Managing innovation strategy

Innovation Strategy as a Top Management Priority
R&D has long been perceived as the holy grail of the pharmaceuticals, diagnostics, and medical devices industries, and rightly so. While improvements in processes such as distribution and customer service can create incremental value for companies, it is the “quantum leap” innovations in products and technologies that yield the huge growth and profitability improvements demanded by shareholders. And while many factors are necessary for success, the companies who best manage their innovation process tend to enjoy differential returns: Pfizer, who has invested heavily in innovation and is renowned to have one of the strongest R&D pipelines in the industry, outperformed the Dow Jones pharmaceuticals index by 48% over the period 1991 to 1997, even before the introduction of Viagra. But the hurdle is rising for companies seeking to “Quantum leap” innovations
develop new products. Despite the adoption of new in products and technologies
techniques like combinatorial chemistry and high yield huge growth and
through-put screening that have greatly improved the profitability improvements.
productivity of drug discovery, the average R&D investment required to bring a new drug to market has more than doubled in the past decade, rising from $230MM to $500MM or more. In the medical devices industry, the cost to develop just one product can exceed $100MM. Furthermore, R&D investments are still extremely risky, with only 2-7% of all pharmaceutical innovation projects is a Manager in Bain & Company’s A number of factors are to blame for these spiraling Innovation as Strategy: The Importance of Process
innovation costs. First, the “low hanging fruit” of the Corporate strategy, innovation strategy, and R&D health care industry has in many cases been harvested. need to be explicitly connected, and in the best-run Advances in treatment and technology have brought organizations they are indeed tightly linked. The under control many of the better understood diseases enormous sums invested in R&D, the lengthy time- and conditions, and companies are now focusing on to-market for pharmaceutical, medical devices and indications that are increasingly complex, some of diagnostics products, and the high risk of development them targeting even narrower patient populations.
failure make it critical that innovation strategy, resource Second, pharmaceutical companies now face even more allocation, and ultimately, the activities of the R&D stringent regulatory requirements for clinical studies and department are carried out with the broader corporate approval of drugs applying novel technologies. Third, the rise of managed care approaches, combined with To illustrate, consider some of the questions managers the availability of more products for the same indication, face as they fashion an effective innovation strategy: has led to heightened emphasis on the economics of new • What are the key medical and pharmacoeconomic drugs and products, especially in the United States. Regulators and payers alike now assess not only a product’s • In which therapeutic areas does the company hold performance, but its impact on overall system costs. Often, the greatest pockets of knowledge, competence, significant total therapy cost improvements are required and resources, and how can they be leveraged? for the product to gain market acceptance, thus creating increased challenges for the R&D organization. This trend • Which clinical indications/physiological pathways is likely to intensify in coming years as managed care gains and market segments should the company target? • How do customers define therapeutic/medical In the midst of these fundamental changes, however, value, and what are the key levers and associated a few companies manage to wring exceptional returns profit economics by which we can create a from their innovation dollars, and produce “blockbuster” drugs and products that lead them to market • What data should the company generate during dominance. What distinguishes these companies? development to prove the value proposition? Our experience working with the leaders in the global • What revenue and profit targets need to be health care industry has convinced us that being a world-class innovator requires not just great scientists and research facilities. It requires a great process for • What resources are available for reinvestment? managing the generation, development, and in some cases, acquisition of ideas. This process must provide a systematic method for evaluating, prioritizing, and investing in the best research projects, and then Being a world-class innovator requires not just
driving these projects through the development stage great scientists and research facilities, but a great
to generate profitable products. Critical to the success of process for managing the generation, development,
this innovation process is a direct link to the corporate and in some cases, acquisition of ideas.
