For most managers, it’s easier to assign resources than to terminate a project, and the result is that unsuccessful projects often live longer than they should.  How does this impact business, and can the capability to manage this process more effectively give a firm a measurable competitive advantage?

 

The 2004 Atlanta Competitive Advantage Conference (ACAC), hosted by Emory University’s Goizueta Business School, explored this question as well as a variety of topics impacting competitive advantage. This academic research conference was co-sponsored by Georgia State University and Georgia Institute of Technology, with corporate sponsorship from BrightHouse, and featured panel discussions and presentations of 42 research studies conducted by professors from 34 different business schools and universities, including Stanford, Columbia, INSEAD, Dartmouth, and New York University.

 

In a session titled “Decisions about Investments in Capabilities”, three professors presented papers concerning how and why managers make—or don’t make—decisions to invest in capabilities.  Two of the papers addressed a common management dilemma—the process of making decisions regarding investments in capabilities, and why management may not “pull the plug” even when resources might be better used elsewhere.  A third paper used a “real options” approach to explore why firms might abandon a patent, proposing that it may make sense for firms to give up potential sources of competitive advantage.

           

The presentations left session chair Russ Coff, associate professor of organization and management at Goizueta Business School, optimistic about future research regarding competitive advantage; specifically, a firm’s ability to terminate resources.  “Managers could do something in a systematic way to improve this capability,” Coff said.

 

In the first paper, “Pulling the Plug:  the Capability to Manage Unsuccessful Investments in Firm Performance,” Boston University’s Isin Guler, assistant professor, strategy and policy department, focused on sequential investments in the venture capital industry.  Guler asked “Is it possible to measure the effect of a firm’s terminating capability on its performance?”  Her answer: “I’d like to suggest that investment management is a distinct advantage we can measure.” 

 

According to Guler, the logic of sequential investments (multiple investments in a capability over time) requires that investments be terminated when they are no longer economically justified.  Her study proposes that firms are likely to exhibit different levels of success in terminating unsuccessful investments.

 

Guler’s study focused on the venture capital (VC) industry, since VC firms must regularly withdraw support from ventures.  Guler studied 331 VC firms and tracked their investments in over 1900 companies from 1979 through 1993 as well as the performance of the ventures through the year 2000.  Her analysis showed that firms exhibited different levels of termination capability and that this capability was a significant predictor of long-run firm performance.

 

“[VC] is about picking the home run, but only 7% of a VC’s portfolio is a home run.  Ninety-three percent is not,” Guler said.  “You have to be good at managing those [non home runs].”  (Guler noted that her findings would apply to industries such as pharmaceuticals, movies and music, which operate similarly to the VC industry). 

 

As Guler and several session attendees pointed out, it’s sometimes easier for researchers to eliminate a number whereas managers have to eliminate not only salaries, but also the employees who go along with those salaries.   “A lot of other things go into terminating capabilities,” said Guler.

 

According to Coff, the tension between assigning resources and terminating capabilities is something managers must come to grips with.  “What’s more important,” Coff asked in response to Guler’s presentation, “the ability to pick the winners or the ability to terminate the [non-winners]?”  Guler’s numbers suggest that a firm’s ability to better manage the “non home runs” gives them a clear advantage. 

 

On the flip side, VC firms that had a specific industry focus tended to do better than those firms that did not.  Guler’s numbers also indicated that companies that received fewer rounds of VC funding did better over time.

 

Columbia Business School assistant professor of management Atul Nerkar addressed a similar problem with the paper, “Giving Up Sources of Potential Competitive Advantage:  The Role of Learning in the Abandonment of Real Options.”  (Nerkar co-authored the paper with Ian MacMillian, professor of management, the Wharton School at the University of Pennsylvania).

 

Their study focused on the pharmaceutical industry.  The two professors used options logic to explore why a firm might not renew a patent.  “Patents are potential sources of competitive advantage,” said Nerkar.  “Ironically, 40% of these patents are given up.” 

