Licensing Intellectual Property in the Presence of Non-Contractible Complements

Abstract

This paper provides a simple model of licensing intellectual property to licensees who sell complementary products, revenues from which are at least partially uncontractible. When the licensor cannot use fixed fees, he prefers output-based royalties over profit-sharing agreements if the licensee's revenues from complements are not too high and if the fraction thereof that can be brought under the incidence of a licensing agreement is sufficiently large. The public policy implication is that, in such licensing contexts, there is a compelling case for broadening the ability of licensors to share in revenues from sales of adjacent products in order to allow for the internalization of externalities due to product complementarities. We illustrate our arguments with two case studies: licensing of printer technology to Dell and licensing of music to Apple Computer.