Strategic Licensing Model Choice with Network Effects in a Dynamic Duopoly

Network effects encourage the innovative firms to expand their market size by licensing the technology to the third-party manufacturers who provide substitutable but incompatible products in a duopoly. Moreover, network effects render consumer valuation inherently dynamic. Consumer perceptions of the sales quantities are constantly changing, causing the impact of network effects is dynamic over time. Therefore, we examine technology licensing and quantity competition in a dynamic duopoly including an innovative firm and a third-party manufacturer, and we consider that consumer utility increases with the dynamic impact of network effects. Because the innovative firm can strategically choose different licensing models in a dynamic production game, we derive the firms’ subgame-perfect Nash equilibrium decisions and profits and analyze the effects of different licensing models and different network effects on firm’s instantaneous and steady-state equilibrium decisions. Dynamic technology licensing contracts will benefit the innovative firm more than a no licensing contract in a long term, especially when the network effect is stronger. Moreover, when the network effect is weak, the dynamic royalty licensing reduces the third-party manufacturer’s production quantities, while the dynamic fixed fee licensing induces a higher total market demand which increases the impact of network effects and thus benefits the innovative firm, consumer and society. Interestingly, when the network effect is stronger, a dynamic royalty licensing is more effective for mitigating market competition by increasing the sales quantities and prices of the licensor and licensee because of the significant impact of network effects, thus benefiting the innovative firm and society.