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Business History

ISSN: 0007-6791 (Print) 1743-7938 (Online) Journal homepage: http://www.tandfonline.com/loi/fbsh20

The evolution of the pharmaceutical industry


Franco Malerba & Luigi Orsenigo
To cite this article: Franco Malerba & Luigi Orsenigo (2015) The evolution of the
pharmaceutical industry, Business History, 57:5, 664-687, DOI: 10.1080/00076791.2014.975119
To link to this article: http://dx.doi.org/10.1080/00076791.2014.975119

Published online: 03 Jun 2015.

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Date: 21 January 2017, At: 02:18

Business History, 2015


Vol. 57, No. 5, 664687, http://dx.doi.org/10.1080/00076791.2014.975119

The evolution of the pharmaceutical industry


Franco Malerbaa* and Luigi Orsenigob,c
a

Department of Technology and Management, and CRIOS, Bocconi University, Milan, Italy;
Institute for Advanced Studies, Pavia, Italy; cCRIOS, Bocconi University, Milan, Italy

This article provides an overview of the main traits of the historical development of the
pharmaceutical industry, using the lenses of the evolutionary approach to economic and
industrial change. After a brief overview of the main evolutionary concepts which
guide the subsequent discussion, our presentation identifies four main eras: from the
formative stages (from the late 1800s to War World II) to the so-called Golden Age
(the 1940s to the mid-1970s), the biotechnology revolution (the 1970s to the new
millennium, approximately) and what we label the Winter of Discontent? (the first
decade of the new century). Within all these epochs, we discuss the main trends in
technology, firms strategies and structures, patterns of competition, demand,
regulation and institutional developments. Section 6 concludes the article, briefly
discussing some main implications for the present and future of the industry on the one
hand and for the relevance of an evolutionary approach to the analysis of corporate and
industrial change on the other.
Keywords: Industry evolution; Pharmaceutical industry; Evolutionary theory;
Technological change; Regulation and institutions

1. Introduction1
There are various reasons why the history of the pharmaceutical industry can be fruitfully
analysed in an evolutionary perspective. Firstly, at the most basic level, pharmaceuticals
have been continuously changing over more than a century as the result of the interaction
of exogenous shocks and as the endogenous outcome of the response of a variety of agents
to emerging scientific, technological, market and political opportunities and constraints.
Secondly, these agents are diverse: they include consumers and profit-seeking firms as
well as regulatory agencies, universities and research centres, political bodies, etc. Such
agents are also heterogeneous in their preferences and motivations, in the ways they have
been perceiving and reacting to opportunities and constraints as well as in their strategies,
forms of organisation and performance.
Thirdly, the differential performances of the firms active in the industry have been
shaped by the interaction of processes of learning (technological, organisational, market)
and (product and financial, political, etc.) selection as well as, crucially, by the
accumulation of chance events.
Fourthly, the pharmaceutical industry has been traditionally highly innovative,
although imitation, marketing and price competition as well as political lobbying
remain crucial aspects of the competitive process. Over time, firms have developed

*Corresponding author. Email: franco.malerbanibocconi.it


q 2015 Taylor & Francis

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665

capabilities in all these domains. Some of them have become world leaders and maintained
their dominant positions over prolonged periods, while others have prospered only in
national market niches. Other have exited, often being acquired by competitors.
Fifthly, the firms organisational forms and the aggregate structure of the industry have
emerged as the outcome of a co-evolutionary process. A distinguishing feature of
pharmaceuticals is that concentration has remained rather low as compared to other
Research and development (R&D)- and marketing-intensive sectors. A remarkably stable
and relatively small group of firms has been consistently dominating the industry, almost
from its inception. However, the market share of these companies has been always lower
than 10% and only very recently has the current largest firm been able to grow larger than
this threshold, mainly through mergers and acquisitions.
This article examines the main features of the evolution of the pharmaceutical industry
in its historical development.2 After a brief overview of the main evolutionary concepts
which guide the subsequent discussion of pharmaceuticals (Section 2), our presentation
identifies four main eras: from the formative stages (from the late 1800s to War World II)
to the so called Golden Age (the 1940s to the mid-1970s, Section 3), the biotechnology
revolution (the 1970s to the new millennium, approximately, Section 4) and what we label
the Winter of Discontent? (the first decade of the new century, Section 5). Within all
these epochs, we discuss the main trends in technology, firms strategies and structures,
patterns of competition, demand, regulation and institutional developments. Section 6
concludes the article, briefly discussing some main implications for the present and future
of the industry on the one hand and, on the other, the relevance of an evolutionary
approach to the analysis of corporate and industrial change.
2.

Distinguishing characteristics of an evolutionary approach

The basic building blocks of the evolutionary approach to industrial change are well
known.3 Here, in extreme synthesis we summarise the basic concepts and assumptions
which will guide the following discussion of the evolution of pharmaceuticals.
First of all, our historical account is evolutionary in the basic sense that the primary
object of the analysis is corporate and industrial change rather than the identification of
equilibrium conditions which are then (somehow) attained by rational, perfectly informed
agents. Instead they are described as being only imperfectly able to understand the
environment in which they act, let alone to make accurate forecasts of the future.
Economic behaviour is then conceptualised as being largely driven by rules and routines,
which are developed over time as robust solutions to recurring problems and which are
painfully modified when new circumstances arise and performance deteriorates below
acceptable levels. Behaviour is therefore intrinsically characterised by some degree of
inertia. Yet, for the same reasons, innovation is always possible and marks the historical
unfolding of events.
Secondly, our analysis of pharmaceuticals is evolutionary in the sense that it rests on a
specific conceptualisation of what firms are and of what they do. An evolutionary approach
understands firms as behavioural entities which are primarily characterised as sets of
specific and idiosyncratic productive, technological and organisational capabilities, stored
in and expressed by their routines. Such capabilities are learned over time and they define
what any particular firm is capable of doing at any time and the range of new things that it
can learn to do in a reasonable period of time. Capabilities can be modified in the longer
term by more explicit strategic orientations. Still, learning typically proceeds along
trajectories which are constrained and structured by the nature of the problem itself

666 F. Malerba and L. Orsenigo


(e.g. technological paradigms and trajectories4), by the specificities of the environment
and by what firms have learned to do in the past.
This emphasis on capabilities provides a first line of exploration of why industry
leaders often seem to be vulnerable to challenges based in new technologies, while on
other occasions leading firms were able not only to survive but to actually maintain
leadership over prolonged periods of time. Capabilities-based explanations are based on
the idea that firms find it hard to change their orientations quickly and drastically, as
they are constrained by their organisational routines whereas continuing leadership is
linked to the ability to continuously innovate and adapt.5 Capabilities are also seen as
fundamental determinants of both the horizontal boundaries and of the vertical scope
of firms.
Thirdly, our analysis of pharmaceuticals is based on a specific evolutionary view of the
patterns of industrial dynamics. The departure point is that, given the properties of agents
behaviour and the nature of firms just discussed, heterogeneity in the traits and
performances of firms is expected to be the norm rather than the exception. Industrial
change is then driven by endogenous processes continuously reducing and recreating such
differences: selection and learning drive and channel industrial evolution along specific
patterns: innovation and new firms increase diversity, selection reduces it.
Selection is a primary force pushing towards the reduction of differences among firms.
But selection is neither instantaneous, nor transparent, or perfect (in the sense typically
used by economists). It takes place in real time and it operates by promoting the growth of
more efficient firms, by suppressing less efficient behaviour and by providing incentives to
adopt more efficient practices. Yet, what exactly the behaviours and traits are that lead to
superior (or inferior) performances is usually not immediately obvious to market
participants. The inability to see clearly in the future coupled with the lack of transparency
of the market feedback implies that incentives cannot fully orientate and determine
behaviour. This is even more so when it is recognised that the ability to change is
constrained by capabilities. Thus, inefficient behaviour can persist for prolonged periods
of time while more efficient ways of doing things may grow only slowly. Market selection
is also partly endogenous, in that it is shaped by agents perceptions and by the structure of
relationships they entertain with other subjects: what Jacobides and Winter define as
structured feedback.6 There cannot be any general presumption that selection necessarily
leads to efficient outcomes, nor that it converges in reasonable time at an equilibrium,
particularly as it is recognised that exogenous events and learning on the part of the agents
disturb the process of convergence.
An evolutionary view of industrial dynamics puts innovation and disequilibrium
Schumpeterian competition at the centre of the analysis. Still, in an evolutionary
perspective, industrial change is not completely disordered. On the contrary, it is
channelled and structured by powerful forces. In particular, along with selection, learning
is shaped by cognitive limitations, frames and often idiosyncratic ways of seeing and
perceiving problems and potential solutions. The notion of technological and demand
regimes provides an illustration of how the properties of the relevant technology e.g.
opportunity and appropriability conditions, cumulativeness of technological advances,
nature of the knowledge base, etc. and of the structure of demand orientate the patterns
of innovation and the properties of market structure. In the case of pharmaceuticals, ample
opportunities to discover new drugs, the quasi-random nature of the innovative process,
low cumulativeness of technological advances and patent protection mixed in such a way
to generate a rather small group of dominant firms but at the same time with low degrees of
concentration as compared to other R&D and marketing-intensive industries.

