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Is Technology Preemption a Motive for R&D Alliances? Evidence from the Biotec...

Yongliang "Stanley" Han

Journal of American Academy of Business, Cambridge;
Sep 2004; 5, 1/2; ABI/INFORM Global

pg. 215

Is Technology Preemption a Motive for R&D Alliances?
E
vidence from the Biotechnology Industry

Dr. Yongliang "Stanley" Han, California State University, Sacramento, CA

ABSTRACT

Using data on 638 R&D alliances formed by 15 large pharmaceutical companies (LPCs) with new
biotechnology firms (NBFs), we conduct ext
ensive demographic analyses of the nature, frequency and exclusivity of
these alliances. We seek to examine the possibility of technology preemption as a motive for R&D alliances formed
by LPCs with NBFs. We argue that equity investment in NBFs may enable
LPCs to monitor the technological
advancements made by the NBFs more closely, and possibly block access by competing LPCs to the same
technologies. The empirical results presented in this study offer very weak support to the argument that LPCs' R&D
allianc
es with NBFs are motivated by their desire to technologically preempt competitors.

INTRODUCTION

Strategic alliances have been an increasingly important mode of interorganizational collaboration for firms
to gain competitive advantage in their current indus
tries, or to explore fresh opportunities in new areas (Hagedoorn,
1993; Powell, Koput and Smith
-
Doerr, 1996). A number of motives for alliances have been identified. They
include
the need to share the costs and risks of innovation (Mowery, 1988; Mowery, Ox
ley and Silverman, 1997);
obtaining
access to new markets and technologies (Powell et al, 1996); combining complementary skills (Teece, 1986; Arora
and Gambardella, 1990); and preserving prospective learning opportunities (Hamel, 1991).

The biotechnology i
ndustry provides a dynamic and rich setting where we can examine what forces
fundamentally drive the formation of R&D alliances between large pharmaceutical companies (LPCs) and new
biotechnology firms (NBFs). Since the 1970s, over a thousand NBFs have bee
n founded and hundreds of R&D
alliances have been established between NBFs and LPCs. Several explanations for the motives behind R&D
alliances in biotechnology have been offered. Among them the most prominent are the transaction cost explanation
(Pisano, 1
990) and the learning with flexibility explanation (Arora and Gambardella, 1990; Powell and Brantly,
1992; Powell et al, 1996). However, in the previous literature, one possible motive for LPCs to form R&D alliances
with NBFs has been relatively less studi
ed; that motive is technology preemption.

THEORY AND PROPOSITIONS

According to Kenney (1986) and Pisano, Shan and Teece (1988), "new biotechnology firms" ("NBFs") are
defined as firms organized specifically to develop and exploit the commercial potential o
f the new biotechnologies
of the 1970s. Between the mid
-
1970s and the mid
-
1980s, more than 300 small to medium
-
sized research
-
intensive
NBFs were founded, and a larger number of NBFs have been formed more recently (Pisano et al, 1988).

Large pharmaceutical

companies (LPCs) entered relatively late into the biotechnology industry. Although
LPCs have obtained a considerable amount of knowledge in biotechnology and control the downstream
manufacturing and marketing resources and capabilities, Gambardella (1995)

predicts that the pharmaceutical
industry will not be dominated by few very large oligopolists. Instead, Gambardella predicts that there will be a
division of labor in this field. Specifically, there will be a large number of small, flexibly organized, hu
man
-
resource
-
intensive NBFs, with a comparative advantage in conducting applied research, and a small number of LPCs
with comparative advantage in large
-
scale development and commercialization. Empirical results have confirmed
this division of labor in bio
technology between LPCs and NBFs. Grabowski and Vernon (1994) find that of the first
16 new biotech medicines released in the U.S. between 1988 and 1992, 13 were developed by NBFs. However, 12
of
the 13 were marketed and distributed by LPCs, as NBFs lacked

the capability to bring their research to the market
place. Koput and Powell (2001) provide further evidence. They estimate that by the end of 2000, 76 biotechnology
drugs have been approved for the market; more than 50 of these were developed by NBFs.

Th
e Journal of American Academy of Business, Cambridge * September 2004

215

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LPCs' Alliance Strategies in Biotechnology R&D

As discussed above, LPCs ente
red into the biotechnology field later than the early NBFs. To catch up with
this new technological wave, LPCs have built various linkages with other firms and research institutions. Arora and
Gambardella (1990) have identified four main types of external
linkage formed by LPCs in biotechnology: research
agreements with universities; joint ventures and agreements with other firms; minority participations in NBFs; and
acquisitions of NBFs. Among all the external linkages established by LPCs, R&D alliances wi
th NBFs are the most
frequent and important form (Barley, Freeman and Hybels, 1992).

