Outsourcing, Teamwork and Business Management

OUTSOURCING, TEAMWORK AND BUSINESS MANAGEMENT

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OUTSOURCING, TEAMWORK AND BUSINESS MANAGEMENT

KARL E. CARETTAS EDITOR

Nova Science Publishers, Inc. New York

Copyright © 2009 by Nova Science Publishers, Inc.

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ISBN 978-1-61470-493-5 (eBook)

Published by Nova Science Publishers, Inc.

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CONTENTS Preface

vii

Chapter 1

Offshoring Knowledge Work: How Far Can it Go? Evidence from Drug R and D David Finegold, Niclas Erhardt and Mari Sako

Chapter 2

Multinational Exploration of Acquired R&D Activities Jens Gammelgaard

15

Chapter 3

Management and Control in Service Firms: Bridging the Gap between Organization Studies and Service Management Per Skålén

31

Chapter 4

Activity Awareness and Complex Teamwork John M. Carroll, Mary Beth Rosson, Craig H. Ganoe, Marcela Borge, Jamika D. Burge, Umer Farooq, Gregorio Convertino, Paula M. Bach, Helena Mentis and Hao Jiang

47

Chapter 5

Teamwork in Today’s World Carol Boswell and Sharon Cannon

73

Chapter 6

Teamwork and PBL-Based Teacher Education: A Study on Prospective Science Teachers’ Opinions Laurinda Leite and Esmeralda Esteves

83

Chapter 7

Developing Effective Teams and Protecting the Vulnerable: An Interprofessional Journey Susan Morison and Moira Stewart

99

Chapter 8

The Impact of Engineering Design on Outsourcing Decisions Mahmood Al-Kindi and Ali A. Yassine

115

1

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Contents

Chapter 9

Time Allocation and Outsourcing within Households. Differences in Lifestyle between Native Dutch and Immigrants in the Netherlands J.R. Cornelisse-Vermaat, H. Maassen van den Brink, J.A.C. van Ophem and G. Antonides

135

Chapter 10

Outsourcing and Public Sector Efficiency: How Effective Is Outsourcing in Dealing with Impure Public Goods? Argentino Pessoa

167

Chapter 11

Examination of Dedicated Relationships between Automotive Suppliers and Carmakers: Evidence on the Flagship / 5 Partners Model Bart Kamp

191

Chapter 12

Allocating Outsourced Warranty Service Contracts Michelle Opp, Ivo Adan, Vidyadhar G. Kulkarni and Jayashankar M. Swaminathan

213

Chapter 13

The Importance of Context in Determining Consumer Response to Food Safety Events: The Case of Mad Cow Disease Discovery in Canada, Japan and the United States Sayed Saghaian, Leigh Maynard and Michael Reed

235

Index

267

PREFACE This new book is dedicated to the nontrivial problems of organizations trying to accomplish anything. Outsourcing, for all its seemingly attractiveness, contains hidden costs in coordinating and can involve creating negative customer responses. Teamwork is a concept of significance in outsourcing as well as in internal activities all of which are within the realm of business management. Chapter 1 focuses on the reasons why drug companies choose to offshore and/or outsource some R and D tasks and not others, and how they manage the process and the issues that arise once the work is moved offshore. The chapter sets forth an analytical framework for analyzing the offshoring/outsourcing decision that includes the availability and cost of talent, how closely related the knowledge is to the core strategy of the firm, and the nature of work/task itself. The task is not treated as a given, but rather is considered to be alterable through the process of offshoring/outsourcing, either necessitated by distance requiring a new mode of working and/or enhancing modularity (i.e. separability of tasks that enable a job to become ‘impersonal’) that had been possible prior to offshoring. Chapter 2 presents the results of a survey of 54 Danish multinational corporations that have acquired activities abroad. The role of the acquired R&D units was the focus of the survey, particularly with respect to the schism between basic and applied R&D, and the schism between autonomous and network R&D. This paper establishes the connection between a multinational corporation that follows a capability-motivated acquisition strategy and the R&D role new subsidiaries should play in order for the acquired resources to be utilized corporation-wide. Statistical findings reveal the need to follow a combination of basic and network-oriented R&D activities when focusing on capability development. Chapter 3 draws together previous research within the boundaries of organization studies and services management, and then proposes an alternative focus for studying management and control in service firms. The chapter argues that organization studies have contributed to the study of management and control in service firms but without actually focusing on the central issues that services management research has argued should characterize management and control in service firms. By bringing together the two traditions an approach to empirical research that would deepen understanding of management and control in service organizations is outlined. Collaborators must attain and maintain reciprocal awareness of shared activity in order to coordinate effectively (Dourish & Bellotti, 1992). They need to be assured that their partners are ‘there’ in some sense, which is not always evident or simple in computer-mediated

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collaboration. They need to know what tools and resources their counterparts can access, who they know that might know something, or know how to do something that would be critical. They need to know what relevant information their collaborators know, and what they expect, as well as their attitudes and goals. They need to know what criteria their partners will use to evaluate joint outcomes, the moment-to-moment focus of their attention and action during the collaborative work, and how the view of the shared plan and the work actually accomplished evolves over time. Research on collaboration and technology support for collaboration has identified several types of awareness: social awareness, action awareness, workspace awareness, situation awareness (for an excellent review, see Schmidt, 2002). Most investigations of awareness research have focused on synchronous phenomena: awareness of who is participating in an ongoing activity, awareness of what each person is currently doing in that activity context, and awareness of how the team as a whole is performing. Asynchronous awareness phenomena, for example those supported by version control systems, shared calendars, and project management software, have received less attention. Our research has focused on activity awareness, a programmatic concept for the mutual awareness of partners in a shared activity of significant scope and duration. Activity awareness transcends synchronous awareness of where a partner's cursor is pointing, where the partner is looking, etc. It involves monitoring and integrating many different kinds of information at different levels of analysis, such as events, tasks, goals, social interactions and their meanings, group values and norms, and more. It involves monitoring and integrating more-or-less continuingly to learn about developing circumstances and the initiatives, reactions, and sense making of other people with respect to on-going and anticipated courses of action. Activity awareness is not merely a matter of coordinating state information. It is continually negotiated and constructed throughout the course of a collaborative interaction. Thus, it is a process that is constitutive of collaboration. In the balance of Chapter 4 we will first describe fieldwork characterizing routine social practices to establish and maintain activity awareness during complex teamwork in regional emergency management planning, emergency room operations, collaborative education, open source software development, scientific collaborations, and management of nonprofit community groups. We then describe software systems we have developed to support activity awareness in complex teamwork in some of these contexts. We close with some discussion of the challenges of supporting activity awareness. Teamwork in all venues today requires management and staff to utilize a variety of approaches to ensure safety in the workplace. The Institute of Medicine’s report is just one example of an organization identifying the importance of effective collaboration by all employees to ensure the wellbeing of engaged participants. Communication is crucial in the response to the call for improved partnership within the workplace. Communication tools such as SBAR (situation, background, assessment, and recommendation), LDS (Let’s Do Something) leadership style, and Huddles can be readily utilized to facilitate effective and comprehensive delivery of key information essential for teamwork regardless of settings. Chapter 5 will discuss these communication tools through the use of safety issue examples such as safe medication administration. Aspects of teamwork will be defined, delineated, and applied. The application of evidence-based practice guidelines would serve as the foundation for the discussion related to effective and successful implementation of a sound alliance within any workplace setting.

