Technology licensing for quality improvement under oligopoly competition

In this paper, we investigate the optimal technology licensing strategy in an oligopolistic market where customers consider both the selling price and quality of each firm’s product when making purchasing decisions. A firm that invests in improving product quality may choose to license its proprietary quality-enhancing technology to either one or multiple competitors (referred to as exclusive and non-exclusive licensing, respectively). We develop models for each of these two licensing strategies, as well as the benchmark model with no licensing. Analysis of the equilibrium outcomes shows that licensing becomes the equilibrium only if the royalty rate is moderate; both high and low royalty rates result in the equilibrium being no licensing. When licensing occurs, there exist thresholds in relation to the royalty rate (above) below which the equilibrium is (non-)exclusive licensing. Crucially, licensing has the potential to yield a Pareto improvement, and we explicitly identify the conditions for this outcome. Moreover, our key findings remain robust when the model is extended to scenarios with varying degrees of product substitutability or a generalized oligopolistic market with n (>3) firms. Finally, we clarify how the licensee’s absorptive capacity and product substitutability affect the licensing equilibrium and the Pareto improvement under both exogenous and endogenous licensing fees. Overall, our findings offer insights for firms investing in quality improvement and seeking to license their proprietary technologies to competitors to enhance profitability.