Bargaining in Patent Licensing with Inefficient Outcomes

A monopoly (M) faces an outside innovator who owns a technology that eliminates the entry cost and hence allows a profitable entry. M is willing to pay for that technology, so as to exclude entry and to keep enjoying its monopoly profits. Before bargaining with M about the technology, the innovator may benefit from selling some licenses to entrants, even though this sale shrinks the total “bargaining cake”, and is inefficient for the bargainers. Introducing entry prior to bargaining typically increases the optimal number of additional licenses that the innovator sells in case the bargaining fails. This increases the (credible) threat vis-à-vis M and strengthens the bargaining position of the innovator. It is shown that entry may occur if the ex-ante bargaining power of the innovator is relatively weak.