Why Interfirm Agreements Are Driving New Product DevelopmentPublished: September 07, 2005 in Knowledge@Emory
On any given day pharmaceutical firms embrace the concept of collaboration. Licensing agreements, strategic alliances, even acquisitions help define the relationships between different drug makers as they seek to develop and sell the next best radical new pill or treatment. MultiCell Technologies announces a licensing agreement between Bristol-Myers Squibb and MultiCell’s licensee, Xenotech; Actavis plans to acquire Amide Pharma; Indevus to acquire marketing rights to Sanctura from Odyssey Pharmaceutical; Sucampo Pharmaceuticals receives $20 million from its business partner, Takeda Pharmaceutical—to name only a few recent deals in the news.
These relationships, called interfirm agreements, often go beyond the commercial to the more cerebral, an exchange that is less about the money and more about the deeper exchange of knowledge. Academic literature validates that in general, interfirm agreements are drivers of new product development. These agreements have proven worthy both academically and in real-world practice.
Research in this area typically looks at individual interfirm agreements between companies to determine the dimensions of that particular information exchange. Stefan Stremersch, a visiting associate professor of marketing at Emory University’s Goizueta Business School, has expanded that analysis to consider the nature of knowledge transfer that occurs through firms’ portfolios of R&D agreements, rather than individual isolated agreements. In other words, he is analyzing groups of these agreements, rather than just one at a time. Stremersch, with the help of Stefan Wuyts, assistant professor of marketing at Tilburg University in The Netherlands, and Shantanu Dutta, professor of marketing at the Marshall School of Business, University of Southern California, studies the impact of portfolios of agreements on firms’ innovative success in the paper, “Portfolios of Interfirm Agreements in Technology-Intensive Markets: Consequences for Innovation and Profitability.” Specifically, the authors study upstream R&D agreements between pharmaceutical and biotech companies because these types of agreements, separate from commercial agreements between firms, are said to aid in innovation. In many industries, firms form R&D agreements to access knowledge from other firms.
“Our focus on the entire portfolio of R&D agreements a firm is engaged in allows us to capture descriptors that cannot be captured by studying agreements in isolation,” explains Stremersch, who has worked for the past eight years on issues related to technology innovation and, through this paper, took his maiden measurements in pharmaceuticals and biotechnology. “I used to not talk a lot about biotechnology and to talk instead about information technology. This spurred me to think more about what issues biotech and pharmaceutical firms are going through in the innovation process.”
Stremersch and his coauthors focus on two specific R&D agreement portfolio descriptors in their study—the portfolio’s technological diversity and level of repeated partnering. Technological diversity of a portfolio refers to how many technologies a firm has agreements with other firms on, over the entire portfolio. Repeated partnering means with how many partners on average?
“There is this tension between the diversity of information that you get and the quality of information that you get from these interfirm agreements,” notes Stremersch. “In our study, we defined this as the theoretical difference between the technological diversity of the portfolio—to what extent does a firm’s knowledge base become diverse as a result of these alliances—and the repetitive partnering, which basically looks at whether firms partner with the same company or various companies and how that affects the quality and the nature of the information that they get.”
The paper specifically studies the effect of these portfolio characteristics on both radical and incremental innovation. “When innovations incorporate a substantially different core technology and provide substantially higher customer benefits relative to previous products in the industry, we call them ‘radical,’ the authors explain. When one or both of these conditions are not met, we call them ‘incremental,’ “ Stremersch explains. They also study the impact of radical and incremental innovation on profitability.
The researchers collected data on pharmaceutical firms’ upstream R&D agreements with biotechnology firms, new drugs from the drug approval list of the Federal Drug Administration (FDA), profitability, firm size, sales expenses and R&D expenses, and on biotechnology patents and patent citations. The resulting database contains yearly data on the agreement portfolios of 58 publicly traded pharmaceutical firms over the period 1985-1998. In total, the database covered 991 R&D agreements.
Stremersch’s findings help to explain the impact of portfolios of R&D agreements on innovation and profitability. The technological diversity of the portfolio may lead to more diverse knowledge getting transferred through the agreements of the firm with other firms, from different technology classes. Repeated partnering may lead to a higher degree of transfer of knowledge from that same partner. In essence, if you have multiple agreements with a certain partner, you may expect that you learn much more, than if these were agreements with all different partners. “The interesting thing we found is that it is very good to have a technologically diverse portfolio for radical innovation, to basically ally several different technologies. We also found that it was consistently good to do it with the same partner,” says Stremersch. “Radical innovations are mostly born out of diversity, people interconnecting with each other who would not connect otherwise. Our findings bring together weakness and strength—the strength of always [associating] with the same partner, which gives you very high-level information transfer, but on the other hand not always becoming obsessed with this one partner and instead getting knowledge from different technology areas.”
The analysis also shows that radical innovation has a much higher effect on profitability, while incremental innovations, surprisingly, don’t have any effect at all. “Only through radical innovations do you build up your profitability,” notes Stemersch. “This is an interesting finding because the risk is much higher. It’s more profits for higher risk.”
This in-depth look at portfolios of interfirm agreements provides managers with clear guidelines on how to build an effective portfolio, stressing the importance of portfolio diversity and repeated partnering. Results also suggest to managers that firms may have to make radical innovation the core objective of their innovation strategies if they want to maximize profits.Through his work on this paper, Stremersch has come to recognize the vast research potential connected with life sciences and innovation. He is currently working on related studies that couple pricing with R&D. “A lot of the innovation decisions that firms are taking are driven by the prices they can charge for those innovations,” observes Stremersch. “In each stage of development and clinical trials, they have a rough estimate of what the efficacy of the drug may be. Given this expected level of efficacy, they can figure out in which countries they can charge which price for it. That price-setting is going to drive whether they are going to further invest in improving the drug and continue developing it or not. That has a huge public policy impact.” Expect more from Stremersch on this topic, as well as efficacy-driven marketing and the development of customized pharmaceutical and medical treatments.