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Faculty Research Managing Intellectual Property as Discretionary Investment Opportunities Biopharmaceutical fi rms can achieve the greatest success by managing their intellectual property as dis cre tionary investment opportunities or real options, according to research being con ducted by Edward Levitas, Asso ciate Professor of Organiza tions and Strategic Management. Levitas is working on a stream of research related to fi rms’ inven tive activities, particularly in the con - text of biotechnology-based pharmaceutical fi rms. Contrary to many popular opinions, a patent does not guarantee the owner/ assignee a certain product or immediate cash fl ows. In fact, evidence suggests that about 90% of all patented technologies are never even transformed into marketable products. Rather, a patent only provides the owner with the right to exclude others from using the technology for a limited period. Upon patent granting, therefore, managers 16 OUTLOOK Edward Levitas do not obtain immediate clearance to commercialize a technology, but only obtain exclusive options on ways in which to attempt to exploit the technology. Patents as Real Options Many academics and practitioners now accept the idea that a fi rm’s value can be “decomposed” into two basic components, says Levitas — the value of cash fl ows from its current operations and the value of discretionary investment opportunities, or options, embedded in the fi rm’s resources. These embedded options provide the fi rm with fl exibility to alter operations in the face of environmental change. For example, upon being granted a patent, the fi rm is essentially given a number of exclusive options — such as the ability to attempt to manufacture a product based on the underlying technology, the ability to license the technology to another entity, the ability to further develop the technology into something more potentially valuable, the right to defer decision on the technology, and even the right to abandon the technology. Important Implications for Management Practice The distinction between current cash fl ows and future options may seem pedestrian, says Levitas, but it does have important implications for management practice. Most investments suffer from a degree of irreversibility — such as building or expanding research facilities — or the inability to fully recover the investment if plans change — which could occur during the marketing or promotion of a new pharmaceutical product. When future conditions are highly uncer tain, Levitas’ research indicates that it is advisable to make a series of incremental investments, when feasible, rather than commit unconditionally at the outset to a project. Assuming that a project can be terminated after each stage, incremental investing allows the fi rm to avoid committing the whole cost of the project upfront, and permits the gathering of information over time to assess whether the next investment (and the entire project) remains feasible. In short, he says, incremental investing allows for the cultivation of options. Options and Biopharmaceuticals Within the biopharmaceutical industry, companies face a host of uncertainties during product development. A company may discover mid-stream that there are low probabilities that the technology will be safe and effective in humans. Or a therapeutically effective treatment may not meet the standards of societal acceptability. Given such uncertainties, Levitas says that managers of these organizations should pay careful attention to managing their fi rms’ portfolios of technology options. Mismanagement of these options, such as over-committing to a project in times of uncertainty, can have drastic consequences. For example, committing to the building of a pilot plant to manufacture a drug for FDA clinical trials before assessing the effi cacy of the drug in animal models, or before assessing the degree to which the drug will be socially accepted, subjects the company to considerable risk of investment loss.
Faculty Research “Option” Value of Patents Levitas and research colleague Tailan Chi of the University of Kansas have found evidence that patents provide “option” value to biopharmaceutical fi rms. This value is highest when uncertainty due to external forces within the industry is highest, suggesting that options provide the greatest benefi t to fi rms by endowing them with multiple opportunities to respond to uncertainty. Furthermore, they fi nd that committing to large capital expenditures during times of high uncertainty results in lower fi rm value. From these results, they conclude that patenting by itself may or may not create value. Value creation results from carefully juxtaposing patenting with conditions of uncertainty. In addition, a strategy of incremental investment tends to be more conducive to value creation when there is high uncertainty. On the other hand, a strategy of aggressive investment through accelerated development or commercialization is more viable when there is low external uncertainty. Flexibility of Holding a Portfolio of Options A separate recent study by Levitas and Chi tests the idea that a portfolio of options on multiple assets is more valuable than an option on a portfolio of assets. The basic idea behind this study is that holding a portfolio of options on multiple assets affords greater fl exibility and thus provides a higher value than holding an option on a portfolio of the same assets. The fl exibility stems from the fact that the holder of the option portfolio is able to exercise the option on each asset individually while the holder of the option on the asset portfolio can only purchase all the assets in the portfolio. (continued on next page) Research Seminar Series The fall semester Research Seminar Series — which provides a campus forum for stimulating research scholarship through the sharing of cutting-edge research — featured the following presentations: “Assimilation of Interorganizational Business Process Standards” was presented by Viswanath Venkatesh, The George and Boyce Billingley Chair of Information systems at the University of Arkansas. Dr. Venkatesh is a top researcher focusing on technology diffusion in organizations and homes. “What Are They Thinking? Capturing Uncertainty When Respondents Are Unsure of Their Likelihoods of an Event” was presented by Professor Emeritus Paul C. Nystrom and Professor Ehsan Soofi of Production and Operations Management faculty. Dr. Nystrom has published research on management topics such as the adoption of tech no logical innovations, corporate turnarounds, organizational growth, executive decision making, and designs for multinational corporations. Dr. Soofi is internationally recognized for his theoretical and applied research in information theory and statistics, developing information measures for statistical and management science problems and showing their usefulness in business, economic, and other applications. “Relational Investing: Evidence from Actively Managed Mutual Funds” featured Pengfei Ye, a doctoral candidate in the fi nance area. “Maximum Entropy Data Disclosure: 100% Confi dentiality Protection Guaranteed” was presented by Kurt Pfl ughoeft of Market Probe Inc. Dr. Pfl ughoeft received his PhD in Management Science from the University of Wisconsin–<strong>Milwaukee</strong>. “The Faces of Asset Securitization” featured Assistant Professor Valeriy Sibilkov of the Finance faculty. Dr. Sibilkov’s current research is focused on capital structure, corporate cash policies, and corporate governance. “Beyond Succession: Frameworks for Investigating Content and Process in Family Business Research” was presented by G.T. (Tom) Lumpkin, Kent R. Hance Regents Chair and Professor of Entrepreneurship at Texas Tech University. Dr. Lumpkin publishes widely on the topics of entrepreneurial orientation, family orientation, opportunity recognition, new venture strategies, and strategy making processes. “Does Corporate Headquarters Location Matter for Corporate Financial Policies?” featured Wenlian Gao, a doctoral candidate in fi nance. “Managing Liquidity in Research- Intensive Firms: Signaling Effects of Patents and Managerial Ownership” was presented by Associate Professor Edward Levitas of the Organizations and Strategic Management faculty. Dr. Levitas specializes in strategic management, with a current research focus on technology and new product development, primarily among biotechnology and pharmaceutical fi rms. Professor and Roger L. Fitzsimonds Distinguished Scholar Ehsan Soofi , of the Production and Operations Management faculty, serves as the Series Coordinator. SPRING 2007 17
Page 1 and 2: Outlook Spring The Lubar School’s
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