Much of the attention paid to biotechnology in recent times has focused on applications that are a long way off, like cloning or a cure for cancer. Amid the futuristic hoopla, it is easy to overlook the fact that biotechnology has already brought important benefits through the discovery of new drugs, vaccines, and diagnostics. Moreover, a quiet revolution has gone almost unreported, even though it is generating unprecedented change in an industry that touches our lives every day. Biotechnology is revolutionizing the food chain in a way that will affect millions of people across the globe.

What media coverage this topic has received has mostly dwelt on consumers' concerns about the safety of genetically modified crops. While this issue must be addressed, the negative press obscures biotechnology's impressive potential to provide plentiful, nutritious, and novel food for the world's growing population. With innovation gathering pace as the new century dawns, biotechnology is also creating exciting opportunities for players in the food industry. The effects on its structure and economics could be profound.

Having made massive investments in new products and processes, biotechnology developers face obstacles in exploiting them fully because of the dynamics of current value delivery systems. These companies are by no means unaware that much of the industry's margins are concentrated in downstream food manufacturing—the area where conventional food and packaged goods companies operate. Traditional mechanisms for capturing value, such as seed innovation, are limited in their potential for generating income. Indeed, inputs as a whole represent 8 percent of food chain margins in the United States, whereas food manufacturing nets 30 percent (Exhibit 1).

This may change. Developers recognize that biotechnology could drive substantial growth in margins and open up new opportunities to shift value upstream. With billions of dollars at stake, they are striving to capture a larger share of these additional margins. In many cases, exclusive or preferential arrangements with forward-thinking food companies could deliver considerable value to both parties.

Food industry leaders will seek to use biotechnology to strengthen their market share, positioning themselves as natural partners to biotechnology developers—as Frito-Lay did in forming an alliance with Procter & Gamble to secure exclusive use of the synthetic fat Olestra in snack foods. For second-tier brands, biotechnology-enabled innovations may represent their only chance to change the rules of the game and vault into leadership contention.

Food industry leaders will seek to use biotechnology to strengthen their market share, positioning themselves as natural partners to biotech developers

Regardless of players and brands, biotechnology innovations will redefine the relationship between packaged food companies and their ingredient and technology suppliers. The era of arm's-length relationships is over. Food companies that fail to recognize the enormous potential of biotechnology could be left out of the coming boom in biotechnology-driven growth. Building a biotechnology strategy and restructuring supplier relationships are among the most urgent strategic tasks they face.

Innovation is accelerating

Biotechnology is reshaping the links between the participants in the food chain: the manufacturers of chemicals, seeds, and fertilizers, the growers, the processors, and the packaged goods manufacturers. Change is already taking place as first-generation biotechnology-enabled innovations penetrate the market: examples include herbicide-tolerant soybeans, slow-ripening tomatoes, virus-resistant squash, and insect-resistant potatoes, corn, and cotton.

Consider Bollgard (Bt) cotton, an innovation developed by Monsanto and commercialized by Delta & Pine Land. Bollgard cotton has been genetically modified to produce a protein that is selectively toxic to boll worms, the crop's biggest pest. As a result, smaller quantities of insecticide are required to protect the crops, and there is less plant damage, raising growers' yields. The success of the new cotton in 1996, its first year of production, was nothing short of phenomenal: it achieved an adoption rate of 55 percent in its target region. Delta & Pine Land's market share in the Bollgard marketing area rose from 64 to 76 percent, despite the premium that Bt cotton commands.

In the space of a year, approximately $150 million in incremental profits was unleashed for the growers, Monsanto, and Delta & Pine Land. The latter has seen its market value soar. In October 1995, when the EPA approved Bollgard cotton, Delta & Pine Land's market capitalization stood at $374 million; by April 1996, the fifth month of commercial sales, it had rocketed to $862 million.

Tomato puree made from genetically modified tomatoes and the NewLeaf potato also illustrate how successful the introduction of biotechnology-enabled products can be. Developed by Zeneca, the tomato used in tomato puree sold at Sainsbury and Safeway is genetically modified to slow down the action of an enzyme that causes the fruit to rot, allowing more pectin, a natural thickening agent, to be retained. As a result, there is less wastage at harvest and processing costs are lower because solid yields are higher, creating additional value that can be passed on to consumers. Priced at an 11 percent discount, the product's early sales have been terrific, outpacing those for standard tomato puree. The initial 1996 production of some 900,000 units sold out.

