Michael Pellini fires up his computer and opens a report on a patient with a tumor of the salivary gland. The patient had surgery, but the cancer recurred. That’s when a biopsy was sent to Foundation Medicine, the company that Pellini runs, for a detailed DNA study. Foundation deciphered some 200 genes with a known link to cancer and found what he calls “actionable” mutations in three of them. That is, each genetic defect is the target of anticancer drugs undergoing testing—though not for salivary tumors. Should the patient take one of them? “Without the DNA, no one would have thought to try these drugs,” says Pellini. 

Starting this spring, for about $5,000, any oncologist will be able to ship a sliver of tumor in a bar-coded package to Foundation’s lab. Foundation will extract the DNA, sequence scores of cancer genes, and prepare a report to steer doctors and patients toward drugs, most still in early testing, that are known to target the cellular defects caused by the DNA errors the analysis turns up. Pellini says that about 70 percent of cases studied to date have yielded information that a doctor could act on—whether by prescribing a particular drug, stopping treatment with another, or enrolling the patient in a clinical trial.

The idea of personalized medicine tailored to an individual’s genes isn’t new. In fact, several of the key figures behind Foundation have been pursuing the idea for over a decade, with mixed success. “There is still a lot to prove,” agrees Pellini, who says that Foundation is working with several medical centers to expand the evidence that DNA information can broadly guide cancer treatment.

Foundation’s business model hinges on the convergence of three recent developments: a steep drop in the cost of decoding DNA, much new data about the genetics of cancer, and a growing effort by pharmaceutical companies to develop drugs that combat the specific DNA defects that prompt cells to become cancerous. Last year, two of the 10 cancer drugs approved by the U.S. Food and Drug Administration came with a companion DNA test (previously, only one drug had required such a test). So, for instance, doctors who want to prescribe Zelboraf, Roche’s treatment for advanced skin cancer, first test the patient for the BRAFV 600E mutation, which is found in about half of all cases.

About a third of the 900 cancer drugs currently in clinical trials could eventually come to market with a DNA or other molecular test attached, according to drug benefits manager Medco. Foundation thinks it makes sense to look at all relevant genes at once—what it calls a “pan-cancer” test. By accurately decoding cancer genes, Foundation says, it uncovers not only the most commonly seen mutations but also rare ones that might give doctors additional clues. “You can see how it will get very expensive, if not impossible, to test for each individual marker separately,” Foundation Medicine’s COO, Kevin Krenitsky, says. A more complete study “switches on all the lights in the room.”

So far, most of Foundation’s business is coming from five drug companies seeking genetic explanations for why their cancer drugs work spectacularly in some patients but not at all in others. The industry has recognized that drugs targeted to subsets of patients cost less to develop, can get FDA approval faster, and can be sold for higher prices than traditional medications. “Our portfolio is full of targets where we’re developing tests based on the biology of disease,” says Nicholas Dracopoli, vice president for oncology biomarkers at Janssen R&D, which is among the companies that send samples to Foundation. “If a pathway isn’t activated, you get no clinical benefit by inhibiting it. We have to know which pathway is driving the dissemination of the disease.”

Cancer is the most important testing ground for the idea of targeted drugs. Worldwide spending on cancer drugs is expected to reach $80 billion this year—more than is spent on any other type of medicine. But “the average cancer drug only works about 25 percent of the time,” says Randy Scott, executive chairman of the molecular diagnostics company Genomic Health, which sells a test that examines 16 breast-cancer genes. “That means as a society we’re spending $60 billion on drugs that don’t work.”

Analyzing tumor DNA is also important because research over the past decade or so has demonstrated that different types of tumors can have genetic features in common, making them treatable with the same drugs. Consider Herceptin, the first cancer drug approved for use with a DNA test to determine who should receive it (there is also a protein-based test). The FDA cleared it in 1998 to target breast cancers that overexpress the HER2 gene, a change that drives the cancer cells to multiply. The same mutation has been found in gastric, ovarian, and other cancers—and indeed, in 2010 the drug was approved to treat gastric cancer. “We’ve always seen breast cancer as breast cancer. What if a breast cancer is actually like a gastric cancer and they both have the same genetic changes?” asks Jennifer Obel, an oncologist in Chicago who has used the Foundation test.

The science underlying Foundation Medicine had its roots in a 2007 paper published by Levi Garraway and Matthew Meyerson, cancer researchers at the Broad Institute, in Cambridge, Massachusetts. They came up with a speedy way to find 238 DNA mutations then known to make cells cancerous. At the time, DNA sequencing was still too expensive for a consumer test—but, Garraway says, “we realized it would be possible to generate a high-yield set of information for a reasonable cost.” He and Meyerson began talking with Broad director Eric Lander about how to get that information into the hands of oncologists.

