Mergers and Alliances within Computational Chemistry
Allen B. Richon
Molecular Solutions, Inc.
4411 Connecticut Avenue NW, STE 514
Washington, DC 20008-8677
Published October, 1996
Please note: The text of this article was compiled in 1996 from interviews with leading software companies and pharmaceutical research directors. This section of the article remains as it was originally published. The History of Computational Chemistry however is updated on an ongoing basis.
Molecular Solutions recently published an analysis of the marketplace which encompassed molecular modeling, structural chemistry, and chemical information (the computational chemistry marketplace). The figures detailed in this survey pointed to the fact that the pharmaceutical industry's approach to compound discovery was changing.
Structure-based design and classical multi-step synthesis of drug candidates have been supplanted by mass screening and combinatorial libraries in many companies. In addition, over the past five years, the chemical industry has witnessed a wave of mergers, acquisitions, and partnerships among companies which were once considered to be the epitome of stability. The primary motivation behind this activity was the desire to reduce costs, remove redundancies and thereby increase profitability while gaining market share. The drive to reduce expenses which began within the chemical companies has now impacted the industries which support chemical R&D. This report will examine some of the forces within the computational chemistry market and the manner in which the vendors are addressing them.
The Current Marketplace
The business model for the computational chemistry market was started by research scientists at several of the leading universities. The individuals within the pharmaceutical industry who licensed computational chemistry software were gathering scientific tools for use in their companies. The direct result of this mix of personalities was that a "culture" developed in which the "vendors" of this period were more interested in disseminating science rather than building a viable business foundation. The computational chemistry marketplace thus evolved in a very different manner than the "commercial" software industry. Some of the factors which continue to impact the business include:
- Software, in many instances, is sold as a perpetual license rather than a lease.
- Maintenance fee schedules are low compared to traditional software.
- The customer base is limited to computationally trained chemists rather than all chemists.
- The need to have scientists assist sales professionals escalates the cost of sales.
- The cost of software development is high due to the fact that customers want the latest science incorporated into each new release of the product.
The issues above did not impact the computational chemistry vendors during the early years due to the fact that there was a relatively large pool of new customers who would frequently purchase all of the available programs. As the market matured however, the vendors found their expenses rising as their customer base shrank. As a result, companies found it difficult to maintain profitability. These problems were compounded when the pharmaceutical industry rapidly changed its approach to compound discovery from structure-based design to combinatorial-based discovery. The result of these events is that the vendors which supply molecular modeling, structural biochemistry/biophysics and chemical information systems are being forced to examine and implement significant changes in the way in which they develop and market their products and operate their companies. The first manifestation of this process is consolidation of the industry.
At the end of 1991, there were 25 companies supplying software for molecular modeling, chemical databases and structural biochemistry (academic groups, unless they market software at commercial prices, are not counted for the purpose of this report). Currently, 19 vendors address this market: CambridgeSoft, Chemical Computing Group, Inc. (CCG), Chemical Design Ltd. (CDL), Daylight Chemical Information Systems (DCIS), Gaussian, Inc., Genetics Computer Group (GCG), Hypercube, Inc. (Hypercube), Interactive Simulations, Inc. (Intsim), Columbia University (MacroModel), MDL Information Systems, Inc. (MDL), MicroSimulations, Inc., Molecular Applications Group (MAG), Molecular Simulations Inc. (MSI), Oxford Molecular Group (OMG), Schrödinger, Inc., SemiChem, Serena Software, Tripos, Inc. (Tripos) and Wavefunction, Inc. While the number of companies has stabilized, the mix of the market has changed dramatically. The forces that led to these mergers were similar in nature to those that changed the pharmaceutical industry: improving support for customers; removing product duplication; increasing efficiency; and building a more viable business.
While several of the companies listed retained their original names, they changed significantly during the past five years. Several of the vendors broadened their product offerings to compete for business outside their traditional customer base. Others formed alliances or merged with former competitors to reduce costs. As a result, the market has evolved into four distinct segments with several companies providing a mixture of products.
