Licensing a technological headstart

We examine how investment possibilities by licensees and nonlicensees affect the two-part licensing contracts offered by an innovator not participating in a homogeneous good oligopolistic market. By undertaking some investments after the decision to accept or reject the licensing contract, licensees and nonlicensees can decrease their marginal production cost. However, the innovation provides a technological headstart in the continuing process of marginal cost improvement. We find that the two-part equilibrium contracts can be of three types: (i) a fixed fee contract such that all firms become licensees; (ii) a fixed fee contract such that the number of licensees is smaller than the number of firms in the market; and, (iii) a contract that specifies a positive royalty rate and a fixed fee such that all firms become licensees.