Few companies — whether government or privately owned — embraced the idea of a knowledge economy with quite as much fervour as Industrial Research Limited.

The Crown Research Institute — one of nine set up by the former National government in 1992 as part of a radical overhaul of New Zealand’s science system — promised to be an agent of economic transformation by extracting commercial value from science. Based around its cutting-edge research in fields as diverse as high-temperature superconductors, the develop-ment of new-generation anti-cancer drugs, hydrogen fuel cells, and robotics, IRL hoped to generate $500 million in new revenue for New Zealand by 2010.

All this was part of a business plan to funnel world-class science with commercial potential into the market through spinoff companies. In 2003 former CEO Nigel Kirkpatrick called it an “excellent adventure — creating significant value for New Zealand from our businesses”.

This passion for making money from science was rewarded with applause and accolades. The government — IRL’s sole shareholder — urged the company to go for it and invested $8 million in equity to help it achieve the goal. Subsidiary company BioPharm, a specialist manufacturer of compounds for drug trials, was named an exporter of the year and biotech company of the year in 2003. And spinoff company HTS-110, formed to cash in on the burgeoning global demand for high-temperature superconducting products, was named startup company of the year in 2005.

Yes, here was an organisation that seemed to represent real hope that New Zealand could escape the shackles of its agricultural past and achieve strong growth via exciting new industrial applications.
But behind the evangelistic language of knowledge-led growth, the proverbial was hitting the fan. IRL went into the red, racking up losses of $578,000 in 2003, $4 million the following year, and $5.37 million last year. It bombed against most of the government’s financial monitoring benchmarks used to assess Crown-owned companies’ performance, including registering a return on equity of negative 20.2% in 2005, making it the worst performing CRI in financial terms. By last year it was being kept under close watch by the Crown Company Monitoring Advisory Unit (CCMAU), which advised the government IRL was at risk of not having enough cash to pay its debt servicing costs (a concern that has since been alleviated thanks, among other things, to two new drug licensing deals).

By late last year, after two rounds of redundancies — including half the staff of BioPharm — and the resignation of Kirkpatrick, IRL staff were so concerned they wrote to board chair Liz Coutts expressing their “dismay” at the state of the company. It is not known how many of IRL’s 400-odd staff were behind the unsigned (but widely circulated) letter, which attacked the “relentless pursuit of commercial objectives to the detriment of underpinning science”, the “burdensome” management system and “growing bureaucracy”, and accused the company of restricting staff recruitment and spending in order to maintain the viability of a spinoff commercial venture.

The “adventure” Kirkpatrick heralded back in 2003 wasn’t looking so excellent after all.

In the hunt for reasons for IRL’s fall from grace, attention has fallen primarily on BioPharm, set up as a wholly-owned subsidiary in 2004 to produce compounds for use by pharmaceutical companies in clinical trails for anti-cancer drugs. BioPharm had emerged out of a decision in the late 1990s to focus IRL’s expertise in chemical fermentation on the human therapeutics market. Around $9 million was invested in various stages of plant development, and at its peak in 2002 the business earned around $15 million in export earnings — significantly boosting the revenue available for IRL’s research work in other areas and compensating for stagnant levels of government funding for core science.

Then in 2004 and 2005 BioPharm’s revenue plummeted. Coutts says a major customer was lost when it proceeded to larger-scale production, which BioPharm isn’t geared up to service. There were further difficulties when a second customer had technical problems with its product.

At the same time, IRL was experiencing delays in commissioning new plant for another major business unit, GlycoSyn. The $7.4 million plant was opened in 2003 to build on IRL’s expertise in the area of carbohydrate chemistry to produce compounds for the pharmaceutical industry.

IRL’s declining fortunes were, in large part, a result of nursing these two biotech businesses through the difficult startup phase.

But hang on, what’s a government-owned company doing venturing into these risky waters anyway? Shouldn’t BioPharm and Glyco-Syn have been flicked on to deep-pocketed private sector venture capitalists rather than being retained by IRL? Or, at the very least, shouldn’t IRL have handed the governance of these businesses over to directors with hands-on -experience of the risks of biotech startups, rather than merely deploying a selection of the parent company’s directors?