Since NBFs are LPCs' most critical alliance partners due to their comparative advantage in conducting
biotechnology R&D projects (Gambardella, 1995), in this study we focu
s on the R&D
-
related alliances established
by LPCs with NBFs. Four types of alliances between LPCs and NBFs

R&D contracts, R&D collaborations,
minority
-
equity
-
based R&D alliances, and joint ventures

are associated with intensive R&D activities and thus
sho
uld be classified as R&D alliances.

Technology Preemption as a Motive for LPCs' R&D Alliances with NBFs

The notion of preemption is related to market power. Schumpeter (1943) argues that firms require the
expectation of some form of
ex post
market power to

have the incentive to invest in R&D. This is the principle
underlying patent law. Thus, industrial organization economists agree that technology preemption based on tight
intellectual property rights provides a strong motivation for firms to invest in R&D

projects. However, an implicit
assumption underlying this argument is that R&D projects are conducted inside the firm. Hence, there will be a
positive relationship between inward R&D spending by firms and appropriability regimes. But under some
circumstan
ces internal development may not be a technologically or organizational viable mode of organizing R&D
activities for LPCs in biotechnology. Theoretically, when the appropriability regime is tight and the rent generated
through preempting critical innovatio
ns is large, LPCs will use every possible method to win a technology race, as
long as marginal benefits exceed marginal costs (Levin, Klevorick, Nelson and Winter, 1987). Establishing R&D
alliances with NBFs that own critical R&D resources and capabilities

may be a first
-
best choice to achieve this goal,
especially when: (i) an innovation is critical for the firm's long
-
term survival; (ii) patent protection is tight; That is'
once a firm wins a technology race, its monopoly position in a certain therapeutic

or diagnostic area will be well
-
maintained; and (iii) technological competition is intense: that is, time is a key factor in determining the winner of
the race. All the above conditions apply to the biotechnology industry.

Tirole (1988) suggests that in t
he case of a drastic innovation, it is optimal for the specialized firm to
transfer its patent exclusively to a single firm. To transfer it to many producing firms would only introduce
ex post
competition in the product market, dissipating the rent from th
e patent. In biotechnology alliances, LPCs may use
equity ownership as a mechanism to create a monopoly position through exclusive or preferential access to key
innovations (Arora and Gambardella, 1990; Lerner and Merges, 1998). In other words, equity inve
stments may allow
an LPC to "preempt" access to an NBF's R&D output, barring other LPCs from access. Due to the intense
technology race in the pharmaceutical industry, LPCs may not only want to have access to key technologies
produced by a given NBF, but a
lso want to have exclusive or preferential access to these technologies (Tirole, 1988).
Although there is a large and increasing number of NBFs, it is possible that some key technologies are concentrated
in a few NBFs, offering the possibility of creating
local monopolies in given technology spaces. By investing equity
in an NBF owning critical R&D capabilities, an LPC may be able to more closely monitor the technological
advancements made by the NBF, and possibly block access by other competing LPCs to the
se technologies. For
example, if a critical technology is generated from an R&D alliance, an LPC can use its equity stake to increase its
chances of obtaining exclusive or preferential access to this technology (e.g., exclusive vs. non
exclusive licensing
rights), or even increase its equity stake in the NBF to achieve tighter administrative control over
its technology
allocation choices (Kenny, 1986; Arora and Gambardella, 1990). Given that the scope of most NBFs' R&D activities
is very narrow (often in a
specific therapeutic area) and is usually not replicated across firms, once an LPC has
invested equity in an NBF and obtained exclusive or preferential rights over that NBF's R&D output, it would be
very difficult for competitors to access the same technol
ogies. Hence, we suggest the following:

Proposition 1
: A large proportion of R&D alliances between LPCs and NBFs will be in the form of either minority
-
equity
-
based R&D projects or joint ventures.

Proposition
2: A large proportion of R&D alliances formed b
y LPCs with NBFs subsequent to equity investment will
be unilaterally exclusive; that is, an NBF involved in an equity
-
based R&D alliance with an LPC will
not establish R&D alliances with other LPCs.

