The nutrition industry has caught the eye of venture capital companies keen to exploit its huge growth potential. But key issues, such as strategic partnering, balancing risk and reward, and working with government, must be addressed if nutrition is to fulfil its promise, says Nestl??s Steve Allen.
Imagine predicting back in 1953 that a scientific paper on the structure of DNA would make the authors, Watson and Crick, household names in 2003. If that fails to surprise you, what about recognising that the same paper would go on to be the foundation stone for the biotechnology business, which took shape in the 1970s.
Today, nutrition represents the same kind of opportunity that biotechnology investors harnessed 30 years ago. Although the nutrition industry has been around for more than 100 years, it is poised for dramatic growth in the next decade.
But important factors need to be taken into account if success is to be achieved. For example, increased outsourcing of R&D work creates issues of integrating the work back into the company. Accurate risk evaluation is also vital, while government legislation has a greater impact on nutrition than other sectors of the food industry.
Strategic Partnering Solutions
The tools of modern biotechnology, which evolved from the work of Watson, Crick and other scientists, are now being deployed in the R&D laboratories of the major food and beverage companies.
We can expect to see the number of external partnerships in the food industry increase dramatically over the next five years. In a recent article in The Cincinnati Enquirer, the chief technology officer at Proctor & Gamble said he was moving the company to a ?virtual R&D capability.? In the future, 50 per cent of its technologies will be sourced from outside companies, compared to the current level of 25 per cent.
Integrating new technologies
Venture investing gives large companies a window on technology they would otherwise not see. But a crucial question is how they integrate this knowledge back into the organisation while remaining faithful to their strategic plan. Even if you can persuade the company R&D to work with a venture-backed small company, it does not necessarily mean they should do so. The goal of the R&D programme should be re-examined and a decision to go ahead implies that external collaboration is going to make it faster, easier or cheaper to achieve the goal.
Another issue to be resolved is compensating the R&D company when its product is partnered into a large organisation. When a drug company concludes a deal with a small biotechnology firm, there are often three financial components: an up-front payment that recognises the value of the technology on the day the agreement is signed; milestone payments which are linked to accomplishments (e.g., successful R&D tests); and licensing fees that flow when the product generates revenues and profits. Similar arrangements are made in the nutrition industry, but they are still rare and obviously need to be crafted in a way that recognises market lead times, margin structures and the competitive situation in the food and nutrition industry.
Risk and reward
Venture capital is about managing risk. Just as a smart individual will diversify his savings to balance risk, venture funds look to build portfolios that can generate an attractive return over the life of the fund. When evaluating a specific opportunity, several elements of risk come into play. For example, researchers who have discovered a new bioactive molecule often misunderstand the market and execution risks. Many questions must be answered: How big is the business you are going after; which products are currently being used; who is buying them and who is selling them; why are they going to buy your product; and how long will it take to achieve that? It is very difficult to get a new product into distribution and the few that succeed seldom meet their pre-launch sales targets.
There are inherent risks in using new technologies, which is why due diligence is so often a focus. But these risks are fairly easy to evaluate—modern science is built upon peer scrutiny of experimental results and investors will always look at this information.
Finally, management risk is obvious, but we should not overlook the fact that when a deal has been signed, the investor and entrepreneur both have a common goal of making the plan work. This implies the need for clear separation between the roles and responsibilities of the management and the board representing the investors. This is necessary because an accomplished and experienced management team will understand, for example, the intricacies of executing a new product launch in an area where the investor might not have first-hand experience.
The role of government
A number of people have called for government action to protect intellectual property in nutrition in a similar way that patents give exclusivity to the prescription drug industry. But just as the Dietary Supplements Health and Education Act (DSHEA) has given the US supplements industry a headache, it is likely that government interference would be a mixed blessing. Food brands are often protected by trade secrets, which, if used well, are far more powerful and durable than most patents.
The hurdles for launching a new nutrition product into mainstream food stores are high and rising fast. Very few investors will back a plan to spend $20 million to $40 million on a national launch of Brand X knowing the failure rate of new product introductions exceeds 90 per cent. Even in the drug industry, with staggering R&D costs and late-stage product failures, the overall financial balance is restored when a successful product can reap sales of $5 billion per year with a 90 per cent margin.
Many successful nutrition products were incubated outside of the grocery store and became big businesses because professionals endorsed them. Meal supplements, now a $1 billion business in the US, were widely used in hospitals. In sports nutrition, gyms have served a similar purpose. One opportunity for venture investors is to find new networks that can help grow the next generation of products. As products become more complex and are designed to meet the needs of small, specialised segments, the influence of a trusted professional on brand choice can be dramatic.
Beating the bubble
Timing is everything and most of the funds listed in Figure 1 are still flush with money and actively investing. Being in a slow-growth, lower-margin business means the food industry has not traditionally suffered from the roller coaster highs and lows associated with the information technology and biotechnology sectors. In these areas the bubble has now burst, but similar dangers are evident in the dietary supplements industry in the US, where some public companies are valued below the cash they have in the bank.
It is seldom easy to raise start-up capital, and the current environment is extremely difficult. Financiers are telling small companies to expect to spend 12 months raising new capital. This imposes a huge strain on a small company as it devotes precious resources building the new company as well as finding the money to grow.
Like the biotechnology industry, which blossomed 30 years ago, nutrition is a well-established business that is poised to grow significantly in the next few years. Venture firms will provide part of the capital and the expertise enabling this growth. It promises to be an exciting time.
Steve Allen is VP of new business for the nutrition division of Nestl? USA, based in Glendale, California. The views expressed here are his own.
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