The influence of mergers and acquisitions on the innovativeness of pharmaceutical companies in the global economic up- and downturns of 1997 – 2008

Author: Ivo Tokarski, 2012.
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This research gives insights on the issue to what extent mergers and acquisitions (M&As) of global pharmaceutical companies influence their innovativeness in economic up- and downturns. In total 1615 pharmaceutical companies were investigated through an empirical analysis. Evidence for three main findings has been found. First, pharmaceutical companies that acquire in slight economic downturns have higher positive returns. Secondly, the number of patents that have been traded does not influence the returns of the company – therefore the innovative performance does not increase measurably. Thirdly, the location of US based target firms has a positive effect on the number of patents that have been traded.

Keywords: Mergers, Acquisitions, Pharmaceutical Companies, Innovativeness, Economic upturn, Economic downturn.

1.    Introduction

In the pharmaceutical industry companies are reliant upon scale and innovativeness to develop products and stay profitable by covering their expenses for R&D. To stay competitive and profitable the companies require therefore large cash reserves. This needed affluence in cash reserves is restrained when a recessionary period strikes the global economy. By investigating how those companies adapt their M&A behaviour to these new economical circumstances and measuring what is affecting their innovativeness, will provide managerial insights on which strategy could pay-off in the end.

Managers and CEO’s of pharmaceutical companies are dealing with a competitive surrounding in which they have to guide their enterprises through the increasing rivalry within their industry sector caused by new technologies, pioneering research and innovation to secure the next blockbuster drug. An additional major concern is the threat of appearing substitutes, which could replace the patented pharmacological products and therefore cut the companies existing commercialization chain – leaving them behind on huge R&D costs, which cannot be compensated for anymore. Furthermore, the economic cycles create another challenge in raising funds and marketing the products to keep the innovativeness up. Those companies and their leaders have to find new ways to secure their innovativeness on the one hand, and block out their competitors on the other. An established method that pharmaceutical firms seem to rely on is mergers and acquisitions (M&As), in order to acquire valuable patents to increase their potential for innovativeness, as well as a method to block out competition strategically.

Previous researchers like Pisano (1997) found out that based on transaction cost theory, M&As compared to alliances, have lower transaction costs in cases that involve insecure property rights and, transaction-specific production goods and when a transfer of complex technology is needed. Basing on the study of Pisano (1997) the pharmaceutical industry follows a logical pattern using M&As as a form of collaboration that have a low transition cost.

Contrasting the idea of transaction cost theory of the pharmaceutical industry towards industry non-specific studies of Kohers and Kohers (2000), shows that M&As in general create slightly negative shareholder value, which gives an indication that even when transaction costs are low – no value is created. Supporting this statement is the study of Moeller et al. (2005), who studied the merger wave of 1998 – 20001 and found out that more value was destroyed than created within this period.

This research will conduct therefore an empirical analysis of the global pharmaceutical industry, in order to investigate how the innovativeness of these acquiring companies is affected by mergers and acquisitions – in the context of economic up- and downturns.

The scope of a global perspective shall have the purpose to distinguish if the number of patents as an innovativeness indicator has an influence on various other performance indicators, which could give important managerial insights.

The focus is laid on global pharmaceutical firms that possess SEDOL codes as an identification standard, so that necessary data can be obtained from several data sources (e.g. “DataStream” and “SDC”) – since those companies are mainly stock listed and obliged to provide financial data to stockholders. Another aspect of focusing on global pharmaceutical firms is related to previous researches that have shown that firm size effects innovation (Bouncken, 2011; Giovannetti et al., 2011), which in this perspective can be translated into the theoretical finding that by investigating large sized companies there should be a measurable effect. Complementing the view from another perspective the research by Christensen (2006) gives indications that small sized companies lose their innovativeness when being acquired by large ones because of the organizational structure. This frames the focus on global companies by adding the negative implication for small sized companies, which gives theoretical insights that when a large sized global firm acquires a smaller company the influence on innovativeness is measureable (Bouncken, 2011; Giovannetti et al., 2011) and should have a negative effect on the small company itself (Christensen, 2006). But what effect does it have on the acquiring company?

To set a researchable timeframe I chose the fifth and sixth global merger waves, which took place in between 1997 – 2008 (see figure 1). This gives the chance to distinguish two economic upturns and two economic downturns, creating a basis for comparison and validity.

This classification creates an opportunity to establish how the M&As of pharmaceutical companies affected the innovativeness of the acquiring companies within this closed time period that had economic upturns as well as economic downturns.

2.    Theoretical reflection

To successfully conduct this research, two main factors have to be put into theoretical perspective when defining them, namely ‘Patents’ and ‘Periods’ – as this research needs to establish measurement criteria for innovativeness (indicated through patents), and economic up- and downturns given by two upturn and two downturns periods.

A big part of the scientific literature believes that measuring innovativeness in any industry is difficult per se, because of the fuzzy logic behind it. When it comes to measurements like R&D spending’s and similar innovativeness indicators it is rather suitable to compare a small amount of companies that have no diverse demographics. When taking a global approach to examine whether there is a general pattern for the worldwide pharmaceutical industry, innovativeness has to be defined by a common measure that is internationally independent. Therefore, the number of patents that have been traded to the acquiring firm by M&A, shall distinguish the transition of innovativeness (potential) from the target company, to the acquirer. Further, this research is focused on examining whether this transition of patents from the target company to the acquirer, has performance benefits for the acquiring company in economic up- or downturns.

The timeframe is set within 1997 – 2008 because it gives additional insights of the performance in two economic upturn periods and two economic downturn periods.

The balancing act of the acquirer in this setting is described as a need to innovate in order to stay in business, which on one hand should focus on not restricting the innovation process, but on the other hand should guide to preferred destinations (Pal, 2010). This means that there should be incentives to foster innovativeness but in a preferable direction for later commercialization. If it is not possible however, the here researched M&As give the opportunity to acquire innovativeness through patents, which fit into the company’s product pipeline.

2.1 M&A influence

Mergers and acquisitions are the main factor of this research and need to be defined in order to extract a measureable dependent variable for the statistical calculation. To evaluate which measure will be the most suitable I will guide myself by already established theoretical findings of scientists that have published articles under this aspect.

The authors Cassiman et al. (2005) performed an empirical analysis of the role of technological- and market-relatedness of M&A on the R&D process, and found out that technological and market- relatedness between M&A partners distinctly affects (amongst other factors) the performance and organisational output. This finding gives an implication that when calculating on quantitative data, a distinctive measure for M&A influence should be the performance of a given company.

The motives for M&As can be classified overall into adaptive or defensive rationales, versus proactive or offensive rationales (Burns et al., 2005). For the industry context of pharmaceutical companies those classifications do also apply because some M&As were performed in order to fill gaps in a company’s product pipeline to maintain growth (Grabowski et al., 2002), so were rather defensive in nature, whereas other M&As were focused on the proactive rationale of increasing the scale, scope and R&D productivity (Cockburn & Henderson, 2001).

Further implications for M&As in the pharmaceutical industry are related to a study of the authors Danzon et al. (2007), who found out that firms with a relatively old portfolio of marketed drugs exhibit a higher propensity to acquire another firm. It can be argued that economic stress is influencing the M&A activity, which should well relate to the economic up- and downturns.

In order to measure the influence of M&As this study will adopt the idea of the authors Arza and Lopez (2011), who showed that companies linked to research organisations invest more in innovative activities and are more prone to patenting – which gives a theoretical hint of the linkage between the number of links and innovativeness.  Therefore, this research shall define the ‘M&A influence’ as the amount of linkages and how often they have been created between the acquiring company and any given target, in other words – the frequency of M&As that have been performed in a given period. This shall be one of the dependent variables of the statistical analysis that should answer what influence the frequency of M&As have on the company’s innovativeness.

Interestingly, there are different motives and frequencies of M&As when comparing global pharmaceutical firms. The research of Demirel and Mazzucato (2010), has found evidence that the location of the most innovative US based pharmaceutical firms is associated with their location. Taking this into account and extending it to a global perspective the question arises whether the different locations of the targets that have been acquired, effects the innovativeness of the acquiring company differently. Also the question of whether demographic areas had different strategies to cope with the fluctuations of the global pharmaceutical market and their implications can be additional insights of this study and broadening the focus of patents and periods by adding another variable.

Therefore following hypotheses shall be tested:

H1: The location of the target firm has an effect on the number of patents that have been traded.

2.2 Innovativeness

The second central factor in the theoretical construct of this study is establishing the innovativeness of a given pharmaceutical company. There are different methodologies to do that, for example the ‘soft’ approach of the authors Marvelakis et al. (2006) who presented a methodology based on measuring and benchmarking innovativeness with fuzzy logic through an innovation survey. They included interrelated measurements like the company’s innovation process, the products developed, the innovation process utilized and the way in which the innovation process is project managed. The same problem as in the performance measurement arises when trying to place those measurement indicators on this research. Because of the global diversity of those ‘soft’ factors, this study will focus rather on ‘hard’ data, which is more exact to compare. The authors Mairesse and Mohnen (2002) presented in their study an illustrative framework for accounting for innovation and measuring innovativeness, which can be regarded as measuring ‘hard’ data in context of innovativeness. Their approach of an accounting framework based on the measure of innovative sales, which gives insights of the validity of this measurement factor in order to distinguish the innovativeness of a firm.

Further, Lanjouw and Schankerman (2002) have researched the patent quality and research productivity by measuring innovation with multiple indicators. One of them was the quality of patents that allowed making a judgement on how productive a company was in terms of R&D. For the research of pharmaceutical companies this measurement criteria should be changed into the amount of applied patents for each given company. As for the other central factors, this innovativeness indicator gives grounds to compare pharmaceutical companies in a global context, without having to constrict the results due to the complexity of the different geographical environments those companies encounter.  Interpreting the research of Lanjouw and Schankerman further, this patenting frequency should be positively related to the stock market value of firms. The stock market value is on the other hand related to the financial performance of the firm, which connects the innovativeness to the above mentioned performance factor and should also in some way relate to the M&As of the firm.

The pharmaceutical industry has its own implications regarding the measurement of innovativeness, because it heavily relies on patenting – were the patent virtually equals the product (Thomas, 2003). Within this industry the patented products could be easily and cheaply reproduced by competitors, when this protection barrier would not exist. And since the capital investment in creating a marketable drug is exceptionally high and has to pass several R&D stages and FDA approval, patent protection is crucial to innovative companies in order to retain a guaranteed period of market exclusivity, which should give the opportunity to recoup the development costs (Bale & Harvey, 1997). For that reason my research will adopt the number of applied patents that have been traded from the target company to the acquirer as a variable to measure the potential increase of innovative output of the acquiring company.

Following hypothesis shall therefore also be tested:

H2: The number of patents that have been transferred from the target to acquire have a positive effect on innovative performance.

2.2.1 Innovation and the moderator: Structural inertia

As the pharmaceutical companies compete in an increasingly technologically and scientifically sophisticated market, their capabilities in researching and developing technologies for product development are crucial for their success (Takayama et al., 2002). The possible implication deriving from this can be defined as structural inertia (Hannan and Freeman, 1984), because the average pharmaceutical company prefers to refine and market the same product, which ensures stability for the firm (Takayama et al., 2002).  In the case of high R&D intensive industries like pharmaceuticals, the result of too much strengthening of a specific core field may stifle innovation and increase the inability to move quickly into complementary or different product areas (Takayama et al., 2002). Interesting to see is however, that according to a study by Leonie Tichelaar (2009) on the relationship between organizational size and age, structural inertia and product innovation in the Dutch pharmaceutical industry – the inertial forces are not stronger in large and old Dutch pharmaceutical firms than in small young ones. This finding gives a clue about the paradox the pharmaceutical firms are experiencing. In order to escape structural inertia and implement ‘really-new’ or ‘radical’ innovations (Garcia and Calantone, 2002), the firms seek outside their boundaries to acquire preferably smaller and cheaper companies in order to stimulate innovation. But the general disadvantage of M&As turns out to lay in the organizational inertia in any established firm, which is being acquired, that raises the cost of integrating the acquired firm into the own system and brining its technologies to a common level (Lall, 2002) – therefore implying that not only old large firms but also young and small ones have common grounds for structural inertia. This seems to be the major opposition force towards the transaction cost theory (Pisano, 1997), which seems to lose validity as structural inertia increases.

In global downturns many businesses experience an increased uncertainty within their industry due to the turbulence in the financial market (Sahin et al., 2011). Even though the pharmaceutical industry seems to be a special case, since there is no recessionary period for illness and need of medication, they nevertheless will be affected by the reduced financial flow caused by the recession. The capital-intensive business model of large pharmaceutical firms is based on high R&D expenditures with only a few products to recoup the investment that went into the development and marketing of the products. As the large pharmaceutical companies were ‘lumbering’ ahead in their early growth phases to attain scale economies and high turnovers, they were sufficient in covering their own investments in product developments (even though financial leverage through debt and/or outside investors was appreciated because of risk reduction and tax savings).  As those companies grew in times of prosperities, they were able to put some financial ‘meat’ on their structural bones, allowing them to survive economic downturns and global recessionary periods for a certain time. Smaller biotech/pharma companies caught by a global recession in their early stages of development do not have the means to attract financial investors and loans in this economic climate of uncertainty, which varies strongly over time – with uncertainty levels rising by 50 percent to 100 percent during recession (Bloom, 2007). Companies with little cash reserves will find themselves soon in the position of standing with their back against the wall, with the only chance of survival by being acquired through a large(er) pharmaceutical company that has got the necessary the cash reserves. The problematic situation for the smaller companies is that they will not have any bargaining power towards the acquiring firm, since their economic survival is dependent on the bigger firms. For the large pharmaceutical companies on the other hand it seems like a global economic downturn is like a private invitation of the top performers of the industry to go on a ‘cheap shopping tour’, buying out prospecting companies along with their patents in order to increase their product portfolio. The question for the acquiring companies should be whether they should integrate those M&As or leave them separate by providing only financial support, since the study of McCarthy and Weitzel (2009) has shown that compared to large firms, acquiring SMEs, are more flexible and more able to avoid deals that turn sour. This new strategic implications could show that bridging the financial needs of a start-up in order to let it grow by itself, could be more profitable in the long run, than vertical integration.

Following hypothesis shall therefore be tested:

H3: Pharmaceutical companies that acquire in economic downturns have higher positive returns.

3.    Methodology

3.1 Sample

The initial raw data sample was extracted through the database SDC, which included all mergers and acquisitions that have been published. The date of announcement for the mergers and acquisitions was narrowed down to the timespan of 01/01/1997 to 31/12/2008. Acquiring companies were narrowed down to companies that possess the primary SIC Code of 2822, 2834, 2835 and 2836. Further, the deal type code (1) was included, as well as the deal status code (C) and the acquirer public status code (P). In total n=1615 deals could be extracted.

The raw data set was then completed by adding financial data extracted from Datastream by searching companies through the SEDOL code that has been coded to a mnemonic expression. The data for the financial performance indicators covers 1137 of the 1615 M&A deals.

Additionally, the data on patents has been counted manually by researching the European Patent Office database (EPO), and counting the patents that have been filed until the day of the M&A. In total patent data for 970 companies could be extracted.

