Can Elephants Dance?

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Can Elephants Dance?

The relationship between organizational size and age, structural

inertia and product innovation in the Dutch pharmaceutical

industry

Master Thesis

by

Leonie Tichelaar s1336703

Supervisor

Iván Orosa Paleo

University of Groningen

Faculty of Economics and Business

Msc Business Administration

Strategy & Innovation

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Abstract

The extent to which inertial forces are stronger in large and older Dutch pharmaceutical firms in comparison to small and relatively young Dutch pharmaceutical firms and how this influence effects product innovation is investigated in this thesis. Based on the case study in the Dutch pharmaceutical industry, it is concluded that the researched inertial forces are not stronger in large and old Dutch pharmaceutical firms than in small and young Dutch pharmaceutical firms. Both types of pharmaceutical organizations experience strong cognitive, experience and institutional inertia which inhibits change. Change is, however, stimulated by the environment and organizational change does not merely occur in the periphery. In order to survive in the industry it is necessary to change the organizational core by broadening the focus of the organization. This stimulates innovation, since the environment forces organizations to search for new means to compete, produce medications and serve unmet medical needs.

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Preface

This thesis regarding to what extent inertial forces are stronger in large and old Dutch pharmaceutical firms in contrast to small and young Dutch pharmaceutical firms and how this influence affects product innovation is the final part of the master of Business Administration “Strategy & Innovation”. The influence of organizational size and age on experience inertia, institutional inertia and cognitive inertia and consequently on product innovation are focal points in this thesis.

During the research and writing of this thesis, I received help from numerous people. I would like to thank, first of all, the interviewees, without their valuable information this thesis could not have been completed. Second, I would like to thank Iván Orosa Paleo for giving me clear and helpful feedback and for reading draft versions over and over again. Last, I would like to thank my second supervisor for his/her willingness to judge this thesis.

Groningen, April 2009

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1. Introduction

Resistance to change can be found throughout economic history. The early days of the Industrial Revolution were, for instance, characterized by strikes, demonstrations and even violence to combat the introduced technological innovations. Artisans and domestic workers feared that the machines would reduce the demand for labor and cause unemployment. Besides, the rapid technological change altered the non-pecuniary characteristics of labor. It created and destroyed labor hierarchies, changed the physical work environment, forced workers to migrate, disrupted families and communities and it made skills redundant, wiping out status and prestige. Especially the French resistance to technological progress appears to have been successful. In many occupations, powerful trade organizations, known as compagnonnages, controlled the trade and protected it from innovation. In the construction industry, for example, the powerful carpenters’ guild managed for a long period to keep a monopoly over the details of material usage and blocked the introduction of iron. In addition, in 1789, a crowd of furious artisans destroyed the workshop of a St. Etienne hardware manufacturer, since the owner had shown interest in mechanized mass production (Mokyr, 1992).

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reproducibility – the relative stability of structure over time – also generates stronger inertial pressures (Singh et al., 1986). Consequently, as Hannan and Freeman argue, selection processes favor reliable and accountable organizational forms that maintain themselves in a relatively inert state (Hannan and Freeman, 1977).

Theories of organizational inertia argue that organizations at any given time will tend to resist significant changes. Particularly, inertia is thought to be the strongest in an organization’s core functions when these would require new or different organizational structures, routines and procedures, roles among organizational members, and associations with other organizations (Hannan and Freeman, 1984). Such deep-seated changes tend to be resisted, especially in established organizations that have learned well from their experiences (March, 1981). When organizational change does occur, new roles, procedures, and structures take time to build. Furthermore, it takes time to form informal network relations within organizations and to establish ties with other organizations. The effort and resources devoted to solving these managerial problems are not available for other purposes, some of which have direct effects on the probability of survival. For these reasons, structural inertia theory predicts that the process of organizational change initially causes higher rates of organizational failure, with a changed organization suffering from the same liabilities as a brand-new organization (Hannan and Freeman, 1984). As time passes after an organization changes, this hazard dissolves as the organization adjusts to its new form and circumstances (Amburgey e.a., 1993).

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conducted by innovative pharmaceutical companies. A study released in 2007 estimated the average cost of researching and developing a new chemical or biological entity at €1.059 million. In addition, high failure rates, the significant cost of clinical trials and the amount of resources needed to get approval by regulatory authorities decrease the chances of new substances becoming a marketable medicine: several studies have produced figures ranging from 1 in 5.000 to 1 in 10.000 (www.efpia.org, 2008). This figure is central to all the problems present in the industry, since the core problem of the industry is lack of innovation in making effective new therapies for the world’s unmet medical needs. Especially the R&D processes have become so complex that it is hardly surprising that its productivity has plummeted. Yet, global demand for medicines is growing, as demographic, economic and epidemiological trends reshape the marketplace, but the pharmaceutical industry will not be in a strong position to capitalize on these opportunities, unless the industry changes the way in which it operates. The pharmaceutical industry will have to use new technologies to improve its understanding of disease, reduce R&D costs significantly and spread its bets to increase its productivity in the laboratory. In addition, it will have to work more closely with governments, regulators and the healthcare community to produce the medicines patients really need, test them as quickly and effectively as possible and provide a more holistic healthcare service. Lastly, it will have to tailor its sales, marketing and pricing strategies to new audiences and markets (www.pwc.com, 2008). However, is the pharmaceutical industry capable of making these changes and consequently increase product innovation? Or is the industry too inert to fundamentally change the way in which it functions? Besides, is there a difference in strength of the inertial forces between the generic pharmaceutical companies and the innovative pharmaceutical companies? These questions are integrated in the main research question of this thesis: “To what extent are inertial forces stronger in large and old Dutch

pharmaceutical firms in contrast to small and young Dutch pharmaceutical firms and how does this influence product innovation?”