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667

The fragmented nature of the drug market in multiple, independent submarkets further
prevented the establishment of monopolistic positions in the industry.7
In addition, an evolutionary approach highlights two further fundamental factors
shaping industrial dynamics: luck and increasing returns. The accumulation of chance
events over time can produce structured patterns of market structure (e.g. concentration).
Increasing returns can arise from mechanisms involving scale economies in R&D,
learning curves, marketing efforts or so-called network externalities. But what is
particularly relevant is that increasing returns reinforce the essential dynamic nature of the
analysis: market power is built over time as a consequence of sequences of actions in
various domains.
Finally, an evolutionary approach focuses attention on the various aspects of the
institutional setting in which the industry operates: intellectual property law, regulation,
the scientific and technological background, etc.. Evolutionary theory highlights that firm
behaviour and structure and processes of industrial change are embedded in a rich
structure of institutions. The now enormous literature on innovation systems has
developed and fleshed out this suggestion, examining matters ranging from cooperative
arrangements among firms, the role of universities in technological progress and modes of
university-industry interaction in different industries, the variety of government
programmes supporting technological advance, and related matters.8 Other relevant
institutions pertain to the political economy of socio-economic arrangements governing
how firms are organised and managed, labour markets, finance/industry relations,
corporate laws, etc.9 Even more fundamentally, institutions are conceived in an
evolutionary approach as social technologies, i.e. the system of norms, beliefs and social
practices shaping the ways of doing things.10
For all these reasons, firms and industry evolution is largely characterised by path
dependence. Capabilities, forms of organisation, market structures and institutions change
over time on the basis of previous history. And in order to understand observed
phenomena at time it is necessary to reconstruct past history.
3.

Rise and growth of the pharmaceutical industry

3.1 The birth of the industry


The pharmaceutical industry was born in the late nineteenth century as a segment of the
nascent chemical sector. The pioneering firms were European chemical companies,
mainly German and Swiss, like Bayer, Hoechst, Ciba, Sandoz, who first entered the
industry exploiting their competencies and knowledge in organic chemicals and dyestuffs
developed in the German institutions of advanced education.11 The club of leaders also
included British and French companies. In the US, the industry began to develop after the
turn of the century. Entrants were firms Eli Lilly, Abbott, Smith Kline, Upjohn, Squibb,
Parke Davis (later merged with Warner-Lambert), Burroughs-Wellcome, Wyeth (i.e.
American Home Products) processing, packaging, marketing and distributing existing
drugs based largely on natural resources. Until World War I the US companies relied on
the technologies provided by the European firms and specialised in two distinct
trajectories. A first group of firms engaged mainly in the production and marketing of their
existing drugs, which were patented and sold over the counter. A second group started to
develop chemically based prescriptions or ethical drugs and to sell them to pharmacists
and doctors.12
Until World War II, the industry was not characterised by intensive R&D: few new
drugs were introduced into the market, the most important innovations being the

668 F. Malerba and L. Orsenigo


introduction of alkaloids, coal tar derivatives and sulfa drugs between 1938 and 1943.13
Conversely, a few firms spent heavily on marketing, enjoying as a consequence a huge
price premium as compared to generics.14
The birth of the modern pharmaceutical industry usually labelled as the Golden
Age effectively took place after the 1940s as the result of different but interacting
events and processes.

3.2 Science and technological opportunities


First, the war crash programmes in penicillin and sulfa provided firms (particularly in the
US and in the UK) with finance, technological and organisational capabilities and
innovative opportunities, initially in antibiotics and then in many other therapeutic areas.
Moreover, from the immediate post-war years scientific medical research began to play an
important role in the process of drug discovery and development. Nearly every
government in the developed world began to support publicly funded health related
research. In the US in particular, public funding of biomedical research increased
dramatically. The National Institute of Health (NIH) became a major actor in the field,
both conducting intramuros research and funding external projects, a large fraction of
which went to universities and towards basic or fundamental science widely disseminated
through the scientific literature.
This explosion of research enormously increased medical knowledge and provided
firms with rich opportunities for innovation. Yet, the understanding of the causes of
diseases and of the mechanisms of action of potential drugs remained poor and the
translation of such knowledge into new drugs was far from automatic. Firms relied on an
empirical and practical approach to drug discovery, which is customarily labelled as
random screening. Thousands of compounds were screened looking for potential
therapeutic activity, with very little a priori knowledge of what could work and why.
In this respect, random screening can be usefully represented as a lottery.15
Unsurprisingly, only a very small fraction of the compounds showed promising potential
and often discovery was the outcome of serendipity. When a lead was identified often
searching for cures for different diseases the molecule was then developed into a
potential drug through lengthy and complex processes of chemical synthesis in order to
optimise safety and efficacy characteristics. The ability to run multiple parallel
experiments on a huge scale,16 the gathering of libraries of potentially useful molecules
and the development of organisational routines governing the R&D process became
crucial capabilities conferring competitive advantages to firms and particularly to large
corporations.17
Despite the random nature of the process of drug discovery, innovation quickly
became the name of the game. On the one hand, since very few effective drugs were in
existence, the space for the discovery of new treatments and cures for most diseases was
simply immense. On the other hand, the discovery of new drugs became a very profitable
business, due to the growth of demand and especially in the US to patent protection.

