Portfolio Management in New Drug Development - Innovation and Marketing in the Pharmaceutical Industry - page 102

innovation when there is neither high complexity nor stability, or when there is
instability but not complexity (as instability may not provide enough time for radi-
cal innovation to realize results). In the scenario where both complexity and insta-
bility are present, the balance of the portfolio depends on the parameters and does
not have a clear cut direction.
Another stream of research suggests that the choice of innovation strategy is
affected by a firm's position in the market. Kauffman et al. ( 2000 ) model technology
development as a search problem in the space of technological possibilities.
Incremental innovation is modeled as searching over small distances relative to the
starting point, and radical innovation is modeled as searching over large distances.
Using simulation and analytical tools, they conclude that if a firm's position is poor
or average at the initial position, it is optimal for the firm to search far away (i.e., to
conduct radical innovation). Once the firm finds the technological improvement
(succeeds in the radical innovation), it is optimal to limit its search to a local region
on the technology landscape (i.e., to conduct incremental innovation).
The key equation governing the firm's optimal search strategy is given by:

¥

( )

ò

( 1- b ) () () zd cd =-+ - b q zddF () () q

c c d

zd ()

c

where d is the search distance, zd

c () the reservation price, b the discount factor,
c () the search cost, and F d () the cumulative distribution of “technology effi-

ciency” at distance d . The firm should search at the distance with the highest reser-
vation price.
However, DiMasi ( 2000 ) presents empirical evidence which contests this theo-
retical result. The firms with the most number of NCEs in the period from 1963 to
1969 continued to dominate filings of NCEs from 1969 to the 1990s. Though the
percentage of NCEs that were self-originated declined from 71.6 to 60.9 % from the
1960s to the 1990s, the data does not seem to support that innovators “sit on their
laurels” after initial successes. However, as a counterpoint, the increasing growth in
small biotechnology firms that take on radical innovation projects, and their subse-
quent licensing deals with big pharmaceutical firms suggests that there may be areas
in which Kauffman et al. ( 2000 )'s theory may apply.
To summarize the discussion on radical versus incremental innovation, we note
that extant literature has suggested a variety of conditions and reasons to pursue
either type of innovation. It appears that the decision depends on both firm charac-
teristics and the external environment. One opportunity for further research is to
consider how to construct a portfolio that balances the two approaches. Most of the
previous work focused on an “either-or” choice between incremental and radical
innovation, whereas per Day ( 2007 ), the real decision is how much of each type to
include in the portfolio. Achieving the right balance requires alignment with the
goals of the organization. However, we suggest that firms which focus too heavily
on incremental innovation may want to consider the opportunity cost of not invest-
ing in areas which promise higher returns (albeit with higher risk).

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