Technology Licensing In Vertically Related Markets

Technology licensing is not only an important way to spread the technology, but also a significant strategy for a patent-holding firm. In the meantime, for those licensees, they can acquire new technologies and improve their productivity and market competitiveness to a higher level. Therefore, it is necessary to study the issues of technology licensing.In this paper, we develop a vertical-market model where an upstream monopoly firm provides intermediate product for two downstream firms. And the upstream monopoly can set differentiated wholesale prices to maximize its own profit. Then we mainly discuss the optimal strategies and the social welfare. In our model, the two downstream firms, one of which holds both a new and an obsolescent cost-reducing technologies, produce homogenous products and make Cournot competition in the product market. For the licensor, its choice completely depends on the impact of the decision on its total profits. In general, licensing can bring two effects to the licensor. One is called income effect which will help improve its overall profits. The other is competition effect that will reduce its total profits. If the income effect is greater than the competition effect, then the patent-holding firm will have an incentive to transfer its technologies. Or licensing will not happen.Based on the analyses in different cases, we finally draw the following conclusions: First, under a fixed-fee contract, the decision of the patent-holding firm depends on the degree of the innovation and the licensee’s efficiency. If the degree of the innovation or the licensee’s efficiency is high, the patent-holding firm has an incentive to transfer its technology to its competitor. Or technology licensing will not happen. However, there is a certain parameter interval where it is not an optimal choice for the patent-holding firm to license. But compulsory licensing, if it is possible, can improve the social welfare.Second, patent-holding firm always has an incentive to transfer its technologies with both royalty contract and two-part tariff contract. And in some cases, the equilibria are the same under these two contracts.Third, irrespective of the licensing contract, it is optimal for the patent-holding firm to transfer its advanced technology, which is also a Pareto improvement. Licensing new technology can improve innovator’s profits without deteriorating other participants’ interest. This finding poses a sharp contrast to conventional wisdom. In real life, especially in technology-related international trade, it is not uncommon to observe that foreign companies usually prefer to license obsolescent technology to its competitor and keep the advanced one for its own use.Fourth, by comparing the three kinds of contract, we find that two-part tariff contract is more beneficial for the patent-holding firm. Under two-part tariff contract, the patent-holding firm can make full use of the advantages of fixed-fee and royalty. Compared with a single charging method, with a two-part tariff contract, the patent-holding firm can not only acquire the licensing fees but also control the licensor’s production process so that it can always enjoy a maximum profit.