Partial Licensing of Product Innovations

Abstract

We study the incentives of a product innovator to license its product partially to a potential entrant. In a duopolistic setting we consider product design of a modular nature, which enables the incumbent to license some modules of its innovation. Competition is characterized by the size of the shared component of the product which determines the degree of product differentiation. Therefore, by choosing how much to license, i.e., the size of the license, the innovator chooses how much to compete. We provide the conditions under which partial licensing occurs, and show that the size of the license increases when i) the entrant has a higher development cost to complete the product, and ii) the marginal effect of the size of the license on product differentiation is lower. We argue that modular design, or possibility of partial licensing, may or may not increase the shared components between products through licensing. We also show that under a per-unit royalty scheme, the equilibrium size of the license is larger compared to that of a fixed fee licensing scheme, as a per-unit royalty rate and size of the license serve as strategic substitutes to the innovator.