Preface

ix

It is fully accepted that successful science learning depends at least in part on teachers’ teaching competences. In addition, there is some evidence that teachers tend to teach as they were taught. Therefore, in order to develop teachers’ innovative and student-centered teaching competences, methods courses should acknowledge teaching methodologies similar to those that prospective teachers will be required to use in their future as teachers. Problem-Based-Learning (PBL) and teamwork are student-centered teaching approaches that may foster the development of relevant competences for students as citizens. In fact, PBL can promote learning how to learn competences while teamwork can foster the development of social and interpersonal skills. However, to successfully put these teaching approaches into practice teachers need to fully acknowledge big role changes. Hence, in order to prepare innovative teachers, PBL, together with teamwork, should be used in initial science teachers’ education programs. Chapter 6 describes how 38 prospective physical sciences teachers evaluate teamwork and PBL carried out within a methods course to approach a module on Using the lab for physical sciences teaching. Data were collected by means of a questionnaire, a self-evaluation grid and a videotaped discussion focusing on the diverse parts of a PBL sequence: problems formulation from a scenario, problem solving and synthesis and evaluation. Results indicate that prospective teachers valued PBL and teamwork, as they felt that the latter helped them to cope with the new roles that they were required to undertake throughout the PBL sequence. However, the facilitating effect of teamwork seems to be insufficient to lead students to fully overcome their difficulties with more unusual tasks. Nevertheless, it seems that they may be prone to use these teaching approaches when they become science teachers. Chapter 7 examines teamwork in medical care and makes particular reference to the pediatric team. It considers the characteristics of an effective team and the perceived benefits of team working in healthcare. It discusses the important role that education, and in particular interprofessional education, might have in helping to prepare a future workforce capable of effective patient focused team working. The contributory effect of different professional cultures is also examined and arguments are presented that reflect on the meliorating role of appropriate interprofessional education. The theoretical arguments are illustrated with reference to recent highly publicized and significant failures by teams responsible for the health and well-being of children. Recent case studies and judicial reviews from the United Kingdom and the United States are discussed. Many models in the literature examine outsourcing based on product modularity; however, modularity is assumed to be known and exogenous. In reality, modularity is a decision variable defined (i.e. built into the product) during the engineering design phase of the product development (PD) process. This paper bridges the gap between the outsourcing literature and the engineering design literature by incorporating into the outsourcing decision model detailed engineering design information regarding the time spent on various engineering design activities within the PD process (e.g., system design, detailed design, and testing and integration). Chapter 8, a mathematical model is developed to study the impact of outsourcing and time spent in the various engineering design activities on firm’s revenue (represented by a marketing window) for different PD scenarios. These scenarios differ in four major factors: technological capability of the firm and its suppliers, design task size and complexity, nature

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of detailed design work (i.e., fraction of rework), and amount of outsourcing. It is shown that this model is a convex optimization problem that admits a global optimum; however, no explicit closed-form solution could be obtained and the problem was solved using optimization software. The optimal solution reveals several interesting managerial insights regarding the impact of the various engineering design decisions on the outsourcing decision. First, spending more time in system design leads to higher outsourcing fraction and vice versa; that is, well defined product architectures lead to higher outsourcing. Second, higher firm capability makes outsourcing less attractive. Third, outsourcing is found to be more attractive at the medium task sizes compared to larger or smaller tasks. Fourth, a product with a complex architecture will lead the firm to spend more time in system design and thus outsource more. Lastly, as the rework fraction of detailed design increases, it is better to spend more time in system design and outsource more. Due to the increased female labour participation in the past decades, households lack time to perform all households and care activities. At present in the Netherlands, households can outsource home cleaning to a cleaning lady/man, cooking to restaurants (or people can eat ready meals or takeaway food), and childcare can be outsourced to day care centres. The increased household income, attributed to higher female labour participation, gives more possibilities to outsource domestic work. Outsourcing could not only be determined by socioeconomic and demographic variables, culture (or ethnicity) can also be of importance in explaining outsourcing within households. Chapter 9 aims to determine the time households spend on domestic tasks and care activities and whether differences in lifestyle and ethnicity are related to outsourcing behaviour. Time spent on household and care activities is estimated with a model including socioeconomic and demographic variables and including some lifestyle determinants. Household expenditures on different types of outsourcing possibilities within households are measured and differences are drawn between native Dutch and non-western immigrants. For the analyses a sample (2001) is used that consists of Dutch, Turks, Surinamese/Antilleans, and Moroccans (N=2551). The analyses show that immigrants spend less time on household and care activities compared to native Dutch. Both Household income and level of education are determinants of the expenditures on outsourcing of domestic tasks and care activities. Native Dutch and Surinamese/Antilleans have comparable expenditures on home cleaning and childcare, whereas Moroccans and Turks spend more on takeaway food and delivery food. The results reveal differences as well as similarities in lifestyle between native Dutch and non-western immigrants. The debate on new public management, together with the shortage of public funds, has had a considerable impact on public administration. Accordingly, many governments have searched positive impacts on the efficiency, equity and quality provision of public services through increasing competition and active participation of the private sector, considering outsourcing as the appropriate instrument to attain such endeavor. However, private involvement in public services provision is controversial. While, on the one hand it is touted as a way to increase efficiency and accountability by turning over choices to individuals in the market place, on the other hand, some argue that it has the potential to produce considerable fraud and corruption if managerial control by the public sector is weak. So, given this context, Chapter 10 aims to assess the private involvement in public services in

Preface

xi

efficiency terms, putting aside ideological considerations. So, after the introduction, we present a definition of public goods and we characterize their different types, with particular emphasis on “impure” public goods. Section 3, focuses on market failures together with equity considerations as the main reasons that configure the role of the public sector in providing impure public goods, as well as on the possibility of government failures. Section 4 deals with the benefits and costs of outsourcing in the public sector. Section 5 describes the most frequent forms of private sector involvement in the provision of impure public goods, as well as the advantages and disadvantages of the different options. Section 6 carries out some comments on the need for regulation. Finally, section 7 concludes. The Flagship / 5 Partners model argues that key suppliers are dedicated exclusively to flagship firms and that flagship firms work on an exclusive basis with key suppliers. As the F/5P model is partly rooted in empirical analyses of the North-American automotive industry, it is interesting to test its external validity on the European car industry. Similarly, it seems relevant to test its claim of exclusive buyer-supplier relationships as there are also scholars that report on non-exclusive b2b practices. Chapter 11 analyzes the component supply relationships for 32 car models to test the exclusivity presumptions of the F/5P model. Results show that industry-wide client bases on behalf of suppliers and multiple sourcing practices by carmakers are a stronger empirical reality than exclusive flagship firm-key supplier relationships. Outcomes also indicate that previously in-house parts of carmakers successfully succeed in establishing client relationships with third party OEMs. Motivated by our interactions with a leading manufacturer of computers, in Chapter 12 we consider static allocation as applied to the problem of minimizing the costs of outsourcing warranty services to repair vendors. Under static allocation, a manufacturer assigns each item to one of several contracted repair vendors; every time a particular item fails, it is sent to its preassigned vendor for repair. In our model, the manufacturer incurs a repair cost each time an item needs repair and also incurs a goodwill cost while items are undergoing repair. We model each service vendor as a finite population multi-server queueing system and formulate the resulting outsourcing problem as an integer-variable resource allocation problem. After establishing convexity results regarding the queue lengths at the repair vendors, we show that marginal allocation is optimal. Through a detailed computational study we compare the optimal algorithm with five static allocation heuristics in terms of time and optimality gap. Our study indicates that the optimal algorithm takes less than a minute to solve industry size problems on average. Further, the commonly used heuristics are far away from the optimal on average, thus emphasizing the benefits of the optimal allocation algorithm. We also compare the optimal static allocation to two simple dynamic allocation heuristics. The results of this study further validate the use of static allocation as a justifiable and easy-to-implement policy. Among other computational insights we show that when the number of items to be allocated is large, a single-server approximation leads to optimal allocations in most of the cases. Chapter 13 consists of three parts that present two complementary statistical analyses. In the first part, we show consumer reactions to BSE in Japan using Directed Acyclic Graphs and historical price and quantity decompositions. The Japanese beef markets faced two subsequent cases of BSE discoveries in 2001, eroding consumer confidence in beef supply channels with huge economic losses to the Japanese beef industry. In the second part, we look at BSE’s impact along the U.S. supply chain using similar contemporary time-series methods. The U.S. beef industry faced BSE in 2003, which led to differential impacts on farm, wholesale, and retail markets. Relative to the U.S., Japanese consumers have a strong

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preference for domestically produced beef, encouraged by retail country-of-origin labeling and BSE media coverage critical of imported beef. Consistent with these differences in preferences, marketing, and information, we observe more negative and more nuanced reactions to BSE in Japan versus the U.S. The third part highlights contextual differences in Canada. A double-hurdle model of Canadian fast food beef purchases shows no significant BSE impacts on the likelihood or quantity of fast food beef item purchases. When applied to Canadian supermarket beef purchases, however, a striking pattern emerges. After the initial BSE event in 2003, when media coverage focused mainly on the plight of ranchers, beef demand increased significantly. Moreover, demand increased the most in Alberta, the center of Canada’s beef industry. Following two later BSE events, beef demand fell significantly. The results illustrate the importance of context along at least five dimensions: the food purchase venue, the geographic proximity of consumers to BSE events, the ordering of BSE events, the role of supplier behavior, and the nature of media coverage.

In: Outsourcing, Teamwork and Business Management ISBN: 978-1-60456-956-8 Editor: Karl E. Carettas, pp. 1-14 © 2009 Nova Science Publishers, Inc.