3.3 Factors sustaining innovation and industry growth: demand and patent protection
A further fundamental pillar of the development of the industry in the US and Europe was
indeed the rapid growth of demand for drugs, driven by population growth, rising living
standards and the vastness of unmet medical needs. The growth of the health care

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669

insurance in the US and of the Welfare State in most European countries further provided a
large, rich and organised market for drugs.
In the US in particular, demand was further sustained by other factors: the sheer size of
the domestic market and the high prices of drugs.
Pharmaceuticals has historically been one of the few industries where patents provide
strong protection against imitation.18 However, most countries the UK and the US being
notable exceptions allowed only for process, rather than product, patents.19
A major turning point occurred however in 1946, when the US Patent Office granted a
patent to streptomycin overturning previous decisions which denied patentability to
antibiotics as naturally occurring substances. Since then, the patent regime in
pharmaceuticals has become increasingly tight, despite recurring debates and
controversies. In addition, imitation, and hence price competition, was made harder by
legislation concerning generic versions of the original product. Until the WaxmanHatch
Act was passed in the US in 1984, generic versions of drugs that had gone off patent
protection still had to undergo extensive human clinical trials before they could be sold in
the US market, so that it might be years before a generic version appeared even once a key
patent had expired. In 1980, generics held only 2% of the US drug market.
Measures to strengthen patent laws in pharmaceuticals spread all over Europe during
this period, but at a highly differentiated pace. France introduced product patents in 1960,
Germany in 1968, Japan in 1976, Switzerland in 1977, Italy, Netherlands and Sweden in
1978, Canada and Denmark in 1983.
In many cases, as in Japan and Italy (and possibly France), the absence of product
patent protection induced firms to avoid product R&D and to concentrate instead on
finding novel processes for making existing molecules. In these countries, the
development of me-too drugs, inventing around and getting licenses from other
companies became the main research activity. In other cases, primarily Germany and
Switzerland, but also in Sweden, the absence of product patent protection did not seem to
produce such negative effects. Similarly, the reforms of patent laws do not appear to have
had a visible and significant impact on the innovative capabilities of industries like the
Italian or the Japanese ones. If anything, they might have had a negative effect, further
weakening national industries mainly composed by generic producers.20
3.4

The take-off

As a consequence, the basis was laid for the transformation of the industry into a highly
innovative, profitable and high-growth sector. Many firms set up large formalised in-house
R&D programmes. In the US, companies like Merck and Pfizer, previously important
suppliers of fine chemicals, entered the drug market through innovation-based strategies.
The rate of innovation started to soar: the R&D to sales ratio rose from 3.7% in 1951 to
5.8% in the 1950s to around 10% in the 1960s, reaching around 15 20% in the 1980s and
afterwards.21
In the following two decades hundreds of new chemical entities (NCEs) and several
important classes of drugs were discovered and introduced, ranging from antibiotics to
antidepressants to diuretics, etc. Correspondingly, the number of new molecular entities
approved by the Food and Drug Administration (FDA) rose steadily from 25 in the period
1940 1949 to 154 in the 1950s to 171 in the 1960s, and reached 264 in 1970s.22
The industry began also to invest heavily in sales efforts and marketing. Whilst, until
the 1930s drugs were sold and advertised mainly directly to patients, subsequent
legislation introduced prescription drugs. In 1929 the latter accounted for 32% of

670 F. Malerba and L. Orsenigo


consumer expenditures. By 1949 this share had increased to 57% and to 83% by 1969.23
Hence, pharmaceutical companies started to contact directly prescribing physicians,
building vast and sophisticated marketing forces. If, until the 1970s two rather distinct
groups of firms the R&D-intensive core and the advertising-intensive segment were
distinguishable, the two trajectories began to converge afterwards, mainly through the
entry in the prescription market by the latter via mergers with the former.
In this period the pharmaceutical industry started also to become truly international.
The high weight of costs sunk in R&D and marketing implied expansion into new markets
in order to reduce average costs. The presence in foreign markets was also often necessary
for complying with local regulation. The largest, highly R&D intensive German, Swiss
and American companies proceeded decisively in their international expansion, also
establishing networks of relations with local firms through licensing and commercialisation agreements.
Within this favourable context, the industry experienced high rates of innovation,
growth and profitability. Rates of growth averaged well above 10% from the 1950s until the
1980s. The profitability of the industry was also high reported rates of return after taxes
were on the order of 21 to 22%. The economic and financial performance of the industry has
remained spectacular until the 1980s and even later it has remained remarkable.
3.5

Patterns of competition and the evolution of market structure

Throughout all its history, the pharmaceutical industry has been characterised by relatively
low levels of concentration, especially when compared to other R&D and marketing intensive
industries. Up until the mid-1990s, no firm had a worldwide market share larger than 4.5%.
The four firm industry concentration ratio (the concentration ratio of the largest four firms in
the industry) (CR4) index was equal to 28% in 1947, 24% in 1967 and 22% in 1987.24
From the outset, this industrys market structure has been characterised by a core of
leading firms and a large fringe of smaller ones. No clearly dominant position has emerged
in the US and in the other large European economies. Within this core of the first 10 20
largest firms around the world, competition is intense; changes in the hierarchy of the
leaders occur but, despite this mobility within the core, the club of the major firms has been
remarkably stable.25 Similarly, entry has not been a significant phenomenon at least until
the biotechnology revolution.
The oligopolistic core of the industry has been composed of the early Swiss and
German firms, joined after World War II by innovative American and British companies.
Many of the leading firms during this period companies such as Roche, Ciba, Hoechst,
Merck, Pfizer, and Lilly had their origins in the pre-R&D era of the industry.
Innovative new drugs arrived quite rarely but after their launch they experienced
extremely high rates of market growth. In turn, this entailed a highly skewed distribution
of the returns on innovation and of product market sizes, as well as of the intra-firm
distribution of sales across products. So, a few blockbusters dominated the product range
of all major firms.26
This picture looks somewhat different, however, at the level of the individual
submarkets or therapeutic categories, such as, for example, cardiovascular,
diuretics, tranquilisers, etc. The largest firms held indeed dominant positions in individual
submarkets. In some of them such as antiviral products the CR4 index was above 80%
in 1995. In many others only two or three drugs accounted for more than 50% of the
market sales.27 Yet, even in submarkets, dominant positions are temporary and
contestable.

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671

Three factors may explain the patterns observed in pharmaceuticals. First, imitation
plays a crucial role. There is little question that large innovative firms enjoyed strong
isolating mechanisms protecting their profits, such as patents and the organisational
capabilities developed by the larger pharmaceutical firms. In addition, under the random
screening paradigm, spillovers of knowledge between firms were relatively small.28 Yet,
innovation and the introduction of really new drugs were only part of the competitive story
in pharmaceuticals. Inventing-around existing molecules, or introducing new
combinations among them, or new ways of delivering them, etc. constitute a major
component of firms innovative activities broadly defined. Thus, firms also competed
through incremental refinements of existing drugs over time, as well as through imitation
after (and sometimes even before) patent protection had expired. Thus, a large fringe of
firms could thrive through commodity production and development of licensed products:
price competition has also always been intense. Indeed many firms did not specialise in
R&D and innovation, but rather in the production and marketing of products invented
elsewhere. This group of firms included not only large companies like Bristol-Myers,
Warner-Lambert, Plough, American Home Products, but also many smaller producers as
well as almost all of the firms in countries like France, Italy, Spain and Japan.
Second, in this industry the innovative process was characterised not only by rich
opportunities but also by high uncertainty and, above all, by the difficulty of leveraging the
results of past innovative efforts into new products. In other words, economies of scope
and cumulativeness of technological advances were limited. Hence, innovative firms have
only limited room for establishing persistent dominant positions. Concentration can still
arise through success-breeds-success processes: an innovative firm enjoying high profits
may have more resources to invest in R&D and therefore higher probabilities to innovate
again as compared to non-innovators. However, to the extent that the probability of
success of any one project is independent from past history, the tendency toward rising
concentration is weakened.
A third crucial factor limiting concentration is the fragmented nature of the
pharmaceutical market. The pharmaceutical market results from the aggregation of many
independent submarkets with little or no substitution between products. Thus, even
monopolistic positions in one submarket do not translate into overall concentration, if the
number of submarkets is large and their size (relative to the overall market) is not too
skewed. As the number of submarkets increases, it becomes more difficult for one firm to
dominate a larger, fragmented market. If the assets and knowledge that are necessary to
gain market shares in one submarket cannot be easily used in different submarkets (as is
the case not only for R&D but also for marketing), there is a high probability that different
firms end up dominating the different niches.

3.6

Regulation in the Golden Age

The spectacular growth of the pharmaceutical industry co-evolved with regulation. There
are, of course, multiple reasons justifying public intervention in the market for drugs.
Many of these reasons can be explained in terms of market failures and standard economic
efficiency.29
The market for drugs is inherently characterised by information asymmetry. Producers
have more information on the quality of drugs than consumers do. Moreover, it is the
prescribing doctor who makes the decision, but even doctors often do not know in detail
the properties of a drug, especially when it is a new one.

