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The Optimal Scope of the Royalty Base in Patent Licensing

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Abstract

There is considerable controversy about the relative merits of the apportionment rule (which results in per-unit royalties) and the entire market value rule (which results in ad-valorem royalties) as ways to determine the scope of the royalty base in licensing negotiations and disputes. This paper analyzes the welfare implication of the two rules abstracting from implementation and practicability considerations. We show that advalorem royalties tend to lead to lower prices, particularly in the context of successive monopolies. They benefit upstream producers but not necessarily hurt downstream producers. When we endogenize the investment decisions, we show that a sufficient condition for ad-valorem royalties to improve social welfare is that enticing more upstream investment is optimal or when multiple innovators contribute complementary technologies. Our findings contribute to explain why most licensing contracts include royalties based on the value of sales.

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  • Gerard Llobet & Jorge Padilla, 2014. "The Optimal Scope of the Royalty Base in Patent Licensing," Working Papers wp2014_1409, CEMFI.
    • Handle: RePEc:cmf:wpaper:wp2014_1409
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    1. Morton I. Kamien & Yair Tauman, 1986. "Fees Versus Royalties and the Private Value of a Patent," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 101(3), pages 471-491.
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    7. Stefano Colombo & Luigi Filippini, 2015. "Patent Licensing with Bertrand Competitors," Manchester School, University of Manchester, vol. 83(1), pages 1-16, January.
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    More about this item

    Keywords

    Intellectual property; standard setting organizations; patent licensing; R&D investment.;
    All these keywords.

    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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