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y Stategy—Developing the Finn's Innovative Capabilies ssorptive capacity is proposed a model to ‘ch R&D both gener- eaming, the devel- ‘opment of this model may ultimately be as valuable for the prescriptive analysis of organizational poli- ies as its application may be as a positive model of firm behavior ‘An important question from a prescriptive per spective is, When is a firm most likely to under invest in absorptive capacity to its own long-run detriment? Absorptive capacity is more likely 10 bx byproduct of routine activity when the knowledge domain that the firm developed and maintained as wishes t© exploit is closely related to its current knowledge base. When, acquire and use knowledge that is unrelated to its jowever, a firm wishes to ongoing activity, then the firm must dedicate effort exclusively to creating absorptive capacity (.e absorptive capacity is not a byproduct). In this case, absonptive capacity may not even occur to the firm as an investment alternative. Even if it does, due to the intangible nature of absorptive capacity, a firm may be reluctant (0 sacrifice current output a well as gains from specialization to permit its tech- nical personnel to acquire the requisite breadth of knowledge that would permit absorption of knowl ‘edge from new domains. Thus, while the current discussion addresses key features of organizational structure that determine a firms absorptive capacity and provides evidence that investment is responsive to the need to develop this capability, more research, is necessary to understand the decision processes that determine organizations’ investments in absorp- tive capacity Case IIL: Advanced Drug Delivery Systems: ALZA and Ciba-Geigy (A) Mark W. Cunningham, Reinhard Angelmar, and Yves Doz In midsummer 1977, the management teams of Ciba-Geigy’s Pharma Division in Basle, of its US. livision in Summit, New Jersey, and of ALZA Corp., Reprined with the permission of INSEAD-CEDEP. Copyright 198 INSEAD-CEDEP, Fonsaincbleau, France. Revised 1995, of Palo Alto, California, had to decide whether 10° cooperate in the development and commercializa tion of pharmaceutical products using Advanced Drug Delivery Systems (ADDS) and, in the event of a positive decision, what form such cooperation should take In order to of this decisi low an understanding of the context this case reviews key aspects ofthe pharmaceutical industry in 1977, presents the ADDS field, and profiles briefly the two companies: ALZA and Ciba-Geigy ‘The Pharmaceutical Industry: Recent Evolution The worldwide pharmaceutical market in 1977 was worth around $48 billion, the largest geographical matket being the United States with some 16 per cent, followed by Japan with 11 percent (see Exhibit 1). Worldwide sales of pharmaceutical companies in current terms had been gre at an average rate 2 percent since 1960, and 15 percent since 1970. The average rate of return on net worth over the last 15 years had been 18 percent, which was consid ably above the average for other n percent), The financial performance of several ofthe leading companies was well above this figure. ‘jor industries (1 However, there were indications that the future might not be quite as rosy. Valuable new drug dis coveries, which had been the main motor for EXHIBIT 1 Worldwide Pharmaceutical Market per capi (dolar) 197 ——_Peroentot millons) World Total United States ‘of Ameria 8 7,800 vapan Federal Republic ‘of Gornany 4.40 85 Fr 60 aly 8 38 Braz 3A Spain 25 United Kingclom 25 Argentina 19 Mexico 17 Otners 425 Total 100.054 0 decide whether to and commerctalizae is using Advanced and, in the event of n such cooperation nding of the context s Key aspects of the presents the ADDS. companies: ALZA Lindustry: tion parket in 197 ingest geographical with some 16 per Jercent (see Exhibit ntical companies in at an average rate >ercent since 1970, worth over the last rich was considers dajor industries (1 cof several of the © this figure ns that the future ble new per capita (lars) 3% $36 48 67 EXHIBIT 2 A. Patent Life and RAD Expeneture ‘Average number of NCES registered levelopment process rand more expensive Petod of patent protection comespondingly [bee Exhibit 2), gh there were ne ehical dru ere made by the hundee« ty 10,000 companies in the 90 percent of sales largest. The top 25 com. nics shared less than 50 percent of sales and the Higest individual market share was 3.5. percent Bhibit 3 shows the top 15, their country of origin, ind the importance of 5 ks. Exhibit 4 shows the area: Phurmaceutical companies and their R&D profile Product innovation was the main key both to Poofitability and but new He remained partly serendipitous. Compa ies’ labs seen for activity and toxicity large numbers of nat ual and synthetic substances which re thought to have U.S. Pharmaceutical Industry Performance ia oe | in One or another therapeutic area, is primary screening is usually done o1 Only sulliciently active and nontoxic 10 deserve trials on human beings the product development process was very slow with anywhere between 1 te 10 years of research sereening chemical substances), andl around 9 years for preclinical and clinical tale ‘pplication for registration. Then ‘ears of tials were likely t0 be needed