This paper develops a duopoly model to explore licensing behaviour in the presence of network externalities. Under the assumption that the licensor and the licensee compete in a duopolistic market, we obtain the following results. First, the larger the network‐externality effect, the more likely it is that the licensor will prefer fixed‐fee licensing to royalty licensing. Second, the larger the network‐externality effect, the more likely it is that the optimal royalty rate will be smaller than the reduction in marginal costs from innovation under a royalty licensing arrangement.