and/or business unit strategy of the company1. A sound strategy, devised at the highest levels of Managing the Innovation Process
the organization, will take all of these factors into The goal of the innovation framework presented here consideration. Yet the activities that turn strategy is to create a structured approach to the innovation into results occur further down in the organization, process, ensuring that the most promising research and when the link between corporate strategy and projects are invested in and eventually brought to innovation strategy breaks down, the results are market, and that the innovation strategy is carried predictable: R&D teams drift into projects that aren’t out in concert with the broader corporate strategy. leveraged, while exceptional capabilities within the To illustrate, let’s use a hypothetical example. Assume organization are under-utilized; products are generated that a pharmaceutical company — we’ll call it that offer no advantages relative to those of competitors, PharmCo — has decided after a strategic review to or worse, aren’t viewed by customers as providing bolster their presence in cardiology. To do this they significant value; key decision-makers lack a clear are seeking to develop drugs to combat a variety definition of desirable outcomes, and so misallocate of indications, including, for the sake of argument, hypertension. Working together in an iterative process, When the link is clearly established, however, the results the marketing, sales, and R&D departments have can be dramatic: an R&D organization leveraging its established a set of revenue and profit targets and core competencies to bring to market products that timelines. Now the organization must deliver.
1 represent fundamental pharmacoeconomic or Based on an understanding of the underlying pathology medical improvements over existing offerings, and the regulation of blood pressure, scientists have 2 are valued by key customer groups, and identified “biological mechanisms” to regulate either cardiac output or peripheral vascular resistance. For 3 improve the overall strategic positioning of decades, drugs such as diuretics or β-Adrenergic antagonists (commonly known as β-Blockers) have When all these gears are turning together, the result been on the market to treat hypertension. Other drugs is higher profits and higher share prices. Profits can such as Renin inhibitors that target different sites or then be funneled back into innovation, perpetuating work via alternative pharmacological mechanisms are a “virtuous cycle” of value creation.
What follows is a framework for systematically managing Questions surround these different mechanisms: the assessment, prioritization, and development of Which will provide the most efficacious treatment for research projects. While it is understood that the hypertension? What will be the pharmacoeconomic innovation process must remain linked to a company’s impact of each possible drug? And will any of them overall strategy, this paper focuses only on managing fulfill the strategic objectives — such as revenue and the innovation process, and does not directly discuss the profit targets and competitive positioning — that have steps needed to develop a long-term corporate strategy. 1For the sake of simplicity, the term “corporate strategy” will be used throughout this piece to denote either a corporate or business unit strategy. 2A value proposition is defined as the combination of attributes of a product or service that a specific customer segment values differentially versus competitors’ products. For some customers, a product’s value proposition may be driven primarily by one attribute, such as price, or quality. Other customers may consider a combination of attributes, such as price, quality, and convenience, in evaluating a product’s value proposition. Figure 1: Innovation Framework
Identify and Develop
Assess Internal
Value and Prioritize
Implement and Manage
Innovation Options
Capabilities
Innovation Options
the Innovation Strategy
Key activities
In the midst of these unknowns, PharmCo must decide Step I: Identify and Develop Innovation Options
upon an innovation strategy. The framework that allows A pharmaceutical “innovation option” is a possible us to prioritize the allocation of our innovation investment in one or a set of treatment mechanisms that investments is as follows (Figure 1):
together represent a distinct strategy for developing a Step I: Identify and develop innovation options
product to treat a stated indication. In medical devices and diagnostics, an innovation option consists of one or Step II: Assess internal capabilities
a combination of product prototypes or technologies.
Step III: Value and prioritize innovation options
To better illustrate both what constitutes an innovation Step IV: Implement and manage the
option and to demonstrate how these options fit into the broader context of our framework, let’s continue This is a straight-forward approach. Its power derives not from any new analytic tool or valuation technique, As mentioned before, a strategic review has established but from its insistence that the decision-maker consider cardiology, and in particular hypertension, as key areas innovation investment systematically, in a way that of focus for PharmCo. Revenue and earnings growth coordinates with the overall strategic direction of targets have been set, and a budget has been allocated for the generation and development of new products. But there are numerous mechanisms for developing a drug to treat hypertension. Which are viable, and how should PharmCo allocate their scarce R&D resources? I.2 Market Overview and Customer Value Proposition Analysis We begin by assembling a robust fact-base consisting We have two goals as we conduct the market and customer overview: to refine our estimates of the potential revenues and profits available to us from each of the mechanisms under research, and to clearly identify the key levers necessary to create a superior value proposition for hypertension treatment.
