Pharmaceutical Companies

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Appendix C: Analysis of importance strategic linkages

Pharmaceutical Companies

Chapter overview

The importance of strategic linkages for pharmaceutical companies will be assessed because the importance of strategic linkages is a substantial subject in this research. Strategic linkages will be shortly defined in the beginning of the chapter.

Value chain analysis will also be outlined in this chapter in order to distinguish primary and secondary activities. The value chain of pharmaceutical companies will be analysed in this chapter and the most important areas will be identified. The developments in these key areas of the value chain of pharmaceutical companies during the past ten years will be determined.

The developments in the key areas will provide a good indication of the drivers of the importance of strategic linkages for pharmaceutical companies.

Strategic Linkages

Literature provides ample arguments to stress complementarities between in-house R&D and external know-how, at least when in-house R&D groups are optimally tuned to absorb external know-how effectively¹.

Furthermore there is growing evidence, over the past decade, that firms no longer rely exclusively on their internal R&D activities to maintain their technological competitiveness². Strategic linkages activities are for example Mergers and Acquisitions, Licenses and Outsourcing. Strategic R&D linkages means that companies are drawing on external participants for R&D activities. During the past few decades, the amount of available technology has increased massively, mainly as a result of the considerable activities in science and technology at universities, companies and public laboratories. These sources have also become much more accessible to companies as a result of the inexpensive means of transportation and communication³.

Strategic linkages for pharmaceutical companies

PCV has the opinion that strategic linkages are important for pharmaceutical companies. The number of alliances and the outsourcing of R&D activities has been analysed for pharmaceutical companies, as this will provide an indication to which extent strategic linkages have become more important for pharmaceutical companies during the past years.

The number of alliances by development stage, that involves the top 20 pharmaceutical companies over the period 1988-1998, is stated in the following graph⁴:

Period Discovery, Lead Pre-clinical, Phase 1, Phase 2 Phase 3, NDA filed, approved

1988-1990 62 18 5

1991-1993 100 35 18

1994-1996 151 55 30

1997-1998 162 38 26

Table 0-1 Number of alliances

1 Veugelers, Internal R&D expenditures and external technology sourcing, Research Policy 26, 1997, page 314

2 Narula, Choosing between internal and strategic linkages activities, Technology Analysis & Strategic Management, vol 13, 2001 page 365

3 G. Haour, Resolving the innovation paradox, 2004, page 53

4 Cavalla, The extended pharmaceutical enterprise, Drug Discovery Today, Volume 8, Issue 6, March 15^th 2003, page 269

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The number of alliances in the pharmaceutical industry has significantly increased as well during the past 15 years. Alliances are most frequent in the discovery and lead phase.

Outsourcing in the pharmaceutical industry has traditionally implied converting the fixed costs of maintaining the necessary personnel, infrastructure and expertise to execute a development operation, into the variable costs of paying of subcontractor the process when it is required⁵.

Different elements of the R&D process are outsourced to greater and lesser extent.

Outsourcing seems to be more important in Development than in Research as outsourcing can add the most value in Development. Development is the process after the discovery of a new chemical entity that may be effective. Business models of the majority of the Contract Research Organisations are aimed at the Development activities⁶.

The value of R&D outsourcing activities in the pharmaceutical industry has grown from USD5,4 billion in 1997 to USD9,3 billion in 2001, representing an average annual growth rate of 14,6%. This is illustrated in the following graph⁷:

1997 1998 1999 2000 2001

Global in-house R&D 34,6 37,5 39,5 43,4 46,7

Outsourced R&D 5,4 6,1 7 8,2 9,3

Total R&D expenditure 40 43,6 46,5 51,6 56

% R&D Outsourced 13,5% 14,0% 15,1% 15,9% 16,6%

Average growth rate 1997-2001

Global in-house R&D 7,8%

Outsourced R&D 14,6%

Total R&D expenditure 8,8%

Table 0-2 Pharmaceutical R&D outsourcing market In spite of the significant lower investing activity of the venture capitalists’ industry in 2001 and 2002, investments in life sciences start-ups, although also reduced, remained relatively strong⁸.

The increased number of alliances and the substantial increase in the value of the R&D outsourcing activities indicates that importance of strategic linkages for pharmaceutical companies has increased significantly during recent years.

Developments in the key areas of the value chain of pharmaceutical companies will provide a good indication of the drivers of the importance of strategic linkages for pharmaceutical companies.

Value chain analysis

Value chain analysis concerns the input and output of economic resources into a chain of value-adding business processes or activities. The result of these business processes is value delivered to customers, and the margin (or value) is the difference between what customers are willing to pay and the cost of producing the product or service.

