Vertical Integration

Vertical Integration Or Why do research? Why do research in house? Outline ƒ ƒ ƒ Exploring the role of IP Why do (basic) research? Why do (basic) research in house? IP in historical perspective US Patents granted per 1000 population 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 1840 1850 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 Survey methodology ƒ ƒ ƒ ƒ Targeted at senior IP managers, typically Chief Patent Counsel Depth at the expense of breadth: 18 page questionnaire, more than 120 questions! Core sample frame: IPO membership, supplemented with additional mailing to Delphion list Response rate: 1/3 of IPO membership, 5% of others. N=66. Sample characteristics ƒ Sample of responding companies dominated by large manufacturing companies – – – – ƒ ƒ Chemicals 22% IT and communications 44% Life sciences 15% Mechanical 16% Average sales $20bn, 2001 market cap $44bn Average of 14 full time IP attorneys, 264 patent applications, $91MM licensing revenue We found: ƒ ƒ ƒ Many companies report limits to the effectiveness of patents: 43% (!) agree that “many of our most important ideas cannot be effectively protected with patents” Yet most rate formal IP rights the most important means of controlling the use of technology Contract law (NDAs, NCAs etc.) also highly rated Strategic use of IP? ƒ Our overall impression is that the IP strategy of the majority of companies is defensive – Non-confrontational responses to competitors – Relatively conservative and cautious policies ƒ Companies are ambivalent about the role of IP in business strategy – Many report that profitability and returns to R&D are linked to strong IP positions and aggressive strategic posture, but few report activity by their company consistent with this… Competitive interaction in IP ƒ 65% of surveyed companies report that the most profitable companies in their industry “react aggressively to IP activity by competitors” ƒ But – Less than 20% would attempt to “fence in” an aggressive competitor by building IP assets – More than 90% do not “always evaluate competitor reactions” when filing patents – Only 1/3 anticipate triggering an “arms race” if many new patents are filed So… why do firms do basic research (with their own money)? Pharmaceutical Firms: Relevant Patents vs Applied Research Articles, 1981-1997 2500 Merck No of Relevant Patents 2000 Hoechst/MMD 1500 Bayer Eli-Lilly WarnerLambert 1000 Ciba-Geigy Pfizer Abbott DuPont Hoffman-LaRoche B-M-S 500 Sandoz Burroughs-Wellcome 0 0 1000 2000 3000 4000 No of Relevant Articles Published in Applied Research Journals 5000 6000 Pharmaceutical Firms: Relevant Patents vs Basic Research Publications, 1981-1997 2500 Merck 2000 No of Relevant Patents Hoechst/MMD 1500 Bayer Ciba-Geigy Eli-Lilly 1000 Pfizer Warner-Lambert Abbott Rhone-Poulenc Hoffman-LaRoche DuPont B-M-S 500 Burroughs-Wellcome 0 0 500 1000 1500 2000 No of published articles in relevant basic journals 2500 3000 3500 Semiconductor Firms - Relevant Patents vs Applied Research Publications, 1981-97 4000 IBM 3500 Motorola Toshiba 3000 Mitsubishi No of relevant patents TI Hitachi NEC 2500 Fujitsu 2000 Philips ST Micro 1500 AT&T Siemens Matsushita 1000 500 NTT 0 0 2000 4000 6000 8000 No of published articles in relevant applied journals 10000 12000 Semiconductor Firms - Relevant Patents vs Basic Research Publications, 1981-97 4000 IBM 3500 Motorola 3000 Toshiba Mitsubishi N o o f re l e v a n t p a te n ts TI Hitachi, NEC 2500 Fujitsu 2000 ST Micro Philips 1500 AT&T Siemens Natl Semi Matsushita 1000 Intel 500 NTT 0 0 1000 2000 3000 4000 No of published articles in relevant basic journals 5000 6000 7000 Research before the World Wars Goal: Understand the world First “gentlemen” & then Universities, Foundations Incentive: Make $$ Incentive: prestige, fun, the social good Firms Goal: Make the widget work Research before the World Wars “Basic”, “Curiosity driven” research ƒ ƒ Researchers motivated by the intrinsic interest of the problem,orientated to their peers, not to application Choice of problems dictated by individual researchers on the basis of curiosity “Applied” research ƒ Researchers motivated by the desire to make money, have an impact on the world ƒ Choice or problems motivated by the needs of the market place Research before the World Wars ƒ “Basic” research makes enormous progress, but few firms invest in it. – Except the German chemical industry ƒ Many major technological