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Fitness first: How pharma can get in shape for the future

As the market changes, existing capabilities become useless and new ones become essential. Professor Brian D Smith describes how pharma companies become fit for the future

You might describe your company in terms of its headcount, locations and products but to a strategy researcher these things are of secondary importance. To those of us who study the sector, pharma companies are best understood as clusters of capabilities; abilities to do certain things such as invent products, gain regulatory approval and create customer preference. 

Your firm's cluster of capabilities is what creates its competitive advantage or, when it weakens, leads to its failure. This capability–performance linkage is critically important because market change destroys or weakens capabilities. For example, detailing products effectively to prescribers was once an essential capability but, in many product categories, this is now a minor success factor and has been substituted by market access capabilities. Similarly, in- and out-licensing capabilities have become essential as in-house innovation has become more difficult. 

So, as the market changes, maintaining the relevance of a firm's capability cluster is essential to its survival. Many firms fail to do so, as the long list of once-great but now 'extinct' pharma companies demonstrates. But some companies are better learners than others and our research suggests that the ability to adapt to market changes by developing new capabilities is, in practice, an example of emerging best practice in three distinct but connected phases. 

To remain fit for the future, pharma companies must first understand the true nature of competitive capabilities, then prioritise what new ones their chosen business model demands and only then set about the task of acquiring them.

Understanding capabilities
The low learner companies we studied made two mistakes. Firstly, they had a poorly defined concept of what capabilities were and confused them with knowledge and skills. Better, faster learning companies understood that capabilities are clusters of routines or processes that collectively enable an organisation to do something. A fast-follower capability, for example, includes processes for observing competitive activity, learning from it and 'leap-frogging' over opinion-leaders and into mainstream users. 

The second error of slow-learners was to clump capabilities together and fail to differentiate between the different types. Fast-learning firms took a more sophisticated view of capabilities and separated them into three classes (see Figure 1).

Figure 1: The three classes of capability




- Capabilities necessary to exist in the market

- Capabilities that confer competitive advantage

- Capabilities that enable strategic change

- Example: gain regulatory approval

- Example: build a strong brand

- Example: create market insight

This taxonomy of capabilities is an essential foundation of how firms adapt to market changes. The weakest firms obsess about core capabilities, which are necessary but not sufficient for competitive advantage. Typical, average firms also pay attention to differentiating, as well as core capabilities. But the best, most agile companies recognise that core and differentiating capabilities rest on dynamic capabilities. For example, differentiating capabilities such as identifying unmet needs and creating strong brands depend on dynamic capabilities such as creating market insight and managing complex, intra-organisational knowledge flows. 

Importantly, while core and differentiating capabilities are visible to the outside world, dynamic capabilities are internally focused, sometimes implicit collections of activities and routines. In any case, the recognition that there are three 'flavours' of capabilities is the first step in acquiring those that are demanded by the future market. 

Which capabilities to develop?
The second stage of capability development, which is perhaps the hardest, is to identify and focus upon which capabilities to develop. In a competitive market this appears to change every day and it is quite possible to list a huge number of new capabilities that are essential to future survival. And these often seem contradictory, such as the capability to cut costs and to customise the customer experience at the same time. 

In those companies whose capabilities were lagging behind the market, we noticed what one research respondent called “initiative-itis” – the condition of attempting so many new things at once and failing to acquire any new capabilities.

By contrast, firms that developed new capabilities faster had learned to prioritise on two levels. Firstly, they recognised that some capabilities, especially those in the core and dynamic categories, were essential to the business. For example, managing a critical and often ill-informed public opinion will always be important. Similarly, developing execution capability is an essential for all companies with more than a handful of people. But the importance of other capabilities, especially differentiating ones, is very dependent upon the business model of the firm. For example, operating at low cost and circumventing patents is essential for generic companies. 

At the other extreme, companies with a very innovation-led business model must develop capabilities such as justifying pricing and defending intellectual property rights. At this second stage, the key to best practice in capability development is to identify which capabilities are essential to the chosen business model, to focus on them and to avoid the temptation to do too many things at once. 

