Sale versus licensing of a cost-reducing innovation by an outside patentholder

Abstract

We investigate an outside patentholder's choice between selling and licensing a cost-reducing innovation to firms that produce differentiated goods in a Cournot duopoly. Sale implies the transfer of ownership rights, whereas licensing—by the patentholder directly or by any assignee—occurs through an endogenously chosen two-part tariff contract. We find that the patentholder has an incentive to sell the innovation (to a single firm that, in turn, licences it to its competitor) only when the goods are close substitutes and the innovation size is sufficiently minimal. Otherwise, the patentholder prefers to licence the innovation to both firms. Although the transfer of innovation, whether through outright sale or licensing, always improves aggregate welfare compared with the pre-transfer scenario, consumer surplus is reduced when the transfer is made by means of sales. Therefore, a socially optimal public policy should aim at banning the sale of outside innovations or, at least, preventing their subsequent licensing by the assignee from within the industry.