The performance indicators for this paper will be set into the context of financial indicators that will allow to make a ‘hard’ data based analysis.

This research shall base on one of the most extensively studied areas, namely the financial component of how economic goals of the company are fulfilled (Barney, 2002). It is rather not beneficial to use the extended model of performance measurement because it gives to complex results for the regression analysis in order to analyse the pharmaceutical companies in global terms.

The financial perspective is defined by the tangible outcomes of the strategy using traditional financial terms, like economic value added, revenue growth, costs, profit margins, cash flow, net operating income, etc (Grigoroudis et al., 2012). In respect to that in this study I will also define further dependent variables influencing innovativeness in terms of cumulative abnormal returns of a given company. There are several reasons for that. Firstly, the availability of data for different measurement indicators like e.g. ‘economic value added’ or ‘profit margins’ are hard to obtain, and mostly not publically available. The return index of pharmaceutical companies on the other hand is available because most of the companies are listed on the stock exchange and therefore need to publish these numbers. Secondly, the cumulative abnormal returns indicate the ability to capture value from the commercialization of products, which gives a variable that includes several indicators of whether the product or innovation is commercially successful from the beginning of the R&D to marketing. Third and lastly, it also gives common grounds to compare companies on a global level because regional taxes are excluded and the focus lays just on the commercial success of income generation. Therefore, cumulative abnormal returns shall be the other main variables in defining the performance measurement statistics, which goes along with the authors Dehning and Richardson (2002) who showed in their research synthesis, on how to calculate returns on investment in a complicated industry like IT, that a wide range of performance measurements can be used, including event studies based on the shareholder return, on stock performance and sales growth percentage ratios.

The research setting for this study is defined as the global pharmaceutical industry. In total 1615 companies were included which acquired other companies within the timeframe of 1997 – 2008. This timeframe was divided into four periods that are defined as economic upturns (Period 1, Period 3) and economic downturns (Period 2, Period 3). The division of into those four periods corresponds with the fifth and sixth global merger wave of pharmaceutical companies (, 2012).

Figure 1 – Merger waves in pharmaceutical industry 1997 – 2008

3.2 Dependent variables

The following section presents the dependent variables that have been chosen to distinguish the behaviour of M&As in terms of frequency, in terms of the change in percentage of returns to the shareholders in long-term, the acquiring companies stock price value change in long-term, as well as a short-term measurement of the cumulative abnormal return. These dependent variables have the purpose of indicating if there are performance indications in long-term, short-term or in relation to the activity in M&A pursuance of the acquiring company.

Frequency of M&As (freq_ma)

The amount of mergers and acquisitions that have been performed within the specific period, in other words the frequency of M&As, is set to be the dependent variable. According to the authors Cassiman et al. (2005) M&As affect performance and organizational output. Setting this dependent variable into contrast to the independent and control variables, should give insights about how the activity of acquirers influence the other factors. It should give valuable strategic insights of whether an active or rather passive M&A behaviour has better implications on later performance and innovativeness. The data could be obtained by counting every M&A the acquirer performed in a given period, therefore covering n=1614 companies. This variable is additionally a good indicator of how risk averse an acquirer is and if it has do with economic up- and downturns, or locations when controlling for them.

Total Return Index – Abnormal return growth (tri_ar)

The abnormal return growth rates of the total return index are calculated on the basis of CAR (-3, -1) Quartiles, as the estimation window, which has been set into contrast to the CAR (0, +1) Quartiles as the event window. This adjusted growth rate has been benchmarked to the growth rates of the total return index global pharmaceutical industry. The t-test shows significance in comparison of the population means with an indicator of 0,26.

The abnormal return growth rates of the total return index, is a measurement to show to which extent shareholder value has been created. This measurement shows if the M&A in the end has created shareholder value in the long-term.

All data has been extracted from Datastream and accounts for n=1137 of the acquiring companies.

Figure 2 – Abnormal return growth rates, Total Return Index

Price Index – Abnormal return growth (pi_ar)

The abnormal return growth rates of the price index of the acquiring company has been calculated as the above-mentioned variable (tri_ar) with CAR (-3, -1) Quartiles as the estimation window and CAR (0, 1) Quartiles as the event window. The adjusted abnormal return has been benchmarked to the price index of the global pharmaceutical industry. The t-test shows also significance at an indicator of 0,47.

This variable is a more pessimistic version of the (tri_ar) variable, and displays to which extent the stock price of the company has been affected through the M&A, in respect to growth percentages. This measurement shows whether the company itself has profited from the M&A in the long-term. The coverage is also n=1137 of the in total n=1615 acquiring companies

Figure 3 – Abnormal return growth rates, Price Index


Cumulative Abnormal Return (car21_1)

An additional dependent variable is calculated by extracting the cumulative abnormal return on a daily basis of -21 days before the M&A, as the estimation window, benchmarking the average to the industry standard, and in the end contrasting this performance to +1 day after the M&A. This variable has the reason to distinguish the companies’ performance on daily basis by examining the return index and not on a quarterly basis like the variables (tri_ar) and (pi_ar). Further, this variable does not investigate the growth rates but the financial performance of the given company and therefore is a suitable measure to distinguish the firms’ returns in the short-term. The coverage of this variable is n=1136 of in total n=1615 acquiring companies.

3.3 Independent variables

Number of patents (num_pat)

The main independent variable for this research is the number of patents that has been traded as the acquiring firm merged or acquired the target company. The number of patents has been extracted by checking each individual target company in the European Patent Office database, and counting the patents they have possessed until the target company has been acquired. The patents that have been traded by M&A from the target company to the acquirer are set to be an indicator of the potential for innovativeness that has been transferred to the acquiring company.

3.4 Control Variables

In general, this study is controlling for periods, location and what influence the periods with locations have on the innovativeness given by the number of patents.

Locations (row_tar), (us_tar), (eu_tar), (ni)

Each Location has been coded with a dummy variable in order to distinguish the areas in which the target companies have been acquired. The variable (us_tar) are US based targets, (eu_tar) distinguish the European based target and all other countries are covered through the variable (row_tar), which stands for the rest of the world. Additionally the variable (ni) is giving insight whether the deals are national or international which provides information about the acquirer.

Periods (p1), (p2), (p3), (p4), (u), (d), (tp)

When controlling for periods the deals have been coded with a dummy variable for each period in that the acquisition took place. Ranging from p1 to p4 the individual periods cover the timeframe of all mergers and acquisition within 1997 – 2008.

(p1) is defined as the period from 1997-1999, (p2) is 2000-2002, (p3) is 2003-2006 and (p4) is 2007-2008. Additionally periods are coded as economic up- and downturns, in which (p1) and (p3) display upturns given by the variable (u), and the periods (p2) and (p4) are described by the variable (d).

Further, turning points (tp) defined as peak performances in the abnormal return growth rates are included into the model by an established event window of -1 Quartile and +1 Quartile from the given max/min of the (tri_ar) and (pi_ar).

3.5 Descriptive statistics

Variable        Obs     Mean              Std. Dev.         Min     Max

freq_ma          1614   2.67658         2.643193       1          18

num_pat         970     128.0495       100.4585       1          309

tri_ar               1137   510.044         297.3644       1          1025

pi_ar                1137   506.197         297.7779       1          1025

car21_1          1136   534.6268       301.4829       1          1067

p1                   1615   1.165944       .3721458       1          2

p2                   1615   1.214861       .4108529       1          2

p3                   1615   1.373375       .4838502       1          2

p4                   1615   1.24582         .4307059       1          2

u                      1615   1.539319       .498606         1          2

d                      1615   1.460681       .498606         1          2

tp                    1615   1.454489       .4980787       1          2

row_tar           1615   1.260062       .438804         1          2

us_tar              1615   1.492879       .5001041       1          2

eu_tar             1615   1.247059       .4314348       1          2

ni                     1615   1.367183       .4821862       1          2

rowp1             1615   1.032817       .1782134       1          2

rowp2             1615   1.040248       .1966004       1          2

rowp3             1615   1.104025       .3053872       1          2

rowp4             1615   1.082972       .2759255       1          2

usp1               1615   1.092879       .2903531       1          2

usp2               1615   1.117647       .3222895       1          2

usp3               1615   1.182663       .3865093       1          2

usp4               1615   1.09969         .2996796       1          2

eup1               1615   1.040248       .1966004       1          2

eup2               1615   1.056966       .2318493       1          2

eup3               1615   1.086687       .2814634       1          2

eup4               1615   1.063158       .2433221       1          2

ltri_ar              1615   1.063777       .2444311       1          2

lpi_ar               1615   1.064396       .2455336       1          2

lcar21_1         1138   1.093146       .2907645       1          2

lfreq_ma         1615   1.091022       .287729         1          2

(For the correlation matrix please see Appendix A.)

3.6 Calculation Model

The basis calculation model of this study is determined by finding the influence of the number patents that have been transferred from the target company to the acquirer by merger or acquisition, on four different performance indicators. The performance indicators are given by the dependent variables, namely, (car21_1), (tri_ar), (pi_ar) and (freq_ma).

The calculation includes three calculation models on which each dependent variable is tested individually for each control variable. The control variables are divided into control variables for periods, as well as control variables for locations. The independent variable is defined as the number of patents.

First an univariate regression analysis is being performed on which the individual performance shall be indicated. The calculation model for the univariate analysis contains:

Dependent = Patents

Dependent = Periods

Dependent = Locations

Dependent = Patents x Periods

Dependent = Patents x Locations

Dependent = Patents x Periods x Locations

The second calculation is a multivariate analysis, in which the four dependent variables, indicating the performance, are controlled by the same independent and control variables as mentioned above (Dependent = Independent + Control).

The third calculation model is a multinominal logitistic regression, which adds the likelihood ratios to the analysis. The performance indicators given by the four dependent variables have been coded displaying positive (coded as 1) or negative (coded as 0) relationships for the dependent variables (car21_1), (tri_ar), (pi_ar). For the dependent variable (freq_ma) the weighted average has been set as a benchmark and if the frequency of mergers and acquisitions for a given company scored above the average, coded as 1, and if it underperformed the average it has been coded as 0. In the dataset those coded variables are called (lcar21_1), (ltri_ar), (lpi_ar) and (lfreq_ma), respectively.

LDependent= Patents

LDependent = Periods

LDependent = Locations

LDependent = Patents x Periods

LDependent = Patents x Locations

LDependent = Patents x Periods x Locations

4. Results

This section contains the summarized result tables of the regression analyses in sequence of univariate regression, multivariate regression and multinominal logistic regression. For each block the main results are presented. For the complete calculation output please see Appendix B, C and D.

4.1 Summary of findings – univariate regression

The univariate regression shows that overall the frequency of M&As is lower in economic downturns than in upturns, with negative implications for financial returns at turning points. Further, it shows that acquiring US based targets in economic downturns has a positive influence on the growth of the stock prize of the acquiring company, as well as for the growth in shareholder value.

Those findings indicate that acquiring in moderate economic downturns, has the best financial implications for the acquirer, especially when they are based in the US. Avoiding turning points, which indicate peak performances in the market, could lower the risk of fluctuations in the market. Further, acquiring companies in moderate economic downturns could mean to get a cheaper deal when performing M&As (see figure 5 and 6).

4.2 Summary of findings – multivariate regression

The multivariate regression shows that when the frequency of mergers and acquisition increases, also the number of patents that have been traded increases. Further it confirms the pattern of the univariate regression that turning points in the market should be avoided, because they account for highly negative performances, especially in generating shareholder value.

Those findings indicate that a high frequency of M&As indeed increases the patent flow to a company, which could increase their potential of generating innovations – but on the other hand no measurable financial performance indicator can be associated to the amount of patents a company acquired. It seems like not the amount but rather the quality or fit of the patents could have a stronger impact on performance.

4.3 Summary of findings – multinominal logistic regression

The multinominal logistic regression distinguishes a similar pattern as the analyses above, by showing that positive returns are significantly associated with economic downturns, whereas negative returns are associated with economic upturns. Interestingly, this calculation shows additionally a pattern that the likelihood of a given location in period 3 (economic upturn) to generate abnormal returns is always negative, whereas the likelihood of generating abnormal returns in period 4 (slight economic downturn) is mostly positive. Further, it can be said that national M&A deals account for the best abnormal returns.

Those findings indicate that (regardless of location) acquiring companies in slight economic downturns, indicated by period 4, has positive financial implications for the acquirer. As mentioned in the results of the multivariate regression, slight economic downturns could have benefits of getting cheaper deals or even benefitting of reduced risk because a slight downturn can be seen as a temporary phase after which the market regenerates for further growth. Further it can be interpreted that national M&A deals account for positive abnormal returns because the transaction costs are the lowest when integrating a company that functions in the same market and under the same legislation.

5. Discussion

This section is structured alongside the calculation models and discusses the implications given by patents, periods and locations. The hypotheses will be answered in this section accordingly.

5.1 Patents

The number of patents that have been traded does not influence the returns of the company – therefore the innovativeness does not increase measurably.

  • No significance on number of patents on performance.

The univariate regression shows no significance as it comes to the number of patents that have been traded from the target company to the acquirer. They rather display that the abnormal returns, being it growth percentages or the cumulative abnormal stock returns, do not increase with the number of patents. It could be the first indicator that patents in the pharmaceutical industry after all, are not related with the companies growth nor the stock performance. When contrasting these findings to the study of Hagedoorn and Duysters (2002), who found out that acquisitions do contribute towards innovativeness of the acquiring firm, when there is an organisational and strategic fit – the question arises if the majority of US based M&As, had no organizational or strategic fit. Further research is needed to distinguish what motives the US acquirers really had, and if they have relied to heavy on the transaction cost theory.

  • The frequency of M&As influences the number of patents that have been traded.

All performed regressions in this study indicate a positive trend as it comes to the frequency of M&As and the number of patents that have been traded. As it comes to this research it is a logical implication that if the frequency of M&As goes up also the number of patents that are transferred increases. Nevertheless, this result underlines the validity of this approach to distinguish further, if there are related performance increases by financial or growth indicators.

The analysis shows no significance as it comes to the correlation of the number of patents and returns. It is possible that this is an indicator of a rather strategic nature of acquiring patents through M&As than for new product developments. The authors Artz et al. (2010) found out in their longitudinal study of the impact of R&D, patents and product innovation on firm performance, in which they investigated 272 companies in 35 industries, that patents had a significantly negative relationship on ROA and sales growth. Their study findings combined with the results of this research begs the question whether patents can really indicate innovative performance as it comes to financial measures – or do firms use patents rather as strategic weapons to secure their own position and block out competitors. Further research would be needed to investigate to what extent traded patents generated product innovations that can be commercialized, or whether those product innovations come from internal R&D.For the above mentioned reasons hypothesis 1, stating that the number of patents that have been transferred from the target to acquirer have a positive effect on innovative performance, cannot be proven and has to be rejected.

5.2 Periods

Pharmaceutical companies that acquire in economic downturns have higher positive returns.

  • Acquiring in downturn periods has better returns than acquiring in upturn periods.