Developed and commercialized by Monsanto, the NewLeaf potato is genetically engineered to protect itself against the Colorado beetle. Crops need less pesticide than normal, benefiting the environment and bringing economies for growers. Now broadly distributed in Atlantic Canada and the Pacific Northwest, the new variety has been well received by both consumers and the grocery trade. Its "grown the better way" positioning translated into positive consumer perceptions regarding taste, health, and environmental friendliness. Sales consistently exceeded those of other potatoes, despite premium pricing in some cases.

In the near future, biotechnology will offer even more exciting opportunities for industry players. It is poised to help food companies better address consumer needs in at least four ways: by enhancing the health and nutritional profile of food products, by creating new flavors, by improving product functionality, and by enabling the creation of entirely new products. Exhibit 2 shows a list of potential innovations, most selected from the pipelines of major biotechnology developers. A few are the fruit of our imagination; can you spot them?

At the same time, food biotechnology will slash product costs, and may even help to reshape entire categories. It can increase seasonal and regional availability, improve processing and manufacturing, and reduce distribution requirements. Exhibit 3 offers a sample of potential reduced-cost products.

Take the example of preservative-free bread. If wheat could be genetically modified to produce bread that stays fresh longer, consider what would happen to the entire business system. The new bread could be delivered to stores less frequently, with far-reaching implications: the current infrastructure for direct store delivery could be virtually dismantled, with bread shipped to grocery chain warehouses instead. Labor requirements would be substantially reduced, as would product waste, and baking operations would be simplified. Such a scenario raises a key question: who would eventually take advantage of the opportunity to reshape the entire bread-making business system—today's bread manufacturers, or an entrant pursuing a new game?

Remarkable though some of these breakthroughs may seem, the revolution has only just begun. Over the next five to ten years, the pace of biotechnology innovation will quicken in response to three accelerators:

Bioengineering capabilities are increasing. Gene mapping is a set of technologies that enables scientists to identify the function of every gene in a living organism. The best-known example is the Human Genome Project, which seeks to pinpoint the role and position in the chromosome of every human gene. Between 1992 and 1995, the number of human gene sequences that had been elucidated and mapped increased more than fourfold. Progress in the identification and mapping of gene sequences for maize is almost as rapid, though less visible. Monthly inquiries into the maize genome database grew more than fifteen-fold between 1994 and 1997, testifying to the intense activity in corn genetics.

Understanding plant genomes allows scientists to target their development efforts much more precisely. DuPont's research into corn has yielded a strain with a higher oil content than current varieties. Monsanto and its affiliate Calgene have developed several types of modified canola oil. As the understanding of lipid pathways deepens, companies will be able to bring to market corn that produces not just greater quantities of oil, but oil with desirable characteristics, such as "good cholesterol" oil or canola and soy oils with the properties of olive oil.

Development times are declining. In parallel with the rise in plant gene mapping, the quality and mastery of genetic manipulation tools are also improving. Scientists are developing more effective gene insertion capabilities, more powerful information capabilities, and more advanced plant breeding techniques. They are preparing the ground for the manipulation of lipids, proteins, and carbohydrates, and the early progress they have made in modified oils—for instance, in margarine produced from canola oil without hydrogenation—demonstrates the feasibility of their efforts. As a result, we can expect to see a dramatic reduction in development times and a rapid stream of new products and ingredients.

Development efforts are now pursuing changes in product characteristics. With agronomic development programs well under way and innovations such as herbicide-tolerant or insect-resistant crops already reaching the market, biotechnology developers seem to be paying increasing attention to food quality. Field permits granted by the US Department of Agriculture are revealing. Food quality innovations grew from 11 percent of all agricultural field release permits in 1988 to a high of 33 percent in 1994 (Exhibit 4). In the past five years, permits have also been granted for the use of plants as "factories" for pharmaceuticals, industrial enzymes, and polymers.

Industry observers anticipate that the number of biotechnology-enabled food innovations will continue to grow as our understanding of the relationships between the genetic structure of plants and the physical attributes of food texture, flavor, and nutrition improves. Food quality innovations are already moving quickly through the pipeline. From the handful of products on the market today—a few new varieties of tomatoes, potatoes, and beans—we will move to a full menu five years from now.

No time to wait and see

Despite the progress that has been made, uncertainties about biotechnology remain. It is easy to be skeptical about the technological feasibility, timing, impact, and value of innovation. Many consumers—especially in Europe—are apprehensive about the possible effects of genetically modified food on human beings. Industry participants, their associations, and government bodies should address these concerns by mounting proactive information and education campaigns.

Given the technological, economic, social, and even philosophical uncertainty surrounding biotechnology, it might appear sensible to monitor developments and take action only when doubts have begun to be resolved. This could be a big mistake. A "wait and see" strategy is risky. Industry change will be rapid, and food companies adopting a passive stance may find their options limited later.

