The Competitiveness of Nations in a Global Knowledge-Based Economy

Ashish Arora and Alfonso Gamardella

Complimentarity and External Linkages: The Strategies of the Large Firms in Biotechnology

 

Journal of Industrial Economics 38 (4)

June 1990, 361-379 (extract)

              

 

   Content

I. Introduction

II. The Strategies of External Linkages of the
 Large Firms in Biotechnology

III. The Model (not included)

IV. The Empirical Results (not included)

V. Conclusions

Abstract                                            

In biotechnology, large firms enter into different kinds of linkages with universities and small/medium sized research-intensive firms.  We test the hypothesis that the strategies of external linkage of’ the large firms with other parties are complementary to one another.  We show that if any two strategies arc complimentary (i.e. undertaking more of one strategy raises the marginal value of the other) then they are positively correlated.  Using data for a sample large US, European and: Japanese chemical and pharmaceutical producers we find that the strategies above are positively correlated even after controlling for firm-specific characteristics.

 

1. Introduction                                                          

Technological advances based on genetic engineering have profoundly affected the scientific and technological basis of the chemical, and in particular, :the pharmaceutical ‘industry.  “Biotechnology could potentially affect any current industrial biological process or any process in which a biological catalyst could replace a chemical one” (OTA [1984] page 5).  New biotechnology products include new drugs, specialty chemicals, animal and plant agricultural products.

At present, innovations in biotechnology depend upon the contribution of three types of agents the universities, small/medium sized research-intensive firms or .the so-called New Biotechnology Firms: (NBFs),: and the large “established” chemical and pharmaceutical corporations.  Universities, NBFs, and large companies are endowed with complementary assets to generate, develop and commercialize new: biotechnology products [1].  Thus, there are wide ranging opportunities for collaboration among them.  Indeed, one does observe systematic linkages among universities, NBFs, and large corporations.

This paper analyzes the external linkages of the large firms in biotechnology.  We identify four types of linkages: agreements with other firms,

Financial support from the Technology and Economic Growth Program of the Center for Economic and Policy Research, Stanford University is gratefully acknowledged.  We thank Tim Bresnahan and Nathan Rosenberg for advice and encouragement  Paul David, Paul Milgrom, Shane Greenstein, Ed Steinmueller, and two anonymous referees provided useful comments and suggestions.  The usual disclaimers apply.

1. See Teece [1986] for a comprehensive discussion of the role of ‘complementary’ assets in innovation.

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research agreements with universities, investments in the capital stock of NBFs, and acquisitions of NBFs.  Each type of linkage targets a particu1ar set of resources specific to the universities and the NBFs.  We then suggest that, from the point of view of the large firms, the four types of linkage above are complementary strategies.  We; test this hypothesis, and find that it is not falsified by the data.

In this paper, we do not model the strategies of the NBFs.  Many NBFs are founded just to exploit a particular discovery.  Apart from a few cases, they do not seem to have major long-run strategic objectives. [2]  Recently, it has even been suggested that many NBFs are founded with the specific intent of later on being sold to large corporations. [3]  To some extent, their behavior can be taken as given.

We think that our paper can be viewed as part of a broader research program dealing with the changing nature of the organizational structures responsible for the development of new technologies in recent years.  Up to the early 1970s, most technological innovations introduced by the large firms resulted primarily, from systematic in-house R&D investments. [4]  However, in the past two decades, in many sectors large firms appear to be unable to internalize all the resources necessary to produce and commercialize new technologies.  The increasing complexity and multi-disciplinarity of resources required for innovation, and of the stock of knowledge itself; tend to make .technological innovations the outcome of interactions and cooperation among fundamentally autonomous organizations commanding complementary resources. [5]  As a result, it is increasingly difficult to identify the innovator with a particular organization.  Imai [1980], Vacc [1986], and Imai [1988], inter alia, have suggested that the locus of innovation could well be a “network” of various types of organizations.  While the empirical results of our paper hold only for biotechnology, we think that they raise interesting questions about whether biotechnology is an isolated case or, perhaps, an extreme case of a more general phenomenon.

This paper is organized: as follows.  Section II focuses upon the four strategies of external linkage of the large firms in biotechnology.  It examines the specific set of tangible and/or intangible resources that each strategy brings to the large firm, and discusses the ensuing complementarities.  Section III develops an analytical model to serve as a more formal and rigorous framework for the empirical exercise in section IV.  Section V concludes the paper.  Appendix 1 describes the data set.

