Equity Alliance, Stages of Products

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J. Eng. Technol. Manage. 21 (2004) 191214

Equity alliances, stages of product development,and alliance instability

Paul E. Bierly III a,, Joseph E. Coombs b,1

a

College of Business, James Madison University, MSC 0205, Harrisonburg, VA 22807, USAb Robins School of Business, University of Richmond, Richmond, VA 23173, USA

Abstract

The purpose of this research is to analyze the stability of strategic alliances initiated at different

stages of the new product development process and to determine the appropriateness of different

governance structures (e.g., joint ventures, minority equity alliances, non-equity alliances). Specif-

ically, we argue that the minority equity form of alliance is an inherently unstable structure for

product development partnerships. Key findings of this study are: (a) minority equity alliances aremore likely to be terminated within 5 years than joint ventures and non-equity alliances, (b) alliances

are more likely to be terminated if they are initiated in the early and late stages of product develop-

ment and less likely to be terminated if they are initiated in the mid-stages of product development,

and (c) alliances are more likely to become acquisitions if they are initiated in the mid-stages of

product development and less likely to become acquisitions if they are initiated in the early and late

stages of product development.

2004 Elsevier B.V. All rights reserved.

Keywords: Alliance instability; Minority equity alliances; New product development

1. Introduction

Partnerships and a network type of structure can help a firm maintain a superior compet-

itive position in dynamic environments (Hagedoorn, 1993; Powell et al., 1996). Firms can

focus on those tasks that they do well (i.e., core competencies) and rely on partners in other

areas (Hamel and Prahalad, 1994). Partners can be valuable in helping to understand the

changing rules of the game. They also can improve a firms strategic flexibility since the

firm commits fewer resources to each of the different technologies and activities. Moreover,

Corresponding author. Tel.:+1 540 568 3236; fax: +1 540 568 2754.

E-mail addresses: [email protected] (P.E. Bierly III), [email protected] (J.E. Coombs).1 Tel.: +1 804 287 6631; fax: +1 804 289 8878.

0923-4748/$ see front matter 2004 Elsevier B.V. All rights reserved.

doi:10.1016/j.jengtecman.2004.05.001


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192 P.E. Bierly III, J.E. Coombs / J. Eng. Technol. Manage. 21 (2004) 191214

strategic alliances provide firms with new sources of competitive advantage, such as access

to complementary technologies, access to new markets, and risk reduction (Hagedoorn,

1993). Interfirm cooperation may also allow industry incumbents to adapt to radical tech-

nological change (Rothaermel, 2001). Koza and Lewin (1998) describe alliances as havingeither exploitation or exploration objectives.

Alliances with exploration objectives aim to reduce information asymmetries and facil-

itate the investigation of new opportunities. They are pursued to provide a framework for

learning, for engaging in innovation and basic research, and for building new capabilities.

Alliances formed to establish a market position have exploitation objectives, which involve

the motive to exploit an existing capability. They are pursued to increase the productivity of

capital and assets, engage in cost-reduction, refine existing capabilities and technologies,

and to gain access to resources to compete in a particular market, such as local market

knowledge, distribution systems, and regulatory policies.

As expected, the increased importance and use of strategic alliances over the last two

decades has prompted a large amount of research in this area. However, most of this re-

search has focused on issues associated with the alliances initial formation and only a few

researchers have studied alliance evolution over time (Doz, 1996; Hagedoorn and Sadowski,

1999; Park and Russo, 1996). This stream of research is important because alliance gover-

nance can change dramatically for several reasons. First, partners strengths and bargaining

power may change over time, changing the alliances dynamics. Second, one partner may

learn from the other at a faster rate thereby devaluing the other partners future contribution

(Hamel, 1991; Doz, 1996). Third, the competitive environment can change, requiring a shift

in alliance focus. For example, the development of a new technology, inside or outside thepartner organizations, can force the alliance partners to redirect their future research efforts.

Finally, the alliances past performance may cause governance instability, whether the al-

liance was exceptionally successful or unsuccessful. When alliance performance is better

than expected, one partner may try to increase its stake, possibly to the extent of acquiring

its partner (Bleeke and Ernst, 1995). When performance is worse than expected, a partner

may reduce its commitment to limit future risk, or it may increase its control in an attempt

to remedy past problems.

In this paper, we intend to determine what circumstances cause strategic alliance gov-

ernance to be less stable. Alliance governance refers to the mode of control the partners

establish through either some form of ownership or formal contract. Specifically, we analyzethe likelihood of the following governance changes throughout the new product develop-

ment process: (1) the alliance turning into an acquisition, (2) the alliance being terminated,

or (3) a major change to the alliances governance structure. While alliance instability has

been the subject of research as a determinant of alliance outcomes (Blodgett, 1992; Oxley,

1997; Park and Russo, 1996; Park and Ungson, 1997; Yan and Zeng, 1999), little is known

about factors that promote or limit instability.

This article aims to reduce this literature gap by analyzing the stability of strategic al-

liances initiated at different stages of the new product development process and deter-

mining the appropriateness of different governance structures. We argue that the minority

equity form of alliance is an inherently unstable structure for product development partner-ships. Further, by focusing on instability, rather than only alliance failure (Hagedoorn and

Sadowski, 1999; Park and Russo, 1996; Park and Ungson, 1997), this research builds upon


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P.E. Bierly III, J.E. Coombs / J. Eng. Technol. Manage. 21 (2004) 191214 193

recent work in the field (Blodgett, 1992; Dussauge et al., 2000; Kogut, 1989) that takes a

broader view of alliance outcomes while fully realizing that a governance change does not

necessarily imply failure of an alliance. Several factors increasing or decreasing alliance

uncertainty that other researchers have investigated are included in our study as controlvariables: partner size, scope of alliance, nationality of partners, financial flexibility, and

previous alliance experience.

We test our research questions by examining a large number of alliances in the pharma-

ceutical industry, where partnerships have become increasingly important in the successful

integration of knowledge and the development of new products (Barley et al., 1992; Bierly

and Chakrabarti, 1996a; Henderson and Cockburn, 1994; Powell, 1998; Rothaermel, 2001).

Each alliance in this study involves a large pharmaceutical firm, which we designate the

studys focal firm. The focal firms partners range dramatically in size from very small

biotechnology firms to large pharmaceutical or chemical firms.

2. The pharmaceutical industry

The pharmaceutical industry has three separate segments: ethical (prescription) drugs,

over-the-counter (OTC) drugs, and generic drugs. All of the focal firms in this study focus

primarily on ethical drugs. The pharmaceutical industry is characterized by extraordinarily

high R&D expenditures, extremely long new product development times, high marketing

costs and very high profits. R&D intensity is higher in the pharmaceutical industry than

any other industry and has consistently risen over the last two decades, resulting in theindustry now spending more than US$ 40 billion a year on R&D. A recent study by DiMasi

(2001) determined that the average cost to develop a new prescription drug is US$ 802

million (2000 dollars). A similar study by the same research group in 1991 determined

the average cost was US$ 318 million (2000 dollars). Part of the reason for this increased

development cost is that pharmaceutical firms have shifted their strategy to focus more on

radically new drugs with large potential payoffs, rather than developing me-too drugs

that imitate competitors successful products. Cost containment efforts and pressure from

health maintenance organizations (HMOs) and pharmacy benefit managers (PBMs) have

made imitation drugs less attractive.

