An analysis of intrabrand competition in the franchise industry

The owner of a franchise chain is analyzed as maximizing profit by selecting the number of establishments, an initial franchise fee, and a royalty on sales revenue. The franchisees are geographically dispersed and imperfectly compete with one another (intrabrand competition). Then, the optimal sales royalty must be strictly positive. If the royalty were set equal to zero, the equilibrium price would be too low to maximize collective profit; the effect of the royalty is to curtail each franchisee's private gain from reducing price. The optimal royalty rises with the intensity of intrabrand competition. The model predicts a positive association of the sales royalty with the density of the chain's establishments. The available evidence is consistent with this prediction.Parts of this paper are based on chapter III of my dissertation (Schmidt, 1990). Further research was supported by the Graduate School of the University of New Hampshire. I would like to thank Roger Blair, David Bradford, Darlene Chisholm, Jon Hamilton, Amy Schmidt, Ed Zabel, and two anonymous referees for their helpful advice. The usual caveat applies.     

Licensing Strategies in the Presence of Patent Thickets

Many key industries (e.g., biomedical, pharmaceuticals, telecommunications, and information technologies) are characterized by cumulative innovations, where the introduction of a new product or service often requires many complementary technologies. When these technologies are protected by intellectual property rights owned by many firms, patent thickets exist, which researchers have argued may hinder the development of cumulative innovations. Specifically, patent thickets may lead to excessive royalty burdens for potential licensees, which is called “royalty stacking,” and if such costs are passed on to consumers, prices of products based on cumulative technologies will be driven up, dubbed as “double marginalization.” The literature, however, does not address these issues under different forms of licensing contracts. This article develops a game‐theoretic model where a downstream firm seeks to license N patents that read on its product from upstream firms. It discusses a variety of licensing forms widely used in practice and attempts to discover whether royalty stacking and double marginalization occur under these forms of licenses. It also studies the impact of bargaining power between parties. It is found that when patent ownership becomes more fragmented, neither royalty stacking nor double marginalization occurs under profit‐based royalty, fixed fee, and hybrid licenses. Such problems occur only under pure quantity‐based or pure revenue‐based royalty licenses when the downstream firm's bargaining power is low. It is also shown that no matter how fragmented the ownership structure of patent is, hybrid licenses consisting of a fixed fee and a quantity‐ or revenue‐based royalty rate lead to the same market outcomes as a fully integrated firm that owns all the patents and the downstream market. This article has interesting implications for both research and practice. First, the results show that even under the same patent ownership structure, different forms of licenses lead to quite different market outcomes. Therefore, it is suggested that firms and policy makers pay more attention to contractual forms of licenses when trying to minimize the negative impact of patent thickets. Second, the extant literature has largely assumed that quantity‐based royalties are used, where double marginalization is the most severe. In practice, revenue‐based royalties are most common, under which double marginalization is much milder. Third, the results show that patent pools can be most effective in mitigating royalty stacking and double marginalization when quantity‐based or revenue‐based royalties are the sole or primary payment form, especially when downstream firms have low bargaining power.     

Patent pools in 5G: The principles for facilitating pool licensing

Patent pools collect patents from multiple patentees and license them out as a package. They offer one-stop-shop licensing efficiencies, reduce transaction costs, and increase the predictability of the licensing environment for the benefit of innovation diffusion. However, pools failed to take off for previous cellular standards. This article analyses both retrospectively the reasons for such failures and prospectively what makes the 5G environment more conductive to pool formation and licensing. Avanci, a patent pool for licensing cellular standards in the Internet of Things (IoT), is a significant development but has limited licensing coverage so far. The article then recommends five policy principles to facilitate pool licensing in the IoT. They include recognising that only enough upstream SEP owners need to join the 5G pool to create a market signalling effect. Some vertically integrated SEP owners may remain outsiders, and some bilateral licensing may co-exist without damaging the pool's success. To encourage upstream SEP owners to join the pool, they should be allowed to set ‘high enough’ royalty rates and divide pools' royalties among members under value proportionality rules. 5G pools must also be flexible and adopt different licensing programs that consider the specificities of each IoT market. Finally, pool administrators should consult with IoT implementers before establishing licensing programs for them and have infringement legal standing if everything else fails. These principles would go a long way in spurring the broader use of 5G pool licensing for a more efficient, straightforward, and predictable IoT licensing environment.     