672 F. Malerba and L. Orsenigo


Much of the information available to physicians is provided by the companies
themselves. As a consequence, an external assessment of the safety of the drug (and
starting from the early 1960s of its efficacy) may be necessary to prevent damage to the
consumers.
Given the value that users may attribute to the product, especially in extreme cases,
demand elasticity tends to be low. Moreover, most consumers are insured (privately or
publicly) against at least a part of the cost of prescription drugs, so they are only partially
interested in drug prices. The prescribing physicians alike are not completely sensitive to
prices, both because they will not pay for the prescribed drugs, and because the respect of
professional norms makes them more attentive to the safety and therapeutic value of
medicines. Despite their role of scientific experts, however, physicians prescribing
behaviour does not seems immune to other forces, as advertising and brand loyalty, and
seems to follow routine patterns. Thus, producers can try to exploit the asymmetry and the
low demand elasticity by charging higher prices.
A further set of reasons for regulation refers to cost containment. In countries where a
national health service exists or when in any case there is a third payer (typically, an
insurer), demand elasticity to price tends to be lower than it would otherwise have been.
This may lead to price increases by firms enjoying market power. In the absence of
countervailing measures, public expenditures are likely to explode, because neither the
patients nor the physicians ultimately pay for the drug. Thus, the governments may act as
monopsonist and through various instruments tend to reduce drug prices.
In fact, on the supply side, the pharmaceutical industry is inherently characterised by
elements of market power and non-price competition. Patent protection attributes
(temporary) monopoly power to inventors. Advertising reinforce this tendency and it tends
to generate brand loyalty effects and therefore some form of dynamic increasing returns.
Price regulation might therefore be justified as a mechanism to countervail monopolistic
pricing.
A significant part of the knowledge used to produce new, better drugs is generated by
and/or based on publicly funded scientific research, in principle available to everybody
through publication. Thus, pharmaceutical companies are partly subsidised through
publicly funded research. Finally, a fundamental argument for regulation is based on
equity and moral considerations and makes the analysis of the market to a large extent a
social rather than a purely economic issue. Regardless of the different attitudes (across
time and countries) towards the industry and its regulation, the main goal of state
intervention has always been to guarantee the access to safe and efficacious drugs by the
largest possible share of the population.
Thus, the policymaker faces very different and contrasting objectives. The goal of the
efficacy and safety of drugs, and equity in their availability to populations, goes along with
the needs for firms of adequate economic incentives (profits) to induce investment in
research. In recent years, the rise of the issue of the containment of drug expenditures has
added a further dimension to the problem, even in those countries, like the US, where the
health care system is almost completely private.
Governments around the world reacted differently to these trade-offs. First, as already
noted, legislation introduced a sharp distinction between those drugs which could be sold
directly to consumers and those requiring a medical prescription. These changes
introduced opportunities and incentives to firms to engage heavily in R&D and marketing:
the leading firms began quickly to develop both large research laboratories and vast sales
forces interacting directly with physicians. Second, most countries introduced some forms
of price regulation, with Germany, the Netherlands and the US being noticeable

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673

exceptions. Third, since the early 1960s, most countries have steadily increased the
stringency of their drugs approval processes. In the US the 1962 KefauverHarris
Amendments introduced a proof of efficacy requirement for approval of new drugs and
established regulatory controls over the clinical testing of new drug candidates. Despite
the hostility of the industry, the size, costs and stringency of these trials have been
increasing ever since, at least until the mid-1990s and led to substantial increases in R&D
costs and to longer gestation times for NCEs.30 Yet, it has also been argued that the
creation of a stringent drug approval process in the US may have also helped create a
strong competitive pressure favouring really innovative firm strategies, because it
significantly increased barriers to imitation, even after patents expiry.31
4.
4.1

The age of biotechnology and cost containment


A changing landscape

Since the mid-1970s all the factors that had sustained the Golden Age have undergone
fundamental changes. These transformations have created the need for new strategies and
organisational arrangements at the level of firms and industry. But, they have also interacted with
broader changes in the geography of health care and drug production: new countries are now
entering the club of producers and they are expressing not only a powerful economic but also an
especially social and political demand for health care. Let us discuss these changes in turn.
4.2 Science, change in the knowledge base and the biological revolution
Beginning in the early 1970s, the industry began to benefit more directly from the
explosion in public funding for health related research. Progresses in pharmacology,
physiology, enzymology, and biology led to a deeper knowledge about the understanding
of the mechanisms of action of drugs as well as of the diseases. In turn, these advances
opened up the way for new techniques of research, that have been named guided search
and rational drug design, that made it possible for researchers to screen and design
compounds with specific therapeutic effects. Further, advances in DNA technologies and
molecular genetics introduced a profound transformation in the knowledge base and in the
forms of organisation of firms and of the industry as a whole. This revolution has changed,
quite drastically, the competitiveness of individual firms and national industries. Europe,
from a position of dominance, started to lag behind the US.32
The birth date of the so-called biotechnology industry is customarily identified as
1976, when Genentech the first specialised biotechnology company was founded by a
scientist and a venture capitalist. In the following years, the industry bloomed, with
significant investments by the incumbents and, particularly since the early 1980s the
entry of a multitude of new firms. The transformation of the industry followed a model
which was partly inherited by the experience of information technologies. This model was
based on three main pillars: the commercialisation of scientific research, venture capital
and a strong Intellectual Property Rights (IPR) regime.
To begin with, basic research has taken a much more direct economic relevance for
firms as compared to the previous era. Existing corporations had to learn the new relevant
scientific base and to absorb it in their strategies and organisation. To a significant extent,
these processes required the establishment of tighter relationships with universities and
with the new specialised biotechnology firms.33
Second, scientific research started to become a commercial and an entrepreneurial
activity, mainly through the development of technology transfer offices within universities

674 F. Malerba and L. Orsenigo


and the creation of academic spin-offs. The financing of these new companies is largely
based on venture capital and private equity, followed by IPOs and in various cases the
acquisition by large incumbent corporations.
The new biotechnology firms were typically university-spin offs, trying to turn basic
discoveries and techniques into marketable products. However, the new companies did not
displace the old incumbents. Rather, with only a few exceptions like Genentech and Amgen,
most of the new firms became essentially specialised suppliers of specific knowledge to the
large traditional pharmaceutical companies, giving rise to a dense network of alliances and
collaborative relationships and to the development of vibrant markets for technology and
knowledge. Indeed, the new biotechnology firms lacked the essential complementary
assets34 which are necessary for extracting profits from innovation: since vertical
integration in crucial downstream activities (like drug development, product approval by the
regulatory authorities, manufacturing and marketing, etc.) was extremely expensive and
required different specific competences and organisational structures, the new
biotechnology firms were forced to sell their knowledge to larger, vertically integrated firms.
4.3