The lengthy development and approval process also contributes to the higher cost. Itusually takes 1015 years to develop a new drug and get approval by the FDA in the US

(DiMasi, 2001). The initial discovery stage may take up to 5 years, and only 1 out of 5000

compounds initially screened end up being commercialized. The testing stage includes four

distinct phases. First, preclinical testing, which lasts 34 years, is conducted on animals

to determine the existence of any major toxic effects. Second, Phase I clinical testing,

which lasts about 12 years, is conducted on 2080 healthy human volunteers to determine

safety and dosage. Third, Phase II clinical testing, which lasts 23 years, is conducted on

100300 patient volunteers to determine the safety and efficacy of the drug. Fourth, Phase

III clinical testing, which lasts 34 years, is conducted on 10005000 patients to monitor

the long-term effects of the drug. The cost of clinical testing has increased substantiallybecause of the difficulty in recruiting patients and the increased focus on developing drugs

to treat chronic and degenerative diseases (DiMasi, 2001). After all of the clinical tests are


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complete, the FDA reviews the new drug application for approval, which can take over a

year.

Recently, a dramatic change occurred in the approach used by organizations to discover

new drugs. No longer do pharmaceutical companies, relying on their expertise in chemistryand pharmacology, use random screening to discover an effective new drug. Almost all

drugs today are discovered by following a rational drug design, an approach that relies on

the structural analysis of target molecules and the deliberate design of agents that affect their

function. However, rational drug design requires the integration of knowledge from many

different disciplines, including molecular biologists, biochemists, physiologists, chemists,

pharmacologists and experts in very specialized fields related to the specific drug. In other

words, successful drug design requires the combination of the traditional knowledge base

of pharmaceutical companies with the knowledge base of biotechnology companies, where

biotechnology companies either provide intermediary products to facilitate the process or

assist in the development of the end product.

From the perspective of the established pharmaceutical companies, biotechnology can

be characterized as a competence-destroying innovation, since the more abstract and tacit

knowledge base associated with biotechnology is markedly different than the knowledge

base of most traditional pharmaceutical companies (Powell et al., 1996; Zucker and Darby,

1997). Since no one company can excel at all of these different knowledge areas, phar-

maceutical firms must rely more on strategic alliances to gain access to and integrate the

knowledge from these different fields (Henderson and Cockburn, 1994; Powell et al., 1996;

Barley et al., 1992). Additionally, pharmaceutical companies use a large number of market-

ing alliances to assist in the fast and comprehensive distribution of their drugs worldwide.Speed to market is critical because patent protection, and hence large profit margins, is only

guaranteed for a limited period.

However, the pharmaceutical industry is also a very profitable industry because of its

high entry barriers, effectiveness of patents, and strong bargaining power. According to

2002 Fortune 500 magazine, the pharmaceutical industry was the most profitable industry

in the US, as measured by return on sales (18.5%), return on assets (16.3%), and return

on shareholders equity (33.2%). The key to success in this industry is successful product

development, especially the creation of new blockbuster drugs, which have revenues of

more than US$ 1 billion a year. Almost all pharmaceutical companies rely on a large network

of partnerships to facilitate the product development process.

3. Theoretical framework and relevant literature

3.1. Alliance governance structure

Strategic alliances can be defined as all partnerships between firms whereby their re-

sources, capabilities, and core competencies are combined to pursue mutual interests in

developing, manufacturing, or distributing goods or services (Hitt et al., 1997, p. 314).

Almost all past research on the governance structures of strategic alliances has classifiedalliances into two categories in some manner: equity and non-equity alliances (Gulati, 1995;

Hagedoorn, 1993; Hagedoorn and Narula, 1996; Kale et al., 2000; Mowery et al., 1996;


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Pisano, 1989; Rothaermel, 2001) or joint venture and non-joint venture (Kent, 1991; Kogut,

1988). Using simplified dichotomous measures such as these is a major weakness in the

literature because firms use three distinct forms of governance structure: joint ventures,

equity, and non-equity (contractual) alliances (Barney, 2002; Das and Teng, 1998). Each ofthese three forms is significantly different from the others concerning control, commitment,

flexibility, knowledge transfer and transaction costs.

3.1.1. Non-equity alliances

Non-equity alliances are contractual alliances that do not include an equity position.

This governance mode provides greater partner flexibility, less commitment, and is usu-

ally shorter-term (Hagedoorn, 1993; Hagedoorn and Narula, 1996). Non-equity alliances

are very efficient for explicit, simple arrangements and can usually be negotiated rapidly

(Gulati, 1995). However, when the alliance involves uncertainty associated with the transfer

and integration of intangible and tacit knowledge, non-equity alliances often fail because

contracts cannot be written that provide for adequate control within the partnership (Kogut,

1988; Hennart, 1988). Additionally, non-equity alliances may provide little disincentive for

partners to cheat since firms usually do not make large alliance-specific investments and it

is difficult to align the interests of the two partners (Williamson, 1975). Since hierarchical

and ownership control are not feasible, rigid contractual control is the only way firms can

manage for contingencies and deter opportunism, which usually coincides with lower levels

of trust (Das and Teng, 1998). However, if firms have worked together in prior alliances,

trust may already be established and may also act as a form of control (Gulati, 1995; Kogut,

1989).

3.1.2. Joint ventures

Joint ventures are arrangements where a new, separate entity is created by the combination

of the resources of the two or more parent companies (Inkpen and Beamish, 1997). Thus,

a major difference between joint ventures and the other two forms of strategic alliances is

that the object of control is not only the partner but also the new joint venture company

(Das and Teng, 1998). Usually, the joint venture has its own board of directors, with repre-

sentatives from both partners, and most top managers were previously employed by one of

the parent firms. Joint ventures are the most effective mode of governance for transferring

and integrating tacit knowledge since many employees from both of the companies are nowworking together (Hennart, 1988; Inkpen, 1996; Kogut, 1988; Mowery et al., 1996). They

are communicating frequently and directly and are able to share experiences. Joint ven-

tures are also effective at aligning the strategic goals of partners to minimize opportunism

(Kogut, 1988; Pisano, 1989). A mutual hostage situation is created since both partners

have made substantial alliance-specific investments and are dependent on the performance

of the other (Kogut, 1988; Williamson, 1975, 1991). This commitment by both firms to the

joint venture causes them to view joint ventures as a long-term relationship (Kogut, 1988;

Hennart, 1988).

