I. Technology Licenses, Firm Strategy and Public Policy
The literature on intellectual property rights (IPRs) [e.g., Ordover (1991); Scotchmer(1991); Besen and Raskind (1991)] frequently insists on the idea that technologylicensing agreements (TLAs) strongly influence the properties of IPR systems. Obtain-ing a better understanding of license contracts is essential to shed light on at least threedebates.
The first debate is related to the economics of science, innovation, and technology.The central question here is the optimal level of protection that should be given to
This paper draws from research funded by the French Commissariat General du Plan. We thank the manyprofessionals, especially Francis Hagel [Schlumberger & Licensing Executive Society (LES)] and Thierry Sueur (L’AirLiquide & LES), who helped us in our investigations. Preliminary versions of this paper were discussed at theUniversities of Paris-Dauphine, Aix-Marseille, Compiegne, and at the EALE and the LES Conferences. We thank theparticipants in these workshops for their comments. We are also grateful to the two referees of this journal for theirsuggestions. The usual caveats apply.
innovators given the “protection/diffusion” dilemma.1 The licensing of technologyseems to be an efficient complement to strong IPRs. [e.g., Ordover (1991); Arora(1995)]. Indeed, when an innovator is allowed to license his technology, he spreads itin the economic system, while at the same time he increases his return on innovationinvestments and efforts. That said, the possible misalignment of incentives for licensorsand licensees has to be carefully examined to better understand how licensing could bestimulated.
The second debate is related to the economics of intellectual property systems.Several recent contributions point out that the various intellectual property laws (IPLs)and institutions in charge of managing IPRs operationalize intellectual property prin-ciples very differently among countries and industries [e.g., Besen and Raskind (1991);Lerner (1995); Lanjouw (1994); Deffains (1997); Bessy and Brousseau (1997a, 1997b)].In these papers, the subtle strategies followed by firms to protect and valorize their stockof knowledge is pointed out. It is therefore essential to analyze how licensing behaviorsaffect the ability of the legal system to generate and diffuse inventions.
The third debate is related to competition law (and to the economics of competi-tion). IPL generally departs from competition law (CL) (antitrust law), but the inter-actions between the two are complex. License contracts profoundly affect the strengthof the monopoly position granted to the patentee, and IPL cannot be considered to beso radically opposed to CL. License contracts, however, must be carefully studied tounderstand whether licensors misuse the dominant position that they have through IPLprotection [see Ordover (1984); Gilbert and Shapiro (1990); Ordover (1991)]. In turn,as pointed out by Jorde and Teece (1990), when applied to interfirm agreements aboutknowledge creation and sharing, CL can strongly affect the ability to innovate.
Thus, the licensing of technology is at the heart of numerous complementary ques-tions of firm strategy and public policy. Moreover, from a theoretical point of view,license contracts are particularly interesting because they govern informational andimmaterial transactions. As pointed out by Arrow (1962), transactions concerninginformation cause particularly complex problems. In the case of technology, theseproblems are complicated because there is a high level of uncertainty (about theeconomic value of invention and the successfulness of the transfer, among otherconcerns). As a result, incentive schemes and governance mechanisms that are imple-mented in license contracts can teach scholars a lot concerning coordination andcontract economics.
The fact that many scholars insist on the importance of licensing practices to graspthe actual attributes of IPR systems and to understand firms’ technological strategiescontrasts with the small amount of research devoted to these practices. Quantitatively,little precise is known about the willingness of firms to license, given their nationality,size, industry, etc. Qualitatively, the actual features of license contracts are not widelyunveiled. In fact, there are several theoretical contributions—mainly based on incentivetheory [e.g., Shapiro (1985)]—that try to explain the basic features of license contracts.Most of these studies are dedicated to the consequences of those theoretical contractson competition and on the technological dynamic [e.g., Gallini and Winter (1985);Shepard (1987); Gallini and Wright (1991)]. However, there is very little research basedon substantial applied studies trying to identify actual firms’ practices [although see
1The literature tries to determine the extent and the duration of intellectual property protection given its effects oncollective efficiency: e.g., Nordhaus (1969), Gilbert and Shapiro (1990), Klemperer (1990), Scotchmer and Green(1990), Gallini (1992), Merges and Nelson (1994), and Chang (1995).
452 Technology licensing contracts
Taylor and Silbertson (1973); Contractor (1981); Caves et al. (1983); Anand andKhanna (1996)].
