Technology Competition, Cumulative Innovation, and a Grant-Back Clause

Abstract

This paper attempts to investigate which scheme of technology development is desirable in the stream of cumulative innovation, in particular, with uncertainty on the part of follow-on innovation. Technology competition is likely to generate social overincentives for innovation especially when consumer surplus is negligible. The study finds that a grant-back clause combined with an appropriate distribution of expected profits mitigates social overinvestment in the both initial and follow-on technologies, and thereby, improves social welfare. Among other things, it is shown that if a government authority can specify a particular distribution of profits between the firms, socially optimal investment in the initial technology can be realized. On the other hand, assuming a significantly positive consumer surplus instead, it is revealed that competition in the follow-on technology creates higher social welfare as consumer surplus is large. Finally, the model is extended so as to include uncertainty on the part of initial innovation, so that it derives the intuition that competition in the initial technology would be much more important for the advent of improved final products through building a basis for cumulative innovation.