Intellectual property rights

The development of the biotechnology industry was made possible by radical changes in the
IPR regime. Since the 1980s and in the US, in particular, various actions and court decisions
introduced reforms essentially aimed at saving the cost and time linked to patent procedures;
extending patent duration for some classes of products, most notably drugs; and
encouraging non-profit research institutions to patent and market technologies developed
with public funding. Moreover, a series of court cases in the mid-1990s overturned previous
practices, granting patents on upstream research and significantly extending patents scope,
even to cases where the practical application of the patented invention had not been clearly
demonstrated: the Bayh-Dole (1980) which facilitated the patenting and licensing of the
results of publicly funded research; the US Supreme Court rule (1980) in favour of granting
patent protection to living organisms (Diamond v. Chakrabarty); the newly established
Court of Appeals for the Federal Circuit (CAFC) supported the equivalents doctrine,
through which inventors were protected not only from imitative products and processes, but
also from those substantially similar. In addition during the 1980s the doctrine of utility by
which the practical and commercial utility of an invention should be clearly demonstrated
for the patent to be granted was substantially weakened.35
Finally, the adoption of Agreement on Trade-Related Aspects of Intellectual Property
Rights (TRIPS) in 1994 extended and homogenised patent protection in all countries
participating in the World Trade Organization (WTO). With specific reference to drugs,
the patentability of molecules became mandatory in all member countries, and the length
of patent protection was extended to 20 years. In addition to TRIPS, bilateral and regional
free trade agreements between the US, Europe and developing countries are introducing
further restrictions, such as requirements to extend the patent term, provisions preventing
marketing approval of a generic drug during the patent term without, the consent of the
patent holder and protection of test data submitted to regulatory agencies for marketing
approval through exclusive rights lasting at least five years
4.4 From the Welfare State to cost containment
As the scientific revolution and the IPR regime were beginning to transform the industry,
the levels and structure of demand also started to change. In the OECD countries, the real

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675

total pharmaceutical expenditure (in constant terms) grew at an average yearly rate of
3.5% in the 1980s and 4.6% from 1990 to 1996, on average 1.5% more than GDP growth
since the 1970s. Other factors, related to increasing prices of drugs and aging population,
contributed also to the rise of expenditures. Increasing pharmaceutical expenditure
implied growing pressure on public outlays. In a period characterised by mounting
concerns over budget deficits and over the extension of public intervention in the
economy, pharmaceutical expenditures became a primary target for expense reduction.
Criticism was directed also towards the inefficiencies that are generated by excessive
public coverage of drug expenditure and by command-and control measures like the
various forms of price controls.
Cost-containment considerations led to profound restructuring in the organisation of
the health systems. In many instances, these policies have implied the introduction of more
market-oriented forms of accounting, incentives and organisational structures. The
approaches towards cost-containment differ substantially across countries and over time.
However, a common trend is discernible towards the increasing use of policies aiming at
intervening on the demand side of the market to make patients and health providers
(doctors and pharmacists) more price conscious and more price sensitive, without or
irrespective of direct price controls.36 Moreover, price controls began to move away from
cost-plus based systems and to converge towards systems of reference pricing. Especially
in the US these developments were marked also by the appearance of new actors e.g.
the managed care organisations which induced a deep transformation in the structure
of the distribution system and more generally in the demand behaviour of the consumers,
by strengthening their bargaining position vis-a`-vis producers and integrating previously
fragmented purchasing decisions.
Finally, a crucial development was the introduction of legislation favouring the
diffusion and the opening of the market for generics. The introduction of the WaxmanHatch Act in 1984 significantly reduced the safety control procedures for generic drug bioequivalent to branded products and allowed pharmacist to sell equivalent generics instead
of branded products prescribed by doctors. Today generics are estimated to account for
more than 50% of drugs prescribed (in volume) and around 10% in terms of value.

5.
5.1

The Winter of Discontent (?)


From hype to disappointment

In the 1990s pharmaceuticals showed high economic and financial performances.


The industry enjoyed also a remarkable reputation in the eyes of the markets,
policymakers and the people at large. Yet, the turn of the century marked a drastic change
in these perspectives. Declining innovativeness casts growing doubts about the
sustainability of the business model that sustained pharmaceuticals so far. Public
perception also underwent a drastic reversal, as a consequence of episodes of withdrawals
from the market of highly successful drugs and by disputes over intellectual property
rights and the prices of drugs.

5.2 The debate on IPRs and access to health care


A primary source of this climate change was a growing concern with the recent evolution
of the patent system and more generally with access to health in both developing
countries and in the US.

676 F. Malerba and L. Orsenigo


In poorer countries the attempts at enforcing more strictly patent laws and the TRIPS
agreements stimulated a counter-reaction. The HIV/AIDS pandemics in the Third World
had brought to extreme levels the costs paid for obtaining medicines. Attempts at
impeding actions by governments for circumventing patent laws and hence very high
prices were fiercely opposed by the big American and European producers. For example,
the Pretoria trial in 2001 brought to the attention of the world the notion that the system
governing the access to medicine for poor people in poor countries was deeply flawed
because research and production concentrates on drugs that serve rich markets at the
expense of neglected diseases which hit disproportionately countries and people who
cannot afford to pay for them and because prices remain high also for off-patent drugs.
The TRIPS and, even more so, the signing of bilateral trade agreements, have
worsened the situation. It is now widely recognised that the adoption of a homogeneous,
tight IPR regime worldwide has no (or even a negative37) impact on domestic innovation
and strong negative consequences on prices and access to drugs.38
In addition, health has recently become a social and political priority in most countries,
as a consequence of either or both economic growth in emerging economies and
persistence of health emergencies in the poorer parts of the world. Against this context,
since the 1990s, a striking range of initiatives have been launched to cope with this
dramatic situation, including the foundation of new large scale charities like the Bill and
Melinda Gates Foundation, new programmes by international institutions like the World
Health Organisation, public and private partnerships of all sorts, etc. These changes are
widely perceived to have important, even if as yet not fully understood, consequences on
the ability to produce and distribute effective and affordable medicines and vaccines.
However, the debate on access to health also raged in the US. The reform of the US
health care system has been a major political issue in the last decade, before and after the
approval of Obamas plan. A discussion of this aspect goes beyond the scope of this
article.
Another related debate concerned the evolution of the IPRs system. Here the crux of
the debate had to do not so much with the role of patents as incentives to innovative
activities but with the benefits and costs of an interpretation and application of patents laws
which drastically extended the level and scope of protection as compared to the Golden
Age. On the one hand it has been argued that strong and wide patent protection is
beneficial as a mechanism for inducing the development and commercialisation of
inventions and for creating markets for technologies.39 Markets for technology would
promote efficient division of innovative labour insofar as drug discovery is not confined
any longer to the laboratories of few giant corporations, but new techniques and new drugs
can be discovered by a much larger pool of independent inventors and each type of firm
can focus on their comparative advantage (i.e. discovery vs development).40
On the other hand, serious worries have been raised that the diffusion of an excessively
permissive patenting regime might actually slow down the process of diffusion and
circulation of knowledge and hence the rate of technological advance. This might be the
case especially in the case of publicly funded research and when broad patents are granted
to basic fundamental research and research techniques. In addition, the strategic use of
(broad and seminal) patents has become the norm, especially for blocking new areas of
research by potential competitors. Excessive fragmentation of property rights may also
make it difficult to gather all the inputs and techniques necessary for pursuing a new
research project (the so-called anti-commons problem).41 Moreover several observers
have argued that this trend can end up seriously undermining the norms and rules of open
science which has so far played a crucial role in opening up new possibilities of major

