ENTREPRENEURSHIP & REGIONAL DEVELOPMENT, 13 (2001), 1-16

Closing the innovative loop: moving from thelaboratory to the shop floor in biotechnologymanufacturing

MARYANN P. FELDMAN and CYNTHIA R. RONZIOInstitute for Policy Studies, Johns Hopkins University, Fifth Floor WymanPark Building, 3400 North Charles Street, Baltimore, Maryland 21218, USA;tel. 410 516 8324

Innovation is a hallmark of successful technology-intensive start-up companies. This paperconsiders manufacturing as a knowledge-generating activity integral to product innovation inentrepreneurial biotechnology firms. The model of the virtual corporation has been advocatedas a means to focus on the resources of start-up companies; yet regional specialization intechnical applications and product categories suggests that manufacturing may be a knowl-edge-generating activity that can provide a potential source of regional advantage. This paperconsiders the manufacturing strategies that bio-entrepreneurs would like to pursue and exploresbarriers to forward integration. While capital constraints may force firms to licence and sub-contract manufacturing, it was found that entrepreneurs believe that it is important to under-take manufacturing and, when they are financially able, they invest in manufacturing facilities.The authors conclude by providing a framework for considering when it might be most appro-priate for biotechnology firms to invest in manufacturing.

Keywords: biotechnology; strategic alliances; bio-manufacturing; regional specialization; virtualcorporations.

1. Introduction

A common theme of research in the emerging field of biotechnology focuses on stra-tegic alliances between small entrepreneurial start-ups and larger, more advancedfirms (Hamilton et al. 1990, Pisano 1990, 1991, Toedtling 1994, Greis et al. 1995,Pisano and Wheelwright 1995, Deeds and Hill 1996). There are certainly benefitsto the small start-up in strategic alliances. First and foremost, alliances can providestart-ups with much needed revenue while avoiding the need to raise capital toexpand operations. In addition, alliances provide access to specialized resourcessuch as manufacturing facilities or marketing expertise that are typically beyondthe means of small firms. Most critically, strategic alliances based on outsourcingmanufacturing and marketing are perceived to provide an attractive means forsmall firms to focus resources on research and development (R&D), their perceivedcompetitive advantage (Lee and Burrill 1995, 1996). The trend toward outsourcingmanufacturing has been mutually beneficial to the early stage of development ofbiotechnology firms and has complemented the excess production capacity in largepharmaceutical firms (Gray and Parker 1998). Under this model, biotechnology firmsdevelop as virtual corporations: owning few assets and outsourcing all activities exceptproduct R&D.

Entrepreneurship and Regionat Devetopment ISSN 0898-5626 print/ISSN 1464-5114 online © 2001 Taylor & Francis Ltdhttp://www.tandf.co.uk/journals

DOL 10.1080/08985620010005484

I M. P. FELDMAN AND C. R. RONZIO

In contrast to the prevailing wisdom, however, entrepreneurs in biotechnologyfirms express a desire to become fully integrated entities and, specifically, to scale-up in order to control their own manufacturing.' Strategic alliances, especially inmanufacturing, may not be the best long-run strategy owing to the specific andspecialized nature of the production processes. Manufacturing, in the form of eitherscaled-up processes or large-scale production, can be a source of commercially valu-able knowledge that may become an integral component of a company's competitiveadvantage (Pisano and Wheelwright 1995).

In this paper, it is argued that bio-manufacturing is in itself a knowledge-generatingactivity: techniques and processes are unique to biotechnology's sub-fields. While theterm biotechnology is used to describe an industry, in reality it is a set of manydiflFerent technologies based on genetic engineering.^ Each sub-category requiresunique and differentiated capabilities. Using data from the Institute forBiotechnology Information (IBI) company database, significant evidence of geo-graphic specialization was found. This suggests that the industry is developing distinctspecializations that reflect the science base of the local innovative infrastructure.Certainly, much of this activity is fundamentally different from the chemical basisof large pharmaceutical companies. Regional technological specialization suggeststhat outsourcing, to the extent that it is likely to occur at the site of existing capacity,may minimize a valuable source of knowledge-generating activity early in the lifecycle of the industry.

This paper contrasts the models of the virtual corporations with vertical integration,focusing specifically on bio-manufacturing in the context of the industry's emerginggeographic specialization. The authors discuss the costs and benefits of the virtualcorporate model compared to forward integration into manufacturing from the per-spective of the small, entrepreneurial start-up.