In fact, the literature is mainly dedicated either to justifying the existence of licensecontracts, or to describing their role in the dynamics of technology. It does not,however, analyze in detail the actual features of license agreements. There are severaljustifications for this:
Y First, license contracts, like much information related to firms’ intangible and intel-lectual assets, are often considered highly confidential;
Y Second, the licensing of technology seems to be a relatively marginal practice formany firms. There are obviously some well-known companies that earn very largeroyalty revenues (e.g., RCA, Texas Instrument, Dolby, Innovatron, etc.), but severalstatistical indicators show that most firms prefer to directly exploit their innovation.2
As will be pointed out hereafter, this is mainly due to the difficulty and cost oflicensing, and to the relatively low profitability of such activity.
Y The third reason is a theoretical one. There are few detailed studies of technologicallicense agreements because many scholars do not consider them substantially specificcompared to trademark licenses or franchise contracts [e.g., Shapiro (1985)]. Wethink, however, that the characteristics of IPRs (cf. the second part of Section III) andknowledge (cf. the first part of Section III) endow technological transactions withvery specific features that should be taken into account to really understand licensingpractices. This type of assumption is also made by Caves et al. (1983), Anton and Yao(1994), Arora (1995), and Anand and Khanna (1996).
It could be argued that the apparent marginality of licensing does not justify majorefforts to overcome the information access problems and to pursue specific investiga-tions. This is not the case for at least two reasons. First, technology licenses play a veryimportant role in many industries because they can represent a substantial share offirms’ revenue and profits, but also because they are essential in technological compe-tition. Second, it seems essential to wonder why there are such strong differencesamong industries and countries. Are there any resource misallocations and underex-ploitations in the sector where patent licensing is not used to valorize firms’ intangible
2Although IPR practices vary from one country to another, French data show several interesting phenomena:
Y First the registration of a patent is not such a common practice. In France only 21.4% of industrial corporations ownpatents. Large firms are familiar with IPR instruments, whereas small firms are not. Moreover, patenting is highlyconcentrated in certain specific industries. U.S. data confirm this [cf. Grilliches (1990)]. Second, many firms do notregister patents for licensing purposes, but exploit them directly. For instance, when French firms register theirpatents abroad, they do it in countries where they are directly operating industrial or commercial activities (in 80%of the cases in the United States and in Japan, and in 90% of the cases within the European Community). If mostfirms will have anticipated licensing agreements, they would have registered in many countries where they are notpresent. Third, licensors generally contract with a small number of licensees [cf. also Caves et al. (1983)].
Y Our own survey of the 450 main French industrial corporations shows that even in that population a large numberof firms do not own any patents (around one third), and half of the patentees (one third of the sample) do notlicense. As a result, licensing practices are highly concentrated in a small number of firms. In fact, only the largestfirms are really able to operate an intellectual property department capable of efficiently managing this type ofrelationship. The industry in which the firm operates is also a major determinant of its willingness to license. Licensecontracts are concentrated in the chemical, pharmaceutical, electronic, electrical equipments, and professionalmachinery industries [cf. Anand and Khanna (1996)].
453C. BESSY AND E. BROUSSEAU
resources? Moreover, one can wonder whether such resource misuse is not due toinstitutional failures.
In this paper, we present the first results of an investigation performed on a sampleof French firms. After a rapid presentation of our sample, methodology, and analyticalframework (Section II), we will point out the essential characteristics of licensingcontracts, essentially by focusing on the major sources of differences between technol-ogy transfers and other types of interfirm intangible transactions (Section III). Then, wewill propose a framework to understand and analyze the diversity of licensing agree-ments (Section IV).
II. Factual Data and Methodology
The Sample
This paper is based on two types of factual data: detailed case studies and a database onTLAs built up through mailed questionnaires.
Ten case studies were carried out in 1997 though detailed interviews with managersresponsible for Intellectual assets management, alliances, research and development(R&D), strategy, business development, etc., in 10 large French industrial firms orFrench subsidiaries of transnational corporations. These case studies describe in detailthe way those firms manage their innovation efforts and their intellectual assets. Thecase studies also survey several cases of technology transmission or technology codevel-opment. In most firms we obtained the details of several licensing agreements. Thisenabled us to collect a wide range of empirical evidences and stylized facts on TLApractices.
These case studies were completed by a wider data collection through questionnairesmailed to the 450 leading French firms. We thus obtained two types of data. First, wecollected basic information by phone on 140 firms concerning their propensity tolicense their technology. Second, we obtained detailed information on about 30 firms.Each questionnaire is composed of two parts. The first part is devoted to the manage-ment of intellectual assets by the firm: resources allowed, patent policy, licensing policy,etc. The second part is dedicated to the collection of data on licensing agreements. Weasked firms to choose the TLAs that they consider to be the most representative of theiractivity and to describe them in detail: type of resources exchanged, contractual safe-guards, payment formulas, renegotiations provision, supervision and arbitration mech-anisms, duration, special clauses, etc. Data on 46 of the most representative licensingagreements drawn up by these firms have thus been collected. There are absolutely nointragroup licensing agreements in our sample.