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677

technological advances in biomedical research.42 More generally, litigation appears to be a


distinct feature of the new biotechnology and pharmaceutical industries and IPR experts
have become crucial components of firms human resources and competencies.
5.3 The decline in research productivity: the demise of Big Pharma?
Whatever the role played by IPRs, in the early 2000s increasing doubts began to arise
about the innovative performance of the industry and the very efficiency of its traditional
business models.
As the big companies were managing to absorb the biotechnology revolution, scientific
and technological progress continued to provide spectacular advances. In the 1980s new
products were successfully brought to the market, including large molecules like growth
hormone, insulin and clotting factor VIII developed by the biotech firms. In the 1990s, the
advent of the so-called platform technologies (combinatorial chemistry, high-throughput
screening and computational chemistry) led to what has been termed industrialised
R&D,43 offering the potential to understand and identify much more precisely the causes
of diseases, to create new compounds, to screen them much more efficiently and to design
rationally drugs with specific effects. Further progress in the various -omics (genomics,
proteomics, etc.), bioinformatics, synthetic and structural biology, and so forth were
continuously adding new frontiers to innovation.
Given the rate of scientific and technological progress, large corporations realised that
they could not rely solely on their internal knowledge to discover and develop new drugs.
The prospect of the expiration of most key patents in the coming decade, coupled with
strengthening competition from the generic segment, put pressure on attempts to discover
and develop new blockbusters. Big companies reacted to this challenge first through a
wave of mergers and acquisitions. Second, as already mentioned, they increasingly started
to rely on small biotech companies and academia for new molecules and research
techniques, through licenses and collaboration agreements. By the end of the decade, it
was estimated that around one third of the molecules in clinical development originated in
the biotechnology sector. But vertical disintegration was not limited to basic, preclinical
research. Increasingly, clinical trials were outsourced to specialised suppliers.
Despite these changes, the hierarchy of leading firms and the degree of market
concentration changed but little. Indeed, the factors that had so far limited concentration
were not radically transformed. Fragmentation remains a structural feature of the drugs
market and despite the scientific advances pharmaceutical research is still (almost) blind,
difficult to cumulate and to extend to different pathologies and products.
Contrary to expectations, the productivity of pharmaceutical R&D was not only not
improving but actually decreasing. The cost of bringing a drug to the market had been
rising dramatically, reaching more than $1bn.44 But, during the period 1978 2003,
research productivity measured by the number of patents per dollar of R&D expenditure,
actually fell. The number of NCEs approved by the FDA in the US during the period
1983 2003 showed an increase until the mid 1990s, but a sharp decline afterwards.
In 2002, US R&D expenditures in pharmaceuticals were 30 times greater than in the early
1980s, while roughly the same number of drugs were approved annually.
These observations triggered serious and widespread concerns. First, it was often
suggested that pharmaceutical companies had moved away from truly innovative research,
not only by increasingly outsourcing pre-clinical R&D but also concentrating on the
development of me-too-drugs and minor improvements upon existing products. Second,
there is considerable disagreement about the seriousness and the causes of the decline in

678 F. Malerba and L. Orsenigo


pharmaceutical R&D productivity. Some interpretations are relatively optimistic,
emphasising that the production of new drugs is characterised by strong cyclical
components. Regulation is also often blamed for rising costs and dwindling productivity.
Yet, substantial progress has also been achieved in shortening development times on the
regulatory side. While certainly much remains to be done in increasing the efficiency of
the regulatory process, a key issue remains that pre-clinical times have increased and
success rates are too low.
5.4.

The biotechnology paradox

Another interpretation suggests that the decline in productivity could be the outcome of an
intrinsic difficulty in discovering new drugs for increasingly complex pathologies: the low
hanging fruits have already been picked and now the challenge becomes harder.45 In this
respect, the stagnation in innovative output would be the outcome of an incumbent
maturity of the industry,46 characterised by a fall in innovative opportunities a little
like the mature phase in the life cycle of such industries as steel or automobiles.
Still, characterising pharmaceuticals as a mature industry looks awkward in the face of
the tremendous pace of scientific and technological progress. Nightingale and Mahdi
suggest that the biotechnology revolution has not, in fact, increased the productivity of
R&D because of the inability of drug firms to keep pace with the increased intrinsic
complexity of the biochemical problems that innovative search is addressing.47 Moreover,
the new science is still largely in its infancy.
In this respect, also, the biotechnology segment does not show a remarkable
performance. Hence, some perplexity has arisen concerning the efficiency not only of the
Big Pharma business model, but also of the structure and organisation of the
biotechnology industry. Ever since its inception, the model that sustained the emergence
of biotechnology in the US became extremely influential around the world, both in terms
of firm strategies and in terms of policymaking. Such a model has attracted innumerable
attempts at replication in almost all countries and regions in the world, trying to foster the
development of the biotechnology industry and of the local economy by promoting
scientific entrepreneurship, technology transfer, venture capital and tighter patent
legislations.
However, it has proved remarkably difficult to replicate this model outside the US and
more precisely outside the main regional American biotechnology clusters like the Boston
Area and California (San Francisco and Dan Diego); Cambridge, UK, is perhaps the only
major exception. It now well understood that the US model rests itself on a set of
institutional specificities which are by and large unique to the US context. They range from
the nature of the university system, to the markets for skilled labour, to the patterns of
corporate governance, to the structure of financial institutions, etc.48
Yet, while these institutional factors are certainly crucial, other variables may have
been equally or even more important. First, the sheer scale and scope of research:
overwhelming evidence indicates that absolute excellence in scientific research spanning a
differentiated spectrum of areas as well as integration along the horizontal and vertical
dimensions of the innovative process are crucial ingredients for the development of
biotechnology. Without these capabilities, the role of other factors appears to be ancillary.
Second, the American superiority in the life sciences derives to a significant extent from
the enormous amount of public funding to biomedical research.49
Not only has the replication of the American model been difficult outside the US,
increasingly it is questioned whether it is actually efficient.50 The new breed of

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679

biotechnology firms have failed to displace the old incumbents and only a tiny fraction of
biotech companies (Genentech, Amgen, Genzyme, Biogen Idec) have ever been profitable
or even able to produce positive cash flows. The few successful companies are typically
early entrants in the industry and their business model is quite different from what was
conceived as the hallmark of the new dedicated biotechnology firm: they have
transformed themselves into quasi-conventional pharmaceutical companies, vertically
integrated into manufacturing and marketing. Moreover, a very large fraction of the profits
come from orphan drugs designations, a market segment where many biotechnology firms
have specialised.51 Even the stock market performance of the industry does not appear to
be so spectacular (especially as compared to initial expectations) when risk and volatility
are adequately considered52
Also the technological impact of the biotechnology sector on pharmaceutical research
is less brilliant than it is commonly perceived. As Pisano shows, the average R&D cost per
new drug launched by a biotechnology firm is not significantly different from the average
cost per new drug launched by a major pharmaceutical company.53 Nor has the number of
compounds that make it to human clinical testing, let alone into the market, substantially
increased. In sum, it would appear that the biotechnology and genomic revolutions have
not yet substantially modified the intrinsically uncertain nature of the process of drug
discovery and development. Despite the spectacular scientific advances, our understanding of the causes of diseases and of the mechanisms of action of drugs remains poor
and innovation in this industry is still largely a random phenomenon. Thus, Pisano argues
that the organisation of the biotechnology industry in inherently flawed.54 Differently from
the earlier cases of semiconductors and software, the business of the new biotech firms is
not simply to provide and commercialise new technological advancements, but to achieve
scientific breakthroughs. In this view, the current structure of the industry is ill-suited to
cope with deep uncertainty, the need to integrate different highly specialised disciplines
and fragments of knowledge and to promote cumulative, collective learning.
As noted earlier, the current IPR regime does not promote easy circulation of
knowledge and cumulative innovation. Similarly, venture capital and the equity market
can only partially support the long time horizons implied by the extremely risky and
uncertain projects typical of pharmaceutical research. Perhaps, the enormous risks
involved in this kind of research can be more effectively managed by more long-term
oriented investment, less dependent on the creation of high expectations based on highly
incomplete information.55
Moreover, the process of vertical disintegration and specialisation might have gone too
far. There are undoubtedly great benefits coming from division of innovative labour
between companies specialised in the exploration phase and larger organisations
controlling the complementary assets necessary for the development and marketing of the
potential new products (the exploitation stage).56 Yet, the very process of
industrialisation of pharmaceutical R&D, with high fixed costs of drug discovery and
experimentation, raises the economic benefits and the need to integrate and cumulate
highly specialised, multidisciplinary knowledge.57 In this respect, biotech companies are
probably too small and too specialised to allow for the extraction of the full potential
offered by the progress of science. In other words, increasing division of labour has created
the need for stronger integration of knowledge. As it had happened in other industries,
however, deepening division of labour raises the risk that large firms progressively lose
their innovative capacities, and even their absorptive capabilities. Should this happen,
the large established pharmaceutical companies might become essentially marketingbased organisations, the function of which is to conduct clinical trials, get approval for the

680 F. Malerba and L. Orsenigo


products, and sell them. But the question remains whether innovative products can be
discovered and developed by small, highly specialised and often transient organisations.
6.
6.1

Conclusion
Pharmaceuticals: A mature industry or the maturation of a new paradigm?