5 Reuter Business Insight, Pharmaceutical R&D Outsourcing Strategies, September 2002, Page 35

8 G. Haour, Resolving the Innovation paradox, 2004, page 100

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Figure 0-1 Value chain framework Porter argued that an understanding of strategic capability must start with an identification of these separate value activities⁹. By modelling the activities of an organisation it is possible to distinguish primary and support activities. Primary activities contribute in getting the product or service closer to the customer and support activities support the primary activities.

Primary activities

Inbound Logistics are the activities concerned with receiving, storing and distributing the inputs to the product/service. This includes materials handling, stock control, transport, etc.

Operations transform these various inputs into the final product or service: machining, packaging, assembly, testing etc.

Outbound logistics collect, store and distribute the product to customers.

Marketing and sales (M&S) provide the means whereby consumers/users are made aware of the product/ service and are able to purchase it.

Service is all those activities that enhance or maintain the value of a product/service, such as installation, repair, training and spares.

Support activities

The group of primary activities are linked to support activities. These can be divided into four areas.

Procurement refers to the processes for acquiring the various resource inputs to the primary activities (not to the resources themselves). Procurement occurs in many parts of the organisation.

Technology development: All value activities have a “technology”, even if it is simply know- how. Research and Development (R&D) product design and process development are examples of technology development.

9 Exploring Corporate strategy, Johnson and Scholes, 1997, page 146 Inbound

Logistics

Operations Outbound Logistics

Marketing and Sales

Service

Margin Procurement

Technology development Human resource management

Firm infrastructure The Value Chain

Support activities

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Human resource management (HRM) is a particularly important area, which transcends all primary activities. It involves recruiting, managing, training, developing and rewarding activities for people within the organisation.

Infrastructure: The systems of planning, finance, quality control, information management etc. are crucially important to an organisation’s performance in its primary activities.

Infrastructure also consists of the structures and routines of the organisation that sustain its culture.

One of the key features of most industries is that a single organisation very rarely undertakes all of the value activities from the product design through to the delivery of the final product or service to the final consumer¹⁰. Key areas can be identified that are most important for an organisation.

Value chain of Pharmaceutical companies will now be discussed and the characteristics of the most important areas of the value chain will be described.

Value chain of Pharmaceutical Companies

The primary activities and support activities in the value chain of pharmaceutical companies will now be discussed and the key areas in the value chain will be determined.

Key areas in the value chain are those areas in which the critical success factors of pharmaceutical companies are situated. These key areas will be determined looking at the percentage of turnover that is spend in these areas.

Inbound logistics is not a key area as receiving, storing and distribution of inputs is not an area in which the key success factors of the companies are situated.

Operations is not a key area, as the production of drugs is mostly a standardised simple process. The cost of goods sold is only a small percentage of the net sales in the pharmaceutical industry.

Outbound logistics is not a key area as the customers of the companies are wholesalers.

Marketing and sales is a key area for pharmaceutical companies. It is important to earn as much as possible from the few treatments that are introduced each year in this competitive industry. It is also important that patients are made aware of the existence of a treatment so that they will request a treatment to the attending physician. The number of patients that requests a treatment is increasing¹¹.

Importance of M&S is illustrated by below graph in which the spending on Sales and General Administration activities is measured as a proportion of turnover for the top 10 Pharmaceutical companies using figures from Bloomberg.

10 Exploring Corporate strategy, Johnson and Scholes, 1997, page 148

11 Division of drug marketing, advertising and communication, FDA, September 22^nd 2003

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The actual M&S spending cannot be determined as these figures are not available for the different companies. I assume that the Sales and General Administration expenses provide a good indication for the M&S expenses in the pharmaceutical industry¹².

2002 2001

Pharmaceutical Company S&GA Turnover % S&GA Turnover % Currency

Pfizer Inc. 16.022 32.373 49% 14.493 29.024 50% USD

Glaxo SmithKline 10.275 21.212 48% 10.006 20.489 49% BP

Johnson & Johnson 16.173 36.298 45% 14.851 32.317 46% USD

AstraZeneca 9.208 17.841 52% 8.236 16.222 51% BP

Novartis 16.907 32.412 52% 16.480 31.643 52% SF

Merck & Co 8.864 51.790 17% 8.680 47.715 18% USD

Roche 17.792 29.725 60% 17.195 29.163 59% SF

Bristol-Myers Squibb 7.436 18.119 41% 7.376 17.987 41% USD

Eli Lilly 5.573 11.077 50% 5.652 11.542 49% USD

American Home Products 7.090 14.584 49% 6.904 13.983 49% USD

Table 0-3 S&GA spent of top 10 pharmaceutical companies compared to revenues Most companies spend around 50% of turnover on Sales and General Administration activities.

