Optimal licensing contract in an open economy. Abstract

Transcription

1 Optiml licensing contrct in n open economy Arijit Mukerjee University of Nottingm Abstrct Empiricl evidences sow tt tecnology licensing contrcts differ significntly nd my consist of only up-front fixed-fee, only output roylty or te combintions of fixed-fee nd output roylty We explin tese possibilities under interntionl tecnology trnsfer Te trde-off between te incentive for sving te trnsporttion cost of exporting nd te incentive for reducing competition fter licensing is responsible for te results Our explntion differs from te existing studies were imittion nd product differentition re responsible for different licensing contrcts I would like to tnk Alessndr Gurigli nd Kullpt Suetrong for very useful discussions Te usul disclimer pplies Cittion: Mukerjee, Arijit, (007) "Optiml licensing contrct in n open economy" Economics Bulletin, Vol 1, No 3 pp 1-6 Submitted: Jnury 13, 007 Accepted: Februry, 007 URL: ttp://economicsbulletinvnderbiltedu/007/volume1/eb-07l10001apdf

2 1 Introduction Tecnology licensing is n importnt penomenon in mny industries nd s generted fir mount of teoreticl nd empiricl reserc 1 However, te evidences sow tt licensing contrcts differ significntly According to Rostoker (184), roylty lone ws used for 3% of te time, fixed-fee lone for 13% of time, nd roylty nd fixed-fee for 46% of time, mong te firms surveyed In n interntionl Cournot duopoly, were te foreign firm is tecnologiclly efficient tn te ost-country firm, we sow tt te optiml licensing contrct my consist of only up-front fixed-fee, only output roylty or te combintions of fixed-fee nd output roylty Te trde-off between te incentive for sving te trnsporttion cost of exporting nd te incentive for reducing competition fter licensing is responsible for te results Our explntion differs from te existing studies were imittion (Rockett, 10) nd product differentition (Mukerjee nd Blsubrmnin, 001 nd Fulí-Oller nd Sndonis, 00) re responsible for different licensing contrcts if te licenser nd te licensee compete in te product mrket Huge mount of evidences on interntionl tecnology licensing (see, eg, Root nd Contrctor, 181 nd Sggi, 00) provide empiricl relevnce to our nlysis 3 In closed economy, Poddr nd Sin (00) sow tt different types of licensing contrcts cn be te equilibrium outcomes if te licenser is cost inefficient tn te licensee Tey sow tt only fixed-fee (only roylty) is optiml for ig (low) cost differences between te firms, nd te combintion of roylty nd fixed-fee is optiml for intermedite cost differences In contrst, we consider licensing in n open economy nd sow our results under te usul ssumption of low cost licenser nd ig cost licensee Our results lso differ from teirs We sow tt, if te own cost of te licensee is sufficiently ig, licensing wit only fixed-fee (only roylty) is optiml if te trnsporttion cost is sufficiently ig (low), wic implies lower (iger) effective cost differences between te firms, wile te combintion of fixedfee nd output roylty is optiml for intermedite trnsporttion costs If te own cost of te licensee is not very ig, te optiml licensing contrcts consist of eiter roylty only or te combintions of fixed-fee nd roylty Te reminder of te pper is orgnized s follows Section describes te model nd derives te results Section 3 concludes Te model nd te results Let us consider firm, firm F, wo wnts to export its product in country, clled ost-country We ssume tt te constnt mrginl cost of firm F is c, wic is normlized to 0, for simplicity Firm F lso needs to incur per-unit trnsporttion 1 See Rostoker (184), Kmien (1) nd Sggi (00) for surveys on tecnology licensing Tere is noter literture wic compres profitbility of te fixed-fee licensing contrct nd te roylty licensing contrct (see, eg Wng, 18, Filippini, 00 nd te references terein) However, unlike te present pper, tis literture does not consider optiml combintion of fixed-fee nd roylty If te licenser nd te licensee do not compete in te product mrket, symmetric informtion bout te qulity of te tecnology my be te reson for different types of licensing contrcts (Gllini nd Wrigt, 10) 3 Kbirj nd Mrjit (003) sow te effects of strtegic trde policy on te incentive for fixed-fee licensing nd consumers Mukerjee nd Pennings (006 nd 006b) consider licensing by monopolist in presence of strtegic trde policy In contrst, we consider optiml licensing contrcts in duopoly witout strtegic government policy