This research proves that performing deals in slight economic downturns given by period 4 is beneficial for the short- and long-term performance of the acquiring company, especially when it comes to national deals. It seems like it is a good strategy to use a countercyclical investment strategy, to acquire and grow market share in economic downturns. The research of Baghai et al. (2008) supports this statement with their conclusion. They have researched different industries in economic up- and downturns and figured out that the most shareholder value and the biggest company growth, was exhibited by companies performing M&As in economic downturns. They also highlight that most companies behave in counterproductive ways, because of the financial implications an economic downturn brings with it by reducing available funds and increasing the uncertainty. My research is in line with their findings and adds another insight, attributed to the turning points.

  • Avoiding turning points by +1/-1 Quartile when acquiring companies is essential to not make negative returns.

The statistics show that peak performances, defined as turning points, should be avoided by the timespan of approximately (+1 Quartile; -1 Quartile), otherwise the returns will have a significant negative result. Therefore, concluding it can be said that not peak performances of the market should be aimed at when performing mergers and acquisitions, but rather slight economic downturns.

The univariate regression analysis gives a good insight on the periods that are defined as economic up- and downturns and the turning points. The cumulative abnormal return (car21_1) shows a positive significance for the economic upturn in period 2 as well as for the turning points, showing that the short term returns are following the economic curve of the market (see figure 4 for orientation).

Figure 4 – Performance of Global Pharmaceutical Index 1997 -2008

The positive significance is supported by the results of the variable concerning the abnormal growth percentage for the price index (pi_ar) for the global pharmaceutical industry. Interestingly, the variable describing the abnormal return of growth percentage of the total return index (tri_ar), shows a countercyclical trend for the turning points (see Result section). The variable (tri_ar) therefore gives insights of the risk for the shareholders, that even though the price index indicates a positive correlation for the acquiring company itself, it fails to generate shareholder value in the long run.

The turning points in the analyses show significantly bad abnormal returns when it comes to the creation of shareholder value and also in not increasing the stock price value of the acquiring company. It seems like acquiring other companies in the timespan of (-1 Quartile; +1 Quartile) of the max / min performance of the global pharmaceutical index, is negatively correlated to value creation for the company itself.

An explanation for this finding can be that the value of the deals that have been performed in those periods were more expensive than in the other periods and drained therefore the funds away from the company, lowering the shareholder’s equity.

When looking at figure 5, a pattern of high valued deals emerges, especially in period 2 and 3 and their turning points.

Figure 5 – Deal values of pharmaceutical firms 1997 – 2008

If we take a step further and take the inflation adjusted deal values and benchmark them to the industry average the pattern intensifies (figure 6).  It turns out that in the economic upturn periods the deal values far exceeded the industry average and the turning points indicate the highest peaks of spending habits.

Figure 6 – Inflation adjusted deal values benchmarked to industry average 1997 – 2008

Going further, the statistical analysis proves also that companies that acquire in economic downturns have a significantly higher likelihood of turning out positive returns, than companies that acquire in economic upturns. Therefore hypothesis 2, stating that pharmaceutical companies that acquire in economic downturns have higher positive returns, is proven.

5.3 Locations

The location of the target firms has an effect on the number of patents that have been traded.

Throughout this research especially US based targets struck attention. The results indicate that most of the target firms were US based and have been acquired by national deals. Interesting however, is the bad financial performance these deals had as a consequence.

  • US based companies seem to have other motives to perform M&As than just to increase their patent portfolio.

The US companies show a high activity as it comes to mergers, especially in period 2 defined as an economic downturn. Through their increased activity a significant number of patents has also been transferred, which theoretically should have resulted in an increase of the likelihood to generate innovations. The statistics show however, that quite the contrary took place. While the US was keen to merge and acquire, the rest of the world was rather passive, showed by a negative significance in period 2 as it comes to the frequency of M&As. Accordingly, less patents were transferred and better financial abnormal returns gained by the company and shareholders, in the long- and short-term.

These results indicate that a high frequency of mergers and the increased transfer of patents do not translate into added value, but rather into added costs. It seems like the transaction cost theory of Pisano (1997) is contra-productive in the end. Because as mentioned before, even though costs of integration and the transaction of highly complex technologies can be saved – the costs of the acquisition cannot be regained.

As the US have been always the capitalist forerunner and model of how to expand and grow business by M&A, they should be regarded with more caution by other nations. The hypothesis 3, stating that the location of the target firms has an effect on the number of patents that have been traded – can be therefore be accepted. The US based targets that have been mostly acquired by US acquirers, have also transferred the most patents in national deals.

It begs the question to what extent those deals were strategically motivated in afford to block the competitors out, or to what extent those gained patents have been used to develop new products. It would be up to follow-on research to investigate what the real motives behind those M&As were, and if it is not an out dated misconception of expanding the ‘the empire’. It could turn out that if money that has been spent on M&A would have been redirected towards other business units like R&D, marketing, etc. could have brought higher financial returns. Additionally, it could turn out that the reasons of not redirecting funds towards internal processes may be for the simple reasons that managers just spent so much time on negotiating and completing the deal that in the end they just wanted to have it done no matter what (Prabhu et al., 2005).

5.4 Limitations

At this point there should be also highlighted that this research contains some limitations to it. When taking a global perspective as this research intended the common ground of comparison should be variables that are comparable internationally. The main independent variable being the number of patents that have been filed by the target company until the date of the M&A, have been extracted manually from the EPO database typing in each name (and combination). Unfortunately companies are not listed by the SEDOL or SIC codes, which the financial databases provide, therefore creating the possibility of not covering companies that have changed their name or which are listed under a different name.

Further, as it comes to patents as the measure of innovativeness, there are different opinions to what extent this measure is legit. While the author Griliches (1980) for example states that patents are valid measure to distinguish innovative output, newer research of Hagedoorn and Cloodt (2003) showed that when it comes to complex highly technological industries, any indicator will be good as the other. And since this research is focused to a big extent on innovations, it is still one of the best measures for a quantitative research that includes a global perspective.

Another limitation is the financial performance data that has been calculated on raw data extracted through Datastream. Only data could be extracted from companies that possess SEDOL codes, which are mostly listed on approximately 16 Indices of the world. This limitation has as a consequence that for some locations e.g. the US, there is more data to obtain than for other regions, which creates a possibility of bias.


This research gives insights about the global pharmaceutical industry and how the innovativeness of the companies seems not to be correlated to the financial performance indicators. However, interesting findings could be gained establishing that turning points in the market should be avoided by approximately +1/-1 Quartiles in order to minimize the risk of turning out a deal accounting for negative abnormal returns. More so, this research could prove that M&As performed in overall economic downturns turn out better than those performed in economic upturns. Further it could be distinguished that the best abnormal returns are associated with period 4 that is determined by being as a slight economic downturn. As it comes to locations there can also be valuable information extracted when looking at the US based M&As, which indicate that the US might have other motives then Europe or the rest of the world.

There could be a unique explanation towards why those US companies perform mergers and acquisitions so frequently and trade more patents then others. More than a potential to generate innovations, those patents can be used to block out costly jurisdictional lawsuits against the pharmaceutical firms, which in the case of the US could have dangerous complications since the penalties a given company has to pay are measured on the basis of the total revenue. The research of Bessen and Meurer (2008) investigated this topic thoroughly and concluded that especially in the pharmaceutical industry it makes sense to spend money on patents because the profits associated with those patents are far higher than the aggregate US litigation costs to alleged infringements.

It can be therefore suggested that US based companies in particular are performing frequently M&A deals not only to secure patents on new drugs by saving transaction costs but especially because they want to prevent lawsuits against them. This explanation is in line with the other findings of this study, which show that the EU and rest of the world have an overall lower frequency.


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Author: Ivo Tokarski, 2011.


This analysis shows that the factors influencing the successful commercialization of Segway, which have been derived from a literature review (not supplied in this post), have a convergence to already established theoretical concepts. Concentrating on Segway, there have been two significant factors distinguished that influence the successful commercialization, namely the ‘lack of legitimacy’ and the ‘negative consumer perception’. The factor ‘amount of resources’ has a positive influence and the factor ‘network organizational form’ has a moderate influence on the successful commercialization of Segway.

Keywords: Segway; innovation; commercialization; factors influencing failure.

1. Introduction

First, we would like to take a step back and look at the short but intense history of the company. In 1999 the inventor Dean Kamen founded the Segway Inc. company in order to fulfill his vision of developing a zero-emission transportation vehicle that can be used on pedestrian sidewalks. This project took Dean Kamen over three years of patenting work and technical development together with the help of the University of Plymouth. On the third of December in 2001, the first Segway Human Transporter was unveiled on the ABC News morning program ‘Good Morning America’. The year 2001 was also accompanied by the peek of the dotcom bubble that soon was up to burst, which could explain the mindset of investors that were very high-tech oriented even though not all of them were experts in this field.

It did not take long and the hype also caught Segway Inc. After having attracted much attention because of the technologically brilliant invention, investors soon saw a possible uprising of a radical innovation (see also 1.3.1; Garcia & Galantone, 2002). One of the first investors was John Doerr who was speculating “it will be the fastest company to reach $ 1 billion in sales” (; 2001), even chief Jeff Bezos and Apple’s Steve Jobs seemed to be convinced and invested in Segway Inc. Those ‘big names’ of the industry were also a way for Segway to achieve legitimacy to gain even further investments. There are no official numbers of how big those investments were, but it is estimated that altogether Segway Inc. has received around $176 million US dollars of initial investments for product development (, 2006).

John Doerr was so convinced of the concept that he said to the Time Magazine in 2001, that “it would become more important than the internet” (; 2001). The following years the company did not fulfill the expectations and performed badly, mainly because the invention was great but the product too expensive to attain a critical mass as the authors Oliver et al. (1985) classified as being “the key to predicting the probability, extent and effectiveness of collective action” (Oliver et al.,1985), so in other words: that the market would accept it. After years of declining sales and bad financial records, the company has been sold in beginning of 2010 to the British millionaire Jimi Heselden who still was convinced of the invention. But like a tragic metaphor, after continuous losses, Jimi Heselden died the same year in September by falling of a cliff on his Segway (, 2010).

1.1 Failure or success?

So if we take a more scientific approach to the analysis of the Segway case, then we need to define first of all if the project really was a failure as we have generically concluded above. When we apply the core measures of new product success by the authors Hultink and Robben (1995) we should have a clearer picture. The authors define in their article 16 core measures of new product success, of which four factors are being perceived as being equally important for short-term and long-term success, namely: customer satisfaction, customer acceptance, meeting quality guidelines, and product performance level (Hultnik and Robben, 1995). We want to guide ourselves by those main four factors because they are not being time-bounded. If we transcribe those factors to the Segway case, it can be seen through the analysis of data, that Segway misses to fulfill any of the four core factors of measuring success as to be seen in table 1.

Table 1 – Measuring new product success

Factor Influence Why
Customer satisfaction Negative High acquiring price since the beginning ranging from $ 5000 – $ 7200 US dollars. In this price range the Segway is competing with small cars or scooters which are not that limited by range, recharge or high acquiring costs.
Customer acceptance Negative The Segway has a radical design concept, that is not yet accepted as the dominant design because the critical mass is lacking. People who ride the Segway look goofy which creates a follower barrier if only few “eccentric” people are using it.
Meeting quality guidelines Negative Even if the technological concept is very good, unfortunate accidents could have attributed to the damage of Segway’s reputation in this segment.  Segway Inc. has missed to counteract this by promoting the safety of the Segway. Famous examples of damaging the reputation were e.g. former US president George W. Bush has fallen from a Segway while the press was filming[1], and of course the tragedy of the British owner Jimi Heselden who has fallen down a cliff with his device.
Product Performance Level Negative The batteries last for around 16 – 39km and need 8 – 10 hours to recharge, which compared to todays standard electric bicycles, that are able to run up to 60-80km in distance with a recharge of 6 hours (, 2011), is quite inferior. Further, there is no common legislation for insurance, each country handles the Segway on own terms.

Those factors show that Segway Inc. is not focused on short- or long-term success of their product because the are ignoring the customer needs and therefore the market pull. Even though they heavily rely on technology push, their product is too isolated from the environment it has to function in. Guiding ourselves with the definition of innovation, ‘that it is something new with added value’ – we determine the Segway as a failure because it did not successfully commercialize on the market, therefore did not add any value, and excluded the customer in the sense that he has to adapt to the product and not that the product is catering to his needs.

2. Stages of innovation management

Segway has driven itself into a difficult position to acquire the critical mass needed to implement their transportation device on the market. There were two main issues that have hindered the market capturing:

Product development phase: Poor alignment of actions to goals during the innovation management (O’Sullivan, 2002).

The case of Segway shows that the company (in their product development phase) was concentrating on technological developments and scientific advances with the goal to target a mass market. The idea was to build this really new, technologically advanced transportation device, which would be adopted by the consumers as their ‘new’ way to get from A to B. The problem was however, that Segway has blocked out any market pull by not gaining knowledge of customer needs, market knowledge or knowledge about legitimacy issues. The effect was that Segway budgeted their product development with exaggerated beliefs of future returns on investment, which resulted in overspending on technological development that made the product expensive to purchase rather than spending the budget on their initial strategy of gaining a big customer base by trying to reduce costs of the Segway device.

Product in market phase: Poor market knowledge and therefore wrong strategic orientation.

Segway in its product development phase did use a technological orientation as their strategic choice, which according to the authors Zhou et al. (2005) is predestined to pursuing technical advances (technology push). The same authors identified that a market orientation has a positive impact on tech-based innovations (like the Segway is). Therefore we also suggest that Segway should apply a market orientation in order to gather knowledge about their customers and create a market pull. As Segway then entered the ‘Product in market’ phase they soon have realized that their initial customer base were not buying their devices. After facing multiple issues explained further in this paper, Segway has reoriented their strategy and are now focusing on a specific customer base, the commercial users like police, tour-operators, etc. The main disadvantages of the wrong orientation is the time they have lost to create efficiencies of scale, therefore their product still is very expensive.

2.1 Social construction and legitimation

When Segway was introduced, it could not rely on existing institutions to provide external legitimacy. This created problems and challenges for the company. In an article in The Economist in 2004, Mr Bills, the company’s CEO at that time, admitted that during the introduction of Segway, the focus was on the machine’s technology, not its value for the market.

According to Aldrich & Fiol (1994), legitimacy at the organizational level can be achieved by creating trust and by storytelling. When looking at the Segway case, legitimation at the organizational level was created. Dean Kamen, the inventor of Segway, figured 2002 would be the year that the Segway Human Transporter launched a transportation revolution. He expected the US Postal Service and police departments across the nation would overwhelm the company together with consumers from around the globe (Rivlin, 2003). After all, the Segway was not just a technically advanced innovation; it was also a green innovation (Rivlin, 2003). With these high expectations, Dean Kamen created trust on the organizational level. This indicates that on the organizational level, a lack of legitimacy was not the case. Everyone expected a lot of this new device, as can be seen by the big investors that invested in the company.

At the intra-industry level and the inter-industry level, Aldrich & Fiol suggest that collective action and negotiating with other industries are strategies to achieve sociopolitical legitimacy. In this case, Segway failed to do this. One explanation might be that the company believed so strongly in its success, that they did not realize they needed help from the industry to create legitimacy at this level. In fact, before launch, the company created so much secrecy around the product that it was often referred to in the media as ‘Ginger’. It was subject of speculation about what it might be, or do (Telegraph, 2008). They believed in their product and had no intention to take collective action to create sociopolitical legitimacy on this level. Moreover, they did not negotiate with, for instance, other green companies in the area of transportation to get a better reputation since they figured the reputation would be build automatically after the product launch. As for cognitive legitimacy, Aldrich & Fiol point out that creating convergence around a dominant design might be a strategy to create legitimacy. However, Segway did not do this, because they kept the product in secrecy as much as possible. As a result, Segway did not match the existing schemas about vehicles and transportation devices that consumers had at the time of launch.