There are substantial barriers to forward integration given the early stage of theindustry's development. While some have argued that biotechnology start-ups shouldfocus on R&D because it is what they do 'best', the authors argue that R&D is theprimary activity at the current early stage of the industry's life cycle. The R&D focusmerely reflects the stage of the industry's development and should not be normativelyunderstood as an identifying hallmark of the biotechnology industry. There are cur-rently only 117 biotechnologically-derived products on the market.* The majority ofcompanies are too young to have products close to the market and have not yet faced amanufacturing decision. Many of those who have approved products lacked the capi-tal resources to invest in specialized facilities. The paper concludes by providing aframework for considering when investing in manufacturing might be an appropriatestrategy for the firm.

2. Geographic specialization in biotechnology

The term biotechnology is used to describe an entire industry; however, there is greatvariety in underlying technology and product segments. To explore regional specia-lization, biotechnology products and processes are analysed by state in tables 1 and 2.For this analysis, a national database of biotechnology companies compiled by the IBIwas used. IBI categorizes biotechnological activity by products and processes and tomaintain a consistency with the data, these categories are retained in the analyses andpresented in the tables. IBI identifies companies by regularly surveying IBI member

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firms and through systematic reviews of trade journals and other publications. Inorder to provide more detail on the industry, the IBI collects data on the areas ofproduct development activity.^ Prevezer (1997) used this source to demonstrate theexistence of geographic clustering in biotechnology but he did not explore regionalspecialization.

Nationally, biotechnology is concentrated in a few states. California, considered bymany to be the birthplace of the biotechnology industry, has the largest number offirms, 294, according to the IBI. Massachusetts accounts for 135 firms. However,biotechnology, as an early stage, high growth industry, exists in the majority of states.

Thirteen biotechnology product groups with at least 1% of the nation's biotechnol-ogy industry were found. The authors analysed the regional concentration of these 13product categories by state; each state included in the analysis had at least fourcompanies within the specified product category. These are shown in table 1. Theproduct areas of specialization include agriculture - animal, agriculture - plant,aquaculture, bioelectronics, bioseparations, diagnostics - clinical human, energy,environmental, immunological products, reagents, therapeutics, vaccines and veter-inary.

Table 2 details state specialization by various biotechnology processes. These arethe technologies in which biotechnology companies report a speciality in the IBIcompany survey. The processes are combinatorial chemistry, fermentation, gene ther-apy, genetic engineering, hybridoma, large-scale cell culture, liposomes, oligonucleo-tides, protein engineering, tissue culture, trausgenics and 'other'. The authors areinterested in regional specialization by process as well as by product because knowl-edge spillovers, which create regional agglomeration, can be found in either the formof a technology or a specific product.

The significant share of a particular product or process category is measured by alocation quotient, a ratio of the percentage of the state's biotechnology industry to thepercentage of the nation's biotechnology industry. A location quotient measures thestate's specialization in comparison to the rest of the country. A location quotient of100 means that the state has the same proportion of companies specializing in acertain product category that the nation has. Areas of specialization are importantto identify because, according to the observed patterns of biotechnological agglom-eration, company founders will establish their companies in areas where they perceivethat there is a regional competitive advantage. The states with the top two locationquotients for each product and process category are reported.

Several states rank in the top two location quotients for more than one product andprocess category. Iowa shows specialization in several agriculturally oriented fields: infermentation (238.81), animal agriculture (614.93), veterinary products (279.76) andplant agriculture (336.19). Maryland has concentrations in various fields signifyingdiversified companies and local industry. Hybridoma technology (147.86), proteinengineering (141.08), large-scale cell culture (134.40), and aquaculture products(190.91), vaccines (154.32), bioseparations (143.75), and immunological products(153.21) are concentrated in Maryland. Such a diversity in Maryland argues againsta trend in regional specialization; however, the large-scale cell culture and biosepara-tion focus could have grown out of supplying the national science and research insti-tutions in the state and suggests a specialization in the development of intermediarybiotechnology processes. The other areas, with the exception of aquaculture, arehuman applications, which could have developed from the concentration of humanscience at the National Institutes of Health and related institutions. Maryland is the

b M. p. FELDMAN AND C. R. RONZIO

only state that has a significant share of the nation's aquaculture biotechnology prod-ucts with a location quotient of 190.91. While it is premature to suggest causal rela-tionships between the environment and the number of firms, it is noted that Marylandhas resources that could attract aquaculture biotechnology firms. The Center ofMarine Biotechnology (COMB) is a marine research institute in Baltimore and isone of the University of Maryland Biotechnology Institute's four centres of biotech-nology research.

