Incentive to Raise Rivals' Costs: Patent Licensing in Vertically Integrated Markets

A key input manufacturer with a patent can raise its rivals’ costs in upstream market either by raising the possibility of patent infringement litigation in case a license is not given or by raising the royalty in case a license is given to its rivals. We study under which scenarios the patent holder has more incentive to raise its rivals’ costs. There is related literature investigating the patent holder’s incentive to license its technology to its rivals such as Farrell and Gallini (1988), Rockett (1990), and Conner (1995) or investigating the vertically integrated input monopolists’ (or the patent holder’s) incentive to supply its input to its rivals such as Padilla and Wong-Ervin (2016) and Moresi and Schwartz (2017). This paper differs from those in that the patent holder allows its rivals to use its patent even without a license but keeps the option of patent litigation. That is, the patent holder has an option to grant a license to its rivals in the input market, called the component licensing, or to allow free access to its rivals and to give a license to the device manufacturers, called the end-product licensing. We show that in the component licensing model the patent holder has more incentive to raise its rivals’ costs.