Managing Risk in Pharmaceutical R&D: Whether You Choose a Buckshot Strategy, a Bird Shot Strategy or Another, Recognize the Cognitive Challenges Each Creates for the Organization (2010)

The management of R&D is risky business. When large sums are invested in the prospect of breakthrough innovation, the results can range from windfall gains to huge losses. This is certainly true in the pharmaceutical industry, where some firms spend billions annually for a chance at a rare blockbuster success. Industry studies indicate that less than 10 percent of U.S. drug development projects successfully produce a commercialized product. The rest can spend tens or hundreds of millions of dollars only to be terminated before they reach the market. Even those rare drugs that do make it to market are far from guaranteed successes. Historically, fully 70 percent of commercialized drugs have failed to return average development costs, even while the top 10 percent reaped profits of more than six times average costs (1). This wide variance in possible returns underscores the point: one of R&D's most important challenges is managing the risk that is its daily stock in trade. In this article I examine two archetypal approaches to managing risk in R&D--so-called buckshot vs. birdshot risk strategies--and their implications for organizational performance in the face of risk. Recently declassified data from two leading pharmaceutical firms make it possible to explore patterns of strategic decision-making with information typically held confidential. A historical perspective also gives us the opportunity to see how these risk strategies have played out over the ensuing years. Cognitive Biases Concerning Risk Most people accept the basic premise that good managers are willing to take (or accept) risk as necessary for success. This idea is consistent with classical economic theory, which holds that risk and return are (or should be) positively related. The underlying assumption is that most decision makers, all other things being equal, avoid risk. Accordingly, returns to low-risk opportunities should get competed away by the great bulk of the marketplace that rushes to them. Theoretically, this leaves the few good managers bold enough to pursue high-risk options with less competition and, thus, more profitable outcomes. If true, however, this theoretical reasoning describes a confusingly self-confounding phenomenon. Most people believe in risk-taking, but avoid risk. Those who intentionally avoid risk bear the greater risk of low returns. If the reader is confused somewhat by these arguments, management researchers have done little to clear them up. Indeed, the theoretical relationship between risk and return in business organizations has not been consistently supported by research (2). One explanation for this is also a fundamental premise of this article: perhaps the most potent aspect of risk is in the eye of the beholder. People's response to risk depends on their perception of it, which is often biased by the particular context from which they view it. It follows that those who would manage risk must understand the biases their organization is subject to and craft their risk strategy accordingly. Loss Aversion One important bias familiar to anyone who has confronted risk in organizations is so-called loss aversion. A large body of research has demonstrated that when confronting risky decisions, managers typically give much greater weight to prospective losses than to prospective gains (3-6). For instance, executives in one classic study typically rejected as too risky a potential project promising an equal chance of either a $300,000 gain or a $60,000 loss (7). With the fear of even a small loss a more powerful influencer of decisions than the prospect for substantial gain, organizations routinely fail to capitalize on opportunities with highly attractive expected values and thereby undermine organizational performance. An industry-wide study of 15 U.S. pharmaceutical R&D divisions documented the pervasiveness of loss aversion, even in a setting where breakthrough innovation is the life blood of the organization (8). …