The Journal of American Academy of Business, Cambridge *

September 2004

216

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EMPIRICAL STUDY

Sample, Data and Methods

The sample of this study consists of 15 global pharmaceutical firms, covering a time peri
od primarily from
1985 to 1998. All of the sample firms have had significant presence in the biotechnology industry in terms of their
patenting activities since the early 1980s. Among the 15 sample firms, nine of them are based in the United States,
while
the other six are European firms. The primary source for the alliance data is
Bioscan,
an independent industry
directory covering a broad range of organizations that are actively involved in the biotechnology industry. We
collected data on R&D alliances es
tablished by sample LPCs with NBFs between 1985 and 1998. The method used
for this study is a series of demographic analyses of the nature, frequency and exclusivity of these alliances.

Equity Investments by LPCs in NBFs

Data on the formation of equity
-
bas
ed alliances by sample firms shows that from 1985 to 1998, the 15
sample firms formed a total of 72 equity
-
based R&D alliances, with 45 of them being minority
-
equity
-
based R&D
alliances and 27 being joint ventures. Overall, equity
-
based alliances accounted

for 11.29 percent of all 638 R&D
alliances. The data shows that this ratio remained stable across regions and across time periods. The relative
infrequency of equity
-
based R&D alliances is inconsistent with the technology preemption argument. Without
equi
ty investment in an R&D alliance, it would be difficult for an LPC to secure exclusive or preferential access to
the R&D output generated by its NBF partners. Therefore, the LPC may not effectively prevent its competitors from
gaining the same or similar t
echnologies from its alliance partners, making technology preemption less likely.

Nature and Unilateral Exclusivity of Equity Ties

Although we find only a small number of equity
-
based R&D alliances formed by sample firms, we believe
it is still worth inves
tigating the motives for these alliances. In order to infer the motives for equity
-
based R&D
alliances, it is necessary to conduct a detailed examination of R&D alliances formed by the partnering NBF pre
-

and
post an LPCs equity investment, and the exclusi
vity of the NBF's R&D and equity ties. These issues are examined in
Table 1, which shows the distribution of single and multiple ties (i.e., R&D alliances) formed between sample LPCs
and NBFs in which they have equity investments. Four types of equity
-
base
d ties are identified in the table: single
tie, multiple exclusive ties, multiple non
-
exclusive ties, and ties with unclear nature.

Table 1 Distribution of Single and Multiple Ties with Equity Investment

Number of Cases

S
ingle Tie"

Multiple Exclusive Ties
b
Multiple Non
-
Exclusive Ties'
Unclear"
1
Total

%

43.06

2.78

43.06

11.11

100.00

Note: " Single equity
-
based R&D alliance
b

Unilaterally exclusive multiple alliances with equity investment
c

Non
-
exclusive multiple alli
ances with equity investment Nature of exclusivity can not be determined

In the case of a single tie, an NBF formed only one equity
-
based R&D alliance with one of the sample
firms during the study period (1985
-
1998). No other equity
-
based or non
-
equity
-
based R&D alliances formed by the
same NBF are found in the dataset. Overall, 31 such single equity ties were formed by sample firms, representing
43.06 percent of all equity
-
based R&D alliances formed by these firms. One possible explanation for these si
ngle
ties is that they were used by LPCs for the purpose of technology preemption. Once an LPC identified NBFs that
were developing promising technologies that might help improve its competitive position, it might first invest equity
in those NBFs, then es
tablish R&D alliances with them, and closely monitor their overall R&D activities. The LPC
might then use its equity investment to obtain exclusive rights over those technologies. Alternatively, an LPC might
offer equity in exchange for exclusive rights at

the outset of an equity
-
based R&D alliance. Given that most NBFs
are financially constrained, they might be willing to accept such a contractual arrangement (Lerner and Merges,
1998). However, since the study sample is not an exhaustive list of all pharma
ceutical manufacturers in the world, it
is possible that some NBFs that are reported as having formed single ties in the dataset might have established R&D
alliances with other LPCs that are not included in the sample. Thus our evidence on single equity ti
es may be less
compelling than it appears.