- Bioinformatics (Current leaders: GCG, MAG and OMG)
- Cheminformatics/Combinatorial chemistry (Current leaders: CDL, MDL and Tripos)
- Molecular modeling (Current leaders: CDL, MSI, Tripos)
- Structural chemistry/biochemistry (Current leaders: MSI)
A perspective on sales volume for this market can be obtained by examining the current market share for the publicly traded companies. Molecular Solutions has combined the revenues reported by public companies with data gathered from R&D organizations which use these tools to arrive at a revenue estimate for the 1995 market. Using this procedure, our best estimate for software, maintenance, consortia and workstation hardware purchased from the top 20 computational chemistry software companies is between $175 and $200 million. Given that the five top organizations (CDL, MDL, MSI, OMG and Tripos) account for over 80% of this total, it is clear that there is room for consolidation to enable the successful vendors to maintain profitable organizations.
Using data gathered from interviews with research managers within the US pharmaceutical industry, a comparison of the usage and market share figures highlights market penetration and effective return for each market segment. For example, nearly "100%" of the structural biochemistry groups reported using MSI's NMR and/or X-ray crystallography packages (note that only fifty percent of the companies surveyed reported having structural biochemistry as a part of their research organization). The cheminformatics market, which currently represents more than 40% of the total computational chemistry budget, is controlled by MDL. Bioinformatics, a rapidly growing segment of the market, is split between in-house development and the vendors identified above. Market share for molecular modeling is more complex.
During 1994 and 1995, the use of molecular modeling tools was reduced within several of the organizations polled by Molecular Solutions. As a result many of the vendors moved into different or complementary business to augment their revenues. Chemical Design released products which integrated construction of molecular diversity libraries, collection of high throughput screening (HTS) data and analysis of combinatorial libraries. Tripos announced the creation of Accelerated Discovery Services which combined elements of their Molecular Spreadsheet, Unity database and QSAR software with compound libraries supplied by Panlabs. MDL expanded their systems to address diversity by adding MDLScreen (obtained from Biodata Corporation), SAR Table and the Diversity Manager to their product offerings. Oxford Molecular Group expanded their business by acquisition.
Molecular Solutions recently contacted research managers to elicit their views of the current makeup of the industry and their concerns for its future. These viewpoints were tabularized as a series of questions which were presented to CambridgeSoft, Chemical Design, Interactive Simulations, MDL Information Systems, Molecular Applications Group, Molecular Simulations, Oxford Molecular Group and Tripos for their comments on recent alliances and the future of the marketplace. Interviews with several of these vendors were used to examine the forces that are shaping the marketplace.
Many of the computational research managers contacted by Molecular Solutions were the early adapters of the technology. They have watched the industry evolve from two companies which provided a useful set of limited tools to one in which several companies offer a wide range of overlapping functionality. While these scientists see the need for changes in the business, many of them expressed two fundamental concerns. The first is that they will have fewer options for software and support which will cost them more money. Second, they feel that the development of new product areas will take precedence over fixing bugs and enhancing functionality within the current products.
When organizations merge, one of the first concerns that their customers raise is the loss of products. The managers contacted by Molecular Solutions gave uniformly high marks to the vendors in this area for the short term. Their concern is that the future is uncertain and that each of the vendors needs to detail their plans for their current set of products. Given that many computational groups are still working with limited budgets, the managers feel that they must have this information to plan effectively.
A question which is related to the range of software is its functionality. A consistent theme of this market has been that commercial products provide only 80% of the routine needs. As one of the managers stated, the "frustration now, as in the past, comes from the limited attempts to improve current tools, the gap between software development and end-user's needs and the relatively poor bridging access tools." While the desire for additional features is universally expressed, many scientists are also realistic in their assessment of the impact of these requests. "I always want more functionality, usually in the form of specialized applications which the vendors can't justify in a cost/benefit analysis." The caveat to new functions/products reflects the business model that has evolved within this industry segment. "The major problem is that if new products become available, the price tag would be such that [the company] would probably be unable to buy them anyway." In place of new modules, research organizations requested the ability to add "extra bits" through a programmable interface as an acceptable substitute.
Given the speed with which this industry has changed during the past two years, one would expect that research managers have strong opinions on the types of products that will be needed to address research goals. Not surprisingly, the answers to this question were as varied as the groups which responded. "We need a software system that will integrate biological and chemical information and manage the flow of data from the automated synthesis of compounds through assays and then present this data to users." In addition, Web-based software, combinatorial chemistry systems, software development environments and diversity analysis tools were mentioned frequently. However, as one manger commented, "Many software tools are available out there but there are so many bits and pieces all over the place that it becomes increasingly time-consuming to find them. That is, if you remember they are there indeed!"
