Free Licensing in a Differentiated Duopoly

We construct a differentiated duopoly model to study whether free licensing can be profitable without network externalities and demand shift effect. The efficient firm possesses a superior input-saving technology and sells inputs to the backward firm. However, the optimal input price can be constrained or unconstrained in equilibrium depending on the constellation of parameters. We have shown that free licensing can be profitable if the innovation size is small and the transferee’s input production cost is sufficiently large. But free licensing is never profitable if products are homogeneous. An increase in market size also reduces the possibility of free licensing. We have also derived an implication of free licensing in the context of pollution problem.