2. See for instance Kenney [1986] and Cheanais [1988].

3. See The Wall Street Journal(1989].

4. The classic references are of course, Schumpeter (1942] and Chandler [1977]; see also Mowery [1981].  A partial re-assessment of the dominant role of the large corporations in: the innovation process during the early decades of this century can be found in Jewkes et al [1958], which emphasizes the role of the individual innovator.

5. 0n the idea of the increasing inter-disciplinarity and complexity of knowledge, see Rosenberg [1976, 1982].

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II. The Strategies of External Linkages of the Large Firms in Biotechnology

Science plays an important role in biotechnology.  Historically, biotechnology originated from fundamental scientific breakthroughs in the 60s, and especially in the 70s [6].  Moreover, in biotechnology the distance between scientific advances and their commercial application is relatively short.  In many cases, a new scientific discovery is almost a new product. [7]

Following the seminal works of Nelson [1959] and Arrow [1962], it is widely accepted that there are serious problems of appropriability in the production of scientific knowledge. [8]  In view of this and the importance of science in biotechnology, the large firms rely extensively upon the services of the university based scientific community

The NBFs are small-medium sized companies whose major asset consists of knowledge capital in biotechnology. [9]  They have skills and know-how in applied laboratory research.  The typical output of their activities is a new protein, obtained from genetically engineered organisms.  The synthesis of a new protein, however, whilst an important step in the development of new drugs or new chemical products, does not exhaust the entire innovation cycle.  Engineering know-how is required to scale up from the laboratory bench to manufacturing, and to control the industrial-scale processes. [10]  In pharmaceuticals, which covers the largest fraction of the present applications in biotechnology, a fundamental asset of the innovation cycle is familiarity with clinical testing procedures, as well as with the regulatory process.  Finally, commercialization structures are vital in successfully bringing a new product to the market.

6. The initial breakthroughs in biotechnology date back to the discovery of the double-helix structure of DNA in 1956.  Important: scientific discoveries during the 70s include the new techniques of recombinant-DNA (r-DNA) and cell fusion (monoclonal antibodies). See, for instance, 0TA [1984], Daly [1985], Olson [1986], and Pisano et al. [1988].

7. For instance, the synthesis of the nucleic acid sequence, which was originally performed at the City of Hope Medical Center immediately raised the opportunity of manufacturing r-DNA insulin.  This was developed, produced and commercialized by a: joint-venture between Genentech and Eli Lilly. Similarly, the successful cloning of a surface antigen to develop a malaria vaccine by researchers at the New York University rapidly captured the attention of potential producers who readily perceived the opportunities of commercial exploitation of that scientific discovery.  See OTA [1984 and Pisano et al. [1988].  An important qualification, however, is that even if “technically” speaking scientific discoveries lead to potential new products new biotechnology drugs still have to undergo clinical testings and obtain formal regulatory approval,  which augments the distance between science and commercialization.  See Yosbikawa [1988].

8. The literature on the notion of appropriability and related issues is voluminous.  For a comprehensive survey, see Dosi (1988).

9. See OTA [1984]; Kenney [1986];Pisano et al [1988].

10. “The ability to scale up and purify a product is often: the key factor in a competitive R&D race with another company.  Many companies have chosen to keep this type of bio-engineering knowledge secret... Such...knowledge can take several years to acquire from start up…”  Daly [1985], page 42.

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These assets are not typically part of the resources and knowledge base of the NBFs.  They are instead part of the tangible and intangible capital of the large firms.  Moreover, the large firms have financial capabilities which are not available within the NBFs.  Thus cooperations and other relations between NBFs and large firms are often critical to successfully complete the development and commercialization of new biotech products. [11]

Following the previous literature in this field [12] one can identify four types of external Inks set up by the large chemical and pharmaceutical producers with other agents in biotechnology: (i) research and/or joint development agreements with other firms, (ii) research agreements with universities, (iii) investments in the capital stock of NBFs (minority participations); (iv) acquisitions of NBFs.  To a large extent, each of these four strategies targets a particular objective of large firms.  Each strategy enables the firm to gain access to a specific set of tangible and/or intangible resources necessary for the development of innovations in biotechnology

