Gary P. Pisano Harvard University This paper examines how two sources of transaction costs, small-numbers-bargaining hazards and appropriability concerns, may affect established firms' choices between in-house and external sources of R&D when technological change shifts the locus of R&D expertise from established enterprises to new entrants, and established firms face a make-or-buy decision for R&D projects. The relationships of other organizational characteristics to the R&D procurement decision are also considered. Hypotheses are tested with data on 92 biotechnology R&D projects that major pharmaceutical companies have sponsored either in-house or through external contractual arrangements. The results suggest that small-numbersbargaining problems motivate firms to internalize R&D. Evidence is also found that a firm's R&D experience, its dependence on the pharmaceutical business, and its national origin affect R&D procurement decisions.'
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