On the duration of technology licensing

We model an innovator's choice of payment scheme and duration as a joint decision in a multi-period licensing game with potential future innovations and some irreversibility of technology transfer. We find that it may be optimal to license the innovation for less than the full length of the patent and that royalty contracts can be more profitable than fixed-fee licensing even in the absence of information asymmetry and risk aversion. Moreover, licensing contracts based on royalty have a longer duration than fixed-fee licenses and are more likely to be used in industries where innovations are frequent and intellectual property protection is weak. Our paper also highlights an important link between the study of technology licensing and the theory of durable goods.     

Patent Hold‐Up and Antitrust: How A Well‐Intentioned Rule Could Retard Innovation

Licensing technology essential to a standard can present a hold‐up problem. After designing new products incorporating a standard, a manufacturer could be confronted by an innovator asserting patent rights to essential technology. This hold‐up problem can be solved with a damages remedy provided by antitrust or some other body of law, but a damages remedy can reduce the innovator's licensing revenue and thereby retard innovation. The availability of an ex post damages remedy also alters the licensing terms in ex ante bargaining with the result that fewer socially beneficial R&D projects are undertaken.     

Per unit vs. ad valorem royalties under asymmetric information

We study an inside patent holder's optimal licensing policy when it has imperfect information about the value of the patent to its rival. The patent holder can choose any two-part licensing fee with either per unit or ad valorem royalties. We demonstrate that the equilibrium will be either a fully separating contract with different per unit royalty rates, or a contract with a single ad valorem royalty that excludes a high cost rival. Fixed fees will not be used. The presence of asymmetric information uniquely drives the per unit royalties that otherwise would not be adopted. Per unit royalties always generate higher social welfare than ad valorem royalties.     

Technology transfer with moral hazard

This paper develops an incomplete contract model of the licensing relationship that is susceptible to the moral hazard problem. The optimal contractual form of licensing derived in the model generates predictions that seem to be consistent with actual practice. For instance, the introduction of inputs that are not contractible and costly explains the prevalence of royalty contracts in the licensing relationship. Moreover, the model is able to relate the size of the royalty rate to the parameters that represent the environments under which the concerned parties operate. Finally, the model can be naturally extended to analyze the choice of a technology holder between direct investment and licensing in an attempt to serve a foreign market.     

Licensing information goods

A significant amount of research on patent licensing and the diffusion of knowledge is organized around static frameworks of analysis. Patent holders, however, may face a dynamic problem, namely the intertemporal consistency problem of the durable-goods monopolist that is induced by durability on the demand side. Licensing practices such as exclusive licensing contracts and most favored customer clauses allow patentees to solve or mitigate this dynamic consistency problem. There are situations, however, where these practices are not possible either due to the nature of the patent (the case of information goods) or due to compulsory patenting laws. We study the effects of the intertemporal consistency problem on patent licensing in these situations. Relative to the existing literature, we obtain the following main results: (i) all of the firms that remain in the industry will be using the innovation; (ii) royalty licensing may be superior to fixed-fee or auction licensing from the licensor's point of view; (iii) social welfare and consumer surplus may be lower than when the patent holder can commit not to make additional sales; (iv) even for non-drastic innovations, the price of the good that is produced may be lower than the competitive price corresponding to the initial situation (before the innovation was discovered).     

Differentiated Standards and Patent Pools

We consider patent pool formation by owners of essential patents for differentiated standards that may be complements or substitutes in use. Pooling improves coordination in terms of royalty setting within a standard but provokes a strategic response from licensors in the competing standard. We characterise the incentives to form and defect from pools within standards and show how pool formation and stability depend on competition between standards. We also examine strategic patent pool formation by consortium standards and show that policies promoting compatibility of standards may increase or decrease welfare depending on the effects on the incentives to form pools.     