First, we already have an idea from our prior strategic Once we have assembled our fact base we can develop review of the broad demographics and market potential the different innovation options available to us.
of a new hypertension drug. But the market potential of a drug could differ based on the mechanism from which By surveying our internal scientific knowledge-base and it derives. For instance, there may be segments of the R&D department, talking to outside experts (academics, hypertension population for which a drug based on independent scientists, even competitors), reviewing Renin Inhibition wouldn’t be appropriate due to contemporary literature, and utilizing emerging sources possible drug-drug interactions or dose-limiting side- of information (such as Genome projects), we can effects. If this is the case, the potential market size for develop an understanding of all the known mechanisms Renin inhibitors would differ from that of hypertension for fighting hypertension. We must also investigate any products utilizing other treatment mechanisms. drugs that are either on the market or in development, Secondly, we must identify the key criteria that will seeking to understand their pharmacological mode of allow us to develop a product with a value proposition action, stage of development, likelihood of development superior to anything currently offered or under success, projected time to market, patent status, and development by competitors. In order to create a availability for licensing. Technologies for generating “breakthrough” product, there must be a fundamental and screening molecular leads should also be investigated, improvement over the existing value proposition (e.g., in with the goal of identifying the technology owner, improved pharmacoeconomics or via causal rather than patent status, and availability for licensing if the symptomatic treatment). The degree of the improvement technology is not available in house.
over current offerings will drive the speed and size of Output: A list and basic understanding of all possible mechanisms that are available to us for fighting For instance, before Viagra, sufferers of impotence hypertension. A list of technologies that could had effective but physically uncomfortable therapeutic assist in the identification, testing, and production of options available to them. Viagra is efficacious, but different possible molecules (drug candidates).
more importantly, it represents a huge quality-of-life improvement over existing therapies. The result has To create a “breakthrough” product, there must
been an extremely fast adoption rate, and a blockbuster be a fundamental improvement over the existing
value proposition.
The key value proposition criteria as judged by customers will, of course, differ based on the indication The profit pool is the sum of all profits
being treated, the therapeutic alternatives available to earned along the value chain of an industry,
physicians/patients, and the offerings of competitors. and can be segmented by product, customer
Customer groups must be segmented to identify the group, channel, geography, or other criteria.
value they would place on improvements along each of the five criteria for evaluating pharmaceutical products: existing mechanism but exhibits distinct pharmacological drug safety, drug efficacy, outcomes, cost effectiveness, advantages. Alternately, it may simply place more and patient quality of life. Once the key customer levers importance on the marketing and sales organizations have been identified, each drug candidate should be to effectively sell our product if it is similar to those re-visited to see which might offer improvement on the most important of these key criteria.
Identifying trade-offs like these requires a thorough The key value proposition criteria will also differ based investigation not only of competitors’ current and on who the customer or decision-maker is. For instance, future product portfolios, but of their overall strategic in pharmaceuticals the key decision maker might be the positioning, including relative market share, sales and physician actually prescribing the drugs, or it could be a marketing capabilities, and relative science capabilities. It pharmaceutical buyer for a managed care organization. is important not to underestimate this last point: smaller Their selection criteria would likely differ. In the case of competitors who have invested differentially in a specific medical devices and diagnostics, the key decision-maker treatment mechanism may hold a significant advantage could be a scientist, physician, or lab technician, each of in product development for that mechanism over larger whom might also have different selection criteria. competitors who have spread their innovation investments across many mechanisms or scientific areas (assuming Output: For each treatment mechanism, a detailed comparable quality of scientists and availability of customer segmentation highlighting key selection technologies). This is so because although a strong criteria and purchase patterns of the decision maker, element of serendipity still exists in the innovation penetration and sales curve estimates (taking into process, innovation is not akin to gambling; indeed, over consideration the current and future products of time, differential investment in certain capabilities will competitors), and an estimate of the drug’s revenue Output: A profile of key competitors, describing their respective share of the market (revenue and profit pools), Competitors may be — and probably are — working key strengths and weaknesses, stated strategy, and a thorough on projects similar to ours. Their current and future listing of relevant products (current and developmental, product offerings and strategic intentions will impact including developmental stage, development risk and how we position our product. For instance, in the case likelihood of reaching the market, patent protection, of hypertension, there are a number of effective licensing status, and availability for licensing).