Segway’s biggest problems in creating legitimacy were at the institutional level, as Aldrich & Fiol (1994) distinguish.

A first big challenge was state legislation in the US. Since the Segway was a completely new type of vehicle, a discussion whether it should be driven on a road or sidewalk developed. The Segway, going 10 miles an hour on average was too slow to be safe on a road, but too fast to be on a sidewalk with pedestrians. Aldrich & Fiol (1994), suggested that one way of creating sociopolitical legitimacy, is through lobbying. This is what Segway did. Segway lobbyist tried to come up with new laws, which were specifically designed for the Segway. In order to speed op the legislation, the lobbyist gave the Segway the official name EPAMD, which stands for Electric Personal Assistive Mobility Device (Allen, 2003). Next up was convincing all 50 states to create “a regulatory framework around the Segway” that would allow buyers of the pricey device to operate it just about anywhere they wanted, including sidewalks. (Kirsner, 2003). This lobbying turned out successful. In 2006, 42 states in the US had passed Segway-friendly laws in terms of transportation, a key to gaining wider acceptance (Paton, 2006).

Another big legitimacy issue at the institutional level is the fact that insurance companies had trouble deciding how they would acknowledge the Segway through liability coverage (Hollmer, 2002). Owners are not required to provide proof of financial liability insurance for the Segway. Insurance companies have several options about how they can insure Segway, according to the Insurance Information Institute. As a result, some insurance companies may sell an umbrella policy stemming from a standard homeowners policy that will cover the Segway. Others companies, the Insurance Information Institute said, may choose to offer a general policy that covers small motorized vehicles that would be separate, like an auto policy.

Cognitive legitimacy represents the amount that is known about the innovation (Aldrich & Fiol, 1994). At the consumer level, Segway was expecting consumers to stand in line to buy a Segway. However, this turned out to be wrong. In The Economist (2004), Mr Bills acknowledges this. Mr Bills started taking a different approach to increase sales, after the first sales were disappointing. He tried making the machines easier to buy and he tried to explain to customers how a Segway could fit into their lives (Economist, 2004). Increasing the sales could be explained as a way to build cognitive legitimacy, increasing the taken-for-granted-ness of the Segway.

But consumers had more problems with the Segway. The price was too high, and they had trouble using the complex device. Therefore, training was necessary. Also, due to the insurance problems at the institutional level, consumers were worried about the safety of the Segway. In addition, because legislation on the Segway was still not clear, consumers were worried about possible restrictions after buying a Segway (Paton, 2006).  Because the problems at the institutional level were not solved yet, the organization could not give the consumers clear answers on their worries, which resulted in disappointing sales. Therefore, it seems that cognitive legitimacy was obtained, but the company failed at gaining sociopolitical legitimacy, since legislation was not clear.

Pinch & Bijker (1989) suggest there are different social groups that have different influences on the artifact (invention), which can influence the legitimacy of an invention. Also in the case of Segway, such social groups exist.

For instance, Segway Enthusiasts Groups (SEGs) were introduced to increase knowledge and public acceptance of the Segway Human Transporter and to provide a resource to local owners for information and group events. There are different local groups in different areas of the US. Eventually this lead to the introduction of the SEG America organization. Another example is, introduced in 2002, and with the intention to create a community of Segway enthusiasts who would ‘educate the public, share information, stories, and photos about the ownership experience, and promote safe and responsible gliding. Within one year more than 1400 people joined the forum.

In 2004, a Segway Enthusiasts Group in California introduced ‘Segway polo’ as a team sport. Segway polo is similar to horse polo, except that instead of playing on a horseback, each player rides a Segway on the field. The sport is getting more and more attention.

In conclusion, legitimacy at the organizational level was obtained. Moreover, the company mainly failed to gain sociopolitical legitimacy. This implies that the relationship between the successful commercialization of Segway and the level of legitimacy is negative.

2.2 Resources

In order to make a product a success, different types of resources are needed. When looking at Segway through the ‘PROFIT’ (Morris et al. 2001) approach it becomes clear that they have failed in certain areas of resources.

As far as the Physical resources, Segways’ headquarter is located in Bedford, New Hampshire. Its construction was completed in November 2001 (, 2011). This location might sound questionable as it is not the first place you think of related to a technological company. However, Manchester NH, the city next to Bedford, ranks 144 in the “Top Overall Cities for Doing Business” (, 2011)

The Segway PT (personal transporter) back in 2001 was hyped by Steve Jobs, “As big a deal as the PC” (, 2011) and John Doerr, “Maybe bigger than the internet” (, 2001), these Relational resources accounted positively for Segway as it generated a huge amount of publicity. It has other relationships throughout the world as it “has a worldwide distribution network of more than 250 retail points in 61 countries” (, 2011).

Organizational resources; Segways’ legal structure it that of a corporation and it is a private ownership. ( After years of disappointing results, Segway was acquired by Jimi Heselden in December 2009. Earlier that year Segway collaborated with GM to manufacture a vehicle “called Project P.U.M.A. (Personal Urban Mobility & Accessibility)” (, 2011). Recently Segway and GM/SAIC presented another concept, the “EN-V (Electric Networked Vehicle)” (, 2011). These vehicles contribute to the green and non-polluting view that Kamen wants to carry out.

Due to the attention that Steve Jobs and John Doerr generated, many people got interested in investing in Segway. There was no shortage in Financial resources. John Doerr also said he “expected Segway would be the fastest ever to reach $1 billion in sales”. ( As he is the venture capitalist at Kleiner Perkins Caufield & Byers, this company invested heavily in Segway. Together with other investors like DAG Ventures, Masdar Clean Tech Fund, Credit Suisse, CSFB and Northgate Capital (, 2011).

Segway reportedly raised “at least $176 million in funding from investors”. (

In the 2008 paper “US venture capital in robotics” by Joanne Pransky it is noted that “’robot’ companies Segway and The Insitu Group (airlines and aviation related), (…) together accounted for $58.95 million or 29.14 percent of the total dollars invested in the 15 robot companies”. (Appendix B) These investments were for the years 2005-2006. This indicates that Segway kept being an interesting product to invest in for many investors. This year’s financial statement of Segway Inc for the United States Securities and Exchange Commission reveals that the corporation is making accumulated losses from inception which now exceeds $ 36,132,000 US dollars. (Segway IV Corp – Quarterly Report August 11, 2011) “Additionally, Segway also received funding that will be used to support the continued growth of the company.” ( Another sign supporting our statement that the company is failing to commercialize is the fact that they are still listed as a “development stage company” in the official financial statements dating back to 2001, which is on one hand resulting in a favourable taxation policy towards them but on the other hand it is showing that Segway is trying to compensate losses. (see: Form 10-Q of Segway IV Corp – Quarterly Report August 11, 2011)

Intellectual and Human resources; Segway was invented by Dean Kamen, he is the big brain behind the invention. He is specialized in technology and highly motivated towards introducing this field towards more people. Although Kamen was a very intelligent man and a great engineer, he did not study to be a manager of any kind. Kamen wanted to be as involved as possible in the whole Segway adventure. He had no experience in sales and marketing, which caused getting the Segway to the market and customer acceptance to be problematic.

Technological resources; Kamen is very active on the patent field. He has numerous patents for various products, “he has amassed more than 440 patents worldwide” (, as well as for the Segway, “You can’t get any broader than our patent” (Kemper, 2003). Even so, there was a little uproar when it turned out that Professor Kazuo Yamafuji in Tokyo had a patent for a similar invention, granted to him in 1996. ( Kamen has a fierce passion for technology, in 1989 he founded FIRST (For Inspiration and Recognition of Science and Technology). ( Kamen set up this program because “his passion and determination to help young people discover the excitement and rewards of science and technology are the cornerstones of FIRST” (, 2011).

As can be clearly seen from the results above, Segway had no problems with generating enough financial resources to launch their product, nor did they lack the technological and relational resources. The physical and organizational resources play an important but minor part in the case of Segway. The intellectual and human resources induce a different outcome. As these kinds of resources cover a large amount of different elements it is hard stay say that Segway failed completely in this area. However, there were shortcomings in several fields like marketing and sales. As this area is strongly related to the ‘customers’ perception’ part we will conclude that resources had a positive impact on the amount of success of Segway.

2.3 Organizational form

As Powell (1990) states and as was mentioned in the literature review before, relationships take a considerable amount of time and effort to maintain and strengthen which in turn can constrain both parties ability to adapt to changing circumstances. Berchicci (2006) also notes there were three broad user categories distinguished for Segway[2]: pure recreation, fun transportation (tourists, shoppers, golfers), and professional application (by the police, postmen, people in airports and warehouses). This classification typology of the user groups is important, as it impacts the way and in which form Segway ultimately chose to operate. Despite the initial successes in terms developing the product and interest among insiders, two conflicts occasionally manifested themselves: one was the extreme secrecy measures Dean Kamen imposed on his core team and hereby effectively hampering market research and field testing and the other was the reluctance to equity sharing and stock options. Instead of accepting the latter, Kamen preferred a traditional incentive system based on salaries and occasional bonuses.

For the introduction of Segway, Kamen had put together a support network, which involved a number of strategic partners. Throughout the rest of the process this team would play an integral role and we will see how great its impact was on the commercialization of Segway. Relationships were set up with outside suppliers and manufacturers, as well as with health care companies such as Johnson & Johnson, investor groups like CSFB and other business groups, which would provide the firm with the required resources and legitimacy. After having formed this network of relationship, the main issue appeared to be how to launch the product successfully, as it had to compete with vehicles such as the bike. Because of the existence of the bicycle the Segway could easily be banned on sidewalks, limiting the usage of it to lanes or playing grounds.

Despite the theoretical upsides of the network form mentioned, in practice it turned out to constrain the company down to having a relatively low amount of options considering sustainability of the product. Being an integrated network type of form that failed to lead the product towards acceptance, we can state that the nature of an innovation is not such that economies of scale and scope are required to succeed. Also, as explained earlier, one of the key factors of success is for the organization to be flexible enough to make room for improvement and creativity regarding the innovation. This is especially the case when analysing a product innovation. A company as Segway could perhaps gain more from the market type of form as one of Segway’s main problems lies in its communication and the form the organization allows for this. In a market form the company would have had low commitment levels and the secrecy it wanted to keep could be kept. However, this could have also backfired, as the end solution would probably have been that in order to make the network form be what it’s supposed to be, Segway’s teams should have been more mature about company knowledge transfers. We can therefore state that the organizational form itself was not a bad choice for Segway, however, the company failed to communicate appropriately and was not able to maintain the important relationships, which backfired on the process development of the product. This implies the relationship between the amount of Segway’s success and the organizational form is negative.

2.4 Consumer perception

As mentioned in the literature review, there are two different ways of looking at quality; namely perceived and objective perception. Besides this, value is an important indicator of consumer perception, as it applies more to the individual itself, rather than the lower level concepts of quality. In Segway’s case there have been numerous signals that the company failed to apply in its market research. In fact, the contradiction between the firm’s perception of the product and the consumers’ is significantly large.

The initial market for the Segway consisted of thousands of corporations, both domestic and international.[3] The vision was that the Segway could provide firms with environmentally conscious, inexpensive, efficient means of transportation and commuting. The market could eventually grow to include millions of fun-seeking consumers, but with a price of around $5,000 and a heavy weight (80lbs), the consumer market would not be as easy to enter, as most leisure devices in the Segway class (scooters) are far cheaper ($300-$1,000) and weigh about 40 lbs less. We will make clear how despite the market entrance warning upfront, Segway still failed to research the market as extensively as was necessary.

The consumer groups of Segway can be classified into pure recreation, fun transportation (such as tourists, shoppers, golfers), and professional application by the police, postmen, people in airports and warehouses (Berchicci, 2006). The first group is where the major drawback in sales was seen. People did not want the Segway as much as expected, due to a difference in needs and opinions. The Segway looked stupid, uncomfortable and was way too heavy. The other group consists of government agencies and corporate clients, which have tested the vehicle, but not agreed to any bulk purchases.[4]

Graham (2010) also points out the main problem of Segway can be traced back to the consumers and their perceptions, by stating the following:

Curiously enough, what got Segway into this problem was that the company was itself a kind of Segway. It was too easy for them; they were too successful raising money. If they’d had to grow the company gradually, by iterating through several versions they sold to real users, they’d have learned pretty quickly that people looked stupid riding them. Instead they had enough to work in secret. They had focus groups aplenty, I’m sure, but they didn’t have the people yelling insults out of cars. So they never realized they were zooming confidently down a blind alley.

The above highlights the difference between invention, believing that you alone have come up with the perfect idea for a great product, and innovation: the on-going iterative process of going back and forth with the market to test and understand what the market wants and how to make your product meet their needs. By focusing so much on the invention, Segway missed the real opportunity for innovation, and that has caused all sorts of problems for the company. It basically failed to concentrate on the most important part of the framework. In more detail, the perceived and objective quality of the product, contradict each other, as well as the value that consumers have towards it. Consumer perspective has therefore had a negative impact on the amount of success of Segway.

3. Summary of Results

  • Segway’s biggest problem lies in creating legitimacy at the intra-industry level and the inter-industry level. Aldrich & Fiol suggest that collective action and negotiating with other industries are strategies to achieve sociopolitical legitimacy. In this case, Segway failed to do this. Therefore we conclude that a lack of legitimacy has a negative impact on the successful commercialization of Segway.
  • Following the theories of Morris et al. (2001) gives evidence that innovations need a mix of resources. (Physical, relational, organizational, financial, intellectual & human and technological resources). It is hard to say that Segway failed completely in this area. However, there were shortcomings in several fields like marketing and sales, which resulted in a disproportional distribution of resources. However, we argue that the amount of resources has no negative influence on the successful commercialization of Segway because they had most of the resources available but did not exploit them properly.
  • Despite the theoretical upsides of the network form in practice it turned out to constrain the company down to having a relatively low amount of options considering sustainability of the product. Being an integrated network type of form that failed to lead the product towards acceptance, we can state that the nature of an innovation is not such that economies of scale and scope are required to succeed. Therefore we can state that the organizational form itself was not a bad choice for Segway, however, the company failed to communicate appropriately and was not able to maintain the important relationships, which backfired on the process development of the product. On this basis we could not distinguish a positive nor negative influence on the overall successful commercialization of the Segway because the main flaw was not the structure itself but the communication with strategic partners. We therefore define the factor influence as moderate.
  • In Segway’s case there have been numerous signals that the company failed to apply in its market research. In fact, the contradiction between the firm’s perception of the product and the consumers’ is significantly large. We therefore conclude that the negative consumer perception has a negative influence on the successful commercialization of the Segway.
  • It is difficult to distinguish the most significant factor of those influencing the successful commercialization of Segway because they are all interdependent; therefore they also overlap in effect. In perspective of our analysis of the case study we have the impression that the most problematic issues with the commercialization had to do with the lack of legitimacy and the negative consumer perception because they created the biggest hurdles to overcome and were the most time and resource expensive. However, we did not gather enough valuable data to distinguish, which one of those two factors is more significant than the other and therefore we have to rely on further research to make a reasonable distinction.

