Commercialization Blues: How a Government Lawsuit Hip-checked the Market for New Ideas

When the costs of collaboration are too high, inventors will go it alone
Commercialization Blues: How a Government Lawsuit Hip-checked the Market for New Ideas

The essentials

A U.S. Department of Justice case aimed at conflict of interest in the medical devices industry has the unintended consequence of changing how inventions are commercialized. As a result of the settlement, it became more costly for existing orthopedic device firms to work with physician-inventors, who were then more likely to take their products to market themselves. This research was led by Aaron Chatterji of Duke University’s Fuqua School of Business. Chatterji discussed his findings at the Queen's School of Business Economics of Entrepreneurship and Innovation Conference.

Once the eureka moment passes, the inventor with commercialization in mind has a choice: don the entrepreneur’s hat and go it alone or collaborate with an existing company with the marketing, manufacturing, regulatory, or other experience to bring a new product to market.

From the inventor’s perspective, it makes sense to work with an incumbent firm when there is robust intellectual property protection to prevent expropriation and when the firm brings skills and expertise that are difficult or costly to source elsewhere.

But even if the inventor is willing to collaborate, what happens when the costs of collaboration are deemed too high by the incumbent firm? What impact would that have on the market for inventions?

If it is the clubby medical devices industry, a big impact, apparently.

Justice investigation shakes things up

Aaron Chatterji, Associate Professor at Duke University’s Fuqua School of Business, has done considerable research into commercialization strategies, and has also spent two years working in public policy circles in Washington. He became aware of a U.S. Department of Justice (DOJ) investigation, launched in 2005, into potential conflicts of interest in the orthopedic device industry. In the DOJ investigation Chatterji saw a great opportunity to test a theory about the costs of cooperation affecting commercialization strategies.

The orthopedic device industry is dominated by five corporations that account for more than 90 percent of sales  of hip and knee implants in the U.S.. Traditionally, the companies have maintained close ties with practising physicians. “It’s a business imperative,” says Chatterji, who presented his research findings at the Queen's School of Business’s Economic of Entrepreneurship and Innovation Conference in June 2012. “Understanding what physicians want, which [products] are easy to implant, which ones have the best outcomes, it’s really important to have that channel of communication with the doctors.”

That channel works both ways. Physicians are the source of many inventions, and their relationships with incumbent firms may factor into how they bring their inventions to market. It is estimated that physicians contribute 20 percent of the patented inventions in medical devices.

But the DOJ suspected the relationship was too cosy. The department opened an investigation into alleged kickback payments flowing from the companies to doctors to try and get them to recommend certain products.

“There’s a constant tension in this industry,” says Chatterji, “trying to balance the source of innovation with a potential conflict of interest.”

The investigation was settled in 2007 with a deferred prosecution agreement and a fine of more than $300 million. Under the agreement (which expired after 18 months), the companies agreed to disclose payments to physicians, obtain independent monitors, and produce needs assessments that justified their collaborations.

The result, at least during the term of the agreement, was that the cost of cooperation between orthopedic physicians and medical device firms rose. And the unintended consequence was to seemingly kick-start new venture activity in orthopedic devices.

According to research by Chatterji and colleague Kira Fabrizio of Boston University, there was an increase in new venture formation and an increase in the percentage of new orthopedics ventures founded by physicians. New orthopedics ventures were 39 percent more likely to include a physician founder during the DOJ settlement period than orthopedics ventures founded in other years. And combing through the patent assignment data, they found a 21 percent decrease in the probability of company assignment of patents during the settlement period relative to other periods.

“We found that after the investigation concluded, you see many more orthopedic doctors starting companies,” says Chatterji. “When we look at the patents filed, you see less patents filed by doctors that get assigned to companies.”

Conflict of interest vs. collaboration

In changing how medical device companies interact with physicians, Chatterji says, the DOJ agreement “also changed the way these companies interact with these physicians. There’s really valuable information that no longer can get from the physician to the company, and that information is instrumental in developing new products.”

One insight from this episode, he says, is that there seem to be trade-offs between the costs of conflict of interest and benefits that come from close collaboration in industry. Similarly, there are trade-offs involved in “open innovation,” which is a management concept that calls on firms to acquire knowledge from outside their organization, whether by hiring hew employees, making venture capital investment, or building alliances and networks.

“There’s a lot you can do to gain knowledge but there are also costs,” says Chatterji. “Every alliance that you enter into, every investment you maintain, every network you participate in. . . There are benefits and costs in engaging in these transactions to bring knowledge inside the firm.”

Alan Morantz

Smith School of Business

Goodes Hall, Queen's University
Kingston, Ontario
Canada K7L 3N6

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