Making R&D more cost effective

New framework for developing and supporting products could improve profitability as much as 30 percent

When it comes to dating, advice commonly given is 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 as well. In business, the advice applies to how firms should manage their research and development (R&D) pipelines.

Professor Jackson Nickerson explains why a new method for managing R&D pipelines could prove beneficial to companies. In this video, Nickerson uses the pharmaceutical industry as an example to compare the traditional way firms manage the assets that support R&D to the format he and his colleagues recommend.

“My colleagues and I have created a model that provides a new way for firms to manage R&D portfolios,” said Jackson Nickerson, the Frahm Family Professor of Organization and Strategy at the Olin School of Business. He co-authored a paper on the subject with Tat Chan, assistant professor of marketing at Washington University, and Hideo Owan, a former professor at Washington University who is now at Aoyama Gakuin University in Japan. “Firms that invest in R&D could potentially improve long-run profitability up to 30 percent or more — depending on certain factors — by following our 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. Dating when desperate was an expensive proposition for these firms.

Owan, Nickerson, 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.

“Historically, firms either manage their portfolio of R&D projects as a whole or manage each project individually. Our 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,” said Nickerson.

For instance, a pharmaceutical firm focusing on cardiovascular and oncology drugs may want to partition its portfolio of projects in two because cardiovascular and oncology drugs are commercialized through two different bundles of co-specialized assets. Each type of drug utilizes different types of manufacturing, marketing and sales representatives. Firms should then manage each one of these partitioned portfolios separately.

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. “Adjusting the financial thresholds depends on the state on the pipeline and whether commercialized products are new or old,” Nickerson said “As firms become more desperate, then they have to find more ways to refill that pipeline. As the pipeline becomes full and the firms feel less desperate, then it can set their thresholds higher and aim at developing only blockbusters.”

Jackson Nickerson
Jackson Nickerson

By finding dates before getting desperate, Nickerson argues 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 — drugs that are focused on a smaller segment of the market — accelerate projects 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. These thresholds depend on the state of the pipeline and should change over time.”

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.

Editor’s Note: Professor Nickerson is available for interviews. Television and radio reporters can conduct live or taped interviews via the University Communication’s studio, which is equipped with VYVX and ISDN line.