Behind the Scenes: Sources of Complementarity in R&D

Management consultants increasingly recommend that internal R&D be outsourced; however, little is known about the substitution or complementarity between internal and external R&D. Through structural estimation of a flexible innovation production function we provide a deeper understanding of firm‐level drivers of complementarity between these two types of investments. Our analysis is based on a unique panel data set on the R&D and in‐licensing expenditures of pharmaceutical firms. Our results suggest that internal R&D and in‐licensing are neither complements nor substitutes. We find that the degree of complementarity is enhanced for firms with stronger absorptive capacity, economies of scope, and licensing experience.