molecules on the market that exhibit the same mode of action and similar pharmacological responses. This may accentuate the imperative of finding a drug that combats hypertension via another mechanism, or that uses an By combining the three building blocks of Step I — rather than incremental improvements4. Secondly, each science, market, and competition — we are now able to innovation option should represent a distinct strategy develop a set of innovation options. In our PharmCo for innovating towards a new product, even if some of example, one innovation option might be to fund the elements are shared across options. And thirdly, research only on Renin inhibition — a fairly risky innovation options need to be consistent with the strategy since there is no guarantee of finding an strategic objectives laid out for the company. effective Renin inhibitor drug. A more moderate Once we have defined the appropriate innovation innovation option would be to invest heavily in research options, we then need to more thoroughly assess on Renin inhibitors, but to also invest in finding a more them in light of our internal capabilities and resources.
pharmacoeconomically advanced drug that relies on a Step II: Assess Internal Capabilities
mechanism that is already proven (such as Angiotensin II Antagonists) (Figure 2). This would allow PharmCo to
The focus of Step I is primarily external: How big is the maintain a presence in the hypertension market should potential market? What are competitors up to? What is the state-of-the-art science for each indication? In Step II we turn our lens inward in order to better understand Clearly a whole array of innovation options can be the requirements for pursuing each innovation option.
identified for any given indication and for each strategic scenario. As we develop our options, we must remember Two primary building blocks make up Step II: the main tenets of the innovation framework. First, we 1 capability and technology requirements, and are searching for innovation options that will yield breakthrough products and improved value propositions Figure 2: Innovation Options of PharmCo
Strategic
Bolster presence
direction
in Cardiology
Indications
Possible
treatment
mechanism
Innovation
economically advancedAngiotensin II-Antagonist 3For more information about profit pools and profit pool-based strategy, please see Profit Pools: A Fresh Look at Strategy, Harvard Business Review, June/July 1998 by Orit Gadiesh and James L. Gilbert. 4It should be noted that companies can and do create significant value through incremental enhancement of existing products. However, the process for developing these enhancements is different than for developing breakthrough products, and is not covered in this paper. II.1 Capability and Technology Requirements Next, we must define the requirements to successfully The science and technology review of Step I provided pursue each innovation option: What are the capabilities, us with a broad overview of the different innovation technologies, and expertise required to develop each options: the “30,000 foot view” of different mechanisms treatment mechanism? Do these capabilities and and technologies for pharmaceuticals, and of different technologies exist in-house? If not, can they be technologies and product prototypes for medical devices developed in-house or must they be sourced via and diagnostics. Now we must better understand the acquisition, alliance, or licensing agreement? What would science of each mechanism, technology, or prototype be the costs of doing so? What are appropriate target contained in our innovation options, and identify the resources necessary to develop them5. To illustrate, let’s To answer these questions, we begin by cataloguing, for each mechanism, all relevant in-house capabilities Having outlined our innovation options for a hypertension and technologies. These may be in the form of current drug, we investigate each further: What is the actual R&D projects, technologies from other projects that science behind each treatment mechanism contained in could be applied to a new mechanism, existing our innovation options? What are the chances of each molecules from past research, or researchers with mechanism’s success or failure, both scientifically and experience in a given area (Figure 3). We then look
commercially? What would be the likely side-effects beyond PharmCo’s walls to identify external innovations or short-comings of a new product? What interactions and technologies, consulting scientific literature, could be expected with other medications? independent scientists, symposia, and the like. Figure 3: Capability and Technology Assessment PharmCo
Physiological
Possible
Drug Discovery
Preclinical
Manufacturing
Clinical
treatment mechanisms
Development
Delivery
Development
(pharmacological
mode of action)
Note: Other drugs for treatment of hypertension include diuretics (impact on extra cellular fluid volume and cardiac output) or ß-adrenergic receptor antagonist (reducing arterior resistance and venous capacity) and apply different pharmacological mechanisms.