Patent hold-out and licensing frictions: Evidence from litigation of standard essential patents

The theory of patent “hold-out” posits that frictions in the market for licensing standard-essential patents (SEPs) provide incentives for prospective licensees to opportunistically delay taking licenses with the goal of avoiding or reducing royalty payments. We construct measures of pre- and in-litigation hold-out from information disclosed in U.S. cases filed 2010–2019. Relying on both SEP and a matched control set of non-SEP disputes, we explore whether frictions in the market for licensing are associated with hold-out. We find some evidence of an association between hold-out and both SEP portfolio size and enforcement uncertainty; however, we find no evidence associating pre- or in-litigation hold-out with the international breadth of SEP rights.     

基于低碳设计的创新产品研发契约激励机制研究

在创新产品市场中低碳环保的产品设计受到消费者的极大关注，本文通过构建生产者和研发方之间的研发合作契约机制，激励研发方在设计中提高零部件的绿色度，从而为企业供应链获得更多的市场利润。在研发方绿色研发成本信息为公共信息和私有信息的不同情景下，生产者作为Stackelberg博弈的领导者设计了包含版权支付和版权收益分成两个契约条款的激励机制。研究比较发现，当研发方的绿色研发能力为低水平的概率超过一定比值时，采用不对称信息下的版权甄别契约组合比对称信息下的单一契约更有效，这时生产商和供应链整体能获得更多利润；反之，采用单一契约效果更好。同时，契约激励机制使低碳研发能力水平高的研发方在甄别契约中获得更多利润，而低水平研发方只获得保留利润。     

To join or not to join: Examining patent pool participation and rent sharing rules

In recognition that participation in modern patent pools is voluntary, we present empirical evidence on participation rates and the factors that drive the decision to join a pool, including the profit sharing rules adopted by the pool's founders. In most participation contexts, the at-risk group is extremely difficult, if not impossible, to identify. For pools centered on technologies that result from a standard-setting process, in contrast, we are able to identify a relatively unambiguous population of patents eligible for inclusion but that have not been included in the pool. We find that vertically integrated firms, with patents and downstream operations, are more likely to join a patent pool and among those firms that do join, those with relatively symmetric patent contributions (in terms of value) to a standard appear more likely to accept numeric patent share rules for dividing royalty earnings.     

Licensing Essential Patents: The Non‐Discriminatory Commitment and Hold‐Up

Licensors of patents essential to a standard are often required to license on reasonable and non‐discriminatory (RAND) terms. Using a model with owners of essential patents and licensees who invest into standard‐conforming technologies, this paper demonstrates that the non‐discriminatory commitment alleviates the hold‐up problem. Moreover, it improves consumer and social welfare, and promotes upstream innovation as licensing revenue is increased. In an extended model with each licensor independently choosing whether to make the commitment, all licensors voluntarily commit in the unique equilibrium.     

The licensing dilemma: understanding the determinants of the rate of technology licensing

The licensing of technology entails a trade‐off: licensing payments net of transaction costs (revenue effect) must be balanced against the lower price–cost margin and/or reduced market share implied by increased competition (profit dissipation effect) from the licensee. We argue that the presence of multiple technology holders, which compete in the market for technology, changes such a trade‐off and triggers more aggressive licensing behavior. To test our theory, we analyze technology licensing by large chemical firms during the period 1986–96 for 107 chemical products. We find that the rate of technology licensing displays an inverted U‐shaped relationship with the number of potential technology suppliers and is negatively related to the licensor's market share and to the degree of technology‐specific product differentiation. Copyright © 2006 John Wiley & Sons, Ltd.     