Current industry dynamics suggest that a few leading-edge developers will play a major role in the commercialization of biotechnology-enabled food products. Most pioneering plant biotechnology research and development is proprietary to a handful of private enterprises with extensive patent and intellectual property protection. They own patents on specific genes with valuable activity, such as the gene controlling the production of certain enzymes in soybeans that give them their taste. At the other end of the spectrum, they own "composition of matter" patents that relate to the characteristics of a final product, such as the oil content of a particular variety of corn.

Developers also control the tools that enable them to progress from discovering a gene to creating a product. Patents in this area involve the markers used to screen for a desirable trait (such as solid content in potatoes), the method of inserting a gene into a plant, the "promoters" used to improve the expression of a trait in a plant, and the molecular markers that help identify plants with the right gene mix.

In 1990, over 30 companies were involved in plant and food biotechnology. Today, there are just seven major developers: AgrEvo (Hoechst/Schering), DNAP Holding Corporation (ELM), DuPont/Pioneer, Monsanto, Mycogen (Dow), Novartis, and Zeneca. While much activity once took place in small to medium-sized research "boutiques," the science is now mostly in the hands of large, well-funded agricultural, chemical, and pharmaceutical giants.

This small pool of powerful developers has an enormous investment at stake. Five of the largest developers had annual R&D budgets ranging from $730 million to $2.5 billion in 1996—about ten times the budgets of most of the top 20 US and European food companies. Only Procter & Gamble and Unilever spend roughly as much as the top five developers; Philip Morris and Nestlé come close, at approximately $500 million each.

While the biotechnology developers' R&D expenses are spread over several industries, an estimated $2 billion has been poured into plant and food biotechnology research since 1990. On top of R&D expenses, the leading players have spent tens to hundreds of millions in acquisition premiums, realizing that they need to achieve scale in R&D and to rationalize patent ownership. Collectively, biotechnology developers need to recoup an investment of the magnitude of $8 billion.

Companies that wait to see how a trend develops could find themselves locked out of the game before it even begins

These developers will seek to recover their heavy research and acquisition spending by realizing the full value of their innovations. In some cases, they will find it beneficial to enter into arrangements granting food manufacturers exclusive or preferential access to their technology. These food manufacturers will then use their first-mover advantage to shape categories around their own economics and products. In such an environment, companies that wait to see how a trend develops could find themselves locked out of the game before it even begins.

With so much at stake, some food manufacturers, catching the sense of urgency, may be starting to adopt positions that could severely limit opportunities for rivals opting for a "wait and see" approach. Companies such as Frito-Lay, Japan Tobacco, Kirin, and Unilever are already actively engaged in biotechnology programs. How, then, should food companies begin to build a biotechnology strategy?

We believe they should take three basic steps:

1. Conduct a business audit to determine which of their product categories are likely to be affected by biotechnology-enabled innovations
2. Identify the best prospective partners among biotechnology developers
3. Form relationships with developers and stake out biotechnology positions in the marketplace.

1. What are the opportunities?

The objectives of a biotechnology business audit are twofold: to identify opportunities and risks, and to determine what level of access should be sought to which technologies. A food company undertaking a biotechnology business audit should first identify and prioritize the category, product, or other areas in which it might gain competitive advantage through biotechnology-enabled innovations, looking at both immediate opportunities and the more distant future. It should initially concentrate on opportunities within its current portfolio of categories and products. Naturally, assessing these opportunities will also involve quantifying potential risks.

The goal is to generate, for a given product or category, a wide-ranging inventory of ideas, concepts, and opportunities to fulfill unmet needs or reduce supply costs. Take potato chips. An inventory of biotechnology-enabled opportunities might produce some of the following ideas: make chips healthier by increasing potatoes' solid content so that they absorb less oil when fried; develop new flavors (for example, "Garlitoes," potatoes with a hint of garlic for natural spicy flavoring); create new products such as "Potatanoes" (or "Bananatoes"), a cross between potatoes and bananas; and reduce handling and processing requirements by cultivating firmer potatoes that are more uniform in size.

To conduct this stage of the audit effectively, companies will need to address such questions as:

• What product attributes could drive share gains—for instance, by improving benefits, by removing barriers for non-users, or by better meeting the needs of heavy users?
• How can the category be expanded—for instance, by better meeting the needs of fringe users, by boosting affordability, or by increasing availability?
• How can product profitability be improved?

