In this paper, we consider the licensing behavior from an upstream firm to a vertically-integrated firm. We find that the optimal contract includes only a per-unit royalty rate when the innovation is small. Moreover, the royalty rate may be even larger than the innovation level. Under such a circumstance, the competing firms can achieve a collusive outcome through technology licensing; however, the social welfare improves. Furthermore, if the upstream firm determines the input price while dealing the licensing contract with the vertically-integrated firm, the upstream firm licenses to the vertically-integrated firm by a fixed-fee and determines a high input price to deter other downstream firms from entry. That may distort the social welfare.
proceedings of the 87th Annual Western Economic Association Conference, 15p.