Component Sharing Through Licensing

Abstract

In this paper, we consider products that are composed of distinct components that can be shared with rival firms through licensing agreements. In contrast to the standard licensing settings in which firms make binary choices (whether to license or not), the innovator decides on the set of product components to be licensed, i.e., on how much to license. The product components that are licensed out determines the degree of commonality in the competing products, which in turn affects post-licensing competition through the degree of product differentiation. In a duopoly setting we show that licensing occurs more often than what a binary choice setting predicts, while it does not necessarily imply more component-sharing between the firms. We also show that in a dynamic setting where the timing of entry depends on the components that are acquired through the license, the innovator may strategically grant a license for a smaller set of components to delay competition unless entry expands the market. Finally, we study a more general licensing scheme and show that a larger set of components are licensed out under a two-part scheme with a per-unit royalty than with a fixed fee scheme.