Saturday, December 28, 2013

Merck & Co: Can the World’s Top R&D Lab Improve by Doing Less?

The pharmaceutical firm Merck & Co. has a famous research and development (R&D) unit with successes that includes first-ever vaccines and cholesterol control drugs, all developed fully in-house from discovery to final development and approval. But the fame is fading these days, because their last successes were drugs approved in 2006, which means that they have had a long dry run and will soon be holding a portfolio of drugs with fewer and fewer patents. That means more competition and lower profits.

Their solution is to do less research. They will sell many of the drug development projects they are doing, reduce the size of their R&D unit, and instead create a set of innovation hubs that are intended to look out for research done by others. These hubs are rumored to be planned for Boston, the San Francisco Bay area, London, and Shanghai. This probably seems like a strange idea. Can a firm improve its research record by doing less research? Is a hub that plans to look for research done by others really an innovation hub, and not an imitation hub? What exactly is going on here?

The explanation is that Merck is finally starting to do what other pharmaceutical firms are doing. The pharmaceutical industry has increasingly lost its advantage in doing research relative to biotechnology firms and universities, and now it is common for pharmaceutical firms to look out for promising research done nearby, with an eye to create an alliance with the biotech firm or get a license for its product once it looks promising. Such arrangements are useful for two purposes. The first purpose is to do the research in an economical place. Biotech firms have two advantages over pharmaceutical firms in doing research. One is that they do it very well; the other is that they either succeed or go broke, which means that the cost of failures is borne by their founders and investors, not by any pharmaceutical firm.

The second purpose is to grab research results from firms that usually cannot commercialize them. There are very few biotech firms that have the capabilities and resources needed to get a new drug approved for use, but pharmaceutical firms are experts in doing that. This means that the biotech firms can't get the full value out of their research, they need to sell it at a "discount." That discount, of course, becomes profits for the pharmaceutical firms.

Researchers have followed this change to innovation and commercialization through a network of firms for a while, with the best-known articles involving Walter Powell and collaborators. The advantages of this system were pretty established in 1996, so Merck is a few years behind the curve in changing to it. The advantages of combining proximity to firms that do research with a central position in alliances is something that was documented in research by Whittington, Owen-Smith, and Powell, and it suggests that Merck not only needs to be in the right place, it also needs to have the right connections – the right alliances.

Getting the right portfolio of alliances actually takes longer to do than building an innovation center, so there is no guarantee that Merck's new strategy will work soon enough for them. And if it took them many years to start following what researchers and other firms saw as the good way to locate research centers, it is hard to tell when they will start following advice on how to build alliances. I know where they could get it, though, having recently finished writing a book with Tim Rowley and Andrew Shipilov on how to get a Network Advantage through alliances.

Loftus, Peter and Rockoff, Jonathan D. 2013. Merck Plans Radical Overhaul of Drug R&D Unit. Wall Street Journal, Dec. 27 2013.

Thursday, December 19, 2013

Juan Valdez Coffee: When Will People avoid Corporations?

You are probably familiar with the corporation Starbucks, and you may also know that its stockholder value is nearly 60 billion US dollar, in part a result of having annual sales of more than 80,000 dollar per employee. Just so you don't misunderstand the last number, Starbucks uses the franchise system with many outlets outside the U.S. owned by contractors, so many of the staff members you see internationally are not Starbucks employees.

For most coffee chains, expanding currently means challenging Starbucks somewhere, or at least some other coffee chain that has a similar product line, ownership, and strategy as Starbucks. It is far from easy given the long experience the largest chains have in making appealing product lines and effective operations. Now there is news that a brand that failed once, Juan Valdez, is going to try again with a new international chain of coffee shops. Juan Valdez sells Colombian coffee, and is aiming to expand to 250 stores by the end of this year. That will make it more than one hundredth the size of Starbucks, so we are talking about a really really small challenge.

