Demand_Creating What People Love Before They Know They Want It

by Adrian Slywotzky

  Consider two companies in two very different industries—pharmaceuticals and venture capital—that have created systems for decades-long success in meeting the challenge of new demand generation. As with Pixar, the systems employed at Merck in the 1980s and 1990s and at Kleiner Perkins Caufield & Byers throughout its four-decade history are designed to generate an enormous quantity of high-quality ideas that are then winnowed down to a very few truly terrific ideas, which magnetize the focus of their respective organizations.

  It’s a simple idea, but a difficult one to practice, as shown by the fact that companies with remarkable portfolios like those of Pixar, Merck, and Kleiner Perkins are so rare.

  LIKE OTHER MAJOR drug companies, Merck has always been financially dependent on the flow of demand to its newly invented, patented medicines. When successful, these drugs play the same role for “Big Pharma” as blockbuster movies do for Hollywood studios: they pay the overhead and compensate for the losses incurred when other drugs in development prove ineffective or simply fail to attract the expected demand. Blockbuster drugs keep pharma companies afloat, create jobs for thousands of scientists, engineers, and manufacturing workers, and, most important, improve the longevity and quality of life for thousands or even millions of patients.

  When Roy Vagelos, a physician and biochemist with a research stint at the National Institutes of Health (NIH) under his belt, joined Merck in 1975, he found the traditional R&D process ineffective and unsatisfyingly random. “The process of discovery,” Vagelos has noted, “was empirical, whether it was conducted in a laboratory or by simple folk observation of what happened when people ingested a substance. This is how aspirin, morphine, digitalis, and vitamin C came into use. The empirical process works, but it depends on luck and takes an enormous amount of time to bear results.”

  Vagelos’s experiences at NIH had suggested to him a more efficient way of developing drugs. It was based on identifying specific naturally occurring enzymes involved in disease processes. “Once we identified a target enzyme,” Vagelos has said, “the medicinal chemists would search for inhibitors in the laboratory, and the micro-biologists and natural product chemists would look for inhibitors in nature.” These inhibitors, adapted for medicinal use, would stop the operation of the enzymes and thereby retard or reverse the progress of the disease. Vagelos’s new approach might be much faster than the traditional method, since hundreds of experiments could be done per day, and it would produce drugs with fewer side effects, since the molecule-to-molecule matchups sought by the researchers were highly targeted and specific.

  It took time for Vagelos to convince his colleagues at Merck to adopt the new approach, but once they did, the results were dramatic. In effect, Vagelos and Merck converted the random trial-and-error structure of traditional pharma research into a system. And having a system, while it did not guarantee success, increased the odds significantly.

  In his years as Merck’s head of research (1975–1985) and later as CEO (1985–1994), Vagelos took other steps to leverage the demand-creating advantage produced by his research system. The most crucial focused on recruiting, retaining, and energizing the very best talent available—an easy objective to articulate but nearly impossible to implement.

  In the early 1970s, the smartest young scientists gravitated to universities; conventional wisdom held that only second-rate talents chose industry. Finding this attitude “depressing,” Vagelos set out to change it. He encouraged Merck scientists to publish research papers and lecture about their work in academic settings. He also gave them unprecedented freedom to pursue basic science interests and to work collaboratively in interdisciplinary teams, giving Merck’s labs an atmosphere of creative ferment that was unique in the industry. The goal was to show young scientists that applied research could be both intellectually exciting and personally fulfilling, leading to new medicines that could improve lives for millions.

  Vagelos’s campaign gave Merck a magnetic allure for hundreds of young research scientists. And as a physician and experienced researcher himself, Vagelos was able to personally vet both these new hires and the work they produced, interviewing potential job candidates, regularly scanning clinical test results, encouraging the most talented researchers, and suggesting new approaches that often paid dividends.