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2. Theoretical Background

In this chapter an overview of the literature is presented regarding the elements containing the general research question. The aim of this chapter is to generate a clear description of the relationship between the age and size of a firm and three elements of structural inertia. Besides, the influence structural inertia has on product innovation is explored. The chapter is structured as followed. First, an elaboration of the concept of structural inertia is given, followed by a description of the influence of organizational age and size. Third, the three different elements of structural inertia are discussed, namely cognitive inertia, experience inertia and institutional inertia in relation to the age and size of an organization. Fourth, the relationship between structural inertia and product innovation is described and the chapter is concluded by the explanation of the conceptual model.

2.1 Structural Inertia

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elements will reduce the reliability of organizational performance and thereby increase the probability of organizational failure (Hannan and Freeman, 1984, 1989).

Any model of organizational change must be reconciled with the concept of structural inertia (Hannan and Freeman, 1984, 1989). In popular parlance, inertia means “a tendency not to move or act”. In its more specific scientific usage, the term indicates the property of a system “by which it remains at rest or continues to move in a straight line, unless acted upon by some external force” (Gresov et al., 1993). If inertial pressures are weak, then organizations will be plastic enough to alter their forms freely. In other words, they will change rapidly enough to adapt to shifting and uncertain environmental conditions. By contrast, if inertial pressures are strong, then organizations will not be able to transform themselves successfully and they will not adjust quickly enough to keep up with shifting environmental conditions. Inertia is a variable property of organizations whose strength may differ from population to population, within a population over time, and with cross-sectional variations in organizational features (Hannan and Freeman, 1984, 1989). More specifically, not all changes that organizations can make are comparable. There is considerable variation in the degree to which different aspects of organizational structure and strategy are stable and resistant to change. Hannan and Freeman (1984) suggested that the organizational core, consisting of the organization’s goals, authority structure, technology and marketing strategy is the least flexible part of an organization’s form. Core change in the properties of form, including strategy, frequently results in inconsistent or poor performance over time, because resources that could have been spent on production or competitive response are instead spent on costly reorganization. Selection forces thus tend to favor organizational forms with highly reproducible, rationalizable structures and strategies, but the price exacted for organizational success is inertia (Hannan and Freeman, 1989).

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activity systems. Greater complexity and interdependence builds resistance to fundamental change. Conversely, inertia is reduced by forces that either prevent the elaboration of complex, interdependent systems, such as continuous environmental turbulence or erode an established base of evolved consistency. For a turbulent environment, change occurs in a continuous, incremental fashion. When an established base of consistency is gradually eroded, periods of equilibrium are interrupted by radical, discontinuous reorientations, in which most of the activity systems and the strategic orientation they support are changed in concert (Gresov et al., 1993).

The two treatments of Tushman and Romanelli (1985) and Hannan and Freeman (1984, 1989) on the role of inertia are similar in several important respects. First, as noted previously, little distinction is made between the activities executed by the organization in a competitive sense and the systems or structures evolved to execute these activities. It is assumed that a given structure is capable of executing only a highly constrained set of activities. Change in competitive response is consequently contingent upon change in organization design. Second, there seems to be a variety of potential factors that may cause or contribute to competitive inertia, including existing investments, structural complexity, interdependence between subsystems, organizational age, organizational size, prior success, lack of fundamental change and standardization of activities, to name just a few. Third, changes in competitive response may be either continuous and incremental or discontinuous and radical. While authors disagree on the performance implications of change under varying conditions, there is consensus that comprehensive models of change should have the potential to incorporate and explain both kinds of change (Romanelli and Tushman, 1986). Consequently, it is more important to investigate to which degree companies display inertia rather than establishing whether or not it is present.

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Proposition 1a: Change is stimulated from external forces.

Proposition 1b: Change occurs in the organizational periphery.

2.2 Rigidity of Aging and Fluidity of Aging

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In short, as organizations grow older, the strengths of inertial tendencies affecting core features are assumed to increase as a result of factors both internal and external to the organization. Singh, Tucker and Meinhard (1990) have referred to this set of arguments as the “rigidity of aging” hypothesis. Considering the buffering effect of power and the impact of increasing bureaucratization leads to the proposition that large and old organizations are less likely to change, given the rigidity of aging hypothesis of organizational change (Haveman, 1993).

Proposition 2: Large and old organizations are less likely to change than smaller and

younger organizations.

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effects of differentiated, formalized and specialized structures along with the effect of slack resources, leads to the expectation that larger and older firms are more likely to undertake and be successful with change than their smaller and younger counterparts.

Proposition 3: Large and old organizations are more likely to successfully change than

smaller and younger organizations.

Although not all organizations are born small, it is beyond the barriers of the research to decouple organizational age and size and investigate whether these factors have, in isolation, a different influence on structural inertia. Furthermore, most empirical literature finds a strong positive relationship between organizational age to size (e.g. Aldrich and Auster, 1986; Baum, 2001; Gresov et al., 1993). Hence, it is assumed that most old organizations are large sized and younger organizations are smaller sized.

2.3 Rigidity of Aging and Cognitive Inertia

The common observation in this thesis is that many firms, especially larger and older firms, are limited to exploit lucrative opportunities that surface from within the organization. This is caused by top management’s inability to adjust cognitive mental models, i.e. cognitive inertia. Cognitive inertia occurs when mental models become so embedded in a top manager’s decision-making process that they become uninterrupted and essentially follow a path that remains within an existing paradigm despite environmental signals strongly suggesting their incongruence (www.babson.edu, 2008).

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permit firms to enjoy profitability in spite of managers’ outdated mental models. Continued growth and profitability might even further confirm and strengthen outdated models, delaying change until growth slows or stops and the effects of inadequate mental models are felt. Furthermore, changes in the environment may not be noticed because they are not central to existing models. Mental models specify the most important or central elements of organizational environments and more peripheral elements may become increasingly important as environments change, but go unnoticed by managers. This problem is complex because most strategic decisions do not present themselves to the decision maker in convenient ways. Given cognitive limitations, mental maps will always be incomplete; inaccuracy may increase, however, as environments change (Barr et al. 1992).