So why is this interesting? You may already have noticed that it sells Colombian coffee, which is a little different from the selection of coffee beans found in many other chains, combined with drinks that are made from blends where the customer knows little about the origin. The reason for the Columbian coffee specialization is that Juan Valdez isn't really a normal corporation: nearly all shares are owned by Columbian farmers through their Federation. Although it is incorporated, the reality is that Juan Valdez is a farmer cooperative oriented toward export of farm goods. (Actually the corporation name is Procafecol, but I like the brand name Juan Valdez better.)

If Juan Valdez succeeds, Columbian farmers will benefit greatly. But will consumers be interested? An important key to the appeal is that coffee is one of the products that has started triggering social conscience in consumers, many of whom are aware that the prices keep increasing (bad weather is the reason this year) while poor farmers keep getting low prices. Buying coffee from the most impoverished places makes no difference; buying from corporations with fair trade practices helps a little; buying from a cooperative would help more.

All this sound promising, and cooperatives have in the past been proven to be quickly growing, as I have documented in a paper with Hayagreeva Rao on the cooperative movement in Norway. But we also showed that the appeal was local: communities with past experience with consumer ownership liked cooperatives much more than communities lacking such experience. This is a challenge for Juan Valdez because many markets that they target lack such experience, so they have to target individual consumers rather than the practices of a community. It would be interesting to see if they can succeed. At least they have some ideas that stir the interest (and conscience?) of consumers, like the live Juan Valdez character used in advertising (see below). It is a fun image, but the serious part of Juan Valdez is the cooperative of farmers trying to reach consumers directly.

Munos, Sara S. 2013. Juan Valdez Plans a New Challenge to Starbucks. Wall Street Journal, December 19 2013. 

Monday, December 9, 2013

Needed Innovations: How Much Misery Does it Take to Innovate?

When we think about innovations, we usually consider high technologies that change quickly because of research, and we consider opportunities rather than threats. I wrote earlier about mobile phones with curved screens, which has now become possible as a result of improved technologies for screen displays. Nobody is sure how necessary they are, but if people like them they will be a big advantage for the two makers of such phones.

But the high-tech, opportunity-driven innovation is just one part of innovations. Other innovations arise from needs and from shortages. Consider nickel. This material is needed in order to make stainless steel, and its extraction is a decidedly low-tech affair that just breaks a lot of rock and uses a lot of energy. But when nickel prices increased to more than 5 times the original as a result of China's use of steel, anyone making or using steel were facing shortages and price increases.

Wall Street Journal has an interesting article on how this led to a complete rethinking of how to get nickel.  Instead of buying nickel from abroad that was extracted from scarce and high-grade nickel ore, steel producers in China started experimenting with a low-grade ore that has a mix of nickel and iron. Such ore is inefficient for producing pure nickel, but prices became high enough that even this material started to be profitable. And more importantly, steel makers don’t actually need pure nickel. Nickel mixed with iron is perfectly fine for them because they will be mixing the nickel into iron anyway. From this insight they started a gradual process of improving an initially inefficient (and high-polluting) process until it has reached efficiency and cleanliness that is high enough to actually push the nickel prices nearly as low as their start. What made the effort successful in the end was the realization that a different kind of furnace was used than the kind had originally seemed best.

This was an innovation born from a need and a shortage. The irony is that this new process could have been used much earlier, but no experimentation was made until the need grew serious.  This is something I have written about before, and that has become an established part of our thinking about how firms behave. We do observe them thinking ahead, but there is also a lot of reactions to their experiences and their current needs. Along with Giovanni Gavetti, Dan Levinthal, and Willie Ocasio, I have written a chapter summarizing much of the current thinking about how firms make changes. The conclusion is pretty clear: It is well documented that firms respond to problems, which is the kind of innovation people don't think about so much. We know less about firms chasing opportunities, which is the kind of innovation people think about often. Wouldn't it be interesting to know whether this is because "responding to problems" happens more often, or because it is easier to discover?

Batra, B. and J. W. Miller. 2013. Innovation and Investment Pop Commodity Price Bubble. Wall Street Journal, Dec 8 2013.