BY the mid-1970s, tye RSD expenditures per new drug actually introduced by Company, taking into account the very high dropout rate during clinical tests, range n $25 mil betwe lion and $80 million, the serendipitous nature of discovery and the need to spread tisks and 10 smooth out the activity jauty 0s jancew w=peS yossncgs 1840004 | ynooeuueyg Buypesy —& LIGIHX3 Lust ‘saquedwoo 1k iy Sourcing 0 561 EXHIBIT4 Drug Companios 8, Selected RAD Characteristic of Loading Pharmacoutieal Companies research Development Histor event ens cronass ergs” praditvy__producty__slatonshps Aobot . . + + Cicer 8 : . : Jonson Joteson : - : Mek 3 7 re 7 Fote 8 ; : meniine : ” Opens : : Warner aster * . : Hisclopment groups created economies of scale Giba-Geigy, Merck, li Lilly, and most of the other G sharmaceutical RED, R&D spending amongst top companies belonged to the first group Jaling companies varied from 5 percent of Despite the owdlown in successful introductio Hinover to aver 12 percent, with an industry aver- the industry still judged that the prerequisite for sue- eof 8 percent (up from 7 percent in the 1960s). Kinparies could be divided into two main groups: cess was a larg ind well-focused R&D program and was increasing spending in this area, Companies Hie which depended heavily for growth and prof- were concentrating their efforts on a smaller num: Benproduct innovation; and those which relied on er of indications with proven market potenta! and Re skills to produce me-too products rapidly ying, where possible, to build on their ¢ cheaply, and on marketing skills to sell them. sting ise. It seemed likely that the smaller compa- 562 cit Enactment 6f Technology Stategy-—Developing the Fim’ Innovative Capabiite EXHIBITS Development Process for Typical Pharmaceutical Product at = LE fiemecees areal en rai | | Sere | anenlmscana shin : /. cee sete ender rapt ae et etree oo all IMTIANON OF FIRST HUMAN STUDIES J Y poe tee pe PHASE OMAN STUDIES ast Honan TUDES PHAGE W HUMAN STUDIES qatar | Now vo speten ‘ange angen nan ea 4) fasts ore ne ne | Seem ss pe ee 1) sgpront tok nd ppt prac ey nb ase o ‘Stig ron ries would continue to ha success rate in Giba and Geigy had not been combined when the) liscovery, but that they would be forced by the costs two companies merged, and it was usual also far of «levelopment to seek partners and licensees to sales forces to remain separate when a large com exploit their discoveries. pany acquired a smaller, specialized one Marketing costs were estimated to average 12 per Marketing and the establishment of a most of its Harge id any c of ‘ament lunder- p with wolved. Alex Zaffaroni first envisaged a company that ould evolve from R&D towards manufacturing and arketing ccived FDA approval. OCUSERT and Progestasert Jud been seen as the first steps in ALZA’s evolution ino an integrated pharmaceutical company. Yet it yas clear from the start that ALZA had neither the fesources nor the competence to compete with fajor companies in the discovery and synthesis of few active ingredients and the manufacture of exist- ing ones, 1s its products were developed and Research was therefore concentrated on the de Jyery systems and the screening of existing generic active ingredients for suitability ERT both used drugs in the would the first transcle jen (expected to use scopolamine against motion sthness). Cooperation with outsid eer or lesser degree. From the very beginning, isussions with pharmaceutical companies cen: feed on the licensing of active ingredients by ALZA, inilor of delivery systems by the partner. The first fonlact with Ciba-Geigy USA, which was of this Jind, occurred in. 1971, but prod wal Dr. Zaffaroni was concerned to avoid excessive tentact with the majors, There was, at first, no ques: fan of undertaking contract research; ALZA had as ch money as it needed and wished to avoid the innsfer of its technology to potential competitors. However, in 197 fee signed with Merck (cardiovascular and ant ilanmatory applications of OROS) and Boehringer Iogetheim of West Germany (antihypertensives in. innsdermal systems), Both agreements were for fonttct research giving ALZA clear objectives and hudgets. Intercompany project teams were not set ip, and the emphasis was on the provision of a ser in, Neither project had though they yielded jens of $1.7 million in that year This change in policy partly reflected ALZA’s need Jpenew sources of revenue, but also the feeling that jjwas now strong enough Co stand the contact with futsde cultures, It was also felt that the launch by fading pharmaceutical companies of major prod: ints based on ALZA's systems would AIZA’s credibility and bring in royalties. There were wexclisivity provisions that would prevent ALZA fom using what they learned in these projects for her products I sys- rs was inevitable to a long-term research agreements hie rather than collabor: fiogressed very far by 197 enhance echnology Sourcing 0 $77 ‘Overseas marketing agreements were sought for the ALZA products because @ dedicated interna- tional sales force would be impossibly expensive However, they were deliberately restricted to small ‘geographically limited concems. Marketing in the United States was kept in-house to retain control and added value. The United States was the largest