Impact of R&D on profitability in the pharma sector: an empirical study from India
| Pages | 194-210 |
| Date | 03 May 2016 |
| DOI | https://doi.org/10.1108/JABS-03-2015-0031 |
| Published date | 03 May 2016 |
| Author | Dinesh Jaisinghani |
| Subject Matter | Strategy,International business |
Impact of R&D on profitability in the
pharma sector: an empirical study
from India
Dinesh Jaisinghani
Dinesh Jaisinghani is
Fellow Scholar at Finance
Department, International
Management Institute,
New Delhi, India.
Abstract
Purpose –The purpose of the current paper is to examine the nature of profit persistence and to
estimate the dynamic relationship between research and development (R&D) intensity and firm
profitability in the Indian pharmaceutical industry.
Design/methodology/approach –A dynamic panel data model with generalized methods of moments
(GMMs) technique has been deployed to estimate the relationship between R&D intensity and
performance. Arellano and Bond (1991) estimation methodology has been used to generate the
estimates. A sample of 55 publicly listed firms operating in the Indian pharmaceutical industry for the
period 2005-2014 has been considered.
Findings –The study finds moderate to heavy profit persistence in the Indian pharmaceutical industry.
The study also finds that there exists a positive relationship between R&D intensity and performance for
the Indian pharmaceutical Industry. The results hold even after considering two separate measures of
profitability – return on assets and return on sales. The results also hint at a possible non-linear
relationship between R&D intensity and profitability.
Research limitations/implications –The results highlight positive profit persistence among
pharmaceutical firms. The results also highlight the need for a sustained investment in R&D, as its
benefits are driven in the long run. Thus, managers should devise proper policies R&D investments.
Also, prospective entrants should properly study the existing entry barriers before deciding upon the
mode and timing of entry.
Originality/value –The degree of profit persistence and the dynamic nature of relationship between
R&D intensity and firm performance in the Indian pharmaceutical sector has not been studied. Thus, this
paper fills this gap and also highlights the impact of certain firm- and industry-specific variables on
profitability.
Keywords Indian pharmaceutical industry, Resource based view, Dynamic panel, Firms’ Profitability,
Generalized methods of moments, R&D intensity
Paper type Research paper
1. Introduction
The traditional resource-based view (RBV) suggests that firms can create competitive
advantage by developing rare, valuable and heterogeneous resources (Rumelt and Foss,
1984;Barney, 1986,1991). This view has invited a huge debate from both developed and
emerging markets. Many empirical studies from the developed markets lend support to the
applicability of RBV for firms operating in different industries and sectors (Mesquita et al.,
2008;Nath et al., 2010;Henard and McFadyen, 2012;Ramirez and Girdauskiene, 2013).
The evidence from developed markets also indicates that the creation of competitive
advantage leads to the slowing of the convergence process which in turn leads to
persistence in firms’ profitability (Mueller, 1986;Gschwandtner and Cuaresma 2013)[1].
Further, it is generally argued that persistence in a firm’s profitability results from
industry-wide restrictions such as entry and exit barriers (Jacobsen, 1988), creation of
strategic alliances (Lazzarini et al., 2013) and choice of business models (Collins et al.,
2011). Apart from these economic justifications, a few authors also cite certain technical
Received 14 March 2015
Revised 14 September 2015
Accepted 29 October 2015
The author would like to thank
Dr Kakali Kanjilal, Associate
Professor, IMI, New Delhi,
India, for her continuous
guidance and support at all
levels of writing the article.
The author would like to thank
the editor and area editor of
JABS for their valuable
feedback. The author also
thanks two anonymous
reviewers for providing their
feedback and comments.
PAGE 194 JOURNAL OF ASIA BUSINESS STUDIES VOL. 10 NO. 2, 2016, pp. 194-210, © Emerald Group Publishing Limited, ISSN 1558-7894 DOI 10.1108/JABS-03-2015-0031
causes of persistence in profitability. For instance, Li (2008) argues that persistence is
higher for firms whose annual reports are easier to read and comprehend. Similarly,
Roberts and Dowling (2002) contend that persistence in profitability is an outcome of good
business reputation.
The economic environment in emerging markets is very different from that in the developed
markets. Specifically, emerging markets are characterized by the simultaneous existence
of developed and under-developed institutions (Meyer and Nguyen, 2005;Billmeier and
Massa, 2009;Bae et al., 2012). This phenomenon is commonly termed as institutional voids
by many researchers (Ma et al., 2006;Mair and Marti, 2009;Puffer et al., 2010). Further, in
these markets, personal relationships are considered to be more relevant than the actual
business acumen in exploiting business opportunities (Peng and Luo, 2000;Freeman and
Sandwell, 2008;Miller et al., 2009). Many researchers argue that these forces create
additional barriers to competition and therefore should lead to higher persistence.
However, the existing empirical work in emerging markets does not support this contention
(Glen et al., 2003;Aslan et al., 2010). Therefore, it becomes essential to study the profit
persistence in emerging markets from different and varied angles. The current study makes
one such attempt by analyzing profit persistence in an emerging market, that is, India. The
study specifically tests the evidence pertaining to profit persistence in pharmaceutical
industry in India. Pharmaceutical industry provides an important setting, as it is generally
accepted that research and development (R&D) plays a significant role in determining the
profitability and sustainability of firms operating in this sector (Hall and Mairesse, 1995;
Graves and Waddock, 1994;Chen et al., 2013). The profitability of pharmaceutical
companies, to a great extent, depends upon new drugs introduced by them at regular
intervals. This requires continual investments in R&D efforts during both development
stages and testing stages. The success of R&D activities in these stages will ultimately
define the profitability of these firms. Therefore, analyzing the nature of relationship
between profit persistence and R&D investments can reveal important implications for both
researchers and practitioners. However, to the best of our knowledge, there is no empirical
study that has analyzed the dual aspect of profit persistence and impact of R&D intensity
on profitability for the Indian pharmaceutical firms. The current study aims at filling this gap
by analyzing profit persistence and impact of R&D intensity for Indian pharmaceutical firms
(a brief overview of the Indian pharmaceutical industry is presented in Section 2). The
results confirm the existence of positive persistence of profitability among pharmaceutical
firms in India. The results also confirm the positive impact of R&D intensity on the
performance of firms operating in Indian pharmaceutical industry.
The study has useful contributions to the existing research related to firm performance
and profit persistence. The current study utilizes better methodology, that is, a dynamic
panel setting. Most of the past studies in the field of profit persistence have generally
deployed the AR (1) scheme. These studies have mostly tested the persistence by
considering the “excess” profitability of a firm over the sample mean. However, the
presence of the firm in question in the sample itself may impact the estimation of the
sample mean. Therefore, the overall estimation of the persistence coefficient can be
biased. This issue can be efficiently handled by deploying a dynamic panel setting.
Moreover, the past studies on profit persistence have mostly focused on advanced
economies. The current study tests profit persistence for an emerging market, that is,
India. Last but not the least, the current study focuses on one particular industry rather
than analyzing the entire economy. This reduces the scope of considering
heterogeneous firms in a single sample. The rest of the paper is structured as follows.
Section 2 presents an overview of the Indian pharmaceutical industry. Section 3
presents a theoretical background and develops the major hypotheses. Section 4
describes the sample, variables and the estimation methodology. Section 5 discusses
the results and managerial implications. The last section summarizes and concludes.
VOL. 10 NO. 2 2016 JOURNAL OF ASIA BUSINESS STUDIES PAGE 195
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