Chapter 1

OFFSHORING KNOWLEDGE WORK: HOW FAR CAN IT GO? EVIDENCE FROM DRUG R AND D David Finegold1, Niclas Erhardt2 and Mari Sako2 1

Rutgers University USA University of Maine USA 3 Said Business School UK 2

Introduction Offshoring of services is seen as a relatively new form of internationalization, enabled by trade liberalization policies and advances in information and communication technologies. Starting with simple and codified tasks, companies are now offshoring increasingly complex and knowledge-based activities requiring more qualified workers. Consequently, there is growing concern in the US and Europe that high quality jobs are being lost to low wage emerging economies, most notably China an India. Historically, primarily unskilled and semi-skilled manufacturing jobs were considered vulnerable to offshoring. By contrast, the extent of offshoreability of service jobs is not so well correlated with the skill content of those jobs (Blinder, 2006). Some white collar tasks that require relatively little formal education or qualifications may remain ‘personal’ requiring face-to-face contact and judgment-based interaction, but other more highly skilled tasks may be rendered ‘impersonal’, enabling delivery from a distance with little need for such interaction. In addition, the very definition of what counts as highly skilled may vary across cultures and nations – Aron (2008), for example, found that complex quantitative analysis was rated as the most highly skilled positions in the US and UK, while in India and China these tasks were rated as relatively routine, while those requiring very contextdependent personal interaction were seen as the most highly skilled. This chapter analyzes the potential and limits of offshoring knowledge work, examining which tasks are being outsourced and offshored in the most knowledge-intensive portion – Research and

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Development (R and D) – of one of the most knowledge-intensive sectors of the economy: the drug industry. Research and development in the drug industry is one of the areas that has attracted a great deal of public investment in regions across the US and Europe, as governments seek to create and retain new biotech and pharmaceutical companies and the high-wage jobs they generate. The hope was that a number of factors would make these jobs unlikely to relocate: their highly skill content – a higher percentage of PhDs than any other sector, the highly regulated nature of the industry, and the huge risks and investment required to develop new drugs, costing an average of over $1 billion per new drug and over 90 percent of projects never leading to an approved product. Recently, however, R and D in this sector has begun to move to locations outside the advanced industrial economies, a relatively new phenomenon, made possible by the internet and the changes in intellectual property regimes in India and China. The sector therefore provides an ideal setting for studying the evolving nature of the offshoring of knowledge work and the factors that are driving this. The chapter focuses on the reasons why drug companies choose to offshore and/or outsource some R and D tasks and not others, and how they manage the process and the issues that arise once the work is moved offshore. The chapter sets forth an analytical framework for analyzing the offshoring/outsourcing decision that includes the availability and cost of talent, how closely related the knowledge is to the core strategy of the firm, and the nature of work/task itself. The task is not treated as a given, but rather is considered to be alterable through the process of offshoring/outsourcing, either necessitated by distance requiring a new mode of working and/or enhancing modularity (i.e. separability of tasks that enable a job to become ‘impersonal’) that had been possible prior to offshoring.

Off-shoring and Outsourcing Knowledge Work: Analytical Framework Offshoring refers to the sourcing and coordinating of tasks across national borders. Offshoring may include both in-house (i.e. captive) sourcing and outsourced activities that cross the boundary of the firm. Outsourcing, in turn, may occur both domestically (onshore) and abroad (offshore). In this chapter, we focus on the simultaneous shifts in the location of work and the boundary of the firm – i.e. when key aspects of drug discovery and development are shifted from being performed in-house at or near the corporate headquarters to a contractor or partner in India or China. The increase in off-shoring/outsourcing has largely been driven by cost reduction, adding flexibility, access to know-how and facilities that a company may be unable to afford alone to address changes in the market and customer demands (Kumar and Eickhoff, 2006; Ward, 2004). In the drug industry, however, the desire for cost savings in R and D must be balanced by the key role that new knowledge generation plays in building and maintaining a competitive advantage. The traditional view of off-shoring (as well as outsourcing) would suggest that intellectual property (IP) such as competencies, processes and know-how that is core to the business is kept in-house, while non-core knowledge is outsourced (Kumar and Eickhoff, 2006). The logic is that keeping the core-knowledge from “leaking” would prevent it from eventually reaching competitors that might copy the capability that the company relies

Offshoring Knowledge Work: How Far Can it Go? Evidence from Drug R and D

3

ge

1.

le d

2.

Low

no w

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Abundant Supply

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on for competitive advantage. This strategy is still practiced in national biotech industries. For example, Norus’s (2005) study on the biotech industry in Copenhagen found that companies tended to in-source core competencies based on collaborative networks fostering flow of knowledge. The growth of the industry was fostered by keeping sticky knowledge (core) within the network and leaking and exporting less sticky knowledge to external supplier and partners. However, intensifying global competition, drying “pipelines”, challenges with finding novel products, and the need to increase the speed of launching products into the marketplace are all trends leading companies to rethink the organization of the R and D function. Producing innovative and quality products is no longer exclusively explored within the boundaries of the firm; an emerging trend suggests that companies are starting to off-shore their R and D function as well. Companies such as Dell, BP and Shell, have enjoyed benefits of outsourcing intellectual capabilities (i.e. R and D) that enabled them to build and maintain their leading positions in their industries (Quin, 1999). Moreover, Toyota’s success has in part been attributed to their inter-firm network among suppliers that enable effective knowledge sharing based on institutional routines (Dyer and Nobeoka, 2000). Kinder (2003) provided evidence on the competitive advantage of having strong external supply network as conduits of value and flow of knowledge to enhance innovation and creativity. Quadros, Consoni and Quintao, (2005) studied the trend of R and D outsourcing in the Brazilian automobile manufacturing, which was larger than previously thought, and is growing based on cooperative research networks. Interestingly, MacPherson, (forthcoming) pointed out that external venders can provide innovative services to complement core competencies of client firm. The evidence suggests that it is not the in-house stock of “core-competencies” per se that seems to generate a competitive edge (as the traditional off-shoring/outsourcing argument would predict), but rather the company’s ability to integrate and execute with speed and rely on external partnerships to compliment and supplement its own R and D capabilities.

Modular (Standardized)

Integrated (Ill-Structured)

Task Modularity

Figure 1. Determining Outsourcing and off-shoring of Work Core Knowledge, Task Modularuty and Talent Availability.

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The research literature identifies three central factors that may determine what types of work in drug discovery and development are likely to be outsourced or off-shored. The cube in Figure 1 provides a framework for integrating these three factors: (a) CORE KNOWLEDGE: control over core capabilities and the protection of core workforce; (b) TALENT AVAILABILITY AND COST: the relative cost and supplyy of talent in off-shored and out-sourced locations and (c) TASK MODULARITY: the extent to which tasks are welldefined and standardized (modular) or ill-structured and require integrated know-how. The first factor affects primarily the outsourcing (make-or-buy) decision but not the location (offshoring) decision; so for example, fear of knowledge leakage may prevent firms from outsourcing to an external provider, but it can be dealt with through captive offshoring. By contrast, the second factor affects primarily the location (offshoring) decision but not the outsourcing decision per se, in a world of imperfectly mobile international labor markets. The third factor, the nature of tasks, however, affects both the decision on the boundary of the firm and that of location. To illustrate how this decision-making framework operates, let us provide examples of drug development work that might fall in some of the key boxes: 1. In house/onshore: for US drug companies, the early stages of drug discovery biology have historically been performed in-house because the supply of talent was greatest, it was difficult to modularize tasks, and there are major concerns about the loss of IP (first quadrant in Figure 1). 2. Outsource/onshore: early stage Phase I clinical trials are often done in partnership with nearby teaching hospitals to gain access to the knowledge and specialized expertise of their key medical thought leaders and facilitate completion of this phase as quickly as possible. These close trust relationships help to foster protection of IP until the firm is ready to release the results. 3. Offshore/outsource: large-scale production of small molecule drugs is increasingly being both outsourced and offshored, since the task is easy to modularize and measure, and the talent to produce the drugs is widely available. This has tended to go to locations (such as Puerto Rico, Ireland, Singapore) which offer both strong protection for IP and tax and other investment incentives that make it a low-cost option for firms. Particularly smaller companies will often use a contract manufacturing organization (CMO) to gain a skill set that is lacking within the organization, to save capital costs, and to leverage economies of scale. Other factors might also affect the R and D location decision. For example, governments may offer incentives to firms to create these jobs in their jurisdiction; we treat such incentives as effectively reducing the cost of labor. We will explore this framework in the context of two case studies of drug discovery work in early-stage US-based drug companies that involve the greatest coordination challenges: shifting work that was previously done in-house at the corporate headquarters (#1) to having the work both outsourced and offshored (#3).