Service is not a key area for pharmaceutical companies.

Procurement is not a key area for pharmaceutical companies.

Technology development and especially R&D product design is a key area for pharmaceutical companies. The development of powerful new drugs led to an explosion in demand since World War II, which made Research and Innovation crucial¹³.

Pharmaceutical companies are fundamentally R&D driven. Drug development costs are extremely high (around USD 800 million per treatment to reach the market) and probability of success is still low. The importance of the R&D activities is also illustrated by the analysis of the R&D spending of the ten biggest pharmaceutical companies compared to their turnover using figures from Bloomberg.

2002 2001

Pharmaceutical Company R&D spend Turnover % R&D spend Turnover % Currency

Pfizer Inc. 5.176 32.373 16% 4.847 29.024 17% USD

Glaxo SmithKline 2.900 21.212 14% 2.651 20.489 13% BP

Johnson & Johnson 3.957 36.298 11% 3.591 32.317 11% USD

AstraZeneca 3.069 17.841 17% 2.773 16.222 17% BP

Novartis 4.339 32.412 13% 4.189 31.643 13% SF

Merck & Co 2.677 51.790 5% 2.456 47.715 5% USD

Roche 4.257 29.725 14% 3.893 29.163 13% SF

Bristol-Myers Squibb 2.218 18.119 12% 2.183 17.987 12% USD

Eli Lilly 2.149 11.077 19% 2.235 11.542 19% USD

American Home Products 2.080 14.584 14% 1.869 13.983 13% USD

Table 0-4 R&D figures for top 10 Pharmaceutical companies Most of these companies spent more than 10% of their annual sales on their R&D activities.

The R&D costs in the pharmaceutical industry seem to be budgeted, as the percentage of the turnover that is spent in R&D is quite constant in the last two full years for the different companies.

12 Reuters Business Insight, Pharmaceutical Market Outlook to 2010, January 2003, page 114

13 A.H. van Reekum, Intellectual property and Pharmaceutical Innovation, 1999, page 10

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Human resource management is a not a key area but it has a significant influence on the efficacy of the M&S and R&D areas.

Infrastructure is not a key area but it needs to be able to support the key areas of the pharmaceutical companies.

Developments in the value chain

The value chain of pharmaceutical companies has significantly changed during the past ten years. The developments in the key areas of the value chain of pharmaceutical companies are evaluated as will provide a good indication of the drivers of the importance of strategic linkages for pharmaceutical companies.

Marketing and Sales

M&S costs have increased substantially in the past ten years as a result of several developments. These developments will be discussed consecutive.

There have been a lot of changes in the pricing of treatments. The price point that pharmaceutical companies want to achieve for new products might not be realised due to problems with reimbursement agencies or a change in healthcare policy. Reimbursement agencies have a lot of power as they determine which treatments are reimbursed. It is of course difficult to realize sales expectations when a treatment is not reimbursed.

Pricing controls in European markets are being used to control drug spending. An increasing number of regulatory authorities require pharma-economic evaluation to be included when a new treatment is submitted. Pharmaceutical companies need to prove cost/benefit advantages over the competition in this evaluation. Measurements of safety and efficacy need to be included as well.

The highest prices of treatments can be demanded in the US and total US drug spending accounts for 50% of the global pharmaceutical spending as a result. It is uncertain whether the US wants to continue this position.

The profits of pharmaceutical companies and the prices of their treatments are also under increasing pressure in the press and the public. The discussion of the prices of AIDS treatments in Africa has become a public issue and the pharmaceutical companies are under heavy pressure to adapt the prices of treatments.

The market exclusivity period for new treatments has also significantly changed in the past ten years. The patent protection period for new treatments is 20 years in Europe and the US.

This period runs from the date of the Initial New Drug Application (IND) and thus includes most of the development time of the new treatment before it is approved by for example the FDA. The market exclusivity period for new treatments is therefore short when you take the development time of new treatments into account. The total development time of new treatments is currently around 14 years.

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Competitors enter the market soon after a new drug entry, which has a substantial effect on the pricing of a treatment. The following graph gives a clear indication that the market exclusivity for new treatments is significantly decreased in the past years¹⁴.