According to the rigidity of aging hypothesis, discussed in paragraph 2.2, managers in larger and older organizations have increased pressures toward internal consistency as a basis for coordination and control, formalization, specification, institutionalization and homogeneity among organizational members. In other words, it can be assumed that when organizations grow larger and older, the mental models become more institutionalized, solidified and complex to enhance the internal consistency, hence resulting in more powerful cognitive inertia delaying change processes (Shimizu and Hitt, 2005).

Proposition 4a: Managers in large and old organizations are more likely to develop inert

mental maps than those in smaller and younger organizations.

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definition provides a description of the characteristics that must be present for something to be called an organizational routine. Organizational routines have been regarded as the primary means by which organizations accomplish much of what they do. Furthermore, organizational routines are also theorized to be a natural product of action that occurs in the context of the enabling and constraining structures. The organizational context makes some actions easier, and therefore more likely, and other actions harder, and therefore less likely. Repetitive patterns of action will tend to emerge as organizational members choose to take the easier actions and avoid the harder ones (Feldman and Pentland, 2003).

While recognized as an essential aspect of organized work, organizational routines are a well-known source of inertia. Selection within organizational populations tends to eliminate organizations with low reliability of performance and low levels of accountability. Reliable performance requires that an organization continually reproduces its structure from day to day. To avoid elimination from the population, organizations attain reproducibility and accountability of structure through processes of institutionalization and by creating highly standardized routines (Freeman et al., 1983). This understanding of organizational routines has deep roots in social theory, as reflected in writings on bureaucracy. Stability, or “regularity and continuity” is a defining feature of bureaucracies (Stinchcombe, 1965). For better or worse, routines enable bureaucracies to organize expertise and exercise power efficiently (Feldman and Pentland, 2003). Whereas routines can be a source of inertia and inflexibility, they can also be an important source of flexibility and change. For instance, many organizations employ meta-routines, such as continuous improvement and total quality management, as a means to generate change. Meta-routines have been theorized as a mechanism for generating dynamic capabilities; the routinized activities directed to the development and adaptation of operating routines in response to change in the environment (Collinson and Wilson, 2006). Additionally, Feldman and Pentland (2003) refer to something more basic, namely the inherent capability of every organizational routine to generate change, merely by its ongoing performance. Change in organizational routines is especially evident when there is a crisis, in the early stages of establishing an organization or in areas of ambiguity (Feldman and Pentland, 2003).

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core rigidities. Core rigidities are routines that served the organization well in the past but have become inappropriate due to changes in the environment and cause structural inertia and resistance to change (Leonard-Barton, 1992). In accordance with the rigidity of aging hypothesis, it can be expected that larger and older organizations are more likely to develop core rigidities than smaller and younger organizations. Consequently, large and old organizations run an increased risk that routines will become a limiting factor towards change and innovation.

Proposition 4b: The routines in large and old organizations are more likely to become core

rigidities compared to those in smaller and younger organizations.

The propositions 4a and 4b lead to the assumption that in order to enhance internal consistency, large and old organizations embed mental models that are inaccurate and inappropriate leading to action that is ineffective in a new environment. The mental maps include ideas regarding the core capabilities. The differentiated set of routines that provides the basis for a firm’s competitive capacities and sustainable advantage in a particular business’ is less likely to be changed, especially when the organization experiences growth and profitability. Continued growth and profitability might even further confirm and strengthen outdated models and routines, even though the routines that served the organization well in the past have become inappropriate due to changes in the environment. The institutionalized, solidified and complex mental maps and routines result in more powerful cognitive inertia delaying change processes. Given the rigidity of aging hypothesis, it is assumed that in order to enhance internal consistency, large and old firms are more likely to be submitted to cognitive inertia.

Proposition 4: Large and old organizations face stronger cognitive inertial forces than

smaller and younger organizations.

2.4 Rigidity of Aging and Experience Inertia

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resources and inputs (Darr et al. 1995). However, when environments are rapidly changing, experience-based learning may lock firms into previously successful strategies, lowering subsequent performance and survival. Even though objective failure rates increase in this case, managers under these circumstances may still perceive the subjective threat of organizational failure to be reduced since persistence with successful strategies partly reflects biased decision making and overconfidence with respect to potential organizational outcomes. Collectively, this suggests that experience buffers the organization and shifts the focus of attention toward exceeding the aspiration level and away from threats to the organization’s survival. When performance falls below the aspiration level, decision makers in firms with substantial experience therefore focus on the aspiration level and interpret the performance gap as repairable through increased risk taking. In firms with lower levels of experience, however, poor performance is interpreted as a threat to the organization and decision makers focus on the survival point, becoming risk averse as performance falls (Desai, 2008).

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individuals, even if their past achievements were due to accidents of timing, can become confident about the effectiveness of their actions and treat their beliefs about strategy-performance links as fact. High confidence in cause-and-effect beliefs increases individuals’ effort and persistence and also leads them to persist with strategies that were successful in the past. Such confidence in the continued efficacy of previously successful strategies is beneficial if the conditions that produced success do not change but detrimental if conditions do change (Schwartz, 1982). Besides, enduring success is likely to lead individuals to seek less information because success increases individuals’ certainty that they are already doing the right thing. Because noticing changes in an environment depends, in part, on the amount of information sought, it is expected that the less strategic decision makers seek information, the higher their persistence with past strategies following a radical environmental change will be (Audia et al., 2000). Concluding, successful experiences stimulate risk adverse behavior and promote the dependence of organizations on previously successful strategies, consequently impeding change and increasing experience inertia (Desai, 2008).

