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The B.E. Journal of Economic Analysis & Policy

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Vertical Integration Smooths Innovation Diffusion

Luigi Filippini / Cecilia Vergari
Published Online: 2017-07-25 | DOI: https://doi.org/10.1515/bejeap-2016-0126


Does vertical integration of an input innovator with a downstream firm entail innovation foreclosure? We study the licensing incentives of an independent input producer owning a patented product innovation which allows the downstream firms to improve the quality of their final goods. We consider two-part tariff contracts for both outside and incumbent innovators. We find that the incumbent innovator has always the incentive to license its innovation to the rival firm so that under vertical integration complete technology diffusion takes place. In contrast, the external patent holder may prefer exclusive licensing depending on the innovation size as well as on the set of allowed contracts. As a result vertical integration does not entail innovation foreclosure, rather it facilitates innovation diffusion with respect to vertical separation. As for the profitability, the vertical integration with either downstream firm is always privately profitable and it is welfare improving for large innovations: this implies that not all profitable mergers should be rejected.

This article offers supplementary material which is provided at the end of the article.

Keywords: negative royalties; patent licensing; product innovation; two-part tariff; vertical differentiation; vertical integration

JEL Classification: L15; L13; L24


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About the article

Published Online: 2017-07-25

Citation Information: The B.E. Journal of Economic Analysis & Policy, ISSN (Online) 1935-1682, DOI: https://doi.org/10.1515/bejeap-2016-0126.

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