market for ALZA's products and thought likely to be the most receptive to new tweatment, Manufacturing was retained at Palo Alto because it was central to the strategy of integration and because ALZA did not feel that anyone else had the necessary skills to handle it Dr, Zaffaroni was concerned that ALZA should not be allowed to grow too large for its entrepre neurial spirit and that its concer for the individual be maintained. Growth would therefore be achieved ot through formation of spin-off companies exploiting research, ese would oper ate independently and would be funded at least partly by outside capital. They would provide new opportunities for scientists and managers from the mother company. ‘The first of these affiliates, Dynapol, was formed in 1972 to exploit ALZA expertise in polymer and other technologies in the nutritional field. nd better methods of er diversification but through the groups’ ex} stise in new are: ALZA Organization Authority in ALZA stemmed from Dr, Zaffaroni, the founder, chairman of the board, and president Though the board of directors included the vice presidents in charge of medical affairs and ALZA Pharmaceuticals (he cial and production anization), and the part-time company secretary \e remaining members were essentially outside advisors, Several had investments in ALZA and all were now close friends of Dr. Zaffaroni The Board of Advisors consisted of 10 very dis tinguished scientific academics who served to keep ALZA in touch with the latest developments in their fields and exercised their influence on its behalf They also added to its prestige and credibility. They played no active role in the running of the company Reporting (0 Dr, Zaffaroni were the heads of finance, pharmaceuticals, res 1 affairs, control, technical development, and administration. The first four formed the management committee with Dr, Zaffaroni ch, medic: 578 0 ML Enactment of Technology Strategy—Developing the Fi Finance Division, Mr. Martin Gerstel, head of the Finance Division, had joined the company direct from the Stanford MBA program in which he had distinguished himself. He had previously been a Cummins following a BS in financial analyst industrial engineering Pharmaceuticals Div Division had been formed in 1973 to handle the pro- duction and market provided the infrastructure and services of ai grated pharmaceutical company, which had not until then been required ‘fon, ‘The Pharmaceuticals of the company's systems. It operating from dedicated facilitie not far from the main ALZA buildings. The origi production facilities had become the pilot plant. fac ‘on a LOacre site cory intended to manufscture Progestasert on a large yen completed in Mexico and w ‘only 49 percent by ALZA for legal reasons, The Pharmaceuticals Division was headed by Dr Carroll Walter jes, who was supported by sales, marketing, and productio mainly from the pharmaceutical industry. Nearly half of ALZA’s em. ployees (250) were still in pharmaceuticals, but the 6 had been formerly VP of Syntex Laborato: division's rapid buildup of staff in lowed by dismissals in both product departments in the financial crisis of 197 Research Division. Dr. Urquhart, the head of research, had been a professor of physiology at Pittsburg University ane of biomedical engineering USC before joining ALZA in 1969. Until 1975 the 0 ALZN’S internal projects, but in 1976 contracts for long-term joint-development projects had bee Merck (OROS) and Boehringer Ingelheim (Trans: derm division had devoted itself exc signed with Dr. Urquhart was supported by directors for Pharmaceutical R&D; Physical Biological, Materials and Engineering Science Administration; Engineer ing; and Analytical Methods. Though it was possible to be involved exclusively in basic research in a narrow field, most of the mem- bers of these departments worked on multdiseipli- nary project teams. Thus, a polymer chemist might leader who was a biologist or engincer. Th stil employed 220 people in mid-1977, havin undergone very little pruning. It was acknowledged to be the company’s essential core Dr. Felix ‘Theeuwes (OROS) with an academic background nost day-to-day purposes lo a project a Belgian chemist and Dr. Janet Shaw (OCUSERT), a British physiologist and biologist who joined from Institutional Research, were typical of ALZA’s project leaders, Most had distinguished backgrounds in research and had either invented or had been ase art, Mr, Peter Carpentes, nistry clegree and com siderable consulting experience fa project leader in 1977 but rapidly took over responsibility for planning, the systems they were developin ciated with them from the a Chicago MBA with che had been hired as Medical Affairs. Dr. Viegil Place, head of the Medical Affairs Division, had been director of ci al pharmacology at Syntex. The department wis literature research and. library see vices, data processing, and regulatory affairs. The department also set up the clinical research required forthe n cting, information package. Pharmaceutical compl nies generally consider the latter role crucial tothe successful launch of any new product, particularly it uses unfamiliar concepts. The Clinical Resear Department had to cover such diverse fields # opthalmolog and cardiology with # limited staff (Seven nurses, two