Massachusetts exhibits regional speciaHzation in therapeutics (137.28) and trans-genics (165.35). Ohio firms have specializations in protein engineering (141.08), large-scale cell culture (138.40) and reagents (153.07). Oregon shows specialization inenvironmental products (294.81) and reagents (164.26). Pennsylvanian firms specia-lize in gene therapy (196.28), bioelectronics (308.00) and vaccines (151.85).Surprisingly, two states with a large number of companies, California and NewJersey, rarely have location quotients of over 100 (although California shows a regio-nal advantage in two areas: combinatorial chemistry [a process] with a locationquotient of 128.33 and in energy products with a location quotient of 116.67). Thismay be due to the fact that CaUfornia might be the dominant cluster but the diverseproduct focus of their numerous biotechnology companies approaches the distributionof national firms.^

This geographic specialization suggests that outsourcing may weaken the genera-tion of knowledge by not developing expertise and experience within the firm orwithin the region where the expertise resides. After all, the industry in the region issimply a collection of firms. Vertical specialization within an industry may adverselyaffect geographic specialization. When the capabilities of any one firm are diminishedthe entire agglomeration is affected. The long run growth potential for anchoring anindustry in a region may be diminished. Instead of developing expertise outsourcingmanufacturing may provide a sub-optimal means for underfinanced firms to survive.

3. Differing perspectives on firm development

Increasingly the Hterature recognizes that the benefits of contracting and outsourcingdepend on specific attributes of the technology and the inherent costs of externalpartnering (Hamilton et al. 1990, Pisano 1990, 1991, Creis et al. 1995). A series ofempirical studies investigated why firms vertically integrate rather than outsourceactivities, and the effects of each of these approaches. Pisano (1991) undertook afirm-level analysis that investigated transaction costs inherent in outsourcing manu-facturing in particular. These transaction costs arise from protecting intellectual prop-erty rights, regulations that make it costly to switch manufacturers after clinical trials,and the complexity of process development. When transaction costs are high, firmspursue in-house manufacturing rather than becoming 'R&D boutiques'. Creis et al.(1995) found that contractual or certain barriers to innovation motivate partneringarrangements among biotechnology start-ups. Biotechnology start-ups lack expertiseto negotiate government regulations and to secure facility financing. This can lead toexternal partnering as a way to overcome these shortcomings. None the less, concernsby biotechnology start-ups about the loss of appropriability of intellectual propertycan limit the firm's willingness to participate in external partnerships (Zeckhauscr1996).

MANUFACTURING IN BIOTECHNOLOGY FIRMS 7

Industrial analyses from the non-academic literature have praised the biotechnol-ogy industry for its flexibility and creativity in structuring manufacturing alliances(Lee and Burrill 1995, 1996). Raising capital is highlighted as a major reason foracceptance of the virtual corporate model by biotechnology start-up firms. Securingventure capital financing or placing an initial public offering are subject to the vag-aries of the financial market and are not an easy or dependable means of raisingcapital.

The cost of manufacturing involves substantial barriers that provide incentives tooutsource production. A bio-manufacturing facility must comply with current GeneralManufacturing Processes (cGMP) and requires a highly skilled stafT that is knowl-edgeable about complex and fragile process technology. Facilities require expensiveventilation and water purification systems; fully equipped facilities typically costbetween S20 million to $60 million and take from 1 to 4 years to become operational(McKown 1996).

Gray and Parker (1998: 1758) also argued in favour of the virtual firm, suggestingthat bio-manufacturing will locate in centres where relevant expertise already exists.

the more established companies are turning out to be major sources of competitive ad-vantage in the new business environment. They are reorienting their own research anddevelopment efforts. ... These manoeuvres strengthen their position to negotiatestrategic alliances, joint ventures, mergers, and acquisitions with biopharmaceuticalfirms specialising in basic research and development.

This argument seems to hinge on the idea that each firm in the industry has its ownniche for competitive advantage. Another viable explanation for the lack of manu-facturing by dedicated biotechnology firms is that it is a factor of the developmentalstage of the biotechnology industry, rather than a general characteristic.

Powell and Brantley (1992) argue that biotechnology is a capacity-destroying tech-nology for large pharmaceutical firms. Biotechnology products that are based ongenetic engineering have the potential to make traditional pharmaceutical productsand processes that are based on chemistry and chemical processes obsolete. Throughlicensing arrangements, large pharmaceutical companies may gain access to newtechnological breakthroughs and receive substantial benefit from synergistic agree-ments with smaller biotechnology start-ups that allow them to exploit their advan-tages in navigating the Food and Drug Administration [FDA] approval process anddistributing and marketing products (Henderson 1994, Greis et al. 1995).

