mention this product because for this antibiotic there is really very good data, so it has been closely followed, and the effect of this medicine has been closely followed by governments around the world. And what we know is that with this single medicine alone, more lives have been saved than World War I and World War II has taken. It's pretty amazing, and to me it shows so clearly that this business model, this contract with society, has really, really paid off for mankind.

Now, there are challenges here. Even though it has paid off for mankind literally over the last century, it's not only about infectious diseases. If you look at the progress which has been made in other diseases, HIV, cancer for example, it is all because of this business model. Nevertheless, the question remains: does it still pay off for the companies? And there are lots of people out there who are really concerned. I've just highlighted the four key concerns you come across, and I come across actually almost every week when I talk with the financial community. They would ask on the scientific side: have all the low-hanging fruits already been harvested? They would point out to increasing regulatory hurdles. You just listened to the IP landscape, I'll make a few comments on those. And then finally, of course, we know that the pressure on prices, the pressure on public households, is dramatically increasing, and so is the pressure of course on our prices for medicines. Let me just make a comment on intellectual property. And there are indeed lots of challenges, and some of them have been referred to. Compliance with TRIPS, yes, India has joined TRIPS after they joined the WTO, but just to have the law is one thing, then to actually execute it and not override it with compulsory licenses is another thing. I'd also like to point out one other point which I find very critical, and we as a company have come across that several times. Typically, in particular in cancer drugs, what you often see is you start off with the first indication, but whilst you have your product on the market, the patent life is running. So at a certain point you know you have new scientific insights and you'd like to develop this very same medicine, for example, for another indication. And it has happened more than once to me that for pure commercial reasons we would not have taken the risk to develop this medicine for an additional indication, simply because you come to the end of the patent life and the medicine would very soon go generic. And I do believe we need a dialogue with governments, with regulatory authorities, to find ways to make that a win-win for companies on the one hand and society on the other hand, so that these medicines really come to patients and are really developed. Now, what I would like to say, however, is nevertheless I take a very optimistic view here, because if you remember back in the early '90s, many emerging markets didn't have any patent laws. So actually, from today's perspective, we have already a much more differentiated discussion. It's about what is a patent, when is a patent to be protected, how can we find a balance, but actually a lot has happened. And if you look over the last 20 years, even though you read so much about potential violations of IP, etc., actually if you look at the big picture, then IP protection in my view has improved and actually is improving as we speak. So in spite of all these challenges, we take a very positive view. And there are two fundamental beliefs I would say. First is that science will progress. I can't prove that, but I'm absolutely sure when we meet here again in 10 years, we won't look back to the 31st of March 2014 and say this was the day when science started to stop. I don't believe that. I think science will progress. I actually believe that we will have almost an explosion in terms of understanding diseases, understanding the underlying causes of diseases, understanding the molecular pathways. And as such, we will have new targets. If you think of all the revolution in genomics ongoing, and those targets again we can take as a basis to turn into new medicines. The second fundamental belief I have, in spite of all the price pressure and all the discussion around it, I'm absolutely convinced, and I can't prove it either, we'll meet again in 10 years, that if you come up with really differentiated medicines, medicines which make a difference in the quality of life, which make a difference in terms of prolonging life, I think societies and patients will continue to reward such innovation. And this is the very reason why we keep spending and investing into research and development. Every year, we as a company spend 10 billion US dollars every year into research and development. And now you can also see why innovation is so close to my heart and why this is of critical importance.

Now, the concept is all fine, but then the question is: how actually do you generate the innovation? When we can agree that science will progress and societies will continue to reward such innovation, that doesn't answer the question of whether you as a company actually generate new innovation. And it's a very critical question for myself also. I've heard: I'm a lawyer, so what can I actually contribute? What can I do in my role as CEO to foster an environment where innovation happens, where innovation is thriving? And I'd like to share five elements which I believe are important to create an environment where innovation happens. First one: allow for duplication. On a very fundamental level, I believe that innovation has a lot to do with freedom. I think that creative people need freedom, they need space to breathe. If you tell people all the time what they have to do, if you bury people in standard operating procedures, all what you get out is what you tell them. But what you don't get is really breakthrough innovations. I believe freedom is essential. And from an organizational point of view, from a management point of view, I therefore very much believe in a decentralized management approach. I very much believe in an approach where you have smaller, independent, autonomous units who have the power to take their own decisions, to do it their way. Now, in our company, to illustrate that, I have four research and development groups directly reporting to myself. So we have a research center in San Francisco, we have a research center in Switzerland, we have one in Shanghai, and we have an organization which we call Partnering, which really takes care of external opportunities, licensing opportunities, where we bring external innovation into the company. And all four of them are directly reporting to myself, nobody in between. And that's the way how I personally assure that we have a decentralized approach and that those groups have their own way of making their decisions. The moment you bring somebody in, the moment you have one global R&D head who might not even report directly to the CEO, at that very moment, I'm afraid, you start to converge things and you start to kind of harmonize decision-making, which I think is not good to foster innovation. But five years ago we bought out the minority of Genentech, which is a biotech company in South San Francisco. This was just at the time when I became CEO. Now, this was an acquisition of over 40 billion US dollars. So imagine, I just became CEO, we do this acquisition, so it was really important for me to get that right. And obviously I thought a lot about how do we integrate Genentech, how do we make this work. And the main concern, both internally and also externally, was that we would lose this special spirit at Genentech. Genentech is known in the industry for really being cutting edge in science. So there was this danger: do we lose the best people, etc. And you can imagine I was very worried about that. And what we did is, in terms of integration, we didn't integrate them. It's also much easier, it keeps your work-life balance in order, and I mean this seriously. I mean, Richard Scheller, who is the head of this unit, directly reports to myself, he was at the head of this unit already beforehand, still the management team is around. And if you ask people there how did it go with the Genentech integration, nothing happened, it's just the same. And that is actually where you have to fight, because in a big organization like ours, there will always people who try, with really good intentions, who want to take out inefficiencies in the systems, who want to streamline, harmonize things, to avoid duplication. That's what you typically hear. I mean, in every acquisition you have an army of people who come in and say: well, there's all this duplication, let's get rid of this duplication. My advice is: don't listen too much to those people. In case of doubt, I'd always go for 10 percent more inefficiencies but also 10 percent more innovation.

