Technology Licensing in a Network Product Market: Fixed‐Fee versus Royalty Licensing

Abstract

This study investigates pricing and technology licensing decisions in a two‐echelon supply chain with one upstream firm that provides a key input to two downstream firms. We assume that one of the downstream firms owns a licensable innovation that exhibits network effects and that the other can either accept the licence from the innovator or develop a substitutable innovation. We analyse the effects of the producer‐innovator's two alternative licensing strategies (i.e. fixed‐fee and royalty licensing) on the members of the supply chain and the supply chain's efficiency. We find that royalty licensing is optimal with low network effects. For high network effects, the innovating firm's optimal licensing strategy depends on the market size and the potential licensee's cost of developing a substitutable innovation. We also find that royalty licensing can achieve better coordination of the supply chain than fixed‐fee licensing.