Per unit vs. ad valorem royalty licensing

Abstract

We consider the licensing of a non-drastic innovation by an innovator who interacts with a potential licensee in a downstream Cournot market. We compare two kinds of license contracts: per unit and ad valorem, combined with fixed fees. Assuming that antitrust authorities apply the same principle to review ad valorem royalty license contracts which they apply to per unit royalty license contracts, we show that per unit royalty licensing is more profitable if the licensor is more efficient in using the innovation, whereas ad valorem royalty licensing is more profitable if the licensee is more efficient. This explains why and when these licensing schemes should be observed.

Ad Valorem Versus Per‐unit Royalty Licensing in a Cournot Duopoly Model

“…More recently, Fan et al () compared two kinds of license contracts: per unit and ad valorem royalties, combined with fixed fees. Our paper differs from Fan et al .…”

“…Our paper differs from Fan et al . () in the following aspects. Firstly, the research subjects are different.…”

“…Secondly, Fan et al . () allowed the two firms to use the cost reducing innovation with different efficiencies, while we follow the literature to assume that the cost reducing innovation yields the same amount of cost reduction to both firms. Thirdly but not lastly, Fan et al .…”

“…Thirdly but not lastly, Fan et al . () incorporated regulations by antitrust authorities that limits the equilibrium price, i.e., the degree of freedom of the licensor. The ad valorem royalty licensing in that paper is ensured to be welfare‐improving.…”

“…Secondly, we allow for any innovation that reduces the constant marginal cost of production of the firms. 5 More recently, Fan et al (2018) compared two kinds of license contracts: per unit and ad valorem royalties, combined with fixed fees. Our paper differs from Fan et al (2018) in the following aspects.…”