Now, the second element I'd like to share with you is: follow a few guiding principles. Even though I'm very convinced of a decentralized management approach, you need some kind of cohesion in a big organization. You need a common sense of purpose. We share some fundamental values, we have a code of conduct. There's also some powers which are reserved at a headquarter level. So if you do a big acquisition, for example, if we do big capital investments, key personnel decisions would be taken in the headquarter. But the important point is we keep that to a minimum. We're extremely public about it. This is a small little booklet where all these — I mean it's very concrete, very practical: up to this amount you can decide yourself, and otherwise you have to come and ask for credit application. We keep this very, very thin. It's on the internet, everybody can see that. And this is important, but it's not so important about the fact that you centralize certain key decisions which you want to keep together. What is really the important part is that the people really know what they can decide on their own. Because if you are not clear and if you are not explicit about that, what happens is people are uncertain and then they start delegating upwards. So it's extremely important, I believe, to define some key principles which are not negotiable, because they enable actually a more decentralized approach. Now my third element: beware of consultants and visionary leaders. The thing is, if your basic conviction is that freedom has a lot to do with innovation and you want to give this freedom to the people, then what you also need is people who make something out of this freedom. And my experience is that there is really a very close correlation — how would you call this — the density of consultants on the one hand and the weakness of the managers. A p-value with lots of zeros. Because it is typically those managers who don't know what they want that they go and look out for consultants. It's the managers who don't have self-confidence, who don't have determination, who ask for consultants and are not able really to use this freedom. And I'm equally skeptical of these visionary leaders. They make for good stories in media, on TV talk shows, etc. But it is my firm belief that innovation comes from the bottom, it doesn't come from the top. Innovation, and I would say leadership in general, is something which comes from the bottom. I have rather thousands of people who really have convictions, who follow their convictions, who follow their ideas, and who live their dreams. That is what makes a company innovative, and not one single guy who has all the revelations and brings them down into the organization.

In San Francisco, we had a scientist, Napo Ferrara, and this guy was completely convinced about a specific mode of action concerning a cancer drug, and nobody really believed it. So what he did is he went to the lab in the company over the weekend, did all the preclinical trials, and at some point he had some evidence that this actually could work. And then the company was coming in, putting more money behind it, and eventually it became an important cancer drug for us called Avastin. It's one of the leading cancer drugs in the world, 6 billion turnover, still growing. And if you just wonder for a moment what would have happened if you would have brought in consultants to help you with your R&D portfolio decisions and trade-offs — when I see the film in front of my eyes, first of all, I guarantee you, they would have made a stakeholder analysis: so who is really involved in the decision-making, let's identify those, let's map them. Step number two: let's send a questionnaire out to them to get all their wisdom, to get their input, let's involve them all so that we have the right fact base. This goes on and on and on, eventually all the data come in, they are analyzed, and then comes the final step, the big hurrah, which is: let's present this to top management and give a recommendation. And I bet with you what we will do is we have to allocate the resources to the most promising projects. Wonderful. And do you think that Avastin would ever make it? For sure not. Because if you collect all the information in the organization, what you get is an average opinion, but what you don't get is breakthrough ideas. Real breakthrough innovation happens when you go against the crowd, when you do something which nobody believes in, because if everybody would believe that it's working, probably there wouldn't be a breakthrough innovation anymore. See what I mean? So I feel this is a very, very important point. And all they did at the time is they didn't invite armies of consultants. The only thing they had to do is leave the lab open over the weekend. Was it? Also much cheaper.

