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The Optimal Scope of the Royalty Base in Patent Licensing

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  • Gerard Llobet
  • Jorge Padilla

Abstract

Legal scholars debate the merits of using the total value of the product, as opposed to the value of the component to which the technology contributes, as the base for a royalty in licensing contracts. In this paper we make use of the fact that these two royalty bases are equivalent to using ad valorem and per-unit royalties, respectively. We abstract from implementation and practicability considerations to analyze the welfare implications of the two rules. Ad valorem royalties tend to lead to lower prices, particularly in the context of successive monopolies. They benefit upstream innovators and do not necessarily hurt downstream producers. This benefit increases when there are multiple innovators contributing complementary technologies, as is typical of standard-setting organizations. Ad valorem royalties are even more desirable when enticing upstream investment is optimal. Our findings explain why most licensing contracts include royalties based on the value of the product.

Suggested Citation

  • Gerard Llobet & Jorge Padilla, 2016. "The Optimal Scope of the Royalty Base in Patent Licensing," Journal of Law and Economics, University of Chicago Press, vol. 59(1), pages 45-73.
    • Handle: RePEc:ucp:jlawec:doi:10.1086/686306
    DOI: 10.1086/686306
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    Cited by:

    1. Gerard Llobet & Jorge Padilla, 2016. "The Inverse Cournot Effect in Royalty Negotiations with Complementary Patents," Working Papers wp2016_1608, CEMFI.
    2. Youqiong Ai & Thomas Y. Lu, 2019. "On the Rationality of Bundled Rebate Program in Modem Chip Industry: an Analysis on Qualcomm’s Case," Journal of Industry, Competition and Trade, Springer, vol. 19(4), pages 641-660, December.
    3. Jeon, Haejun, 2019. "Patent protection and R&D subsidy under asymmetric information," International Review of Economics & Finance, Elsevier, vol. 62(C), pages 332-354.
    4. Gregor Langus & Vilen Lipatov, 2022. "Efficient Level of SEPs Licensing," CESifo Working Paper Series 9574, CESifo.
    5. Wipusanawan, Chayanin, 2023. "Standard-essential patents, innovation, and competition," Other publications TiSEM 292e319a-9e6a-4465-8f8f-7, Tilburg University, School of Economics and Management.
    6. Gerard Llobet & Jorge Padilla, 2016. "The Optimal Scope of the Royalty Base in Patent Licensing," Journal of Law and Economics, University of Chicago Press, vol. 59(1), pages 45-73.
    7. Chryssoula Pentheroudakis & Justus A. Baron, 2016. "Licensing Terms of Standard Essential Patents: A Comprehensive Analysis of Cases," JRC Research Reports JRC104068, Joint Research Centre.
    8. Karbowski, Adam & Prokop, Jacek, 2015. "Patent hold-up and royalty stacking: the case of multiple downstream firms," EconStor Conference Papers 127475, ZBW - Leibniz Information Centre for Economics.
    9. Llobet, Gerard & Neven, Damien, 2022. "Investment and Patent Licensing in the Value Chain," CEPR Discussion Papers 17405, C.E.P.R. Discussion Papers.
    10. Sinitsyn, Maxim, 2022. "On the inefficiencies of anti-stacking royalty clauses," Economics Letters, Elsevier, vol. 221(C).
    11. Ismail Saglam, 2023. "Licensing cost‐reducing innovations under supply function competition," Bulletin of Economic Research, Wiley Blackwell, vol. 75(1), pages 180-201, January.
    12. Dingwei Gu & Zhiyong Yao & Wen Zhou, 2022. "Proportional Fee vs. Unit Fee: Competition, Welfare, and Incentives," Journal of Industrial Economics, Wiley Blackwell, vol. 70(4), pages 999-1032, December.
    13. Anderson, Simon & Bedre-Defolie, Özlem, 2022. "Online trade platforms: Hosting, selling, or both?," International Journal of Industrial Organization, Elsevier, vol. 84(C).
    14. Stefano Colombo & Luigi Filippini, 2016. "Revenue royalties," Journal of Economics, Springer, vol. 118(1), pages 47-76, May.
    15. Sushil Bikhchandani, 2020. "Intermediated surge pricing," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 29(1), pages 31-50, January.
    16. Siyu Ma & Yair Tauman, 2021. "Licensing of a New Product Innovation with Risk Averse Agents," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 59(1), pages 79-102, August.
    17. Jinshi Cheng & Bengang Gong & Bangyi Li, 2018. "Cooperation strategy of technology licensing based on evolutionary game," Annals of Operations Research, Springer, vol. 268(1), pages 387-404, September.
    18. Junghee Lee & Vish Krishnan & Hyoduk Shin, 2020. "Business Models for Technology-Intensive Supply Chains," Management Science, INFORMS, vol. 66(5), pages 2120-2139, May.
    19. Zhu Wang & Julian Wright, 2017. "Ad valorem platform fees, indirect taxes, and efficient price discrimination," RAND Journal of Economics, RAND Corporation, vol. 48(2), pages 467-484, May.
    20. Bonani, Michela, 2023. "Essays on innovation, cooperation, and competition under standardization," Other publications TiSEM 1c87d7fc-2c24-430a-9d4e-1, Tilburg University, School of Economics and Management.
    21. Luca Sandrini, 2023. "Price vs Market Share with Royalty Licensing: Incomplete Adoption of a Superior Technology with Heterogeneous Firms," Discussion Papers 2302, Budapest University of Technology and Economics, Quantitative Social and Management Sciences.
    22. Chen, Jingxian & Liang, Liang & Yao, Dong-qing, 2017. "An analysis of intellectual property licensing strategy under duopoly competition: Component or product-based?," International Journal of Production Economics, Elsevier, vol. 193(C), pages 502-513.
    23. Andrei Hagiu & Julian Wright, 2019. "The Optimality of Ad Valorem Contracts," Management Science, INFORMS, vol. 65(11), pages 5219-5233, November.
    24. Anne LAYNE-FARRAR & Gerard LLOBET & Jorge PADILLA, 2014. "Patent Licensing in Vertically Disaggregated Industries: The Royalty Allocation Neutrality Principle," Communications & Strategies, IDATE, Com&Strat dept., vol. 1(95), pages 61-84, 3rd quart.

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    More about this item

    JEL classification:

    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality
    • L24 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Contracting Out; Joint Ventures
    • O31 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Innovation and Invention: Processes and Incentives
    • O34 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Intellectual Property and Intellectual Capital

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