Which intermediate input source is best for innovation in non-multinational enterprise groups?

Abstract

This article examines how different sources of intermediate inputs–domestic internal sourcing (i.e. internalisation), domestic external sourcing and international external sourcing (i.e. importing)–affect innovation performance in non-multinational firms, distinguishing between incremental and radical innovations. Drawing on Transaction Cost Theory, we hypothesise that domestic external sourcing favours incremental innovation by reducing transaction costs and facilitating tacit knowledge transfer, while importing promotes radical innovation through exposure to diverse knowledge sources. We further argue that absorptive capacity enhances the effects of domestic sourcing. Using a conditional mixed process estimator with multilevel random effects, we analyse 4176 firm-year observations from Spanish business groups (2006–2020). The results support our hypotheses: domestic purchases drive incremental innovation, while imports are correlated with radical innovation. Absorptive capacity, measured by internal R&D intensity, amplifies these benefits for firms that leverage domestic sourcing. Our findings highlight strategic trade-offs in input sourcing and underscore the role of absorptive capacity in maximising innovation outcomes. For practitioners, this involves aligning sourcing strategies with innovation objectives; for policymakers, it suggests that investing in firm-level internal R&D can improve the innovation performance associated with internal sourcing.