Cross-Licensing in a Supply Chain with Asymmetric Manufacturers

Problem definition: Qualcomm, the largest cellphone chipmaker in the world, had adopted a cross-licensing agreement with its clients, downstream cellphone manufacturers. It requires cellphone manufacturers to allow each other to use their patents for free. This cross-licensing practice has received considerable scrutiny and attention around the world. We study the impacts of cross-licensing in a supply chain in which an upstream supplier requires its downstream competing manufacturers to cross-license, where they are asymmetric in their innovation capabilities. Methodology/results: We build a stylized model of a supply chain consisting of one supplier and two competing manufacturers and conduct game-theoretic analysis. We find that the supplier always prefers adopting cross licensing ex post after manufacturers' investments are sunk, but it may prefer committing to no cross-licensing ex ante. Specifically, the supplier should commit to not using cross licensing if the inferior manufacturer's cost of innovation is high or the effectiveness of cross-licensing is high. Furthermore, cross-licensing may increase innovation, the superior manufacturer's profit, and social welfare under certain conditions. Interestingly, when the superior manufacturer's cost advantage is intermediate, the inferior manufacturer's innovation level first increases and then decreases in the effectiveness of cross-licensing. In addition, the inferior manufacturer's profit also first increases and then decreases as the effectiveness level of cross-licensing increases. The cross-licensing policy benefits consumers when its effectiveness level is low and the superior manufacturer's innovation cost is either high or low. Managerial implications: Our results provide guidance on when a supplier should adopt the cross-licensing strategy. For policy makers, our findings show that cross-licensing can be beneficial for consumers and the society. In particular, to increase social welfare, policy makers may consider encouraging cross-licensing with low effectiveness level when the superior manufacturer's innovation cost is either low or high.

Automated summary

This study examines the impacts of cross-licensing in a supply chain and finds that the supplier tends to adopt cross-licensing after manufacturers' investments are sunk. Additionally, cross-licensing may increase innovation, the superior manufacturer's profit, and social welfare under certain conditions. For policy makers, encouraging cross-licensing with low effectiveness level when the superior manufacturer's innovation cost is either low or high may enhance societal welfare.