trials manages {stration of new products and for the mae gynecok and two research A series of highly detailed organization chats been drawn up in 1974, but their release had net been authorized by Dr. Zaffaroni; he felt that ti company’s interests were best served by pli ive was tote ne company as fluid a5 98 sible since he believed that flexibility and mi channel essential 10 the maintenance of the entrepreneurial spitt of AUN This was considered particularly important in i R&D and medical areas. Consequently, though their immediate respi bilities and reporting lines were clear 10 All employees, they had little sense of the compa Is were given the il traditional in the industry (principal, seniog al junior scientist) but the exact status of each indi tual was not clear in all situations; a senior sca in charge of a project might even have Jent reporting to him or her if the later had spel skills essential to the project. the lack of role definition could cause probly A high proportion of scientists joining ALLA Ill again very rapidly because they found it hard Of in. They were given few clear orders and expected to propose their own work program sistant), down the formal structure, His ol relationships within communications were overall structure, Individu who fal of [shed bnted ner con- edas The bined mpa- > the ely if arch Is as ith agers I the lying keep pos aut the ZA, } the Aza iny’s titles and ants fecial left fo fit Kign on for those of others. The omganization Gmanded and received a very high degre Bitwent from its members. Very few left alter the fist ew months, and all seemed not only prepared but lso happy to work long hours. mosphere was similar to that Insome senses the university research departments with their fmphasis on creativity and the free flow of ideas. Mis was not surprisi from that background, fonment but also, for thos je, a ver hat they were cloing was n ako unique. since most employees came was a challenging envi who were fully commit- supportive one, People believed that only worthwhile but There was no rest contacts between Upariments and Dr Gents were well known to all the research staf jnelectual standards were said High; most lab technic Agrees tar to all concerned that town, there's one person to hi Zaffaroni and his vice presi to be extremely ns/assistants had graduate ‘The Role of Dr. Zaffaroni De Zaffaroni had ve Were central to the way ALZ. acl been set up and fontinued to be run, He believed that one of a com: pny’s or chief executive's main tasks was to ealance nicl promote the per Sonal growth of his employees, He provided the appropriate framework in the form of an attractive thes. luxurious working ¢ nd tried t0 sure that his researchers we ne job satisfacti not disturbed by Administrative or budgetary controls, He pe -ienifically elegant solution to a problem, and thoug! he was aware that this might lead to operational inef fiiencies, he felt that this attitude was the only one posible in clependent ainization. Employees were encouraged! (0 take an interest in areas in which they fi for qualifications, andl several scientists ¢ al man eved in recruiting the best avail omoted the intellectual content of work, the Dr. Zalfaroni be : red (0 go to great lengths tog ALZA bought Virgil Pce’s consulting company, and set up a shell com: my for Alan Michaels, the first head of research Technology Sourcing © 579 and an expert in core membrane technology, which was eventually bought out on advantageous terms. Dr. Higuchi, the originator of much of the ADDS the ory, wanted (0 continue to teach in Kansas, so an stitute was set up around him, which was later sold to Merck when he wanted to move on. Alex Zaflaroni believed that one major objective of the company must be to foster the personal growt he organiza tion must be adapted to the individual rather than the other way of its employees. To this end. round. One way of encouraging per research groups or individualls o Form spin-off com: panies that would exploit ALZA technologies in new fields. The first of these was Dynapol, set up to work Perhaps the most important element of Dr. Zaffa- roni’s leadership was his ability around him with his own enthusiasm and sense of major factor in the very low tumover of scientists which was maintained even (© inspire those when the going got tough. He was respected for his past scientific achievements, for his obvious concern for his colleagues, and for his refusal to compromise quality for commercial convenience. He was some body of whom his employees be prout. Dr. Zal nd colleagues could rons ability to attract and retain the faith $2 million came from his own pocket, by 1976 he om private place- of this money ends and acquaintances both within ments and public issues. A great d ind outside the industry. The list of highly lists advisors and consultants also the confidence of in helped maintain estors. The techniqui ilopted by the biotechnolo; start-ups of the late 1970s, ‘The Financial Crisis Since the start of operations in 1968, ALZA hi mulated a deficit of around $75 million, C\ operating revenues (at various points investment income and interest were sizable) had reached $10 million by mid 1977. Annual operat jumped from $9 million to $13.5 million in 1975 with running at ears. (A