Product Launch year Years of market exclusivity (US)

Inderal 1965 13

Tagamet 1977 6

Capoten 1980 5

Mevacor 1987 4

Prozac 1988 3

Losec 1989 4

Zocor 1989 2

Cozaar 1995 1

Evista 1998 1

Celebrex 1999 0,5

Table 0-5 Market exclusivity period for selected treatments Several drivers of this development can be identified. The producers of generic treatments are substantially more successful in challenging patents due to changing legislation in favor of generic treatment manufacturers. This enables producers of generic treatments to enter the market with generic treatments sooner. Competing pharmaceutical companies are also more successful in entering the market with treatments that have a similar mechanism.

Research and Development

R&D costs have significantly increased in the past ten years as a result of several developments. These developments are now discussed consecutive.

The total development time has increased in the past ten years. A major cost driver in the R&D process is the total development time required to bring a treatment to the market. Each month that a treatment is not on the market adds additional costs in terms of lost revenues, increased cost of capital, extra R&D time and shorter exclusivity period.

The total development time is influenced by requirements for new drug approval. The development time is currently approximately 14 years and consists of three phases. The preclinical phase takes approximately 6,1 years, the clinical phase 6,3 years and the approval phase 1,8 years. Total drug development costs are around USD 800 million per treatment to reach the market¹⁵.

Productivity of the R&D activities is a significant issue for pharmaceutical companies. M&A transactions have increased significantly as a consequence. These transactions aim at creating instant pipeline growth with the acquisition of Pharmacia by Pfizer with a total value of USD60 billion as an example. These M&A transactions compound the problems the companies seek to address by creating huge, geographically dispersed R&D organisations.

During the past 10 years there has been an explosion of investment in new technologies, services and data management systems. This investment is based on the belief that these new technologies, services and data management systems would improve throughput, improve knowledge transfer and thereby result in more new drugs coming to market. The expected increase in new drug approvals has however not been observed¹⁶.

14 Source: Pharmaceutical research and manufacturers of America

15 Reuters Business Insight, Pharmaceutical Market Outlook to 2010, January 2003, page 42

16 Cambridge Consultants, Interface, Issue 35

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There have been important changes in the pharmaceutical legislation in the past ten years.

Legislation has toughened and this has several effects on the pharmaceutical industry:

• The number of late stage treatment terminations is increasing as companies are comparing results of tests with the increasing stringent requirements for drug approval.

• Problems with treatments are sooner identified and thus withdrawn from the market sooner.

• Companies more often choose to delay request for approval of new treatments.

• The number of non-approvable decisions and requests for additional information is increasing as well. The request for additional information by the FDA for AKZO Nobel’s new treatment Ariza is an example of this¹⁷. The share price of AKZO Nobel decreased with 5% of value when the news was announced.

Generics legislation has changed in favor of the generic producers, which influences the margins that pharmaceutical companies are able to realize. An example of this is the collapse of the sales of AKZO Nobel’s Remeron with 40% as soon as generics came on the market after patents, that protected Remeron, expired in the US.

The substantial increase in R&D costs per new treatment is illustrated in the following graph¹⁸:

R&D costs per new treatment

84

214

335

54

467

138

318

802

104

0 100 200 300 400 500 600 700 800 900

Hansen (1979) DiMasi et al. (1991) Current

Costs (million $)

Preclinical Clinical Total

Table 0-6 R&D costs Research techniques that are used and needed for the development of new treatments also changed substantially during the past ten years. First research technique that was used can be described as inspired by nature. The bark of a tree could help against certain illness. This research technique was followed by the chemical modification technique in which the chemical characteristics of a certain entity were altered. Computational chemistry was introduced but this technique was rapidly abandoned for high frequency screening. A vast array of possible effective compounds is analysed in the hope of finding an effective compound. This technique does not meet the expectations of the big pharmaceutical companies.

New research techniques are more and more designed at developing molecular medicine for which genomic and proteonical information is needed. Specific capabilities are required for this research technique that are currently not available in the mix of research capabilities of the big pharmaceutical companies¹⁹.

17 NRC Handelsblad, 11 April 2002

18 The price of innovation, DiMasi et al., Journal of Health Economics 22 (2003)

19 Philips Research, Prof. Dr. H. Hofstraat

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Drivers of strategic linkages

R&D and M&S are the key areas in the value chain of pharmaceutical companies as is discussed in this chapter and there have been significant developments in these areas during the past ten years.

The market exclusivity period of new treatments has substantially decreased as a result of longer total new treatment development time and changes in the legislation. M&S costs have clearly increased as a result. R&D costs have significantly increased in the same period due to the longer total new treatment development time, changes in legislation and stagnated productivity. Companies focus their resources and thus their R&D capabilities on a selected number of therapeutic areas as a result of the high R&D costs.

New research techniques require capabilities that the pharmaceutical companies do not have.

As a result pharmaceutical companies increasingly focus on cooperation with other companies that have these capabilities.

