Research versus development, external knowledge, and firm innovation

Abstract While the positive influence of external knowledge on firm innovation is widely recognized, our understanding of the interplay between the quest for external knowledge and internally conducted research and development (R&D) remains incomplete. Previous research has identified certain conditions that shape the synergy between internal and external knowledge, such as the institutional origin of the external knowledge and the overall scale of the firm's internal R&D activities. In this study, we focus on an important but not yet considered dimension and analyze whether the returns from external knowledge sourcing are contingent upon a firm's internal involvement in basic or applied research as opposed to development . We argue that engaging in research, while supporting a firm's absorptive capacity, leads overall to lower benefits from seeking external knowledge because of knowledge crowding out and spillover effects. We test our predictions using a representative panel dataset from Spain (Panel de Innovación Tecnológica [PITEC]) and show that the benefits of external knowledge decrease for higher shares of internal research investment. This substitution effect is particularly pronounced in settings where sector‐level appropriability is limited and in nonhigh‐tech sectors. We contribute to the innovation literature by underscoring the important role of the nature of internal R&D efforts in shaping firms' capacity to benefit from external knowledge sources.