Optimal technology licensing contract with quality improvement innovation under Cournot competition

Abstract

This paper analyzes the optimal licensing contract for the patentor with a quality improvement innovation in a Cournot duopoly market. We examine and compare three licensing contracts (fixed-fee licensing, royalty licensing, and two-part ad valorem licensing) in terms of the patent-holding firm’s profit, consumer surplus, and social welfare. We also study the impact of quality differences on the choice of licensing contract. One might expect that consumer surplus and social welfare are greater under fixed-fee licensing. However, we show that this conclusion seems to be untrue under quality improvement technology licensing. Moreover, we find that (1) there exists a threshold for the degree of quality difference above which fixed-fee licensing will be listed for the consideration of the patent-holding firm and below which it will be abandoned; (2) royalty licensing and two-part ad valorem licensing are always profitable for the patent-holding firm and two-part ad valorem licensing brings the patentee the most profit.