Coutts says the intention was to get the business established first, and then look for outside investment. And she says in the early stage of BioPharm’s development no one was really thinking about the best model for such a business. “It’s only in the last two years we’ve really started thinking what the model should be.” In the case of IRL’s latest spinoff company, HTS-110, outside equity and board expertise has been brought in via investors Endeavour Capital and the American Superconductor Corporation.

Founding IRL CEO Geoff Page, who ran the company for its first ten years, including the formative years of BioPharm, also rejects the criticism. He says IRL had learned from previous experience there’s a risk of not maximising value if spinoff companies are sold prematurely, and his vision was to look for an investor for BioPharm when it had hit revenues of $25–30 million. The company was well on the way to this target when it hit problems.

As for recruiting directors with deep experience of BioPharm’s market, he says the problem was there was no industry in New Zealand from which such experience could have been drawn.

But the issues surrounding IRL go deeper than two risky startups. They are also symptomatic of the fact the company has had little choice other than to pursue an aggressive commercialisation strategy. Set up with a brief to serve New Zealand’s manufacturing sector, IRL’s natural client base is dominated by SMEs with little money for contract research. So, unlike the big agricultural CRIs, which service large and fairly unified sectors of the economy, the potential for IRL to earn big revenue from private sector contracts has been limited.

Page says in this context IRL’s vision was to become a “leader in technology exploitation”. He concedes the process of investing in plant such as BioPharm in order to build a client base in an emerging industry is a tightrope: “It’s the classic high-tech business growth cycle.” But he says IRL was conservative, and aimed to make new startup businesses self-sufficient.As the BioPharm experience shows, however, startups often fail to behave in the manner their founders wish.

Coutts says IRL remains committed to its commercialisation strategy and believes the target of generating $500 million in revenue for New Zealand by 2010 will be achieved (although no figures on progress are available). But she appears to have an uphill battle convincing IRL’s highly skilled staff that the company is on the right track. In the December letter to Coutts, staff accused the board of sucking money out of science to finance spinoff companies: “[These] should be funded through normal business methods, and not by placing crippling taxes on the very activities that create those opportunities.”

But Coutts says they forget that when the going was good for BioPharm its revenue subsidised core science work. And she insists the 41 redundancies announced late last year were unrelated to BioPharm’s performance and were part of normal business restructuring. Still, she acknowledges the need to improve communication with staff and a consultative process has been kicked off.

But what about the political masters of CRIs? Have IRL’s difficulties frightened them off commercialisation? Science minister Steve Maharey isn’t admitting to cold feet. He refused to give Unlimited a copy of the 2006 draft operating framework for CRIs, but he said it was not greatly different from previous documents. These have urged CRIs to commercialise technology while at the same time maintaining their public-good science functions. Boards of CRIs are expected to take “considered risks”, according to the 2005 operating framework.

As Unlimited went to press IRL was due to announce a major drug sub-licensing deal through US company BioCryst. Industry insiders say the deal could yield around $30 million in the next three years, and follows an earlier deal with BioCryst late last year. Maharey claims this shows the company’s commercialisation cycle has “gone from the downside to the upside”.

In fact the recent BioCryst deals, following on from two miserable years for IRL, merely illustrate the huge uncertainty of the biotech business, and underscores concerns about the Crown’s involvement in such a volatile sector.

Maharey acknowledges there’s an issue to be debated about CRIs’ commercialisation endeavours, but in the meantime he seems to want a bob each way: “We don’t want organisations that the taxpayer owns not to take risks because if they don’t they won’t achieve a commercial return. But we also want them to take prudent risks … We have to develop a culture where an appropriate blend of business and science is established.”

Just what “prudent risk” means for a CRI working in the emergent spheres of superconductors, new-generation drug development and high-tech robotics is far from clear and something the IRL board will have to try to decipher for itself.