THEORY & HYPOTHESES
The challenge of going public is particularly acute for entrepreneurs in biotechnology. These firms are years away from any significant revenue stream, have very few tangible assets, are sustaining significant accounting losses, and require large amounts of capital (Burill & Lee, 1992). Exacerbating these problems, start-up biotechnology firms generally have little or no revenue. Thus, their research capabilities are their only valuable assets as these capabilities represent the potential to develop and deliver state of the art billion dollar drugs. Although part of the overall pharmaceutical industry, there are distinct differences between biotechnology companies and pharmaceutical companies. These start-up firms typically have no products in the marketplace - only in the pipeline. Further, their research pursuits are very limited in scope. Most biotechnology firms are pursuing a very limited number of potential drugs treatments. Failure of a single project can severely threaten the continued existence of the company (Burrill & Lee, 1992).
In light of this, the development of scientific/research capabilities is critical to a biotechnology firm's success. Specifically, this is due to the fact that (a) the industry is based on highly complex and specific knowledge which is still emerging, unlike the mature knowledge structure of the traditional pharmaceutical companies; (Pisano, 1994) (b) these firms typically do not generate the number of new products which pharmaceutical companies do; and (c) they are much smaller in size and product scope than the pharmaceutical companies. This leads to our basic premise that in the biotechnology industry the development of scientific/research capabilities is critical to the creation of shareholder wealth.
Geographic Location and Wealth Creation
Process and product innovations do not occur in the isolated confines of a firm's research and development department. External sources of knowledge are critical to innovation. This is evidenced not only at the national level as in the case of Japan (Mansfield, 1988; Rosenberg and Steinmuller, 1988) but also at the industry level as illustrated in the case of computers (Brock, 1975), aluminum (Peck, 1962), and semiconductors (Saxanian, 1990). In fact, March and Simon (1958) have suggested that "borrowing" is the catalyst for innovation, not "invention". Innovation then, to a large extent, is dependent on a firm's ability to absorb information from the external environment.
Organizations have an 'absorptive capacity' which is the ability of an organization to evaluate and assimilate external knowledge and is a function of the level of a firm's prior related knowledge (Cohen and Levinthal, 1990). Absorptive capacity enables a firm to recognize valuable new information, assimilate it and apply it to commercial ends. Interfacing with the external environment is critical to an organization's absorptive capacity. The structure of communication between the external environment and the organization enhances the learning capacity of individual firms. Consequently, the physical location of a firm may serve to enhance absorptive capacity through communication flows. Close proximity of organizations with similar interests promotes the natural exchange of ideas through both formal and informal networks established among the organizations.
The idea that location matters to competitive advantage is not new (Marshall, 1920) and is receiving renewed attention (Almeida and Kogut, 1994; Jaffe, Trajtenberg and Henderson, 1993; Saxenian, 1994; Krugman, 1991). Marshall (1920) describes how, throughout history, economic activity was clustered in areas rich in the 'atmosphere' of ideas. Krugman (1991) discusses three factors which foster the concentration of industries in particular geographic locations. The first two reasons are economic in nature: (a) the pooling of demands for specialized labor and (b) the development of specialized intermediate goods industries. The last reason he cites for geographic proximity of industries is based on knowledge spillovers. That knowledge spillovers exist among firms has tremendous implications for their internal capabilities.
Knowledge spillovers leading to interorganizational learning occurs through formal and informal channels of communications among employees. There are many mechanisms of knowledge diffusion. Formal mechanisms among firms include licensing, technology partnerships, strategic alliances, and acquisitions . Informal channels of knowledge may be found in the inter-firm mobility of scientists and engineers (Rogers and Larsen, 1984). These informal mechanisms also include such events as social meetings and trade meetings (Almeida and Kogut,1994; Saxenian, 1994).
Recent empirical work on knowledge spillovers also attests to the fact that knowledge tends to be localized. Jaffe, Trajtenberg and Henderson (1990) investigated the extent to which knowledge spillovers are geographically localized by examining the geographic location of patent citations to that of cited patents. They found strong evidence of localization of knowledge spillovers on three geographic levels - country, state and Metropolitan Statistical Area (MSA). Almeida and Kogut (1994) examined the relationship between geographic location and patent holders in the semiconductor industry. Their fine-grained analysis examined the movement of inventors of major patents from 1974-1994. They found significant intra-regional mobility, particularly in the Silicon Valley.
Saxenian (1990) performed a comprehensive comparative case study of two semiconductor regions: California's Silicon Valley and Boston's Route 128. Her findings suggest that the Silicon Valley is much more successful than Route 128 due to the embedded network of relationships and communications which simply do not exist on Route 128. She points to the importance of regional infrastructure and relationships, collective learning and collaborative relationships with customers and suppliers as contributing to the resurgence of Silicon Valley in the 1980's. This was not the case on Route 128 where firms were characterized by independence and isolation from one another. Finally, regional institutions (such as Stanford University), trade associations, local business organizations and varied consulting, market research and public relations firms provide specialized services for the area's businesses.
