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One lab, two firms, many possibilities: On R&D outsourcing in the biopharmaceutical industry

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  • Billette de Villemeur, Etienne
  • Versaevel, Bruno
Abstract
We draw from documented characteristics of the biopharmaceutical industry to construct a model where two firms can choose to outsource R&D to an external unit, and/or engage in internal R&D, before competing in a final market. We investigate the distribution of profits among market participants, and the incentives to coordinate outsourcing activities or to integrate R&D and production. Consistent with the empirical evidence, we find that the sign and magnitude of an aggregate measure of direct (inter-firm) and indirect (through the external unit) technological externalities drives the distribution of industry profits, with higher returns to the external unit when involved in development (clinical trials) than in early-stage research (drug discovery). In the latter case, the delinkage of investment incentives from industry value, together with the ability of firms to transfer risks to the external unit, imply a vulnerability of early-stage investors’ returns to negative shocks, and the likely abandonment of projects with economic and medical value. We also find that competition in the equity market makes a buyout by one of the two firms more profitable to a research biotech than to a clinical services unit, and can stimulate early-stage investments. However, this long-term incentive can be minimal, notably if the superior efficiency of outsourced operations originates from economies of scope that can hardly be exploited when a firm takes control of the external unit exclusively for itself. R&D outsourcing thus does not always qualify as a relevant pathway to address the declining productivity in innovation that has characterized the industry over several decades.

Suggested Citation

  • Billette de Villemeur, Etienne & Versaevel, Bruno, 2019. "One lab, two firms, many possibilities: On R&D outsourcing in the biopharmaceutical industry," Journal of Health Economics, Elsevier, vol. 65(C), pages 260-283.
    • Handle: RePEc:eee:jhecon:v:65:y:2019:i:c:p:260-283
    DOI: 10.1016/j.jhealeco.2019.01.002
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    Cited by:

    1. Francesca Barigozzi & Izabela Jelovac, 2020. "Research funding and price negotiation for new drugs," Health Economics, John Wiley & Sons, Ltd., vol. 29(S1), pages 83-96, October.
    2. Billette de Villemeur, Etienne & Versaevel, Bruno, 2019. "One lab, two firms, many possibilities: On R&D outsourcing in the biopharmaceutical industry," Journal of Health Economics, Elsevier, vol. 65(C), pages 260-283.
    3. Cisnetto, Valentina & Barlow, James, 2020. "The development of complex and controversial innovations. Genetically modified mosquitoes for malaria eradication," Research Policy, Elsevier, vol. 49(3).
    4. Howell, Sabrina T. & Rathje, Jason & Van Reenen, John & Wong, Jun, 2021. "Opening up Military Innovation: Causal Effects of 'Bottom-up' Reforms to U.S. Defense Research," IZA Discussion Papers 14297, Institute of Labor Economics (IZA).
    5. Joan Costa‐Font & Rosella Levaggi, 2020. "Innovation, aging, and health care: Unraveling “silver” from “red” herrings?," Health Economics, John Wiley & Sons, Ltd., vol. 29(S1), pages 3-7, October.
    6. Howell, Sabrina T. & Rathje, Jason & Van Reenen, John & Wong, Jun, 2021. "Opening up military innovation: causal effects of reforms to US defense research," LSE Research Online Documents on Economics 114430, London School of Economics and Political Science, LSE Library.
    7. Billette de Villemeur, Etienne & Scannell, Jack & Versaevel, Bruno, 2021. "Biopharmaceutical R&D outsourcing: Short-term gain for long-term pain?," MPRA Paper 108233, University Library of Munich, Germany.

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    Keywords

    Research; Development; Biotechnology; Pharmaceuticals; Externalities;
    All these keywords.

    JEL classification:

    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L65 - Industrial Organization - - Industry Studies: Manufacturing - - - Chemicals; Rubber; Drugs; Biotechnology; Plastics
    • O31 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Innovation and Invention: Processes and Incentives

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