Here is an opportunity to go beyond gradual improvements and use biotechnology as a licence to be creative

After completing an inventory of opportunities within the current business portfolio, companies should use the audit to widen their field of view. For decades, innovation in the food industry has been essentially incremental: a new flavor, a new size. Here is an opportunity for brand and product managers to go beyond gradual improvements and use the potential of biotechnology as a licence to be creative. Companies can identify the most promising innovations and explore new products and categories by asking questions like:

• What new categories could we enter—for instance, by applying to other businesses the biotechnology breakthroughs we anticipate in our current business?
• How can we totally restructure the category? Instigate an economic discontinuity? Play a new game?
• What brand-new categories can we create?

In the second part of the audit, a food company should try to determine how different levels of access to developers' technology would affect its ability to offer innovations to consumers and capture value. In many cases, exclusivity or narrow access will be its preferred option. The biotechnology developer, on the other hand, may feel that broad diffusion of its technology is critical to earning an adequate return on its R&D investment. Food companies thus need to acquire a clear understanding of a technology's market value under several different levels of access before they embark on serious discussions with biotechnology developers.

The questions they should ask themselves include:

• What happens if the biotechnology developer opts for exclusive access arrangements? What would be the value of incremental share, category growth, or unit profitability captured through exclusive access for our company? What would be the value of exclusive access for our competitors? Are we a natural owner of the technology, or does its developer have a better candidate for exclusive partner?
• What happens if there is broad access to the technology? What will be its value for us and for our competitors? Is the biotechnology developer better or worse off than if it granted exclusive access? What would happen if we had one or two years' lead time over the competition? How much would that be worth to us?

The results of the business audit will drive a company's biotechnology agenda. Once opportunities are identified and valued under various access scenarios, selecting areas to target will be a straightforward matter. The company should then seek to influence the development and commercialization agendas of biotechnology developers in its chosen priority areas.

The ability to influence should not be underestimated. Food companies are, after all, in the best position to understand consumers and their needs and identify market opportunities. Leveraged judiciously, their knowledge can be used to steer biotechnology partners' efforts in the most productive directions, saving years of development and optimizing the use of valuable R&D resources.

2. Who are the players?

As its business audit gets under way, a food company needs to make its own assessment of the current field of biotechnology developers—a task simplified by the consolidation that has taken place since the early 1990s. Close study should reveal how and where developers' research efforts might fit with the food company's categories and opportunities. This process should also include an evaluation of developers' strengths and weaknesses as revealed in their patents, technologies, and product pipelines. The food company should develop hypotheses about areas in which partnerships might be formed, and be aware of those in which alliances have already been established.

Once it has put in place a clear picture of business opportunities, an understanding of the value of various technologies under different access scenarios, and an assessment of biotechnology developers, the food company will have the essential building blocks for a biotechnology strategy.

3. Where should we play?

Equipped with precise objectives regarding product specifications, target crops, sought-after benefits, and level of access to desirable technologies, the food company should embark on a series of discussions with biotechnology developers with a view to staking out a position in the industry. These discussions should touch on a number of issues, among them whether any relationship would be for a single licence or for multiple technologies, whether it would involve research into a particular trait or into a series of improvements in a given crop or portfolio of crops, and what level of access to the technology and to its future generations would be provided.

The food company should see itself as eventually being at the center of a web of biotechnology providers—a web that acts as its virtual R&D laboratory. It may ultimately form a single-technology alliance with developer A, an across-the-board partnership with developer B for all advances made in a specific crop, and a research agreement with developer C for a particular trait.

As its relationship strategy takes shape, the food company will need to assemble an appropriate set of in-house capabilities, which are likely to be very different from those found in a traditional internal R&D organization. The challenge will be to manage the complexity of a web that embraces a variety of partners and partnership forms. This will involve new processes such as joint planning, R&D interfaces, and regulatory coordination, and new positions including product development liaison, manufacturing experts, and a small cadre of researchers. Market research will need a complete overhaul so that instead of merely confirming short-term trends, it helps identify changes in needs that may be several years off. R&D skills will have to be constantly upgraded to keep pace with the progress of nutritional science. A new culture characterized by increased transparency, a forward outlook, and broad-based teamwork will bind the virtual organization.

Finally, food companies will need to determine what role they want to play in influencing consumer acceptance of biotechnology-enabled innovations, and hence governmental and other regulatory policy. A critical first step could be to help define an overall industry perspective on food biotechnology. This could lead to a set of concerted actions to promote a better understanding of biotechnology and its potential to help feed the planet in the new millennium.

Biotechnology is already creating exciting opportunities for food companies, and the pace of innovation is accelerating. The food industry will be transformed far more rapidly than conventional wisdom suggests. Now is the time for companies to focus on this issue; partnerships formed today will become the basis for a new industry structure. A "wait and see" strategy could mean missing out on perhaps the most potent source of innovation and growth in the entire food business.