ON THE DIVISION OF PROFIT IN SEQUENTIAL INNOVATION

In markets with sequential innovation, inventors of derivative improve ments might undermine the profit of initial innovators through competi tion. Profit erosion can be mitigated by broadening the first innovato r's patent protection and/or by permitting cooperative agreements betw een initial innovators and later innovators. We investigate the policy that is most effective at ensuring the first innovator earns a large share of profit from the second-generation products it facilitates. In general, not all the profit can be transferred to the first innovator , and therefore patents should last longer when a sequence of innovati ons is undertaken by different firms rather than being concentrated in one firm.