1. Measuring Competence? Exploring firm effects in Pharmaceutical Research Rebecca Henderson Iain Cockburn Strategic Management Journal (1994) A Paper Summary By Amit Darekar

2. Introduction This paper begins where the NBER Working paper “Scale, scope and spillovers: The determinants of research productivity in drug discovery' by Henderson and Cockburn (1994) concludes. This paper explores the role of “competence” in pharmaceutical research: ◦A large proportion of the variance in research productivity across firms could be attributed to firm fixed effects. ◦Results also suggested that even though differences in research portfolio had very significant effects on research productivity, variations in portfolio structure across firms were both large and persistent. The paper is thus built on the above results to explore the nature of firm effects and the role of competence in pharmaceutical research. MEASURING COMPETENCE? EXPLORING FIRM EFFECTS IN PHARMACEUTICAL RESEARCH 2

3. Literature Review For an organizational “competence” to be a source of competitive advantage, it must be - 1.Heterogeneously distributed within an industry 2.Impossible to buy or sell in the available factor markets at less than its true marginal value 3.Difficult or costly to replicate (Barney, 1986; Peteraf, 1993; Wernerfelt, 1984; ) To structure our empirical analysis, we draw on literature 2 classes of capabilities ◦Component competence – local abilities and knowledge ◦Architectural competence – ability to use component competence MEASURING COMPETENCE? EXPLORING FIRM EFFECTS IN PHARMACEUTICAL RESEARCH 3

4. Hypotheses Hypothesis 1: Drug discovery productivity is an increasing function of firm-specific expertise in particular disciplinary areas. Hypothesis 2: Drug discovery productivity is an increasing function of component competence in particular disease areas. Hypothesis 3: Firms with the ability to encourage and maintain an extensive flow of information across the boundaries of the firm will have significantly more productive drug discovery efforts, all other things equal. Hypothesis 4: Firms that encourage and maintain an extensive flow of information across the boundaries between scientific disciplines and therapeutic classes within the firm will have significantly more productive drug discovery efforts, all other things equal. MEASURING COMPETENCE? EXPLORING FIRM EFFECTS IN PHARMACEUTICAL RESEARCH 4

5. Econometric Model We focus on productivity of drug discovery as measured by counts of “important patents” We hypothesize that patent counts are generated by a production function: We assumed that the patent counts “y” is generated by Poisson Distribution function λ as a explanatory function Re-writing the equation, we have MEASURING COMPETENCE? EXPLORING FIRM EFFECTS IN PHARMACEUTICAL RESEARCH 5

6. The Data & Construction of Variables The data – drawn from public sources and internal records of 10 major pharmaceutical companies ◦Quantitative data – up to 30 years of data on each research program & upto 30 program per firm ◦Qualitative data ( from primary and secondary sources) The variables: ◦Hypothesis #2 – KPATS ◦Hypothesis # 3 - PROPUB, ◦Hypothesis # 4 – CROSS, DICTATOR, GLOBAL ◦Control Variables MEASURING COMPETENCE? EXPLORING FIRM EFFECTS IN PHARMACEUTICAL RESEARCH 6

7. 7 Descriptive Statistics for the sample

8. Results Exploring the roots of firm heterogeneity at the firm level – ◦Rise in R 2 confirms firm-specific competence as a factor in competition ◦The standard likelihood ratio tests indicate that our measures of architectural competence are significantly related to research productivity ◦The firm-level analysis suggests that heterogeneity across firms plays a significant role in determining variation in research productivity, and provides significant support for our third and fourth hypotheses ◦It also suggests that the ability to integrate knowledge across and within the boundaries of the firm is an important determinant of heterogeneous competence Exploring firm heterogeneity at the program level – ◦The results lend strong support to Hypothesis #2: 'local' competence appears to have a very significant impact on research productivity. MEASURING COMPETENCE? EXPLORING FIRM EFFECTS IN PHARMACEUTICAL RESEARCH 8

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11. Conclusions and Directions for Further Research Results provide strong support for the importance of “competence” as a source of advantage in research productivity It supports the view that the ability to integrate knowledge both across the boundaries of the firm and across disciplines and product areas within the firm is an important source of strategic advantage. It also suggests that a focus on “architectural” capabilities as a source of sustainable competitive advantage; but can have challenges on 2 fronts: ◦It highlights the methodological problems inherent in attempting to measure 'organizational competence‘ ◦It highlights the importance of exploring the sources of organizational competence and their implications for the strategic choices made by the firm MEASURING COMPETENCE? EXPLORING FIRM EFFECTS IN PHARMACEUTICAL RESEARCH 11