advances driven by engineers “tinkering” – Steel, Steam ƒ And technological advances that do use science use old, publicly available science – Electricity – Telephony Sputnik and the World Wars Goal: Understand the world First “gentlemen” & then Universities, Foundations Radar The Atom Bomb Penicillan The Man on the Moon Incentive: prestige, fun, the social good Incentive: Make $$ Firms Goal: Make the widget work After the Wars Goal: Understand the world Universities, Foundations Central Research Labs Office of Naval Research NIH Incentive: prestige, fun, the social good Incentive: Make $$ NASA DOD Traditional Applied Research Goal: Make the widget work Corporate Research Labs in the Golden Age ƒ ƒ ƒ ƒ ƒ ƒ ƒ ƒ Bell Labs RCA Sarnoff Labs Xerox Parc IBM & the Watson Labs GE Alcoa DuPont Kodak The Golden Age Research Model “Build it and they will come” For Example: Do the very best science Make major breakthroughs Take them to the market And get really rich The transistor The CAT scanner Cohen/Boyer patent Nylon Protease Inhibitors Core assumptions of “golden age” research ƒ ƒ ƒ ƒ Curiosity driven – understand the problems and the applications will follow Not overly constrained by financial or cost goals Hire the very best people and give them freedom Stay closely connected to the university and to the community of public science More recently: The Golden Age model in question ƒ Many firms unable to capitalize on major discoveries, or benefits take years to emerge: – – – – ƒ The RCA disc Xerox PARC Kevlar Lucent & Bell Labs A significant number of breakthroughs come through close user/market contact, not from the corporate labs Why would a private firm ever invest in basic research? ƒ Monopoly power – (Tight appropriability or tightly held complementary assets!) ƒ Maintain & attract key people – (Do scientists pay to do good science?) ƒ Build absorptive capacity Absorptive Capacity: ƒ What: – The ability to take advantage of knowledge generated outside the boundaries of the firm, the function or the business unit ƒ Why: – Much key knowledge generated outside: » “Basic” research » Competitive research » Knowledge elsewhere in the firm ƒ How?? Building absorptive capacity ƒ ƒ Reading the journals is not enough: to understand outside developments one must invest in the science - “to decode the signal one must build a receiver” Thus it may be necessary to: – – – – ƒ Invest in “basic” or leading edge research Reward individuals on the basis of their standing outside the firm -- and to allow publication “Give away” key ideas in order to be a “player” Take part in joint ventures or industry consortia that keep the firm “in the loop” Notice that such “research tourism” will have to be managed/incented differently! Current “best practice” attempts to balance & integrate the two poles: “Basic” or “fundamental” science “Applied” research Some firms continue to fund central research aggressively “Basic” or “fundamental” science Genomics, Photonics Msoft, P&G “Applied” research But others have moved away from central research completely “Basic” or “fundamental” science Intel “Applied” research A variety of approaches are used to balance this tension: ƒ ƒ ƒ ƒ ƒ Explicit funding levels (Tier 1, Tier 2, Tier 3) Organizational structure Control over the central research budget Processes or temporary structures: cross functional teams, working groups “In-bound” marketing Many companies set explicit funding levels: “Basic” or “fundamental” science Tier I 5% Tier 1 Tier II 25% Tier II Tier III 70% Tier III Source: Hauser. Check numbers! “Applied” research Many firms give some control over central research funding to the business units % Funding From Business Units Siemens, Philips, Xerox, GE NEC, IBM, Sony DuPont 3M, Ford GM % Funding from Corporate Office Or experiment with alternative organizational forms Science A A A A R PD AR AR PD PD Specialty Materials Specialty Materials PD Display Technologies PD AR= AR= Applied Applied Research Research PD PD == Product Product development development A A == Acquisitions Acquisitions Display Technologies AR Telecommunications PD AR Telecommunications AR Science A A A Other firms have experimented with hybrid organizational structures Centers of Excellence BU B Matrix BU C Function 1 Function 2 BU 1 Degree of Team Leader Influence Product Concept Team Leader Cons ‹Supports necessary scale for critical technologies ‹Manage career paths ‹Avoid redundancy BU 2 