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

Etienne Billette de Villemeur () and Bruno Versaevel ()

Journal of Health Economics, 2019, vol. 65, issue C, 260-283

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.

Keywords: Research; Development; Biotechnology; Pharmaceuticals; Externalities (search for similar items in EconPapers)
JEL-codes: L13 L65 O31 (search for similar items in EconPapers)
Date: 2019
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Working Paper: One Lab, Two Firms, Many Possibilities: on R&D outsourcing in the biopharmaceutical industry (2019)
Working Paper: One Lab, Two Firms, Many Possibilities: on R&D outsourcing in the biopharmaceutical industry (2017) Downloads
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DOI: 10.1016/j.jhealeco.2019.01.002

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