However, joint ventures, which involve a high degree of commitment, limit firms strate-

gic flexibility (Hagedoorn, 1993). To dissolve a joint venture can be a complex and lengthyprocess, resulting in high exit costs. The large alliance-specific investments often cannot

be recovered for use elsewhere. There also is the threat that the partners will have different


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learning rates such that one firms competitive advantage may erode as critical tacit knowl-

edge is leaked (Hamel, 1991; Beamish and Banks, 1987; Kogut, 1988). Of all the forms of

strategic alliances, joint ventures are the most likely to have unintended knowledge trans-

fer since employees from both firms are working so close together. Additionally, many ofthese arrangements fail because of management problems, such as conflicting cultures and

different control systems (Ohmae, 1989). Finally, joint ventures may be trojan horse in-

vestments by one of the firms that have the hidden intention of acquiring its partner (Bleeke

and Ernst, 1995). However, empirical research by Hagedoorn and Sadowski (1999) has

determined that this actually occurs infrequently.

3.1.3. Minority equity alliances

Equity alliances are arrangements where contractual agreements are supplemented with

an equity purchase by one or both partners in the other partner. Typically, a larger firm, such

as a pharmaceutical firm, takes an equity position in the smaller firm, such as a biotechnology

firm. With this type of direct equity position, no new separate entity is formed. The equity

position usually includes a position or two on the other firms board of directors. This type

of governance structure has been described as a favorable form that has the advantages of

both of the other two forms (Pisano, 1989). As compared to non-equity alliances, the firm

taking the equity position has better access to information, can better monitor performance,

and has more control. Equity alliances are structured for a longer time period and require

more commitment, which is reassuring to the smaller firm. As compared to joint ventures,

equity alliances involve more flexibility, and they do not involve the management challenges

associated with forming a third separate entity, such as integrating organizational culturesand systems.

However, this positive bias toward equity alliances can be misleading. Equity alliances

may be unstable alliance structures that have significant disadvantages in addition to their

frequently stated advantages. In practice, equity alliances are not used at all in most indus-

tries and are used frequently in very few industries, most notably the pharmaceutical and

biotechnology industries. Institutional forces may have legitimated these types of alliances

in certain industries, but little research has been conducted to determine whether this gov-

ernance structure is effective. The positive bias toward equity alliances focuses on their

advantages relative to non-equity alliances and joint ventures, but each advantage is also

associated with a disadvantage.The advantages, relative to joint ventures, come at the cost of more difficulty in trans-

ferring and integrating knowledge, less commitment, and lower levels of trust (Das and

Teng, 1998). Even though individuals from equity alliance partners may interact on a fre-

quently regular basis, this communication is not as rich as employees working together in

a joint venture; also, these interactions are usually at a higher, strategic level in the orga-

nization, not at the lower, operational levels that are critical to the success of transferring

more tacit knowledge. Partner commitment is usually higher for joint ventures than equity

alliances because joint ventures involve more alliance-specific investments and higher inter-

firm embeddedness (Das and Teng, 1998), creating more of an environment for a long-term

relationship. The advantages of equity alliances, relative to non-equity alliances, comeat the cost of less flexibility and increased possibilities for opportunism (Das and Teng,

1998).


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In addition, an equity alliance creates a single hostage position, which is not stable and

makes trust among partners difficult. Joint ventures are effective at aligning the strategic

goals of partners to minimize opportunism by creating a mutual hostage situation, where

both partners have made substantial alliance-specific investments and are dependent on theperformance of the other (Williamson, 1975, 1991; Kogut, 1988). This commitment by both

firms to the joint venture causes them to view joint ventures as a long-term relationship

(Kogut, 1988; Hennart, 1988) and is associated with more trust and confidence in the

relationship (Das and Teng, 1998). However, in an equity alliance, only one firm has made

a substantial alliance-specific investment, and that firm is held in a single hostage position

relative to the other, usually smaller firm.2 This will help align the incentives of the larger,

investing firm with the smaller firm and reduce opportunism by the larger firm, but it is not

necessarily reducing opportunism by the smaller firm.

This can be illustrated with the example of a pharmaceutical company taking an equity

position in a biotechnology firm. The financial support the biotechnology firm receives may

be what it needs to remain viable for an extended period of time, but the tacit knowledge

associated with its research may be difficult to transfer back to the large pharmaceutical

company. After the biotechnology firm has used the investment from the pharmaceutical

company, the smaller firm may hold the larger firm hostage. It no longer has incentive to

act in the best interest of the pharmaceutical firm and the monitoring ability of a member

of the board of directors may not be as effective as expected. Often the opportunism by the

small firm is not a deliberate malicious act in the form of direct cheating the larger firm, but

in a more indirect manner.

For example, a small biotechnology firm in such a situation may shift the focus of itsR&D to areas more promising to itself and less promising to the larger pharmaceutical

company, or it may not fully assist in the knowledge transfer process concerning tacit,

complex knowledge that would require extensive resources. Actually, the link with the

pharmaceutical firm may hinder the biotechnology firms performance in that it may limit

its ability to further develop partnerships with other firms, who may be competitors, or

partners of competitors, of the investing pharmaceutical firm. If the alliance is terminated,

the individuals working at the biotechnology firm maintain control of the newly developed

tacit knowledge, which may have substantial value elsewhere.

Equity alliances are also less stable than the other governance forms because each

partners roles and expected contributions are less defined. An equity alliance is oftenused precisely because there is too much ambiguity associated with a partnership such that

a contractual alliance could not provide adequate control. However, we argue that using an

equity alliance does not necessarily provide the additional control needed. The increased

control is primarily based on the investing firm being granted a position on the board of

directors, which should provide a greater understanding of the partners inner workings.

However, this representative may be allowed to observe the partners top management

teams decision-making process, but their influence in decision-making is usually limited.

2

This argument of a single hostage position assumes that the equity alliance only involves one firm taking anequity position in the other. If the equity alliance includes both partners taking an equity position in each other,

then a more stable mutual hostage position is created. However, these types of situations are rare, especially in

the pharmaceutical industry.


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If, over time, the equity alliance is not producing the desired results, the company will feel a

strong responsibility to change the governance structure. Part of this feeling of responsibility

may be a justification for past investments. Due to higher levels of commitment and famil-

iarity, equity alliances are more likely to be adjusted over time or become an acquisitionthan other forms of alliances. Occasionally, firms enter into equity alliances with ulterior

motives, such as the long-term goal of acquiring the partner. They follow this sequential

path to acquisition to minimize their initial investment costs and to provide a trial period to

see how the culture, systems, and structures will be able to be integrated (Bleeke and Ernst,

1995).