As organizations age and grow, decision makers are less likely to engage in risky activities induced by the dependence on experience, than are their counterparts in younger and smaller organizations (Shimizu and Hitt, 2005). Additionally, past success favors the development of rigid organizational structures and increases the pressure for stability coming from external stakeholders (Hannan and Freeman, 1984). Such constraints in turn stifle decision makers’ ability to alter a current strategy and they depend on previous successful strategies (Audia et al., 2000). It can therefore be assumed that large and old organizations with a greater history of success are more likely to “stick” with their past strategies than small and younger organizations with a lesser history of success.

Proposition 5: Large and old organizations persist with previous successful strategies

and are therefore more likely to be risk averse than smaller and younger organizations.

2.5 Rigidity of Aging and Institutional Inertia

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constituents of its institutional environment (DiMaggio and Powell, 1983). This external legitimation elevates the organization’s status in the community, facilitates resource acquisition and prevents questions about an organization’s rights and competence to provide specific products or services (Oliver, 1991). The study of institutional relations and their effect on the mortality rate of organizations sheds additional light on Hannan and Freeman’s (1984) contention that selection forces in contemporary populations favor reliable, accountable organizations. Establishing collaborative linkages to legitimated community and public institutions may be an important means by which organizations achieve reliability and accountability and increase their survival prospects. Paradoxily, high reliability and accountability induce structural inertia and striving for strong institutional linkages resulting in legitimacy can inhibit change within an organization. Therefore, institutional inertia is defined as the presence of strong institutional linkages which inhibit change due to the threat of losing legitimacy (Baum and Oliver, 1991).

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Hannan and Freeman (1984, 1989) have proposed that selection pressures favor organizations that are able to demonstrate their reliability and accountability. Reliability, the capacity to produce products or services of a given quality repeatedly, and accountability, the appearance of compliance with institutional norms of rational and acceptable behavior, are more likely to characterize organizations with institutional attachments than free-standing organizations that compete without the benefit of institutional linkages. However, to secure reliability and accountability standard operating procedures are created and organizational actions formalized by applying inflexible routines. Standard operating procedures increase internalization of organizational rules by organizational members and they increase the use of categorization as a decision-making technique, thereby decreasing the extent of search for alternatives. All of these processes rigidify behavior. In other words, high reliability and accountability induce structural inertia and striving for strong institutional linkages resulting in legitimacy can inhibit change within an organization, i.e. institutional inertia (Baum and Oliver, 1991).

The connection between organizational age and size and institutional inertia is based on the fact that large size tends to legitimate organizations, to the extent that large size is interpreted by external stakeholders as an outcome of an organization’s prior success (Baum and Oliver, 1991). Furthermore, it should be noted that the establishment of institutional linkages may take years, if not decades, to create and sustain (Narula, 2002). Hence, the short term influence of institutional linkages is limited for younger and smaller organizations (Hannan, 1997). In addition, given the rigidity of aging hypothesis, it can be assumed that older and larger organizations have made commitments and developed strong dependencies with institutional linkages that limit their ability to make fundamental changes. Besides, older and larger organizations experience increased pressures towards internal consistency, e.g. high reliability and accountability. High reliability and accountability resulting in legitimacy consequently leads to a reduced propensity to change (Singh, et. al., 1990).

Proposition 6: Large and old organizations are more likely to be hampered in the

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2.6 Structural Inertia and Product Innovation

Innovation is the fuel on which a progressive enterprise feeds. Its absence is the root of decline in most unsuccessful enterprises (Corson, 1962). Despite the importance of innovation to an organization, there is much ambiguity regarding the definition of innovation. According to Garcia and Calantone (2002) innovation is an iterative process initiated by the perception of a new market or a new service opportunity for a technology based invention which leads to development, production and marketing tasks striving for the commercial success of the invention. Garcia and Calantone (2002) distinguish between a macro and a micro perspective of innovativeness. From a macro perspective they state that innovativeness is the capacity of a new innovation to create a paradigm shift in the science and technology and/or market structure in an industry. From a micro perspective, they see innovativeness as the capacity of a new innovation to influence the firm’s existing marketing resources, technological resources, skills, knowledge, capabilities, or strategy. Furthermore, they make a distinction between radical innovations, really new innovations and incremental innovations. Radical innovations have been defined as innovations that embody a new technology that results in a new market infrastructure. Really new innovations are termed by the authors of the article as a moderately innovative product. They can evolve into new product lines, product line extensions with new technology or new markets with existing technology. Incremental innovations can easily be defined as products that provide new features, benefits, or improvements to the existing technology in the existing market (Garcia and Calantone, 2002).

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The discussion above emphasizes that successful new products are critical for many organizations, since product innovation is one important way that organizations can adapt to changes in markets, technology and competition. However, many organizations still have difficulty with managing product innovation. Introducing new products may induce strategic advantages but they also generate disruptions since innovations rapidly change the basis on which organizations compete. These events typically are marked by the entry of new organizations pursuing novel strategies, employing new organizational processes, producing innovative products, and offering new services. Adaptation to the new situation is further complicated by inertia (Barnett and Freeman, 2001). When organizational change does occur, new roles, procedures, and structures take time to build (Stinchcombe 1965, Hannan and Freeman 1984). It also takes time to form informal network relations within organizations, and to establish ties with other organizations. The effort and resources devoted to solving these managerial problems are not available for other purposes, some of which have direct effects on the probability of survival. For these reasons, structural inertia theory predicts that the process of organizational change initially causes higher rates of organizational failure, with a changed organization suffering from much the same liabilities as a brand-new organization (Hannan and Freeman, 1984). As time passes after an organization changes, this hazard dissipates as the organization adjusts to its new form and circumstances (Amburgey et al., 1993). These ideas apply as well to new product introductions. New routines are put in place to design, produce and distribute the new product. These routines often require different workforce and organizational capabilities. The formal job responsibilities of some positions in the organization may be changed, including those of managers responsible for controlling the work activities of those using the new routines. With new and changing roles among the workforce come changes in the networks of relations and communications within the organization. Similarly, relationships with other organizations may need to be changed to accommodate the requirements of the new product and new ties with other organizations may need to be formed. Following the logic of structural inertia theory, these various adjustments are unlikely to occur optimally at first, and so the organization is likely to experience disruption immediately following product innovation. Over time, these initial problems are then likely to dissipate as the organization learns how to support the new product (Barnett and Freeman, 2001).

