Licensing as a vehicle of external finance under network effects

Abstract

Although a lot of scholars have offered valuable insights into licensing, there is little theoretical research on the role of licensing contracts as a vehicle of external finance for technology innovation. By addressing specific issues in markets with network effects, demand uncertainty, and the innovator's difficulties in financing of follow-on investments in development and commercialization of the licensed technology, we demonstrate how the innovator can manage the trade-offs between expected licensing revenues losses and upfront fee payments which the licensee may finance. What's more, conditional on the intensity of network effects, the ex-ante licensing contract involves a fixed fee component, either alone for high intensity of network effects or in combination with a royalty component for low intensity of network effects. We also explore how ex-ante licensing contract can both dissuade potential licensees from challenging the patent's validity and alleviate the financing problem when firms have financial constraint.