Equity alliances tend to be less stable, when compared specifically to joint ventures,

for an additional reason. Equity alliances are a more flexible mode of governance than

joint ventures and can be rather easily adjusted. Joint ventures are usually established for

the long run and an attempt to change the governance arrangement may signal reduced

trust in a partner; thus, parent companies often use a hands off management style. In

summary, we argue that equity alliances are more unstable than other forms of alliance

governance structures, and the changes to the alliance structure may be in the form of

alliance termination, alliance amendment, or acquisition.

Hypothesis 1. Equity alliances are more likely than non-equity alliances and joint ventures

to experience governance changes after their initial formation.

Hypothesis 1a. Equity alliances are more likely to be amended than non-equity or joint

ventures.

Hypothesis 1b. Equity alliances are more likely to be terminated than non-equity or joint

ventures.

Hypothesis 1c. Equity alliances are more likely to become an acquisition than non-equity

or joint ventures.

3.2. Product development stage

Recent work on alliance instability has focused on the pattern of interdependence betweenpartners (Dussauge et al., 2000; Park and Russo, 1996), including the development stage of

the alliances main product. The stage at which a strategic alliance is initiated will affect the

likelihood that the alliance will become unstable such that alliances formed during the early

stages of a products development are less stable. During earlier stages of development,

the technology associated with the product is usually based more on basic than applied

science, the knowledge is usually more tacit and less detailed, there is more uncertainty

associated with development, and the knowledge is less dispersed throughout the scientific

community (Almeida and Kogut, 1997). Alliances formed in the earlier development stages

involve higher risk.

However, forming alliances in the earlier development stages also enables a better flow ofknowledge and a better opportunity for learning. A firm involved in the development of new

technologies from the beginning will understand the technology better in the long run, and


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will be better able to integrate the new knowledge with its existing knowledge base. Forming

alliances in earlier product development stages shows commitment to the development of

certain capabilities and such strategic actions may have importance by either blocking direct

competitors or countering their previous moves. Thus, alliances that are formed earlier in theproduct development process are more likely to experience governance changes, particularly

in the form of major amendments, because the large pharmaceutical firms know the partners

better and have already demonstrated a large degree of commitment.

Conversely, alliances formed later in the product development process are more likely to

focus on manufacturing and marketing, and less on R&D. These types of alliances usually

involve more explicit and unambiguous knowledge resulting in more stable alliances.

Hypothesis 2. A higher proportion of alliances initiated earlier in the product develop-

ment process will experience governance changes after formation, as compared to alliances

initiated later in the product development process.

Hypothesis 2a. A higher proportion of alliances initiated earlier in the product develop-

ment process will experience a major amendment after formation, as compared to alliances

initiated later in the product development process.

While we argue that in general strategic alliances are less stable early in the product

development process and more stable later, the timing of acquisitions and terminations

does not necessarily follow that general trend. Terminations are most likely to occur after

development projects reach stages where there is a major test of the project and there isfailure. For example, in the pharmaceutical industry this would be during the preclinical

trials (tests on animals), clinical trials, and Phases I, II and III tests on human volunteers.

Alliances formed after the drug discovery period, but before these tests are complete involve

gambles by the pharmaceutical company. Their intent is not to combine complementary

technologies, since the drug is already discovered. Essentially, they are betting that the drug

will be approved. They may be assisting with the approval process, or they may be acquiring

an option to manufacture and distribute the drug, if it is approved. If the drug fails any of

the tests, then it is likely the alliance will be terminated.

Terminations are less likely to occur when alliances are formed in the early stages of

the development of basic research and the initial design of a product. When alliances areformed at these early stages, both partners know the alliance involves risk and uncertainty

and they are usually both getting involved in an alliance at this stage for long-term benefits.

Forming an alliance in the later stages of development are less likely to end in a termination

because there is less uncertainty since the product has completed the testing stages and now

more focus is on preparations for manufacturing and marketing.

Hypothesis 2b. Terminations occur less frequently when alliances are initiated in the early

and later stages of new product development, than the mid-stages (inverted U-shape rela-

tionship).

On the other hand, we propose that acquisitions are more likely to occur when alliances

are formed in the early and later stages of product development, but are less likely to occur


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when alliances are formed during the mid-stages of product development. Alliances formed

early in the product development process, before a specific product is ready to be tested, are

often formed to either integrate two complementary technologies or combine resources in

a common technological area. While working together in these types of alliances, the twopartners can ascertain how well their cultures, structures and systems fit and whether an

alliance would work. Alliances formed later in the product development process involve less

uncertainty and typically focus on manufacturing and marketing the product. This type of

alliance may also lead to an acquisition as the acquiring firm looks to expand its product line;

the alliance in this situation was formed prior to the acquisition to obtain more information

about the firm being acquired so that it is properly valued and that there is a proper fit

between the two companies.

Alliances formed during the mid-stages of product development are less likely to lead

to acquisitions because the acquiring firm has less incentive to own the target firm in this

situation. The alliance is formed after the design is already established, so there is no need to

integrate different technologies. The alliance is formed before a final product is established

(and approved by the FDA in the case of pharmaceutical companies), so the alliance is

not used as a precursor to an acquisition because there is still a large degree of uncertainty

associated with the viability of a product. If the larger firm intends to acquire the smaller firm

in this situation, it would make sense to wait until the mid-stages of the product development

process are completed. Acquiring the partner before the drug is approved could be a major

mistake if the drug fails one of the tests. Without being able to market the new drug, the

benefits of the alliance probably would not exceed the substantial integration costs. It would

be better to maintain the flexibility of the alliance until after the drug approval.

Hypothesis 2c. Acquisitions occur more frequently when alliances are initiated in the early

and later stages of new product development, than the mid-stages (U-shape relationship).

4. Research design and measures

4.1. Sample and data

The study focuses on strategic alliances in the pharmaceutical industry from 1988 to 1994.Our specific focus is on the behavior of 27 large pharmaceutical companies (e.g., Merck,

Eli Lilly, Ciba-Geigy) based in the US (70% of the sample), Japan (14% of the sample) and

Europe (16% of the sample). Firms that were involved in a major merger either during the

period of our study or within 5 years after the alliance, such as SmithKline Beckman and

Beecham forming SmithKline Beecham, were not included in the study. Alliances involving

these companies were not included because the merger may have influenced the decision

to either terminate or change the governance structure of previous alliances. We focus only

on large companies to control for differences due to size.

Many issues for small companies entering strategic alliances are quite different than

the issues for large companies. We designate these firms as the focal firm and the othermembers of the alliance as the partner firm. The sample includes alliances with a wide

variety of partners including other pharmaceutical companies of various size and location,


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biotechnology companies, and companies from related industries. In total, 249 alliances are

included in the sample, with the focal firm of each being one of our 27 large pharmaceutical

companies. Thus, there is some lack of independence of observations since many of the

firms have multiple alliances. The Windhover Information Inc. Pharmaceutical StrategicAlliances database was used as the primary data source for information concerning the

alliances. Windhover is internationally respected as a leading provider of reliable databases

for the health care industry. They compile their databases from SEC documents, company

reports and extensive industry contacts. Firm-specific financial information was obtained

from COMPUSTAT.