state the buildup of overheads, and had been xound $15 million for the last two 973-1977 ment of operations for can be found in Exhibit 12 of Case 1MI-3.) > ixhibit 13 of Case III-3) the company's liquid ke very largely inventory f° sion, while current liabil & con because the bank loan had sas ALZA failed to meet working, worth conditions. The banks were .et for repayment or for proof of a new funds which would guarantee survival agreed not to force ALZA into liquidation long as negotiations with a real chance of suc ceeding were in progress with potential partners, ALZA caleulated that the company’s cash shortfall over the next five years would be somewhere between $30 million and $50 million, depending on the speed with which successful new products coud be brought to the market and on the reading of the banks to extend payment terms, ‘The Search for Partners Gerstel The search for financing occupied Marti and Dr. Zaffaroni to the exclusion of almost all other activities from late 1976 onwards. The company's Scientific Advisors and non-executive board mem: bers were also mobilized cat from early 1976 that some additional Th was financing would probably be necessary, but the real ‘extent of this only became clear with the eaily sales figures for Progestasert. The company's financial position (see above) and operational difficulties led its investment bankers to advise that a public issue of stock would not be taken up by the market, Pri- vate placements would yield litle or nothing for the ‘A was already in default of the teims of its bank loans by 19 from which to pay interest charges. There was there- Fore no possibility of further bank financing Since ALZA could not raise money in expectation of pure financial return, it was obliged to look for a partner interested in its research expertise, existing technology, of both: In the first half of 1976 ALZA had signed agreements with Merck and Co., one of the biggest U.S. pharmaceutical companies, and with Boehringer Sohn, Ingleheim am Rhein from West Germany Merck hael agreed to finance a three-to-five-yea! joint-cevelopment program for cardiovascular and antiinflammatory systems using the OROS technol ogy. It also bought $3.5 million of ALZA stock at over $20 a share with an option for $1.5 million more. Boehringer Ingleheim had signed up for a long-term joint clevelopment of transdermal systems but bought no equity There was no immediate prospect of an inerease in the financial commitment of either of these com: panies, and it was now clear that similar agreements with other companies would be insufficient to save ALZA. At least half of any research payment repre sented real costs 10 ALZA, so the contribution (0 ‘overheads and Joan repayments would always be fairly small Approaches mace to almost all the remaini ‘major pharmaceutical companies failed to produce’ 4 positive response. Dr. Zaffaroni also approached! a large number of companies in the chemical and) petrochemical industries, though he felt that pur chase by a company outside pharmaceuticals was not in ALZA's best interests. Arco expressed interes filed to come up but in detailed discussions had with a seal offer ALZA and Ciba-Geigy The first contact with Ciba-Geigy USA in 1971 had not led to any further discussions, though it had revealed that company’s interest in this area. Dr. Zak n board (KL) member faroni met the Ciba-C responsible for their Pharma Division at a scientific conference in March 1977 and suggested cope: tion, He was put in touch with the head of Phanma Division, Dr. Staehelin, and flew to Basle to meet him in April. The meeting was very successful ona, personal level and it was followed in May bya Ciba Geigy visit to Palo Alto. The Ciba-Geigy team consisted of the Swiss heads of research (Dr. Heusler) and production (Dr. Goet) and the head of Pharma US Qtr. Mackinnon). They any way, but were not authorized to negotiate looked at the ALZA operation and (ook a great deal of financial and technical data away with them, Not ing of importance was heard from them for some time despite the obvious need for a quick decision, but in late July Dr. Zaffaroni heard that Ciba-Geigy was ready to discuss the terms of a possible coll oration or purchase He did not know what these terms might be. Pos sibilities ranged from outright purchase of all shares and integration into Ciba-Geigy to a. large-scale research contract with litle or no infusion of cape fal, As far as Ciba-Geigy knew, negotiations with another potential buyer, possibly Arco, were still i progress, LZ: Ciba. ALZS orga US. done cil preps inter Th pater migh streny and t contr Dr wouk bur he Resea fessor IBA favor. Objec ALZA’ relativ them of the The banks effect turing radlica resear thean living Hos pany ¢ condi main ¢ bra ems ents pre- nto bbe ing tuce hed and pur e up had had Za tnber tific pera: ama meet ona, Ciba reads oct) They hp deal Noth. Geigy bllab- Pos: shares pscale icapi- with, still ine AIZA Assessment of Ciba-Geigy Libt-Geigy’s Financial power were not in doubs, and itc AWZA generous fina Hyginizationally ALZA would be associated with the subsidiary, thou Hhne in Basle Gba-Geigy had one major sustained-released peparation on the market Slows hu-matrix system) and a number of slow-release janants of major