BU 3 Market ENGINEERINGMFGMKG Function 3 Pros Ceo Heavyweight Project Team Ceo BU A Teams R&D Area 1 R&D Area 2 R&D Area 3 ‹Focused cross functional coordination ‹More efficient development ‹Development of team and management skills ‹Confusion of team roles ‹Difficult inter-unit ‹Shortage of good project communication ‹Restricted view of whole management ‹Can become too removed ‹Death by many teams ‹Degradation of fxnl skills from the business ‹Focused attention to multiple objectives ‹Best of both worlds: coordination and specialization ‹Confusion of roles ‹High overhead ‹Powerful individuals tip the balance of power ‹Worst of both worlds All R&D structures have limitations that can (in principle) be managed with the right processes Making Central Research more Decentralized ƒ ƒ ƒ ƒ ƒ ƒ Institute “contracting” mechanism whereby Business Units can invest their R&D dollars by sponsoring projects in central Research Create Councils comprising senior technical members (e.g. TDOs) from the business units to win endorsement for Research programs and ensure relevance Provide communication mechanisms for central Research to showcase their programs (conferences, “technology fairs”, “catalogs”, “trolling”) Institute funding mechanisms that require project transfer to the business at a future date or require projects to win matching funds from the business Support internship programs that lend researchers to the businesses Organize by product technology Making Decentralized Research more Central ƒ ƒ ƒ ƒ Employ Portfolio process that ensures balance between platforms, derivatives, and breakthroughs Create cross-Business Councils responsible for synergies between research done within the businesses Fund outside research in universities, start-up companies, or other outside organizations Co-locate Decentralized R&D resources within central labs to promote synergy and preserve critical mass in scientific disciplines Should we do (basic) research in house? Or If the money is in lobster restaurants, should the lobster fisherman go into the restaurant business? The ideal R&D Organization is: ƒ ƒ ƒ ƒ ƒ ƒ Fast Efficient Close to the leading edge of science Generating critical knowledge internally Creative and freewheeling Staffed by the best people Ð Ð Ð Ð But close to the business and the customer But able to take advantage of outside developments But disciplined & focused But not dominated by prima donnas Managing R&D thus means managing tension: ƒ ƒ ƒ ƒ ƒ Between the long and the short term Between “basic” and “applied” research Between the inside and the outside Between pure technology focus and pure market focus Between managing by results and managing by effort Key Questions: ƒ When should an entrepreneurial firm develop it’s own: – – – – ƒ Manufacturing Research Sales ….. capabilities? When should a mature firm outsource it’s: – – – – Manufacturing Research Sales ….. capabilities? Exercise: ƒ Under what conditions should an entrepreneurial firm develop it’s own: – – – – ƒ Manufacturing Distribution Sales ….. capabilities? And when should it subcontract/partner for them? Comparing “make” vs. “buy” Startup/ Research house Startup/ Research Asset Asset Large firm Supplier Integrating Basic Research: IBM? Supplier “Effort” Asset User (Value=P) Intermediate good User (Value=Q) Outsourcing Basic Research: Intel? Supplier “Effort” Asset User (Value=P) Intermediate good User (Value=Q) Key Considerations: ƒ How easy is it to write contracts? – How tight is the IP regime? – How much uncertainty is there? – “Specificity” of the asset – how “thick” is the market? ƒ What will happen to “entrepreneurial energy”? ƒ What will be the key complementary assets going forward? So “make” (i.e. do it in-house) if: ƒ ƒ There are significant IP worries There are likely to be contractual problems – We can’t be sure of getting the “fair” price – We can’t be sure they’ll do the work “right” – I.e., when market are “thin” or there is limited information ƒ ƒ We have unique competencies that are relevant And if buying won’t destroy everyone’s incentives to be creative and energetic But remember… ƒ ƒ ƒ One cannot “buy” profit – if everyone knows it is there – it will be in the price Besides, shouldn’t we “stick to our knitting”? Wouldn’t you rather deal with an independent firm, whom you could fire, than an internal subsidiary? Make vs. Buy Entrepreneurial Drive, Freedom from the “old ways” Buy? Make? Control & Coordination