Optimal licensing in a differentiated Bertrand market under uncertain R&D outcomes and technology spillover

Abstract

This paper studies the licensing behavior in a differentiated Bertrand duopoly market in which the innovative firm engages in a cost-reducing R&D with uncertain outcomes. We also assume that there will be technology spillover if R&D ends in success. The results show that, in the case of a non-drastic innovation with uncertain outcomes, (i) the optimal licensing contract in terms of fixed-fee and royalty licensing is fixed-fee licensing when product substitution and technology spillover are both small, while it is royalty licensing otherwise; and (ii) if two-part tariff licensing is available, it is superior (equivalent) to royalty licensing when technology spillover is small (large), but always better than fixed-fee licensing for any degree of product substitution and technology spillover. Moreover, the results also indicate that the probability of R&D success in each licensing method plays an important role in determining the innovative firm's optimal licensing strategy.