Licensing of a quality-improving innovation

This paper considers the licensing of a quality-improving innovation. We analyze a duopoly model with heterogeneous firms and consumers. Firms compete in prices and face logit demand functions. The innovator is an outsider to the market and his set of licensing policies consists of the auction, the royalty and the two-part tariff policies. We analyze the cases of a covered and an uncovered market. For the former case we show that irrespective of the magnitude of the innovation the innovator sells licenses to both firms using positive royalty and zero fee. Moreover, the increase in social welfare due to the innovation is fully appropriated by him. For the case of an uncovered market we show that when consumer heterogeneity is sufficiently high the innovator sells again two licenses. The optimal policy depends on the valuation for the outside alternative and consists of either only royalty or royalty plus fee.

• Type: Journal
• Year: 2008
• Where: MSS
• Authors: Giorgos Stamatopoulos, Yair Tauman
• Keywords: Hardware, Innovator, Logit Demand Functions, MSS 2008, Uncovered Market