Incumbency and R&D incentives: Licensing the gale of creative destruction

This paper analyzes the relationship between incumbency and R&D incentives in the context of a model of technological competition in which technologic ally successful entrants are able to license their innovation to (or be acq uired by) an incumbent. That such a sale should take place is natural, sinc e postinnovation monopoly profits are greater than the sum of duopoly profi ts. We identify three key findings about how innovative activity is shaped by licensing. First, since an incumbent's threat to engage in imitative R&D during negotiations increases its bargaining power, there is a purely stra tegic incentive for incumbents to develop an R&D capability. Second, incumb ents research more intensively than entrants as long as (and only if) their willingness to pay for the innovation exceeds that of the entrant, a condi tion that depends critically on the expected licensing fee. Third, when the expected licensing fee is sufficiently low, the incumbent considers entran t R&D a strategic substitute for in-house research. This prediction about t he market for ideas stands in contrast to predictions of strategic compleme ntarity in patent races where licensing is not allowed.