Compared to previous studies, our sample, although small, seems to be representativeof the diversity of TLA practices. Indeed, the general characteristics of our sample ofcontracts (in terms of frequency of the various types of clauses) are very close to thosedescribed in previous studies by Caves et al. (1983), Arora (1995), and Anand andKhanna (1996). The major interest of our data set is that it describes quite precisely thecontractual practices.
Statistical Methodology
Our paper relies both on qualitative descriptions pulled out of our case studies, and ona statistical processing of our database. We will also make extensive references tostatistics displayed in previous studies.
454 Technology licensing contracts
Given the nature of this paper and the space constraint, we will not be able to presentin detail all the statistical and econometric tests that have been performed on ourdatabase. The detailed results are available in Bessy and Brousseau (1997c) and inforthcoming, more econometric, oriented papers. According to the aim of this paper,we will display descriptive statistics as well as some results of a data analysis throughoutthe paper.
Correlations between the variables were calculated using the Pearson correlationcoefficient. The results are comparable to those obtained by computing the phi coef-ficient (w) derived from the chi-square (x2) statistic (Table 3). Correlations do notobviously prove a causality relationship but are good indicators of the existence ofrelationships between phenomena.
Correspondence analysis is a weighted principal component analysis of a contingencytable. We processed several analyses to ensure a robust synthesis of the structuralrelationships among the variables. The taxonomy is obtained by a clustering methodthat is based on the reciprocal neighbor method from the measures tables obtained inthe correspondence analysis. The aggregation criterion is the centered moment oforder two of a partition. At each step, one minimizes the intraclass variance of thepartition built. This supported the division of the sample into five main classes. Theresulting taxonomy is analyzed by examining the correlation between each class and thecategorical values (Table 4).
TABLE 1. Frequency distribution of the likert based variables
Reciprocity requirementCross-licensing 65.2 13.0 13.0 2.2 2.2 100Sales of goods to the licensor 54.3 13.0 13.0 2.2 6.5 100Providing of services to the licensor 56.5 19.6 10.9 8.7 4.3 100
Additional Transfer of ResourcesTest and development data 21.7 4.4 13.0 30.4 30.4 100Consultant services 23.9 13.0 26.1 28.3 8.7 100Plans, red books, manuals 32.6 21.7 8.7 21.7 15.2 100Prototypes, equipment 32.6 10.9 19.6 21.7 15.2 100Commercial data 39.1 23.9 13.0 15.2 8.7 100Training 30.4 6.5 32.6 19.6 10.9 100Personnel delegation 43.5 10.9 23.9 8.7 13.0 100
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Conceptual Framework
In technology and innovation, decisions are made in a radically uncertain environment[Knight (1921); O’Driscoll and Rizzo (1985)]. Consequently, substantive rationality[Savage (1954)] cannot apply, and the modeling of economic behavior should prefer-ably be based on the bounded rationality paradigm [Simon (1987)]. Moreover, intechnology and know-how transfers, transaction costs are of particular importance.Indeed, it is difficult to define (“measure”) what is transferred and to make commit-ments enforceable. Last but not least, in intangible exchanges institutions matter
TABLE 2. Frequency distribution of the discrete variables
Governance Mechanism Implementation 43.4Arbitration 23.9Supervision committee 30.4Coexistence of two mechanisms 10.9
Renegotiation Provision 63.0On royalties 34.8On the object of the TLA 15.5“Hardship” clause 21.7On the exclusivity conditions 26.1
Contract Duration,7 years 34.8[7.12] years 28.3.12 years 17.4Patent life 19.6
SafeguardsExclusivity clauses 71.7
On the technology 54.3On a geographical area 54.3Technology 3 geographical area 37.0
Usage restriction clauses 87.0Not reselling the technology 37.0On a specific geographical area 58.7On a specific field of application 50.0On a specific mode of commercialization 13.0
*Correlation coefficient (Level of significance: 10%. *:5%).
