Internal and External R&D: An analysis of costs and benefits

Abstract

This paper analyzes the costs and benefits of internal and external R&D activities. Using Dutch production and innovation surveys between 2000 and 2020, focusing on the ICT industry, I document an increasing share of firms performing R&D and the four-way mix of in-house research, contracted-out research, both, and neither. To rationalize these findings, I build and estimate a dynamic discrete-choice model of R&D with mode-specific investment costs. The cost of contracted-out R&D is much higher than the cost of in-house R&D, which explains the small share of firms that contract out alone. Doing both is cheaper than the sum of the two costs: in-house R&D offsets almost all of the extra cost of going outside. I read that extra cost as a hold-up problem with the partner. The offset is absorptive capacity: a firm that already does in-house R&D keeps more of the collaboration, so the two activities cost less together than apart. Productivity gains are similar across modes, so the mix of activities is driven by these costs. A uniform subsidy that does not favor a mode raises the share of R&D-active firms and firm value by more than a subsidy aimed only at in-house R&D.