Therefore, a firm located in a geographic area with a high concentration of similar firms will have access to information, personnel and support structures which are unavailable to firms which are geographically isolated. Because of this increased access to scientific and technological resources a firm's absorptive capacity is enhanced by its geographic location. Thus, the location of a firm is an indicator of its propensity to absorb new information and to develop the scientific capabilities required to create new products. Thus, these location advantages should increase the speed with which new products are developed by the firm.
Hypothesis 1: The concentration of biotechnology firms located in a firm's geographic area will have a direct positive relationship with the wealth created by the firm.
Citation Analysis and Wealth Creation
The quality of a firm's scientific team is critical to the product development process. However, attempting to make comparisons of scientific teams across firms leads to the question of how to measure the quality of scientific research. A widely accepted method of assessing research quality in the academic community is citation analysis. Citation analysis uses the number of times a paper or an author is cited as an indication of the importance of the work to the field. The more frequently the paper or an individual's body of work is cited the more important and hence the higher the quality of the work. Those of us who have chased or are chasing tenure in academia are quite familiar with the importance citations are given during the tenure process.
Citation analysis has been used to map the development of fields of scientific inquiry (Small & Griffith, 1974); to estimate the quality of the scientific capabilities of countries in specific fields (Heeley, 1986); the performance of academic departments (Wallmark, et.al., 1988) and as the basis for the assessment of scientific and technical research programs (Narin & Rozek, 1988; Vinkler, 1986). In addition, citation analysis has recently entered into the discussion of strategic planning. Van Der Eerden and Saelens (1991) discussed the use of citations as indicators of research group performance and the quality of the scientific research being undertaken by the group, as well as a tool to guide competitive assessment, mergers and acquisition targeting and research strategy. Therefore, it is our contention that the number of citations a firm's scientists have is an indication of the quality a firm's scientific capabilities and a predictor of a firm's research productivity.
Hypothesis 2: The total number of times the works of a firm's top scientists have been cited will have a direct positive relationship with the wealth created by the firm.
Patents and Wealth Creation
Patents have been associated with innovation and performance at many levels: region, country, company. Patents are considered indicators of important technology positions and innovative activity (Ashton & Sen, 1988) and can be considered inputs in the new product development process (Mansfield, 1977; Pakes, 1985). Therefore, firms with a higher level of patent activity should have a higher level of research productivity. This leads to our next hypothesis.
Hypothesis 3: The number of patents controlled by a biotechnology company will have a direct positive relationship with the wealth created by the firm.
The Rate of New Product Development and Market Value
In industries populated by entrepreneurial high-technology firms a primary determinant of enterprise success is the rate at which the firm develops new products (Stalk & Hout, 1990). The ability to rapidly develop new products and bring them to market is important in order to gain early cash flows for greater financial independence, gain external visibility and legitimacy as soon as possible, gain early market share, and increase the likelihood of survival (Schoonhoven, Eisenhardt and Lyman, 1990). Moreover, the faster a firm is at developing new products and bringing them to market, the more likely it is to capture first mover advantages. This is certainly true in industries such as pharmaceuticals where the relative effectiveness of patent protection leads to patent races in which a "winner takes all" scenario exists (Gilbert & Newbery, 1982; Tirole, 1988). But even in industries where patent protection is weak the advantages of being first, in terms of market pre-emption, reputation effects, experience curve effects, and the like, can still be of major importance (Lieberman & Montgomery, 1988). Given the nature of the biotechnology industry the rapid development of new products is sure to a critical factor in the creation of shareholder value.
Hypothesis 4: The rate at which a biotechnology company develops new products will have a direct positive relationship with the wealth created by the firm.
Relative Research and Development Expenditures and Market Value
The intensity of a firm's expenditures on research and development has traditionally been used as an indicator of innovative activity in many industries (Scherer, 1980). Several studies have looked at the relationship between R&D spending and productivity returns (Comanor, 1965; Grabowski and Vernon, 1990; Graves & Langowitz, 1993; Vernon and Gusen, 1974) and several studies have linked R&D expenditures to increases in market value. Therefore, in an industry in which R&D productivity is as critical to success as the biotechnology industry the relative level of R&D expenditures is an indication of the intangible scientific assets of the firm and a predictor of the probability of the firm successfully completing the R&D process. Therefore, those firms which invest a use a higher proportion of their expenditures for R&D will create significantly more shareholder wealth.
Hypothesis 5: A biotechnology company's relative R&D expenditures will have a direct positive relationship with the wealth created by the firm.
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