Patent Licensing and Entry Deterrence: The Role of Low Royalties

Abstract

We study how an incumbent patent holder can use its licensing policy strategically to reduce the threat of further entry. The patent holder can license its technology to another incumbent firm via a low royalty. This licensing strategy makes the terms of future licensing agreements less favorable to potential entrants, who find entry unprofitable. Strategic licensing induces a trade-off between a more concentrated market structure and a lower price. Within the region of parameters (entry cost and technological asymmetry between the incumbents) where the patent holder has an incentive to deter entry, this type of strategy is welfare enhancing if and only if the entry cost and/or the size of the technological asymmetry (size of the innovation) are high. Our analysis yields new policy implications with respect to strategic licensing.

Keywords: Patent Licensing, Cross-Licensing, Entry Deterrence, Royalties, Innovation

JEL Classification: L13, L24