The performance of pharmaceuticals has been remarkable in every respect, particularly as


it concerns innovativeness and profitability. Today many of the pillars which have
sustained the tremendous growth of the industry seem to be weakening. First, strictly
binding public budget constraints may hinder the growth of demand at a time when health
has become more than ever a fundamental issue defining what a decent society should be
in poorer as well as in richer countries. Second, science and technology have not yet
delivered their promises and the organisational structure of firms and of the industry as a
whole looks less efficient than previously thought. Firms are experimenting with new
business models, strategies and forms of organisation, but no clear solution has yet
appeared. The third pillar was a reasonable IPR system, which granted profits to
innovators, but preserved the public nature of knowledge, especially basic research
findings and techniques. This system in now under threat.
A further crucial transformation of the pharmaceutical industry is related to the entry
of new countries in the competitive arena. Thanks to the absence of patent protection,
India had developed since the 1980s a vibrant generics industry, exporting drugs at low
prices in developing countries and becoming the pharmacy of the third world. Other
countries Thailand, Brazil have achieved in recent years significant manufacturing
capabilities. China is predicted to become a very significant player in the near future and
many other less developed countries are contemplating the idea of supporting the
development of domestic capabilities in the production of essential drugs.
Fifth, controversies continue to characterise the industry. Given the extreme economic,
political, and ethical trade-offs that are inherent in the very nature of pharmaceuticals, they
are here to stay and will not easily disappear.
In all these respects, it is tempting to interpret the past and current evolution as
processes of painstaking co-evolution of technology, organisations and institutions. New
technological paradigms like the current biological revolution take time to establish
themselves, and their diffusion into the economy requires concomitant changes in the
whole organisational and institutional structure of the economy.58 As happened with
electricity, cars, and the PC, it might take decades for the new products to be developed
and adopted by businesses, consumers, regulators and policymakers.
6.2. An evolutionary tale
For these reasons, we believe that the history of pharmaceutical is really an evolutionary
tale.
In the introductory sections to this article, we suggested ex ante a few reasons why an
evolutionary approach might be useful in interpreting the history of the pharmaceutical
industry. We hope that our overview of the birth, development and perhaps decline of
pharmaceuticals justifies this claim ex post. Here, we try to summarise ex post the more
salient evolutionary traits of our interpretation of the evolution of pharmaceuticals and to
provide a tentative, preliminary answer to the questions: what can an evolutionary perspective
offer to historians and to business historians in particular as distinct from other possible
approaches? And what can historians offer in reverse to an evolutionary perspective?

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6.3 The objects of the analysis


An immediate, simplistic answer might be that an evolutionary approach as any theory
offers a specific way to identify and organise relevant historical events and observed facts.
Second, it suggests specific causal mechanisms which might have led to those events.
In the case of pharmaceuticals, our attention has focused first on how different
typologies of firms and one dominant form Big Pharma have emerged, coexisted with
other business models and perhaps declined, for almost a century. Second, we have looked
at how the structure of the market has been forming, consolidating and transforming.
These objects of the analysis are not, as such, distinctive of an evolutionary approach. But
the emphasis on change probably is, at least in contrast to competing economic theories.
More to the point, it is the properties by which we look at the objects of analysis that
characterise an evolutionary approach: e.g. firms as repositories of knowledge, routinebased behaviour, innovation, dynamic competition, and so on.
Thus, as was discussed in the previous historical account, the dominant business model
in pharmaceuticals Big Pharma emerged in the post-War World II years as a
specialised offspring of the chemical industry, driven by new technological opportunities
in the drug market. The random nature of the innovative process allowed large
corporations to diversify into several product submarkets and at the same time induced
vertical integration as a response to the need to integrate and control all the phases of the
productive process from drug discovery, to development and clinical trials, to production
and marketing (and finance). Yet, Big Pharma coexisted with smaller imitators and local
producers which lacked the technological, organisational and financial capabilities
necessary for further expansion. The biotechnology revolution introduced a new
knowledge base and made relevant different sets of capabilities. New firms entered the
market, but only a handful of them were able to develop and integrate the requisite
capabilities for entering the drug market. As incumbents were struggling with the process
of learning and adaptation to the new knowledge, (partial) vertical specialisation became a
distinctive feature of the industry and remained so thereafter, despite the widespread
feeling that such an organisational architecture is far from optimal.
6.4 Causal mechanisms
The very definition of the objects of analysis and of the relevant facts leads to hypotheses
about the causal processes that led to observed facts and events. Our emphasis has been
placed on the nature of the innovative process (from random screening to the molecular
biology revolution), on the details of market competition, on the regulations governing
prices, product approval, reimbursement policies, etc. In particular, we have stressed how
market selection and learning processes within firms have led to the growth of a relatively
small club of very large, dominant corporations. Industry leadership did not emerge
simply by one firm outspending competitors in R&D or marketing. It matured over time as
a consequence of sets of complementary actions, and luck.
Remarkably, these events had long-lasting effects. First mover advantages were
critical in determining firms fortunes at all stages of the history of pharmaceuticals: in the
formative years, at the outset the Golden Age and at the time of the biological revolution.
A few companies emerged as dominant already in the early years and they have been able
to preserve and, in some instances, to reinforce their position despite all the dramatic
transformation of the industry and of the whole world around them. In this respect,
path-dependency appears to be an important property of the evolution of firms and of the
industry as a whole. Whereas often, path-dependent processes triggered by increasing

682 F. Malerba and L. Orsenigo


returns linked to economies of scale and scope, innovation, marketing, etc. have only a few
winners, in pharmaceuticals the emergence of concentration has been limited by the
almost blind character of the processes of discovery and by the fragmented nature of the
drugs market, i.e. by the nature of the technological and demand regimes.
Our analysis has also tried to highlight the complex co-evolution of behaviours,
technology, market processes and institutions. The history of pharmaceuticals is
characterised by a complex blend of continuity and discontinuities, incremental and
radical change. Throughout its history, the pharmaceutical industry has experienced deep
transformations in the scientific and technological domain, in the political and regulatory
environment, in public perception, in the organisation of firms and markets. Facing deep
uncertainty, diverse actors have reacted to these transformations developing
heterogeneous behaviour, strategies and forms of organisation. Firms but also
consumers and other institutional actors have been able to gradually learn their way,
introducing innovations in their products and ways of doing things. Firms have also
actively attempted to change consumer behaviour through marketing and also regulation
and legislation through lobbying and political pressure. In a few instances some of these
agents have even anticipated and triggered further change. In other cases, adjustment has
been quite rapid. In most occasions e.g. the biotechnology revolution, changes in
regulation, public policies and IPR legislation adaptation has been painful and timeconsuming. In all cases, the influence of technological, political and social variables has
been so important to suggest that pure economic logic cannot explain exhaustively
industry evolution. Certainly, economic factors have also deeply impacted on policies,
institutions and technological change, prompting further change and adaptation. But,
economic motivations, institutional and political processes, as well as scientific and
technological dynamics have also followed their intrinsic and autonomous trajectories.
Thus, the patterns of change of the strategies and organisational structures of firms
and of the industry as a whole are not the result of an intelligent, grandiose ex ante
design or coherent rational planning, but the product of myopic but sometimes innovative
decisions and actions of heterogeneous actors facing multiple and multifaceted challenges.
6.5

From history to theory and back again

In sum, we believe that business history and evolutionary theory have a lot to offer to each
other. History offers first the facts and the evidence which theory must try to explain.
An evolutionary explanation is historical in nature, as it focuses precisely on change and
on causal processes that unfold over time. In evolutionary theory, history matters because
in most cases the explanation of observed facts requires the reconstruction of previous
facts and behaviours.
In reverse, an evolutionary theory offers to historians a conceptual framework for the
interpretation of those facts. Such a framework can originate more specific interpretations
of particular historical phenomena like the evolution of the pharmaceutical industry and
other industrial sectors. These interpretations can be also formally modelled, with the aim
of checking the consistency of the proposed explanations. This is what some of us have
been engaging by developing so-called history friendly models of the evolution of
industries.59 Inevitably the modelling efforts end up calling for more and deeper historical
analysis.
Disclosure statement
No potential conflict of interest was reported by the author(s).

