Duration and payment of licensing contracts for users to reveal what they know

Abstract

Non-producing patent holders usually have to license their innovations to users capable of marketing them and usually ignore their market value. This article is aimed at analysing the dynamics of licensing contracts for an innovation that is owned by an independent patentee and is applied in the production of a good. Both contract duration (which may be the length of the patent or less) and per-license payment (which may be based on the licensees’ expected profits or an amount per unit of output they produce, but not both) are examined in Cournot competition when licensees enjoy privileged information on their own innovation-related production costs (i.e. the value of innovation for each one). The patent holder prefers to issue the licenses for less than the length of the patent rather than issuing them for the whole patent length. Besides, a series of period-by-period payments based on the licensees’ expected profits in each period is preferred over any payment collected from applying an amount to each unit produced by licensees. This is primarily because a series of annual payments based on licensees’ expected profits in each period induces them to report their type honestly through period-1 output at the least cost for the patent holder. Either a series of annual payments or a single initial payment (both based on licensees’ expected profits) also yield greater welfare than any other contractual scheme. However, the preferred outcome for the patentee – a series of payments based on licensees’ expected profits in each period – is socially efficient only when licensee-production costs disparity is large enough and the pre-license probability of having productively good applicants for the innovation is high enough.