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Are Pharma Companies Too Big to Innovate?

By Max Macaluso – Jan 2, 2014 at 2:33PM

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Does size matter when it comes to innovation in the pharmaceutical industry?

Ask any investor what they think about Johnson & Johnson (JNJ -0.56%), and you'll probably hear that it's a diversified pharma company, a blue-chip stock that pays a hefty dividend, and it's a relatively safe investment for investors looking for exposure to the health-care sector. But you might also hear investors criticize its size. With a market cap of almost $260 billion, Johnson & Johnson is one of the largest companies in the U.S., and it edges out both Merck and Pfizer as the largest pharma company in the Dow. Can a company this massive be nimble and entrepreneurial enough to innovate? Is its size holding back its long-term potential to bring new products to market?

Looking at Johnson & Johnson's stellar performance in 2013 and its growing pharmaceutical division, size doesn't seem to be a problem here. In fact, Bernard Munos, innovation expert and founder of the InnoThink Center for Research in Biomedical Innovation, doesn't believe that it's impossible for a large company to innovate. He thinks investors are better served looking at a company's culture and leadership, citing historical examples from Merck and Roche's subsidiary Genentech. In the following interview, Munos further explains why size doesn't matter when it comes to innovation. A transcript follows the video.

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Max Macaluso: Bernard, we've been talking a lot about innovation, companies that have embraced it in the Big Pharma industry. I'm curious, is it possible to be too big to innovate? Do you look at a company like Johnson & Johnson, for instance; its market cap is enormous. You look at Merck. Merck is so diversified -- they do pharmaceuticals, consumer health, also animal health -- is it difficult to innovate when you're that big? Is it impossible to innovate when you're that large?

Bernard Munos: It's not. But you've got to keep in mind that, when it comes to innovation, the critical mass is one human brain. It's not 1,000 people. It's one human brain. This is why Rockefeller does it so well. They've got 75 outstanding brains that spin out one Nobel Prize after the other.

I think the pharmaceutical industry over the last 15 years, certainly the large companies, have tended to forget that. In fact, they have purged their "mad scientists," so to speak, because those people tend to be tough to manage, because they always have a different idea.

The leaders of the industry fail to recognize that this is the critical ingredient that you need in order to spur innovation, so they got rid of them and they ended up with lots of people that were easier to manage, but didn't produce anything; hence, this industrywide innovation crisis.

Look at Merck when Vagelos was managing it. It was a big company, one of the biggest ones in the industry, and yet it performed extremely well. At $100 billion market cap, Genentech was not small, and yet it kept coming with one breakthrough after the other.

It's all about leadership. I think wherever you have effective leadership, size doesn't matter. You can have an innovative culture and organization that will produce breakthroughs. If the leadership isn't there, you're not going to get that. It doesn't matter how much money you throw at it, it doesn't matter the processes that you've got. It doesn't matter how many times you reorganize the organization. It just isn't going to work.

Max Macaluso, Ph.D. and Bernard Munos have no position in any stocks mentioned. The Motley Fool recommends Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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