Revenue Sharing and Vertical Control in the Video Rental Industry

Revenue sharing contracts, in which retailers pay a royalty on sales to their suppliers, are now widely used in the video rental industry. We show that revenue sharing is valuable in vertically separated industries in which demand is either stochastic (unpredictable) or variable (e.g., systematically declining), downstream inventory is chosen before demand is realized and downstream firms engage in intrabrand competition. Unlike two-part tariffs, revenue sharing achieves the first best outcome by softening retail price competition without distorting retailers' inventory decisions. Our theories are also consistent with trends in prices and availability following retailers' adoption of revenue sharing contracts.     

Optimal choice of a reserve price under uncertainty

The revenue function for a standard auction is typically asymmetric around the revenue maximizing reserve price. Thus, choosing a reserve price that is smaller than the revenue maximizing reserve price can result in a substantially different loss than choosing one that is larger by the same amount. Therefore, when the revenue function is unknown, it is important to consider uncertainty around the revenue function and its asymmetric structure. For this purpose, I propose a Bayesian decision rule and illustrate its typical revenue gains. I then apply the rule to the bid data from the U.S. timber sales.     

Grantbacks,territorial restraints,and innovation

We analyse the effect of grantback clauses in licensing contracts. While competition authorities fear that grantback clauses might decrease the licensee's ex post incentives to innovate, a standard defence is that grantback clauses are required for the patent-owner to agree to license its technology in the first place. We examine the validity of this “but for” defence and the equilibrium effect of grantback clauses on the innovation incentives of the licensee for both non-severable and severable innovations, which roughly correspond to infringing and non-infringing innovations. We show that grantback clauses do not increase the patent-holder's incentives to license when non-severable innovations are at stake but they do when severable innovations are concerned – suggesting that the “but for” defence might be valid for severable innovations but not for non-severable ones, in direct contradiction to regulation in some jurisdictions. Moreover we show that, for severable innovations, grantback clauses can increase the range of parameters for which follow-on innovation by the licensee occurs. Our work extends the large literature on sequential innovation to an environment where information diffuses through licensing rather than through the mere act of patenting. In this different informational set up we show that Green and Scotchmer (1995)’s conclusion that the initial innovator should have a patent of infinite breadth no longer holds.     

Price Commitments in Standard Setting under Asymmetric Information*

Standards may create market power for the holders of standard essential patents (SEPs). To address these concerns, the literature advocates price commitments, whereby SEP holders commit to the maximum royalty they would charge were their technology included in the standard. We consider a setting in which a technology implementer holds private information about profitability. In this setting, price commitments increase efficiency not only by curbing SEP holders' market power, but also by alleviating distortions in the design of the royalty scheme. We derive conditions under which price commitments can be implemented using a simple royalty cap as used in practice.     

The role of short-term contracts and subsidies in licensing

An innovator without production facilities owns a patented invention that lasts two periods, and looks for the best licensing arrangement with a producer that has private information about the market value of the invention. The license is either a single long-term contract in force over both periods or a series of short-term contracts, one per period. Under short-term contracts, the licensee can strategically signal the value of the invention with its level of production in the first period and thus influence the terms of the contract in the second period. We show that the licensor prefers successive short-term contracts rather than a single long-term contract for intermediate-level probabilities of dealing with an efficient licensee, while the first-period contract may optimally include a per-unit subsidy (a negative royalty rate) in order to correct signaling distortions in the licensee’s production for this period. We also show that prohibiting such subsidies can lead to welfare losses.     

Screening and signalling for technology licensing: a comparison

This article studies, in an adverse selection set‐up, how a patentee licenses a new technology in a two‐period context where the licensee has private information on its marginal cost of production. Two different ways of licensing are considered: the patentee offers, in the first period, either a menu of contracts that screens the different types of licensee or a single contract that obliges the licensee to signal its true type. Of these two contracts, the better for the patentee depends on the probability of the innovation gives rise to a low marginal cost and the difference between the high and low cost. Findings explain, to some degree, the variety of licensing contracts observed in practice (some including only a fixed fee, and others including both a royalty and a fixed fee). This variety may be rationalised by the use of different devices (signalling or screening) aimed at alleviating the effects of opportunism. A welfare comparison of the two means for extracting hidden information from the licensee is also made.