3 cost, t, for exporting its product to te ost-country 4 Tere is firm in te ostcountry, firm H, wo cn produce omogeneous product t te constnt mrginl cost of production c > 0 We ssume tt c <, wic will ensure tt te equilibrium output of firm H will lwys be positive We lso ssume tt t < c, wic implies tt te licenser (firm F ) s lower cost tn te licensee (firm H ) We ssume tt te inverse mrket demnd function is P = q (1) were te nottions ve usul menings We consider te following gme At stge 1, te firms decide on licensing Under licensing, firm F offers tke-it-or-leve-it licensing contrct wit up-front fixed-fee ( L ) nd per-unit output roylty ( r ), nd firm H ccepts te contrct if it is not worse off under licensing tn no licensing At stge, te firms produce like Cournot duopolists, nd te profits re relized We solve te gme troug bckwrd induction 6 Stndrd clcultion sows tt under no licensing, wic will give us te reservtion pyoffs of te firms under licensing, te pyoffs of firms F nd H re ( t + c ) respectively ( c nd Let us now consider te gme under licensing If firm F licenses its tecnology to firm H, firm F mximize te following expression to determine te optiml licensing contrct: ( t + r) + 3r( r Mx + L, r, L () subject to ( r ( c L (3) ( t + r) + 3r( r ( t + c ) + L (4) r, L 0 nd q f, q 0, () were q f nd q re te equilibrium outputs of firms F nd H respectively, nd (3) nd (4) sow te prticiption constrints of firms H nd F respectively Since, ex- 4 Toug triff brriers ve reduced in recent yers, interntionl trnsporttion costs re still significnt (Hummels, 11 nd Milner, 00) We will consider non-negtive fixed-fees nd output roylties Like te existing literture on licensing, tis my be motivted by te nti-trust lws 6 It must be cler tt it is optiml for firm F to license its tecnology to firm H, nd not to enter te ost-country mrket, tus creting monopoly in te ost-country However, te commitment by firm F for not entering te ost-country my not be credible eiter due to lck of enforcement in te world economy or it my be esy for firm F to enter te mrket wit lmost similr tecnologies, tus preventing monopoly in te ost-country (see, eg, Mrjit, 10, Wng, 18, Kbirj nd Mrjit, 003 nd Mukerjee nd Pennings, 00, to nme few, for similr ssumptions) Te ssumption of nocommitment by te licenser for not entering te product mrket fter licensing cn lso be found in Gllini nd Winter (18) nd Ktz nd Spiro(18) for licensing in closed economies We follow tis strnd of te literture nd ssume wy credible commitment by firm F for not entering te ost-country mrket fter licensing, tus creting competition fter licensing

4 post licensing, firm H s no incentive to use te licensed tecnology if r > c, te optiml vlue of r does not exceed c Terefore, te optiml roylty rte stisfies 0 r c Since, firm F offers tke-it-or-leve-it licensing contrct to firm H, te ( r ( c optiml L equls to, nd terefore, () reduces to ( t + r) + ( r + 3r( r ( c Mx (6) r Ignoring te constrint 0 r c, we find tt te optiml roylty rte is * ( t) r = Note tt, if t, te optiml roylty rte is 0 Hence, te optiml * ( t) roylty rte stisfying te constrint 0 r c is r = Min{ Mx{0, }, c }, nd * * ( r ( c te corresponding up-front fixed-fee is L = Mx{,0} Given te ssumption t < c, te optiml roylty rte cn be zero (ie, t ) provided c > However, t cnnot be greter tn if c <, nd terefore, te optiml roylty rte cnnot be zero in tis sitution 7 It sould lso be cler tt firm F would lwys license its tecnology to firm H 8 Te following proposition is immedite from te bove discussion Proposition 1: Assume t < c We find tt firm F lwys licenses its tecnology to firm H, nd (i) if c (, ), te optiml licensing contrct consists of te roylty * ( t) rte r = Min{ Mx{0, }, c } nd te up-front fixed-fee * * ( r ( c L = Mx{,0}, but (ii) if c (0, ), te optiml * ( t) licensing contrct consists of te roylty rte r = Min{, c } nd te up-front * * ( r ( c fixed-fee L = Mx{,0} Licensing s certin effects First, it elps to increse cost efficiency in te industry by llowing bot firms to produce wit te reltively superior tecnology, 7 If we relx te ssumption tt t < c, te optiml roylty rte cn be zero even if c < 8 Te following reson mkes licensing lwys profitble Given te option for two-prt triff licensing contrct, firm F s lwys te option to crge roylty rte c, wic mkes firm H indifferent under licensing nd no licensing, nd mkes firm F better off under licensing tn under no licensing, tus mking licensing lwys profitble We will consider non-negtive fixed fees nd output roylties

