Strategic Investment in Technology Standards

Abstract

Developing a technology standard requires significant upfront investment. The value of a new technology depends on how it is deployed (whether proprietary use or licensing) and is uncertain at the time of investment. Hence, the rules governing investments in technology development must be conditioned on the eventual deployment strategy (such as through licensing) and the nature of uncertainty. The model developed here considers a single firm that has an initial monopoly over an investment opportunity. By committing the investment, the firm establishes a technology standard that can be licensed to a potential competitor. The competitor can either adopt this standard or develop its own incompatible standard. The model predicts a unique optimal royalty rate that results in a single standard. Surprisingly, if technologies create network effects, the optimal royalty rate may even be lower than the level needed to deter the competitor from developing its own standard. Finally, we solve for the investment threshold as the expected future size of the market where the firm is indifferent between investing immediately and postponing the investment. The investment threshold is found to decline monotonically with both the intensity of network effects and the level of uncertainty.