Licensing process innovations when losersʼ messages determine royalty rates

- An innovator offers unrestricted licenses and royalty licenses to an oligopoly.
- Firmsʼ messages signal their own cost reduction to rival firms and to the innovator.
- A high threshold level assures existence of an incentive compatible transfer rule.
- Adding royalty licenses for losers pointwise lowers winnersʼ transfers.
- The royalty income generally exceeds the loss in revenue from the winners.

We consider a licensing mechanism for process innovations that awards a limited number of unrestricted licenses to those firms that report the highest cost reductions, combined with royalty licenses to others. Firmsʼ messages are dual signals of their cost reductions: the message of those who win an unrestricted license signals their cost reduction to rival firms, while losersʼ messages influence the royalty rate set by the innovator. We explain why a sufficiently high threshold level for awarding the unrestricted license is essential to induce truth-telling, show that the innovator generally benefits from the proposed mechanism, and derive conditions for implementability by a modified second-price auction.