458T
echnologylicensing
contracts
particularly: Their properties play an essential role because they influence the strengthof IPRs and provide agents with collective resources that can bring down the costs ofnegotiation, contract design, supervision, conflict settlement, etc. For at least thesethree reasons, our analysis is based on new institutional economics (NIE) categories[Williamson (1985, 1996); North (1990)]. Moreover, the NIE framework is particularlypowerful in this case because it provides us with a framework that is able to deal withboth property rights settlement [North (1990)] and transaction governance [William-son (1985, 1996)].
According to North (1990), one of the essential roles of the institutional frameworkis to set up property rights (PRs) to enable economic agents to use and transferresources. But he also emphasizes that agents must always dedicate resources and effortsto establish the boundaries of the resources they exploit or to transfer them to a thirdparty (measurement costs), and to exclude unauthorized parties from access to theseresources (enforcement costs) because the institutional setting of PRs is never com-plete. This explains why agents have to build governance structures—largely studied byWilliamson (1985, 1996)—when rights to use resources are transferred or shared.Indeed, governance structures enable agents to specify what is transferred, under whatconditions, and to make these agreements enforceable.
This was especially pointed out by Macneil (1974) who explained that when the rightsand duties are quite ambiguous and complex, it is impossible (or too costly) to write acomplete contract (a “transactional” contract) to precisely state the rights and duties ofboth parties in a transaction and, therefore, to make them enforceable by the institu-tional framework (i.e., the judicial system). He therefore explained how agents createa private order through the settlement of a “relational” contract that enable them tonegotiate throughout their relationship to state their actual rights and duties and tomake them enforceable. This view of contracting strongly influenced the concept ofhybrid forms settled by Williamson (1985, 1996).
The analyses of Macneil (1974) and North (1990) are congruent in the sense thatboth authors, using a different language, develop the idea that the delimitation of therights and duties of economic agents depends on both collective coordination devices—e.g., the institutional framework—and interindividual coordination devices: the gover-nance structures set up by contracts. They also recognize that in various cases theestablishment and enforcement of these rights are performed in various proportions atthe collective and at the general level. Macneil links the ability to govern a transactionat a more or less collective level with the features of the transaction (basically asWilliamson does). North insists on the idea that governance depends upon the abilityof the institutional framework.
In our view, both factors play a role, but to get a better understanding of what is goingon, a third category of coordination device has to be recognized between the generalinstitutions of the society—i.e., the institutional framework—and the interindividualgovernance structures: the private or specific institutions. Industry unions, standardiza-tion and certification bodies, scientific societies, trade associations, etc. indeed play arole in the economics of coordination because they create (sometimes informal) rulesand provide agents with supervision and enforcement means (both for these collectiverules and for their private agreements). These rules and enforcement mechanismscomplete the institutional framework in that they state individual rights and duties
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more precisely. They therefore facilitate interindividual governance and bring coordi-nation costs down.3
We will argue that, given the nature of knowledge and characteristics of the IPRsystem, technological transactions tend to be governed by “relational” contracts. Thisexplains why TLAs are costly for patentees and therefore why there are so few TLAs(Section III). However, we will point out that in some situations, private and specificinstitutions tend to enable property rights to be more precise, knowledge transfers to beeasier, and technology licensing contracts to be less complex to design and to run (i.e.,more “transactional”). Technology transfers will be less expensive and, therefore, morefrequent. This will enable us to explain why there is a concentration of TLAs in someindustries and in some relational situations (Section IV).
III. The Specificities of Technology Licensing Agreements
TLAs are designed to govern the exchange of a particular resource: knowledge. In ourview, among the various intangible resources, knowledge has specificities that willinfluence the nature of the contractual arrangements that govern transactions concern-ing it. As a result, TLAs cannot be assimilated, as is often done in the economicliterature, to simple franchise or trademark license contracts, even if some aspects of thetechnology license relationship resemble other contractual relationships (e.g., themoral hazard problem). Two major characteristics differentiate the licensor-licenseerelationship: Knowledge is a specific intangible resource that must not be reduced toinformation (the first part of Section III); and involved IPRs are relatively weak andincomplete (the second part of Section III). TLAs tend, therefore, to be relativelyincomplete and complex contracts because technological transactions are complex toperform, highly uncertain and hard to secure. Moreover, because these contractualfeatures lead to relatively high transaction costs, economic agents are incited to imple-ment cost-saving solutions that, in turn, reduce the profitability of licensing for thelicensor.
