Bargaining on the Sale of a New Innovation in the Presence of Potential Entry

We consider an industry with one incumbent and many potential entrants. Initially the high entry cost does not enable a pro table entry. Suppose an outside innovator holds a patent on a technology that eliminates the entry cost but has a marginal cost at least as high as the current one. The innovator wishes to sell his intellectual property (IP) to the incumbent, through bargaining. Even though the technology itself is useless for the incumbent, he may purchase the IP to limit or exclude further entry. The innovator may sell a few licenses to new entrants before approaching the incumbent. This on one hand reduces the total industry pro t but enables a better credible threat on the incumbent and hence may increases the innovator's payo . A licensing contract with an entrant speci es the license fee together with the maximum number of licenses that can be sold. The contracts are signed sequentially and they are bound by previous commitments. The rms are engaged in Cournot competition in the last stage. It is shown that depending on the marginal cost of the new technology and on the bargaining power of the innovator relative to that of the incumbent, there are three types of subgame perfect Nash equilibrium (SPNE): (i) the innovator sells rst a license to one entrant before selling his IP to the incumbent. The incumbent then put the technology on the shelf to exclude further entry. (ii) the innovator sells one license to an entrant before selling the IP to the incumbent. The incumbent then licenses the new technology to one additional entrant and (iii) the innovator sells the IP directly to the incumbent who then put the technology on the shelf. ∗Department of Economics, Stony Brook University. Email address: [email protected] †The Eitan Berglas School of Economics, Tel-Aviv University. Email address: [email protected] ‡Department of Economics, Stony Brook University. Email address: [email protected]