Are you in control of your new products?

pharmafile | January 19, 2007 | Feature | Research and Development |  academia, innovation 

The quest to convert inventions (i.e. promising ideas) into innovations (i.e. commercial products) is a central and vital feature of technological progress and economic growth, and integral to this process is the gamble of investing capital – which can be substantial – in order to reap the hoped-for ultimate rewards.

It has been estimated that the average R&D cost for a new chemical entity launched in the US pharmaceutical market is $802 million. Such estimates are frequently used in policy debates and part of the reason these estimates are so large and controversial is that they take into account the cost of previous ideas that have failed to make it to launch.

On average, the odds of a promising idea making it past the various stages of drug development to eventual product launch are less than one in five, but these figures can vary to a great extent across companies, leading to the assumption that development costs per launched product will also show large variations.

All companies, whatever their business or size, sink much hard-earned capital into generating inventions and bringing them speedily to market. Every stage of product development adds substantially (and cumulatively) to costs, and these costs have major implications for companies, policy makers, and consumers.

Efficiency in product development due to higher conversion rates can yield resource savings that can be reallocated in other ways, such as in lower prices, higher profits, or greater investment in future innovation. Yet differences in conversion rates are rarely discussed in policy debates, and it appears to be assumed that firms have little control over conversion rates and are all subject to the same odds of conversion.

Pressure to convert

Looking specifically at the world of pharma, are some companies better than others at converting their promising ideas into launched products? If so, what distinguishes companies that can do this well from those that find it difficult? Despite the importance of these questions, research on conversion is rare, and measuring conversion ability remains a puzzle. Product development is the lifeblood of the pharmaceutical industry. New drugs have dramatically benefited the lives of many patients, not to mention the bank accounts of shareholders. Nevertheless, drug development is an extraordinarily expensive proposition, and converting promising ideas into launched drugs is no easy task. Given strong pressures to innovate and bring forth a steady stream of launched products, many managers have gravitated toward two solutions: generate larger numbers of promising ideas, and increase the speed with which ideas are brought to market. An implicit assumption is that a greater number of ideas leads to greater innovation outputs.

The measure of a company's proficiency at translating a given idea into a launched product is called conversion ability. As such, a company is deemed to have high conversion ability if its likelihood of converting a given idea into a launched product is higher than that of other companies, although these will show huge variations in their conversion ability. Why is this? Part of the difficulty in answering questions about conversion is the lack of data availability for both inputs (i.e. promising ideas) and outputs (i.e. launched products).

Data difficulties

Conversion ability appears to have an intuitive, seemingly obvious, impact on performance in various contexts, and increasing conversion ability is a desirable and, indeed, a profitable objective for companies. But the benefits are difficult to quantify as the efficiency gains derived in the period when ideas are converted into launched products take a significant length of time to materialise and cannot easily be tied to performance in a particular year.

One way to get round this problem is to collect data during a given timescale on a company's return on investment (ROI) and compare this performance with companies with high and those with low conversion abilities. Although this type of analysis is far from definitive, it provides some suggestive evidence for the importance of conversion ability as companies that have this ability usually perform better overall than those that lack it.

Empirical research on conversion requires data on the number of promising ideas in a company. These data are often exceedingly difficult to quantify as ideas are dispersed across many individuals and many areas within companies. Moreover, companies have highly varying propensities to record and report information on development projects; failures are quickly forgotten and are difficult to track, and for secrecy and policy reasons, many firms keep projects in development strictly under wraps. For all these reasons, it is difficult to obtain comparable data across companies – but fortunately, the pharma industry is an important exception to this general trend.

Because of the nature of its products, pharma, researchers have access to reliable data at both ends of the conversion process. On the output side, pharmaceutical regulatory bodies provide detailed data on all drugs that have been approved for launch within their areas of jurisdiction, and on the input side, some institutional characteristics of the pharma industry facilitate the collection of accurate, comprehensive, and comparable data on the promising ideas in individual firms.

Speed is of the essence

Speed is an important element in determining the level of conversion ability – and it kills, both when there is too much of it or too little. It has been claimed that greater speed leads to the possibility of building brand loyalty, by moving down experience curves faster, building channel relationships, and creating switching costs, but, in practice, a strong focus on speed and the generation of many ideas may actually be damaging to firms by lowering their conversion ability. The companies with the highest conversion ability are those that have focus and deliberation in their approach to product development, and neither of these are factors which can be rushed.

Too much time pressure hinders problem solving, which can be due to managers giving insufficient importance to the time-sensitivity of both information and decisions, which can result in reliance on out-of-date or obsolete information. Moreover, decision-makers may ignore crucial information and fail to learn from mistakes, plus there is a tendency to emphasise negative rather than positive information and this can cause managers to prematurely drop projects before they reach conversion stage.

Conversely, where there is little time pressure, co-ordination can be loose, controls are likely to be lax and decision-makers may lack the sense of urgency needed to engender concentration on product conversion goals. The results for both these kinds of timeframes are lower than expected outcomes.

The obvious implication for companies is that they should ensure they do not operate at either end of the spectrum on speed, but rather identify the more productive middle ground. In particular, firms that base their new product development programmes on achieving time-bound targets should pause and allow their personnel to deliberate. In the pharmaceutical industry, the optimal speed appears to be around nine years from initial idea to final drug approval, and any speed targets that are set too far below or above this level can prove to be detrimental to the drug development programme.

Despite this, with increasing pressure to innovate, many companies have gravitated toward generating larger numbers of promising ideas and increasing the speed with which these ideas are taken to the market. There is an implicit assumption in both managerial practice and academic research that more is better and that speed is a requirement for success in innovation.