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direction are thwarted by the inertia that success creates. The deeper the enterprise is into the life cycle and the more successful it has been, the greater its tendency to return to its former course. For most executive teams, battling the inertia demon is the biggest challenge they face. Sad to say, the demon usually wins. To overcome inertia, management must introduce new types of innovation while deconstructing old processes and structures (Moore, 2004). However, since selection favors organizational forms with highly reproducible, rationalizable structures and strategies, it is unlikely that organizations will change these (Hannan and Freeman, 1984). Therefore, it can be assumed that larger and older firms are more hesitative to introduce new product innovations since this type of organization experience increased pressures towards internal consistency, e.g. high reliability and accountability. As production innovations have a disruptive effect on accountability and reliability, they will endanger organizational survival, making organizations cautious to change processes and risk taking needed for the introduction of product innovations.

Proposition 7: Large and old organizations are less likely to introduce new product

innovations due to the disruptive effect on accountability and reliability, endangering organizational survival.

2.7 Conclusion

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function all serve to facilitate control. The by-product is diminished flexibility, for established control systems must be overruled to change structure or activities (Aldrich and Auster, 1986). On the other hand, the fluidity of aging hypothesis argues that structural complexity, differentiation, specialization of personnel, decentralization and slack resources are positively related to the adoption of innovations and change (Singh et al., 1990). The effects of these factors leads to the expectation that larger and older firms are more likely to be successful with change than their smaller and younger counterparts (Haveman, 1993). For these reasons it is proposed that larger and older firms are less likely to change than their smaller and younger equivalents. However, when this type of organization does change their structures and process it is expected that they are more successful in this process than smaller and younger organizations.

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commitments and developed strong dependencies with institutional linkages that limit their ability to make fundamental changes. Additionally, older and larger organizations experience increased pressures towards internal consistency, e.g. high reliability and accountability. High reliability and accountability resulting in legitimacy consequently leads to a reduced propensity to change (Singh, et. al., 1990).

As the title of Peters (1990) mentions, “get innovative or get dead”, e.g. product innovation is necessary to respond to changes in the environment and in the end to survive as an organization. However, structural inertia negatively influences the amount of product innovations since innovations demand a change in structure, processes, routines and institutional linkages. A change in these factors will decrease the accountability and reproducibility of the structure and processes, consequently increasing the chance on organizational failure. To prevent organizational death, an organization should maintain present structures and processes. In other words, inertia is essential for an organization to survive. This finding is extremely paradoxical since most literature regarding innovations claim that for an organization to survive, they have to innovate (Moore, 2004; Hannan and Freeman, 1984).

To conclude the theoretical framework the propositions discussed are graphically displayed in the conceptual model.

Figure 1. Conceptual model.

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3. Methodology

The research methodology is discussed in the following chapter. Subjects like research design, data collection, the sample of the research and the coding method are dealt with and will make the research method used for this study more clear.

3.1 Research Design

According to Gomm et al. (2000) all research is in one sense case study: there is always some unit, or set of units, in relation which data is collected and analyzed. The term case study is employed to identify a specific form of inquiry which contrasts with two other influential kinds of social research, namely the experiment and social survey. Case study differs from the other two kinds of social research in the number of cases investigated and the amount of detailed information that the researcher collets about each case studied. Usually case study refers to the research that investigates a few cases, sometimes just one, in considerable depth. The term case study is also often utilized to explain the kind of data that are collected and how these are analyzed. Frequently it implies the collection of unstructured data and qualitative analysis of these data. However, it is often argued that the aim of case study research should be to capture cases in their uniqueness, rather than to use them as a basis for wider generalization. This is therefore one of the most important limitations of case study research (Gomm et al., 2000).

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when the generalization is based upon a study of a representative sample of contexts (Gomm et al., 2000). The sample of this thesis is discussed in part 3.3.

3.2 Data Collection

To understand the concept of inertia, the relationship between structural inertia and product innovation and whether the size and age of the pharmaceutical companies influences this relationship, a preliminary research was executed. The internet was searched to find relevant articles, but the main sources of information were Business Source Premier from the University of Groningen and the Economic and Social Sciences library of the University of Groningen. Topics regarding cognitive inertia, institutional inertia and experience inertia were sought after. Besides these topics, specific information about the relationship between the different kinds of inertia under investigation and the age and size of firms and the relationship between structural inertia and product innovation was searched and found. After finding enough information, a literature study was completed to analyze the secondary data. The used articles, websites and books can be found in the reference list.

To gather the primary information seven in-depth interviews were conducted at generic and innovative pharmaceutical companies. In-depth interviews are a commonly used method of data collection employed by qualitative researchers. This technique uses individuals as the point of departure for the research process and assumes that individuals have unique and important knowledge about the social world that is obtained through verbal communication (Nagy Hesse-Biber et al., 2006). The in-depth interviews were carried out in each company in November and December 2008. The duration of the interviews was on average one and a half hours.

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An interview guide was developed to prepare for the interviews. To begin, a “topics-to-learn-about” list was composed based on the factors influencing inertia. Each factor listed is a line of inquiry that is pursued during the interview session. Specific interview questions were then constructed to collect information in each of these lines. This process of composing an interview guide is helpful since it identifies key foci and clarifies the issues that need to be asked during the interviews (Nagy Hesse-Biber et al., 2006). The interview guide with the specific questions for each line of inquiry can be found in Appendix 1.