products, It seemed to have a fair fnount of soundness and commercial tld afford to offer cial terms. It seemed likely t h the bulk of research was pharmacokinetic and systems develop: ent experience. The system which seemed to ineest them the most was OROS The Swiss company produced a wide range of jutented and generic compounds, many of which, faght be suitable for inclusion in ALZA systems. It ako had considerable marketing and distribution, srength worldwide, ‘There was a visioncare section, ini though research in endocrinology was being fared out, Ciba-Geigy had only litle presence in foatraception. Dr: Zalfaroni’s impression was that Dr. Staehelin ould svish to preserve ALZA’s unique character Hythe had no clear indication of the thinking of the Jusearch Department and American subsidiary. Pro~ fesor Woodward, an ALZA. scientific advisor and, {UBA-Geigy main board member, was very much in Iuorof linking the two companies. Objectives of ALZA and Ciba-Geigy N's negotiating strategy would depend on the felaive importance of different objective hem perhaps conflicting, bithe obj ‘The primary objective of ALZA was survival. ‘The Jenks were ready to foreclose on their loans and Hfecively bankrupt the company spaesarily mean the end of ALZA because a restruc i be possible, but it would undergo a we. It might, for example, become a fewarch and development laboratory relinquishing lheambition to become an integrated! concern and Jhing/off research contracts and royaltie: However, Dr, Zaffaroni wished to see his con pinychangedl as litte as possible. He wanted to pres lene its unique character: the excellent working, tunditions, the freewheeling creativity, the employ ies sense of commitment, Therefore, the second tin objective was to retain ALZA's autonomy, or at some of and upon its perception tives of Ciba-Geigy This would not Technology Sourcing 0 $81 least a degree of freedom of action; Ciba-Geigy might be prepared to save ALZA but only under terms which would be less acceptable than a1 structuting—integration as an in-house research unit of Ciba-Geigy, for example. Dr. Zaffaroni believed that if the company could hang on for another three to five years, the next generation of ADDS, principally OROS and tans dermal systems, would make it financially viable. They had applications for a much wider range of treatments than the first generation, He therefore wanted to keep ALZA’s options for the future as: open as possible A third objective was to retain as much as possible of the technology already developed under ALZA's control, and to maintain a real interest in future de velopments, The granting of exclusive rights to all or part of the technology would jeopardize ALZA’s long-term development The position of Ciba-Geigy with regard to these issues was by no means clear, ALZA could be regarded primarily as an almost risk-free investment if majority control was obtained because of the tax advantages available. ALZA had several years of losses and R&D and capital depreciation that could be written off against the profits of Ciba-Geigy’s American subsidiary A deal could be seen as a means of getting Ciba: Geigy up to speed in a promising new area through technology transfer, of asa quick way of getting new of revitalized products onto the market. How: ever, the interests and positions of Basle and Sum- mit“ management might not necessarily be identical. within Ciba-Geigy Case MI Ciba-Geigy Limited: Pharmaceutical Division (A) Mark W. Cunningham, Rein and Yves Doz yard Angelmar When Dr. Gaudenz Staehelin was appointed chair of the Pharma Divisional Committee (Division Reprinted wit the permission of INSEAD-CEDEP. Copyright © 198 by INSEAD-CEDEP, Fontanebleu, France, Revised 1992, $82 0 Il ow chology Stategy—Dewop or DL) ir he as the first nonscientist to hold this position, A lawyer by training, the soft spoken, 39-year old scion of an old Basle family hac fore his nomination chelin had worked in the com- ‘entered the company in 1964 » Pharma, Dr. Si pany’s corporate legal department. He had been deeply al and organi zational a Ciba valved in the complex Ie aspects of the 1970 merger betwe and Geigy The appointment of a nonscientist as DL chairman was interpreted by Pharma staff as a signal of pos sible change livision’s way of operating, The division's evolution since the 1970 merger provided his expectation: internal esti- he division had dropped from further grounds for mates suggested tha in world second to fourth place pharmaceutical les since 1970; moreover, there were few promis- ng new compounds in the pipeline. At the same ime, the total group was becoming more dependent fon the Pharma Division for growth and profits, as the inclustrial divisions (dyestuffs and chemicals and plastics and additives), the traditional backbone of hit by the recession. ‘One of Dr. Stachelin’s first moves Was 10 an explicit statement of the division’s mission, objec tives, and strategies in the form of a divisional Lei bild (charter), It stated the intention maintain and improve , .. our leading position in the We intend to concentrate or Ibu) to health care industry the pharmaceutical business extend the veope of out activities and to develop from a Pharma eutical Division 10 a Health Care Division. the growth and profitability