The issue of new functionality versus profit margins is traditionally one of the hottest areas of contention for many organizations. "The group always wants enhancements from the vendors but they usually don't get them (i.e., trying to get more color options for display). Most of the enhancements that we want are not seen as revenue generators by the vendors and therefore, just don't happen. In the area of combichem, there are products appearing, but at this point they are very immature. We have looked at the offerings, but we are taking a wait-and-see attitude since we have been burned repeatedly by buying early in the product development cycle."
In addition to products, the user community has also noticed a shift in the way that their suppliers conduct business. The trend toward licensing software rather than a purchase/maintenance agreement was noted in several conversations. In general, research managers do not object to the concept of licenses, however, they do not observe the vendors providing an adequate case for the change. This area of discussion highlighted a potential problem for the vendors; that many of the larger modeling groups "expect to reduce maintenance costs as the 'merged' programs become redundant."
Overall, while research managers identified areas which were of concern, their general opinion was that the recent mergers have not changed costs significantly or the way they address their job. However, they are uniformly concerned for the future. If there is additional consolidation, they feel that they will be left with fewer choices and thus, larger holes in product functionality. Should this occur, many groups stated that they would use in-house development or academic collaborations to address unmet needs rather than industrial consortia.
Addressing Customers' Needs: The Commercial Viewpoints
As the information above illustrates, the computational chemistry market is at a cross-road. The markets for molecular modeling and structural chemistry show signs of saturation, software companies are being pressured to undertake new development projects while cutting costs and new approaches to pharmaceutical R&D presage changes in the computational tools used by scientists.
The executive officers at each of the computational chemistry software companies have a similar history to their counterparts within the pharmaceutical industry; they have been a part of the industry from its inception and are well aware of the problems which now confront the industry. As can be seen from the chronology above, the computational chemistry marketplace rapidly reached its high point of 25 companies in 1990. While the number of companies has stabilized at around 20, the mix of the market changed dramatically.
Growth of the Market
According to Thomas Jones, President and COO of MDL Information Systems, Inc., "Our current customers are going through one of the biggest business shifts in their history. They are radically changing the way they are conducting their business. In research they are looking at ways to get their products to market faster, reduce costs, establish a reproducible process and a process that can adapt to change. This is one reason combinatorial chemistry and high throughput screening (HTS) are so important today.
Concurrent with this business paradigm shift is a technology shift that is unprecedented in our industry. Intranet was a term unknown to us 18 months ago. Internet was known but its usefulness unclear. Today these technologies are driving business decisions and business solutions. Three years ago, combinatorial chemistry and HTS were talked about, but very few, if any, organizations were implementing these approaches. It is obvious that our customers want an integrated systems approach to their overall discovery effort. Their goal is to have a 'High Throughput Discovery Research' process, not simply discrete components that increase the throughput in singular areas."
Charlene Son, Director of Marketing at Molecular Applications Group agrees with this assessment. "The smaller biotech companies have traditionally looked to the latest technologies to give them an edge in research. At this point in time, the competitive nature of the industry is pushing the pharmaceutical companies to examine new approaches to discovery. For Molecular Applications Group, the emphasis on bioinformatics and the World Wide Web has led to a significant interest in our products."
Keith Davies, Chemical Design LTD's founder and COO expressed a similar view of the market. "Since research is a dynamic event, the future of the business depends on watching the strategic directions that our customers choose and aiming solutions at the growing market segments. Given the current emphasis on molecular diversity, we have positioned Chemical Design to provide tools which focus on information extraction rather than compound archives. Our agreements with Advanced Chemtech and ChemBridge provide solutions that streamline operations for the user and give Chemical Design the ability to have a broader impact on the market, control costs, and provide value to our customer."
Molecular Simulation's CEO, Mick Savage, summarized the organizational issues facing many of the vendors. "One year ago, the merger of Biosym and MSI was announced. This merger culminated an analysis of the marketplace as both a business model and as an effort to advance the science. In looking at both companies, it was apparent that there were three major areas of concern. First, given that the product lines were complementary, there was a large duplication of effort in all areas of the two companies. Second, sales efforts had turned into a check-list competition which focused development into areas where there was little return on the investment. Third, efforts to differentiate the companies had polarized the community. The end result of these factors was that there was a lack of critical mass to drive the market forward.