Pisano and Wheelwright (1995) argue that the most successful long-term competi-tive strategy for firms may be to integrate manufacturing and R&D within the firm.This has become a common competitive strategy across industrial sectors. In biotech-nology, control over the manufacturing process is preferred as it allows acceleratedtime to market, a more rapid time frame to scale-up production, and extends thecompanies' proprietary position. Indeed, Pisano (1997) argues further that processinnovation is critical to commercialization as it provides a means to control costs andimprove quality. With an unproven new product process innovation may be a criticalconcern for developing competence and long-term advantage.

Patel and Pavitt (as discussed in Turney 1991: 37) present archetypes of innovativesystems. The myopic system, exemplified by Britain in the 1980s, gives more weight tofinancial competence over technical competence. The dynamic system, exemplified byGermany, gives greater weight to potential long-term performance and the underlyingvalue of companies' intangible assets such as technical know-how. This characteriza-

8 M. p. FELDMAN AND C. R. RONZIO

tion of the archetypes of myopic and dynamic systems may be extended to the level ofthe organization: some types of behaviour may be considered to be myopic while othertypes of behaviour are dynamic. A dynamic organization would emphasize long-termperformance and place value on knowledge as an intangible asset. By comparison, amyopic company would emphasize short-term financial gain.

In contrast to the traditional vision of manufacturing as a standardized large-scaleassembly process, bio-manufacturing is highly specialized and fragile, requiringunique facilities with high quality standards and controlled environments.Biotechnology begins with research in the laboratory and moves along a continuumthat requires scale-up with new types of expertise, additional personnel and capital asproducts are developed. Firms that have chosen to outsource manufacturing suggestthat this strategy has left them vulnerable. Biotechnology product development andmanufacturing rely on laboratory processes that do not have a long history and pres-ent opportunities that necessitate novel solutions and extend the frontier of knowledge.The technical demands of manufacturing, especially in the early stages, are intense.Integrating manufacturing with R&D creates a reinforcing set of capabilities andcompetencies that define a start-up biotechnology company's most valuable asset:technical and technological expertise. The market success of biotechnology productsis predicated on product quality and reliability, thus in addition to generating knowl-edge manufacturing provides necessary controls and safeguards. Most critically, theexperience gained in manufacturing may suggest ideas for new innovations thatfurther create a sustainable competitive advantage.

4. Perspectives from firms

A survey of biotechnology start-ups in Maryland was conducted in order to under-stand company decisions and expectations regarding manufacturing.® The analysiswas confined to one state due to resource limitations yet this strategy had the benefit ofallowing the results to minimize the effect of variation in state policies and localenvironmental factors. In November and December 1996, the authors surveyed 88small biotechnology start-ups in the state of Maryland as identified by the 1996-97Directory of Maryland BioScience Companies (Fernandez 1996). The Directory listed 102firms in total. The large firms for which biotechnology was only one division wereeliminated. Four firms refused to participate outright and two companies had goneout of business since the list was compiled, reflecting the volatility of the industry.Forty-one companies responded to the survey for au overall response rate of 49%.

The first interest of the authors was in understanding the role of regional scientificinfrastructure in the developing specialization in the industry. Firms were asked whythey located in the state of Maryland." The importance of the factors cited in theacademic literature were tested and open-ended questions were asked so that responseswould not be directed. Specifically the authors were interested in testing the hypoth-esis that firms had ties to the state's research institutes and universities (Liebeskindet al. 1996, Zucker and Darby 1996). The responses indicated that proximity toMaryland's well known scientific and technical infrastructure is important. Themajority of respondents, close to two-thirds, named proximity to the NationalInstitutes of Health (NIH) and other government agencies such as the Food andDrug Administration or the Walter Reed Army Institute for Research (WRAIR) assources of cutting-edge research in the industry. Another one-quarter of the

MANUFACTURING IN BIOTECHNOLOGY FIRMS »

responses mentioned proximity to academic institutions (Johns Hopkins Universityand the University of Maryland) as an important reason for locating in Maryland.Proximity to other biotechnology firms and the availability of a skilled workforce werealso mentioned, giving further credence to the theories of the significance of informalnetworks and the enhanced innovation based on firm location (cf Malecki 1997).