  The case of Dr. Arthur Patchett is a vivid illustration of how Vagelos’s system unlocked the scientific potential of Merck. Patchett had joined the company shortly after obtaining his PhD from Harvard. An outstanding researcher, he quickly rose to become head of the entire synthetic chemistry operation. He was a poor manager, however, and was “banished” to a decaying old lab where his boss relegated him to mixing random peptides, work with minimal creative or productive potential. He had been doing this for two years when Vagelos arrived at Merck.

  During one of Vagelos’s Saturday strolls through the laboratory, he came across Patchett. Listening to him “free-associate” about research ideas and sketch connections on a whiteboard, Vagelos realized that Patchett was a “genius in chemistry.”

  Vagelos offered to work with Patchett to design a project for him to spearhead. Ready for a change, Patchett eagerly agreed. Within a few years, Patchett and his team had successfully explored a new treatment for high blood pressure and had made vital contributions to cholesterol research. Vagelos later observed, “Art Patchett was one of the most innovative chemists [at Merck], but he had to be allowed to be productive—not told what to do.” Stories like this one have a way of traveling throughout an industry, and they helped make Merck under Vagelos the place to be for talented, ambitious scientists.

  By 1988, Merck plowed fully 11 percent of its revenues into R&D—a higher percentage than any other company, and a greater than fivefold increase from just under 2 percent in 1976. Special investment emphasis was focused on research areas where the potential demand was greatest—areas where chronic conditions required ongoing therapy, current treatments were not very effective, and large numbers of patients could benefit. Scientists don’t often think about demand in shaping their agendas. Vagelos always did.

  Guided by these principles, Merck focused on cardiovascular disease, AIDS, cancer, arthritis, Alzheimer’s, and osteoporosis. Like all pharmaceutical companies, Merck had dozens of drug candidates in its pipeline. Vagelos successfully narrowed his organization’s focus to between six and eight of the highest-potential candidates. He succeeded in getting the organization to focus obsessively on drug projects that addressed the biggest needs, and gave them the critical mass of resources, attention, and emotional energy that they needed to achieve breakthroughs.

  The final dimension of Vagelos’s approach was a contrarian attitude toward the Food and Drug Administration (FDA), the national agency whose approval was required before new drugs could be brought to market. For most pharmaceutical companies, the FDA was the antagonist, the enemy. Vagelos thought differently: “Let’s treat the FDA as a customer—a very important customer.”

  And Merck did. The new orientation shifted attitudes within Merck. Rather than asking, What do we have to do to get the FDA off our backs with as little trouble as possible? Merck researchers began asking, What information does this important customer need to make their decisions? Then they took whatever steps were required to provide it. Submissions and presentations were over-prepared, and FDA approvals began to flow more quickly than ever.

  As a result of Vagelos’s innovative portfolio management system, Merck produced more blockbuster drugs during his tenure than the next three competing pharmaceutical companies combined (see the table below). By streamlining the process of identifying the most promising projects, emphasizing the importance of attracting and motivating talented people, and turning the FDA approval process into a matter of customer service, Vagelos transformed drug development from a shot-in-the-dark game into a system that produced consistent results.

  “Nobody knows anything”? Tell it to Roy Vagelos.

  MERCK’S BLOCKBUSTER PORTFOLIO (1978–1993)


  Drug FDA Approval Condition Treated Revenue (in Billions, 1993–1998)

  Timoptic/XE 1978/1993 Glaucoma $2.268

  Ivermectin 1981* Parasitic infections $3.244

  Vasotec 1985 High blood pressure $14.112

  Primaxin 1985 Bacterial infections $3.210

  Pepcid 1986 Ulcers and heartburn $5.882

  Mevacor 1987 High cholesterol $6.996

  Prinivil 1987 High blood pressure $2.735

  Prilosec 1989 Acid reflux $10.001

  Zocor 1991 High cholesterol $14.490

  Proscar 1992 Enlarged prostate $2.175

  *Ivermectin is a group of veterinary medications for which FDA approval is not required; 1981 was the year it first went on sale.

