Radical innovation helps dominant pharmaceutical firms most

September 24, 2003

MINNEAPOLIS/ST.PAUL--A new study shows that dominant pharmaceutical firms introduce many more radical innovations than nondominant firms and that Wall Street values their innovations much more.

In the October 2003 Journal of Marketing (Vol. 67, No. 4), authors Alina Sorescu of Texas A&M University, Rajesh Chandy of the University of Minnesota, and Jaideep Prabhu of Cambridge University report that more than two-thirds of radical pharmaceutical innovations come from "big-pharma" firms. Moreover, more than 70 percent of these innovations are invented in-house. During the 1991-2000 period, Glaxo SmithKline introduced the largest number of radical innovations among all pharmaceutical firms, followed by Roche and Merck.

"The popular perception of radical innovations is that they generally come from entrepreneurial firms. At best, dominant firms are seen as waiting for new ideas to be discovered in entrepreneurial firms and then pouncing on them through licenses or buyouts," said Sorescu. "In fact, we find that most truly radical innovations are invented and commercialized by dominant firms."

Not only do dominant firms introduce more innovations, but they gain much more from them. Dominant firms average a $456 million gain in stock value during the three days after a product approval by the Food and Drug Administration, as compared to $37.3 million for nondominant firms. Singulair, the asthma medication, added nearly $7 billion to Merck's stock value within three days after its approval. Viagra added over $6 billion to Pfizer's stock value over the same time period.

The rewards of radical innovation vary dramatically, even among dominant firms. Dominant firms that invest heavily in marketing and technology average about $930 million in revenues from their radical innovations, compared to $144 million for dominant firms that do not invest heavily in such support. Moreover, firms that have strong depth and breadth in their product portfolio average about $760 million from their radical innovations, compared to $122 million for dominant firms that do not have such depth and breadth, the researchers said.

The authors analyzed data on a census of three types of innovative drugs introduced in the United States in the 1991-2000 period: technological breakthroughs, market breakthroughs and truly radical innovations. They identified these three types of drugs by using the FDA's scientifically driven classification of drugs. Technological breakthroughs involve the use of new chemical entities (NCEs). Market breakthroughs provide substantially higher therapeutic benefits and were therefore given priority review. Truly radical innovations were classified as NCEs worthy of priority review.

Results from the study, said the authors, have important implications for at least three strategic issues facing businesses today: mergers and acquisitions, licensing of technology, and innovation. The findings support a common logic for mergers and acquisitions.

"Given the crucial role of resources in the radical innovation process, it's no surprise that pharmaceutical firms, for one, continue to pursue aggressive strategies for resource growth, said Prabhu. "The larger you are, the logic would seem, the more radical innovations you develop and introduce, and the more you stand to gain from their commercialization. Of course, as we find, it isn't aggregate resources alone that count, but rather their productive, per product deployment. Still, dominant firms have more to gain because they have more resources to deploy per product, both in terms of technology investment for product development and marketing investment for product support."

The study has important implications for nondominant firms, too.

"All is not doom and gloom for the small player," argued Sorescu. "Indeed, if they deploy their relatively meager resources cleverly, they can gain from radical innovation, too. But more significantly, perhaps, our findings suggest that nondominant firms have tremendous opportunities for licensing their innovations. A nondominant firm that licenses its radical new drug to a dominant pharmaceutical firm to commercialize can hope to bargain, on average, for a figure between $37.3 million and $456 million in licensing fees. Anything higher than $37.3 million is a bonus to the small player, and anything less than $456 million means the big-pharma firm still stands to make a profit from the deal."

On innovation--radical innovation in particular--the findings fly in the face of much recent pessimism about the ability of dominant firms to successfully commercialize radically new products, the researchers found.

"Much has been made of the curse that incumbents face when it comes to radical innovation," said Chandy. "The prevailing view is that dominant firms, although they may be good at developing new technology, often fail to commercialize it because of their fear of cannibalizing the sales of their existing products. Instead, it is smaller, hungrier entrepreneurial firms, we are told, who carve out new markets with new technologies. In stark contrast, we find that the role of resources in radical innovation is so overwhelming that dominant firms, despite any other disadvantages they may face, introduce far more radical innovations than less dominant firms do. Dominant firms also are rewarded more by Wall Street for these innovations than their smaller counterparts are. The additional gains of being dominant are as much as ten times greater for dominant than nondominant firms for the same type of innovation."
Rajesh Chandy, Carlson School of Management (contact through Catherine Peloquin).
Catherine Peloquin, Carlson School of Management, 612-626-0556.
Deane Morrison, University News Service, 612-624-2346.

University of Minnesota

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