Licensing at the patent cliff and market entry

We study the incentives for a monopoly incumbent to reach an agreement allowing a generic to enter just before its patent expires, i.e., at the patent cliff, and its consumer and social welfare effects. In our model, entry by more than one entrant is unprofitable. Thus, in the absence of an agreement, the entry game has a “grab the dollar†structure, with each generic entering in each period with a low (high) probability if entry costs are high (low). In that case the incumbent can remain a monopolist for some time after patent expiry, until one or more generics finally enter. An early entry agreement guarantees a single generic enters the market immediately, and it allows the incumbent to extract the entrant's profit. It will be reached in equilibrium when entry costs are low or the entry process is short. In these instances, early entry agreements do however tend to hurt consumers. Yet, allowing for such agreements increases overall social welfare in a benchmark model of vertical differentiation, even if the expected competition on the market is reduced. The same holds in a benchmark model with captive consumers and shoppers, provided the share of captives is not too high.