Now let me get to a fourth element, and this is about celebrating failure. Of course, if you have a success like Avastin, you'll have lots of people who are happy to join you celebrating such a success, and there's nothing wrong about it, and we should celebrate success. The problem is 90 percent of our projects fail. And I believe that failure is the other side of innovation. If you have a culture, in particular in a big company, where people are afraid to fail, then you kill innovation. And therefore, I mean this very seriously, in a very tangible way, sometimes if you have a failed project, what I do is I invite the team over lunch, and we discuss about the learnings of that specific project, what can we do differently the next time. Then at one point I would get out a bottle of champagne, and then we very formally celebrate the good work which has been done and the failure. Well, and we all toast to this great failure which we achieved together. And sometimes I'm lucky and somebody takes a photo, and these photos go viral, and I love it. Because what it signals to the organization is: failure is all right. It's all right, you can fail, actually it's appreciated if you fail and if you try again and if you try again and if you try again. So I do believe this is very, very important. Now let me close with a fifth element, and that is: lead on behalf of the next generation. I just recently had the opportunity to present our company's results at the annual general meeting, and we had a good year and I could present good results. But make no mistake, these results are not so much the result of the decisions I took over the last year. These results are very much a result of the decisions which were taken by my predecessor, and actually many of the decisions which were taken by my pre-predecessor. It was my pre-predecessor who at the end of the '80s and beginning of the '90s had this wisdom to invest into biotech and to go into biotech at a time when most people couldn't even write biotech. I remember at the time when we took a majority ownership in Genentech, our share price was going down because people said Roche is completely crazy, they have no product, doesn't make sense, this will take years until you potentially see something. And actually they were right. It took years, it took 10 years before the real tangible products were coming from Genentech and before they turned profitable, took 10 years. And it just shows to me how important it is that you think in long cycles in an industry where it takes you so many years to bring a new medicine to patients. I'm also in the lucky position that our company is still majority owned by the founding families, Hoffmann and Oeri. And when I talk with peers, I see this difference, because if you have a shareholder like that, they don't care so much about the fluctuations of the share price and the quarterly results, because what they really care about is handing over their company in a healthy state to the next generation. And if you talk with them, they actually mean that, they want to hand over the company to the next generation, from the fourth to the fifth generation, and these are long cycles. And I think this is something which is in particular important in our industry. So to close up, I believe that innovation has a lot to do with freedom, and we need people who are guided by a few key principles and follow a long-term vision. Thank you very much. And with this I suggest we go right into your questions and comments.

I think external innovation and to bring in external innovation into the company is absolutely vital. And I think it is also vital that you make no difference where the innovation comes from. It doesn't matter whether it comes from within the company or from some external academic institution or another pharma company, a biotech company. I think it's really, really important. The complexity of this field is so huge, and I keep saying that even though we are very proud of our science and our scientists, 99 percent of the innovation, just for quantitative reasons, 99 percent of the innovation happens outside of our company's walls. So it is essential for us to tap into external innovation. And I think actually it's always been a strength of our company to be able to work together with partners. And actually, I also believe it has a lot to do with this decentralized approach, because the way we work internally, we also work with external partners. We don't feel that we have to control everything, almost digest it and you wonder what comes out. So we keep it like a fleet of approaches. Very often those companies would stay where they are, and even if they're very small units, we would not necessarily integrate them. We had an acquisition in Switzerland, a company called GlycArt, a spinoff of ETH, you might have heard about that. Now they had their place in Schlieren, which is a village outside of Zurich, not the nicest place in the world. On top of it — I hope nobody is from Schlieren — on top of it, it is only about 40 minutes away from our main center in Basel. I bet with you, many companies would have said: well, it just doesn't make sense, it's so inefficient, they have their own infrastructure, let's get rid of this duplication, let's invite them to join our labs in Basel and integrate them. Now, we actually asked them what their plans are, what they want to do, etc. And we paid a lot of money for them, so somehow they must have done something right. And they had very personal preferences, whether you believe it or not, some of them wanted to live in Schlieren, and then we said: okay, stay there, fine. And now it is almost eight years later, we launched Gazyva just last year, which is a major opportunity, a blockbuster medicine, developed by this small group of about 50 people or so. Of course they work together with the rest of the organization, but they stayed pretty independent. It tells you also that innovation is not a matter of scale. Now you asked for what is the trend, is it getting more or less. It's quite interesting to see, we seem to have, as a company, and that's different from company to company, we seem to have found a balance which is okay for us. So it's about a third of our medicines which are marketed that come from the outside, from licensing deals, acquisitions, etc. And if you look at our current pipeline, it's about a third as well. So that seems to be a ratio which works well for our company, and the trend is pretty stable.

Yeah, I come back to the point I made, especially in the earlier part of the value chain. If you talk about discovery, if you talk about research, I think freedom is the name of the game. I think people really should have the liberty and the freedom to do what they think is the right thing to do. And they really know what's going on. It's not me sitting in the headquarter office, it's the scientists who are really close to what is happening, and they would have their ideas. And then you have to give them enough space to work on those ideas. The more you progress in the value chain, then the more organized you get, if you like. So when you come into late-stage development, for example, and it makes a lot of sense to leverage the worldwide infrastructure, and it would be counterproductive if everybody does it on his or her own.