My assumption is that importance of strategic linkages has increased as a result of these developments in the key areas of the value chain of pharmaceutical companies.

Other industries might be identified in which the same dynamics are valid. PCV has the opinion that strategic linkages have become more important in the CE industry as well. Value chain of CE companies will be analysed in the next chapter in order to determine similarities and differences in the developments of the key areas in this value chain.

Conclusion

The increased number of alliances and the substantial increase in the value of the R&D outsourcing activities indicates that importance of strategic linkages for pharmaceutical companies has increased significantly during recent years.

The developments in the key areas of the value chain of pharmaceutical companies will provide a good indication of the drivers of the importance of strategic linkages for pharmaceutical companies.

Value analysis concerns the input and output of economic resources into a chain of value- adding business processes or activities. Primary and support activities can be distinguished in the value chain. Key areas are the areas in which the key success factors are situated.

Key areas in the value chain of pharmaceutical companies are M&S and R&D. The M&S area is key because it is important to earn as much as possible from the few treatments that are introduced each year in this competitive industry. Increasing the number of patients that requests a certain treatment at the attending physician is also important. R&D is key as this industry is fundamentally R&D driven. The investments in R&D are high and account for more than 10% of total turnover.

The market exclusivity period of new treatments has substantially decreased during the past ten years and R&D costs have significantly increased in the same period. Pharmaceutical companies also increasingly focus on cooperation with other companies that have these capabilities.

My assumption is that importance of strategic linkages has increased as a result of these developments in the key areas of the value chain of pharmaceutical companies. The value chain of CE companies will be analysed in the next chapter in order to identify similarities and differences in the developments of the key areas in this value chain.

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CE Companies

Chapter overview

The value chain of CE companies will be evaluated and the key areas will be identified in this chapter. The developments in the key areas in this value chain during the past ten years will be determined to be able to compare these developments with the developments in the key areas for pharmaceutical companies that have been discussed in the previous chapter.

Differences and similarities between the developments in these industries will be evaluated.

The differences and similarities between the developments in the key areas of the value chain of pharmaceutical and CE companies will be analysed. This analysis can be used to assess the change in importance of the role of strategic linkages for CE companies.

Value chain of CE companies

Primary activities and support activities in the value chain of CE companies will be determined and the key areas will be described.

The definition of a CE company as it is used in this document is: companies that actively manufacture and market Display, Entertainment and Connectivity products. Display products can be characterized as products that are used to visualize content and Entertainment products are products that are used to entertain consumers. Connectivity products can be described as products that are used to share content and connect consumers.

Inbound logistics is not a key area as receiving, storing and distribution of inputs is not an area in which the core competences of the industry are situated.

Operations is still a key area for CE companies but not for all product categories. New innovative products that are being manufactured increasingly need dedicated manufacturing facilities, as for example is the case with LCD displays. LG.Philips LCD is the LCD manufacturing joint venture between Philips and LG. This joint venture recently announced a USD21 billion investment in manufacturing capacity over the next ten years. This indicates the importance of manufacturing capabilities.

Manufacturing of low-end CE products is however increasingly outsourced to third parties.

Dedicated manufacturing companies are able to manufacture products of the same quality at lower costs.

Outbound logistics is not a key area as this is not an area in which the key success factors of CE companies are situated. Retail presence is part of M&S.

M&S is a key area for CE companies because it is important to earn as much as possible from new products before competition intensifies. Other reasons for the importance of this area are²⁰:

• Strong brand name allows easier penetration of new markets/segments, premium pricing, stronger customer loyalty and greater control over channel partners.

• Cooperation with Research and Development in order to identify and successfully enter new markets/segments.

20 Andrea Ragnetti, Chief Marketing Officer, Philips Electronics N.V.

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This importance of M&S is illustrated by below graph in which the spending on Sales and General Administration (S&GA) activities is measured as a proportion of revenues for the leading CE companies using figures from Bloomberg.

The actual M&S spending cannot be determined as these figures are not available for the different companies. I assume that the Sales and General Administration expenses provide a good indication for the M&S expenses in the CE industry.

2002 2001

Company S&GA Turnover % S&GA Turnover % Currency

Philips 9.476 31.820 30% 10.349 32.339 32% EUR

Samsung 36952 59.658 62% 32.657 46.433 70% KRW

LG 1390 4.921 28% 340 1730 20% KRW

Sony 379 2.644 14% 384 3.007 13% JPY

Matsushita 229 859 27% 245 917 27% JPY

Sharp 190 1.372 14% 208 1.602 13% JPY

JVC 128 501 26% 132 567 23% JPY

Table 0-7 S&GA spend of leading CE companies The percentage that companies spent on the S&GA activities varies between the different companies. Philips spends 32% of turnover on the S&GA activities.