The second most frequently cited reason for locating within Maryland was that thefirm's founder, president or CEO was already living in the state. This finding under-scores the importance of the research environment: people living and working atresearch institutions in the state are likely to stay to form spin-off companies. It hasalready been shown that star scientists who become entrepreneurs stay in areas neartheir original place of research (Zucker and Darby 1996). These results support theidea that regional technological infrastructure is an important source for developingbiotechnology specialization.

Another interesting response indicated that Maryland's academic and governmen-tal institutions are potentially the biggest consumers of many biotechnology servicesand products. Proximity to this market is the reason why firms, such as BioWhittaker,started before the biotechnology gold rush. BioWhittaker began as a supplier of ser-vices and specialized research products for government and university researchlaboratories in 1947. These service companies have contributed to creating an envir-onment supportive to biotechnology, training a labour force knowledgeable aboutbiotechnology laboratory procedures, and providing a platform from which R&Dfirms can grow. In Silicon Valley, Fairchild Semiconductor is known to have gener-ated a family tree of 38 spin-off firms including Intel Corporation through the entre-preneurial efforts of people who left the mother company to start their own firms. Theinterviews conducted suggest that there are similar family trees developing inMaryland as biotechnology scientists and entrepreneurs move between companies(for subsequent follow-up, see Eaton et al. 1998, Feldman 1999).

Most importantly and the focus of the present study, it was found that 80% of thefirms would like to control their own manufacturing. However, it was consistentlyfound that motivations to integrate manufacturing were countered by a lack of capi-tal. According to over two-thirds of survey respondents (68%), the biggest challengeto the future viability of biotechnology in Maryland, and in general, is access tocapital. This result is not surprising since biotechnology requires a continuous fundingstream from product development through the licensing and manufacturing stages.The sustainability of start-up companies, in particular, requires creative financing.Biotechnology products are costly to develop.'* There are a variety of financingalternatives for companies, such as venture capital, equity financing and conventionalbusiness loans.

Venture capital remains an important source of biotechnology funding, althoughrecently investors are noted to favour companies with products that are closer to finalregulatory approval. Disappointment in the market over a large number of biotech-nology companies that failed to meet investors' expectations limited this option in theearly and mid-1990s. Indeed, venture capital financing of early-stage biotechnologycompanies during 1994 and 1995 was one-half of that raised in 1992 and 1993 (Leeand Burrill 1995). Nationally, venture funds are noted to back only 1% of the tech-nology oriented start-ups that submit business plans to them each year (Fenn et al.1995).

The respondents mentioned strategic reasons to integrate manufacturing and tolocate manufacturing facilities near the firm's R&D operations. Close collaboration

10 M. p. FELDMAN AND C. R. RONZIO

between laboratory scientists and production engineers is important for two practicalreasons. First, collaboration ensures quahty product development as the plan formanufacturing is devised (McKown 1996). There is often a need to modify or cus-tomize equipment and production procedures when the plant goes on line. All of thesefactors favour accessibility of manufacturing plants to firm headquarters and R&Dlaboratories. In addition, there is a risk of developing an inferior product, which coulddamage the resiliency of the entire industry, when key suppliers outsource manu-facturing overseas. An example is the American semiconductor industry, which wasa global leader in semiconductor technology and production (Angel 1994, Appleyardet al. 1996). The companies decided to manufacture abroad where they could takeadvantage of cheaper and less skilled labour. Consequently, the quality of the prod-ucts declined and the American semiconductor industry lost its competitive advan-tage. Far-sighted policy makers will also be aware of the dangers of rampantoutsourcing. Excessive outsourcing runs the risks of slowed or halted technologytransfer, which in turn can create technological and intellectual stagnation.

Two local companies that were part of the interview survey warrant discussion.Medlmmune, a Maryland based vaccine start-up, became profitable in 1998 and wasranked as the world's eighth largest biotechnology company. The company undertookmanufacturing because it found that outsourcing was not advantageous. WayneHockmeyer, President of Medlmmune, reported that 'Keeping the work in-housegives the company complete control of its own quality and quantity'. The companyfound that contract manufacturers were not responsive, did not have the appropriateexpertise and created a revenue drain on the company.

A second company, Martek Bioscicnces, is a recognized leader in the developmentof products for health and nutrition from micro algae, a diverse group of 'micro-plants' that produce many different and unusual fats, sugars, proteins and bioactivecompounds. Martek is unique in the application of biotechnology to algae products.In 1995, Martek felt the need to scale up production. They were able to purchase afermentation plant at a highly discounted price from a bankrupt firm. The ability togrow commercial quantities of micro-algae allowed Martek to perfect the productionof their product Formulaid for use as an additive to infant formula.