The Specificity of Knowledge
Technology licensing contracts support technology and knowledge transfer amongfirms. Two characteristics of knowledge seem to deeply influence their specificity:
Y First, knowledge is embodied in many and diverse supports. Technological transac-tions cannot therefore be assimilated to pure informational transactions. In particu-lar we will point out that technological transactions enable licensors to link thetransfer of knowledge to the transfer of other resources that are more easily control-lable than information flows (see the first subsection of the first part of Section III);
Y Second, knowledge is characterized by a very high level of uncertainty regarding itseconomic value and its uses. At the same time, the uncertainty that characterizesthese transactions explains why contracts are incomplete and why they implementmany safeguards. It also explains the type of payment mechanisms that often intro-duce a risk-sharing principle between the licensor and the licensee (see the secondsubsection of the first part of Section III).
3On the one hand, the collectivization of governance enables agents to dedicate fewer private resources tocoordination. On the other hand, it enables the generation of economies of scale and scope.
460 Technology licensing contracts
The Diversity of Knowledge Embodiments. Knowledge is incorporated into diverse sup-ports. In concrete terms, it is embodied in very diverse resources: written material,drawings, statistical data, organizational rules, operating processes, equipment, otherphysical resources, human capital, etc. The very nature of knowledge implies that it isnever totally codifiable.4 Consequently, the wording of a patent is generally not suffi-cient to reproduce the technical work that is patented.5 That is why technology licens-ing implies many transfers in addition to the patent description6: private informationthat is not capable of being patented [industrial secrets and test data, among otherthings; cf. Hilgartner (1995)], training, technical support, consultant services [cf. Tay-lor and Silbertson (1973); Contractor (1981); Arora (1995)], equipment, and otherphysical resources that are essential to implement and use the technique. In our sample,78.6% of TLAs cover the provision of technical test data and development data inaddition to the transfer of the right to use them. The proportion reaches 76% fortechnical support, 67.4% for prototypes and physical resources, the same percentage forplans and manuals (“red books”), 65% for employee training, 60.8% for commercialdata, and 56.5% for employee delegation in the licensees facilities.7
Arora (1995) suggests that this plurality of knowledge embodiment enables patentusers to protect themselves against the failure of the patent system. Indeed, Arora pointsout that there are at least two transfers in a licensing agreement: the right to use publicbut protected knowledge; and the necessary know-how to make that knowledge oper-ational. According to Arora, the patent system enables the innovator to solve the moralhazard problem caused by the irreversible transfer of know-how. If the licensee is anopportunist, then the licensor can rely on the law and public institutions to prevent himfrom being so. Moreover, the fact that the transmission of know-how is indispensable toimplement the technology protects the patentee against patent infringement withoutstrong search and defense efforts (and costs). On the licensee side, the duality ofknowledge helps him to solve the adverse selection problem. Indeed, because knowl-edge is partially protected by IPRs, the potential licensee can evaluate the technologybefore using it.
We agree with Arora’s contribution. However, in our view, it is not sufficient toestablish a difference between codified and noncodifiable knowledge to understand theeconomics of licensing contracts. Indeed, knowledge is also incorporated in tangibleresources.8 This view is very close to that of the cognitive sciences.
4The codification of knowledge implies, moreover, that the various users of the codified material share commonknowledge about the codification principles.
5We argue [in Bessy and Brousseau (1997a)] that the incompleteness of patent codification is due not only to theboundaries of human language, but also to description costs and failures of the IPR institutions (which inciteeconomics agents to hide some essential aspects of the information); cf. the second part of Section III.
6Callon (1993) notes that these exchanges must be accomplished through diverse types of relational networksrelying on different strategies for coordination (market exchanges and scientific cooperation, for example).
7These figures are very comparable to those highlighted by previous surveys [e.g., Caves et al. (1983)]. Moreover,these percentages reflect the intensity of these exchanges. In our survey firms’ willingness to exchange additionalresources in addition to the rights of use is weighed on a scale of 1 to 5. Technical and test data ranked first (3.3),followed by consultant services (2.9), personnel training (2.7), plans (2.7), material and prototypes (2.7), commercialdata (2.4), and employees delegation (2.4).
8In the biotechnology industry, where many scientific laws remain undiscovered, much of the knowledge is basedon statistical inferences made from the properties of biological material. The transmission of this material is one of themajor means of knowledge circulation. [cf. Hilgartner (1995); Cassier (1995); Cassier and Foray (1997); Zylbersztajnand Lazzarini (1997)]. Even in fields where the codification is more intensive—e.g., chemicals and mechanicalequipment—the circulation of prototypes is a major vector of knowledge diffusion.