Service is not a key area for CE companies.

Procurement is not a key area for CE companies. There are a lot of suppliers that supply to different CE companies. Competitive advantages are not situated in this area. Scale benefits can however be realised in this area.

Technology development is a key area for CE companies. Companies are continuous looking for new products that can improve baseline profits and top line growth.

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CE companies spend a considerable percentage of total turnover on R&D as is illustrated in the following graph.

2002 2001

Company R&D spend Turnover % R&D spend Turnover % Currency

Philips 3.043 31.820 10% 3.312 32.339 10% Eur

Samsung N.A. 59.568 - 2.485 46.443 5% KRW

LG N.A. 4.921 - N.A. 1.730 - KRW

Sony 341 2.526 13% 351 2.644 13% JPY

Matsushita 260 4.237 6% 249 3.900 6% JPY

Sharp 129 1.552 8% 123 1.372 9% JPY

JVC 40 522 8% 39 501 8% JPY

Table 0-8 R&D spend of leading CE companies The percentage of R&D that is invested in the CE industry does not become completely clear in this graph as for example Philips’ R&D spend is the total amount of R&D for all five product divisions. The R&D spent seems to be budgeted in the CE industry as well as a percentage of the turnover.

More specific figures of R&D spending are available for the CE activities of Samsung, Sony and Philips. These figures are illustrated in the following graph²¹.

EUR billion 1999 2000 2001 2002 2003 Samsung Electronics 1,3 1,6 1,7 2,3 2,5

%of sales 6,9% 6,8% 7,7% 7,1% 7,5%

Sony Electronics NA NA NA 3,0 3,0

%of sales NA NA NA 8,0% 8,4%

Table 0-9 R&D spend of leading CE companies The percentage of R&D that is invested does not become completely clear in this graph as for example Philips’ R&D spend is the total amount of R&D for all five product divisions. The R&D spent seems to be budgeted in the CE industry as well as a percentage of the turnover.

HRM is a not a key area but it has a significant influence on the efficacy of the M&S and R&D areas.

Infrastructure is not a key area but it needs to be able to support the key areas in the industry.

21 PCE Competitor Analysis

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Developments in the value chain

The value chain of CE companies has changed substantially during the past ten years. The developments in the key areas of this value chain are identified and compared with the determined developments in the key areas of the value chain of pharmaceutical companies.

Marketing and Sales

M&S costs have significantly increased during the past ten years as a result of several developments. These developments will now be discussed.

The CE market is extremely competitive and has become more competitive in the past ten years. The number of competitors in the CE industry is still increasing as is illustrated by the following graph²².

Figure 0-2 Number of competitors in CE worldwide 1999-2004 The existence of a lot of Original Design Manufacturers (OEM’s) in Asia make it possible for anyone with enough money and a marketing and distribution strategy to get in almost any segment of consumer electronics. OEM’s are companies are dedicated manufacturing companies that manufacture products on demand for several customers.

Personal Computer companies are entering the CE industry with new business models. Dell has for example entered the CE industry with their direct-to-consumer strategy.

New competitors are able to become important competitors soon after entry. Apex Digital is a striking illustration of this development. Apex Digital started in 2000 to sell products made in China that combined state-of-the-art specifications with low prices and is currently a market leader in the US DVD market. Apex has however not been able to turn a profit despite annual revenues of USD1 billion.

The market exclusivity period for new CE products has significantly decreased in the past 10 years. The digital revolution is a major contributor in this development because it has significantly reduced access barriers.

This short market exclusivity period should be reflected in high price erosion and equal distribution of shelf share within a few years after market introduction. Prices should decline fast when competition becomes fierce soon after the market introduction of a new product.

22 Philips Amalgation based on annual reports, industry studies and press releases 1998-2003

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The shelf share of the different brands should become equal within a few years after market introduction as brands enter the market soon after market introduction. Shelf share is monitored as the average number of products that each manufacturer has in the stores in the different product categories.

This hypothesis has been tested for the DVD, LCD TV and Plasma TV, which are relative new CE products.

