Innovative Productivity in Pharmaceutical Firms

Overview: As mergers and acquisitions continue throughout the pharmaceutical industry, firms grow larger. Yet, in pharmaceutical research, bigger is not necessarily better. Evidence from a 19-year study of new product output across 31 firms suggests that the number of new chemical entities produced per R&D dollar is not enhanced ever-increasing firm size. As a result, large pharmaceutical firms should consider restructuring and rationalizing their R&D efforts with an eye toward trying to create a smaller firm atmosphere within their larger firm environment. Tactics available to help realize this goal include decentralization, nurturance of researchers, and strategic alliances with other firms. In July 1990, the Wall Street Journal described the pharmaceutical industry as one "undergoing cataclysmic changes as companies merge and forge alliances with one another in unprecedented numbers"(1). Indeed a number of mergers and joint ventures have taken place. In 1989, Bristol Myers merged with Squibb, Smithkline Beckman was bought by Beecham, and Marion Laboratories merged with Merrell Dow. In 1990, American Home Products purchased A. H. Robins, Sterling Drug was acquired by Kodak, Hoffman-LaRoche gained a controlling interest (60 percent) in Genentech, and a 50-50 joint venture was established by Merck and Du Pont. The general trend in the industry, quite clearly, has been toward increasing size and resources. What can be expected in terms of new product output (which we call innovative productivity), given this trend to larger and larger firm sizes? That is, what happens to the output of new products as pharmaceutical firms grow? We have completed a 19-year study of new product output defined as new chemical entities (NCEs) introduced, in 31 pharmaceutical firms. Our research shows that bigger is not necessarily better. That is, while there is a positive relationship between increasing firm size and increasing output of NCEs, the level of that increased output tends to decrease with increasing size. In other words, innovative productivity--the number of NCEs per sales dollar or R&D dollar--is not enhanced by ever-increasing firm size and R&D spending. (See editorial box, next page, for details of our methodology.) FIRM SIZE AND INNOVATIVE PRODUCTIVITY To some extent, logic suggests that the bigger the firm, the better its research output should be. First, pharmaceutical research is expensive. It requires specialized researchers across multiple specialties, expensive materials, and intricate and costly laboratory equipment. In large firms, more capital may be available at lower cost either through internally generated funds or through the securities markets. Second, the market power of large firms may lead to greater innovative activity, and as a result, more new products. Large firms with established product distribution systems may enjoy more rapid market penetration and higher profits than smaller firms, enhancing their ability to generate funds internally and thus pursue more projects. Third, the availability of funds in large firms may mean that they can afford larger research laboratories and a larger staff. These resources, in turn, may lead large firms to pursue a broader portfolio of R&D projects, including more high-risk ventures, to generate a new drug. Indeed, a large number of leads must be pursued to find substances worthy of clinical testing and final FDA approval. In 1987, only five percent of those drugs entered into clinical testing received FDA approval(2). Despite this logic stressing the innovative advantage of large pharmaceutical firms, a counterargument is easily constructed. The main line of reasoning against the bigger-is-better theory is that firm size adds layers of complexity and bureaucracy to the R&D process, counteracting any resource advantage. This has been called the "creative backwardness of bigness"(3). Highly creative individuals may become discouraged in large bureaucratic firms, preferring to work in smaller organizations. …