461C. BESSY AND E. BROUSSEAU
One of the major consequences of this specificity of knowledge is that its circulationcan be controlled through the control of the movements of physical resources. Hence,the rights to access physical resources are a way to compensate for the failures of theIPRs. For instance, some industrial firms (e.g., oil companies) license to engineeringcompanies the development of (process) technologies. The access to industrial instal-lations (e.g., oil wells) is in that case a licensor’s means of avoiding a licensee’sopportunistic behavior. In our sample, the majority of TLAs (67.4%) cover the provi-sion of physical resources. Moreover, firms declare that their licensing agreements arelinked to additional selling contracts. These contracts cover the provision of physicalresources with a greater intensity (mean of 3.3 on a scale of 1–5) than the provision ofintellectual services (3.0) or of other services (2.7).
Thus, due to the heterogeneity of exchanged resources, economic agents can resortto several legal tools to construct license agreements. Beyond the IPL that organizes thegranting of exploitation rights, the licensor can protect confidential information andknow-how through trade secret law, can secure payments by relying on general contractlaw (etc.) because he provides its licensee with diverse services or even physical re-sources. From a public policy point of view, this means that IPL is far from being the soletool on which action can be taken when one wants to modify the license features.9
The second contractual consequence of the variety of knowledge embodiment is thatit enables economic agents to govern knowledge-based transactions more easily byplaying on the fact that several resources with complementary features have to beexchanged:
Y The tacit dimension of knowledge obliges the firms to organize personnel circulationbetween the two entities. This is done through the provision of technical support(76% of the licenses in our sample), training (65%), and employee delegation(56.5%), among other ways. This substantially decreases information asymmetriesbetween the licensor and his licensee. The former is able through employee visits tosupervise his partner to some extent. Obviously, potential opportunistic behaviors arenot definitely eliminated.
Y Should opportunistic behavior occur, the licensor can suspend the provision of theresources that are necessary to exploit the patent. Indeed, in many cases the licensorcontrols resources that have to be regularly provided to the licensee (e.g., somespecific technical support or a very idiosyncratic input, among other things). He can,therefore, avoid building a very specific governance structure to monitor his licen-see’s behavior.10
In conclusion, the patentee can play on the fact that it is possible to bundle theprovision of several resources to govern knowledge transaction at a lower price. Suchpractices are, however, often in conflict with antitrust laws. Indeed, antitrust commis-sions can estimate that these bundled sales result from monopoly power. Consequently,
9It is important to emphasize that a firm’s ability to secure their IPRs can be affected by other laws than the IPL;especially through the standard contract law that usually does not allow interfirm agreements to depart from basicantitrust principles [e.g., Ordover (1991)].
10He can even oversimplify the TLA. Some licensors prefer to give up for free the right to exploit a patent and basetheir remuneration on the provision of an unavoidable resource. This withdraws the supervision costs that are oftenassociated with the management of royalties. We observed such a case in the chemical industry where a companydevelops technologies that can be used only with some of the chemical products it produces. As a result, it controls theuse of its technology and is remunerated for it by the provision of a physical input.
462 Technology licensing contracts
this potential to transform intangible exchanges into tangible ones cannot be fullyexploited by patentees as a mean of withdrawing intangible transfer costs and risks.
The Uncertainty about the Value and Uses of Knowledge. Regarding its value, knowledge isa highly uncertain resource when it is transferred between two economic units. This ispartly due to the well-known information asymmetry about quality inherent in everymarket transfer of information [cf. Arrow (1962)]. But it is also due to the radicaluncertainty over the potential use of knowledge. Two different phenomena are inquestion:
Y First, the receiving party can use knowledge in ways that are not easily observable bythe prior holder. This is typically a moral hazard problem (hidden action), but in aspecific informational context where it is quite impossible to build ex-ante incentiveschemes or (infallible) supervision mechanisms because all the potential uses ofknowledge cannot be anticipated and made observable (because of the cognitivelimits of the licensor over the licensee’s activities).
Y Second, knowledge is itself an input in the process of knowledge creation. The unitthat benefits from a transfer can be conducive to the creation of new knowledge thatwill increase the value of the initial knowledge. The question is then how to remu-nerate each party for its contribution to the knowledge-creation process. Again, dueto the uncertainty of such a process, it is very difficult to solve it ex-ante by an optimalincentive scheme. Ex-post there are great problems of observability (and therefore ofverifiability) and of indetermination of the right quasi-rent sharing because of thejoint production problem [Alchian and Demsetz (1972)]. Moreover, the new knowl-edge can encapsulate the old, and its usage by a third party can spoil the propertyrights of the initial innovator. In fact, the new innovator’s rights overlap with those ofthe initial innovator.
