Review of Industrial Organization 12: 271–278, 1997.
1997 Kluwer Academic Publishers. Printed in the Netherlands.
License to Be More Innovative
Department of Economics, Southern Methodist University, Dallas, TX 75275-0496, U.S.A.
Abstract. A patent holder may choose to give up its current leading position through patent licensing
in order to increase its incentive to innovate further and thus avoid falling behind its rivals in future
R&D races. We show that because of this “catching-up” effect, licensing may occur even when it
reduces current industry proﬁts. The overall effect of licensing is to slow down the pace of innovation,
as it reduces the licensee’s incentive to conduct R&D.
Key words: Licensing, R&D race.
It is widely recognized that the rate of diffusion of new technologies inﬂuences
long-run industrial performance. Patent licensing is a basic channel through which
dissemination takes place. In this paper, we analyze a strategic incentive for licens-
ing: the “catching-up” incentive. In the absence of licensing, the patent holder of
an existing technology tends to rest on its innovation and, hence, is more likely to
be defeated by rivals in future R&D race (Arrow, 1962; Reinganum, 1983, 1985).
To catch up with its rivals in the race for the next generation of innovations, the
patent holder may license its current technology so as to create more competitive
pressure from the rivals and therefore enhance its incentive to innovate further. By
giving up its dominance through patent licensing, the current leader may, in effect,
improve its position in the next battle of technological rivalry.
To study how the “catching-up” incentive to license inﬂuences the likelihood of
technological transfer and the pace of innovation, we use an asymmetric version of
the R&D racemodel ofLee and Wilde (1980).At time 0, the currentleader(the low-
cost ﬁrm) has an opportunity to license its technology to a rival ﬁrm. Following the
licensing decision, the ﬁrms engage in an R&D race the winner of which becomes
the monopolist in the market. During the race, the ﬁrms compete against each
other in the pre-innovation product market with the existing technologies. Our
main ﬁnding is that licensing occurs if and only if post-licensing industry proﬁts
exceed a threshold equal to pre-licensing industry proﬁts minus a term measuring
the “catching-up” incentive. Hence, licensing may occur even when it reduces
I thank an anonymous referee for valuable comments and suggestions on an early draft of the
Our analysis is in line with the work of Leibenstein (1966), who argued that competition acts as
a “stick” that promotes innovative activities.