One lab, two firms, many Possibilities: On R&D outsourcing in the biopharmaceutical industry

We draw from documented characteristics of the biopharmaceutical industry to construct a model where two firms can choose to outsource R&D to an external unit, and/or engage in internal R&D, before competing in a final market. We investigate the tension between outsourced and internal operations, the distribution of profits among market participants, and the incentives to coordinate outsourcing activities, or to integrate R&D and production. Consistent with the empirical evidence, we find that: (1) each firm’s internal R&D activity is monotonic in the technology received from the external unit, and the sign of the relationship does not depend on the technology received or generated by the competitor; (2) a measure of direct and indirect technological externalities drives the distribution of industry profits, with lower returns to an external unit involved in research (drug discovery) than in development (clinical trials); (3) upstream entry is stimulated by the long-term perspective for the external unit’s owners to earn a larger share of industry profits by selling out assets to a client firm than by running operations. However, in the case of early-stage research, the delinkage of investment incentives from industry value, and the vulnerability of investors’ returns to negative shocks, both suggest the abandonment of projects with economic and medical value as a likely consequence of R&D outsourcing.(This abstract was borrowed from another version of this item.)