Firms who were at the scale-up stage were asked what factors would be important inchoosing a manufacturing site (table 3).'^ Access to capital, in terms of cost of land orfacility, and the general costs of business were the most frequently cited factors. Afavourable tax structure was also frequently cited, underlying the perceived import-ance of minimizing financial risk in manufacturing. Only three company representa-tives mentioned the importance of strategically locating manufacturing aroundintellectual capital. Proximity to headquarters, to other biotechnology start-ups,and to estabhshed universities were each mentioned once. While companies acknowl-edge the strategic importance of co-locating manufacturing with R&D, most feelconstrained by cost issues.

Despite concerns about access to capital, eight firms in Maryland have built (or arebuilding) their own manufacturing facifities (table 4). These firms, except Novavaxand Osiris, are large firms with at least 130 employees. Firms that have matured andgrown have the capital and accumulated expertise to undertake their own manu-facturing.

Most biotechnology firms are still small and it is only as they become more suc-cessful and grow that they create employment for a broader range of workers.'^ It is atthis point that they are vulnerable to what has been witnessed in the USA as bidding

MANUFACTURING IN BIOTECHNOLOGY FIRMS 1 1

Table 3. Important factors in locating a manufacturing site.

Factor Number of mentions Challenges to industry

Local costs (facility, land, etc.)Tax structure/Tax benefitsAvailability of a skilled workforceTransportationQuality of life

16131042

CapitalCapitalCapital, Business expertiseCapitalOther

Source: Survey results.

Table 4. Maryland companies with dedicated manufacturing facilities:activity (includes facilities under construction).

American Type Culture Collection Faeility in VirginiaGuilford Laboratories, manufacturing facilities, and corporate head-

quarters in Baltimore, MarylandHuman Genome Sciences, Inc. Plans to build in Roekville, MarylandMartek Retrofit faeility in KentuckyMedlmmune Plant in Frederick, MarylandNovavax Expansion and HQ^ move to Columbia, MarylandNorth American Vaccine Plant in Bcltsville, MarylandOsiris Facility in Empowerment Zone, Baltimore, Maryland

Source: Survey results.

wars in state and local governments that attempt to draw companies away from theirinitial start-up locations. An example is the bidding war for Medlmmune betweenBaltimore and Cleveland. Medlmmune, a company headquartered in Bethesda,Maryland, wanted to build a manufacturing plant for its newly FDA-approved prod-uct, RespiGam. Maryland triumphed over Ohio by offering S43 million in incentives,one of the costliest economic development packages ever put together from the state'sSunny Day Fund and other sources. While the Medlmmune 'deal' received amplepress coverage, companies in Maryland regularly receive information and incentivesfor relocation from other Mid-Atlantic and New England states (table 5).

One-third of respondents answered that states had mentioned specific relocationincentives, the most common of these being tax abatements, followed by direct loansand loan guarantees. As seen in table 5, the states that sought to recruit companiesincluded Massachusetts, Virginia, Ohio, Pennsylvania and Delaware. Maryland'snearest neighbour, Virginia, mentioned by 38% of the respondents, was the mostactive in recruiting Maryland firms, followed by Iowa with 19%. Iowa is noted tobe actively recruiting biotechnology firms nationally as a way to foster economicgrowth and to leverage the state's manufacturing expertise. Ohio andMassachusetts were noted to have contacted 14% of the firms each. It is interestingthat none of the respondents had been contacted by a western state, indicating thatthere are perceived limits to state recruiting efforts. These bidding wars are typicallyseen as zero sum games that create no real economic value. One may hypothesize thatfirms that are lured away from the scientific agglomerations that defined their initialsuccess may not fare as well in other locations. The net result would also decrease themass of the source agglomeration and may diminish the national growth potential ofthe industry.

12 M. p. FELDMAN AND C. R. RONZIO

Table 5. Active recruitment of Maryland bio-technology firms.

