R&D Delegation in a Duopoly with Spillovers

There is evidence that competing firms delegate R&D to the same independent profit-maximizing laboratory. We draw on this stylized fact to construct a model where two firms in the same industry offer transfer payments in exchange of user-specific R&D services from a common laboratory. Inter-firm and within-laboratory externalities affect the intensity of competition among delegating firms on the intermediate market for technology. Whether competition is relatively soft or tight is reflected by each firm's transfer payment offers to the laboratory. This in turn determines the laboratory's capacity to earn profits, R&D outcomes, delegating firms' profits, and social welfare. We compare the delegated R&D game to two other ones where firms (i) cooperatively conduct in-house R&D, and (ii) non-cooperatively choose in-house R&D. The delegated R&D game Pareto dominates the other two games, and the laboratory earns positive profits, only if within-laboratory R&D services are suffciently complementary but inter-firm spillovers are suffciently low. We find no room for policy intervention, because the privately profitable decision to delegate R&D, when the laboratory participates, always benefits consumers.