Abstract
We consider licensing of a non-drastic innovation by a licensor that interacts with a potential licensee in a Stackelberg duopoly, comparing per-unit and ad-valorem royalty two-part contracts and showing why and when each licensing deal should be used. We contribute three findings to the literature. First, ad-valorem royalty is preferred when the licensor plays as leader in the marketplace, but per-unit royalty is preferred when the licensor plays as follower. Second, only innovations that do not hurt consumers are socially beneficial. Third, our model also suggests that both the licensor’s status as a leader or follower in the marketplace and the innovation size determine the incentive to engage in innovative activities.
Highlights
Empirical evidence on licensing deals indicates that innovators often transfer their patented innovations to direct competitors (Jiang & Shi, 2018) and that most licensing contracts feature positive royalties (Bousquet et al, 1998; Lim & Veugelers, 2003).1 In this paper we discuss two additional aspects relevant for licensing1 3 Vol.:(0123456789)Journal of Industrial and Business Economics arrangements
There are many firms playing as leaders in their product markets and that frequently license their patented innovations to competitors
There are situations when a follower’s innovation generates larger welfare than a leader’s innovation. This assumption ensures that all firms are previously active even if licensing does not take place or, alternatively, that the innovation is non-drastic irrespective of whether the owner behaves as leader or follower in the product market
Summary
Empirical evidence on licensing deals indicates that innovators often transfer their patented innovations to direct competitors (Jiang & Shi, 2018) and that most licensing contracts feature positive royalties (Bousquet et al, 1998; Lim & Veugelers, 2003). In this paper we discuss two additional aspects relevant for licensing. The empirical literature shows that contingent royalties—either per-unit royalty (non-negative uniform royalty per unit of production) or ad-valorem royalty (non-negative royalty based on a percentage of licensee sales)—are commonly included in licensing contracts (e.g., Bousquet et al, 1998; Lim & Veugelers, 2003; Trombini & Comacchio, 2012) In this respect, our work examines how the position of a firm in a market, namely its role as a leader or a follower in the Stackelberg game, affects the type of royalty chosen (per-unit or ad-valorem) when licensing a process technology. We show that the incentive to undertake innovative activities and license an innovation largely depends on both the licensor’s status in the product market and the size of the innovation: when the size of the innovation is sufficiently small, the incentive to innovate and disseminate the resulting innovation is higher for a leader licensor than for a follower licensor, while the opposite holds for a large innovation In this respect, our paper complements Wang and Yang (2004)’s research.
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