General licensing schemes for a cost-reducing innovation

Two general forms of standard licensing policies are considered for a non-drastic cost-reducing innovation: (a) combination of an upfront fee and uniform linear royalty, and (b) combination of auction and uniform linear royalty. It is shown that in an oligopoly, the total reduction in the cost due to the innovation for the pre-innovation competitive output forms the lower bound of the payoffs of both outsider and incumbent innovators. Further, the private value of the patent is increasing in the magnitude of the innovation, while the Cournot price and the payoff of any other firm fall below their respective pre-innovation levels. Sufficiently significant innovations from an outsider innovator are licensed exclusively to a single firm. Otherwise, all other firms, except perhaps one, become licensees. The dissemination of the innovation is generally higher with an incumbent innovator compared to an outsider. For both outsider and incumbent innovators, the monopoly does not provide the highest incentive to innovate; for sufficiently insignificant innovations, it is the duopoly that does so, and, the industry size that provides the highest incentive increases with the magnitude of the innovation. Finally, it is argued that significant innovations are more likely to occur when the innovator is an incumbent firm.