Exclusive and non-exclusive licensing with shelving

Abstract

We consider a market of technology transfer and licensing with an outside innovator and two asymmetric potential licensees where the licensees have asymmetric absorptive capacities of a cost reducing innovation. The low-cost efficient licensee/firm can only benefit from the new technology if the size of the cost reducing innovation is strictly bigger than the cost difference from its competitor. The high-cost firm always benefits from the new technology regardless of the size of the innovation. This leads to the possibility of strategic shelving of the innovation by the efficient firm. Under this backdrop, we characterize the optimal licensing contracts of the outside innovator. We find that in equilibrium, the innovator will use a fixed fee contract for some parameters and royalty or two-part tariff contract(s) for other parameters. Equilibrium fixed fees and royalty rates will also vary depending on the cost asymmetry and the size of the innovation. The optimal licensing contracts can be exclusive or non-exclusive, and shelving of the new technology may or may not happen which has welfare implications. We also investigate the first- and second-best licensing contracts in this environment and discuss their possible implementation.