In sum, although it is to a large extent irreversible, the transfer of knowledge cangenerate future uses that are very difficult to forecast but that spoil the value of bothparties’ cognitive assets as well as the revenues they receive. That is why, as pointed outby Caves et al. (1983), firms hesitate to license technologies linked to their corecompetencies. This also explains why they restrict their number of licensees.
Uncertainty also has an impact on technology licensing contracts, especially on theircompleteness, on the payment mechanisms, and on the implementation of restrictionclauses.
Uncertainty as it has been defined above induces a high level of contract incomplete-ness. It is quite impossible to design ex-ante a contingent contract that will precisely settlethe rights and duties of the two parties, especially as regards rights to use the techniquesin specific ways, resources that have to be provided to the licensee, and payments to thelicensor. A fortiori, an optimal contract is out of reach. First, such contracts would notnecessarily be enforceable ex-post both because supervising licensee’s behavior would bevery difficult (especially for a court), and because the contract would be very compli-cated. Second, the ex-ante design of such a contract is radically impossible becauseagents do not know all the possible future situations. These favor the implementationof “relational” contracts [Macneil (1974)] or “hybrid” contracts [Williamson (1985,1996)] and related governance structures dedicated to the management of a coopera-tive process between two independent units that have some degree of interdependence.Moreover, this notion of cooperation is present in French license law [Foyer and Vivant
463C. BESSY AND E. BROUSSEAU
(1991)]. In our sample, 63% of the contracts implement a renegotiation provision and45.6% design a specific governance device to settle conflicts (either a committee or athird-party arbitrator).
It must be clear, however, that even if the general features of technology transfer tendto favor the implementation of incomplete contracts (implementing negotiation struc-tures), the level of incompleteness can greatly vary from one industry to another andfrom one transaction to another. Indeed, the incompleteness is influenced by thepotential preexistence of collective coordination mechanisms such as common behav-ior conventions, information circulation networks, and common knowledge, amongothers. The more collective mechanisms there are, the more complete contracts therewill be (cf. first part of Section IV).
Beyond the incompleteness of technology licensing contracts, uncertainty leads tothe laying out of contractual safeguards that are implemented through the paymentmechanism (1) and through diverse usage restrictions (2) [cf. also Caves et al. (1983)].
CONTRACTUAL SAFEGUARDS IMPLEMENTED THROUGH THE PAYMENT MECHANISM. Theuncertainty about the effective economic value of technology leads the licensee toprefer the payment of annual royalties to that of a set price [this is the case in 90.5% ofthe contracts implementing a payment mechanism in our sample; cf. also Degnan andHorton (1997)].11 Indeed, the annual fee enables the licensee to avoid making a sunkinvestment, and allows him to assess each year the net profitability of the license. Hethus avoids committing himself to a transaction in which he is uncertain about what hewill actually receive in exchange. This calls for the implementation of renegotiationclauses in the contract (63% of our contracts implement a renegotiation provision).
Uncertainty has a second consequence: Royalty rates are to some extent convention-ally set. The studies of Contractor (1981) and Caves et al. (1983) confirm this. Becauseof the uncertainty about the actual value transferred though a technology transfer,economic agents would probably reach any agreement about a royalty rate customizedto each transaction only with difficulty. By referring to an average royalty fee, parties canreach an agreement more easily. This is due to the logic both of focal points [Kreps(1991)] and behavioral norms [of fairness norms in that case, cf. Granovetter (1985)and Orlean (1994)] that are embodied in conventions [Lewis (1969)]. One can,moreover, suppose that these conventional rates are set at about the average level ofprofitability of technology transfer in that industry. The norm is thus “fair” because onaverage each licensee pays the actual value for the transfer (less a risk premium grantedby the licensor). Additionally, one can point out that the licensor agrees to practice sucha conventional rate because it decreases the intensity of intertechnology competition[Contractor (1981)].12
The fact that payments are generally based on royalties rather than on fixed feesmeans that licensors bear a part of the licensee’s industrial and commercial risks. This
11In some cases, uncertainty is so great that parties prefer to substitute payment in kind for monetary payments.Indeed this avoids the complex task of estimating the value of a technology. This opens the door to barter. See secondpart of Section III.
12In their survey of 428 licensing executives’ practices, Degnan & Horton [1997] pointed out that conventions wereconsidered as a relatively important factor (3.7 on a 1 to 5 Likert scale) in the determining of royalty rates. They alsopointed out that it is not the only means since those rates are also quite sensitive to the implemented safeguards andthe expected value of technology when it is possible to assess it through past experience. This is thus coherent with ourinterpretation.
