Clusters’ Last Stand?

By Andrew MacGarvey, Quanticate | June 6, 2011

Does R&D benefit from bio-clusters?

The problem of diminished pipelines for our pharmaceutical and biotechnology companies is very much in the news at the moment. Many observers cannot remember a more turbulent environment in the drug development sector. The major players are scrambling to reorganize their businesses to refocus on discovery and are displacing thousands of jobs as they streamline portfolios. There are a number of factors behind this state of affairs, including the rising cost of drug development, the drive to treat rarer diseases, and biopharm’s place in the global economy. To the latter point, the sector had been largely immune to recessionary economies, but the scale of the most recent global financial crisis created problems for even the largest pharmaceutical companies. It may appear difficult to identify positives for biopharm now; the sense is of companies trying to survive in chaotic circumstances. In fact, this chaos may be the lifeline the sector is looking for.

The problem for biopharm is that it is operating in an innovation/productivity paradox. Put simply, the investment in research and development is increasing and the number of new drugs is decreasing. Those charged with bringing new drugs to market are struggling to innovate. At this point, it is worth stressing that innovation is not the same as invention. For a product to be innovative, it must return some value. In the case of biopharm, the reality is that the product must return profits. This dynamic constrains innovation because the profit imperative compresses the ‘space’ to make mistakes. The freedom to make mistakes, learn from them, and move on is critical for innovation to thrive. Any constraints that firms apply in the discovery context will reduce innovative activity. Whether these are financial in nature or a restriction on technology or focus on a particular therapy, setting parameters brings increased order.
They diminish the chaos that innovation requires. Scholars such as Kimberly Boan and Ysanne Carlisle have described the need for firms to operate ‘on the edge of chaos’ to deliver innovation. I recommend readers interested in exploring this concept more deeply to read some of their work.

So, you may ask, what is a cluster, and what does this preamble have to do with clusters? A cluster is a way of organizing a group of competing companies in geographic proximity to one another. Perhaps the most well known clusters in the drug development world are the biotechnology clusters in Cambridge, MA and San Diego, CA. There are also clusters in Scandinavia and throughout Europe, and new ones are appearing in the Asia-Pacific region.

The concept of clusters is not new. Celebrated economist Alfred Marshall discussed the benefits to companies of operating in geographic proximity as early as 1890, but it was in the late 1980s and 1990s that Michael Porter brought the concept back into popular management theory. Researchers have studied clusters in detail and have settled into two schools of thought. The first group extols the benefits of operating in the cluster model. They perceive the phenomenon of ‘spillover’ to be highly beneficial.
Spillover occurs where one firm in the cluster can leverage a resource available at one of its neighbors. A great example of this is knowledge spillover. Knowledge gained in one company can be accessed by others through local networking events — be they formal or social — or by hiring their new staff from them. The knowledge does not necessarily need to relate to intellectual property; indeed, on most occasions transfer of this knowledge will be limited contractually. Rather a person operating in a similar company in the same geography will bring useful procedural knowledge to the hiring firm.

In contrast, the second group believes that the number of relationships a company has is more important than proximity of links. They cite an increasingly sophisticated telecommunications infrastructure and the shrinking of the world through affordable air travel as nullifying the competitive edge gained by companies choosing to operate in a cluster.

Whoever is right, clusters remain popular. Governments in many regions have used grants and tax breaks to encourage inward investment by firms into designated regions. As the recent financial crisis began to bite, many firms chose to take the incentives; this was particularly true for biotech companies. I believe this trend was a major contributor to the innovation/productivity paradox.

Pharmaceutical companies have been aware of the ‘patent cliff’ for some time; they have realized that they cannot sustain the blockbuster model through the traditional small molecule approach. Their hopes were pinned on the new technologies offered by biopharma companies. Unfortunately, the biotech sector was among those most affected by the recent financial crisis. As investors have grown more cautious and liquidity has become scarcer, investments in biopharma firms have fallen significantly.
Drug development is not a good match for venture capital. The cost of developing a drug is very high, the process is lengthy, and the risk profile is prohibitive. This challenge has driven many firms to the safety of a cluster environment, where they have gratefully received grants, tax breaks, and even free accommodation as they have sought to minimize their cash burn rate.

