Impact of Licensing on Investment and Financing of Technology Development

Technology innovations continue to be one of the greatest drivers of economic growth. Realizing the value of such innovations, however, requires substantial follow-on investments in development and commercialization. The value of these investments depends on not only the demand, but also actions by potential competitors, which are uncertain at the time of the investment. This uncertainty creates difficulties in obtaining outside financing. Creative use of licensing contracts can capture the value and alleviate the financing problem. We develop an investment-timing model that includes a variety of licensing possibilities, including fixed fees, royalty schedules, and two-part licenses consisting of an upfront payment and a capped royalty schedule. In our model, investment in development efforts gives a firm the ability to license its technology and dissuade other firms from developing alternative technologies. We show that a royalty schedule that depends on realized demand dominates a fixed licensing fee. When investment funds are constrained, a two-part license can serve as a source of financing. We also study the investment problem conditional on the licensing and financing decisions.