4.2. Dependent variable

The primary dependent variable, change, builds upon previous research that has oper-

ationalized change as a major governance structure change (termination, acquisition, or

major reorganization) within the alliance (Blodgett, 1992; Dussauge et al., 2000; Killing,

1983; Lee and Beamish, 1995). This differs from research that focused solely on alliance

termination (Harrigan, 1988; Kogut, 1989, 1991; Park and Russo, 1996; Park and Ungson,

1997). This dichotomous variable is 1 when there is a major change and 0 when there is not

within a 5-year period after alliance initiation. Change is also disaggregated into its three

main componentstermination, acquisition, and amendment. Dichotomous variables are

used for each of these components indicating whether or not they occur in the 5-year period

after the alliance initiation.

4.3. Independent variables

We classify strategic alliance governance structures into the three categories of joint ven-

tures, equity alliances, and non-equity alliances by using two dichotomous variables labeled

equity and joint venture. These variables are given a value of one when the alliances are

equity or joint ventures, respectively, and zero when they are not. Non-equity alliances are

those that are neither equity alliances nor joint ventures. Equity alliances include alliances

where either one or both companies have an equity stake in the other, but do not include

situations where a third separate entity is formed, which we label a joint venture. Non-equity

alliances are purely contractual alliances that do not include an equity position.The variable representing alliance product development stage is an ordinal variable rang-

ing from 1 to 4, and is used to differentiate alliances depending on the development stage of

the primary drug involved in the alliance. The four stages we use in this study are aligned

to development stages frequently used in the industry in the following manner. The first

stage involves R&D, where a specific drug is not yet identified. The second stage, which we

broadly define as the early testing stage, includes: (a) preclinical trials, where the product is

tested in animals or in vitro trials to determine toxicity, (b) investigational new drug appli-

cation (IND) filed, (c) clinical trials, and (d) Phase I testing, where drug safety is analyzed

in human volunteers.

The third stage, which we define as the late testing stage, includes: (a) Phase II testing,where drug efficacy is analyzed in a sample of patients, (b) Phase III testing, which includes

advanced trials to accumulate drug efficacy data, and (c) new drug application (NDA) filed.


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The fourth stage includes: (a) the drug being registered, where the product has received FDA

approval but marketing has not yet begun, and (b) after marketing of the drug has begun.

In most cases, there is more uncertainty during the earlier R&D stages and less uncertainty

in the final stages. This is a more exacting approach than the common view of alliancesas either marketing-related or R&D-related (Dussauge et al., 2000; Kogut, 1991; Park and

Russo, 1996).

4.4. Control variables

Variables were included to control for possible confounding effects in the analyses.

A dichotomous variable separates alliances involving the development, manufacturing or

distribution of a biotechnology product from those that do not. Biotechnology products

are differentiated from other drug categories because knowledge in biotechnology tends

to be more abstract and tacit. Powell et al. (1996) claim that biotechnology represents

competence-destroying innovation because it is based on knowledge that differs signifi-

cantly from the established pharmaceutical industrys knowledge base. Alliances involving

biotechnology products are coded as 1 while all other alliances are coded as 0.

Alliances formed between partners in the same domestic market can be expected to

experience less difficulty than alliances formed across national borders because of cultural

similarity (Lane and Beamish, 1990; Mowery et al., 1996; Yan and Zeng, 1999 ). Thus,

the variable domestic identifies whether or not the company and partner are from the same

country (coded as 1) or not (coded as 0). Alliances with partners from two different European

countries are classified as international, even though they are both within the same region.Firms from societies that value long-term relationships and encourage collective respon-

sibility, such as Japan, are more likely to trust each other and have more stable relation-

ships (Park and Ungson, 1997). Considering these results and the increasing importance of

Japanese firms, especially in terms of their partnerships with US firms (Osborn and Baughn,

1990; Park and Ungson, 1997), this study follows Park and Ungsons (1997) example and

identifies whether or not the partner firm is from Japan (coded 1) or from another coun-

try (coded 0). Park and Ungson (1997) also differentiated alliances involving a European

partner. Thus, we also control for alliances with a European partner using a dichotomous

variable that is coded 1 if the alliance involves a European company and 0 if it does not.

Previous alliance experience between partners is expected to increase the stability of al-liances because previous relations promote reciprocity, increase trust (Gulati, 1995; Kogut,

1989) and increase social capital (Tsai and Ghoshal, 1998), thus acting as a deterrent to

opportunistic behavior. Results presented by Park and Ungson (1997) support these argu-

ments. Prior alliance experience between partners may also promote cooperation with the

expectation that future alliances may be better coordinated while bureaucratic complexity

is minimized (Park and Ungson, 1997). Previous alliance was coded as 1 if the firms had a

previous alliance and 0 if they did not during the 5 years prior to the current alliance.

The scope of an alliance has been found to be associated with both equity (as opposed to

non-equity) alliances (Pisano, 1989) and hierarchical modes of alliance governance (Oxley,

1997). Alliances of broader scope may also be expected to be more complex, have higherlevels of uncertainty, and require more coordination by the partners ( Boris and Jemison,

1989). Alliance scope is measured as the number of products involved in the alliance.


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The control variable size is a measure that represents whether the alliance partners are of

equal or different sizes (Hagedoorn and Sadowski, 1999). Size may be a critical factor in

the stability of alliances as small firms are more likely to cooperate with larger firms ( Shan

and Hamilton, 1991) and smaller firms may be more vulnerable to exploitation by largerpartners (Osborn and Baughn, 1990). Further, the greater the difference in size between the

two firms, the more likely they will have different organizational structures, cultures, and

processes (Scott, 1992).

Lane and Lubatkin (1998) provided evidence that firms of different size should have other

organizational similarities to support the transfer of tacit knowledge. Size is coded as 1 if

the partner is of relatively equal size (has over US$ 1 billion of sales) and is coded as 0 if the

partner firm has less than US$ 1 billion of sales. Although it would be preferable to use a

ratio to capture size difference between alliance members, two problems inhibit this option.

First, both foreign and domestic firms are included. Financial size measures then would not

be consistent as there are differences in accounting standards in many countries. Second, a

number of alliance partners in the sample are private firms and little specific information,

such as number of employees, is available.