State j Location Percentage oJfirms contacted (Yo )

Virginia 38Other countries 38Iowa 19Massachusetts 14Ohio 14Delaware 10Pennsylvania 10

Source: Survey results

5. Evaluating the manufacturing decision

Ghesbrough and Teece (1996) developed a theoretical framework to consider whethera firm should engage in strategic alliance or keep projects under development in-house. This framework may be extended to consider the conditions under which itmight be most appropriate for biotechnology start-ups to invest in manufacturing.The decision should depend on both the type of innovation the company is developingand the type of knowledge underlying the innovation. For example, if the innovationis systemic, that is, interrelated with the firm's other technologies and developments,and the knowledge of the technology does not exist elsewhere, then the firm shouldintegrate all aspects of product development, including manufacturing, in-house. Insuch a case, contracting with suppliers or forming alliances can be risky as the pur-chasing firm has no bargaining power to guarantee that the supplying firm willcomply with exact product specifications and product time lines.

In addition, if the innovation has not yet been codified and standardized, it will bedifficult to communicate its requirements precisely. In this case the contracting firm islikely to resort to using its own familiar operating procedures that may not be wellmatched to the innovation and may compromise its integrity and performance.

Gonsider the example of a biotechnology product ready for clinical trials. To engagein clinical trials, the firm must produce a large batch of the technologically sophisti-cated product. This may be a systemic innovation because the production technologyis new and closely related to the R&D. The biotechnology firm must provide all theknowledge for scaling up the laboratory processes to the manufacturing partner; inthis way the biotechnology firm gives away its knowledge competency. In addition,there may be a loss of experience and specialized know-how to the biotechnology firm.Additional exposure to the technology may provide knowledge that may suggest newcommercial opportunities. Another drawback is that the technology transfer betweenthe two companies can be time-consuming and costly. Finally, the biotechnology firmrisks losing time in product development as the contractor is not under the same timepressures as the smaller firm.

If the product is not systemic, with codified knowledge required to generate theinnovation, if the production process is not likely to involve complex problems thatrequired tacit experience with the technology or if production is not likely to generatenew knowledge then contracting out manufacturing would be a viable strategy for thesmall biotechnology firm. Under these conditions, the virtual model would befavoured.

MANUFACTURING IN BIOTECHNOLOGY FIRMS 1 3

6. Conclusion

Biotechnology has captured the imagination of ambitious scientific investigators,investors seeking high rates of return, as well as economic development officials whohope to anchor the industry in their locality and reap the industry's economic andemployment rewards. Biotechnology is still at an early stage of its development andthere are many competing hypotheses about its future. It is well known that biotech-nology firms start-up in regions with prominent research universities and 'star scien-tists' (Zucker and Darby 1996). Where and how the industry will scale up is less clear.Gray and Parker (1998) argued in favour of the virtual firm suggesting that bio-manufacturing will locate in centres where relevant expertise already exists. On theother hand, the authors argue that manufacturing may be viewed as an integralsource of knowledge that supports innovation in this industry. It is expected thatthe most successful biotechnology firms will integrate forward into manufacturingand that the knowledge gained from this activity will create competitive advantage.In addition, those regions that are able to capture bio-manufacturing will havegreater expertise and a higher probability of success.

Support for the virtual model of biotechnology with reliance on strategic alliances ispredicated on the linear model of innovation, which assumes that research is distinctand separate from development. The linear system may be credited to Vannevar Bush(1945). Yet it is now recognized that the linear model of innovation is an inaccuraterepresentation of the process (Barfield 1997). Co-locating manufacturing with R&D isa break with what has been described as the American system of innovation in whichseparate divisions perform different functions - specifically R&D laboratories design-ing a product and then throwing the design over the wall to production (Bluestoneand Harrison 1982, Dertouzos et al. 1989, Reich 1991, Tyson 1992). This system hasbeen criticized as a cause of America's pre-1990 competitive dechne vis-a-vis its tradingpartners and calls into question the use of this model in systemic innovation in emerg-ing technologies.

Biotechnology is not a single industry; rather it is a constellation of product appli-cations and technological processes. There is an emerging regional specialization ofthese products and processes. There is a lack of significant experience with biotech-nology and the additional information gained through designing and monitoringengineering processes adds economically valuable new knowledge. Integrating manu-facturing with R&D creates a reinforcing set of capabilities and competencies thatdefine a start-up biotechnology company's most valuable asset.

Yet capital constraints may force firms to subcontract and licence manufacturing.While it is recognized that manufacturing should be linked to R&D activities, thechallenges facing biotechnology in linking manufacturing to R&D is based largely onthe early stage of development of the majority of firms in the industry and financingconstraints.