The price erosion for DVD players compared to the number of units sold is evaluated in the following graph:

Developments DVD player

791

545

394

301

201

128 106

0 5000 10000 15000 20000 25000 30000

1997 1998 1999 2000 2001 2002 2003 2004

Units sold (000)

0 100 200 300 400 500 600 700 800 900

Units (000) Price (EUR)

Figure 0-3 Price development DVD players compared to units sold The price erosion for 20-21 Inch LCD televisions compared to the number of units sold is evaluated in the following graph:

Development 20-21 Inch LCD TV 6.197

3.640

1.271 1.209 962 0

50 100 150 200 250 300 350

1997 1998 1999 2000 2001 2002 2003 2004

Ye ar

Units (000)

0 1.000 2.000 3.000 4.000 5.000 6.000 7.000

Figure 0-4 Price development LCD TV compared to units sold The price erosion for 40-49 Inch Plasma televisions compared to the number of units sold is evaluated in the following graph:

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Developments 40-49 Inch Plasma TV

12.233

10.481

7.009

5.324

4.305 10.800

0 50 100 150 200 250 300 350 400

1997 1998 1999 2000 2001 2002 2003 2004

Units sold (000)

0 2.000 4.000 6.000 8.000 10.000 12.000 14.000

Figure 0-5 Price development Plasma TV compared to units sold There are different screen seizes for both LCD televisions and Plasma televisions. The chosen evaluated seizes have a large market share in these product categories.

The graphs confirm that price erosion is high for new CE products. Total market seize for these new products is increasing significantly but prices are decreasing at the same time. The net value of the markets (units sold times price per unit) is stabilizing within a few years after entry.

Distribution of shelf share for the different brands in the years after market introduction is evaluated for LCD television and Plasma television as a percentage of the average number of models in each shop.

The shelf share distribution for LCD Television is evaluated in the following graph:

Shelf share Europe % 2001 2002 2003

SHARP 74,4 40,2 23

SAMSUNG 3,1 20,9 22

PHILIPS 9,7 16,7

SONY 12,3

LG 13,3 14,6 6,3

PANASONIC 2,5 8,8 3,2

LOEWE 5,2 1,7 0,7

OTHERS 1,5 4,1 15,8

Table 0-10 Shelf share distribution LCD Brands Europe The shelf share distribution for Plasma Television is evaluated in the following graph:

Shelf share Europe % 2001 2002 2003

PHILIPS 35,8 23,1 20,4

SONY 3,9 13 15,9

PANASONIC 6,8 6,9 9,1

SAMSUNG 3,1 9

THOMSON 16,7 9,9 7,8

PIONEER 6,6 9,8 7,8

HITACHI 3,3 6,7 7,7

LG 0,2 9,4 6,5

OTHERS 26,7 18,1 15,8

Table 0-11 Shelf share distribution Plasma Brands Europe Shelf shares of the different brands change substantially within the first years after market introduction. Brands are able to gain a substantial shelf share percentage soon after entry and shelf shares are distributed more equally within two years.

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Research and Development expenses

The total development expenses have been analysed for a number of PCE products to provide an indication of the total amount of these costs. The following graph in which new products the used analysis:

New Philips CE product expenses

0 20 40 60 80 100 120 140 160

1 2 3 4 5 6

Time

Value

R&D CF

M&S CF

M&S and R&D CF Combined Gross Margin

Figure 18: New Products expenses analysis

R&D and M&S expenses are compounded and compared with the gross margin. The total bring to market costs of new CE products consist of the difference between the compounded R&D and M&S expenses until the gross margin is higher than these combined expenses. This would be somewhere in period 5 in the following graph. The development expenses of four CE products are illustrated in the following graph:

The graph indicates that development expenses of new CE products are high. PCE has recently announced that the R&D resources will be reallocated towards the emerging and growth phases instead of the mature phase. This development is illustrated in the following graph in which the allocation of R&D resources over the different phases is stated²³:

CE R&D allocation

17

220 178

415

81

223

62

366

0 100 200 300 400 500

Emerging Grow th Mature Total Phas e

Costs

2002 2004

Table 0-12 R&D resources allocation

23 Philips Consumer Electronics Analysts presentations

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The number of CE product categories has however clearly increased since the 1970s and this development has continued during the past ten years. As a result it is not feasible anymore that PCE is active in all the different CE product categories but has to focus on selected product categories. PCE is currently restructuring the division and will focus only on a number of selected product categories going forward. R&D capabilities will also be focused on the selected product categories.

The increase in CE product categories is illustrated in the following graph:

Pre 1970s 1970s 1980s 1990s

Transistor radio Stereo Audio PC DVD

Grammophone Casette HDD Digital Camera

Telephone Walkman Monitor Video Camera

Black & White TV VCR Printer Laptop

Walkie Talkie Colour TV Mobile phone Digital TV

Tape Recorder CB Radio Pager Minidisc

Calculator CD Discman

Digital Watch Laser Disc Gameboy

VCD Tamagochi

Portable TV PDA

Game Console Smartphone

Fax Home Theater

Flat screen TV

DAB

GPS

PVR

Webcam

Memory stick

Scanner

Table 0-13 CE product categories

Strategic linkages

The market exclusivity period of new CE products has decreased significantly during the past ten years. The short market exclusivity is illustrated by high price erosion and fast equal shelf share distribution for new CE products. Digitalisation of CE products has significantly decreased the entry barriers of the industry.

