Optimal Two-Part Tariff Licensing in a Stackelberg Structure

This article studies the optimal two-part tariff licensing mechanism for a cost-reducing innovation in a Stackelberg duopoly for an incumbent innovator. We find that the innovating leader licenses a non-drastic innovation by means of a pure ad valorem royalty, whereas the innovating follower does so by means of a pure per-unit royalty. We show that the leader’s licensing of the innovation lowers social welfare, whereas the follower’s licensing of the innovation raises social welfare. Moreover, both consumer and social welfare are higher in the case of the follower’s innovation than in the case of the leader’s innovation. We also find that the leader’s innovation incentive is higher than the follower’s in the case where the licensing is profitable for the innovator