A control variable, financial flexibility, was used to account for the focal firms financial

capabilities to make a major change to the alliance. According to Bourgeois (1981), financial

flexibility, or organizational slack, allows a firm to adapt to changes in both internal strategy

and external pressures. Specifically, the focal firm would require a high level of financial

flexibility to either acquire its partner or restructure the alliance. Firms with more financial

flexibility may be more likely to simply terminate a low-performing alliance and focus

their resources on other projects. Lacking financial flexibility, firms may become lockedinto alliances with little ability to change the alliance as internal and/or external conditions

change. The focal firms financial flexibility is measured by the ratio of total debt and

shareholder equity. This variable is also a measure of a firms leverage and its ability to

invest in large, long-term research projects (Aaker and Mascarenhas, 1984; Bierly and

Chakrabarti, 1996b; Cheng and Kesner, 1997). Low levels of financial flexibility have also

been shown to adversely impact R&D intensity and innovation in large multiproduct firms

(Baysinger and Hoskisson, 1989).

5. Results

Some general information describing our sample is provided in Tables 1 and 2. Table 1

provides a summary of alliances terminated, acquired, and amended when initiated at dif-

Table 1

Percentage of alliances terminated, acquired and amended when initiated at different new product development

stages

NPD stage Terminated Acquired Amended No change

(1) R&D 0.19 0.05 0.33 0.43

(2) Early trials 0.30 0.02 0.17 0.51(3) Later trials 0.29 0.00 0.17 0.54

(4) FDA approved 0.05 0.10 0.08 0.77


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Table 2

Percentage of alliances using an equity, non-equity and joint venture structure when initiated at different new

product development stages

NPD stage Equity Joint venture Non-equity

(1) R&D 0.28 0.01 0.71

(2) Early trials 0.21 0.08 0.72

(3) Later trials 0.24 0.02 0.73

(4) FDA approved 0.05 0.08 0.88

ferent new product development stages. Terminations and major amendments tend to occur

more often during R&D, early trials, and late trials. Acquisitions occur more often following

FDA approval. Table 2 shows the percentages of alliances using equity, non-equity, and jointventure structures when initiated at different new product development stages. Non-equity

alliances are clearly the preferred structure accounting for 71 (R&D) to 88 (FDA approved)

percent of total alliances. Equity alliances are used primarily during R&D (28%), early tri-

als (21%), and later trials (24%) while being initiated infrequently following FDA approval

(5%). Joint ventures are the least frequently used alliances structures accounting for only

one percent of R&D alliances, eight percent of alliances during early trials, two percent of

alliances during later trials, and eight percent of alliances following FDA approval.

Descriptive statistics are presented in Table 3 and correlations are presented in Table 4. Lo-

gistic regression models are used to test hypotheses associated with dichotomous dependent

variables. The chi-square statistic is used to test the significance of each logistic regressionmodel. Independent variable logistic coefficient significance is used to test our hypotheses.

Table 3

Descriptive statisticsa

Mean Standard deviation

(1) Change 0.46 N/A

(2) Terminate 0.21 N/A

(3) Acquisition 0.04 N/A

(4) Amend 0.22 N/A(5) Equity 0.22 N/A

(6) Joint venture 0.04 N/A

(7) Biotechnology 0.47 N/A

(8) Domestic 0.56 N/A

(9) Japan partner 0.02 N/A

(10) European partner 0.08 N/A

(11) NPD stage 2.06 1.13

(12) Financial flexibility 50.63 43.93

(13) Partner size 0.10 N/A

(14) Previous alliance 0.16 N/A

(15) Scope 1.40 0.55

Standard deviations for dichotomous variables are meaningless and not displayed.a Means for dichotomous variables, with values of 0 and 1, indicate the proportion of cases with a value of 1

(Pampel, 2000).


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Table 4

Correlation matrixa

Variables

1 2 3 4 5 6 7 8 9

(1) Change 1.00

(2) Terminate 0.55 1.00

(3) Acquisition 0.22 0.05 1.00

(4) Amend 0.57 0.27 0.11 1.00

(5) Equity 0.27 0.14 0.01 0.22 1.00

(6) Joint venture 0.04 0.06 0.06 0.02 0.11 1.00

(7) Biotechnology 0.19 0.05 0.01 0.17 0.28 0.09 1.00

(8) Domestic 0.09 0.09 0.03 0.04 0.13 0.09 0.03 1.00(9) Japan partner 0.15 0.08 0.03 0.08 0.08 0.03 0.10 0.18 1.00

(10) Europe partner 0.11 0.01 0.06 0.09 0.12 0.01 0.09 0.34 0.05

(11) NPD stage 0.20 0.04 0.03 0.23 0.17 0.12 0.39 0.04 0.07

(12) Financial flexibility 0.23 0.21 0.00 0.08 0.04 0.07 0.00 0.01 0.11

(13) Partner size 0.13 0.11 0.13 0.12 0.15 0.12 0.22 0.26 0.38

(14) Previous alliance 0.02 0.07 0.24 0.08 0.10 0.08 0.08 0.14 0.07

(15) Scope 0.17 0.04 0.11 0.12 0.63 0.02 0.16 0.10 0.02

a Correlations between an ordinal variable and either a dichotomous or interval variable are Spearman correlations; correlati

phi correlations; correlations between a dichotomous and interval variable are point-biserial correlations; correlations with two

(Nunnally and Bernstein, 1994).

P < 0.05. P < 0.01. P < 0.001.


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Table 5

Logistic regression results for change in alliance governance

Variables Change Amend Terminate Acquisition

Model 1 Model 2 Model 3a Model 3b Model 4a Model 4b

Partner size 0.196 0.377 0.045 0.14 2.343 2.488

Previous alliance 0.304 0.419 0.364 0.385 2.814 3.496

Scope 0.102 0.378 0.658 0.891 0.829 1.209

Biotechnology 0.366 0.161 0.113 0.042 0.790 0.388

Domestic 0.008 0.391 0.327 0.364 0.179 0.227

Japan partner 6.742 5.632 5.202 5.590 7.585 7.534

Europe partner 0.972 1.198 0.047 0.075 7.110 8.722

Equity 0.933 0.211 1.212 1.363 0.495 1.205

Joint venture 0.795 0.515 0.033 0.180 0.807 2.026

Financial flexibility 0.015 0.005 0.025 0.024 0.000 0.004NPD stage 0.404 0.548 0.011 3.117 0.273 8.813

NPD stage squared 0.679 1.703

Model chi-square 49.891 25.431 25.396 36.510 20.911 29.199

Cox and Snell R2 0.205 0.110 0.110 0.154 0.091 0.125

Nagelkerke R2 0.273 0.165 0.170 0.238 0.314 0.431

Change chi-square 11.114 8.288

P < 0.05. P < 0.01. P < 0.001. P < 0.10.

Additionally, block chi-squares, which represent the change in model chi-squares when a

new variable is added, are used to test our hypotheses that propose a nonlinear relationship

and include the squared term of product development stage. We also display Cox and Snells

R2 and Nagelkerkes R2 for each model (Cox and Snell, 1989; Nagelkerke, 1991). These

pseudo R2 measures should not be compared directly to OLS regressions R2; they are

usually lower in value, especially Cox and Snells R2, which has a maximum less than 1.0.

