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Patent Licensing in Models of Spatial Competition: A Literature Review

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Abstract

We survey the main theoretical contributions on patent licensing in spatial models of competition. Building on both the shopping models à la Hotelling and the shipping models of spatial discrimination, our analysis focuses on how the spatial dimension of competition drives the choice of the optimal licensing contract by an innovating firm. The work also sheds light on some features determining the optimal technology transfer method in a spatial context, which allows us to better position patent licensing in the debate on technology transfer.

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Notes

  1. 1.

    An innovating firm can be either a non-producer or a producer in the market. An outside innovator that discovers a new technology or develops a new product (a university or a research laboratory) licenses her innovation to firms producing within the market, thus reaping a reward from her R&D investment. By contrast, an inside innovator directly uses her patented invention for her production process, keeping the option to license it to current or potential competitors.

  2. 2.

    Kamien and Tauman (2002) and Sen and Tauman (2007), among others, consider patent licensing by both an outside and an incumbent innovator.

  3. 3.

    An innovation is drastic if it is large enough to create a monopoly, namely if the resulting equilibrium price is not affected by the threat of competition. It is non-drastic otherwise.

  4. 4.

    Most of the above literature was reviewed in Kamien et al. (1992), but significant research has been done since then.

  5. 5.

    While spatial economics is mainly concerned with the location of economic activities in a geographic space (Duranton 2008), the issue of firms’ locations in the product characteristics’ spaces of Hotelling or Salop is spread in industrial organization (Gabszewicz and Thisse 1986; Anderson et al. 1992) and is aimed to capture the degree of product differentiation endogenously chosen by firms.

  6. 6.

    See Biscaia and Mota (2013) for a review of the literature on spatial competition.

  7. 7.

    As regards innovation strategies, see Harter (1993) and Li and Zhang (2012) who introduce R&D into a Hotelling framework.

  8. 8.

    Seminal contributions in the literature of spatial discrimination are Hamilton et al. (1989) and Anderson and Neven (1991).

  9. 9.

    Each considered spatial model may deal with either Bertrand or Cournot competition. However, while the shopping models à la Hotelling are generally developed under Bertrand competition, Cournot-type models are considered within spatial discrimination literature. On this point, see Matsumura and Shimizu (2006, pp. 585–588).

  10. 10.

    Only a few cases of product innovations have been considered in literature. Some examples are given by Arya and Mittendorf (2006), Bagchi and Mukherjee (2014), and Chang (2017).

  11. 11.

    The result that a royalty contract is more profitable than a fixed fee is also obtained in the Cournot oligopoly of Sen (2005) in which the number of licenses is subject to an integer constraint.

  12. 12.

    Both Poddar and Sinha (2010) and Wang et al. (2013), in a Cournot setting with non-drastic innovation, study the impact of the cost differences between an insider patentee and a licensee on the choices of the optimal licensing contract. With respect to earlier literature, both works relax the assumption on licensee(s) with an inferior production technology. They show that, when the licensee has a production cost advantage relative to the licensor after licensing, a fixed fee turns out to be optimal and dominate both royalty and two-part tariff licensing.

  13. 13.

    This commitment effect of a royalty under Bertrand has been also highlighted by Faulí-Oller and Sandonis (2002), although they consider a two-part tariff. The authors also show how this strategic effect of a royalty on the one hand favors licensing a drastic innovation and on the other hand lets a social welfare detrimental result arise.

  14. 14.

    The only work addressing the issue of licensing a product innovation in a spatial context is the article by Caballero-Sanz et al. (2005).

  15. 15.

    This contrasts with earlier literature in the non-spatial contexts showing that, under quantity competition, a fixed fee may be profitable when product differentiation is high enough (Wang 2002).

  16. 16.

    This is in line with the conventional literature proving that royalty licensing is always profitable with respect to no licensing in a Bertrand framework with an insider patentee (Wang 2002; Wang and Yang 1999).

  17. 17.

    Notice that the superiority of a royalty contract offered by an outside patentee as compared to fixed fee/auction is also proved by Caballero-Sanz et al. (2002) who consider symmetric locations in a Salop circle, this result being robust to the possibility of licensing to a potential entrant. Conversely, Caballero-Sanz et al. (2005) demonstrate the dominance of a fixed fee under a product innovation.

  18. 18.