3.3 Research Sample

Demographic, epidemiological and economic shifts are transforming the pharmaceuticals market. The population is growing and aging and new areas of medical need are emerging. These changes will generate some huge opportunities for the pharmaceutical industry. Yet the pharmaceutical industry will not be in a strong position to capitalize on these opportunities, unless it can change the way in which it operates. Its core problem is lack of innovation in making effective new therapies for the world’s unmet medical needs. Furthermore, several political, legal and financial factors have contributed to the problem. For instance, most pharmaceutical companies use internal valuation mechanisms to assess the clinical and commercial potential of the pharmaceuticals in their pipelines, and select the ones they want to pursue. But when they start developing a new medicine, they do not know whether it will be eligible for reimbursement if it reaches the market, unless it addresses a disease for which there is no existing treatment or looks likely to prove much better than any comparable therapies. Many firms therefore try to minimize their risks by playing it safe (www.pwc.com, 2008). The Centre for Medicines Research International reports that, in 2004, more than 20% of the money 10 of the largest pharmaceutical companies invested in R&D was spent on line extensions and other work, as distinct from new development projects. In smaller companies, the percentage was over 40% (Centre for Medicines Research International, 2005/2006 Pharmaceutical R&D Factbook, 2005).

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The political and legal framework in which the pharmaceutical industry operates has deterred it from taking risks that are required to produce genuinely innovative new therapies. In addition, most pharmaceutical companies’ revenues are becoming more cyclical, as the billion-dollar blockbusters in their portfolios come off patent and they struggle to develop new medicines that can replace this income (www.pwc.com, 2008).

In order to investigate the highly interesting dynamics in the pharmaceutical industry and to research whether inertial forces are stronger in large and old Dutch pharmaceutical firms in contrast to small and young Dutch pharmaceutical firms and how this might influence product innovation, seven pharmaceutical companies were selected. Three organizations are considered to be generic pharmaceutical organizations that sell pharmaceuticals which are produced and distributed without patent protection. The remaining four organizations are, on the other hand, active in the Dutch innovative pharmaceutical industry, where the produced pharmaceuticals are protected by patents up to 20 years. Since these two types of pharmaceutical organizations differ in size and age, it is suspected that the factors contributing to structural inertia are less present in the smaller and younger generic pharmaceutical companies in contrast to the large, cumbersome and old innovative pharmaceutical organizations. However, according to DiMasi (1995), the sales per new drug approved are shown to increase with firm size. This means that large and old pharmaceutical firms produce a larger number of product innovations, despite the stronger inertial forces. This dual relationship is the focus of this thesis and will be further investigated in the following chapters.

3.4 Coding Method

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4. Case Study Results

This chapter provides an overview of the case study results. The propositions discussed in the theoretical background are tested and either accepted or rejected. The chapter is structured as followed. First, the results regarding structural inertia are reviewed. Second, the propositions whether large and old organizations are less likely to change, but when these types of organizations do change they are more likely to be successful, are discussed. Third, the question whether large and old organizations are more likely to be submitted to cognitive inertia is answered. This proposition is followed by the discussion whether large and old organizations persist with previous successful strategies and are therefore more likely to be risk averse. The fifth proposition concerning the subject whether large and old organizations are more likely to be hampered in the change process due to well-established institutional linkages is presented. The last proposition which will be accepted or rejected is whether large and old organizations are more likely to be hesitative to introduce new product innovations due to the disruptive effect on accountability and reliability, endangering organizational survival. The chapter is brought to a close by summarizing the key terms in the conclusion1.

4.1 Structural Inertia

Changes that occurred in the pharmaceutical industry are mostly induced by mergers and acquisitions. For instance, the acquisition of company X by company A led to changes in the organizational culture, packaging and parent company. The acquisition went fluently since company A did not have any activities in The Netherlands yet and no employees had to be laid off. In addition, company X impeded investments due to the sale of the division and the acquisition by company A brought new life into the division. For these reason, most people had a positive attitude towards the acquisition. Company D experienced the same positive attitude when the former division of company Y was taken over by company D. On the other hand, the merger of company Z and company W into company E was more problematic, since several offices were closed down and a large percentage of the employees did not want to transfer to other offices abroad. Knowledge and expertise was lost and specialists had to be

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replaced from all over the world. In addition, the organization grew tremendously accompanied by small “hick-ups” and problems. Nevertheless, all the employees had positive feelings towards the new challenges, the new products and the increase of organizational scale.

The environment for generic products changes in a rapid pace. This is caused by the preferential policy which lowers the prices of the products and decreases the profit margins of the pharmaceutical organizations. Due to the preferential policy2 it is not possible to continue producing products in a high volume and some products are taken out of the portfolio, since they are not profitable anymore. In addition, the preferential policy makes it more attractive for competitors from abroad to become active on the Dutch pharmaceutical market. Especially pharmaceutical organizations from India and the People’s Republic of China offer their products at dump prices, against which Dutch pharmaceutical organizations cannot compete. Since the Dutch pharmaceutical organizations do not want to incur a loss, they will sell the product until they are out of inventory. This will lead to discontinuity in the supply of certain products and organizations will eventually disappear from the population. In short, as the interviewee from company C argued, the main threat is the industries’ focus on price and the suppliers from India and the People’s Republic of China, who offer products at a lower price than the Dutch generic pharmaceutical organizations.

