Transcript New Product Licensing_vEFSLANG

NEW PRODUCT LICENSING:
Why do companies license their IP?
Feryal Erhun
Enis Kayis
Management Science and Engineering
Stanford University
Mark Wilkinson
Intel Corporation
MSOM Conference 2005
The Transformation of the Computer
Industry (80’s and 90’s)
Retail
Stores
Sales and
distribution
Application
software
Superstores
Word
Perfect
Word
Operating
system
DOS and Windows
Computer
Compaq
Dell
Packard
Bell
Intel Architecture
Chips
IBM
DEC
Sperry
Univac
Mail
Order
Dealers
Application
software
Etc.
OS/2
HP
Mac
IBM
Sales and
distribution
UNIX
Etc.
Motorola Etc.
Operating
system
Computer
Chips
Wang
Source: A.S. Grove (1999) Only The Paranoid Survive: How to Exploit the Crisis Points That
Challenge Every Company, Currency-Doubleday, New York, NY.
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Motivation: The Tale of Three Companies
(The Story of IBM, Intel, and AMD)
•
IBM adopted x86 chips for its first computers in 1982
•
As part of the deal, Intel had to license the x86 architecture to AMD so
that IBM could have a second source of chips
•
Intel, as a new player in the arena, did not have enough capacity to
satisfy all the demand and needed the extra respectability that second
sourcing provides
•
Licensing helped Intel by encouraging other producers to push the Intel
product while discouraging their own future generations of chips
Source: http://www.redhill.net.au/c-amd.html
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Motivation: Moving R&D to High Volume
(R&D Labs)
• Lack of production capacity to produce output at a
level necessary to satisfy total market demand
• Manufacturing costs at R&D facilities are usually
higher than at high-volume manufacturing facilities
• Outsource/license the product to reach a bigger
market at lower costs
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Research Questions
• Why/when would a company license its intellectual
property (IP)?
• What is the role of an inventor’s capacity in the
market equilibrium?
• What is the role of manufacturing cost in product
licensing?
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Agenda
• Model Definition
• Analysis of the Model
• Conclusion
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Model Definition-I
End consumers
Price p
OEM
Wholesale price,
w1
CS
Literature Review
Model Definition
CS2
Analysis of the
Model
Extensions
Conclusion
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Model Definition-II
End consumers
End consumers
Price p
Price p
OEM
OEM
Wholesale price,
w1
Wholesale price,
w2
CS
Wholesale price,
w1
CS2
CS
CS2
Royalty Fee, α
Transfer Price, t2
Outsource the production to CS2
License the component to CS2
Literature Review
Model Definition
Analysis of the
Model
Extensions
Conclusion
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Modeling Demand
• CS develops a component, which will be embedded
within OEM’s new product
• The potential number of customers attracted by
OEM’s product is N
• The probability that any customer purchases OEM’s
product at price p with price sensitivity b is:
 ( p )  1  bp
• The aggregate demand is therefore:
D  N   ( p)  N  (1  bp)
Literature Review
Model Definition
Analysis of the
Model
Extensions
Conclusion
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Modeling Supply
• CS may produce her proprietary component at unit
production cost c and sell it to OEM at a wholesale
price w1
• CS has limited production capacity K
• CS can subcontract the production to CS2, who has
“virtually unlimited capacity” and lower production
cost c
Literature Review
Model Definition
Analysis of the
Model
Extensions
Conclusion
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Agenda
• Model Definition
• Analysis of the Model
• Licensing
• Conclusion
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LICENSING
Analysis
NO
YES
License
the product?
NO
Produce capacity,
license the rest
(K,D-K)
Case I
Produce all
(D,0)
License all
(0,D)
D<K
Literature Review
YES
Case III
Case II
Condition:
Participate in
production?
Condition: D>K
Model Definition
Analysis of the
Model
Extensions
Conclusion
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LICENSING
Results
K
CASE II
(D,0)
CASE I
(0,D)
N
4
CASE III
(K,D-K)
1 2
b(  2 )
1
b( 2   )
1
b
c
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LICENSING
Summary of the Results - Licensing
• Royalty fee is independent of CS’s capacity
 It depends only on price sensitivity and CS2’s cost
• Even when CS has “virtually unlimited capacity,” she
may still want to license
• When the capacity is limited, licensing creates
competition for CS2
 CS2 produces more than he wants
• More capacity is not always good for CS
Literature Review
Model Definition
Analysis of the
Model
Extensions
Conclusion
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Agenda
• Model Definition
• Analysis of the Model
• Licensing
• Outsourcing
• Conclusion
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OUTSOURCING
Analysis
• Similar to licensing contracts, three cases to analyze:
 CASE A: CS2 sets transfer price t2<c, hence CS
outsource all her production - (0,D)
 CASE B: CS2 sets transfer price t2=c, hence CS is
indifferent between in-house production and
outsourcing - (0,D)
 CASE C: CS2 sets transfer price t2>c, hence CS
outsource the residual demand – (K, D-K)
Literature Review
Model Definition
Analysis of the
Model
Extensions
Conclusion
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OUTSOURCING
Results
CASE B
(0,D)
CASE A
(0,D)
CASE C
(K,D-K)
Literature Review
Model Definition
Analysis of the
Model
Extensions
Conclusion
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OUTSOURCING
Summary of the Results - Outsourcing
• CS2 has “virtually” moved up in the supply chain
Hence it is:
 Driving the supply chain
 Getting most out of the relation
 Always participates in production
• CS’s capacity can be used strategically when she
does not have “virtually unlimited capacity”
 CS does not participate in production even if she has
too much capacity
Literature Review
Model Definition
Analysis of the
Model
Extensions
Conclusion
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Agenda
• Model Definition
• Analysis of the Model
• Licensing
• Outsourcing
• Comparison
• Conclusion
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Licensing vs. Outsourcing (CS’s profit)
• Licensing is weakly preferred
for almost all of the K-c
region:
 Better outcome is
sustainable with licensing
 Royalty fee is higher than
profit margin from
outsourcing
Literature Review
Model Definition
Analysis of the
Model
Extensions
Conclusion
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Conclusion
•
Licensing is a reasonable alternative to outsourcing for a low
cost, under-capacity supplier
•
Capacity can be used strategically by both suppliers to achieve
higher profits, especially when CS’s capacity is low
•
Even when building capacity is free, it is not always in CS’s best
interest to increase her capacity, especially when her supply chain
partners know her exact capacity
 CS does not always produce more when her capacity increases
Literature Review
Model Definition
Analysis of the
Model
Extensions
Conclusion
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