  After Vagelos’s retirement, the system that worked so well for two decades began to experience neglect and decline. One wonders how different the results for demand creation at Merck would have been if that unique system had been protected and continued to evolve.

  ONE POWERFUL demand-generation system that has continued to evolve is that of Kleiner Perkins. Founded in 1972, Kleiner Perkins is the leading venture capital firm in the United States and has achieved enormous success as a demand creator in a very unusual world, that of start-up investing.

  Investing in existing companies, as everyone knows, is notoriously difficult. Even when companies are mature, markets are well defined, and multiyear track records are available, the vast majority of active investment managers (by some measures as many as 80 percent) fail to match average market returns.

  Now imagine a different investment arena—one in which there are no company track records and no well-defined markets, where you must invest in companies that are five to ten years away from selling a single product. During that painfully long trek to market, most companies fail, some spectacularly so. The reasons are innumerable, but four main risks stand out:

  The technology didn’t work.

  The management team didn’t work.

  The company ran out of money.

  There was no demand for the product.

  Venture capital is supposed to be a highly glamorous business. But the fact is that most venture capital firms earn mediocre returns, and even the few successful firms experience results that are frighteningly volatile.

  In this strange parallel universe of punishingly low odds and brutally long cycles, Kleiner Perkins stands out. It has returned more than a billion dollars to its investors in each of the last ten years, and its list of major successes (see the table on this page) looks magical to anyone who understands the harsh realities of the arena in which they operate.

  How do they do it?

  Many have delved into the history of Kleiner Perkins, and the conventional explanations for their success are intuitive and appealing. Some attribute it largely to the personality of their leading partners. For example, there’s John Doerr, who is indeed a fascinating, colorful character. After graduating from Rice University and Harvard Business School, he joined Intel in 1975 as an engineer and project manager, then switched to system sales, an arena in which his powerful drive, aggressiveness, competitive zeal, seemingly endless energy, and penchant for dramatic flourishes rose to the fore. For example, Doerr supposedly once captured a new client for Intel’s microprocessors by throwing a lawn mower into the deal.

  A magazine profile once described Doerr as “a rail-thin man in a rumpled blue blazer, with a lick of hair falling across his forehead, rushing to a conference, simultaneously holding a conversation with three people around him and talking on his cell phone.” Toss in the fact that he is widely considered the single most influential figure in the entire world of high-tech venture capital and you have a reasonably accurate portrait.

  Doerr has other partners who are just as memorable. There’s Ray Lane, former COO and president of Oracle, then the second-largest software company in the world and a famously opinionated, outspoken authority on technological innovation. Lane and Doerr have an ongoing friendly rivalry over who can amass the largest collection of business contacts. At last count, Lane was in the lead with more than six thousand names and numbers, including such outré characters as Olafur Ragnar Grimsson, president of Iceland since 1996.

  KLEINER PERKINS’S BLOCKBUSTER PORTFOLIO (1972–2010)

  Company Market Cap (in Billions, 2009)*

  Google $147.0

  Genentech $47.0

  Amazon $36.0

  Cerent $7.3

  Electronic Arts $6.9

  Sun Microsystems $5.9

  Netscape $4.2

  Lotus $3.5

  AOL $2.4

  Brio Technology $0.143

  Compaq $25.0

  Intuit $13.7

  LSI $2.65

  Macromedia $3.4

  Quantum $0.316

  Tandem $3.0

  *Several of these companies have been acquired by others: Genentech by Hoffman-LaRoche (2009); Cerent by Cisco Systems (1999); Netscape by AOL (1998); Lotus by IBM (1995); Brio Technology by Hyperion (2003); Compaq by HP (2002); Macromedia by Adobe (2005); and Tandem by Compaq (1997).