Table 5 presents the logistic regression analysis results with change in alliance governance

and each of the three components of changeamendment, acquisition and terminationas

the dependent variables. All of the models are significant based on the model chi-squares

and pseudo R2s that range from 0.17 (Model 2) to 0.43 (Model 3b) using Nagelkerkes R2.Hypotheses 1 and 2 proposed that alliances are less stable if they are minority equity

alliances and if they are formed early in the product development process, respectively.

Model 1 of Table 5 is used to test these hypotheses. The logistic coefficient for minority

equity alliances is marginally significant (P < 0.10) and in the proposed direction, par-

tially supporting Hypothesis 1. The logistic coefficient for product development stage is

significant and in the proposed direction, supporting Hypothesis 2.

Hypotheses 1a and 2a proposed that alliances are more likely to be amended if they are

minority equity alliances and if they are formed early in the product development process,

respectively. Model 2 of Table 5 is used to test these hypotheses. The logistic coefficient

for minority equity alliances is not significant; thus Hypothesis 1a is not supported. Thelogistic coefficient for product development stage is significant andin the proposed direction,

supporting Hypothesis 2a.


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Hypotheses 1b proposed that alliances are more likely to be terminated if they are minority

equity alliances. Model 3b ofTable 5 is used to test this hypothesis. The logistic coefficient

for minority equity alliances is significant (P < 0.05) and in the proposed direction; thus

Hypothesis 1b is supported. Hypothesis 2b proposed that alliances are less likely to beterminated if they are initiated in the early and later stages of product development, and more

likely to be terminated if they are initiated in the mid-stages (inverted U-shape relationship).

This hypothesis is supported if there is a significant change in model chi-square after adding

the squared term of product development stage. The change of model chi-square in Model 3b

is significant as compared to Model 3a, supporting Hypothesis 2b. The logistic coefficient for

the square of product development stage in Model 3b is negative and significant, as expected.

Hypotheses 1c proposed that alliances are more likely to become acquisitions if they

are minority equity alliances. Model 4b of Table 5 is used to test this hypothesis. The

logistic coefficient for minority equity alliances is not significant; thus Hypothesis 1c is not

supported. Hypothesis 2c proposed that alliances are more likely to become acquisitions

if they are initiated in the early and later stages of product development, and less likely

to become acquisitions if they are initiated in the mid-stages (U-shape relationship). This

hypothesis is supported if there is a significant change in model chi-square after adding the

squared term of product development stage. The change of model chi-square in Model 4b is

significant as compared to Model 4a, supporting Hypothesis 2c. The logistic coefficient for

the square of product development stage in Model 4b is positive and significant, as expected.

Most of the control variables are not significant in any of the logistic regression models.

The only two control variables significant in a model are previous alliance and financial

flexibility. Previous alliance is a significant predictor of an alliance becoming an acquisition.Financial flexibility is a significant negative predictor of both termination and change. In

other words, firms with high debt (low financial flexibility) are more likely to terminate

alliances.

6. Discussion

The purpose of this study was to determine what circumstances cause strategic alliance

governance to be less stable. This study has illustrated that the instability of strategic al-

liances in the pharmaceutical/biotechnology industry is influenced by both alliance andalliance partner characteristics. More specifically, we found support for increased instabil-

ity in strategic alliances that have an equity governance structure, are formed in the early

stage of product development, and where the focal firms have a greater level of financial

flexibility. These effects are more robust than the effects of other variables that have been

generally thought to influence alliance stability, including the partners size, the partners

previous alliance experience (except as a predictor of an acquisition), the alliances scope,

the type of technology involved in the alliance, and the partners nationality.

6.1. Governance structures

A major contribution of this paper is the disaggregation of equity alliances into joint

ventures and other equity based alliances. Previous alliance literature has equated equity


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alliances with joint ventures (Hagedoorn and Sadowski, 1999). Our results provide evidence

that equity based alliances are a source of instability in alliances, as measured by termination

of the alliance, while a joint venture structure does not impact alliance instability. The

rationale is that, even though joint ventures also require a high degree of commitment, theyare generally not flexible governance structures. They are also better than equity alliances at

transferring and integrating knowledge, and usually foster more trust among partners (Das

and Teng, 1998).

This is interesting given the growing literature concerned with joint venture instability

(Blodgett,1992; Gomes-Casseres, 1987; Harrigan and Newman, 1990; Inkpen and Beamish,

1997; Kogut, 1991; Park and Russo, 1996; Park and Ungson, 1997). This literature docu-

ments a high rate of instability in joint ventures and especially international joint ventures

(Inkpen and Beamish, 1997). Our results conflict with these findings in that we found no evi-

dence that an alliance organized as a joint venture in and of itself causes instability. Research

into the discrepancy between our findings and the literature on joint venture instability is

clearly needed.

While our results provide strong support for equity alliances being more likely to be

terminated (Hypothesis 1b), we did not find significant support for our arguments that

equity alliances are more likely to be amended (Hypothesis 1a) or end in an acquisition

(Hypothesis 1c). One reason why equity alliances are not amended significantly more than

joint ventures and non-equity alliances may be that when equity alliances are not progressing

as expected, firms usually terminate the alliances instead of trying to change them. Equity

alliances are formed more frequently in the early stages of product development. When

it becomes apparent that the development of the drug is not going to be successful thepharmaceutical company chooses to end the relationship instead of starting over with a

different project.

An alternative reason why equity alliances are not amended significantly more than

other types of alliances may be that non-equity alliances, which account for over seventy

percent of the alliances in our sample, are amended more than we hypothesized. This

would be consistent with the practice of developing fewer, more in-depth and long lasting

relational partnerships with suppliers and other alliance partners (Dyer, 1996, 1997). This

practice builds more trust among partners, allows flexibility, and helps communication and

knowledge transfer across firms (Dyer, 1996, 1997). Thus, partners may frequently expand

their working relationship, extending non-equity alliances to cover new research and newprojects.

There are two probable reasons why equity alliances are not more likely than other types

of alliances to become acquisitions. First, our data indicate that a very small percentage

of alliances (4%) become alliances, making it difficult to identify patterns with certainty.

This finding is consistent with Hagedoorn and Sadowskis (1999) finding using a very large

sample across numerous industries, and contradicts Bleeke and Ernsts (1995) warning

that alliances, especially equity alliances, can be precursors to an acquisition. Our results

indicate that the only significant predictors of an acquisition are the existence of a previous

alliance and stage of development, not the type of governance structure.

Second, our rationale for equity alliances being unstable may not apply as directly toacquisitions as terminations or amendments. Acquisitions, unlike terminations and amend-

ments, are only the consequence of a successful alliance, not a result of a failed alliance.


19/24


Alliances that are successful are less likely to be changed than alliances that are not suc-

cessful. Our argument that equity alliances are inferior governance structures may still be

true, and hence a lower proportion of them are successful, creating fewer opportunities for

an acquisition.