targets set by the Lelt- he industry average Organization Structure Ciba-Geigy’s worldwide Pharma Division ¢ the divisional management in Baste, with functional units directly subordinated to the divi zement_ (research, p ministration operation: sclministea ing), and the Pharma divisions of group companies technical and plan: marketing exhibit 1 Divisional Management ‘The chairman of the d plementa tion through local divisions, for the management of the worldwide function: and, in rd to the R&D process, for decisions conceming, groups in Basle the research program, the inclusion of new prepa rations (including licensed products) in the devel opment process, their inclusion in the product line and product withdrawal Dr. Stachelin was highly sensitive to Ciba tradition of decision makin meant that major decisions were in fact taken by the divisional management committee which, in addition to the chairman functions (see Exhibit 2). The arrival of Dr in the Pharma Divi by consensus, This ncluded the heads of the staehelin on had coincided with or pre ceded other changes in DL and other key positions mr. Karl Heusler, 54 years old, was appointed Pharma research in 1974. Dr. Heusles, & chemist, had entered Ciba in 1951. After a distin head of guished scientific career in the area of stereokd syn hhesis, Dr. Heusler had successively occupied the positions of head of the Woodward Research Insi- bite, head of chemistry with Ciba and, after the merge Geigy While Prof. Oberholzer remained in place as head of the Medicine Division, immediately below him Dr. P. Loustalot (4 years old and with 25 yeas service in Ciba-Geigy) had recently taken over the responsibilty forall Phase 3 and 4 clinical wal Dr. Gatz, 41 years old, had moved from phir macy research fo production and had taken over the production function in 1975 after many years sph head of chemistry of Cib: abroad establishing new units = Nince he returned to headquarters in 1967, had take ‘Omsinger, 48 years old, and in marketing over the function in 197 The Worldwide Functional Groups in Basle Research Basle. Research Basle had the follow 1. Provide new candidate-compounds and pre ons for development 2 Contribute to the development o! compounds by peeforming human/clinical pham ase 1) studies sell cology + Provide scientific support to Pharma divisian 2 group companies (€.., for marketed prod) { Provide evaluation and expert opinion a third-party products Basle research accounted for about two-thirds of division’s annual research effort. All of Ciba-Gelil nd, in bring: drepae devel ting, icigy's This en by bf the ehelin itions: vinted $ler, a Histin. Usyn- ba the Last er the below er the: phar: ver the spent keting le bllow prepa lected ‘ofthe extiarr 4 Ciba Geigy Pharma Division, 1978 583 ror ‘cheraty ‘iatoay | =a] aaa | internally developed products had theit origin in Gializing in tropical diseases, only the US. Bisle research had no direct authority over fnunagement, which in principle had the power to tuordinate worldwide research, had not taken an fe active role in Bile pa Except for India, which had a research unit spe- the division ton ddead BoObd research st formulation. In cular, there was no clear policy concerning assignment of research programs rch units. This had led to some duplication fad a research unit capable of drug discovery and of effort and communication and cooperation preclinical development. Its size was about one- problems, especially between Basle and. the thd that of the Basle unit United States. The US. division felt that its size, the highly com- reearch carried out in group companies. Divisional __ petitive nature of the U.S. market, and the scientific resources available in the United ites all argued or a greatly expanded role for the U.S. research ne F's Innovative C poral =" | ea epee | o | ees = _——ae mal al | EEE ar = Seco eee 1_ unit, Basle managers typically responded that US. research was too narrowly focused on the U.S. mar ket, and that this parochial orientation was inappto- priate for a worldwide operating company Medical Department. its major regard to new product development were 1. Plan, and oversee the conduct of clinical studies at headquarters and by departments of group companies (Phases II, TIl nd IV). 2. Design clinical research, 3. Ensure the coordination of the clinical activi iny Pharma divisions worldwide. 4, Ensure timely registration and revalidation of products with appropriate authorities workiwide initiate, and develop new methodology for ties of group comp Only about 20 percent of the division’s total medical expenditures were spent by the Basle Medical Department Ik of the clinical studies were performed outside Switzer land and paid for by group companies. Like the Research Department, the Medical Depart: nent in Basle had ao direct authority over the med: ical departments of group companies (MEGROCS). This reflected the fact that the Group companies were free to decicle whether orl to conduct clinical tials on a compound proposed Basle, and with what priority and speed. Typically, there between the physician in Basle in charge of pound and the clinical investigators actually Of ducting clinical trials in the countries. Pend involved in Basle were: the immediate superior Bereichsleiter in charge