Reference list        

Aldrich, H.E., Fiol, C.M., 1994. ‘Fools Rush In? The Institutional Context of Industry Creation’. Academy of Management Review, 19 (4), pp 645-670.

Allen, J.S., 2003. ‘The Segway – Corporate Lobbyists write the law’.

Ashcroft, L.S., (1997) “Crisis management – public relations”, Journal of Managerial Psychology, Vol. 12 Iss: 5, pp.325 – 332

Berchicci, L. (2006). Of bikes and men – Innovation patterns and strategic entrepreneurship in the human-powered vehicle sector. Vrije Universiteit Amsterdam, paper prepared for the workshop on Strategic Entrepreneurship: the role of Networking. July 3-4, pp. 1-36

Gartner, W. B., & Low, L. 1990. Trust as an organizing trope. Paper presented at the annual meeting of the Academy of Management, San Francisco.

Hollmer, M. 2002. ‘Segway poses challenge for pedestrians and insurers’. Insurance Times, Vol. XXI(17).

Hultink, E.J. and H.S.J. Robben (1995), Measuring New Product Success: The Difference that Time Perspective Makes, Journal of Product Innovation Management, Vol. 12, pp. 392-405

Kemper, Steve., Code name Ginger: the story behind Segway and Dean Kamen’s quest to invent a new world; 2003

Kirsner, S. 2003. Segway makers lobby for sidewalk rights. Boston Globe (June 16) C1.

Morris, Michael H. Kuratko, Donald F. and Schindehutte, Minet., “Towards integration: understanding entrepreneurship through frameworks”, Entrepreneurship and Innovation, February 2001. pp 35-49



Graham, P. (2010). “About why the Segway failed”:

Reinventing the wheel: Interview with John Doerr; Time Magazine 2001;,8599,186660-1,00.html

Williams, P. (2011) :

Rivlin, G. 2003. ‘Segway’s Breakdown’. Issue 11.03 March 2003.

Telegraph, 2008. ‘Dean Kamen: part man, part machine’.,8599,186660-1,00.html


by Ivo Tokarski, 2011.

This paper synthesizes secondary and empirical research findings on the ageing workforce into a hypothetical research, focusing on the interdependency of increasing health of ageing staff on the success of implementing a job rotation strategy in the assembly line in the manufacturing sector. This paper will focus on a literature review of peer-reviewed articles, completed through own interpretations. The goal of this paper is to find conclusions for management, about the ever more important issue of ageing workforce, and give findings for future implications of a job rotation strategy in the assembly line.

Keywords: Ageing Workforce; Job Rotation Strategy; Health Of Ageing Staff; Assembly Line; Literature review.

1. Introduction
The increase of the world population, as well as the ever-increasing average age each person reaches is shown in several studies (see, for example, European Foundation for the Improvement of Living and Working Conditions, 2003). Longer life expectancy is especially evident in many developed countries mainly due to differences resulting from the quality and access to health services, lower birth rates and economic prosperity. If we look at the United States for example in the year 2006, approximately over 37 million citizens were aged over 65, which makes a 12,5 percent share of the total population. According to the article of Schlick (2010), this number is likely to grow to about 72 million by the year 2030, which makes a 19,3 percent share of the total population. This demographic change, which results through the ageing population, is also having an impact in the European Union (EU). The proportion of the working population between the ages of 55 and 64 is expected to increase from 56 million in 2006 (11.4 percent of the total population) to 70 million in 2030 (13.5 percent). Furthermore, the number of people in the EU aged 65 and older is expected to increase from 82 million in 2006 (16.8 percent) to 122 million in 2030, which equals an increase from 16,8 percent in 2006 to 23,5 percent of the total population in 2030 (Schlick, 2010).
The topic of ageing populations has also a natural impact on the issue of ageing workforce. The changes of demographics affected by the shrinking working-age population for instance, lead Germany to change the age of receiving the full social security retirement benefits from 65 to 67 (Thun et al., 2007). This proves that ageing workforce has a significant economic impact, but literature shows (Raina et al., 2001), that the issue of this topic is far more complex because of the fact that as people age it includes variables like perceptual, cognitive and motor systems which can have significant effects on their performance in work-systems (Schlick, 2010). This questions whether the German approach is the right one and to which level overall fitness and health is playing a role in the performance of ageing workforce.
In this research paper I will narrow this topic down and investigate to which extent health of ageing staff is influencing the successful implementation of a job rotation strategy in the assembly line. This hypothetical research will show if and how strong the variable of health influences the success of implementing a job rotation strategy in the scope of an assembly line.
Chapter 2 will give a more detailed view on the intention and research gap, which will lead into a literature review in chapter 3, a resulting conceptual model of influencing factors in chapter 4, completed by the methodology and findings in chapter 5 and 6.

2. Research question and research gap
Many empirical studies have been conducted to evaluate the influence of ageing workforce on the overall productivity in companies. In this research the focus shall be laid on the health factor of ageing staff and to what extent it increases the successful implementation of a job rotation strategy in the assembly line. If a given company knows the result of this research, it will provide the possibility to invest in preventive measures to increase the health of ageing staff, being it through training, health care or the improvement of ergonomics in the company, given that the research will show a significant correlation between the level of health and the successful implementation of a job rotation strategy. The goal of this research is to show that due to the increasing pool of ageing workforce, companies in the manufacturing sector can increase their efficiency and therefore reduce their production costs by implementing a job rotation strategy, which will also allow them to use the ageing staff in a flexible manner. Staff will deal with different production areas, which should stimulate their motivation and prevent singular working load in their job, which could have a positive influence on the level of health due to reduced physical stress resulting through manual routines in the assembly line process.
This research will supply the needed answer to the question if investment in preventive measures to increase the health level of ageing staff is a factor, which influences the implementation of a job rotation strategy in the assembly line positively.
In the progress of this research following sub questions shall be also addressed:
• To what extent does an increased level of health contribute to an increased productivity in the assembly line?
• To what extent can innovations in assembly lines increase productivity?

2.1 Definition of terms
Because I will use several terms excessively, I would like to explain them briefly in order to create a common understanding of what is meant by them. I will excerpt the most important terms and explain the definition briefly in this section.
The level of health of ageing staff – is the overall condition of the ageing staff, which is determined by physical, motoric, sensoric or/and cognitive conditions. In this research I assume that a healthy person can be distinguished by not having any of those conditions to a degree which is limiting them in their working environment, being it through limitation to perform certain tasks because of physical predispositions like e.g. back pain vs. heavy lifting. The level of health can be theoretically measured in percents relative to the possible abilities of performing a task. 100 percent means the highest level of health determined by work freedom, then scaling downwards to zero percent determines the level of “unhealthy” staff, which are restricted by some conditions to perform certain tasks.
Job rotation strategy – “Job rotation is defined as lateral transfer of workers among a number of different workstations where each requires different skills and responsibilities. […] As a benefit to firms, job rotation is said to improve a firm’s ability to deal with change. Flexible workers can provide buffer against uncertainties in manufacturing systems (Kher et al., 1999).”
Successful implementation of job rotation strategy in the production line – A successful implementation of this strategy is determined by whether it results in an increased efficiency at the assembly line, after the strategy has been implemented. This can be theoretically measured by comparing assembly times and output prior to the job rotation scheme, to the assembly times and output after implementation.

3. Literature review
3.1 The ageing workforce and health issues
As the author Arnone (2006) puts it:
“An ageing society faces many challenges that involve a broad range of economic, social, political and cultural issues. One aspect is the impact of an ageing workforce on a nation’s productivity, economic growth and global competitiveness. The deployment and contributions of older workers affect not only the economic and social well-being of the workers themselves, but also the standard of living enjoyed by current and future generations.”
Because the trend of increasing age of workforce is prospering in many countries, it can be argued that the impact on the economy will continue for years to come. The concern that the ageing workforce brings with them some associated impairments regarding work capacity and productivity seems to feed concerns in the industry. The age-related impairments can be found in several cognitive abilities, which can suffer. The authors Sülzenbrück et al. (2010) give a good overview of functions in which age-related impairments have a negative effect on working capacity and productivity. Their classification shows not only cognitive but also physical/ motoric impairments. The impairments can be divided into:
„Divided attention, sustained attention over long time spans and selective attention, further visuospatial attention, auditory attention, working memory, and inhibition. Also motor abilities suffer from an age-related decline. Loss of muscular strength, endurance and tone have been associated with aging making the execution of physically demanding jobs more difficult at older age (Sülzenbrück et al., 2010).“
So what does that mean in connection to the variable of increased health of ageing staff with respect to the successful implementation of a job rotation in the assembly line? Well, according to the results of Sülzenbrück et al. (2010) research, the generalized slowing of aged workforce and the therefore resulting impairments do not generalize across all types of motoric skills. In their empirical research they have shown that older participants even though they scored slower in cognitive speed, they scored significantly higher in motoric accuracy and speed testing than younger participants.
These findings are especially interesting for this research because they prove that there is a competitive advantage of aged staff in comparison to young staff. Aged staff is able to compete with younger ones by their experience and knowledge, which the results of the above-mentioned research showed in a faster motoric speed that can be related to experience and a higher motoric accuracy that can be related to both, experience, and knowledge. That is why I want to investigate if these motoric abilities can be even more increased through a higher level of health, which hypothetically could result in an overall motoric improvement and therefore contribute to the increase of efficiency and productivity within aged staff. The job rotation strategy will give an additional factor of keeping the level of workload diffused so that any action towards increasing the health and fitness of the aging staff will not be dimished. The assembly line will narrow the scope of the research because it is the smallest possible researchable application sector.
The report from Bupa “The Healthy Work: Evidence into Action”, mentioned in the article of Paton (2010) goes a step further and argues that the trends in demographic changes will mean that workers in the future generally will be sicker and older. The report does not see the health of ageing staff as an opportunity for increasing productivity but rather argues that there will arise a big threat to management of decreasing productivity by having to concentrate on managing absence, attendance and promoting workplace health because of the chronic health conditions, like e.g. obesity, of their staff. The report, which was taken in the UK, estimates that about 40% of adults will set to be obese by 2025.
In my opinion introducing preventive measures in increasing the level of health can hinder this scenario and turn this evident threat into an opportunity.

Productivity, performance, innovation and aged staff
The perception of aging staff is changing throughout the last years, because of the economic impact this demographic group gains. The worldwide development of the economy to a knowledge based economy brings a large amount of complementary needs with it, which can be supplied by the constant development of new technologies that help the aged workforce to be able to extend their working lives without sacrifice of health (Arnone, 2006).
Complementary to this there is the economy shift to supply better fitted services to the ageing workforce, e.g. health insurances coverage and better medical care, which support the productivity increase in the economy by increasing the mental and physical well-being of the aged workforce (Arnone, 2006).
Companies in the industry have realized the chance and benefits that an aged workforce can bring with them. Not only the knowledge base can be increased but also a primary contributor could be the diversification of labour force, where aged staff can create a synergy effect on young employees by functioning as a mentor. Increasingly interesting for firms could be a model in which the education costs can be lowered by assigning an aged staff member to a group of younger ones, who constantly can teach and supervise his teammates. This win-win situation can not only reduce education costs on one side but contributes also to counteract the diffusion of knowledge, because a one time education will not be that good memorized like constant repetition with the guidance of a mentor. Another positive factor could be that if the aged staff member teaches the younger ones, he is able to delegate more of his tasks, and therefore will not be that much physically exhausted like he would have been when performing all of the tasks assigned to his position by himself.
Those implications are especially important in the lean production systems in which the assembly lines play a crucial role in the speed of processing that is highly vulnerable to interruptions. Without buffering the stock and creating a balanced assembly line, the production rate will be only constant until a problem is detected and as a result the whole line will stop (Allwood & Lee, 2004). So from the management perspective it is a key success factor of exploring the problem solving in the lean production systems. One way of responding to the increasing need of operator problem solving skills therefore is the job rotation scheme, which increases the efficiency of operators who are facing repeating tasks that influence positively on their learning-curve (Allwood & Lee, 2004). The positive effect of job rotation schemes is researched by Allwood & Lee (2004) extensively and their results show that “the run-ratio generally increases as operators learn more rapidly and forget more slowly, and decreases as the number of problems increase.” This shows that a job rotation strategy avoids any possible advantage in specialization on certain problems, which do not occur uniformly at all workstations. The interesting part for my research is that Allwood & Lee (2004), did not divide their research groups by age, which could be interpreted in the way that the general result of advantage through the learning curve and the therefore resulting “allround-problem-solvers” is not age related, ergo: Organisations and management will also benefit from ageing staff.
What implications are then important for the performance part, in other words: How can management create incentives to increase performance of ageing staff?
Job rotation is widely used and recommended as an administrative control to the risk of developing work-related musculoskeletal disorder (Frazer et al., 2003), or more generally speaking the decreasing physical health. This is also the tag that I am using while defining the influencing variables, which have an influence on the factor of the successful implementation of the job rotation strategy. I suggest that an increased level of health in the aging staff will influence the success of the strategy, in the way that it will enhance efficiency, productivity, flexibility and foster innovation through the continuous improvement process (Freiboth in Frazer et al., 2003).
Nevertheless, this view is not supported by all researches. Keyserling et al. (1991) indicated that job rotation “by itself only changes the cumulative daily exposure but does not alter other generic risk factors (e.g. awkward postures, repetition) to which a worker is exposed. While a job rotation strategy might evenly distribute cumulative loading, raising it for some workers, lowering it for others, it also exposes all workers involved in the rotation schedule to the highest peak load, increasing the predicted risk for everyone rotating.”
Keyserling et al. (1991) have made a good point but nevertheless the probability seems less likely that a shorter exposure to e.g. awkward postures has a lower impact on the physical health than the exposure of only a part of the staff to perform those tasks, which recommend awkward postures. The main problem stays the same – the awkward postures remain while Keyserling et al. (1991) prefer to choose certain people who do not have health issues and implicitly increase their probability of developing health issues, rather than expose the staff who already have a lower level of health. I see two problems with that: Firstly, like I have mentioned in the introduction, the number of ageing workforce increases and there is no sign that this trend will change, therefore management will have problems with implementing Keyserling et al. (1991) theories in some time, simply because there will not be enough workforce with an high level of health because a big proportion will be aged by then and will have age related health issues. Secondly, this theory suppresses the knowledge exchange and therefore innovativeness within the company because there will be an informal selection of workforce which not only will discriminate a certain part of the staff (mainly the aged staff), but will engage a closed mentality (“we against them – syndrom”). This could result in specialization on a specific task in the assembly line, which will decrease flexibility because the worker cannot swiftly replace another one, which further can enhance the lack of communication that could result in inertia.
Aged staff take an important part in future decisions for management. Especially innovations like the increased replacement of human workforce by automatisation will have an effect on aged workers, because of the increased knowledge and technology load they have to process in an innovation-driven economy (Streb et al. 2009).
But there is the chance of aged staff to take advantage of these economic trends. When we take the classification of innovations by Jacobs (2007), we can divide them into product innovation, process innovation and transaction innovation. The innovations, which the aged staff will increasingly have to deal with, are the process innovations because of the automatisation process, they will have to work on the assembly line with robots and automatic tools. If we take a look at the job rotation strategy now, we can see that this is also a kind of process innovation because it uses a new distribution of tasks which result in an added value for the company (e.g. less fluctuation of staff) as well as for the worker (e.g. less health issues). Furthermore, the job rotation at the assembly line will increase communication, problem solving and can be used to extract knowledge of young as well as aged staff in order to make work processes or tasks more efficient. Therefore it can be argued that the implementation of the job rotation strategy could result also in an increased innovativeness through an open innovation approach within the company and in the end result in a competitive advantage due to increased efficiency in the assembly line.