Offshoring Knowledge Work: How Far Can it Go? Evidence from Drug R and D

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Company Cases Biologics. Biologics1 is a midsize drug company in the northeast region of the USA that focuses on immunological diseases, with drugs that can be administrated via tablet, inhaled or topical forms. In 2007 the company had 150 fulltime employees, and sales of over $20 million. It has several promising clinical compounds in phase I and II clinical development and in order to sustain its growth, they have been collaborating with both large and small external companies. Starting in 2000, Biologics began to contract out work to emerging clinical research organizations (CROs) in both China and India. They started with a firm where they had a personal relationship with the founder, who had extensive experience in the U.S. pharmaceutical industry. Routine chemistry, and later stage clinical development have been the main tasks being contracted to offshore partners, while pharmacokinetics and animal testing have been outsourced to partners in the U.S. Most of the early stage biology, proprietary chemistry, and Phase I trials continues to be kept in-house. Biologics presently pays for 30 full-time equivalents (FTEs) at their partner compared with 55 internal medical chemists. Most of the internal chemists have PhDs or Masters degrees, while a majority of the chemists in their China partner are at the B.S. level, with only a handful of PhDs who manage the work. While India has been the main location for contracting out development work to this point, Biologics believes China may become the preferred location for earlier stage research, as the Chinese government invests heavily in research universities and developing their own know-how and supply of PhDs, and opens up its economy further for western companies and foreign investments. Small Pharma. Small Pharma is a private company founded in the late 1990s that focuses on small-molecule drugs that target the protein transcription process, with application to a wide range of rare genetic diseases. Their current pipeline is promising with products targeting a range of areas. Similar to Biologics, Small Pharma is currently collaborating with large pharmaceutical companies to strengthen their access to development and commercialization capabilities and financial resources. The company has enjoyed rapid growth in the last two years, more than doubling in size to over 150 employees thanks to success with several large grants and deals with large pharma. But the CEO has been determined to grow conservatively, avoiding investment in expensive facilities and to avoid costly mistakes and having to lay off part of its workforce. Small pharma began experimenting with outsourcing/offshoring in 2006. Their first partnership with an external CRO was in China for routine chemistry work. It later shifted its offshoring focus to India, where its research partner now has 25 chemists and five managers. The relationship was viewed as such a success that they decided to expand into biology, both with the original partner and a second firm in India.

Reasons for Offshoring and Outsourcing Our semi-structured interviews with senior executives and project managers at these two companies identified a set of key drivers and barriers to offshoring R and D work. 1

Names are fictitious to protect companies’ identity.

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Cost Reduction The primary driver of offshoring in biopharma R and D, consistent with findings from other sectors, is cost reduction. A fundamental challenge for small biotech companies is to generate funding and to manage cost associated with the discovery and development process – a long and risky endeavor. The need for contracting emerged in the chemistry area, as a way to both save costs and allow existing scientists to be more productive. It freed up time for scientists to focus on interesting and promising work while reducing the cost of labor intensive work. According to both firms, in India and China: The CROs can do the work for roughly one quarter of the labor cost. There are things we simply cannot get done. They help us meet our goals and milestones. Travel expenses are additional, but we try not to travel more than two times per year.”

The labor cost estimate assumes relatively similar productivity from the offshore workforce, which the firms are able to achieve for most workers after an initial start-up training period. Close monitoring of individual output allows them to identify where there are productivity or quality issues and to have their partner take corrective action. This cost-saving estimate, however, does not include the additional burden this places on the firm’s already hard working scientific managers who must oversee the relationship with the Indian or Chinese partner. Said one: “What is not factored in is the extra cost in managerial time. That comes out of the hours of salaried managers on top of other duties.”

Managing Risk and Volatility: Protecting the Core Workforce Contracting out work also provides the firms with a means to minimize risk, by allocating exploratory projects to external contractors since it would be riskier to hire core employees for projects that may not be sustainable. One of the CEO’s goals when he founded Small Pharma was never to have to lay any employees off. This can be a major challenge in a highly volatile and risky sector where only one of 1,000 drug targets makes it from the lab to the market, and typically requires a decade or more of development. To minimize the chance of layoffs, he has tried to grow his firm as conservatively as possible, hiring only individuals for whom there are multiple projects to fully occupy them and several years of funding to support their work. Contracting provides the firm with a buffer workforce for those projects whose future is highly uncertain and providing flexibility necessary in drug discovery and development.

Extending the Drug Portfolio Contracting out work to much lower cost providers allows biopharmaceutical companies to use their scarce internal capital to fund small-scale development projects that would not be feasible with a US workforce. By farming out certain non-mission critical projects, Small Pharma was able to conduct early stage research on focused compounds to “test the waters.” If the research proves promising, these results can then be used to attract additional funding

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from government grants, foundations, investors, and/or corporate partners. As one manager explained: We have multiple therapeutics and a number of targets that we are not exploring, we have interest in them, but we are simply not working on them (internally)… It's not about replacing work; with our limited space, we outsource work that was not currently being done here. We did not take jobs away from the US. The economics is such that we could not afford the work if we did it here.

This is how Small Pharma advanced a small anti-bacterial program, which began with some exciting preliminary results identified by one of Small Pharma’s researchers working on an anti-infectant. The project, however, was a lower priority than many of the others in their pipeline and the firm had neither the personnel nor the resources to pursue it internally. The offshoring option, enabled the project to progress to the next stage of development. If the firm is able to use this new data to attract further funding, then the initial offshoring will have generated additional employment both in New Jersey and India, thus contradicting a common perception of offshoring as a zero sum game, where a fixed number of jobs is done in the US or in Asia.

Not Skill Shortages Another rationale that is sometimes cited for reasons for offshoring is the lack of specialized skills available in the local labor market. In the case of these two firms, however, that was not the case. This may be due to the fact that they are based in New Jersey, a state where 75% of the world’s largest pharmaceutical companies have a significant presence. Many large pharmaceutical firms have merged and/or restructured over the last decade, resulting in large layoffs. This experienced workforce, along with the graduates from strong research universities in the area, has resulted in a large supply of bioscience talent available for start-up companies. Indeed, many international firms -- such as Novo Nordisk, Roche, Bayer, and many of the Japanese pharmaceutical companies -- have located their US headquarters in New Jersey to tap into the supply of workers with experience in all stages of bringing a drug to market.

Challenges to Effective R and D Offshoring Although the firms saw a number of potential benefits from moving some R and D work to India and China, they faced a common set of challenges to making these relationships work effectively. The challenges, similar to those found in other sectors (Quin, 1999), ranged from managerial and personnel issues -- such as managing expectations, increased complexity, virtual interaction and cross-cultural differences -- to logistical challenges.

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Managing Virtually Offsetting some of the significant direct labor cost savings, were the indirect costs associated with managing a workforce halfway around the world. The challenge began with identifying local companies that had the necessary competence and facilities to conduct the work. Although the hiring process was the responsibility of the contractors in India and China, Biologics and Small Pharma had to devote significant time to training the offshore workers to develop the specific competencies needed to carry out the required tasks. The physical distance also can create communication issues, particularly in the early stages of the relationship. Without the ability for daily, informal face-to-face interactions that they had taken for granted when all the work was performed in-house, firms were forced to establish more formal work routines, processes, and expectations to manage the relationship. As one Small Pharma manager observed: For the first six weeks we didn’t know how the work was going. It was frustrating. We realized we needed more structure on the report in the beginning. So we said, we need a written report….We reached a point when productivity was low. I talked to the lead PhD. I needed to tell her about our expectations and their performance. The productivity was less than 10% of expected. But it was just for one person. I got good realistic output from the others… We are very clear about our expectations these days.

Cheap and rapid communication -- through the phone, internet and e-mail – are essential enablers of managing virtually. But while such mechanisms are useful for sharing data and transmitting factual information, they are not as useful for hashing through problems. The lack of non-verbal cues needed for reaching agreements and understanding are amplified in cross-cultural settings where terms like “no” and “deadline” may be interpreted quite differently. Trouble-shooting complex problems or sharing “lessons learned”, tends to work best when teams have had enough face-to-face interaction to foster high degrees of trust. One mechanism to try to build such richer communication is video conferencing. However, in this case the 13-15 hour time difference meant that members on one side of the team would have to make calls from home and would not have access to the company’s communication technology in the office. For routine work, this time difference could be an advantage, allowing the Asian partner to advance projects after the US scientists had gone home. But when problems or questions arose that required more immediate action, individuals sometimes became frustrated with the long delays in getting an e-mail response. Even when video conferences could be scheduled they were not viewed as a full substitute for in-person meeting. It was in part for this reason that US managers still traveled several times/year to Asia to spend time with their partner.