In the 1990s, Lander had helped start Millennium Pharmaceuticals, a genomics company that had boldly promised to revolutionize oncology using similar genetic research. Ultimately, Millennium abandoned the idea—but Lander was ready to try again and began contacting former colleagues to “discuss next steps in the genomics revolution,” recalls Mark Levin, who had been Millennium’s CEO.

Levin had since become an investor with Third Rock Ventures. Money was no object for Third Rock, but Levin was cautious—diagnostics businesses are difficult to build and sometimes offer low returns. What followed was nearly two years of strategizing between Broad scientists and a parade of patent lawyers, oncologists, and insurance experts, which Garraway describes as being “like a customized business-school curriculum around how we’re going to do diagnostics in the new era.”

In 2010, Levin’s firm put $18 million into the company; Google Ventures and other investors have since followed suit with $15.5 million more. Though Foundation’s goals echo some of Millennium’s, its investors say the technology has finally caught up. “The vision was right 10 to 15 years ago, but things took time to develop,” says Alexis Borisy, a partner with Third Rock who is chairman of Foundation. “What’s different now is that genomics is leading to personalized actions.”

One reason for the difference is the falling cost of acquiring DNA data. Consider that last year, before his death from pancreatic cancer, Apple founder Steve Jobs paid scientists more than $100,000 to decode all the DNA of both his cancerous and his normal cells. Today, the same feat might cost half as much, and some predict that it will soon cost a few thousand dollars.

So why pay $5,000 to know the status of only about 200 genes? Foundation has several answers. First, each gene is decoded not once but hundreds of times, to yield more accurate results. The company also scours the medical literature to provide doctors with the latest information on how genetic changes influence the efficacy of specific drugs. As Krenitsky puts it, data analysis, not data generation, is now the rate-limiting factor in cancer genomics.

Although most of Foundation’s customers to date are drug companies, Borisy says the company intends to build its business around serving oncologists and patients. In the United States, 1.5 million cancer cases are diagnosed annually. Borisy estimates that Foundation will process 20,000 samples this year. At $5,000 per sample, it’s easy to see how such a business could reward investors. “That’s … a $100-million-a-year business,” says Borisy. “But that volume is still low if this truly fulfills its potential.”

Pellini says Foundation is receiving mentoring from Google in how to achieve its aim of becoming a molecular “information company.” It is developing apps, longitudinal databases, and social-media tools that a patient and a doctor might use, pulling out an iPad together to drill down from the Foundation report to relevant publications and clinical trials. “It will be a new way for the world to look at molecular information in all types of settings,” he says.

Several practical obstacles stand in the way of that vision. One is that some important cancer-related genes have already been patented by other companies—notably BRCA1 and BRCA2, which are owned by Myriad Genetics. These genes help repair damaged DNA, and mutations in them increase the risk of breast or ovarian cancer. Although Myriad’s claim to a monopoly on testing those genes is being contested in the courts and could be overturned, Pellini agrees that patents could pose problems for a pan-cancer test like Foundation’s. That’s one reason Foundation itself has been racing to file patent applications as it starts to make its own discoveries. Pellini says the goal is to build a “defensive” patent position that will give the company “freedom to operate.”

Another obstacle is that the idea of using DNA to guide cancer treatment puts doctors in an unfamiliar position. Physicians, as well as the FDA and insurance companies, still classify tumors and drug treatments anatomically. “We’re used to calling cancers breast, colon, salivary,” says oncologist Thomas Davis, of the Dartmouth-Hitchcock Medical Center, in Lebanon, New Hampshire. “That was our shorthand for what to do, based on empirical experience: ‘We tried this drug in salivary [gland] cancer and it didn’t work.’ ‘We tried this one and 20 percent of the patients responded.’”

Now the familiar taxonomy is being replaced by a molecular one. It was Davis who ordered DNA tests from several companies for the patient with the salivary-gland tumor. “I got bowled over by the amount of very precise, specific molecular information,” he says. “It’s wonderful, but it’s a little overwhelming.” The most promising lead that came out of the testing, he thinks, was evidence of overactivity by the HER2 gene—a result he says was not picked up by Foundation but was found by a different test. That DNA clue suggests to him that he could try prescribing Herceptin, the breast-cancer drug, even though evidence is limited that it works in salivary-gland cancer. “My next challenge is to get the insurance to agree to pay for these expensive therapies based on rather speculative data,” he says.

Insurance companies may also be unwilling to pay $5,000 for the pan-cancer test itself, at least initially. Some already balk at paying for well-established tests, says Christopher-Paul Milne, associate director of the Tufts Center for the Study of Drug Development, who calls reimbursement “one of the biggest impediments to personalized medicine.” But Milne predicts that it’s just a matter of time before payers come around as the number of medications targeted to people’s DNA grows. “Once you get 10 drugs that require screening, or to where practitioners wouldn’t think about using a drug without screening first, the floodgates will open,” he says. “Soon, in cancer, this is the way you will do medicine.”

Adrienne Burke was founding editor of Genome Technology magazine and is a contributor to Forbes.com and Yahoo Small Business Advisor.