To survive and stay competitive, firms must adapt to changes in technology and knowledge. One way they do this is by creating alliances with other firms in the area of R&D (research and development). By linking up with external R&D partners, companies can become more innovative and improve their performance. However, success depends on their ability to absorb and use the knowledge created through the alliance. Often, as firms gain more experience of external R&D alliances, they become better at realising benefits from them, through what is called ‘organizational learning’, and often see improved business performance too.
The pharmaceutical sector involves a large number of external R&D alliances, as large-scale multinationals partner with biotechnology startups to develop and market new drugs. Being first to market often confers the right to sell a drug exclusively for a time, so rapid and effective development is a key aim.
Exploitation & Exploration
We can divide external R&D alliances into two types: exploitation and exploration. Exploitation focuses on using existing knowledge to take known opportunities, while exploration is about gaining new knowledge and uncovering new opportunities. For drug companies, exploration is about finding a new therapeutic compound, while exploitation is about testing it, clearing regulatory hurdles, distribution and marketing. In this research, we examined how experience in each type of alliance affected drug firms’ R&D capability in subsequent projects – in other words, how well they learned from their experiences.
In exploitation alliances, drug companies bring their decades of commercial experience to bear, while biotechnology firms contribute a drug that is already well advanced in development. Roles are clear, and each party does what it is best at. Projects are often managed with tried and tested formal processes and usually progress quickly. It is relatively easy to retain and use the knowledge gained. This suggested the first of our four hypotheses: external exploitation experience improves R&D project performance.
In contrast, exploration projects involve scientists from two very different organizations trying to push scientific frontiers forward in partnership. This may create a ‘culture clash’, as incumbent firms collaborate with entrepreneurial start-ups, requiring extra management effort to make the arrangement work. The scientific knowledge involved is cutting-edge and unfamiliar, which makes it harder to share and communicate. Because the collaboration is less formal, it is more difficult to integrate the knowledge gained into the drug company, and benefit from it. And when the firm does try to leverage its experience, there is the risk of ‘negative knowledge transfer’: the misguided attempt to transfer highly specialized knowledge from one area to another. This leads to our second hypothesis: external exploration experience has a negative effect on R&D project performance.
To benefit from their external R&D experience, companies must be able to absorb what they learn and internalize it within their own knowledge base – and this depends on their own internal experiences of both exploration and exploitation. When drugs are developed, the initial exploration phase (when a drug is discovered) is followed by the exploitation phase (when it is marketed). Focusing on these complementary stages, we were interested in whether internal exploration experience affected the impact of external exploitation experience, and also whether internal exploitation experience affected the impact of external exploration experience.
Internal exploration experience gives a firm important skills in using external knowledge. In the drug industry, a firm with strong R&D is well placed to evaluate new biotechnology knowledge, select the best R&D partners (from the thousands available), manage R&D projects and internalize the learning benefits of R&D alliances. So our third hypothesis is that the positive effect of external exploitation experience on R&D project performance (as covered by hypothesis 1) is enhanced further if the lead firm has more internal exploration experience.
When big pharma firms collaborate with startup biotechs, they sometimes try to use established methods that have been honed through years of experience – but are actually less effective with new, unfamiliar scientific knowledge. If the firm has lots of internal exploitation experience, the effect is more pronounced. This is an example of a ‘competency trap’, where a firm becomes too focused on using particular approaches because they have worked well before. Also, reliance on external partners for exploratory R&D can put a firm at a disadvantage, since it has less in-house ability to select promising projects or assimilate knowledge. Thus our final hypothesis is that the negative effect of external exploration experience on R&D project performance (as covered by hypothesis 2) is made even worse if the firm has a lot of internal exploitation experience.
To test our hypotheses, we investigated drug development projects to see how the companies involved capitalised on their previous experience of external R&D. We focused on firms involved in developing biotechnology-based drugs – a relatively new area, since the first biotech drugs hit the market in the 1980s. This area therefore gave us a good example of a radical innovation that established players in the market have been forced to deal with. We investigated 385 projects, managed by 43 global pharma firms from 1980 to 2000. We cross-referenced sales data with information on project type and project success to measure firms’ ability to exploit their knowledge and capabilities. We then linked the sample firms to information on R&D alliances to measure their external experience. Following detailed analysis, we found empirical support for all four of our hypotheses from a number of statistical models.
Our finding that external exploration experience leads to poorer R&D project outcomes suggests that, in some cases, the nature of the scientific knowledge involved and the organizational differences between the partners in the alliance make it too difficult for the lead firm to learn from experience. In contrast, exploitation alliances, where knowledge is less ambiguous and less integration is required, provide knowledge that is much easier to leverage for future success.
Our research suggests that firms should focus on alliances where each side can focus on complementary specializations, using knowledge that the other partner lacks. Also, they should bear in mind that a strong internal R&D capability can help realize more benefits from external exploitation alliances. Internal exploration competencies lay the foundation for leveraging external experience.
Conversely, extensive internal experience in exploiting knowledge can become a straitjacket, preventing firms from building flexible, responsive alliances in fast-developing areas of knowledge. Internal and external capabilities can only be combined in certain ways; some alliances may actually harm performance instead of improving it.
"Leveraging internal and external experience: exploration, exploitation, and R&D project performance", published in Strategic Management Journal.