While clusters provide many benefits to those companies that choose to operate within them, my view is that those same benefits can also harm innovation. I question whether operating in a cluster is the right decision for a drug development company, or indeed any knowledge-based organization. Access to suppliers, the power of group buying syndicates, the ability to hire qualified staff without relocating them, and the political strength in numbers are all useful attributes for those in the cluster. But at what cost?

Once a firm joins a cluster and begins to leverage knowledge spillover, the environment restores an element of order to the system. An example of this might be the head of discovery moving from one company to another and imposing similar standard operating procedures at the new company. Prior to the move, the two groups might have tackled a problem in different ways, now they may try to tackle it in the same way. This problem has the potential to arise in similar situations as staff at various levels move from company to company. The problem is exacerbated as they move to their third or fourth companies. Of course, this situation could just as easily occur when a person moves from one country to another; the difference in the cluster is that other factors increase the risk. For example, when a head of discovery moves within a cluster, the risk that its members move too is higher compared to the same person undergoing an interstate or inter-country move. Furthermore, local networking events and presentations could lead to certain approaches being implemented across the cluster and becoming the ‘norm.’ As staff move between companies, these organizational routines become embedded across multiple firms and those with new ideas can find it difficult to get them adopted.

An ordered approach to business drives the benefits derived by members of a cluster, but it can have downsides. Group purchasing schemes increase purchasing power but limit the number of vendors in the value chain. Membership of local trade groups aligns the political views of those members but has the potential to stifle change. Joint presentations at funding events brings access to money but does introduce the members to the same potential funders. While order might be useful in terms of how easy it is for smaller firms to do business, it is not useful in helping them to innovate.

Researchers have identified that two domains of knowledge are important in stimulating innovation. They are technologically distant and geographically distant knowledge. The best example of technologically distant knowledge was probably the introduction of biotechnology techniques into a pharmaceutical-based world. The geographically distant domain is interesting: there is research that suggests that introducing team members from geographically distant companies can increase innovation, but that there is a limit. Studies reported that an interstate move within the U.S. could increase innovation but an international move could hinder innovation.
The researchers attributed the results to cultural differences over-riding the innovation benefit. We are back to Boan and Carlisle; managers need to ‘dance at the edge of chaos’ to achieve innovation. If the environment is too chaotic, innovation will not thrive either. 

Clusters have a place in the commercial world; I am just not sure they have a place in drug discovery. They encourage those that work within them to move away from the edge of chaos and towards an ordered environment. It is interesting to note that biotechnology firms seem to attract more investment if they sit in a cluster because the venture capitalists perceive the risk to be lower. Both government and the investment community want new drug development companies to succeed, yet both may be setting them up to fail.  


Further reading


Boal, K. B., & Schultz, P. L. (2007). Storytelling, time, and evolution: 

The role of strategic leadership in complex adaptive systems. 

The Leadership Quarterly, 18(4), 411-428. doi: 10.1016/j.leaqua.2007.04.008


Carlisle, Y., & McMillan, E. (2006). Innovation in organizations from a complex adaptive systems perspective. Emergence: Complexity & Organization, 8(1), 2-9. 


Marshall, A. (1890). Principles of Economics. London: Macmillan.


Porter, M. E. (1998). Clusters and the new economics of competition. Harvard Business Review, 76(6), 77-90.


Andrew MacGarvey is the commercial director of Quanticate, a global CRO, and the president of its U.S. operations. He is currently completing his DBA at Walden University where he is researching the innovation/productivity paradox. His interests lie in Complex Adaptive Systems and the impact of Chaos Theory on major businesses. He can be reached at andrew.macgarvey@quanticate.com.