4. Conceptual model and hypothesis
In this chapter I will give the graphical illustration of the conceptual model, illustrating how and which factors do influence the successful implementation of the job rotation strategy and further state the relevant research hypothesis.
During the literature review I have noticed the repeated usage of describing factors which where connected to aged staff and health issues. Because the issue of health in ageing workforce is so dominant in the literature I have reviewed, I have decided to make it my main factor, which is influencing the successful implementation of a job rotation strategy in the assembly line. This factor is very complex by itself and in respect to the influence of other variables. In this research the level of health should be seen as a generalized term which includes the overall condition of the ageing staff, which is determined by physical, motoric, sensoric or/and cognitive conditions, as stated in the definition of terms (see chapter 1).
Because the level of health brings with it a chain reaction it is at the left hand side of the conceptual model (see Figure 1). In my argumentation the level of health influences the performance of aged staff in the assembly line due to an increased ability of performing tasks. The authors Cropanzano et al. (2003), mentioned in the article of Streb et al. (2008), would not be convinced by my personal interpretation because they argue that as a criterion for job performance, emotional exhaustion goes beyond factors such as age. I want to point out that they are concentrating on the cognitive and more or less sensoric side of exhaustion and I am taking also physical and motoric factors into consideration.
Further, the performance affects the productivity because it increases the output through increased input of aged staff, like the authors Azizi et al. (2009) mention, that manufacturing productivity is affected by both the human and machine factors, because in the end the human operates the machine.
Productivity on the other hand is contributing to the learning curve and to the increase of knowledge because when the output increases through a higher productivity, the staff has a more intensive link to the tasks, machines and processes they have to maintain. The increased knowledge gained through the increased productivity could result in an open innovation approach at the assembly line, which could contribute towards efficiency improvement. If the efficiency can be increased – the overall workload for aged staff could decrease because of the job rotation strategy. If the overall process initiated through the increased level of health could have a “dripple-down” effect on those other factors, the implementation of the job rotation strategy will be successful.

Figure 1 – Conceptual model

Resulting from my evaluation, I therefore want to research following hypotheses:
H0: ihas = sjrs ; (increased health of ageing staff has a positive effect on the successful implementation of the job rotation strategy)
H1: ihas ≠ sjrs ; (increased health of ageing staff has not a positive effect on the successful implementation of the job rotation strategy)
By researching these hypotheses I will be able to distinguish to what extent the increased level of health within aged staff will increase the successful implementation of a job rotation strategy in the assembly line.

5. Methodology
In this research qualitative, as well as quantitative data is needed in order to supply a valuable conclusion. The main implications for this empirical research will be important for management decisions in the manufacturing sector, where assembly lines are used in. The main industries where assembly lines play a crucial role in the overall production are especially the automotive and electro technique industries where complex products are being mounted together in many steps.
Several companies could be taken into consideration for the scope of this research. To prevent on focusing only on the automotive industry on which most studies concentrate (Streb et al., 2009; Weichel et al., 2010) when researching the effects of job rotation I shall also include different sectors in the manufacturing industry like the high-tech electronic goods assembly lines. Because of the different sectors the factors will concentrate on the level of health of the staff, especially the aged staff, which can be compared with other companies.
To draw a bigger scope of comparison companies like Daimler-Benz, Volkswagen, Fiat, Ford, General Motors, and Toyota could be compared together with high-tech companies like Bosch, Siemens, Whirlpool, Electrolux, Samsung and Sony. This will give a global insight on trends in the assembly lines, where job rotation can be implemented and has the possibility to increase competitiveness through a better “exploitation” of aged staff. The comparison between the matured automobile sector where job rotation is already used in many processes, and the high-tech sector can show if there is a relationship in an increased level of health of ageing staff and a successful implementation of a job rotation strategy or not. Comparing two different market sectors will give insight if this variable is significant or not, and will give information if the hypothesis can be rejected or not.
Firstly, in order to gather the needed information about the companies I suggest performing a qualitative research by sending questionnaires to the companies regarding the measureable factors I want to investigate. Those questionnaires would be designed to answer current, past and predicted trends of demographic changes regarding the ageing of staff and the impaired developments affected by that. The factors will be those ones mentioned in the conceptual model, namely the increased level of health, performance, productivity, knowledge, innovativeness and workload.
Secondly, quantitative research will be performed by collecting data from the emission prospects of the mentioned companies and available scientific literature concerning the topics of job rotation strategy and ageing workforce. This second stage will show if there are similarities of performance, productivity, knowledge, innovativeness and workload when comparing the results of the qualitative research with the overall trends and challenges businesses’ globally have to deal with. The next step is to research if those factors can be generalized to the main hypothesis that if the level of health would increase it will have a positive effect on the implementation of the job rotation strategy. If the comparison of qualitative and general quantitative data will show a significant correlation, the result could be translated into the assumption that the challenge of increasing efficiency for companies when dealing with ageing staff can be positively influenced by increasing the level of overall health, which will positively influence the successful implementation of a job rotation strategy and therefore increase efficiency in manufacturing processes.

6. Expected Findings
With the outcome of this study I expect to have gathered valuable information that could help to influence future management decisions which have to deal with the challenge of managing ageing staff. These findings should give insight if it makes sense for management to invest in health increasing matters for their ageing staff, for example – training, improving ergonomics, workouts, physiotherapy, massages, etc. (Landsbergis, 2007), in order to gain efficiency improvements in the manufacturing process.
Figure 2 shows the expected influence each of the factors has on the successful implementation of a job rotation strategy.

Figure 2 – Conceptual model of expected findings

I expect that an increased level of health has a positive effect on performance, hence performance increases. Performance has a positive effect on productivity because an increased performance level should result in an increased productivity. Through an increased productivity the output of the assembly line is being increased, therefore also the amount of task-handling increases, hence the knowledge increases because staff is exposed to a higher product flow. The increased knowledge on the other hand has a positive effect on innovativeness because it can contribute to problem solving skills, inventiveness and synergy effects (Allwood et al., 2004). The therefore increasing level of innovativeness has a countercyclical effect on workload, because innovativeness can enhance process optimalisation, which will result in the decrease of workload and increase of efficiency.
All those factors combined influence the success of implementing a job rotation strategy in the same way as they are interrelated. Workload is the only factor, which is having a negative, or moderate influence on this. If workload is reduced because of the interrelation-effects to the other factors, management can question whether the job rotation strategy is still needed and if the main purpose of increasing efficiency in the manufacturing process at the assembly line, is not being compensated by a reduced workload.
From this research and the gathered data I do also expect to find answers to my research sub questions, namely:
• To what extent does an increased level of health contribute to an increased productivity in the assembly line?
Through preventive measures the physical, motoric, cognitive and to some extent the sensoric abilities can be increased and result in a higher level of health, which hypothetically could result in an overall motoric improvement and therefore contribute to the increase of productivity within the aged staff at the assembly line.
• To what extent can innovations in assembly lines increase productivity?
The increasing need of operator problem solving skills in the job rotation scheme, contributes positively to the learning curve. If communication is stimulated and an open innovation approach is adapted the organization can profit from the increasing innovativeness of their aged staff. They could contribute to optimalisation of the manufacturing process through their gained problem solving skills, inventiveness and synergy effects.

The limitation of this research is that there is no evidence that the generalized level of health within aged staff has a significant impact on the efficiency of the organization. Efficiency can be regarded as a factor, which is determined by the management and not by the staff. Therefore not only the argumentation that an increased level of health increases the productivity of the staff should be proven first, but also if this productivity has an influence on the efficiency of the company.
A further limitation to this research is the comparability of data, which is gathered from two completely different industries (automotive and high-tech electronics) that could make the results of the comparison irrelevant because of the different sectors they supply. High-tech electronics assembly lines could vary a lot from automobile assembly lines, therefore it has to be proven that the job rotation strategy will have the same effect in both industry sectors.
The final limitation can be the problem of translating the results to another industry. It can turn out that the outcomes are so specific that there will be no added value for other industries besides those researched. In the worst-case scenario the outcomes will not be even valuable for the companies, which are being researched because the results will be diffused by the different demographics of those industry sectors.

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Azizi, N., Zolfaghari, S., & Liang, M. (2009): Modelling job rotation in manufacturing systems: The study of employee’s boredom and skill variations. In: Int. J. Production Economics 123, (2010), 69 – 85.
European Foundation for the Improvement of Living and Working Conditions (2003): Age and Working Conditions in the European Union. Dublin.
Frazer, M.B., Norman, R.W., Wells, R.P., & Neumann, W.P. (2003): The effects of job rotation on the risk of reporting low back pain. In: Ergonomics, (2003), vol. 46, no. 9, 904 – 919.
Jacobs, D, (2007): Adding Values: The cultural side of innovation. ArtEZ Press. ISBN 9789089101242, 27 – 51.
Keyserling, W.M., Armstrong, T.J., & Punnet, L (1991): Ergonomic job analysis: a structures approach for identifying risk factors for low back pain at work. In: American Journal of Public Health, 91, 1069 – 1075.
Kher, H. V., Malhorta, M. K., Philipoom, P. R., & Fry, T. D. (1999): Modelling simultaneous worker learning and forgetting in dual resource constrained systems. In: European Journal of Operational Research, 115, 158 – 172.
Landsbergis, P.A. (2007): Interventions to Reduce Job Stress and Improve Work organization and Worker Health. In: Unhealthy Work, Chapter 11, 198 – 208.
Paton, N. (2010): Report predicts future with an ageing, less healthy workforce. In: Occupational Health, 00297917, Vol. 62, Issue 7.
Raina, S.M., & Dickerson, C.R. (2008): The influence of job rotation and task order on muscle fatigue: A deltoid example. In: Work 34, (2009), DOI 10.3233/WOR-2009-0917, IOS Press, 205 – 213.
Schlick, C.M. (2010): Age-Differentiated Work Systems. In: Occupational Ergonomics 9 (2010) 65-66, DOI 10.3233/OER-2010-0171, IOS Press, 1 – 3.
Streb, C.K., Voelpel, S.C., & Leibold, M. (2008): Managing the aging workforce: Status quo and implications for the advancement of theory and practice. In: European Management Journal 26, 1 – 10.
Streb, C.K., Voelpel, S.V., & Leibold, M. (2009): Aging Workforce Management in the Automobile Industry: Defining the Concept and its Constituting Elements. In: Zeitschrift für Personalforschung, 23 – 1, 1 – 20.
Sülzenbrück, S., Hegele, M., Heuer, H., & Rinkenauer, G. (2010): Generalized slowing is not that general in older adults: Evidence from a tracing task. In: Occupational Ergonomics 9, DOI 10.3233/OER-2010-0176, IOS Press, 111 – 117.
Thun, J.H., Größler, A., Miczka, S. (2007): The impact of the demographic transition on manufacturing: Effects of an ageing workforce in German industrial firms. In: Journal of Manufacturing and Technology Management, (2007), vol. 18, no. 8, DOI 10.1108/17410380710828299, 985 – 999.
Weichel, J., Stanic, S., Diaz, J.A.E., & Frieling, E. (2010): Job rotation – Implications for old and impaired assembly line workers. In: Occupational Ergonometrics 9, DOI 10.3233/OER-2010-0172, IOS Press, 67 – 74.

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Authors: Ivo Tokarski and Robin Vegter, 2011.


This paper aims to research how BAE Systems try to gain competitive advantage, in the European market for combat vehicles, in terms of product and process innovations and how they relate this to their strategy.

We have analysed secondary data in order to distinguish forces influencing the macro-, meso- and micro-environment of the business.

Our analysis shows that BAE Systems is focusing mainly on product innovations in order to counteract the high risk of substitute products. They adopt a strategy of becoming an expert in military supply to gain competitive advantage, because of the heavy regulated market they operate in. Our recommendations for them suggest a consideration of process innovations and the targeting also public markets that are less heavy regulated.

Keywords: Industry Analysis, BAE Systems, Defence Industry, Strategy, Innovation.

1. Introduction

This study will investigate the defence industry In Europe. The defence industry is a heavily regulated industry, which deals with enormous amounts of money. We like to explore the defence industry, because for most people it still is relatively unknown, while being such a big industry. Especially in this moment, where the Middle East (Iraq, Afghanistan, Libya, Syria etc) is about to experience a revolution. This revolution goes hand in hand with military interventions of Western countries. Therefore, the defence industry affects so many people on the world. We like to investigate what kind of industry is behind all these developments.

At the same time the defence industry is under pressure because of the financial crisis. Because the main buyers in this industry are governments of different countries. The same governments who have to cope with the financial crisis, which is still going on. Governments are cutting their spending’s in order to decrease their debt ratio. The defence industry will suffer from these cuts, because governments will also cut on their defence spending (Anderson, 2011). The consequences for the defence industry will be further analysed in chapter 2. Overall, we think that a industry, which is so big and affects so many people deserves a closer look.

1.1 Definition of the industry

The defence industry is a very broad industry, which is active all over the world. Besides the fact that the market is a global one, it has also several segments, like land, air and sea defence products. Every segment is already so big, that it could be considered as an individual market. Therefore this paper will focus on the European market of combat vehicles. The segment “land” is the biggest segment in terms of turnover and therefore we decided to choose for combat vehicles. Although land defence products comprises more than just combat vehicles, this study focuses on combat vehicles.

Combat vehicles are special designed vehicles with a specific fighting function and are mostly used at the frontline of combat area (Lechevin et al., 2009). There are a lot of different kinds of combat vehicles, the most known combat vehicle is probably “the tank”, which also has different types. Combat vehicles are often used for a specific mission or target, when there is incomplete information available about the area, target or enemy. Combat vehicles are than deployed to complete the mission (Lechevin et al., 2009).

Europe spends, after North America, the most money on defence products with a share of 16.4 percent of total spending compared to North America 51 percent (Anderson, 2011)[1]. Asia, including China, only holds 15.1 percent. For an emerging continent, which is numerous times bigger than Europe, this is quite remarkable. As said, in this paper we focus on the second largest continent, namely Europe.

Within Europe there are three countries that have a significant market share in defence industry, namely The United Kingdom, Germany and France (Anderson, 2011). They are all listed in the top 5 countries in terms of market share in defence products. In this paper we will therefore mainly focus on these countries.

1.2 Individual company

After having explained the industry, the individual company will be highlighted. This paper is written from the perspective of BAE Systems. BAE systems is the second largest global defence company of the world, based on their 2010 turnover, which was 22.4 billion pounds. They have home bases in Australia, India, Saudi-Arabia, South Africa, Sweden, United Stated, United Kingdom and provide their products and services to more than hundred countries in the world. They provide almost every possible product or service within the defence industry. BAE Systems deliver products and services for air, land and sea forces, as well information technology solutions and support services. Because of this broad range of products and services BAE Systems offers, we chose to only focus on BAE Systems land defence products and more specifically combat vehicles. BAE systems offices in United Kingdom and Sweden are responsible for the land and Armaments segment.

