Licensing in a Vertically Separated Industry

Abstract

The literature on technology licensing has ignored the importance of market power of the input supplier. In this paper we examine the incentive for licensing in the downstream industry when the firms in the upstream industry have market power. We show that licensing in the downstream industry is profitable if and only if licensing increases competition in the upstream industry. We also find that a monopolist in the final goods market has the incentive for licensing if licensing changes the market structure of the upstream industry. Thus, our analysis provides a rationale for 'second sourcing'.