Output: A map for each innovation option of Step III: Value and Prioritize Innovation Options
all required capabilities and technologies, and an By the time we have completed Step II, we have a clear understanding of the resources and time needed set of innovation options from which to choose. We to develop or acquire those we do not have.
have also compiled a fact base about the key strategic and tactical elements of each option. The goal of Step III This is a critical, and often overlooked, element of is to prioritize our investment in innovation options, managing the innovation process. Too frequently, R&D using both quantitative and qualitative tools. projects are conscripted on a one-on-one basis, only We begin by calculating a present value for each innovation to find that the cumulative requirements of all the option, providing us with an “apples-to-apples” metric for various outstanding projects overwhelm the research comparing our options. We then balance this quantitative and development functions. The result is a capacity evaluation with a more qualitative strategic perspective, bottleneck that can cause severe delays in the innovation allowing us to direct our allocation of research funds.
process, and ultimately, in the development and III.1 Probability-weighted, risk-adjusted present values The first step in calculating a present value for each To avoid these bottlenecks, we must manage not just innovation option is to develop a base case financial individual R&D projects, but the entire R&D portfolio. scenario. In our PharmCo example, we describe the We begin by mapping out the financial and human most realistic revenue forecasts of the drug or drugs resource needs for each innovation option. These that would be the output of each innovation option. “resource maps” must then be integrated to give a We then factor in research and development costs comprehensive picture of the demands that would be (including any additional expenses incurred by acquiring placed on research, development, and production teams new technologies or adding R&D or production over time depending on which innovation options are capacity), production costs, sales and marketing costs, selected. (Remember that the innovation process we overhead, and so on, to arrive at a set of base-case have outlined for hypertension is also being pursued for discounted cash flows and a discounted present value. other indications, and that the organization will need Things may go better or worse than planned, of course, to invest in multiple projects simultaneously.) In some and we need our valuation to reflect this uncertainty. We cases, qualified external resources such as Clinical incorporate this risk by creating a set of scenarios — at the Research Organizations (CROs) can be employed for simplest level, an optimistic and pessimistic scenario — that additional capacity. Any capacity planning should also take into consideration the inherent risks of the business. take into account the likely attrition of projects over time.
Typically these risks come in the form of clinical or Output: Resource maps showing for each innovation regulatory failure, market adoption, project attrition or option the resource requirements and resulting gaps. delay, patent issues, or competitive substitution. When Cost estimates and timelines for the development of combined in a thoughtful and consistent way, the result is three scenarios with different — sometimes very different 5In some cases, the same mechanism or technology will feature in more than one innovation option, allowing information to be shared across innovation options. 6Alternative methods of valuation, such as option theory, may also be applied to innovation strategy. It is our experience, however, that while option theory may yield more precise valuations, the advanced technical requirements of such analysis render it less pragmatic than present value scenario modeling. To complete our risk-adjusted present value we must up to new competition. The implication might be that weight each scenario for its likelihood of occurrence. it is necessary to invest in the innovation option with For instance, the optimistic scenario may yield an the shortest development cycle, even if the present value extremely high present value, but we may give it just a 20% chance of occurring. By combining the optimistic, Strategic assessment of the innovation options requires base case, and pessimistic scenarios with their probability re-visiting the broader strategic objectives laid out for weightings, and then summing them, we arrive at the company. Managers should ask themselves whether a probability-weighted, risk-adjusted present value for collectively the innovation options they could invest in each innovation option (Figure 4). This present value