Understanding the different types of capability and prioritising those that deserve attention are the two essential, fundamental steps to adapting to a changing market. These two steps require careful thought and disciplined leadership yet not many companies are doing this.

Most chose to skip these foundation stages and, in a mad rush to make change happen, often attempted to develop too many new capabilities at once, many of which are either unnecessary or unimportant to the success of the business model. 

In the early stages of the research, we labelled such firms 'the tail-chasers' because, like an over-excited dog trying to catch itself, they worked very hard but didn't get anywhere. However, more positive findings came out of those few, exemplary firms that had begun to acquire new capabilities quickly and efficiently. 

How to develop new capabilities
The third stage of developing new capabilities is that of acquisition. When we asked fast-learning firms to explain how they had acquired new capabilities in any area of their value chain, their answers described three different approaches which, in the best companies, often operated simultaneously and complemented each other. 

1. Double-loop learning 
This involves challenging current practice with objective information. For example, one company challenged its traditional business planning cycle with information that suggested the existing process added little value at great cost. This revealed flaws in embedded, implicit assumptions, such as the ability of the process to manage business risk and the value of the market analysis process. As a result, the company radically altered the way it developed and approved its business plans and acquired a new, dynamic capability for allocating strategic resources. 

2. Exaptation
This is the adaptation of an existing process into a new one. This is an effective, efficient approach but its weakness is that it can create superficial change dressed up as something more significant. For example, two similar pharma companies we researched each attempted to adapt their existing business intelligence capabilities in order to create a dynamic capabilty for creating market insight. One suceeded but the other merely re-named existing activities, introduced new jargon and failed to make any signficant difference to its insight-creation capacity. Successful exaptation typically requires an innovative, open-minded culture that is rare in long-established, heavily regulated pharma companies. 

3. M&A
A newly acquired company will bring with it a new capability, for example in a particular part of the value chain or some new therapy area. This can be the fastest, easiest way to acquire new capabilities but it has its limitations. Newly acquired capabilities may be submerged under the acquirer's culture and key people,  the so-called capability-carriers, may leave, taking the capability with them. Retaining the capabilities of an acquired company is an important part of post-merger integration but, because it is a qualitative and intangible issue, it is often neglected. 

Significantly, we found that the most common way of attempting to acquire new capabilites, by copying competitors, often failed. This is because, like a transplant, new processes and routines need to be carefully matched to the host culture. Ideas that are picked up and transferred without appropriate adaptation are either rejected or don't work. In the early stages of our research, we called such copy-cat companies 'the kindergarten kids', because like children they mimicked others without really understanding what they were doing.

Meeting the demand for new capabilities
So what should a pharma company do when faced with a changing market that demands new capabilities? Our research suggests four lessons are emerging from the small number of leading companies that are evolving and adapting faster than their rivals. 

Lesson 1: Recognise that change makes existing capabilities redundant or less effective, and this creates the urgency to develop new capabilities 

Lesson 2: Understand that not all capabilities are the same. It is especially important to look beyond the obvious core and differentiating capabilities to those dynamic capabilities that enable organisational change 

Lesson 3: Avoid “initiative-itis” by prioritising and focusing upon those capabilities that need to be developed. This can only be done in the context of a company's business model, since different models demand different capabilities 

Lesson 4: Exemplar firms teach us that there is more than one way to acquire new capabilities. Double-loop learning, exaptation and carefully-integrated acquisitions all have their role, but simply copying seems to be the least effective approach.

Our research provided bad news and good news. The pharma industry should worry that the fundamental changes that the sector is undergoing will make many of the industry's traditional processes and routines irrelevant and will demand many new, challenging capabilities. But pharma companies should be encouraged by the fact that we are beginning to understand the nature of those new capabilities and how best to acquire them. Whether the good news outweighs the bad depends on how quickly pharma executives learn to think of the company not as a people, buildings and products but as clusters of capabilities.

Article by
Professor Brian D Smith

Visiting Research Fellow at the Open University Business School and Adjunct Professor at SDA Bocconi. He welcomes questions and comments at

1st March 2013

From: Sales



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