Logistics Offshoring work to developing nations makes coordination particularly challenging (Parker and Anderson, 2002). Given the complexity in the R and D process, coordinating the know-how, processes, resources, personnel, timelines, etc has the potential to reduce much of the added value that the partnership was intended to generate. Initially the Asian firms faced delays and added costs in getting all of the materials needed for their experiments, but as the

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industry has expanded in these countries, the leading global reagents and material suppliers have all set up operations in these nations. The shipment of chemical and biological materials across national borders, however, can still create obstacles, and has forced the US firms to organize the work process so they are not offshoring any mission critical steps on key projects. This might slow down the work as one informant commented: Shipment of bacterial strains that are drug resistant was a big problem. We had to jump through hoops. It does not matter how well you do the paper work, they will get stuck in customs. One package sat for a month... And now, I requested them to ship back two strains so we can reproduce them for internal testing and they can’t get it out of the country. US customs is more strict on the incoming stuff. We have alternatives. I don’t like it, I’d prefer to work in the original strain, but we can make it work.

Cross-Cultural Differences Cross-cultural managerial issues have long been a part of managing the innovation process in most US bioscience start-ups, since the scientific workforce graduating from US universities is very international. In our relatively small sample firms, for example, over a dozen different nationalities were working side-by-side in the R and D labs. Contracting work to India and China can create additional challenges, such as language barriers and different norms of communicating expectations and progress (Anderson, Davis-Blake and Parker, 2007). A common theme was that the eagerness of the suppliers to get and retain the business created the risk of exaggerating capabilities and failing to notify the partner right away when inevitable problems occurred with experiments. When asked about potential issues, the Indian firm’s first response was typically “we have got it under control,”, which was not always the case as one manager from Small Pharma commented: That's one of the problems, with India, they say they can do everything! But it’s a difference of what they think they can do and what they really can do. You have to think about what do you need help with and make clear you need to know if problems arise.

These communication challenges seem to create a need for increased formalization of procedures, processes and expectations in off-shoring due to the lack of close supervision. This is not surprising since many of the CRO relationships are somewhat new and emerging which implies a great deal of learning required from both sides. For the CRO, it means to learn what is expected, how the work should be done and in what form to report it. And from the company’s side, learning involves understanding how to manage from a distance and establishing and enforcing reasonable expectations.

Intellectual Property The potential loss of intellectual property (IP) has traditionally been a major concern for companies considering outsourcing to India or China (e.g. Carson and John, 2007). This concern would appear to be magnified in the drug industry, where IP is a vital source of competitive advantage. Surprisingly, our firms indicated that for the types of work they were contracting, loss of IP was not a major concern. This was in part because they had proceeded

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cautiously, starting with small assignments while they built trust with their partners. This is reinforced by the social networks within this industry and the strong reputational effects, which create a disincentive for a firm to cheat as one project manager from Small Pharma described: We have had some discussions around IP and are comfortable with our CRO. They now have a huge relationship with a large pharma company that we know as well; they are not going to screw us over, or it would go down in flames…And realistically, it’s the same risk we face if people leave our company; we have as much protection with our internal employees. It’s not much difference there.

A similar response was given by a manager at Biologics: IP? I'm not paranoid about this. The external vendors are very careful to manage their reputations to make sure things don’t leak out. The real issue is not the chemistry (used to produce inputs into the discovery process); the worry is more about knocking off the end product so that they can start producing it.

The firms also used a number of specific techniques to protect their IP including: code words, secure FTP servers for protected file transfers to share large data files inherent in development work, and compartmentalizing the work. For example, while the CRO was working on a compound to screen and identify promising molecular structures, its employees were not provided the knowledge of the molecule’s actual purpose, thus minimizing the risk if the compound was to leak to a competitor.

Enablers for R and D OffShoring and Outsourcing Many of the barriers noted at Small Pharma and Biologics are common to other companies that have offshored knowledge work. Prior research suggests some strategies for coping with these issues which were tried by our two companies. For example, Tarakci, Tang, Moskowitz and Plante, (2006) suggest adopting incentive contracts to minimize coordination problems, by encouraging the contractor to operate in a way that seeks to take proactive actions to correct problems and to create a win-win situation by optimizing total profit for both firms. Another mechanism to address these challenges is to employ personnel dedicated to managing outsourcing relationships, referred to as “boundary spanners”. Boundary spanners are staff whose primary task is to integrate, coordinate, and manage work across functional, company and national boundaries. Anderson et al. (2007a) found boundary spanners were particularly important for effective distributed product development to reduce potential language barriers and cultural differences. In our sample, both parties in the outsourcing relationship used boundary spanners. In the Asian contractors, there were key managers of each project, who were PhDs, often educated in the US or UK, who had strong English skills and spent time at the client getting to know the key people and process so that they could translate it to their workforce back home. Likewise, the US partners assigned a point person, often someone who was himself a native of the contractor country, to act as a point person to work closely with the CRO to oversee the project, to travel to Asia to provide onsite training

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and knowledge transfer, and to track statistics to check quality of data and costs. The main focus is not the cost per se, but rather the cost effectiveness to assure that the company really achieves the value added.

Discussion Evidence from our case studies suggests that the framework set out in Figure 1 appears to provide a useful guide for understanding the offshoring and outsourcing R and D decisions of drug companies. Both Biologics and Small Pharma were more likely to shift those aspects of the research process to an offshore partner where the work was not seen as core to the critical development path, where the work could be modularized, and where comparable talent was available with a significant cost advantage in offshore locations.

Cost and Availability of Talent The core driver of the decision to offshore research in our cases was clearly labor cost savings. Unlike past global movement of R and D, where many international firms set up R and D operations in the US to tap into the supply of talent and to gain access to the world’s most lucrative drug market, in this wave of offshoring the goal is to try to make limited R and D dollars go further by spending less for comparable quality work. In chemistry, the prime driver of offshoring was to lower the cost for key labor intensive, yet less time sensitive tasks, while in biology, the much lower cost per project allowed US firms to pursue lower priority projects that otherwise it could not afford, in hopes that some will yield promising results that can attract additional resources.

Task Modularity In order to outsource and offshore work effectively, a degree of modularity must occur in the work process. A central question that we wanted to explore in the study is whether modularization of work preceded outsourcing or was driven by the requirements of outsourcing. In both of our cases, it appears to be the latter, but the way in which work was modularized, differed substantially between the two scientific areas based on the nature of the work. In chemistry, the CRO’s were asked to produce discrete batches of compounds in certain quantities, one piece of a multi-step process. In biology, CRO’s were given whole projects, but ones that were, as noted, small and not seen as core to the success of the company. Contracting out of biology was at a far less mature stage than chemistry. This appeared to be due to all three factors in our framework: the work is highly integrated and uncertain, and thus more difficult to modularize. The integrated nature of the tasks required the contracting researchers to know the target under exploration, thus making it harder to protect IP for core work. And the tacit expertise for commercial discovery biology is much harder to find in India and China at this point, as one of the informants from Biologica commented:

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David Finegold, Niclas Erhardt and Mari Sako The problem is that they [CRO’s in India and China] lack the experience in the drug discovery. They don’t have the know-how that you need. They can follow instructions to make a drug part of the development process but they don’t have the softer knowledge you need to make decisions along the way. The chemist area is more developed.

In contrast, creating and testing chemical compounds is far more standardized and labor intensive, which makes it easier and more attractive to contract out to take advantage of differences in labor cost. The routine nature of work reduces the need for interdependent collaboration, since clear guidelines can be identified and enforced. Less interaction is necessary to solve problems. The most standardized work, however, has been automated on expensive, high throughput machines, and is generally retained in-house because labor cost advantages are outweighed by transaction cost disadvantages. While certain elements of the development process are thus more prone to be contracted out, the evidence suggests that contracting R and D has evolved gradually, in an opportunistic fashion, rather than being part of a pre-defined sourcing strategy. It was the chance to take advantage of these lower cost suppliers that drove changes in the design of the work process, rather than a decision to modularize the way the work was performed in the US creating the opportunity to outsource. As one manager from Small Pharma noted, they started by asking: What could they do for us? We wanted to see how they performed. We have increased their responsibilities as they showed performance. We also want to develop good working relations with them. Are they just CRO or a collaborator that will impact our work?