(which essentially represent the company’s innovation is a consistent metric by which to compare different strategy) will allow the broader strategic targets and imperatives of the business to be met. Making this assessment may be difficult, for the resources necessary The outcome of the financial scenario modeling for this kind of strategic review are often concentrated provides some powerful insights into the best paths at the highest levels of the organization. The solution is for innovation investment. However, there are strategic to ensure, again, that innovation strategy and corporate elements that the quantitative analysis may not overtly strategy share an explicit link within the organization, reflect, or that are difficult to include in a present value. and that the time of key personnel is formally dedicated For instance, PharmCo may have a product that is losing to the ongoing process of developing both innovation its patent protection in the near future, thus opening it Figure 4: Probability-weighted, Risk-adjusted Present Value Calculation
Projected cash-flows
Probability-
Probability-
weighting
weighted, risk
adjusted present
By carefully balancing the quantitative and qualitative When the primary goals and pre-determined milestones aspects of each innovation option we can arrive at a of R&D are ignored, the result is wasted time and money, prioritized list of options deserving investment. It is and the delay of other projects more deserving of scarce now the responsibility of the manager to ensure that organizational resources. A common trap that companies fall into is a failure to eliminate projects that are not meeting the results of innovation are realized in the form of pre-determined milestones and goals. The key ingredients to new products and heightened profits.
success here are discipline and objectivity: the discipline to cut Step IV: Implement and Manage
off projects with “potential” if they’re not meeting their pre- the Innovation Strategy
determined goals, and the objectivity to avoid the political complexities that tend to inform many R&D-related decisions.
The notion of a “pipeline” has always connoted an element of mystery: in the classic sense of the word, Summary: Driving Exceptional
once something enters a pipeline it disappears from Returns Through Innovation Strategy
view until it emerges from the other end. Step IV seeks Innovation strategy has received increased attention in to create transparency around the R&D pipeline, and recent years, and it will continue to be a top priority of to establish concrete goals and timelines that allow a management as long as new product breakthroughs are manager to control the flow of innovation projects. the primary driver of value creation in the pharmaceuticals, diagnostics, and medical devices industries. We strongly The first and most important factor in successful believe that the allocation of R&D resources is a critical implementation of the innovation strategy is to establish component in a company’s overall strategy, and that poor a detailed migration plan. Each organizational unit that management of the innovation process can have huge long- is to be involved in the project — this includes production, term economic and strategic implications. In an industry sales, and marketing, not just R&D — should have a clear where innovation and time to market are the key determinants set of deliverables and timelines for turning the project of success, the companies who best manage their innovation into results. Multi-functional project teams should be efforts stand to gain at the expense of their competitors.
established and empowered to facilitate decision-making While there will always be a strong element of risk in and to drive each project through the R&D process. innovation, the process of managing innovation should These teams must be sufficiently funded to be effective. never be haphazard or risky. Instead, a holistic, balanced, In addition, investments may be necessary to alleviate and data-driven approach to prioritizing innovation investments can increase R&D efficiency and greatly Deliberate go/no-go hurdles and checkpoints need to reduce the risks of research bottlenecks, wasted R&D resources, or worse, product droughts.
be established for each research project, and progress should be measured periodically against these checkpoints. The framework for managing innovation proposed here The checkpoints should be tied to the key criteria that ensures that investments made in innovation are consistent would make the project a breakthrough value proposition. with the overall strategy established by the company. This For instance, consider a project whose goal is to link between innovation strategy and corporate strategy introduce a new ACE inhibitor with an improved safety must be established early and re-established often; the four steps of the innovation framework should be part of the profile and decreased costs. If at any stage the clinical ongoing strategic process, not one-time events. Only by data demonstrate that the efficacy profile is not superior linking these processes in an ongoing cycle can a company to existing ACE inhibitors, the development should be ensure that the innovation strategy it designs is the strategy terminated and the resources re-allocated, even if the B a i n & C o m p a n y : S t r a t e g y f o r S u s t a i n a b l e R e s u l t s
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