But it can be argued that a strong focus on speed and the generation of many ideas may actually be detrimental to a company by reducing its conversion ability. Those companies with the highest conversion ability focus on a moderate number of ideas, in areas of importance in which they have expertise. They also spend valuable time considering the viability of promising ideas, rather than rushing in to develop them.

The four factors

The conversion of ideas into new products is a problem-solving process and this involves four factors: workload, time pressure, expertise, and task importance. Workload refers primarily to the number of tasks that are being solved at a given time; time pressure refers to the time within which these tasks must be solved; expertise refers to the domain-specific knowledge that the problem solver brings to the task; and task importance is the value attached to succeeding at a particular task. Each of these factors has a correlate in the new product development (conversion) context.

Workload is a direct function of the number of ideas that the company is attempting to convert at any given time  the greater the number of ideas it is working on, the greater is the workload. Time pressure is a function of the speed with which the company is attempting to convert ideas into products  thus, the greater the speed for a given number of ideas, the greater is the time pressure.

Companies also differ in the extent to which they have prior experience with certain domains or areas of knowledge  so, the more experience they have within certain areas of knowledge, the more expertise they can bring to tasks that involve those areas of knowledge. Not surprisingly, companies that focus on ideas in technical fields in which they have expertise are better at converting these ideas into approved drugs than those that do not. These results imply that conversion is greater when companies stick to what they know when it comes to new product development.

Finally, new product ideas differ in their commercial and technical importance; if only some ideas are converted into new products, they are likely to be major innovations, with huge technical, marketing, and financial gains for the company involved.

These four factors can be integrated under the umbrella of focus and deliberation, and they form the drivers of conversion ability. The companies with the highest conversion abilities are those that focus on a moderate number of ideas of importance within their areas of expertise, and also deliberate by adopting a moderate level of speed in conversion.

Playing the numbers game

Further to the considerations of product development pressure and speed of conversion, working on too many ideas simultaneously is counterproductive for most companies and can, in fact, yield less. Those that seek optimum conversion ability may be better advised to focus on a moderate number of promising ideas. There are several possible reasons for this. Capacity-sharing explanations for the effect suggest that working on too many tasks simultaneously means less attention is given to any individual task. In addition, when multiple tasks need the same resources at the same time, bottlenecks can arise, with the result that all tasks are impaired.

There can also be the danger that some tasks may produce outputs or side-effects that are harmful to the processing of other tasks, and these deleterious effects become especially severe as the number of tasks becomes larger. But, despite this, it's important not to drift to the other extreme of working on too few ideas at any given time as this can also lead to lower conversion ability. This is because there is a reduction in the beneficial spillovers in knowledge that can arise when several ideas interact, because such spillover effects can exist only when multiple ideas are considered simultaneously.

Recognising the importance of an idea is also vital. Companies that focus on important ideas have higher conversion ability than those that do not. The implication is that when managers are selecting ideas to pursue, they should focus on ideas that have important technical and commercial implications. Such a goal might seem to be an objective in any case, but it is not uncommon for companies to take ideas that might be incremental and pursue them because they are perceived as being low-risk.

In the long-term, the outcome of taking this route ultimately diminishes the firms likelihood of converting ideas. In contrast, important ideas have the advantage of galvanising employees, motivating them to ensure that the idea matures into a finished product, with the result that firms which focus on important ideas enjoy high conversion ability.

The cost-benefit R&D conundrum

Companies vary greatly in their conversion ability, and this has a direct implication for policy-related research. It suggests that average numbers, such as the figure of $802 million for the cost of developing a new drug, could be a poor basis for policy making. This amount might be significantly lower, for example, for companies that focus on a few ideas within their areas of expertise.

In recent years, the pharmaceutical industry has come under heavy criticism for the high prices it sometimes charges for life-saving drugs that consumers in many parts of the world can barely afford. Critics also point out that many of these drugs are based on publicly funded research, that companies' expenditure on salesforce activities is greater than that spent on R&D, and that the industry has been extremely profitable for the past two decades or so. The arguments that drug companies use in their defence are that drugs cost huge amounts to develop and if firms are not assured of recouping these costs (by pricing high), they would not have the incentive to develop these drugs in the first place.

A crucial input in this argument is the cost of drug development. The numbers presented are often based on average development costs and conversion rates across companies, but this cannot give an accurate picture as companies vary in their conversion ability; i.e. some are more efficient than others at converting new ideas into drugs.

But this is not the whole story. More evidence is needed to clarify the performance implications of conversion ability, such as the quality of the products that are converted. For the sake of comparison, it would be useful to examine conversion ability in contexts other than the pharmaceutical one, as efficiency in converting inputs to outputs is likely to be desirable in many new product development contexts.

Against this, however, is the possibility that particular patents and product launches may not have the same significance in other contexts as they do in pharmaceuticals, while other inputs (e.g. development expenditures) and outputs (e.g. product sales) may be more relevant in other industry contexts.

In addition, there are several alternative strategies that companies can follow, such as focusing on novel drugs that have a low conversion probability but, if successful, have the potential to give a large payoff. Similarly, there are some firms which are good at selecting ideas from elsewhere (through acquisition or licensing), while others specialise in inventing good ideas that they then seek to convert in conjunction with other companies.

In this way, companies can justify or spread the risk, but will still benefit when the seed of a marketable idea eventually matures to bear its very profitable fruit.

Rajesh Chandy is Carlson School Professor of Marketing  rchandy@csom. umn.edu