Core Knowledge Our case study firms continue to keep the work that is seen as most critical – in terms of protecting core knowledge and time sensitivity – in-house in the US. For the elements of R and D that are moved to India and China, three factors appear to explain why the firms are not overly concerned with the loss of intellectual property: 1) the work that is being performed offshore does not involve core IP: the specific chemicals being synthesized do not reveal the drug targets of interest and the biology projects are not the key ones in the drug pipeline; 2) they are using a series of standard control and security measures to protect information; and 3) perhaps most important, in the closely knit drug industry, reputational effects are vital, particularly for new start-up service companies. The US firms are confident that their partners will do everything possible to protect their IP, because any leakage would become known and jeopardize their ability to attract and/or retain much larger pharmaceutical clients. As the relationship has progressed, these factors were reinforced by a form of implicit institutional trust that evolved between the partners. Mangers made it clear that traveling to the CRO’s periodically was vital for developing this trust and a healthy working relationship.

Conclusion We have offered a framework for understanding what types of drug R and D work is likely to remain in US biotech companies and what is likely to be outsourced and offshored. Our study also helps to explain why this is occurring and likely to increase in the future and provides insight into how firms can manage these relationships effectively. It appears that in

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this case, unlike some other sectors of the economy, the desire to access lower cost labor outside the US is leading to the modularization of the work process, rather than modularization occurring as a more effective way to perform bioscience R and D, some of which can then be outsourced or offshored. It is interesting to note that in an industry where IP has historically been seen as essential to creating value, that the loss of knowledge is not perceived as a major barrier for offshoring or outsourcing. While we have attempted to shed some light on the emerging trend of offshoring of R and D in the biotech industry, we clearly do not know the long term impacts of this trend. As the Indian and Chinese firms continue to develop their capabilities, moving from more routine chemistry to discovery biology, it would seem plausible that their current relationship as “service organizations” to US and European biotech companies, could evolve toward becoming more of a collaborative partnership in which drugs are co-developed. This might ultimately promote more cost effective drug development and foster more therapies for neglected diseases of the developing world (Finegold, Shakti, and Shahi, 2005). We already observed some evidence of such win-win relationships, where promising results from exploratory work in India that the firm could not have afforded in the US has enabled a novel antibiotic to move forward in development, generating more jobs in both Asia and the US. As this trend toward global movement of bioscience R and D is likely to grow, it will be important to explore the implications for firms and the workforce. One possibility is that US firms will set up their own research operations in India or China. While this may be more feasible for large pharmaceutical firms, it is a possibility that Small Pharma’s leadership team is already considering, led by a manager in the US who would be willing to return to his native India. While there are major challenges with operating effectively in the Indian market, this would potentially allow better control of more proprietary work, enhance communication, and cut out the costs of the middleman. We may also observe mergers between leading players in the different countries, such as the recent announcement of an offer by DaiichiSankyo, the second-largest Japanese pharmaceutical company to take a controlling interest in one of India’s largest bioscience firms, Ranbaxy (Krauskopf, 2008). If offshoring of R and D continues, and if more offshoring relationships were to become collaborative partnerships, it also has important implications for the education and training and labor market for US scientists. It seems to offer enhanced prospects for the select few who are doing the most cutting-edge research. Different career ladders may be created with new types of jobs for those capable of managing complex global relationships, which will require new ‘boundary spanning’ skill sets. But more prevalent R and D offshoring also suggests the destruction of face-to-face apprenticeship of junior scientists undertaking routine work, and the threat of growing wage pressure and/or loss of routine jobs in the US. It might become increasingly difficult to regard advanced science qualifications as tickets to good jobs.

References Anderson, E. G., Davis-Blake, A. and Parker, G. G. (2007). Managing Outsourced Product Design: The Effectiveness of Alternative Integration Mechanisms. Working Paper. Anderson, E., Davis-Blake, A., Erzurumlu, S., Joglekar, N., and Parker, G. (2007a). “The Effects of Outsourcing, Offshoring, and Distributed Product Development Organization

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on Coordinating the NPD Process,” Chapter in Handbook on New Product Development, Eds. C. Loch, S. Kavadias. Aron, R. (2008), Global sourcing of knowledge-intensive services: Operational risk, complexity and the demand for skilled workers in the U.S., paper for Sloan Industry Studies Annual Conference, Boston, MA, May 1-2. Blinder, A. S. (2006). Offshoring: The Next Industrial Revolution? Foreign Affairs, March/April. Carson, S. j. and John, G. (2007). A Transaction Cost Explanation of Property Rights Sharing in Outsourced Research Development and Engineering Relationships. Working paper. Dahlman, C. J. (2005). China and India: Emerging Technological Powers. Issues in Science and Technology, Spring: 45-53. Dyer, J. H. and Nobeoka, K. (2000). Creating and Managing a High-Performance Knowledge Sharing Network: The Toyota Case. Strategic Management Journal, 21(3): 345-367. Finegold, D., Shakti, D. and Shahi, G. (2005). “A New Variety of Capitalism: Case Study of the Emerging Business Models Indian Bioscience Industry,” paper presented at the EGOS Conference, Berlin, Germany, July. Kinder, T. (2003). Go with the flow – a conceptual framework for supply relations in the era of the extended enterprise. Research Policy, 32: 503-523. Krauskopf, L. (2008). Daiichi-Ranbaxy May Signal Big Pharma-Generic Deals,” Reuters, http://in.reuters.com/article/businessNews/idINIndia-34037120080612. Kumar, S. and Eickhoff, J. H. (2006). Outsourcing: When and how should it be done? Information Knowledge Systems Management, 5: 245-259. Norus, J. (2006). Building Sustainable Competitive Advantage from Knowledge in the Region: The Industrial Enzymes Industry. European Planning Studies, 14(5): 681-696. Parker, G. G. and Anderson, E. G. (2002). From Byer to Integrator: The Transformation of the Supply-Chain Manager in the Vertically Disintegrating Firm. Production and Operations Management, 11(1): 75-91. Quadros, R., Consoni, F. and Quintao, R. (2005). R and D outsourcing to research institutions: a new look into R and D in teh Brazilian automobile industry. Paper presented in the 13th GERPISA International Colloquium. Quinn, J. B. (1999). Strategic Outsourcing: Leveraging Knowledge Capabilities. Sloan Management Review, Summer: 9-21. Tarakci, H., Tang, K., Moskowitz, H. and Plante, R. (2006). Incentive maintenance outsourcing contractss for channel coordination and improvement. IIE Transactions, 38: 671-684. Ward, S. (2004). Outsourcing research: What is your position? Business Information Review, 21(4): 227-239.

In: Outsourcing, Teamwork and Business Management ISBN: 978-1-60456-956-8 Editor: Karl E. Carettas, pp. 15-30 © 2009 Nova Science Publishers, Inc.

Chapter 2

MULTINATIONAL EXPLORATION OF ACQUIRED R&D ACTIVITIES Jens Gammelgaard* Copenhagen Business School, Department of International Economics and Management Porcelænshaven 24, 2000 Frederiksberg, Denmark

Abstract This paper presents the results of a survey of 54 Danish multinational corporations that have acquired activities abroad. The role of the acquired R&D units was the focus of the survey, particularly with respect to the schism between basic and applied R&D, and the schism between autonomous and network R&D. This paper establishes the connection between a multinational corporation that follows a capability-motivated acquisition strategy and the R&D role new subsidiaries should play in order for the acquired resources to be utilized corporation-wide. Statistical findings reveal the need to follow a combination of basic and network-oriented R&D activities when focusing on capability development.

Keywords: Acquisition; Research and Development (R&D), Basic R&D, Applied R&D, Autonomy, Network, Capabilities.

Introduction Is it possible to advance capability-creating processes in a multinational corporation (MNC) through the acquisition of another firm’s R&D activities? The MNC’s awareness of the acquired firm’s R&D activities and subsequent use of integration strategies influence the utilization and exploration of the acquired resources. Awareness reflects an acquiring MNC’s initial intention to explore the acquired firm’s capabilities instead of following other strategic goals, such as market access. Integration indicates the MNC’s choice among possible roles for its new R&D units, including the need to address the schism between autonomy (a situation where the R&D unit does not cooperate with other MNC R&D units) and a network *

E-mail address: [email protected]

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model (a situation which emphasizes interdependencies among different MNC R&D units). The nature of the R&D activities is also topical in terms of capability development. The strategic possibilities are again two-fold, since the acquired R&D unit can be assigned to applied R&D activities, i.e. modifications of existing products, or it may create new products or processes, a strategy that approaches basic research. The purpose of this paper is, therefore, to analyse whether the initial strategic wish to gain access to another firm’s capabilities, and the subsequent strategies concerning integration and the acquired firm’s R&D role are related. The architecture of the arguments is as follows. The following section briefly treats acquisition motives and emphasizes the importance of access to the acquired firm’s R&D activities as a reason for acquisition. The subsequent section stresses the different roles an acquired R&D unit is allowed to play in an MNC. Discussions of methods and measurements are followed by the presentation of results from a survey that covered 54 Danish acquisitions abroad in the period from 1994 to 1998. Finally, conclusions are presented.