However, the preferential policy is not only a threat to the generic pharmaceutical organizations, but it can also be regarded as a chance, since it is an opportunity to seize a large market share. If all insurance companies decide that only product A will be refunded, the producer of that product can generate a monopoly position and seize a large market share in a short period of time. Generally, the most important chance is to broaden the supply to the market, for instance by penetrating the hospital market and by offering over the counter (OTC) products. OTC products are medications that are sold at drug stores and do not require a prescription for a physician. Another opportunity is facilitating pharmacies to differentiate by offering extra services to the patient. Nowadays, insurance companies do not refund these extra services, however this will change in the near future. By developing these services in

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advance, pharmaceutical organizations will have an advantage when these extra services are refunded. For instance, instruments that measure cholesterol levels are developed and produced to jump into this market as soon as cholesterol lowering medication is allowed to be sold at pharmacies. In general, the threat induced by the preferential policy forces generic pharmaceutical organizations to change, differentiate and broaden their spectrum beyond producing generic medication in order to survive. Nevertheless, as the interviewee of company B mentioned, the generic pharmaceutical organizations can easily adjust to the new circumstances, since they are small sized which makes the generic pharmaceutical organizations more flexible to change.

In contrast, the environment for innovative pharmaceutical products does not change rapidly. The most important changes in the environment are social and demographic changes; people live to a greater age, new diseases are discovered and patients are better informed. The main chance is connected to these environmental changes, since elderly suffer from more diseases and need more medical assistance. The main threat, on the other hand, is not discovering and serving the unmet medical needs. Company G adapted to these changes by focusing merely on discovering new niche markets and medication which can be utilized in hospitals. Furthermore, the organization dissociated from OTC products, since the market was over served by this type of medication. The OTC products did not fit anymore with their main focus, innovation. By clinging onto past performance, being rooted into old procedures and creating a share of voice for a single product, innovation was hampered. The new innovation strategy seems to be fruitful for company G, since it is expected that the organization will be the largest pharmaceutical organization in a few years.

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environment which is turbulent and constantly changing. In the Dutch context, evidence shows that changes in both the generic and innovative pharmaceutical organizations have been induced to a large extent by transformations in the environment. Therefore proposition 1a, which states that change is stimulated by external forces, is accepted.

According to Hannan and Freeman (1984), not all changes that organizations can make are comparable. There is considerable variation in the degree to which different aspects of organizational structure and strategy are stable and resistant to change. Especially the organizational core, consisting of the organization’s goals, authority structure, and technology and marketing strategy is the least flexible part of an organization’s form. Core change in the properties of form, including strategy, frequently results in inconsistent or poor performance over time, because resources that could have been spent on production or competitive response are instead spent on costly reorganization. Selection forces thus tend to favor organizational forms with highly reproducible, rationalizable structures and strategies, but the price exacted for organizational success is inertia (Hannan and Freeman, 1989). However, as the results discussed above indicate, both generic and innovative pharmaceutical organizations change the organizational core. Especially the strategy is adjusted to environmental change. Changing the strategy by broadening the organizational activities is necessary in order to survive in the population. Two examples who changed the organizational core are company D and company C. Company D not only changed the organizational strategy, but also left the vision, mission and strategies of their previous parent company behind them and incorporated the organizational core of company D. Company C changed the organizational core by developing a new bio-pharmaceutical division. That decision consequently led to changes in the periphery, since investments in new technology were necessary and new specialist had to be recruited. For this reason, proposition 1b, which states that change merely occurs in the organizational periphery, is rejected.

4.2 Rigidity of Aging and Fluidity of Aging

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the remaining of this thesis, small and young organizations refer to generic pharmaceutical organizations and large and old organizations refer to innovative pharmaceutical organizations. Given the rigidity of age hypothesis it is assumed that the older and larger pharmaceutical organizations are less likely to change. The relationship between size and change may be negative, because it is assumed that larger and older organizations are more bureaucratic and bureaucratic organizations are more rigid. Merton (1957) argued that there is an increasing emphasis on reliability of behavior in organizations, which creates a need for accountability and predictability of behavior. The technique used to secure reliability is bureaucratization: creating standard operating procedures and formalizing organizational actions by applying inflexible rules. Crozier’s (1964) argued that bureaucratization is caused by the use of impersonal rules, centralization of discretionary decisions, increased use of parallel power and isolation of organizational members on different strata. Bureaucratic organizations cannot correct their behavior by learning from their mistakes. Bureaucratic patterns of activity are so stabilized that they generate a self-reinforcing equilibrium. Rather than changing in line with their environments, bureaucracies resist change until a crisis occurs. This model of bureaucratic rigidity implies that larger and older organizations can be expected to undertake change less readily than small and young organizations because greater organizational mass leads to bureaucratization and thus to structural ossification.

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interviewee from company C indicates large and old organizations are more likely to become bureaucratic, leading to a culture where one’s hands are tight and consequently the organizations become more inflexible to respond to changes in the environment. It is the responsibility of the management team to prevent such a culture from developing. In conclusion, the results from the primary data do not confirm the assumption that large and old pharmaceutical organizations are more bureaucratic than their small and young equivalents. However, the likelihood that they become bureaucratic is larger. According to this conclusion, proposition 2, stating that large and old organizations are less likely to change, should be rejected.

The discussion above indicates that the relationship between size and change is negative. Yet, there is also considerable theoretical and empirical support for the idea that organizational size has the opposite effect. Singh et al. (1990) referred to this alternative pattern as the “fluidity of aging”. For instance, correlates of organizational size, like structural complexity, differentiation, specialization of personnel, decentralization and slack resources, have been found to be positively related to the adoption of innovations (Singh et al., 1990). This leads to the expectation that large and old organizations are more likely to be successful with change than small and young organizations.

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are the “front soldiers” that sell the products to physicians. These three types of personnel are combat-ready in all business units. In other words, they are not specialized in a certain business unit, but they have specialized knowledge and expertise within their profession. This leads to the cross fertilization of knowledge, information and experiences stimulating change. In addition to differentiation, slack resources have been found to be positively related to the adoption of innovations. Slack resources are more present in large and old pharmaceutical organizations than in small and young pharmaceutical organizations. Financial resources are the most common slack resource that buffers the organization from organizational failure. For instance, the statement by company G saying that they can lose millions of Euros in a day indicates the tremendous cash flows in the industry. Small and young pharmaceutical organizations usually do not have the financial resources to develop medication throughout all the development phases, let alone risk losing millions in a day. Therefore, larger and older organizations with greater financial slack resources are better able to withstand setbacks that occur during the change process. Furthermore, the greater financial slack resources facilitate experimentation with new strategies, new products and new markets, because slack buffers organizations from downside risk, thereby lowering the likelihood of failure during the process of change (Haveman, 1993). For this reason, proposition 3, which states that large and old pharmaceutical organizations are more likely to be successful in the change process, can be confirmed.

