The smaller the number of NBFs in a particular area, the less likely it is that the large firm would be able to find a suitable partner with the appropriate research capabilities. Moreover, Pisano assumes that the choice or problem facing the large firm can be adequately represented by assuming that the project is initiated by the large firm, which then decides whether to use external subcontractors or not. Our understanding of the industry is that NBFs initiate the bulk of the new projects in the sector, some of which may be offered to large firms for their participation.

Furthermore, firms such as Eli Lilly, Johnson & Johnson, and Monsanto, which began their in-house research efforts early (in some cases even before the start of the 1980s), were precisely the firms that led in making external collaborative alliances. In essence, the analogy with the make-or-buy decision in production can be misleading in the context of innovation. To be sure, transaction costs are important, but technological knowledge is a special type of good. It requires a great deal of specialized knowledge and skill to successfully utilize technological information. In order to "buy" such knowledge, one has to have a great deal of prior knowledge—inexperienced and unskilled buyers are at a severe disadvantage.

In other words, it is precisely firms with strong in-house R&D capabilities that would derive the greatest value from external linkages. Cohen and Levinthal (1989) argue that firms invest in R&D for two purposes. On the one hand, they invest in R&D to generate innovations; on the other hand, R&D serves as a device for exploiting external research. Rosenberg (1990) argues that in-house basic research is necessary to monitor the flow of scientific information in the outside world. Mowery (1981) showed that, during 1921–1945, large U.S. firms, when starting new innovation projects, also contracted out part of the research to specialized institutes. These studies emphasize the potential synergies between external and internal knowledge. However, their discussion does not deal with the multidimensionality of knowledge, and therefore does not "unpackage" the source of the synergies.

In Arora and Gambardella (1994b), we attempted to distinguish between two types of knowledge-based capabilities: The ability to utilize and the ability to evaluate information. In the present context, therefore, there are two considerations involved in entering into an external alliance. The first is concerned with the skills and competencies that the large firm has in the development and commercialization of the innovation—in other words, how capable the large firm is of utilizing the information that it is "purchasing" from an NBF. The second consideration is related but logically distinct and has to do with the ability of the firm to form judgments about the potential usefulness of the information that it is buying.

Consider, therefore, a large corporation at the point of deciding whether or not to enter into a collaborative agreement with an NBF. The latter typically offers an "idea." For instance, it may have synthesized in an E. coli culture a

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