  Then there’s Bill Joy, a famous whiz kid whose many intellectual exploits veer unknowably between the factual and the legendary. He could read at age three and play chess at four, and during oral exams for his PhD degree he improvised a sorting algorithm so brilliant that one of his examiners later compared the experience to “Jesus confounding his elders.” Joy later became an awe-inspiring hacker at Berkeley whose exploits earned him a Fortune magazine cover story dubbing him “Edison of the Internet,” and then, for good measure, he cofounded Sun Microsystems.

  Doerr, Lane, and Joy are just three of Kleiner Perkins’s thirty-six partners. Celebrity statesmen like former vice president Al Gore, another Kleiner partner, and former secretary of state Colin Powell, a “strategic limited partner,” add further luster and clout to this remarkable team.

  But the success of Kleiner Perkins is based on more than Doerr’s salesmanship, Lane’s intelligence, Joy’s technical brilliance, or anyone’s Rolodex. Others say the key is Kleiner Perkins’s brand: They have the best reputation in the world of venture capital, and that means they see all the most promising business plans before anybody else. This theory is intuitive, appealing—and quite misleading.

  Yes, Kleiner Perkins does have a strong brand and great deal flow. But all of that is just one aspect, and perhaps the least important aspect, of the fascinating, multifaceted demand creation process that Kleiner Perkins has built.

  Kleiner Perkins knows that of the Big Four risks that ventures face—technology, team, finances, and demand—demand is the toughest, and they conduct themselves accordingly. They don’t focus on companies, but on market sectors, looking for big break points that will lead to major new explosions of demand. They first looked for those break points in semiconductors, later in the Internet, and today in energy and water.

  Kleiner Perkins partners sit on hundreds of boards and interact with thousands of entrepreneurs, and the singular focus of all those interactions is to develop unique insights on how demand will evolve. “We are on the board of everything from Sun to AOL to Excite. As a group, we have developed a sense of how to forecast the future before the market researchers can,” says Vinod Khosla, a former partner.

  Against that backdrop, they seek out companies that are customer-centric. John Doerr explains what convinced him of the enormous potential in the then-nascent financial software company called Intuit: “At the first Intuit board meeting I attended, I was surprised: more than half the meeting took place at Intuit’s tech support center, listening to tech reps answer customers’ product questions and fix their problems. Founder Scott Cook’s uniquely intense focus on happy customers and first-hand customer feedback impresses me to this day.”

  Doerr shares our awareness of how rare it is for company leaders to have the guts to talk to customers and to respond to the uncomfortable truths they learn. Scott Cook not only listened to customers, but brought board members
into the process, completely changing the nature of the conversation that took place at the board level. For Doerr, this was a crucial clue that this company was on the verge of creating significant new demand.

  Being obsessed with demand is a great beginning. The next step is to generate the maximum number of good ideas to address that demand. The process begins by listening to the thousands of voices in Kleiner’s network. It then quickly goes “outbound.” Kleiner partners scour the nation’s leading universities, looking for the better idea, and not just waiting for referrals but wearing out shoe leather like investigative reporters or peristent detectives. Partners like Doerr, Ray Lane, and Brook Byers spend enormous amounts of time prowling university labs: Doerr focuses on Stanford, Lane on Carnegie Mellon, and Byers on the University of California at San Francisco. They use the connections they make to learn about innovative research projects, build long-term relationships with top scientists, and encourage collaboration and connection among the very brightest.

  The shoe leather strategy extends past the conventional university sources and beyond national borders. In support of their energy investments, Kleiner Perkins partners have found worthy ideas not just in Massachusetts, Florida, Texas, Pennsylvania, New York, New Jersey, and Georgia, but also in Israel, Germany, and China.

  Referrals play their part. Doerr sees them as a guarantor of quality:

  Look, this is not a matter of odds, like a lottery. It’s a matter of quality. Here’s a key: Kleiner Perkins has invested in over 250 ventures. In almost every case, the project was referred to the partnership by someone—a CEO, an engineer, a lawyer, friend, or another venture capitalist—known to both the founders and our partnership.