Most agreements signed by large chemical and pharmaceutical producers with other companies, usually with NBFs, tend to be product-specific.  They focus on rather “downstream” activities of the innovation cycle [13]  They are aimed at developing and commercializing a particular discovery of the NBF, (e.g. the synthesis of a new enzyme or hormone or growth factor) in the areas of specialty chemicals, agricultural biotechnology, and, above all, pharmaceuticals. [14]

The agreements with universities tend to focus on more basic research objectives  Large firms finance research activities performed by academic laboratories to acquire, by interacting with the university scientists, some familiarity, with the basic knowledge in this field.  Moreover, the relations with a university laboratory often provide the large firms with a first option on the license of any new discovery made: out by that research center. [15]

Minority participations in the capital stock -of small biotech start-ups provide a means of monitoring the internal research activities of the NBFs

11. See for example, OTA [1984], Daly [l985],Kenney [1986], Arthur Young [1988], Chesnais [1988], and Pisano et al [1988], ‘

12. See in particular OTA [1984], Daly [1985], Kenney [1986], Roberts and Mizouchi [1988], and Pisano et al [1988].

13. In: biotechnology, however, one also observes a few agreements between two large established corporations.  This is particularly true of agreements between “large” American and Japanese firms.  Major examples include Abbott-Dainippon, Merck-Shionogy, Monsanto-Mitsubishi, Schering Plough-Suntory, Upjohn-Chugai Pharmaceuticals [Bioscan, 1988].  These agreements relate either to the supply of specialized equipment, or materials like cell lines, or to marketing agreements in each others (national) territories..

14. “Our approach...leans towards outside research contracts while doing developmental work in-house...”. (John Donaldson, Director of Bio-technology, Dow Chemicals.  Quoted in Brown [1982], page 14.  See also, Kenney [1986] chapter 2 and especially page 31.

15. The agreements with universities are also important sources of recruiting qualified scientists and researchers, and they serve as a means, by which firms can engage the services of top researchers while they continue to work in environments they find most congenial.  See Kenney [1986].

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The objective of the large firm is to keep in touch and acquire some familiarity with the applied laboratory research skills of the NBFs.  By acquiring part of the capital stock of an NBF, the large companies also hope to establish a ‘preferential” link with the biotech company.  This offers the possibility of preempting rivals in the commercialization of any relevant discovery made by the NBE.  Moreover, in keeping with the theoretical predictions of Williamson [1985], we observe that in many cases large firms acquire part of the capital stock of a biotechnology company, and also develop formal agreements with the same company to; develop a particular product.  Such investments may be useful in averting problems of moral hazard, and serve as tokens of good faith. [16]

As far as acquisitions are concerned, there seem to exist two different - and in part contrary -motives for acquiring a small biotech company.  On the one hand, large companies that have substantial in-house capabilities aim at acquiring NBFs specialized in particular areas of biotechnology research.  The NBFs top specific lack of expertise in the general knowledge base of the large companies.  On the other hand, the direct acquisition of a biotechnology firm represents a way of “catching-up” when large firms are relatively late entrants in this business and have not yet invested substantial funds in internal  biotechnology R&D.  In both cases, acquisitions add internal knowledge to the large firms, and they are motivated by long run objectives of the large companies. [17]

These considerations strongly suggest that each of the four types of external links targets a separate goal of the large firms:

The agreements with universities provide the large firms with access to basic scientific knowledge.  They are complementary to agreements with other firms, which typically focus on more “downstream” product-specific development activities.  They are also synergistic with acquisitions, as the latter aim at internalizing a whole body of laboratory and/or product development capabilities of the small firms.  Finally, they are complementary to minority participations.  To the extent that the knowledge base of the NBFs

16. In 1986, for instance, American Home Products bought 13.5% of the shares of California Biotechnology, and in that same year the two companies entered in formal arrangements to develop and commercialize products in the fields of cardiovascular drugs, veterinary therapeutics, drug delivery systems.  Other examples of this sort include the cases of Abbott and Amgen, American Cyanamid and Cytogen, Johnson & Johnson and Cytogen, Smithkline-Beckman and Amgem, Smithkline-Beckman and Synbiotics.  These are reported in Bioscan [1988].

17. Compare the acquisitions in 1986 of Hybritech by, Eli Lilly and of Genetics System and Oncogen by Bristol Myers.  Eli Lilly is one of the most research intensive pharmaceutical corporations in the US (the R&D over world pharmaceutical sales ratio of Eli Lilly in 1986 is about 0.20), and is the firm with the highest number of US patents in biotechnology (27 US patents as of December 1987).  On the other hand, Bristol Myers is relatively less research intensive than Eli Lilly (R&D over world, pharmaceutical sales ratio in. 1986 about 0.09), and it owns only I US patent in biotechnology, i.e. clearly a late entrant in this business. (Data source: Medical Advertising News [1987]; OTAF[1987]).