Acquisition Motives Cisco Systems gained access to specific R&D capabilities within the Internet server and communication equipment fields through acquisitions. Corporations like Intel, General Electric and Nestlé all initiated technology-driven acquisitions during the 1990s as a vehicle to develop capabilities (Bower, 2001; Mitchell & Capron, 2002; Ranft & Lord, 2002). However, Gammelgaard (2004) found that earlier surveys of mergers and acquisitions (M&A) motives were restricted to include only resource exploitation strategies: investigating the direct outcome effect such as increased market shares, cost reductions and risk minimization through diversification. Wernerfelt (1984) extended this approach by using the resource-based view of the firm to put an emphasis on the acquired firm’s resources and their exploration. Here, acquiring firms followed a long-term oriented goal of creating value from utilising and improving the resources and capabilities of the acquired firm in a corporate-wide setting. In this respect, resources can be defined as anything tangible or intangible controlled by the firm that enables it to conceive of and implement strategies that strengthen or weaken its ability to create, produce and offer goods and services to a market (Wernerfelt, 1984; Barney, 1991; Sanchez et al, 1996). Christensen (2000) defined capabilities as functional, operational or technical superior capacities that may be further subdivided into specific individual skills or specialised team-based resources. Through acquisitions, the acquiring MNC gains access to the skills of the employed R&D engineers (see Nelson & Winter, 1982) and organisational learning processes, i.e. the social interaction of R&D engineers that result in new knowledge and products (Teece et al, 1997). The M&A literature seldom stressed access to the acquired firm’s R&D activities as a main motive. Different surveys investigating M&A motives clearly pointed to the growth of the firm through the extension of existing markets or the entering of new markets as the dominant motive (Newbould, 1970; Baker et al, 1981; Lindgren, 1982; Hunt et al, 1987; Suverkrup & Hauschildt, 1990; Davis et al, 1993; Norburn & Schoenberg, 1994). Furthermore, Ansoff et al (1972) found the completion of product lines through M&A, which made it possible to offer customers a full line of services, to be momentous. Additionally, Chakrabarti et al (1994) saw cost reductions through scale or scope economies as an important motive. Chakrabarti et al (1994) did highlight the capability perspective as among

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the most important motives. Finally, Belderbos (2003) established that a major motive for Japanese manufacturing MNCs to acquire abroad was to gain access to R&D capabilities at a faster pace. Presumably, firms tend to focus on the capabilities embedded in the acquired firm. According to Serapio et al (2000, p. 2), MNCs now accelerate their direct investments in overseas R&D since “more than 100 multinational companies have acquired multiple laboratories abroad and are increasingly tapping into these laboratories for new sources of technologies”. Weston et al (1999) provided the example of M&A in the global chemical industry. They highlighted the motive of gaining access to key scientists in the acquired firm, who in turn were used for development of particular R&D programs, and pointed to the creation of broader technology platforms at the higher strategic level. However, surveys of acquisition motives have rarely touched on the acquired firm’s R&D activities as a strategic motive. Sometimes, access to R&D activities was only a motive subordinate to a strategic desire for cost reductions through economies of scale (Hughes et al, 1980) or through avoidance of duplicate efforts. Cooke (1986) spoke for the full, or more efficient, utilisation of intangible resources, such as specialists or high-tech equipment. This discussion is often associated with the synergy approach, where combinations of, for example, technical expertise embedded in one firm and manufacturing knowledge in the other create added value (Capron & Mitchell, 1998). In addition, Hagedoorn & Duysters (2002) found that a strategic and organizational fit between companies improved technological performance in general. Other contributions more directly connect acquisition motives and the R&D activities of the acquired firm. Dettmer (1963) focused on this perspective by addressing access to better and complementary unexploited technology in the acquired firm as an acquisition motive. Later, Chen & Su (1997, p. 73) highlighted the motive of “seeking of technological advantages or knowledge capital of a takeover target”, making it top priority on their motive list. More recently, Bower (2001) stated that access to the acquired firm’s R&D activities was one of five acquisition motives emphasized. Acquisitions were, in this context, a substitute for in-house R&D activities, and helped the acquiring firm to quickly build up positions in highly competitive and dynamic markets. Finally, Chakrabarti, et al, (1994) provided a closer look at the technological perspective of acquisition by identifying one cluster of “technological acquirers” that strategically sought new technology and know-how. This aim was achieved through close cooperation between the two R&D departments subsequent to the acquisition, which resulted in the redeploying of R&D resources into more productive uses. Using this line of argumentation, one can assert that a knowledge-seeking acquisition is positively related to integration strategies, based on the interdependencies between the acquired firm, its headquarters, and other subsidiaries.

Characteristics of R&D Activities Ranft (1997) argued that R&D activities were often the driver in a firm’s innovative processes. A major challenge for acquiring firms has, therefore, been to tap into and explore the acquired firm’s R&D resources and capabilities. Håkanson & Nobel (1993) suggested that the acquired unit’s R&D activities be expanded by assigning it a group-wide responsibility within specific areas. Decentralised and loosely coupled networking organisations (Hill et al, 2000), theoretically describable as a ‘heterarchy’ (Hedlund, 1986), a ‘transnational

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organisation’ (Bartlett & Ghoshal, 1989), or a ‘differentiated network’ (Nohria & Ghoshal, 1997), have typically used this strategy. In decentralised MNCs, subsidiaries have acted very independently by being responsible for capability development within specified areas. In the end, these are assessed by other MNC units as highly important (White & Poynter, 1984; Birkinshaw & Hood, 1998; Holm & Pedersen, 2000; Frost et al, 2002). Subsidiaries have played a wide range of roles within MNC’s (Schmid, 2000). This paper focuses on the role of the acquired firm’s R&D unit and therefore emphasizes a unit acting as a centre of gravity that significantly contributes to the entire MNC capability development (Chiesa, 1995; Brockhoff, 1998). In terms of R&D activities, the subsidiary can play different roles that more or less qualify for specific mandates and positions. The R&D unit may, on the one hand, concentrate on pure capability creation processes that do not specifically relate to a certain product. On the other hand, the unit may centre on more product-oriented activities, in which the R&D unit only pays attentions to pure modifications of the headquarters products to fulfil local market demands. Secondly, the R&D unit can be very autonomous in its behaviour when R&D activities take place independent of other R&D activities in the MNC. In contrast, the R&D unit might be fully integrated with other R&D units of the MNC, so that R&D activities come about interdependently with other corporate units. Figure 1 illustrates these two spectres by including the four archetypical roles of a subsidiary’s R&D unit in an MNC.

Figure 1. Roles of an R&D unit in an MNC subsidiary

The purpose of following a combination of an applied and autonomous R&D strategy is to customise MNC developed products to meet local customers’ specific demands. To fulfil this role, the R&D unit modifies headquarters’ or other sub-units’ products without depending on additional resources from other MNC units. Consequently, the final product is often not usable (or saleable) in other MNC units or in their related markets. In the combination of network and applied R&D activities, the subsidiary R&D unit is responsible for modifying existing products in cooperation with headquarters or other sub-units, so the final product design meets global demands. Development of subsidiary-specific capabilities, as in the situation of an autonomous and basic R&D strategy, requires concentrated R&D activity without control or influence from other R&D units in the MNC. The outcome of such a

