Optimal licensing of uncertain patents in the shadow of litigation

This paper investigates the choice of a licensing mechanism by the holder of a patent whose validity is uncertain. Focusing …rst on weak patents, i.e. patents that have a high probability of being invalidated by a court if challenged, we show that the patent holder …nds it optimal to use a per-unit royalty contract if the strategic e¤ect of an increase in a potential licensee’s unit cost on the equilibrium industry pro…t is positive. The latter condition ensures the superiority of the per-unit royalty mechanism independently of whether the patent holder is an industry insider or outsider, and is shown to hold in a Cournot (resp. Bertrand) oligopoly with homogeneous (resp. di¤erentiated) products under general assumptions on the demands faced by …rms. We then examine the optimal licensing of patents that are uncertain but not necessarily weak. As a byproduct of our analysis, we contribute to the oligopoly literature by o¤ering some new insights of independent interest regarding the e¤ects of cost variations on Cournot and Bertrand equilibria. Keywords: Licensing mechanisms, Uncertain patents, Patent litigation, Cost comparative statics. JEL Classi…cation: D45, L10, O32, O34. A previous version of this paper was circulated under the title "Per-Unit Royalty vs Fixed Fee: The Case of Weak Patents." For valuable comments and discussions, we are grateful to Claude d’Aspremont, Claude Crampes, Christian Helmers, Patrick Rey, Isabel Ruhmer, Cédric Schneider, Jean Tirole and Yaron Yehezkel. We would also like to thank participants at the Sixth Bi-Annual Conference on the Economics of Intellectual Property, Software and the Internet in Toulouse, the 4th ZEW Conference on the Economics of Innovation and Patenting in Mannheim, the International Conference in honor of Claude d’Aspremont and Jean-François Mertens in Louvain-la-Neuve, and EEA-ESEM 2011 in Oslo, as well as seminar participants at the Copenhagen Business School, for useful comments and suggestions. All remaining errors are ours. yUniversity of Iowa. Email: [email protected] zParis School of Economics, Université Paris-1 Panthéon Sorbonne. Email: [email protected] xToulouse School of Economics. Email: [email protected] 1 ha ls hs -0 08 47 95 5, v er si on 1 24 J ul 2 01 3