Acknowledgements

This project was supported, in part, by funds from the Abell Foundation and theGerman Marshall Fund. The authors appreciate the comments and suggestions oftheir colleagues at the Institute for Policy Studies. They also would like to acknowl-

14 M. p. FELDMAN AND C. R. RONZIO

edge the suggestions and encouragement of Bengt Johannisson and Ed Malecki andthe anonymous referees.

Notes

\. This assertion is based on three independent sources. First, a reading of biotechnology firm stockprospectives and annual reports typically mention the plan to integrate manufacturing. Second, inter-views with biotechnology entrepreneurs reveal a desire to become fully integrated entities. See Hall(1997) for an example. Third, in the survey it was found that 80% of the respondents believed that theywould be more innovative and profitable if they could control product manufacturing.

2. There was similar confusion in early discussions of computers when mainframes and personal computerswere considered together as the computer industry. Regional specialization was very different (Saxenian1991). The divergence of the economic fortunes of these regions provides insights into the comparativeimportance of technology and industrial structure for regional growth (Kenney and von Burg 1999).

3. See Werth (1994) for a detailed documentation of the failure of large pharmaceutical companies tounderstand the importance of biotechnology and to move aggressively in this field.

4. Estimate by Vector Securities International, as reported by Southall (1999).5. The IBI database has been used by other researchers (Greis et al. 1995, Prevezer and Toker 1996, Swann

and Prevezer 1996, Prevezer 1997) but has not been formally validated. The present authors cross-referenced companies in Maryland identified by IBI with those identified by their other sources. IBImissed a total of 55 companies that were identified by the CorpTech Directory and Maryland TechnologyResource Council. However, IBI identified 20 companies that the other two references missed.

6. The very high location quotients are in the product and process categories that comprise a smallpercentage of the nation's biotechnology industry. For example, animal agriculture is only 6.7% ofthe nation's biotechnology industry, or 93 companies nationwide.

7. A problem with location quotients is that coefficients may indicate specialization in a state when thetotal number of firms is relatively small. Thus, the location quotients should be interpreted with care:they indicate specialization; however this may not refiect comparative strength or long-term viability.Indeed, differences in input factors such as venture capital and skilled labour availability may be criticalto the strength of the industry but are not reflected in the location quotient.

8. The survey protocol used was to contact each company's president, CEO or general manager first with aletter explaining the purpose of the study and advising him or her that a member of the research teamwould be calling to conduct a short survey over the telephone. Each company received at least twotelephone calls; if neither call was successful in reaching the party, the researchers offered to fax thesurvey.

9. For the full results of the survey, see Feldman and Ronzio (1999).10. Face-to-face interviews were conducted with six firms to aid in the design of the written survey. These

interviews allowed clarification of the relevant questions and the set of structured responses to include.11. The survey instrument is available upon request.12. All the open-ended results were coded using standard quahtative analytical methodology. Patterns and

themes in people's responses were coded by keyword or phrase, which in turn were assigned a numericalvalue. These values and the quantitative results were entered in a SPSS database and were analysed inSPSS.

13. Respondents could give more than one answer to this open-ended question.14. Perhaps the costhest part of this process is the clinical trials necessary to prove a drug or vaccine's

effectiveness (and the safety of food additives). (Clinical trials can take up to 6 years to complete andrequire the monitoring of over 1000 patients.) There are three phases of human clinical trials. Phase I isdone on a small number of healthy people to determine dosing and to monitor for adverse effects. PhaseII controlled testing is done on 200-300 patients to test efficacy. Phase III trials test for effectiveness andadverse reactions.

15. This was an open-ended question and respondents were allowed numerous answers. Twenty-sevencompanies responded and the average respondent mentioned two factors.

16. This growth potential has been seen for individual companies. For example, Amgen, one of the earliestfirms, grew from seven employees in 1981 to a current employment of4100. The company currently hassales of $1.9 billion and market capitalization of $10.6 billion.

17. The Sunny Day Fund is a discretionary economic development tool used to attract and retain com-panies in the state of Maryland. The total cost of this deal, including all state, county and local funds, isestimated to be $43 milhon. This package countered Ohio's offer of $11 million in low-interest loans,$250 000 in job training, a $3 milhon loan for the plant itself and an additional $700 000 from the city ofCleveland. Ohio's offer complemented the proposed sale of the land which was to be 'steeply discounted'(Bullard 1996). The estimated cost of Ohio's package was $40 million (BuUard 1996). Medlmmunepromised to provide 219 jobs by 1999, or a public sector cost of about $54000 per job.

MANUFACTURING IN BIOTFXHNOLOGY FIRMS 1 5

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