Strategic Licensing of Product Innovations

Obtaining a patent provides the patentee with the ability to offer a potential entrant a license to operate within the patent that has been claimed. This paper shows that the patentee always has an incentive to provide a license if the patentee is unable to use patent breadth to deter entry (if the patentee can deter entry, it is optimal for the patentee to do so). Licensing a new product to a competitor has two benefits for the patentee. First, licensing creates an incentive for the entrant to select the product location that maximizes the joint profits of both it and the patentee, rather than just its own profits. Second, the patent breadth decision determines the default profits for both the patentee and the entrant, which in turn affects the manner in which the benefits of the cooperative R&D are shared between the two parties. Generally the patentee has an incentive to choose a smaller patent breadth when licensing is possible than it would choose where licensing not possible. The smaller patent breadth is optimal because it lowers the probability of the patent being found invalid, which in turn lowers the default profits for the entrant (i.e., the profits earned in the absence of a license).