It is clear that BAE Systems is trying to be a big player in every possible product category and geographic market. They claim to deliver the best and most innovative products in all segments. Besides that, they also provide through-life support on their products. Therefore BAE systems likely to be classified as an organization who uses product leadership as main strategy.

1.3 Purpose of this paper

The purpose of this paper is to see how BAE systems tries to gain competitive advantage in the European market for combat vehicles by making product and process innovations. Secondly this paper looks how this is integrated into their strategy. The purpose of this paper is formulated into a research question:

How does BAE Systems try to gain competitive advantage, in the European market for combat vehicles, in terms of product and process innovations and how do they relate this to their strategy?

1.4 Methodology

Because of limited time, this research will be conducted with secondary data. There is a lot of secondary data available about the defence industry. The website of BAE Systems does provide a lot of information, mission statement, figures and annual reports on the organization, which will be used for the company analyses. For the industry analyses academic journals, articles, websites and newspaper will be used. A total list of references can be found in the reference list at the end of this paper.

1.5 Structure of the paper

The paper is divided in two main chapters, namely the industry analyses, which will be the next chapter. Here the industry will be explain with Porter 5 forces model and a PEST analyses of the macro environment. After the industry analyses, BAE systems will be discussed by performing a SWOT analyses, which will results in the main Strengths, Weaknesses, Opportunities and Treats of BEA Systems. Finally, this paper will end with our conclusions and a answer on the research question.

2. Industry Analysis

In this section we will perform an industry analysis starting at the meso-level with the five competitive forces that shape strategy according to Porter (2008), which will be put into a macro level perspective by the second part by performing a PEST analysis (Kotler, 1998).

2.1 Macro-level

In this chapter we will address the macro environment of BAE Systems. The macro environment will be assessed by a PEST analysis, which stands for Political, Economical, Socio-cultural and Technological developments. The goal of this chapter is, to give an insight on the forces on macro-level, which influences the performance of BAE Systems.

2.1.1 Political/legal force

The political force is a very important one in the defence industry. As described in the introduction, the defence industry is a heavily regulated industry, where the main buyers are the governments of different countries. The relation between governments and manufacturers can be described as a Military-industrial complex (MIC) (Lens, 1970). This concept explains the monetary and policy relations between governments, defence manufacturers and Ministries of Defence. The US arm industry is known for this concept, but industries in Europe are more or less the same. This can be explained by the facts that stable political countries want to regulate the defence industry, to make sure that contracts with private organizations or persons cannot be made. In countries where the political situation is less stabile, you often see more illegal trades and contracts, which have an influence on the safety in a certain country.

Secondly, governments decide to a certain degree what kinds of products are developed. Because governments are by far the most important customers of manufacturers, they have significant influence on what kinds of products are being developed and put into the market. Besides that, defence manufacturers are forced by regulations to meet all kinds of safety and quality standards. Off course, every industry has to meet certain standards, however in the defence this is significantly higher (Steinberg, 1992).

Third, politics are in fact the founder of the defence industry. Defence products in all their kind are necessary for situations where governments (or networks; see Al Qaida) of different countries are not able to solve their problems with sound arguments. Currently we see conflicts between Western and Middle East countries.

2.1.2 Economic force

The second force, is also a very important one in the defence industry. Because the main buyers of defence manufacturers are governments, it makes them vulnerable for economic recessions. The current economic recession and financial crisis forces governments to cut their spending’s and debt ratio’s. Important countries for BAE Systems like France, United Kingdom, Germany and especially Italy spent too much money during years of economic welfare (Anderson, 2011) This caused high debt ratios for certain European countries like, Greece, Italy, Spain, Portugal and Ireland. History shows us that countries cut their spending’s during recessions on defence products. Because most of BAE Systems customers are governments, this is a real threat. Probably the recession causes no problems at this moment, because most contracts are multiple year contracts, but they are more likely to feel the effect of the financial and economic crisis in a few years.

However, countries will always need defence products and technology will continue developing, so in the long run governments will keep spending large amounts of money on military equipment and in this case on combat vehicles. Era’s of economic and financial crisis only might postpone spending’s on defence products until moments of economic welfare arise again (Steinberg, 1992).

Another issue is that the global economic fluctuations in raw material prices for steel, aluminium and copper might fluctuate, (10% in of November 2011,, 2011), which might effect the predictability and planning of the business. However, BAE Systems has experience to overlap those times by essential financial resources they have gathered over time.

2.1.3 Socio-cultural force

Because the defence industry is a business to business industry, there are less social forces, which influence BAE Systems. However, the users of the combat vehicles BAE System delivers are off course soldiers. During wars in the Middle East a lot of soldiers died, which raises questions whether it could be prevented. Especially in the United States, which lost a lot of soldiers during wars in the Middle East, the soldiers safety has become an issue. Therefore the demand for safer equipment is increasing (Anderson, 2011). This results in research and the development of unmanned combat vehicles. BAE Systems already offers a limited amount of unmanned combat vehicles. However, a lot of progress can still be made in this sector also in perspective of the ethical questioning the social environment has created. But in the end even unmanned combat vehicles serve a rather unethical mean, namely killing.

2.1.4 Technological force

The technological force influencing BAE Systems gives an opportunity for them to develop certain new capabilities in developing areas like internet networking, robotics and unmanned combat vehicles. Defence product manufacturers like BAE Systems claim to develop their products and make incremental innovations on current products and technologies. However, those new applicable technologies influence the directions of product innovations as well as further incremental changes. The development of internet networking for example, triggered the R&D towards an integrated network of combat technologies as well. Current product developments try to combine, integrate and cooperate several technical elements to a holistic combat networking systems. The developments are guided by the idea of networking websites where individuals can effectively cooperate with each other. In military terms this cooperation should increase communication in combat situations. The future according to BAE Systems will bring soldiers that are equipped with eye-pieces displaying all relevant information for their task (distance, position of enemies, emergency calls of fellow soldiers etc.). This device will be connected to the vehicles themselves that will track and identify their users and positions. All the military equipment therefore at some point can be tracked and controlled by a centralized headquarter. Another trend influenced by technology is the implementation of unmanned combat vehicles and robotics. The development of those technologies is still in its beginnings but first successes can be seen in fully workable unmanned ‘drones’ (small remote controlled airplanes) that are able to spy on foreign territories or even carry bombs. The technological advances in the combat vehicles are still in their first development stage but are guided by the robotic advances done by universities and other researching companies. With the automatization processes that robotics can offer, the future trend is guided towards the automatized delivery and remote steering of vehicles to the war front, being it for supply or fighting reasons.

Overall the economic surrounding and the evolution of technology supply technological trends. The individual company itself does the adaptation and development of those technologies to defence industry needs.

2.1.5 Interpretation of findings on the macro level

The political force has a strong influence on the macro surrounding of BAE Systems. It creates a heavy regulated market sector in that the main customers (governments) decide about the rules of the game. The economic forces therefore are indeed also influenced by the political forces and can increase the fluctuations in armament spending’s but because of the long-term nature of this industry those fluctuations can be counterweighted. The socio-cultural force has no powerful leverage towards the overwhelming defence industry players. The ethical problems concerning the supply of warfare materials have been common ever since but in the same way the governments and manufacturers were able to ignore concerns. The ethical questioning however could have influenced the decision of starting to research and produce unmanned combat vehicles. The technological force is influencing to some degree the trends into the research of BAE Systems is being guided. The main emphasis lays in networking the technology and create unmanned vehicles by using robotics.

2.2 Meso-level

Using the five forces model on the defined market sector of BAE Systems, we can distinguish following factors that shape the industry competition.

Figure 1 – Five Forces

In the next section we will evaluate each point displayed in this model that was build in according Porter’s Five Forces in respect to BAE Systems.

Bargaining power of suppliers

The defence industry usually works like the ThyssenKrupp company manages their supply chain and innovation processes, namely in an integrative platform (, 2011). The companies’ within this industry try to form networks in which they can reach for the individual competences of the members (suppliers) involved. This is basically done by the joint development of innovative products and the exchange of information and know-how. Those business contacts that are formed in this network give access to new markets and possibilities. Those platforms are usually located outside the company and are not integrated in the hierarchy.

BAE Systems on the other hand is claiming to rely on external an open architecture in order to increase their own technological capability in order to fulfil the requirements of their customers (, 2011). They use a tiered approach to increase the added value throughout their supply chain, which ranges from full strategic and operational performance partnerships (, 2011). One of their main suppliers is the Advancing UK AeroSpace, Defence & Security Industries (ADS) that cooperates with BAE Systems in four main sectors, namely: Technology, Skills and Operational Improvement; Routes to Market; Policy and Events (, 2011). ADS is a supplier that has the same diverse technological diversity to support the four sectors BAE Systems has foothold in, being it aerospace, defence, security or space. ADS supplies BAE Systems primarily in matters of services like advice on export licensing, offsets, international trafficking in arms and security directive – a smaller share of services is concerned with technological improvement (, 2011). We therefore can define this supplier as the main consulting partner in legal matters, operational improvement and skill/knowledge transfer.

Because of secrecy issues and high ranked technological development and innovations, BAE Systems has adopted a new supplier development program in 2006 (BAE Systems, 2011) that changed from the traditional supplier quality approach from a series of reviewing in timely periods (initial six months, six to twenty months and twelve of eighteen months) – to a lean production process adopted from the car industry. Especially for this purpose they have developed the FRACA systems in order to make the qualitative improvements of suppliers measurable. The FRACA systems is working with complex variables to calculated a balanced scorecard in supplier management that consists of four main sectors, namely Process and KPI’s (Key Performance Indicators), Project Management, Relationship Management, critical milestones and joint actions (Penfors & Jaros, 2011).

Taking this into consideration we can conclude that the bargaining power of the suppliers in the case of BAE Systems is low, because the suppliers that are providing technological solutions are mainly integrated in the ‘Advanced Technology Centre’s ’  and slipped into the internal network of BAE’s lean production. Furthermore, due to secrecy issues concerning the developed technologies and the strict monitoring by the FRACA program, suppliers are constrained from serving also other manufacturers. Supporting this statement is also the research conducted by the author Sanderson (2008) on the buyer-supplier partnering in the UK defence procurement, that “none of the power relations in the supply network discussed is primarily characterized by interdependence and there is no evidence of partnering.”

Threat of new entrants

The defence industry is a world of ‘big players’, which divide the market among them. In the end of the year 2010, BAE Systems announced a turnover of £22,392 million pounds with a profit of £1,081 million pounds (BAE Systems Annual Report, 2010). The capital requirements to enter such a playground are enormous. Another barrier is the access to distribution channels because the main purchasers are governments, more specifically the MOD’s (Ministry of Defence), which need to be convinced of the legitimacy of the manufacturer (Aldrich & Fiol, 1994). This market is a international one, which means that not only that he is heavily regulated by international law but also requires an immediate scale efficiency from the producers in order to gain profitability and growth.

Putting it in terms of the authors Aldrich & Fiol (1998), new entrants will face a barrier in creating cognitive legitimacy and even more essential for this industry, socio-political legitimacy. In order to attain cognitive legitimacy, new entrants would have to achieve trust and reputation without having historical background in this field and they would also have to be cooperating with the already established organizations in this industry in order to help building their own reputation and legitimacy on a socio-political level (Aldrich & Fiol, 1998). Because it is very unlikely that the established companies have the intention to cooperate with new entrants, and the entrants themself will have to come up with huge capital requirements and production facilities, we therefore conclude that the threat of new entrants is low in this case.

Bargaining power of buyers

The defence industry, as mentioned before, is a heavy regulated business sector in which the entry requirements for new companies are high and difficult to obtain, but once established there are a very focused and affluent buyer base. The main buyers are governments represented by their Ministries of Defence (MOD), which invest the budgets granted by the governmental policies on a national level. From the perspective of the companies selling there are up- and downsides to such a market. The upsides are that their buyers have big capital reserves to spend and it is rather unlikely that a country will go completely bankrupt (neglecting the not foreseeable outcome of Greece’s future). The purchases are made in bulk so the profits generated by the companies are also dependent on the governmental spending habits. If the government has nothing to spend, the company has nothing to gain. But as the government buys the company has immediate profits due to secured financing. The MOD’s in general are the negotiating partners in forming deals with the companies within this industry and has a very strong bargaining power towards them because it can negotiate with several competing companies on a global basis and can create political pressure relating to the restriction of supplying different governments with whom they are in conflict. The only really effective countermeasure BAE Systems (or a company in their position) has, is the negotiating power of workforce employment. BAE Systems employees over 111,578 people in the UK alone which gave a certain negotiation power for the UK government to invest in their products in order to ensure employment for British citizens. But the fact of the matter is that a company in the defence industry cannot be represented in each country with such a big work force as a ‘negotiation hostage’. With governments of other countries they have to negotiate on a price basis.

Therefore we conclude that the bargaining power of buyers is high, because they are their main and only target market. To underline our statement we would like to point out a study conducted by Sanderson (2001), where he concludes, that “government regulation is a double-edged sword. It can either create or sustain a firm’s exchange power advantage, or it can be used to constrain or remove such an advantage.”

Threat of substitutes products or services

The defence industry is rather sensitive to the threat of substitutes in products rather than services. As explained before, services like legal matters and operational improvement can be outsourced to suppliers. The main threat lays in the development of superior products that could substitute the product of the own company in this sector. The R&D in the defence industry is considered as top secret because in the end the purpose still is to ensure that the product is superior to the enemy and therefore is an essential part of ‘winning a conflict’ in difficult times (or war). Manufacturers have big switching costs when they realize that a substitute has been developed. The timing of those moments is unforeseeable because as mentioned earlier their R&D is considered top secret. That means that the competitor is putting the company in front of a final product, which is ready to go to market immediately. The company with the inferior product will have to bear big switching costs in order to redirect production into the same direction as the competitors or putting capital into new product developments that on the other hand will surpass the substitute that has destroyed their market share and therefore comply with the industry growth and demand. We classify the threat of substitutes as high, because of that reasons. Supporting to our statement is the result of the research on patents, trade secrets and the correlation among R&D projects by the authors Bulut and Moschini (2006), who conclude that “the availability of additional modes of protection (trade secrets) may in fact lead R&D competitors to choose less correlated projects.” Following our argumentation this would imply a threat of substitution. 

Rivalry among existing competitors

The database of the Stockholm International Peace Research Institute (SIPRI) reveals that there are major regional differences among arms producing companies (SIPRI, 2011). The data reveals that of the top 100 arms producing companies in 2009 which generated worldwide a turnover of over $368 billon US dollars. 45 of those companies were located in the USA, and 33 in Western Europe. 26 of the top Western European countries are based in Italy, France, Germany and the UK (SIPRI, 2011).

As we define our industry analysis to the European market we will distinguish the main competitors from Europe in order to focus on a specific market. We have to admit however, that the defence industry is a global business were the biggest producers, coming from the USA (e.g. Lockheed Martin, Boeing, Northrop Grumman, General Dynamics, Raytheon, etc) also sell their products to Europe. We want to however to focus on the regional rivalry of this sector, which concentrates on those four countries mentioned before: Italy, France, Germany and the UK. The main competitors are defined by the list of the top 50 arms producing companies based in those four countries.