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strategy is the creation of unique and disparate capabilities, which will be considerably different from the resources and capabilities located in other MNC units. A negative effect here is the substantial degree of tacitness and inimitability in the underlying knowledge of the developed capabilities. Consequently, the capabilities will probably not be utilised in other parts of the MNC. The mixture of network and basic R&D is, therefore, preferable for building MNC relevant capabilities, because the R&D unit embraces the advantage of being inspired by other R&D units in its creation and development of capabilities. In this combination, the developed capabilities will still be unique, while at the same time, they will fulfil the requirements of other MNC units. Literature addressing capability-creating R&D activities in MNC subsidiaries often classifies basic R&D activities at the top of the hierarchy of different subsidiary R&D roles. The “corporate technology unit”, where subsidiary-generated new technology, which is of a long-term or exploratory nature for either headquarters (Ronstad, 1978) or in general (Taggart, 1998), has been an example of a top-hierarchical position. However, Medcoff (1997) and Nobel & Birkinshaw (1998) found that basic R&D was not necessarily usable for other corporate units in the short term or even in the medium run. According to these researchers, the purpose of basic R&D is to discover new platforms of knowledge, which is not specifically associated with particular products. Zander (1999) considered basic R&D to be an exploration strategy focusing on new insights and fields of expertises by developing certain items of knowledge not producible elsewhere in the corporation or, at times, elsewhere in the industry. The end goal of the subsidiary’s R&D unit was, therefore, to develop knowledge considerably different from existing MNC knowledge. Gerybadze & Reger (1999) pointed to a trend of more foreign R&D sites being assigned the role of creator of basic technologies. Conversely, surveys by Papanastassiou and Pearce (1999), and Pearce (1999) revealed that basic R&D activities in subsidiaries were of only minor importance. Further, Florida (1997) demonstrated that applied R&D had a much higher importance when it encompassed the aim of creating commercial concepts. The other aspect investigated in previous research is the division between autonomous and network R&D strategies. Persaud et al (2002, p. 61) defined autonomy as: ”the degree to which a subsidiary R&D lab has control over the strategic decisions affecting its direction and operations”. The authors further claimed that autonomy positively effected innovation, by leading to greater freedom in developing unique relationships with both internal and external partners, although the risk of opportunistic behaviour - the subsidiary R&D unit following its own research goals rather than the goals defined by headquarters - was present. Furthermore, the writers further statistical support for autonomy being dividable into two areas: the freedom to choose with whom one establishes relationships, and the freedom to select which areas the R&D unit was to do research. Reflecting the scope between autonomy and network, Brockhoff (1998) described three standards of R&D roles: the ‘hub’, the ‘competence centre’ and the ‘network model’. In a hub, decision-making was centralised and headquarters co-ordinated all other R&D laboratories. In the competence centre, R&D activities were experimental, isolated and specialised. Finally, the network model was characterised by high intra-organisational integration and intensive subsidiary involvement in the formulation and implementation of strategies. Likewise, Birkinshaw (2002) divided R&D roles into the ‘integrated network’, where R&D centres were tightly, and the ‘loosely-coupled network’, in which laboratories were given autonomy positions and specific roles to fulfil. Birkinshaw (2002) recommended the integrated network solution when the underlying R&D

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knowledge was not easily observed and the loosely-coupled network when assets were characterized by a low degree of mobility (the extent to which the knowledge base could be separated from its physical setting). In general, Chiesa & Manzini (1996) advised that headquarters govern R&D units if the network model is implemented. As suggested by Birkinshaw and Hood (2001), this would allow headquarters to distribute resources by delegating mandates and supporting initial “genius” knowledge creation while, at the same time, enabling the blocking of unprofitable research programmes. The surveys investigating the success rate of network-based R&D activities have not provided a clear picture. Brockhoff & Schmaul (1996) and Ensign et al (2000) spoke of positive success rates, whereas Taggart (1997) and Taggart & Hood (1999) took the opposite position. Several MNCs have used the network-oriented structure, making R&D units dispersed in different countries responsible for certain product or technology areas. For example, Chiesa (2000) described how Nissan, the Japanese car manufacturer, developed a minivan as an outcome of cooperation between headquarters and different US-located R&D centres in California, Michigan and Tennessee. Downey (2003) provided the example of Nokia having 18,000 engineers scattered across 69 sites worldwide. Furthermore, he described the development of the 777 aircraft in which Boeing operated with 238 crossfunctional teams, including customers, operators and line mechanics in collaborative design networks. Birkinshaw’s (2002) case study of Ericsson’s Radio System business reflected on this complexity by portraying how the firm developed its third generation mobile telephony by involving 10,000 engineers located in at least 20 different R&D sites around the world. Finally, Gassmann & Zedtwitz (1999) demonstrated how the Schindler Group, at present a worldwide leader in escalators and elevators, built up its R&D capacity through acquisitions, where acquired firms took specific positions in a highly integrated organisation. Today, the company employs around 500 engineers working in several R&D centres around the world. Through both intraorganisational cooperation, and close collaboration with local science centres and universities, they have developed the complex technology behind the elevator keypads that operate the car based on the number, location and destination of waiting passengers together with aerodynamic influences. The network system makes sure that the development of such unique components is usable worldwide. The question then becomes which strategy the acquiring firm should emphasize when integrating the acquired firm if: (1) it is a capability-based acquisition, and (2) the purpose is to create synergy subsequent to the acquisition. Haspeslagh & Jemison (1991) highlighted the risk of simply absorbing the acquired firm, emphasizing value destruction caused by key employees leaving the firm. Conversely, preserving the acquired firm by leaving it in an entirely autonomous position will not lead to synergy in the long run. Haspeslagh & Jemison (1991) proposed to start the integration process with a preservation strategy, and build a symbiotic approach over time. This becomes a kind of networking organisation where the acquired firm keep elements of autonomy while it is simultaneously absorbed. Gassmann & Zedtwitz (1999) also recommended that the acquired firm reserve some degree of autonomy, but the unit must be forced into a corporate network at the same time, creating the opportunity to improve MNC knowledge. Håkanson & Nobel (2001) advised strong integration, since the acquired firm typically favoured transfers of developed technology to the parent organization - apparently since transfers of tacit and complex knowledge has been interpreted as easier within hierarchies (Kogut & Zander, 1995; Almeida et al, 2002).

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The discussion leaves two dilemmas. One is the choice between autonomous and network-oriented R&D, while the other is the availability of the two alternatives: basic or applied R&D. The challenge is to find the right balance when walking the tightrope between the different strategies. A recommendable strategy is to bring in elements from all four extremities, but still emphasising the network and basic R&D. Using this model, the capability-based acquired firm keeps its superiority in terms of a specific knowledge or technology, but at the same time this capability will be of use elsewhere in the corporation. The model advocates a more cohesive approach to decentralisation and networking, a proposal that corresponds to a recent finding of Gerybadze & Reger (1999) concerning MNC organisational structures. Based on this discussion, I hypothesize: Hypothesis: An acquired capability-based R&D unit focuses its activities on basic and network-oriented R&D.

Methods and Measurements Data for this study was collected through a questionnaire survey undertaken in the spring of 2000. The questionnaire was sent to those Danish industrial firms that acquired a foreign firm in the period from 1994 to 1998, during which 151 Danish MNCs acquired 469 firms abroad. Three mailings by post and a follow-up phone call to non-responding firms resulted in 54 returned questionnaires bringing about a response rate of 35.76 percent. A bias control of the responding acquiring firms compared to non-responding firms, including figures on numbers of acquisitions made in the survey period, investments countries, the year of establishment, numbers of employees at the end of 1993 and the end of 1998, and corporate turnover in 1993 and 1998, showed no bias of significance when comparing mean values using a one-tailed t-test. The questionnaire primarily contained questions concerning factual figures, such as the percentage of R&D cost compared to turnover, and questions to be answered on a 1 to 7 point Likert scale. This section presents the descriptive data and statistical analysis based on a t-test. The purpose of using the t-test was to distinguish the group behaviour of capability-based acquiring firms from an opposing group of acquiring firms that solely follow growth and market-related strategies. The partitioning of observations was based on a non-hierarchical clustering method resting on a random selection of five variables’ seed points covering different aspects of the acquired firm’s capabilities. The purpose of the cluster analysis was to group objects based on the characteristics they possessed, including high internal homogeneity on the one hand and high external heterogeneity on the other. Different clustering tests were run for selecting the procedure leading to the highest degree of external heterogeneity. The clustering of firms was based on recommendations from Hair et al (1998) and Der and Everitt (2002). This paper elucidates basic characteristics of the capability-based acquisition building on the resource-based view framework of Wernerfelt (1984) and Barney (1991). The five variables selected for clustering are: (1) the importance for the acquiring firm of gaining access to the acquired firm’s capabilities; (2) the importance for the acquiring firm of gaining access to the acquired firm’s relations to local science centres; (3) the inimitability of the acquired resources; (4) the non-tradability of the acquired resources; and (5) the uniqueness

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of the acquired resources. The interrelatedness between the five factors was satisfactory with a Crombach Alpha Coefficient of 0.78. Using a non-hierarchical clustering procedure assigned the clusters in regard to a specified number. In this case, the number was two. In this survey, the cluster seeds were randomly selected. Using this technique, one cluster of 22 capability-based acquired firms and another cluster of 32 market-based acquired firms emerged. The differences in means are presented in Table 1. Table 1. Mean differences: Five clustering variables using a non-hierarchical random selection clustering method Variable Access to capabilities Access to scientific centres Degree of inimitability Degree of non-tradability Degree of uniqueness

Mean capabilitiesbased cluster 5.79 3.59 4.06 4.50 5.41

Mean markedbased cluster 3.66 1.76 2.33 2.53 2.14

F – Statistics 26,70*** 17.29*** 30.91*** 29.63*** 71.52***

n = 53 Based on 1-7 Likert scale questions †p