Strategic Investment in Technology Standards

Developing technology standards require significant upfront investment expenditures. The value of the resulting technology depends on how it is deployed (e.g., proprietary use versus licensing) and remains uncertain. Hence, the rules governing investments in technology development must be conditioned on the subsequent deployment strategy (e.g. licensing fee) and the nature of uncertainty. In this paper, we consider a single firm that has a temporary monopoly over an investment opportunity. By committing the investment, the firm establishes a technology standard that can be licensed to a potential competitor who can either adopt this standard or develop an incompatible standard. We find that there exists a unique optimal licensing fee that results in a single standard. Surprisingly, for technologies that create network effect, the optimal licensing fee may even be lower than that needed to deter the competitor from developing its own standard. Finally, we solve for the investment threshold as the expected future size of the market at which the firm is indifferent between investing immediately and postponing the investment. The investment threshold is found to be monotonically decreasing in both the intensity of network effects and the level of uncertainty. * We would like to thank Robert Kauffman, Frederick Riggins, Hamid Mohtadi, John Henderson, and other seminar participants at the University of Minnesota, Twin Cities, Boston College, and Boston University for their insightful comments. Funding was provided by the Boston University Institute for Leading in a Dynamic Economy. All errors and omissions are ours.