General licensing schemes for a cost-reducing innovation

Optimal combinations of upfront fees and royalties are considered for a cost-reducing innovation in a Cournot oligopoly for both outside and incumbent innovators. It is shown that for any nondrastic innovation (a) the license is practically sold to all firms, ensuring full diffusion of the innovation, (b) consumers are better off, firms are worse off and the social welfare is improved, (c) the optimal licensing policy involves positive royalty for relatively significant innovations, (d) compared to an incumbent firm, an outsider invests more in R&D and has higher incentive to innovate and (e) as a function of the magnitude of the innovation, the industry size that provides the highest incentive to innovate is U-shaped.