Are Companies Stuck in Incremental Innovation?

For most industries, the mantra is “innovate or die.” But what are the incentives for companies that rely heavily on research and development (R&D) to pursue radical innovation rather than tweaking what already works?

A new paper, Blockbusters, Sequels, and the Nature of Innovation, studied decades of data from the pharmaceutical industry and found that companies with high-selling drugs choose to keep targeting their existing customer segments with a new product that is technologically similar to the successful one.

The expectation is that a follow-on product will achieve comparable sales to the original product  — similar to the frequent release of newer iPhones, said Professor Yoko Shibuya of Duke University’s Fuqua School of Business, who co-authored the paper with Fuqua’s Snow Family Professor Wesley Cohen, Matthew Higgins of Tulane University, and Fuqua PhD student William D. Miles.

“They tweak the iPhone 17 a little bit, and basically they’re going to move their customers to the iPhone 18,” Shibuya said.

Why companies pursue ‘sequels’

R&D is notoriously expensive. In the pharmaceutical industry, it can take between 10 to 15 years for any new drug candidate discovery to receive FDA approval, the authors note. 

Scholars have long explained pharmaceutical companies’ tendency to incremental innovation with factors such as risk aversion, the convenience of using existing expertise, rising R&D costs and timelines, and broad theories such as “ideas are getting harder to find.”

“It’s argued that ‘all the good ideas have been taken, and new ideas are getting smaller and smaller,’” Shibuya said.

But the researchers hypothesized that companies have a rational incentive to stick to their successful product lines, and that their choice to pursue “sequels” rather than radical innovations may not be dictated by scarcity of resources or ideas.

How the blockbuster effect magnifies the familiar

The pharmaceutical industry offered the authors a particularly useful case study. It has particularly robust data on sales and product development, as well as other useful metrics. 

The researchers studied a dataset of drug sales in the US, UK, France and Germany from 1998 to 2010. They tracked approximately 60 pharmaceutical firms, with sales accounting for 89% of all market sales of therapeutic drugs across the four countries. They also collected data on global drug development pipelines – showing therapeutic classes and developmental stages.

“If a company pursues clinical studies or trials for a drug in the same narrowly defined therapeutic class as their blockbuster drug, this may signal the company is strategically pursuing the same customer segment with a sequel of the blockbuster drug,” Cohen said.

They found a significant blockbuster effect: one billion dollars of additional sales of individual products are associated, on average, with 17% more drug development projects in the same narrowly defined therapeutic class as the original drug. 

Moreover, one billion dollars of additional sales are associated with 30-80% more drug development projects that employ similar technology as the original drug.

Customer stickiness versus other drivers

But what drives such behavior? A skeptic could argue that top-selling drugs benefit from massive marketing budgets, which may keep the customer base loyal to a well-known brand.

The researchers hypothesized there might be something in the product characteristics — in addition to the company’s marketing spending — that may affect demand stickiness.

To investigate, they isolated a unique factor of patients' loyalty to certain drugs: adverse side effects.

Using the FDA Adverse Event Reporting System (FAERS), the researchers calculated the reported side effects of different therapeutic classes. If a class presents high risks of side effects, you would expect patients and physicians to stick with a drug in a class with higher likelihood of severe side effects. 

The researchers found that in therapeutic classes with high numbers of reported side effects, companies were more likely to pursue sequels of their top-selling drugs with similar technologies, rather than developing completely new products.

Longer wait for cheaper generics?

Economists have long debated a general decline in returns of R&D investments.

Cohen and colleagues want to add to this discussion by showing that “demand stickiness” could be an additional explanation of productivity decline.

“Aside from ‘new ideas are harder to find,’ firms may have an incentive to stick with prior successes,” Shibuya said. “If most firms are pursuing this strategy, then it might contribute to a decline in productivity.”

This less risky approach is particularly relevant today, she added, because sales data — at least in the pharmaceutical industry — show that a handful of blockbusters account for a growing share of sales. “Such concentration might increase the blockbuster effects over time,” Shibuya said.

Blockbuster dominance may negatively impact consumers, the researchers point out. In the pharmaceutical industry, a market dominated by a few brands who produce chains of sequels may delay market access to cheaper generic alternatives.

From a company's perspective, there is an incentive to exploit demand stickiness. But at the same time, companies may be missing even more rewarding opportunities in the long term.

“In the short term, the optimal strategy might be to focus on your guaranteed customers. But this may mean investing less in new R&D with greater potential upside,” Shibuya said. “Someday, you may regret not having invested in other product lines.”