Antitrust Scrutiny of Price-Fixing Clauses in Patent Licenses

Patent licenses are frequently subjected to antitrust scrutiny, especially when they contain restrictions beyond simple fixed fees and royalties. Clauses that fix the price at which a product is sold have proven contentious, upheld by the courts in some circumstances and rejected in others. No agreement has yet emerged on how to reconcile court decisions and economic rationale. We study the effects of price-fixing with a stylized model featuring heterogeneous consumers choosing between two product generations, sold by firms that compete on price. Licenses can be compared according to how much reward is collected by the inventors. In our example license schemes, we find that royalties and fixed fees are not enough to make a license profit neutral, even with zero-cost manufacturing. The erosion of profit when price-fixing is forbidden depends on the quality gap between generations of product and on whether the license is based on flat royalties or a percentage rate. A percentage-rate license has particularly poor performance for small quality gaps, as total profits approach zero in the limiting case. A flat-royalty license is nearly optimal in this case, but may be more difficult to negotiate if there are information asymmetries. For large quality steps, a percentage rate license is a better choice, with nearly no erosion of profit. In all cases, price fixing can be used to restore optimal profits. In general, only the price of one product must be fixed, since the other can be controlled with royalties.