Licensing interim R&D knowledge

Licensing interim R&D knowledge

Yossi Spiegel

Tel Aviv University

Licensing interim R&D knowledge 2

Background Many licensing agreements are reached in early stages of

the R&D process A 1/3 of all licensing deals between the top 12

pharmaceutical companies and biotech firms in 1991-2002 took place during preclinical testing (Kalmas, Pinkus, and Sachs, 2002)

Over 60% of all licensing deals between the top 20 pharmaceutical companies and biotech firms in 1997-2002 took place at the discovery and lead molecule phases (Howard, 2004)

About 50% of all biotechnology licensing agreements in Lim and Veugelers (2003) were made at the preclinical testing stage

The success rate for drugs at the preclinical testing stage is low (about 20% - see DeMasi, 2001)


The main idea Consider a winner-takes-all R&D contest for developing a new

commercial technology (e.g., new drug, new cost effective production process)

Question: Should the leader in the contest, before it is decided, hold on to its lead or should it license/sell its superior knowledge to lagging firms?

Answer: If the leader can choose between licensing and selling the answer is YES.

If it can either license or sell (but cannot select between these two options) the answer is IT DEPENDS.

The problem differs from traditional patent licensing because what is licensed is only a chance to invent, not a sure thing (due to Bertrand competition, complete technologies will never be licensed)


Main effects of licensing

Value creation: Raises the prob. that the licensee will succeed when the licensor fails

Value destruction: Raises the prob. that the licensee will succeed when the licensor succeeds

Rent extraction: The licensor can play the licensees off against one another since a non-licensee faces a lower prob. of being the sole developer of the new technology

The rent extraction effect is similar to the blackmail effect in Anton and Yao (AER, 1994; RES, 2002) and to the effect of licensing in Katz and Shapiro (QJE, 1986)


Related literature Kamien (Handbook of IO, 1992) - how should an outsider license a

patent?

Gallini (AER, 1984) - An insider licenses knowledge to deter entry

Rockett (Rand, 1990) - An insider licenses to invite a weak rival

Bhattacharya, Glazer, Sappington (JET, 1992) - optimal design of RJV, including cross licensing of interim knowledge

d’Aspremont, Bhattacharya, Gerard-Varet (RES, 2000) – bargaining over licensing of interim knowledge under asym. info.

Bhattacharya and Gurive (JEEA, 2006) - comparison between patent-based licensing (exclusivity is feasible) and trade-secret-based licensing (exclusivity is not feasible)


The model 3 firms engage in an R&D contest, followed by

Bertrand competition

The profit from being the sole developer of the new technology is 1; otherwise the profit is 0

Knowledge: > ≥

Knowledge is Blackwell ordered

The expected profits absent licensing:

kjii 11


Exclusive licenses Firm 1 makes take-it-or-leave-it offers to firms

2 and 3 at fees, T2 and T3, and sets a tie-breaking rule in case both firms accept

Exclusive license to firm 2 (the case of firm 3 is analogous):

23111 11),( Tny

23112 11),( Tny

2133 1),( ny


Nonexclusive licenses The expected payoffs:

322

111 1),( TTyy

22

112 1),( Tny

32

113 1),( Tyy


Lemma 1 If firm 1 wishes to issue an exclusive license to firm j = 2,3, then it will

set T2 and T3 such that

so (accept, accept) is a NE and set a tie-breaking rule that says that firm j gets an exclusive license if both firms accept

If firm 1 wishes to issue nonexclusive licenses to both firms 2 and 3, then it will set T2 and T3 such that

so (accept, accept) is a NE and set a tie-breaking rule that says that both firms get licenses if both accept

Interestingly, T2* >(<) T3* when < (>) 1/2: firm 2 faces a weaker non-licensee so it values a license more, but it also cares less about being left behind

),(),(),(),( 3322 nyynynny

),(),(),(),( 3322 nyyyynyy


Proposition 1 – the equil.

1 is large: a license is not worth much to firms 2 and 3 but entails a large loss of technological lead from firm 1’s perspective

1 is intermediate: firm 3 is willing to pay more (T3>T2), but licensing to firm 2 entails a smaller loss of technological lead (firm 2 has a “good” chance anyway)

1 is small: licensing entails a small loss of technological lead (firm 1 is “far away” anyway) and allows firm 1 to play firms 2 and 3 off against one another (a license not only provides knowledge but also ensures that the firm is not left behind)

1/3 1/2 1

Nonexclusive licenses

1

Exclusive licenseto firm 2

No licenses

1


Partial transfer of knowledge What happens when firm 1 can control how knowledge it transfers? Let 2 ≤ - 2 and 3 ≤ - 3 Again, firm 1 makes take-it-or-leave-it offers such that rejection

implies that firm 1 will transfer its entire knowledge to the rival firm. The offers are complemented by appropriate tie-breaking rule:

3

2

21322133

21233122

33221321

111

111

11),(

T

T


Partial transfer of knowledge – the equil.



