Optimal licensing contracts with a downstream oligopoly: insider versus outsider innovation

• Published in: Economic theory bulletin Vol. 10; no. 1; pp. 147 - 165
• Main Authors: Tsai, Tsung-Sheng, Wu, Cheng-Tai
• Format: Journal Article
• Language: English
• Published: Cham Springer International Publishing 01.05.2022; Springer Nature B.V
• Subjects: Auctions; Contracts; Cost reduction; Economic theory; Economic Theory/Quantitative Economics/Mathematical Methods; Economics; Economics and Finance; Game Theory; Innovations; Licensing; Macroeconomics/Monetary Economics//Financial Economics; Oligopoly; Payoffs; Public Finance; Research Article; Royalty; Social and Behav. Sciences; Social welfare; D43; D45; Outsider innovator; Technology licensing; Insider innovator; Oligopoly; L13; L24
• ISSN: 2196-1085; 2196-1093
• DOI: 10.1007/s40505-022-00224-4

In the literature that deals with cost-reduction technology licensing in an oligopolistic downstream market, the paper by Sen and Tauman (Games Econ Behav 59:163–186, 2007) has been a milestone in that it thoroughly characterizes the optimal licensing contracts for both cases of insider and outsider innovation under complete information. However, when determining the licensee’s fee payment to obtain the license through an auction, their treatments for different numbers of licensees are inconsistent. We instead use a consistent approach that can be applied to all numbers of licensees, in which a firm’s reservation payoff is determined by its Cournot profit if it rejects the contract. We find that the optimal contract is for both the insider and outsider innovator to sell the license to all downstream firms. We also show that an insider innovator sets a (weakly) higher royalty rate and generates a (weakly) lower social welfare than an outsider innovator.