Figure 2 – Top 50 Western European companies

Arms sales, 2009 (US $ milions)

Source: SIPRI database, Top 100 arms sales (2009).

Figure 2 shows that there are companies in Europe that make more turnover in the defence industry sector, but BAE Systems is still one of the commercially healthiest of the sated rivals because they are able to generate profits from the turnover. Another advantage towards their rivals is the product portfolio of BAE Systems, which covers a diverse spectrum from land, air, space, water defence products to the technology, service and maintenance. If we take EADS for example as a comparison then we see a focus strategy on the air sector.

The distribution of market gain by division for BAE is divided as following.

Figure 3 – BAE Systems revenue by division (2008)

Source: BAE Systems, Preliminary Results (2008)

Figure 2 shows that approximately 34% of the $32,420 million generated in sales in 2008 have come from Land & Armaments. Therefore a substantial part of the $11,022 generated can be attributed to the armed vehicle business. Using the same percentage on the $33,250 million generated in 2009, $11,305 million can be attributed by estimation to the sector of Land & Armaments so that we can conclude that the combat vehicle sector is growing. From this simple insight we can draw a line to the industry life cycle and argue that the industry is still in growth. We find similar evidence when looking at the rivals.

We therefore conclude that the rivalry is high in this industry sector. According to the article of Anderson (2011), we also argue that in times of worldwide financial crisis the military spending’s plunge accordingly, and therefore the defence industry faces greater challenges in generating profits. This certainly is a factor that increases rivalry.

2.2.1 Interpretation of findings on the meso level

Summing up the five forces analysis we conclude that:

  1. The bargaining power of the suppliers in the case of BAE Systems is low, because the suppliers that are providing technological solutions are mainly integrated in the Advanced Technology Centre’s and slipped into the internal network of BAE’s lean production.
  2. The threat of new entrants is low because of the mature industry life cycle, the high capital requirements and entry barriers generated through the established companies as well as through legislation.
  3. The bargaining power of buyers is high, because the governments are their main and only target buyer.
  4. The threat of substitutes is high because of secret product developments and big switching costs when they realize that a substitute has been developed.
  5. Rivalry among existing competitors is high because they are established companies with big resources to cover competition costs.

3. Company analysis

In this section we consider the micro level analysis of BAE Systems and give insights to the organizational structure, the internal strengths/weaknesses, the external opportunities/threats, as well as innovation activities and how the company adjusted their corporate strategy according to this.

3.1 Structure of BAE Systems

The organizational structure of BAE Systems is ordered in hierarchical manner due to the high needs of reliability and accountability (Powell, 1990) towards the governments as buyers, as well as for the need for information processing and the successful exploitation of resources.

The downsides to this organizational structure are inflexibility and a danger of structural inertia (Hannan and Freeman, 1984) as well as hindering the capabilities of exploring new technologies and processes.

The normative basis of this structure is explained by employment relationships that are based on routines in the means of communication, where conflicts are ruled out through supervision.

The structure of BAE Systems plc can be depicted from figure 4 in which the headquarter is supervising three functional levels divided geographically, namely the USA, UK and the rest of the world. The adnotation to the company name in form of the three letters ‘plc’ stands for ‘public limited company’, which means that shares of the company can be sold to public investors – we will not continue to add plc in the paper unless necessary for distinction. The most important aspect for our analysis lays on the UK based group that includes the ‘Advanced Technology Centre’, which is the ‘think tank’ or innovation generator for the USA based group as well as the rest of the world. This R&D unit employs more than 400 scientists and engineers and works throughout the supply chain also with collaborations and partnerships to academia and innovative organisations. The innovations that have been generated will be diffused to the division that produces the preceding product or can benefit from the new insights, for production. The sector that we base our analysis on is the combat vehicles, which are produced in the USA based group in the ‘Land & Armaments’ division (see Appendix A).

This localized separation between the innovation centre and the manufacturing facility, in our opinion, can have a negative impact on the rate of innovation success because a big input for R&D is geographically too far abroad to transfer tacit knowledge. More so, the hierarchical structure might have also impediments for knowledge transfer because the employees will follow certain routines and therefore create structural inertia, or the R&D department might develop technologies that are not applicable in the ‘real world’.

The downsides to such a structure are that the divisions can be too isolated from each other, therefore there could be a deficit of cross-pollinations between the R&D department and those employees working on the operational level that could also have influence incremental changes of the products. We believe that a more network like function of the R&D department within the company boundaries of the company, would benefit the success rate of innovation because it would add also possibilities for process innovation or manufacturing capabilities.

3.2 SWOT Analysis

3.2.1 Confrontation Matrix

In this paragraph we will elaborate on the SWOT analyses by performing a confrontation matrix. In a confrontation matrix internal and external elements are confronted in order to see how they affect each other. At the same time you see which elements have big influence and which have less influence by the number of pluses and minuses you see at the end of each row. A confrontation matrix will result in a number of strategic issues. In the case of BAE Systems this will be three strategic issues, namely: Emerging markets, private sector and technological possibilities.

Strategic Issue 1: Technological possibilities (O2, O3, O4, T3, T4)

The first strategic issue that BAE System faces are technological possibilities they have. Because of their R&D department with high expertise, they have the possibility to continuously develop the latest innovations like; unmanned combat vehicles, safer equipment and integrated network systems. Secondly BAE Systems could create an technological lock-in, which means that certain products won’t work without complementary products of BAE Systems. At the same time it will take them relatively more time and more money, because of structural inertia and high transaction to process those changes. This way BAE Systems can block threats like that facts that technology is imitatable and cope with the ethical pressure.

Strategic Issue 2: Emerging markets (O1, T2, T3)

The second strategic issue which arises from this matrix, are new emerging markets like for example Brazil. It fits the current strategy of BAE Systems, because they are already a global player and they have a good reputation and the capital reserves for it. Thereby, it is also a good way of dealing with the economical crisis and to spread the risks of it. Because of the economical and financial crisis in Europe it would be smart to invest in emerging markets. Emerging markets do also have less regulations and are therefore easier to enter.

Strategic Issue 3: Private sector (W4, O2, T2, T5)

BAE Systems does not sell parts of technology, which they developed for defence products, to the private sector. For example, in case BAE Systems develops new shock breaks with a whole new technique, that would be interesting for car manufacturers as well. Some  competitors of BAE Systems do sell to the private sector, but for BAE Systems this would be very interesting because they have a very good R&D department. The private sector is way less regulated and would make them less dependable on government contracts. Secondly it would spread the risk of the economical crisis.

3.3 Innovation & Strategy

The case of BAE Systems shows a two pillars of innovations, one focusing the product innovations to create inferior technologies and products – and the second focused on the process innovation, which mainly focuses on increasing security of the systems involved.

3.3.1 Product innovation

The centralized key department is the ‘Advanced Technology Centre’ (ATC) that is located in the UK (see Appendix A) is focused on the product innovations. This ATC is just another expression for the in-house R&D. As mentioned before this ATC is the key central element for all innovations generated and then implemented in the manufacturing process worldwide. The reason for the centralized R&D is the classified information with which the scientists and engineers are working with. Only with this format it is somehow possible to prevent sensitive knowledge to spill over the company boundaries. In the armament industry this knowledge is rather not tacit but codified, which means that it can be copied and used for counteractive systems. In this industry this can mean the difference between life and death, e.g. if the knowledge about a certain composite of the armour-plates leeks to competitors they will engineer weapons that can penetrate this armour. The nature of this industry makes this form of engineering a closed vacuum contrary to the network structures and cross-pollination emphasized by the author Powell (1990). This necessity brings a certain implication with it, namely the danger of getting caught in the ‘exploration trap’ as described by March (1991). The possibility exists that within this ATC they will focus too much on exploration, which could result in many undeveloped ideas and too little distinctive competence.

A minor critique towards the product innovations and technologies developed are primarily concepts for the military market and are not commercialized in the first instance on the public market which in some cases could benefit from the commercialization, as well as the company could increase profits by also commercializing a public version of the innovation in the public market. In case of the combat vehicles it could be the heavy-duty shock absorbers that could be implemented in regular Off-road cars.

3.3.2 Process innovation

To avoid the exploration trap BAE Systems has created an ‘Investment In Innovation’ program, which is dedicated to investments in security and technology development by external organizations. BAE Systems offers in this program not only monetary funding of projects but also engineering and technology resources and testing facilities. This outside-in knowledge transfer increases their own process innovation capability and on the other hand by sending out own engineers they have a bigger chance of not sharing classified knowledge about their products. The main interests and investments by this program relate to the focus on cyber-security, biometrics and surveillance that not only focus on a innovative way of securing their company’s technologies and manufacturing against cyber-crime and ensuring secrecy but in some degree this also allows to create a synergy between with technology platforms, which can cooperate safely. This gives a clue that the own capabilities of BAE within this area are not enough developed to engineer those in-house and therefore are not integrated in the internal innovation process. It can also be the sign of a rapidly changing and fast paced industry sector, which BAE Systems due to its structure cannot cope with.

Taken those two pillars of the ATC regarding the product innovations and the Investment In Innovation program for the process innovation together, we can distinguish upsides in the controlled knowledge transfer, trade secret control and engineering capabilities in the ATC, supplemented by the open approach towards investments in innovations with generate a knowledge flow outside-in and also controls the knowledge spill-over inside-out.

A critique towards the process innovation approach is the neglect of innovations or improvement suggestions coming from the operational level. The manufacturing plants and assembly line workers could give additional insights into product production matters, e.g. the accessibility of screws in tanks, easiness of repairs (etc), which could give valuable insights to the product innovations and the product performance. Through the centralized R&D approach, those information take a long time or even never get heard.

3.3.3 Competitive advantage

Competitors of BAE Systems use a rather more network-like type of innovation integration compared to the hierarchal structured, centralized innovation integration of BAE Systems. The competitors rely on a joint development of certain technologies in order to cut development costs. The example of ThyssenKrupp, a main competitor of BAE Systems, shows that they cooperate with e.g. Siemens, Frauenhofer Institue, etc. (, 2011), in order to develop a common base in which technological insights and knowledge can be used by each member involved into the innovation creation process. The finial implementation of those technologies is done by every company on its own, so the detailed implementation into armament systems is also covered by secrecy issues. However, the innovations generated in this network can serve also other purposes for example the commercialization on the public market, like e.g. precision tools created for a certain prototype production where sold on the public market to watch manufacturers and aircraft engineers.

BAE Systems focuses rather on the in-house product innovations that are generated through their ATC and complements it by some degree of outside-in knowledge through their investments in innovation program. However, they do not follow a strategy of supplying other markets besides the defence industry through their main company, but rather focuses on becoming an expert and leader in the defence industry. The facts speak for itself, BAE Systems is one of the market leaders within the industry and is securing their knowledge through isolation. This seems to work in favour of them because they therefore try to stay in touch with technological developments and there scientific engineering in order to create a sustainable knowledge base. The advantages in this focused approach is by reaping all the benefits from an innovations once it is created without having to share it. Benefits are not only monetary ones, but in the same extent BAE wants to increase their knowledge asset, which can be benefical for each further step in development. By not sharing this knowledge they also make it harder for their competitors to follow, because – “how can you follow when you can not see the footsteps?”

3.3.4 Corporate strategy

The corporate strategy of BAE Systems is strongly related to the strategy of their buyers, which in this case will be explained on the example of one of the biggest buyers, namely the MOD (Ministry of Defence) in the UK. This MOD itself has implemented a strategy for the defence industry, which aims to “improve how military equipment, supplies and services are produced and supported” (webarchieve.nationalarchieves,, 2011). This is accompanied with strategic assessments for future military requirements and identifying the need for industry restructuring. This Defence Industrial Strategy (DIS) gives a guiding function to BAE Systems in order to develop certain technologies or capabilities within their ATC (Advanced Technology Centre) were the innovation activity is held. This link between governmental requirements and future assessments therefore influences the innovation activity at the ATC and furthermore influences the corporate strategy of the company.

With this in mind we can distinguish hints for a strong bargaining power of the buyers also in the corporate strategy. The official strategy statement is “developing a culture of Total Performance, which includes delivering our Corporate Responsibility (CR) priorities through Responsible Behaviour, is embedded in our Group Strategic Framework” (, 2001). This “Group Strategic Framework” can be seen in appendix A, where also can been seen that the internal strategies are all focused on growth in the defence and security markets, growth in existing and new markets as well as growth in the export market.

This main focus on growth means a strong interdependency on governments and their MOD’s. Only if they can lay out their future needs and requirements, the company can start researching and developing the required capabilities. The framework in appendix A also gives a insight that BAE Systems is aware of the strong influence and control from the governments but tries to use this in order to lock in their buyers in their technology systems. This can be seen by strategic investments in services, platforms, electronic systems and the maintenance.

Summing up we can argue that even though BAE System is heavily reliant on buyers and their interpretation of future needs, they also have implemented a strategy that allows them to lock in their buyer once he has acquired their products.

3.5 Interpretation of findings on the micro level

BAE Systems is able to secure and defend their tacit knowledge within the boundaries of the hierarchal structured company. Even though competitors might adopt a different approach by using rather open network-like innovation structures to reduce R&D costs and increase the knowledge spill-over, BAE is performing the opposite approach by ensuring no knowledge transfer inside-out but just inside-in. This focus can influence the market positioning and recognition as being an ‘expert’. From this expert positioning BAE System could benefit in the future which might influence the performance of their products.

4. Conclusion

In this chapter we will try to give an answer to the research question, which was formulated in the introduction:

How does BAE Systems try to gain competitive advantage, in the European market for combat vehicles, in terms of product and process innovations and how do they relate this to their strategy?

The first thought which became pretty clear is that the defence industry is a heavily regulated industry, which has also influence on the innovativeness of BAE Systems, because governments subside the R&D of certain manufacturers, which is off course not without any expectations. Secondly we saw that from ethical perspective, product innovations get stimulated, because there is a demand for saver equipment and unmanned combat vehicles.

The main conclusions we can draw from the five forces model of Porter, is that there is a constant threat of substitution. Therefore innovation becomes even more important, which causes a rivalry among competitors. For BAE Systems it is important to be continuously be one step ahead of their competitors in terms of new products and the latest adjustments.

In the company analysis we performed a SWOT analysis, which showed that BAE Systems has a strong focus on product innovations. In terms of competitive advantage, they try to create this by offering the best and newest products. Therefore their R&D department, with high expertise, is very important for them. In our opinion they could utilize their innovativeness more, by also selling to the private sector and secure it by creating technological lock-in. Because some competitors of BAE Systems already sell to the private sector, it is remarkable to see that BAE Systems is not following them. It would make them at the same time less dependable on government contracts.

In general we can conclude that BAE Systems is very (product) innovative. They could focus more on process innovations and try to create knowledge spill lovers of their R&D department. Besides that, the strategy of BAE Systems is totally focussed on serving governments. In our opinions BAE Systems should adjust their strategy by entering emerging markets and the private sector to fully utilize their innovativeness and create even more competitive advantage.


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[1]Based on figures from 2008