Licensing of sequential innovations

Abstract

This paper uses a strategic licensing framework to study firms licensing behaviour when there are two generations of technology in the market. The innovations are sequential with the second invention built on the first one. We analyse two different licensing schemes: fixed fee payment and royalty payment. The results indicate that the optimal licensing strategy depends on the market size and magnitudes of the two innovations. When two inventors use the same licensing scheme, for most parameter ranges, royalty payment scheme out-performs fixed fee payment scheme for inventor one if the second technology is significant. When inventors can choose different licensing schemes endogenously, for some parameter ranges, the early inventor prefers licensing by royalty and the second generation inventor prefers licensing by fixed fee. Contrary to the standard literature with outside innovators, royalty can be supported as the best licensing scheme.