Absorptive capacity and R&D outsourcing

I analyze the determinants of research and development (R&D) outsourcing, or investments in R&D purchased from external providers. I build on the knowledge-based view of the firm (KBV) and the concept of absorptive capacity to propose a separation between the mechanisms that form the potential absorptive capacity that enables the firm to identify and integrate outsourced R&D knowledge into the firm, from the mechanisms that form the realized absorptive capacity that enables the firm to use and transform outsourced R&D knowledge into innovation. First, I propose that firms that engage with foreign customers and with foreign suppliers develop the potential absorptive capacity, an ability to understand new and complex external knowledge that is useful for integrating it with firm-internal knowledge, and thus invest more in R&D outsourcing. Second, I argue that firms that have more skilled employees and invest more in internal R&D develop the realized absorptive capacity, an ability to use and transform external knowledge, and as a result invest more in R&D outsourcing. Finally, I propose that these relationships are weakened when the firms are subsidiaries of foreign multinational firms operating in the country, because these firms can also build their absorptive capacity by being integrated with other country subsidiaries and the headquarters within the multinational. I test these arguments on a sample of manufacturing firms and find that firms that import, export, have more skilled employees, and have more internal R&D investment tend to invest more in R&D outsourcing. I also find that, for subsidiaries of foreign firms, the impact of skilled employees and internal R&D on R&D outsourcing is lower than for domestic firms. These ideas provide a theory-driven explanation of the determinants of R&D outsourcing that refine the notion of absorptive capacity and its two dimensions, potential and realized.