Elsevier

Research in Economics

Volume 74, Issue 4, December 2020, Pages 349-353
Research in Economics

Research Paper
Does an incumbent monopolist have an incentive to invite new entry through granting a free patent license?

https://doi.org/10.1016/j.rie.2020.10.005Get rights and content

Abstract

We examine whether an incumbent monopolist has an incentive to invite a new entry. In particular, we demonstrate the condition of a profit-raising entry effect in the presence of network externalities. Here the incumbent monopolist grants a free patent license for a perfectly compatible product for a new firm when it can choose the level of compatibility.

Introduction

The orthodox economics literatures relies on the assumption that increased levels of competition, i.e., an increase in the number of new firms entering a market, leads to lower prices and reduced profits but improved social welfare. Most commonly, in a standard Cournot–Nash oligopoly model, an increase in the number of firms leads to a reduction in an individual firm's output and profit, and in industry profits.1 Thus, the typical design of competition policy is to reduce market concentration and ensure appropriate levels of competition.

Conversely, incumbent firms should create barriers that make it difficult for new firms to enter the market to maintain above-normal levels of profits. If a patent license is a barrier that protects the profits of incumbent firms, it is important to consider whether in a network product market, where a winner with an advanced technology can take all, the winner (i.e., an incumbent monopoly holding the patent) has an incentive to invite new entries by granting a free or low patent license. That is, we should consider the research question presented by Economides (1996, p. 211) that “… the incentive of an exclusive holder of a technology to share it with competitors in a market with network externalities.” Economides (1996) uses this to draw on a standard Stackelberg game where one leader and many followers compete on quantities and not prices in a homogeneous product market.2

Assuming a unit linear city model with network externalities, Kim (2001) later considers the cases of an incumbent monopoly and Bertrand duopolistic competition in a post-entry market. Comparing the profits between the monopoly and duopoly, Kim (2001) demonstrates whether the incumbent monopoly invites new entry or not. In particular, if the network externalities are strong and/or the products less differentiated, the monopoly profit exceeds the duopoly profit. Thus, the incumbent monopoly has an incentive to deter entry. This is because the incumbent monopoly fully captures the market via the strong network externalities, such that the new entrant does not contribute to network expansion.

Alternatively, if the network externalities are weak and/or the products are highly differentiated, the duopoly profit exceeds the monopoly profit. Thus, the incumbent monopoly has an incentive to invite new entry. In this situation, the incumbent monopoly partially captures the market and, thus, the network size expands sufficiently with a new entrant without serious price competition, largely because the post-entry market will be a local monopoly under weak network externalities.

In a related study to this analysis, Fanti and Buccella (2017) investigate entry effects in a network product market and demonstrate that a profit-raising entry for an incumbent takes place when the network effect is of a sufficiently high level. However, their model depends on a specific setting in which firms behave in line with coperate social responsibility (CSR), implying that firms maximize a combination of profits and consumer surplus.

Similar to Fanti and Buccella (2017), by assuming a quasi-linear utility function with network externalities, we reconsider the Economides’ problem by comparing the profits of an incumbent monopoly in the pre-entry market and a duopoly in the post-entry market with both price and quantity competition. We demonstrate that an incumbent monopolist has an incentive to invite a new entry if the degree of network externalities is sufficiently large.3

Section snippets

Incumbent monopoly (M) in the pre-entry market

We assume the following linear inverse demand associated with network externalities for an incumbent monopoly:pM=AqM+F(SME),where F(SME)=nSME and n[0,1), F(SME) expresses a linear network externality function of the expected network sizes, SME,4 and n is the marginal coefficient of the

Conclusion

We have demonstrated that in the presence of strong network externalities, and/or low product substitution, the incumbent monopoly has an incentive to invite a new entrant by granting a free (or nearly free) patent license for a perfectly compatible product. This result may help explain Internet services markets for applications installed with Android.

Declaration of Competing Interest

The authors declare that have no competing financial interests in this investigation.

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