In the Classroom
R&D Takes on a More Strategic Role

For pharmaceutical companies, R&D strategy is fundamental to the success of the firm. Indeed, a new study of large, publicly traded pharmaceutical firms by Wharton professors Christian Terwiesch and Karl Ulrich, and PhD candidate Karan Girotra, shows that a failure in Phase III drug development (the last stage before official drug approval) corresponds to an average decline in firm value of $551.9 million. Substantial fixed costs — time, manpower, and resources — mean that a late-stage failure of a compound can be devastating to a company.

With a few back-to-back failures, said Terwiesch, you have a critical situation. “Two failures in a row are worse than 2 times 1,” said Terwiesch, academic director of Wharton's Strategic R&D Management program. “You have armies of R&D people on the payroll. After two failures, you have people sitting around with not much value-added work to do.”

The Power of the Pipeline

But an effective R&D strategy can make a big difference. The study by Terwiesch, Ulrich, and Girotra showed that pharmaceutical companies that had developed (or in-licensed) a backup compound that could potentially serve the same indication were able to dramatically decrease the impact of a late-stage failure. If failures must occur — and they always do — an effective R&D strategy can lessen the sting.

“One of the lessons here,” said Terwiesch, “is that you can't value a drug in a vacuum.” The value depends in large part upon the company's strategy and portfolio. “Net present value won't do it,” he continued. Instead, you need to look at how the drug fits into the overall pipeline. He and his colleagues are working on models that will value the whole pipeline, taking into consideration the balance of risks involved as well as the utilization of knowledge resources.

Stepping Out of the Lab

This work, together with other research that Terwiesch and Ulrich have conducted over the last 10 years, serves as the basis for the Strategic R&D Management executive education program. Together with colleagues from INSEAD, Terwiesch and Ulrich have taught this program at INSEAD; and in March 2006, the program will make its North American debut at Wharton's Philadelphia campus.

This course is in response to R&D's expanding role. No longer relegated to the lab, R&D managers now have to look at the broader business and must be particularly attuned to market forces. Risk management and portfolio analysis are a major part of this week-long program. For example, one of the teaching cases that Girota, Terwiesch, and Ulrich developed for the program involves an R&D manager at Merck who is presented with 30 potential compounds but has the resources to develop only 20. Knowing the odds — on average, only one of six compounds that enters Phase I clinical trials receives regulatory approval and is introduced in the market — participants explore the best strategy for the R&D manager.

Participants also engage in a simulation that puts them in charge of the R&D pipeline of a major research-driven firm. Other cases and simulations used in the course include a telecommunications firm, a diamond manufacturer, and a global food manufacturer. “The week gives participants a thorough look at some of the major issues affecting strategic R&D management,” said Terwiesch.

In addition to portfolio management, this includes topics such as creativity and innovation, organizational forms of R&D (e.g., managing the tension between the market side and the technology side), global R&D (e.g., accounting for regulations as well as styles and tastes in different parts of the world), R&D partnerships and alliances, and radical innovation.

A Strategic Approach

Among the insights on R&D strategy that Terwiesch and colleagues have gleaned from their research and consulting, which they share in the program are:

  • When valuing and selecting projects, it is essential to evaluate the project in the context of the development portfolio of the firm, as opposed to valuing the project in isolation.

  • Firms must align their R&D pipeline management strategy with business strategy. Pharmaceutical firms that focus on blockbuster drugs need to have lots of upfront options, but an overall lean pipeline.

  • Adopting professional risk management practices in R&D pipelines allows firms to create more financial value out of their R&D spending.

  • Management must invest over-proportionally in early-stage development to create options for the more expensive later stages. This is in contrast to the common practice of investing heavily in late stages to improve short-term financial performance (in effect, sacrificing long-term growth).

“Based on the program offerings that we had at INSEAD, plus our own research and work with these companies, we've been able to home in on some managerial 'take-aways' that can serve as general guidelines for anyone involved in R&D management,” said Terwiesch.

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