New Way to Develop, Support Products May Boost Profits 30 Percent
Jack A. Nickerson, Tat Chan, Hideo Owan
Olin School of Business, Washington University, March 2007
In dating, it is commonly said that you don't want to be looking for a date when you're desperate; you want to find one before you become desperate. Business professors at Washington University in St. Louis have found that the same concept applies to business. Jackson Nickerson, Professor of Organization and Strategy at the Olin School of Business, and his team find that in business the advice applies to how firms should manage their research and development (R&D) pipelines.
Nickerson makes the case that firms that invest in R&D could potentially improve long-run profitability up to 30 percent or more by following the authors' guidelines.
Using the pharmaceutical industry as an example, Nickerson pointed out how several drug companies in the 1990s set their sights on developing blockbuster drugs. Firms used the more traditional approaches of managing their R&D portfolios to achieve their goal. Yet, these same firms were typically the ones that later suffered from thin pipelines and the threat of running out of products in particular therapeutic classes in which they enjoyed a long-standing position. With precariously thin pipelines, firms grew desperate and paid top-dollar to acquire or license drug candidates or to acquire or merge with other firms that had complementary pipelines.
Nickerson, Owan and Chan's main insight comes from the observation that firms often make downstream, co-specialized investments that are unique for commercializing a particular product or set of products. These outlays support the success of launched products and provide much value for supporting future products. These investments, once made, create an incentive for firms to keep the co-specialized assets fully utilized. Nickerson claims that firms are even willing to lose money in the short run just to keep the assets from deteriorating or, in the case of human assets, to keep them from walking out the door.
The authors' model offers two main findings that differ from the standard management approaches. First, firms should partition their portfolios based on how projects match up with the different bundles of downstream co-specialized assets owned by the firm. Second, firms should actively manage these partitioned portfolios by varying up and down the financial thresholds used to advance projects to the next stage of development.
By "finding dates before getting desperate," the authors argue that in the long run it is more profitable for firms to keep the pipelines full, which means that they may have to advance projects for smaller drugs or accelerate or acquire projects as soon as the pipeline begins to thin. It doesn't mean every drug in a company should have the same financial threshold.
The findings suggest that the traditional way of teaching students to calculate the expected value of projects may not be the optimum rule for considering R&D as long as there are co-specialized downstream investments. The research also indicates when companies should commercialize their R&D projects and when they should sell them.
The paper, "Strategic Management of R&D Pipelines with Co-Specialized Investments and Technology Markets," is to be published in the journal Management Science.