There are no indications that R&D costs have substantially changed during the past ten years but the number of product categories has clearly increased in this period. CE focuses its resources on a number of selected product categories. R&D capabilities will also be limited to these product categories as a result.

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The dynamics in the value chain of CE companies are comparable with the developments in the value chain of pharmaceutical companies as the importance of market exclusivity has significantly decreased during the past ten years and because control of R&D costs is important.

There are thus indications that the importance of strategic linkages has also increased substantially during the past ten years.

Corporate Venture Capital is a strategic linkage activity as is previously mentioned.

Importance of Corporate Venture Capital has thus also increased during the past ten years.

Conclusion

The key areas in the value chain of CE companies are M&S and R&D. M&S is a key area because it is important to earn as much as possible from new products that arrive in this competitive industry before competition intensifies for the products. Other reasons are the benefits of a strong brand name and the cooperation with R&D. CE companies are R&D driven because companies are continuous looking for new products that can improve baseline profits.

M&S costs have significantly increased as a result of a substantial shorter market exclusivity period in the value chain of CE companies. The number of CE competitors has increased and is still increasing due to the digitalisation of the CE industry. The shorter market exclusivity period is illustrated by high price erosion and equal shelf share distribution for new CE products within a few years after market introduction.

CE focuses its resources on a number of selected product categories. R&D capabilities will also be limited to these product categories as a result.

Dynamics in the value chain of CE companies are comparable with the developments in the value chain of pharmaceutical companies as the importance of market exclusivity has significantly decreased during the past ten years and because control of R&D costs is important. There are thus indications that the importance of strategic linkages has also increased substantially during the past ten years.

Corporate Venture Capital is a strategic linkage activity as is previously mentioned.

Importance of Corporate Venture Capital has thus also increased during the past ten years.

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Appendix B: Test

Monitoring CVC investments

Company Name:

Objective of the test: to be able to identify best-in-class concepts in Corporate Venture Capital to monitor the strategic objectives of each minority investment.

We define ‘monitoring’ as a set of items that are used to track and review the progress in realising the strategic objectives of corporate venture investments.

The test is designed for electronic completion.

This test consists of five questions and will take approximately 5-10 minutes to complete.

Results of this test will be used as input during the EVCA Corporate Strategic Investor (CSI) Workshop in Barcelona, hence the respondents to this test will only be participants of the Workshop.

__________________________________________________________________________________

Please score each item on a scale of 1 to 7 where 1= not important, 4= neither important nor unimportant, through to 7= very important:

1. What role do strategic objectives play in the evaluation of Corporate Venture Capital investment proposals in your organisation?

Not important very important

1 2 3 4 5 6 7

2. What is the value of monitoring the strategic objectives of Corporate Venture Capital investments?

Low value High value

1 2 3 4 5 6 7

Measuring pace (timing) of realisation of strategic objectives:

Quantifying of realisation of strategic objectives:

Identifying lessons learned:

Show value of corporate venturing to Stakeholders in the company:

Other, please elaborate…

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3. Monitoring strategic objectives of Corporate Venture Capital investments consists of a number of different items. Please indicate which of the following items apply to your method of monitoring strategic objectives.

Formalized planning of monitoring sessions

Classifying the strategic objectives in different categories (growth, market share, cost, etc) Dividing the strategic objectives into smaller operational objectives

Using well defined milestones to track the progress in realising the strategic objectives Clearly identify entity (group or person) accountable for realisation of strategic objectives Involvement of all functional groups that can influence the realisation of strategic objectives No monitoring of strategic objectives at all (only financial objectives)

4. Please indicate how you perceive the importance of the following items in monitoring the realisation of strategic objectives in Corporate Venture Capital investments.

Not important very important

1 2 3 4 5 6 7

Formalized planning of monitoring

sessions :

Classifying the strategic objectives in different categories:

Dividing the strategic objectives into smaller operational objectives:

Using well defined milestones to track

the progress:

Clearly identify entity (group or person)

accountable:

Involvement of all functional groups:

Regular portfolio company visits:

Top management review included:

5. Please elaborate on the two items mentioned in question 3, which you perceive to be most important and explain how you have implemented these in your organisation.

Item 1:

Item 2:

Thank you in advance for your cooperation!!