 

Nerkar considers patents to be a real option.  (A real option is defined as the right, but not an obligation, to undertake a business decision, typically the option to make a capital investment.)   Because patents are rare, provide a barrier to entry in a market, are inimitable and valuable, Nerkar considers them to be a source of competitive advantage.  So why would a firm give them up?

 

“The ‘three L framework,’” said Nerkar.  “Litigate.  License.  Leverage.”  Even though the cost of renewing a patent is less than $1000, the legal fees associated with the renewal average $30,000.  Licensing is costly, too.  Many companies, such as IBM, have departments relegated to nothing but licensing its patented technology.  “The cost of litigation is not so trivial,” Nerkar noted, “and the costs of licensing and administrative costs are substantial.”

 

Nerkar took a look at several hypotheses, including the likelihood that the patent—the real option—would be abandoned depending on whether the use of the patent (or the knowledge or technology associated with the patent) increased or decreased within the firm.  “If more outsiders are using the technology, the more you want to keep [the patent],” said Nerkar.  “If there’s high internal use, the firm may not gain much from external use of the patent because some patents are difficult to license.”

 

Nerkar found that firms made decisions about whether or not to abandon patents along those lines.  According to Nerkar, this indicates that management “values internal learning over external learning.”

 

Nerkar and MacMillian also investigated the amount of time pharmaceutical companies held onto patents.  Since the cost of bringing a drug to market is substantial (according to GlaxoSmithKline, bringing a drug to market can cost $800 million and take 15 years), adeptly managing resources is incredibly important to pharmaceutical companies.

 

Pharmaceutical companies, much like the VC firms in Guler’s study, must choose potential “winner” drugs and protect those “winners” from competitors by garnering a patent; thereby establishing a competitive advantage.  As in Guler’s study, the “non home runs” out weigh the home runs, so how companies manage the so-called losers is important to a firm’s performance.

 

Nerkar noted that in 1995, approximately 4000 patents were granted in the pharmaceutical industry.  When those patents came up for renewal in 1999 (patents come up for renewal every four years), Nerkar discovered that each patent had been renewed.

 

Over time, however, 40% of patents are abandoned. “By not renewing a patent, what [the firm] is telling us is that the potential has run out,” added Coff.  “When the firm dumps them, it’s no longer a source of competitive advantage.”

 

State University of New York at Buffalo assistant professor, management science & systems, Catherine Maritan presented a paper (co-authored with Corinne Coen, assistant professor, organization and human resources, State University of New York at Buffalo) that looked at building capabilities rather than terminating them.  The paper, “Investing in Capabilities:  An Agent-based Model of Processes, Decisions and Performance,” linked capability building to resource allocation.  The authors also investigated the process of investing in capabilities.

 

What they found was that a superior initial endowment in capabilities mattered, but not for long.  “Over time, the rivals can catch up,” said Maritan.  They also discovered that a low initial endowment in capabilities was worth noting, but that if a firm had a better chance of seeing new projects than its rivals, “it could compensate for a low initial endowment,” Maritan added.

 

“Initial capability endowments and search routines both matter for performance,” Maritan said of her findings.  “And a superior capability endowment and better search routines can substitute for each other.”  What can managers do to improve the process?  According to Maritan, managers can only improve the process “within certain ranges under certain conditions.”

 

In discussing Maritan’s presentation, Coff translated the “chance of seeing new projects” into the word, “vision,” or, as he elaborated, “the ability to see what others miss.”

 

After the presentations, Coff concluded, “there’s a whole resource investment cycle we need to be looking at in terms of how firms acquire resources and what they do with them.”  According to Coff, researchers need to examine “P.A.I.D.:” how firms Pick new resources, how they Accumulate complementary resources, how they Integrate resources and how they Dispose of resources. 

 

Of the session topics, Coff seemed most excited about future research regarding the disposal of resources.  “Hanging on too long is a fundamental management problem,” Coff said.  “And there’s very little research on that.”