The objectives for the merged companies were thus very simple. Use the complementarity of the products and the expertise within each of the companies to develop a value formula for customers. This included providing higher quality support and service, improving the validation of the techniques, and increasing revenues and profitability so that the business can thrive."
Customer value was also a theme expressed by Thomas Jones. "The alliances, joint marketing agreements, and acquisitions that MDL has made over the years have been driven by the need to provide our customers with better solutions. We have formed alliances with Oracle and Tripos over the last few months to enable our customers to more easily access various types of data and to integrate that data as they desire. Our agreements with the major robotics companies: Zymark, Saigian, SciTec, Robocon, and TomTec were driven by our customers' desire to more tightly integrate their high throughput screening and combinatorial chemistry efforts. These agreements will allow our MDL Screen and Central Library users to come one step closer to their goal of building the High Throughput Discovery Research process."
The cost of competition during the late 80's and early 90's has forced many of the computational chemistry vendors to re-examine their approach to product development. In this regard, one of the first issues to address is the synergy of product lines. "We feel that when organizations can combine their core competencies to produce a more effective solution for the customer than the individual companies can provide, we have the basis for a successful alliance" stated Jones. "Oracle chose MDL as a global solutions partner" he added, "based on our ability to answer customer needs and our unique ability to integrate with the Oracle family of products. We currently offer a number of products based on Oracle and we are nearing completion of an Oracle relational chemical gateway with our enterprise solution for combinatorial chemistry, the Central Library, which is due out in the fourth quarter of 1996." In the case of Biosym and MSI, "the companies were focused on the same market with strengths in slightly different areas." said MSI's Savage. "Biosym was strong in NMR, MSI in crystallography. The companies had two of the most respected force fields in the industry. It was felt that combining the strengths of the two organizations would provide value to the community and enable the new company to run more efficiently." CDL's Keith Davies has found that "the time scales for consortia-based product development do not generally match our customer's objectives. CDL's alliances have provided us with the ability to more effectively leverage the core strengths of market leaders."
Each of the companies contacted for this survey expressed the concern that the customers should not expect the mergers to be completed quickly. As Mick Savage views their efforts, "We are one year into the process of merging cultures, products and customer's expectations. We haven't achieved all of our goals, but we feel we are on the right path." MDL's Jones agrees that "our relationships with our partners are still in an early stage so the activities of each alliance are still in progress. Like all alliances, they take time to define and to organize, but we are certainly happy with the current results."
Research managers contacted for this report identified the possibility of losing products as the biggest issue which would effect their groups. MSI's Savage stated that his organization's approach to managing the integration of their product lines is based on four points. "First, MSI will create a mechanism which does not force the customer to choose between products. The company will support the full set of products for two years. During this period, we will look at each area of the business and determine the leading product which will be enhanced. Second, we have an incremental strategy to build the products around the C2 architecture. All of the company's small molecule and materials programs have been ported to this data model. The biomolecular programs are well underway. Third, MSI's tools need to be deployed to a broader group. Thus, we have developed a web enabled interface, WebLab, to our computational instruments. This new plugin is available at no cost for both Netscape's Navigator and Microsoft's Explorer. Finally, MSI is committed to providing a means for research professionals to gain access to the latest science. The company has strong ties to over 20 of the leading academic research groups including Harvard, Yale, York, Emory, Northwestern and others. Each of these groups uses the C2 Software Developers Kit to tightly integrate their code into a commercially supported architecture. This mechanism allows each group to focus on their respective strengths; MSI can add value by enhancing mature technology and the academic centers can quickly release the latest advances in science."
Will these mergers continue? "I believe we will continue to see consolidation in all areas of our industry. The cost of supplying products and services to our industry is very high. We all sell products that are very complex and that require a highly talented distribution and service organization. In order to keep costs low and to produce ever more sophisticated products and solutions, you need to have an economy of scale that will allow you to run a financially strong business. These factors alone will force more consolidation" stated MDL's Jones. According to Mick Savage, "customers cannot continue to support multiple relationships given their budgetary and head count limitations. They are instead focusing their support to one or two vendors. On the commercial side, today's business climate requires that an organization have the critical mass needed to aggressively support their product lines. Small and medium sized companies will not be able to provide the depth and breadth of products that customers need." "Our market place is shrinking by necessity" added Keith Davies. "We have to make the decisions which will help us be competitive and get on with the business."
Note: The author gratefully acknowledges the assistance of Ms. Merry Ambos in the preparation of this article.
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