No licenses

1/3 1/2 11 1



“vacuous” licenses to firms 2 and 3


Transfer of knowledge between firms 2 and 3 Firm 1 sets T2 and T3 such that 2 = 2(1-1)2 and 3 =

3(1-1)2 – the rival obtains an exclusive license

2 + 3 = (2+3)(1-1)2 - firms 2 and 3 benefit from transferring firm 2's knowledge to firm 3 and improve their bargaining positions vis-a-vis firm 1

The agreement does not affect firm 1's choice between exclusive and nonexclusive licenses since this choice depends only on whether 1 is above or below 1/3

Since 1* with λ₃, the agreement narrows the range of

1 for which firm 1 issues an exclusive license to firm 2


Firm 1's knowledge is worth more to firms 2 and 3 In many cases, relatively small firms license out their interim R&D knowledge to large

corporations (e.g., software industry or biotechnology)

Suppose that when firm 1's knowledge is , its prob. of developing the new technology is , ∈[0,1]

Licensesto firms2 and 3

Exclusivelicense to firm 2

Nolicenses


Correlation Suppose that after licensing, the success prob. of firm 1 and its licensee(s)

become positively correlated: with prob. , they are perfectly correlated and with prob. 1- they are completely independent

The expected payoffs under an exclusive license to firm 2:

The expected payoffs under nonexclusive licenses to firms 2 and 3:

23111 111),,( Tny 23112 111),,( Tny

21133 111),,( ny

322

111 11),,( TTnn jj Tnny 2

11 11),,(


Correlation – the equil. When is not too large, the qualitative results of Prop. 1 remain valid:

Nonexclusive licenses to firms 2 and 3 when 1* is small Exclusive license to firm 2 when 1* is intermediate No licenses when 1* is large

When is relatively large, things change: Firm 1 will never issue nonexclusive licenses to both firms 2 and 3 whenever

Firm 1 will issue an exclusive license to firm 3 whenever 1 < 1/3 and

211

211

331

31

3211

211321

211

211

221

2111

331

31


Bans on exclusive licenses In some cases, U.S. firms were not allowed to issue exclusive licenses - in

two separate consent decrees signed in 1956, AT&T and IBM were required to license their patents on a nonexclusive, world-wide basis to any applicant at a reasonable royalty

Bans on exclusive license may backfire!



No licenses

1/3 1 1


No licenses

11


Acquisition of knowledge Selling differs from licensing because after firm 1 sells its

knowledge, it exits the R&D contest (e.g., firm j = 2,3 acquires firm 1 or acquires the relevant R&D lab or division of firm 1)

The expected payoffs under exclusive sale of knowledge to firm 2:

The expected payoffs under nonexclusive sale of knowledge to firms 2 and 3:

21 ),( Tnys 2312 1),( Tnys

133 1),( nys

321 ),( TTyys

jsj Tyy 11 1),(


Acquisition of knowledge – the equil.



No licenses

1/3 1/2 11 1

Nonexclusive sale to firms 2 and 3 if(1-2-3)(1-21) > 123

or no sale otherwise

Nosale

Exclusive saleto firm 2


Sell or license?



No licenses

1/3 1/2 11 1

Nonexclusive sale to firms 2 and 3 if(1-2-3)(1-21) > 123

or no sale otherwise

Nosale

Exclusive saleto firm 2


Conclusion A leading firm in an R&D contest may be

better off licensing or selling its interim knowledge rather then holding on to its lead

Selling is particularly attractive when the leading firm is very close to being successful because it allows to avoid competition

Licensing/selling is profitable because it may create value and may also allow the leading firm to extract rents from its rivals

Exclusive licenses may promote knowledge dissemination especially when the leading firm has a relatively high amount of knowledge


Possible extensions Endogenize the success prob. of the three firms Add a second investment stage after licensing takes

place - for example, the overall success prob. could be p(i,i), where i is the ex post investment In such a model, licensing will allow the licensee(s) to

save ex post investments Replace Bertrand competition with some other type of

competitive model Make the success prob. private info. Knowledge is non-Blackwell ordered

Cross-licensing agreements may emerge

Documents

Licensing interim R&D knowledge