This study explores the effect of expenditure on research and development (R&D) on the output of pharmaceutical firms in Egypt. It does so by estimating a knowledge production function using a panel of 29 pharmaceutical firms employing more than 50 persons over the period 2004-2009. Findings indicate weak firm-level R&D performance. To explain these findings, we select five pharmaceutical firms for in-depth interviews. We find firms to lack an R&D strategy, tending towards piecemeal research tasks as opposed to having a mediumto- long term research strategy. This leads to limited and inconsistent firm expenditure on R&D, as well as to research being mostly of the development type as opposed to basic or applied types. Firms’ collaboration with universities or with each other in research and intellectual property is also weak. The poor R&D performance, however, is not exclusively a micro-level symptom, but also a macro-level one. This owes to low public R&D expenditure, lack of good governance of the public R&D system, and absence of coordination between public research institutions. To conclude, the paper stresses the importance of formulating a well-defined medium-to-long term research strategy that spans all economic activities, introduces fiscal and financial incentives for R&D and puts pharmaceuticals high on the national priority list.