5 toug positive roylty rte elps to reduce te cost efficiency Second, licensing elps to sve te trnsporttion cost by reducing te cost of firm H, nd terefore, by sifting production from firm F to firm H Tird, licensing exposes firm F to more intense competition in te product mrket by reducing te cost of firm H, nd te positive roylty rte elps to reduce te intensity of competition fced by firm F fter licensing compred to no licensing In te bsence of trnsporttion cost, ie, for t = 0, it is lwys optiml for firm F to crge zero up-front fixed-fee nd positive roylty rte c <, since it elps firm F to rise its profit troug roylty income nd lso to minimize its loss of profit due to te intense competition fter licensing Tis is in line wit Rockett (10), Mukerjee nd Blsubrmnin (001) nd Fulí-Oller nd Sndonis (003) Similr rgument follows even for low trnsporttion costs c If te trnsporttion cost is not very smll, ie, t >, te incentive for sving te trnsporttion cost is lso very importnt, nd induces firm F to crge lower roylty rte nd to extrct te benefit of iger cost efficiency in firm H wit suitble up-front fixed-fee Hence, in tis sitution, te optiml licensing contrct is combintion of up-front fixed-fee nd output roylty If te trnsporttion cost is very ig, ie, t >, te incentive for sving te trnsporttion cost domintes te incentive for reducing competition fter licensing, nd induces firm F to license te tecnology ginst positive up-front fixed-fee only 3 Conclusion We provide new reson for te existence of different types of licensing contrcts We sow tt, in cse of interntionl tecnology licensing, te trde-off between te incentive for sving te trnsporttion cost of exporting nd te incentive for reducing competition fter licensing generte licensing contrcts wit only output roylty, only up-front fixed-fee or te combintions of fixed-fee nd output roylty References Fulí-Oller, R nd J Sndonis, 00, Welfre reducing licensing, Gmes nd Economic Bevior, 41: 1 0 Filippini, L, 00, Licensing contrct in Stckelberg model, Te Mncester Scool, 73: 8 8 Gllini, N T nd B D Wrigt, 10, Tecnology trnsfer under symmetric informtion, RAND Journl of Economics, 1: Gllini, N T nd R A Winter, 18, Licensing in te teory of innovtion, RAND Journl of Economics, 16: 37 Hummels, D, 11, Hve interntionl trnsction costs declined? Mimeo, University of Cicgo Kbirj, T nd S Mrjit, 003, Protecting consumers troug protection: te role of triff induced tecnology trnsfer, Europen Economic Review, 47: Kmien, M, 1, Ptent licensing, in R J Aumnn nd S Hrt (Eds), Hndbook of gme teory, C Note tt t must be less tn to generte positive output of firm X under export

6 Ktz, M nd C, Spiro, 18, On te licensing of innovtion, RAND Journl of Economics, 16: 04 0 Mrjit, S, 10, On non-coopertive teory of tecnology trnsfer, Economics Letters, 33: 3 8 Milner, C, 00, Protection by triff brriers nd interntionl trnsction costs, Scottis Journl of Politicl Economy, : 10 1 Mukerjee, A nd N Blsubrmnin, 001, Tecnology trnsfer in orizontlly differentited product-mrket, Reserc in Economics, : 7 74 Mukerjee, A nd E Pennings, 006, Triffs, licensing nd mrket structure, Europen Economic Review, 0: Mukerjee, A nd E Pennings, 006b, Corrigendum to triffs, licensing nd mrket structure, Europen Economic Review (Fortcoming) Poddr, S nd U B Sin, 00, Ptent licensing from ig-cost to low-cost firm, Working pper 0/03, Ntionl University of Singpore Rockett, K, 10, Te qulity of licensed tecnology, Interntionl Journl of Industril Orgniztion, 8: 74 Rostoker, M, 184, A survey of corporte licensing, IDEA, 4: Root, F R nd F J Contrctor, 181, Negotiting compenstion in interntionl licensing greements, Slon Mngement Review, : 3 3 Sggi, K, 00, Trde, Foreign Direct Investment, nd Interntionl Tecnology Trnsfer: A Survey, World Bnk Reserc Observer, 17: 11 3 Wng, X H, 18, Fee versus roylty licensing in Cournot duopoly model, Economics Letters, 60: 6