Licensing versus assignment: Innovation transfer in an asymmetric duopoly

• Published date: 01 December 2019
• DOI: http://doi.org/10.1111/jpet.12414
• Author: Shuai Niu
• Date: 01 December 2019

J Public Econ Theory. 2019;21:1286–1308.wileyonlinelibrary.com/journal/jpet1286

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© 2019 Wiley Periodicals, Inc.

Received: 11 July 2019

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Accepted: 3 November 2019

DOI: 10.1111/jpet.12414

ORIGINAL ARTICLE

Licensing versus assignment: Innovation

transfer in an asymmetric duopoly

Shuai Niu

School of Economics, Shandong

University, Jinan, China

Correspondence

Shuai Niu, School of Economics,

Shandong University, No. 27

Shandananlu, Jinan, 250100 Shandong

Province, China.

Email: niushuai1@163.com

Abstract

Suppose that the relatively inefficient firm in an asym-

metric duopoly market develops a nondrastic process

innovation. To maximize returns on the innovation, the

innovator must determine the most lucrative commercial

policy. Should it be in‐house exploitation, or licensing or

assignment? It turns out that the innovator never uses

innovation exclusively. The choice of licensing or assign-

ment depends on the size of the initial cost difference.

When the initial cost difference is relatively small, the

innovator would resort to licensing, whereas when there is

a significant initial cost gap, the innovator would rather

assign the property rights of the innovation to the rival. In

the case of assignment, the assignee may license the

innovation back to the assignor. With the option of reverse

licensing, an assignment will always be more profitable

than (direct) licensing. Interestingly, if the initial cost gap

were sufficiently large, the innovator would exit the

market postassignment, and thus act as an outside

nonoperating licensor.

KEYWORDS

assignment, in‐house exploitation, licensing

JEL CLASSIFICATION

L13; L24; L41

1

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INTRODUCTION

Suppose that one day an innovative firm creates a process innovation. The innovator wishes to

maximize returns on the innovation. What is the most lucrative commercial policy—in‐house

exploitation or licensing or assignment? In the past, most technology‐oriented firms focused

exclusively on applying innovation to their own products or services (Lichtenthaler, 2008).

Today, however, an increasing number of innovative firms have started to commercialize their

knowledge assets through external transactions such as licensing or assignment (Jeong, Lee, &

Kim, 2013).

1

What the licensing policy and the assignment policy have in common is that they give

entities other than the innovator access to the innovation. The difference between them lies in

whether or not ownership of the innovation is transferred. Under licensing, the innovator

grants permission for the use of the innovation to another entity, but retains the right to use the

innovation or further license it to other entities. Under the assignment, however, ownership of

the innovation is transferred from the innovator to another entity. Following assignment, the

innovator loses all control of the innovation and can no longer use it, or license others to use it

(Irish, 2005, p. 143).

To put into context comparisons of different commercial policies, think of a homogenous‐

product market with two producers, Firm 1 and firm 2. Firm 1 produces at a constant marginal

cost of c

1

, and firm 2 produces at marginal cost

c

2

. There are no fixed costs in production and the

two firms engage in quantity competition. Initially, firm 1 is less efficient than firm 2 (i.e.,

cc>

1

2

). The initial cost difference is nondrastic, in the sense that firms are both active in

Cournot equilibrium. One day, firm 1 creates a process innovation. Using this innovation, the

marginal production cost of firm 1 drops to c

x

−

1, where

x

is the amount of cost reduction.

Depending on the size of xc

x

,−

1can be greater than, equal to, or less than

c

2

.If

cxc−<

1

2

,

we make necessary restrictions on

x

so that firm 2 will not go out of business in equilibrium if

firm 1 were to apply the innovation exclusively. Suppose that the innovation is a “common”

one. If firm 2 is given access to the innovation through licensing or assignment, its marginal

cost would decline also by x.

2

The choice of commercial policy affects the cost structure of the duopoly market. Under in‐

house exploitation, the marginal production cost of firm 1 drops to c

x

−

1, while that of firm 2

remains at

c

2

. In the case of assignment, firm 1, in losing the right to use the innovation, needs

to produce at the initial‐level marginal cost, c

1

, whereas firm 2, as the new owner of the

innovation, produces at

c

x

−

2

.

3

Under licensing, firm 1 retains the right to use the innovation,

and produces at c

x

−

1. Although firm 2 is given permission to apply the innovation in

production, it may need to pay per‐unit royalties to firm 1.

4

Thus, the marginal aggregate cost of

firm 2 under licensing should be written as

cx

r

−+

2, where

∈rx[0, ]

is the per‐unit royalty

rate.

5

Variations in marginal costs affect the equilibrium industry profit under quantity

competition. Suppose that the innovator switches from the policy of in‐house exploitation to

the assignment policy. Then, the sum of the marginal costs remains cc

x

+−

12 , but the

1

Statistically, in 2010, about 4% of the Danish patent‐active businesses sold their patents, and more than 10% of them outlicensed their patents (refer to http://

www.ip‐tradeportal.com/statistics‐on‐trading‐ipr/trading‐patents.aspx for details). In addition, data from the United States Patent and Trademark Office

indicate that about 13.5% of all granted patents are traded at least once over their life cycle (Serrano, 2010).

2

Refer to Sinha (2016) for an explanation of the difference between a “common innovation”and a “new technology innovation.”

3

Note that, due to the initial cost gap, although it is assumed that the exclusive use of the innovation by firm 1 will not drive firm 2 out of the market, it is

entirely possible that the solo application of the innovation by firm 2 may force firm 1 to shut down in equilibrium. We do cover this possibility in this study.

Nonetheless, for brevity, in the introduction, we assume that both firms are active postassignment.

4

Under licensing, the innovator usually requests from the licensee a lump‐sum payment and/or some running royalties. Under the assignment, the innovator

can also receive royalties, but lump‐sum payments are much more common. Refer to the report titled “Should I License or Should I Assign My Patent?”by Mary

Bellis at https://www.thoughtco.com/should‐i‐license‐or‐should‐i‐assign‐my‐patent‐1991823.

5

It is natural to require that ≥r

0

. The other requirement,

≤r

x

, originates from Shapiro (1985) and is widely adopted in the licensing literature.

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