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relates to applied laboratory research and skills, monitoring the activities of the small firms is complementary with the basic scientific knowledge of the universities. .

The synergy between agreements with universities and minority participations deserves some further comments.  Both strategies aim at acquiring fami1iarity with the activities and knowledge base of; respectively, the universities and the NBFs.  One could argue that universities and NBFs provide the large firms with access to partially overlapping sets of resources.  For one, NBFs do perform some basic research. [18]  Moreover, as many NBFs are direct spin-offs of the university system, the university scientists bring with them basic scientific knowledge.  Thus, from the perspective of the large firms, monitoring the activities of the NBFs and setting up agreements with the universities target activities with some degree of over1ap.  In addition, both strategies aim at establishing a preferential link with the other party to exploit important discoveries of the university or the NBF.

Yet, it is not unreasonable to think that the more one leans towards the basic end of the scientific research spectrum, the better do universities provide access to basic knowledge that is not available within the NBFs.  On the other hand, the closer one gets to applied research with specific product orientation, the better do NBFs provide access to resources that are not available within the universities.  We believe that the non-overlapping portions of the resources commanded by the two agents are important enough to make minority participations in NBFs and agreements with universities complementary to one another.

Acquisitions of NBFs are complementary to agreements with other firms.  The internalization of an entire body of laboratory and applied research knowledge is complementary to the set up of cooperative ventures to develop a specific new product.  Similarly, with regard to minority participations, the addition of internal knowledge to the in-house capabilities of the large firms is complementary to the goal of establishing preferential links with other NBFs to possibly exploit important breakthroughs in the initial stages of the innovation cycle.  Moreover, acquisitions reflect long term objectives of the large firms.  By contrast, minority participations are motivated by short horizon perspectives, and they enable the large firms to remain “plugged in” in ways that acquisitions typically do not allow. [19]

Finally, monitoring the activities and the general knowledge base of many

18. For instance, The Economist [1988] reports that an NBF, Collaborative Research, recently participated in a project aimed at producing a “map” of the human genome.  By almost any standards, this must qualify as a piece of fundamental research.

19. For example, autonomous NBFs have better opportunities to interact with the universities on an informal basis.  Once the NBFs are acquired by a large company, the universities may be less willing to have informal contacts with what has now become a division of a large corporation.  For one, the universities are likely to be reluctant to provide a large company with access to their internal activities unless the two parties enter into a “formal” relation.

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NBFs through minority participation is complementary with joint product development agreements to implement and commercialize a specific compound.  Moreover, we have seen that the large firms often acquire minority participations in an NBF, and set up formal agreements to develop a particular product.  It appears that minority participations and agreements are complementary also because the preferential link between an NBF and a large company, which: follows from the acquisition of minority stocks, translates into a formal agreement once a specific new discovery needs to be implemented and possibly commercialized.

[III. The Model, pp. 367-370, not included]

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[IV. The Empirical Results, pp. 370-374, not included ]

 

V. Conclusions

This paper explores the relations among the strategies of external linkage, of the large chemical and pharmaceutical producers in the new biotechnology business.  We find that agreements with other firms, research agreements with universities, minority participations in New Biotechnology Firms, and acquisitions of New Biotechnology Firms, are positively correlated even after controlling for firm characteristics.  We conclude that these strategies target distinct and complementary sets of resources, and therefore, are complementary to one another.

Our analysis suggests that in biotechnology the large firms are no longer the sole locus of innovative activity.  The locus of innovation should be thought of as a “network” of inter-organizational relations.  Biotechnology is probably an extreme case of this tendency.  Moreover, the network-like structure of the organizations responsible for innovation, in biotechnology may well be a temporary phenomenon arising from the relative immaturity of the technological paradigm.  Yet, our findings raise the question whether in modern capitalist economies the innovation process requires new and different organizational arrangements in order to allow specialized complementary assets, controlled by different types of agents, to be combined.  An interesting topic for further research is .to see whether (viz., to what extent and in what forms) other “high tech” sectors, e.g. semiconductors or electrical machinery, also display similar organizational patterns in the innovation process.

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