6.2. Product development stage

With respect to product development stage, firms in alliances formed in the early stages

of product development are more likely to change the alliances governance structure,

especially through major restructuring. Early stages of product development are inherently

risky and involve more tacit knowledge and uncertainty (Almeida and Kogut, 1997). When

product development advances, firms may choose to change governance structures to either

increase or decrease commitment to the project or to change their level and form of control

over the developing technology. Activities in the later stage of product development usually

involve more explicit knowledge and more specific and formalized control systems can be

used. The likelihood of major amendments to alliances decreases as alliances are formed

later in the product development stage since the control systems of these alliances are

initially more formalized and require less change.

These results are interesting in light of earlier findings. Dussauge et al. (2000), using a

variable that differentiated between marketing and technical alliances found no significant

relationship with alliance outcomes. They did determine that link alliances, where partners

contribute different capabilities, are more likely to be reorganized; and scale alliances, where

partners contribute similar capabilities, are more likely to continue without material change.They claim that the reorganization of an alliance is an indicator of firms learning within the

alliance, with the results indicating that link alliances lead to greater levels of learning, as

compared to scale alliances. Extending this logic to our study, reorganizations occur more

frequently in the early stages of product development, indicating that more learning among

partners occurs in the early stages of product development than the later stages.

However, the likelihood of alliances being terminated or acquired follows different pat-

terns. Alliances formed during the R&D stage, along with alliances formed after the prod-

ucts are approved, are more likely to result in an acquisition than alliances formed in the

mid-stages of product development. Alliances formed during the mid stages of product

development are more likely to be terminated than alliances formed in the early or latestages. Our results expand on the findings ofPark and Russo (1996), who found somewhat

ambiguous results when examining whether or not R&D activities were included in joint

ventures. They determined R&D activities were not significantly related to failure but were

significantly associated with acquisitions.

Our studys findings add value to this area of research by using a product development

stage variable that is better delineated than a simple R&D/marketing variable. Certainly,

governance issues concerning alliances focusing on basic R&D are very different than

those for alliances focusing on R&D activities associated with the later stages of product

development. Our results are consistent with Park and Russos (1996) in that alliances

focused on basic R&D activities are more likely to lead to acquisitions, but we also findthat alliances formed after the primary product of the alliance is developed and approved

are more likely to become acquisitions. Acquisitions are less likely during mid-stages of


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product development. This implies that firms either acquire to internalize a new technology

that has not been fully developed or acquire to get a finished product. They do not acquire

as frequently to obtain products in development.

This study also adds to our understanding of the actions taken by incumbent firms facingradical technological change (Christensen and Bower, 1996; Rothaermel, 2001). Table 2

provides evidence that incumbent firms initiate non-equity alliances with their alliances

partners far more than either joint ventures or equity alliances. Table 2 also shows that

non-equity alliance use increases as a percentage of all alliances used as product develop-

ment advances from R&D to FDA approval. Further, the use of equity alliances remains

fairly consistent throughout product development but decreases dramatically after a drug

is approved for sale. Joint ventures, as a percentage of all alliances, are used fairly consis-

tently in earlier and later product development stages. Our results also provide evidence

regarding the use of different alliance structures for the exploration and exploitation of

new technologies by incumbents (March, 1991; Rothaermel, 2001). Table 2 shows that

incumbent firms clearly prefer equity and non-equity alliances when exploring new tech-

nologies (R&D stage). When exploiting technological certainties (drugs approved for sale

by the FDA), incumbents clearly favor non-equity alliances over either joint ventures or

non-equity alliances.

6.3. Financial flexibility

Additionally, our findings concerning financial flexibility yielded interesting results, even

though they were not the primary focus of the study. The results support the view that firmswith greater financial flexibility, which is a key element of strategic flexibility, are bet-

ter able to redirect resources quickly when either internal or external conditions warrant

(Aaker and Mascarenhas, 1984; Bierly and Chakrabarti, 1996b; Bourgeois, 1981; Cheng

and Kesner, 1997). Increased strategic flexibility allows an alliance partner the option of

changing alliance governance structure to take advantage of shifting inequalities between

alliance partners (Doz, 1996; Hagedoorn and Sadowski, 1999; Hamel, 1991) or to read-

just the alliance after a period of learning and reevaluation (Doz, 1996). We specifically

found that firms with higher financial flexibility are more likely to terminate alliances.

Previous research has implicitly assumed that firms make changes to alliances when cir-

cumstances are appropriate. This result provides evidence that firms are better able to makechanges to alliances when they have the financial flexibility to do so, possibly because

they have a buffer against any downside risk associated with alliance changes ( Singh,

1986).

7. Study limitations, implications, and directions for future research

While our research provides strong support for most of our hypotheses, we acknowledge

that these results may be questioned on the basis of generalizability and the hypotheses

should be tested in other industries. The pharmaceutical industry is unique in that largeamounts of resources are spent on R&D and marketing, patent protection is very robust, and

the drug approval process is formal and lengthy. Additionally, the new product development


21/24


process in the pharmaceutical industry is probably more of a linear process, an assumption

in our study, than in other industries where product development follows more of an iterative

pattern (Wheelwright and Clark, 1992). Furthermore, Cheng et al. (1996) provided empirical

support that the beginning stage of the product development process (Stage 1 in our study)tends to be chaotic, while later development periods (Stages 24 in our study) tend to

be more orderly. Each of the specific characteristics of the pharmaceutical industry could

provide a rationale for using different types of governance structures.

However, ours is a study of how firm and alliance characteristics affect alliance instability.

We believe that the organizational and alliance processes underlying alliance instability

operate widely. Consistent with this belief, other researchers have found evidence that

firm (Blodgett, 1992; Doz, 1996; Hagedoorn and Sadowski, 1999; Park and Russo, 1996;

Park and Ungson, 1997; Saxton, 1997) and alliance characteristics (Dussauge et al., 2000;

Park and Russo, 1996; Saxton, 1997) affect alliance instability. Nevertheless, while our

paper provides several initial insights into alliance governance and instability throughout

the new product development process, further research is needed in other industries to test

our findings in other settings and to test for more complex relationships, particularly in

industries with less formal product development.

The lack of consistently significant results among the control variables suggests that

there are other variables not included in this study that may have a bearing on alliance

instability. Factors such as the technical background of top managers within each firm,

previous experience with alliances in general (not only with a specific partner), and the

compatibility of firm cultures need to be examined. Additionally, multi-industry studies

could test environmental effects, such as competitive intensity, technological dynamism,and demographic dynamism, on the stability of alliances.

Acknowledgements

The authors would like to thank David Deeds, Scott Gallagher, Brian Miller, and Dean

Shepherd for their helpful comments. This work was supported, in part, by a Grant-in-Aid-

of-Creativity Award from Monmouth University and a Research Grant from the College of

Business, James Madison University.

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Documents

Equity Alliance, Stages of Products