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Notes
1.
2.

3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.

20.
21.
22.
23.
24.

25.
26.
27.
28.
29.
30.

We thank two anonymous referees, whose remarks greatly improved our article.
For a detailed discussion of the evolution of the pharmaceutical sector see, among others,
Pisano, The Development Factory; Henderson, Orsenigo, and Pisano, The Pharamceutical
Industry; Malerba and Orsenigo, Innovation; Sutton, Technology; Pammolli, Innovazione;
Grabowski and Vernon, 1994 and Innovation; Chandler, Scale and Scope and Shaping;
Galambos and Sewell, Network; Galambos and Sturchio, The Pharmaceutical Industry and
Pharmaceutical Firms; Gambardella, Science and Innovation.
Nelson and Winter, An Evolutionary Theory; Dosi and Nelson, Technical Change.
Dosi, 1982.
Bresnahan, Greenstein, and Henderson, Schumpeterian Competition.
Jacobides and Winter, Capabilities.
Breschi, Malerba, and Orsenigo, Technological Regime; Malerba F. Nelson R. Orsenigo L.
Winter S., 2016.
Freeman and Louc a, 2001; Lundvall, 1992; Nelson, 1993.
Nelson, 2006; Freeman, 2008; Hodgson, 1999.
Nelson and Sampat, 2001.
Murmann, Knowledge.
Chandler, Shaping.
Sutton, Technology.
Temin, Technology; Sutton, Technology.
Sutton, Technology; Gambardella, Science and Innovation.
Nelson, Uncertainty.
Pisano, The Development Factory; Henderson et al., The Pharmaceutical Industry.
Levin, R. Klevorick, A. Nelson R. and Winter S., 1987.;
According to Murmann (Knowledge) this did not represented an obstacle to the establishment of
the German dominance in chemicals and in pharmaceuticals before World War II. The concession
of strong product patents early on in the history of the British industry prevented the entry of new
firms and gave to few companies monopoly profits without having to develop strong competitive
capabilities. Moreover, frequent and costly litigation over patents among British firms further
weakened them. Conversely, the German system allowed the industry not simply individual
monopolists to grow and to build such competencies, also exploiting the ample possibilities of
infringing British patents. As the German industry established itself as the world leader in
chemicals, the domestic patent regime began to act as a reinforcing mechanism, providing further
incentives to innovate especially as it concerned processes and to build systematic R&D
efforts. The existence of a strong technical and scientific base and the development of technical
societies made it also possible for the patent regime to work in the interests of the industry. Indeed,
the German industry was very active in eliciting changes in legislation and in actually creating an
appropriability regime favourable to the industry itself. Conversely, in the British case the weaker
technical and scientific background on the one hand and the relative fragility of the domestic
industry on the other made it more difficult to design and impose a robust patent regime.
Scherer and Weisburst, Economic Effects.
Chetley, A Healthy Business?; Ballance, The Worlds Pharmaceutical Industries, cited in
Sutton, Technology; Inside Biotechnology & Pharmaceuticals, 1992.
Lichtenberg, 2006.
Chandler, Shaping.
Sutton, Technology; Over the last decade concentration has been increasing, despite the entry
of the new biotechnology firms and the expansion of the generic segment of the industry,
mainly as a consequence of mergers and acquisitions. Yet, in 2004, the largest pharmaceutical
firm held a world market share close to 10% and the CR5 concentration ratio was around 1/3 in
the US and in the EU, i.e. still denoting relatively low concentration.
Pammolli, Innovazione.
Matraves, Market Structure; Sutton, Technology.
Chong, Crowell, and Kend, Merck.
Pisano, The Development Factory; Henderson et al., The Pharmaceutical Industry.
See Comanor, The Political Economy and Scherer, The Pharmaceutical Industry, for
excellent reviews of these issues.
See for instance Chien, Issues; Peltzman, Regulation; Comanor, The Political Economy.

684 F. Malerba and L. Orsenigo


31.
32.
33.
34.
35.
36.
37.
38.
39.
40.
41.
42.
43.
44.
45.
46.
47.
48.
49.

50.
51.
52.
53.
54.
55.
56.
57.
58.
59.

Thomas, Implicit Industrial Policy.


Orsenigo, The Emergence; Gambardella, Science and Innovation; Henderson et al., The
Pharmaceutical Industry; Gambardella, Orsenigo, and Pammolli, Global Competitiveness.
Cockburn and Henderson, Scale and Scope.
Teece, Profiting.
Merges and Nelson, On Limiting; Coriat, Orsi, and dAlameida, TRIPS.
This type of measures include various forms of co-payment, the use of formularies and other
interventions attempting at changing the behaviour of providers through financial incentives
and penalties.
Qian, Do National.
In 2001 the Doha Declaration on TRIPS and Public Health explicitly acknowledged that IPR
can damage public health through their effect on the price of drugs and it affirmed the right of
countries to interpret and apply the TRIPS in the best way to protect public health.
Arora, Forfuri, and Gambardella, Markets for Technology.
Arora et al., Markets for Technology.
For example, Mazzoleni and Nelson, Economic Theories; Heller and Eisenberg,
Can Patents Deter.
For example, Dasgupta and David, The New Economics; Merges and Nelson,
On Limiting.
Pisano, Science Business.
Di Masi, Hansen, and Grabowski, The Price.
Pammolli, Magazzini, and Riccaboni, The Productivity.
Nightingale and Martin, The Myth.
Nightingale and Madhi, The Evolution.
McKelvey, Orsenigo, and Pammolli, Pharmaceuticals.
Lazonick and Tulum (US Biopharmaceutical Finance) calculate that from 1978 through 2004,
NIH spending on life sciences research totalled $365 billion in 2004 dollars, providing a
continuously growing and stable flow of funds to biomedical research. Thus, they argue that
through the NIH, the US government has long been the nations (and the worlds) most important
investor in knowledge creation in the medical fields, creating the indispensable knowledge base
which further allowed venture capital and public equity funds to flow into biotech.
Pisano, Science Business.
Lazonick and Tulum, US Biopharmaceutical Finance.
Pisano, Science Business.
Pisano, Science Business.
Pisano, Science Business.
Pisano, Science Business; Nightingale and Madhi, The Evolution.
Arora, A., Fosfuri, A., and Gambardella, A., 2004.
Pisano, Science Business.
Freeman, The National Systems; David, The Dynamo.
Malerba, Nelson, Orsenigo, and Winter, History-friendly Models and Malerba, F. Nelson,
R., Orsenigo, L. Winter, S., 2008; Malerba and Orsenigo, Innovation; Garavaglia, Malerba,
Orsenigo, and Pezzoni, Technological Regimes and 2012.

Notes on contributors
Franco Malerba is a professor of Applied Economics at the Department of Management and
Technology at Bocconi University, Milan and President of CRIOS (Center on Innovation,
Organization and Strategy), Bocconi University.
Luigi Orsenigo is a professor of Applied Economics at the Institute for Advanced Studies at the
University of Pavia and Fellow of CRIOS (Center on Innovation, Organization and Strategy) at
Bocconi University.

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