Licensing Uncertain Patents: Per-Unit Royalty vs Up-Front Fee

In this paper we examine the implications of uncertainty over patent validity on patentholders' licensing strategies. Two licensing mechanisms are examined: per-unit royalty and up-front fee.We provide conditions under which uncertain patents are licensed in order to avoid patent litigation. It is shown that while it is possible for the patentholder to reap som e "extra profit" by selling an uncertain patent under the pure per-unit royalty regime, the opportunity to do so does not exist under a pure up-front fee regime. We also establish that the relatively high bargaining power the licensor has even when its patent is weak can be reduced if the patentholder cannot refuse to license an unsucessful challenger or if collective challenges are allowed for. Furthermore we show that the patentee may prefer to license through the per-unit royalty mechanism rather than the fixed fee mechanism, especially if its patent is weak. This finding contradicts the traditional theoretical result that fixed fee licensing dominates royalty rate licensing from the patentholder's perspective.