of the indication aret which the compound was targeted), the mei coordinator for the region, the head of Gl Research, andl the head of the Medical Depat ‘The main intermediaries in each country were head of the Medical Department and the phil responsible for the indication area. ‘The dic of managing international clinical trials created sonnel problems for the Basle medical depat recruitment of highly qualified specialists wisi cult and physician turnover was high, were many intemed Technical Operations. ‘The major conti Of this unit during the new product develop process were: 1. The production of sufficient amounts ofa ingredient to enable preclinical and clinical BT 3.7 prepar With in Swit new p unit hi which Mark produ LI range the m: 2.1 group ‘world Grou, ts 1 = a) her or not posed by mediaries of a com: ually con Persons serior (the © medical Xf Clinical partment were: the physician difficulties ‘eated per partments i was diff! tributions velopment ts of active al testing 2, The development of deli 3, The preparation for market introduction, ery (dosage) forms scaling-up of production. pro With production of active substances concentrated inSwitzerland, most of the technical development of ried out in Basle, Only the US. init had complete technical development facilities hich were managed independently of Basle eo products was ¢ Marketing. Marketing's role in regard to new product development was as follows: 1. Defi and help build the division’s product way that it meets the needs of consistent with divisional goals. in such the market and strategies for products or [poips of products to ensure best possible local and goridwide market penetration and profitability (Group companies were free to decide which prod: les to introduce and with what strategy The Pharma Divisions of Group Companies Prisional management at Basle had no direct con- inl ever the actions of local divisions, though it ffen had considerable influence. Financial Ggenitional targets were set by the KL (Konzerr- jung) afier discussions with the DL. Contributions bppirent company expenses and profits were the fin target variables. The annual budget and the Ipagierm plans for the divisions were ewveen the Je, and performance ‘wsthen monitored by the latter. Group companies fonsidered generally that their primary task was to fot the stated objectives and t hich they dil so were their affair, This attitude was {ively encouraged by Dr. Stachelin, who felt that ‘ouniry organizations were in the best position to juge heir own market and should be free to act as Facependent, entrepreneurial units J to new products, this meant that coun- tes nace their own evaluations of the probability ithe commercial suece: eelopment in Basle and, on this basis, decided hather to conduct clinical trials or introduce the ooduct. Basle frequently had to sell its reat! products t0 the countries. Countries could J ilolicense in products in order to round out their ost range Tie US. group company, in particular, has repu Mion for going its own way, in Pharma as well as in agreed tc ‘ountries and Bi the means by of a compound under Sourcing a 585 the other divisions. It had not launched VOLTAREN, an antirheumatic produet which by 1976 had be- come the company's second most important seller or TRASICOR, a cardiovascular product (number 4 in 1977). Both of these products were developed inter nally and both were rej the other hand, several products had been licensed from the outside to fill gaps in the ran, R&D in the Ciba-Geigy Pharma Division. Basle, RSD in the Pharma division, prised the following activities mainly com- = Drug discovery (chemistry development, ‘opment, biotechnologic piology-nonclinical toxicology, pharmacokinetics, phar analytics, chemical devel- development, = Medicine (human pharmacology/clinical phar ‘euitical development, clinical research macolog drug monitoring). Licensing in and out of products. R&D activities of affiliated firms and institutions. Various R&D management and support func ions (e.g., patents and documentation). Exhibit 3 shows the main R&D functions, their rela jonship aver time and the departments responsible ich Financial Resources for R&D The overall level of R&D effort amounted t0 about 11 percent of sales. Because of the increasingly strin= gent requirements, the amount of resources devoted to developmental activities had At present, percent, absorbed about nonclinical develop- ment 24 percent, and medical activities 27 percent of the total R&D bu One of the motives for the 1970 merg to benefit from economies of scale in R&D. Conse quently, division management had attempted to contain the rise of R&D costs alter the merger. The ‘ er had been ambitious profitability targets set by the 1976 Leit- bild and the recent economic recession had led to a viral freeze on R&D expenditures Shifting of resources between research projects and programs was difficult. The major reasons for this were: the fragmentation of the R&D activities partments, the lack of an ganizational process for setting clear and op. 506. Eaaciment of Technology StategyDevelping the Fins tanovative Capabiiies EXHIBITS Main Tasks and Departments in Ciba-Geigy R&D Process Medee rrovseconpenie |i Chemisty

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