The Journal of American Academy of Business, Cambridge * September 2004

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Type of R&D Alliance

31

2

31

8

72

An in
-
depth examination of the
timing of the formation of single ties further weakens the technology
preemption explanation. Evidence shows that the majority (67.74 percent) of single equity ties were formed between
1992 and 1998. Moreover, 48.39 percent of single equity ties were forme
d between 1996
-
1998; 38.71 percent of
single equity ties were formed between 1997 and 1998. Since the study sample ends in 1998, some NBFs that
formed single equity ties might have formed, or will form other R&D alliances with other LPCs after 1998. If thi
s
were the case, it could substantially dampen the validity of the technology preemption argument. That is, single
equity
-
based ties may be recorded early in the life of an NBF, to be followed by subsequent investments as the firm
increases its scale and s
cope. However, it is still possible that preemption may motivate equity investments in the
early life of an NBF. Another implication of the technology preemption argument is that subsequent to an equity
investment, the NBF involved should not form R&D alli
ances with other LPCs. Again, since most NBFs worked in
narrowly defined R&D fields, forming multiple alliances with different LPCs would very likely allow several LPCs
to access the same set of critical knowledge or technologies developed by a given NBF.
In the cases of unilaterally
exclusive multiple ties with equity investment an NBF formed R&D alliances only with an LPC that had an equity
investment. Only two cases of unilaterally exclusively multiple ties (2.78 percent of all equity ties) are identifie
d
from the dataset. For instance, the only alliance partner EntreMed had in the pharmaceutical industry was Bristol
-
Myers Squibb. EntreMed formed an R&D collaboration with BMS in 1995 and a minority
-
equity
-
based R&D
alliance in 1997. Vical signed an R&D co
ntract in 1994 and formed a minority
-
equity
-
based R&D alliance in 1997,
both with Merck.

In the case of non
-
exclusive multiple ties with equity investment, an NBF established R&D alliances with
other LPCs in the presence of an equity investment made by a g
iven LPC. For instance, California Biotechnology
formed two joint ventures with American Home Products in 1986. However, these equity
-
based alliances did not
prevent California Biotechnology from forming R&D alliances with other LPCs: it signed an R&D cont
ract with Eli
Lilly in 1986 and formed an R&D collaboration with Pfizer in 1988. Although no information on the exact nature of
the technologies involved in these R&D alliances is available, overall it would be difficult for an LPC to obtain
exclusive righ
ts over critical R&D capabilities from NBFs that were involved in R&D alliances with multiple
pharmaceutical firms. We therefore conclude that in these instances, technology preemption cannot be assumed to be
the motivation for the equity alliances. There
are eight cases of equity ties with unclear exclusivity. In these cases, an
NBF formed an R&D alliance with an LPC prior to the equity investment made by another LPC. For instance, before
Eli Lilly made a minority equity investment in Ophidian in 1996, Oph
idian was involved in an R&D collaboration
with American Home Products, starting in 1992. In another case, RiboGene signed an R&D contract with Warner
-
Lambert in 1995. In the following year, RiboGene formed a minority
-
equity
-
based R&D alliance with Abbott
Laboratories. Since information on the nature and duration of these R&D alliances is not available, it is difficult to
determine whether the LPCs would have exclusive access to critical technologies developed by NBFs that were
involved in previous or pendi
ng R&D alliances with other LPCs. We consider this unlikely.

CONCLUDING REMARKS

The technology preemption explanation receives very weak support from the empirical results presented in
this study. We argue that equity investment in an NBF may enable an LPC

to monitor the technological
advancements made by the NBF more closely, and possibly block access by other competing LPCs to the same
technologies. A detailed examination of equity
-
based R&D alliances formed by LPCs reveals that about 43 percent
of these
equity ties are single ties. However, we find that most of these single ties were formed recently. It is very
likely that some NBFs that formed single equity ties might have formed, or will form other R&D alliances with
other LPCs after the study period. T
herefore, the prevalence of single equity ties cannot offer significant support to
the technology preemption explanation.

In addition, we find that only few multiple R&D alliances with equity investment are unilaterally exclusive;
the majority of multiple
R&D alliances are non
-
exclusive. That is, in most cases when an NBF formed multiple
R&D alliances, it formed alliances with different LPCs even after one of them had made equity investment in it.
Given that most NBFs worked in a narrowly defined drug area,

these multiple non
-
exclusive alliances would very
likely leak critical knowledge to several competing LPCs. Therefore, equity investment in these alliances should not
be perceived as a mechanism to preempt key technologies developed by NBFs. This evidence

provides weak support
to the technology preemption explanation. In sum, evidence presented in this study is generally not consistent with
the technology preemption explanation for LPCs' formation of R&D alliances with NBFs.

The Journal of American Academy

of Business, Cambridge * September 2004

218

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For future research on the R&D alliances between LPCs and NBFs, we suggest that the unit of analysis be
b
roken down to the program level, rather that the firm level. Due to the segmented nature of the pharmaceutical
industry, it is argued that learning and technology preemption often occur at the R&D program level and not at the
firm level. Therefore, the pro
gram
-
level data would better allow researchers to more rigorously determine the
validity of the technology preemption explanation or other competing explanations. We believe that refined
methodologies and greater data availability will considerably deepen
our understanding of the nature, motives, and
evolution of R&D alliances in knowledge
-
intensive industries such as biotechnology.

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