    In this regard, it is worth mentioning that the superiority of a two-part tariff contract over a royalty contract is also found by Kabiraj and Lee (2011) in a Hotelling linear city with exogenous firms’ locations, where the optimal licensing policy is discussed in relationship with the level of transportation costs and the endogenous outcome on market coverage. While a fixed-fee contract is shown to be never profitable, an equilibrium with royalty licensing is found to exist, provided that the transportation costs lie in a specific interval ensuring full market coverage.

  19. 19.

    Rostoker (1984) finds that licensing by royalty is used in 39% of the cases, a fixed fee is used in 13%, and a two-part tariff is used in 46%. Some empirical evidence is also provided by Macho-Stadler et al. (1996) in a study based on a sample of licensing contracts between Spanish and foreign firms and showing that 59% of the contracts impose royalty payments and 28% include fixed-fee payments, while 13% consist of a two-part tariff.

  20. 20.

    Another well-known benchmark in this literature is D’Aspremont et al. (1979), which finds a principle of maximal differentiation with the two competing firms located at the opposite ends of the Hotelling line.

  21. 21.

    Biscaia and Mota (2013) mainly focus on the strategic effects of location decisions in their critical review.

  22. 22.

    As shown in D’Aspremont et al. (1979), transport costs must be quadratic in distance for the principle of maximum differentiation to hold.

  23. 23.

    Spatial discrimination literature is mainly concerned with the determinants of equilibrium dispersion or agglomeration of firms in a spatial market. It has been shown that Cournot competition leads firms to agglomerate at the central point of a linear city (Hamilton et al. 1989; Anderson and Neven 1991) and to choose (dispersed) equidistant locations in a circular city (Shimizu 2002). Hamilton et al. (1989) also show that Bertrand competition promotes dispersion.

  24. 24.

    Agglomeration of firms toward the center of a linear city implies full symmetry of firms’ behavior at all market addresses. See Hamilton et al. (1989) on this point.

  25. 25.

    We refer to the “efficiency effect” as the increase of the total quantity produced in the industry which positively affects the profits obtained by the licensee under a fixed fee.

  26. 26.

    In such circumstances, each market competitor chooses to acquire the innovation, thus lowering their transport costs, even if such a choice reduces overall market profitability and determines a prisoner-dilemma-type equilibrium.

  27. 27.

    Technology transfer, as broadly defined by Maskus (2004), “refers to any process by which one party gains access to a second party’s information and successfully learns and absorbs it into his production function.”

  28. 28.

    The motivation for an outside innovator to sell her innovation property right is to avoid significant licensing costs and let an incumbent firm implement more efficiently a new technology. From a theoretical perspective, it is assumed that the auctioning innovator guarantees a higher payoff than an inside innovator (Tauman and Weng 2012).

  29. 29.

    Banerjee and Poddar (2019) offer new insights to the analysis of licensing strategies under firm cost asymmetries showing that, when initial cost asymmetry is small enough, royalty licensing to both firms is optimal, while fixed-fee licensing to the efficient firm becomes optimal in the presence of a sufficiently large cost asymmetry.

  30. 30.

    The cost-inefficient firm might choose to outsource an input because of the significant costs associated with transferring labor-intensive technologies or a strict regulation of property rights. By contrast, technology transfer may be optimal since it can contribute to either enforcing tighter controls over product quality or limiting the hold-problem that may arise in the relationship with an external supplier.

  31. 31.

    Both outsourcing and technology transfer are based on unit pricing policies.

  32. 32.

    Location equilibria with non-uniform consumer density are discussed by both Gupta et al. (1997) and Benassi (2014) in a spatial discrimination Cournot setting and by Neven (1986) in a location-price Hotelling game.

  33. 33.

    The assumption of incomplete information may alter the existing results on technology licensing. As an example, the result that a fixed-fee contract is superior to a royalty contract for an outsider innovator does not hold in the non-spatial context of Gallini and Wright (1990) due to incomplete information.

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  1. Università del Salento, Lecce, Italy

    Marcella Scrimitore

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  1. Marcella Scrimitore
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  1. Department of Economics & Finance, Università Cattolica del Sacro Cuore, Milano, Italy

    Stefano Colombo

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Scrimitore, M. (2020). Patent Licensing in Models of Spatial Competition: A Literature Review. In: Colombo, S. (eds) Spatial Economics Volume I. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-40098-9_7

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