4.3 Rigidity of Aging and Cognitive Inertia

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they do not have the time and resources to map out the environment in detail. To make sense of the world, managers rely on simplified representations or mental models. As a result, change is the environment or the consequences of the changed environment may take an organization off guard. Small and young pharmaceutical organizations have the advantage, though, of being more flexible to turn the steering-wheel around and change according to the situation.

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information since, “results from the past are no guarantee for the future”. In other words, the environment might have changed and information obtained in the past may not be applicable anymore. The problem that mental models may be, or become, inaccurate and inappropriate should be prevented. It is always necessary to adjust to changes and developments in the environment, also because competitors will not stand still either. To quote the interviewee from company E “you are not on an island and you cannot function in isolation”.

The results indicate that both small and young pharmaceutical organizations and large and old pharmaceutical organizations experience cognitive inertia. Cognitive inertia in small and young pharmaceutical organizations is caused by inaccurate mental models since they have limited capabilities to collect information regarding changes in the environment. On the other hand, cognitive inertia in large and old pharmaceutical organizations is caused by inappropriate mental models. Growth within the organizations hides the warning signs to adjust their mental models. Top management’s inability to adjust cognitive mental models limits the exploitation of lucrative opportunities that surface from within the organization. Therefore, proposition 4a stating that managers in large and old organizations are more likely to develop inert mental maps is rejected.

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The effect of routines on change is twofold. On the one hand, routines can also be restrictive, since not all creative ideas can be implemented given that deviation from the SOPs and GMP is difficult and endangers the organizational returns. In this sense, organizational routines are the natural product of action that occurs in the context of the constraining structures. The organizational context makes some actions easier, and therefore more likely, and other actions harder, and therefore less likely. Repetitive patterns of action will tend to emerge as organizational members choose to take the easier actions and avoid the harder ones. In this case, it is not the choice of the organization to take the easier actions, taking the harder ones is restricted by the government. In addition, the routines that are demanded by the Dutch government inhibit organizations in their competitive position, since certain organizational changes are not allowed. For instance, several forms of production are not allowed any more due to new and stricter environmental laws. Competitors in India do not have this problem, since the rules and regulatory processes are less present and strict in India. Besides, organizational change is less easy to put into operation, since SOPs and GMP cannot be changed. These routines serve as a boundary within which change can occur. On the other hand, routines give clarity about the process and the consequences of decisions, the routines warrant quality of the products and therefore the continuity of the organization since flaws in medication can have serious consequences for pharmaceutical organizations. In other words, to avoid elimination from the population, organizations attain reproducibility and accountability of structure through processes of institutionalization and by creating highly standardized routines (Hannan and Freeman, 1983).

Change in organizational routines is especially evident when there is a crisis, in the early stages of establishing an organization or in areas of ambiguity (Feldman and Pentland, 2003). In the pharmaceutical industry, routines are changed when the regulatory process of the national government changes. The operating standards increase and the routines have to be adjusted to that level. Occasionally, routines become redundant and these routines will eventually come to rest. The only organization that does not change its routines is company G. As the interviewee mentioned, changing the routines “during the game” is not desirable.

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old pharmaceutical organizations. Therefore, proposition 4b stating that the routines in large and old organizations are more likely to become core rigidities is rejected. The inertial influence of routines is applicable to all types of pharmaceutical organizations.

In conclusion, both types of organizations have inappropriate and inaccurate mental models, inhibiting change. Additionally, the entire industry has to comply with routines in order to avoid elimination from the population. The institutionalized, solidified and complex mental maps and routines result in more powerful cognitive inertia delaying change processes. However, the effect of cognitive inertia on both small and young pharmaceutical organizations as large and old pharmaceutical organizations is similar. For this reason, proposition 4 stating that large and old organizations face stronger cognitive inertial forces than smaller and younger organizations is rejected.

4.4 Rigidity of Aging and Experience Inertia

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The targets discussed above are a function of the organization’s past performance or the performance of comparable others. These targets represent the minimum levels required for performance to be perceived as satisfactory, and performance below these levels signals that the organization’s routines or practices may not match the requirements of its environment. Since the environment changes in a rapid pace, it is very complicated to accomplish the short term goals, let alone the long term targets. Therefore, it is generally not expected that every detail set out in the goals is realized. When actual or expected performance falls below aspiration levels, decision makers respond by changing the strategies to realize the targets. These changes are taken into the budget of next year to assure that enough resources are available for the realization of the targets. In addition, large and old pharmaceutical organizations have the disadvantage that the development of new products takes decades. Therefore, it is essential to anticipate on changes in the environment in an early phase to introduce the new medication to the market on time. In short, the strategies necessary to accomplish the targets are yearly evaluated and adjusted. This is essential, since the environment changes and the fulfillment of the targets in year one and does not guarantee the fulfillment of the goals in the next year. It is crucial to stay alert to changes in the environment and anticipate on these. The interviewee of company B compared this process with going on a holiday. You have decided on a destination and the direction to get to the destination. However, every once in a while you have to evaluate whether the highway you have chosen is the correct one. Are there for instance any traffic jams or other hurdles that will delay your journey? If so, then you have to take another route to reach your final destination.

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arrive at the finish line, resulting is losing millions invested in the development, is according to all the interviewees, not a reason to avoid risk taking.

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is essential to map out changes in the environment nor changed their strategy due to their success.

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