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has two consequences. First, licensors are incited to implement safeguard clauses andsupervision mechanisms to avoid hold-up (see the next subsection and the second partof Section III, below). This increases the licensor’s cost of licensing. Second, thelicensor is not able to extract the whole innovator’s rent. This incomplete extraction isall the stronger when conventional royalties rates are applied.
CONTRACTUAL SAFEGUARDS THROUGH DIVERSE USAGE RESTRICTIONS. Uncertainty aboutthe potential uses of the transferred technology and knowledge leads licensors toimplement safeguard clauses to avoid licensees’ opportunistic behavior and hold-up:
Y First, uses rights are transferred only with restrictions (in 87% of the cases in our ownsample) either by limiting the geographical scope of the licenses [in 58.7% of thecases in our sample and in 68% of the contracts reviewed by Caves et al. (1983)], orby defining market segments or niches (in 50% of our contracts). In fact, theserestriction clauses are due to two factors: the uncertainty about the exact transferredrights of usage (which gives a large margin of maneuver to potential opportunists);and the incompleteness of IPRs (which makes defense against patent and licenseinfringements difficult, time consuming, and costly; cf. the second part of SectionIII). For these two reasons, licensors have to diversify their risks by licensing to severallicensees and by restraining each licensee’s scope of activity to reduce damagesshould opportunism occur. To benefit from efficient protection, these restrictionshave to be easily verifiable by a court. This explains the frequent recourse to geo-graphical restrictions. Geographical restrictions also enable the patentee to avoiddirect competition with its licensee on the markets where he exploits his technology.The patentee, therefore, does not lose his monopoly position, despite his licensingpolicy. Due to this situation, such restrictions could be considered as pro-monopolypolicies by antitrust authorities. It should be remembered, however, that when thepatentee licenses his technology the licensor is not able to efficiently capture hisinnovator’s rent and face risks. Geographical restrictions are thus essential to incitehim to license. Such geographical restrictions frequently lead to bilateral dependen-cies. Indeed, to accept such restrictions, licensees frequently ask for territorial exclu-siveness.13 Such exclusivity gives them a monopoly position that can compensate forthe usage restrictions to which they are subject. Licensors are incited to concede suchadvantages because, on the one hand it increases the commercial value of theirlicense, and on the other hand it facilitates the supervision of licensees (becausethere are few horizontal externalities among licensees). The rationale of territorialexclusiveness is, in this case, very close to the rationale that explains such principlesin franchise contracts [cf. Williamson (1985)]. However, it creates a bilateral inter-dependence that can be harmful for the licensor (cf. the second part of Section III).
Y Last but not least, “technology flowback” clauses can be implemented. These give thelicensor a right over any development by the licensee. We observed this clause in65.2% of the contracts in our sample [43% in the study by Caves et al. (1983)]. It hastwo advantages. First, it enables the licensor to benefit from the unanticipateddevelopment of his initial innovation. Second, it substantially decreases the licensee’sincentives to invest in R&D efforts. As a result, the probability that the licensee will
13A large portion of the contracts in our sample (71.7%) contain an exclusivity clause that can be a geographicalexclusivity (75.7%) or a market exclusivity (75.7%). Moreover, these exclusivity clauses are positively correlated with theimplementation of geographical restrictions: see Table 3 (RGEO2 3 GEO2). See also Caves et al. (1983).
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develop the required competencies to compete technologically with the licensordecreases.
Caves et al. (1983) point out that all these restrictive clauses are likely to be imple-mented when the licensed technology is a core activity of the licensor’s.
The Incompleteness of the Patent System
In a recent article [Bessy and Brousseau (1997a)], we pointed out that the specificfeatures of knowledge and technology, and the cognitive and economic constraints thatbind patent and judicial institutions, limit the completeness of industrial propertyrights. This incompleteness has two aspects. First, the usage rights to an idea are nevercompletely and totally clearly set. Second, knowledge codification is often incomplete.This is due to both the boundaries of human language and to patentees’ strategicbehaviors. Because the patentees anticipate the incompleteness of the patent system,and therefore incomplete protection, they try to make the patent unusable without thetransmission of complementary resources.
This incompleteness of intellectual title deeds has some convergent influence ontechnology licensing contracts with uncertainty:
Y The rights and duties of the two parties are never unambiguously and completelystated. This calls for the implementation of an ad hoc governance structure organizingnegotiation between the two parties or, at least, an arbitrage mechanism.
Y Economic units have to exchange resources other than the patent itself. This providesthem with additional governance means.
But there are also specific consequences of this incompleteness.One of them is the implementation of the “most favored nation” clause in some
contracts (17.4% in our sample, but that is systematic in some industries like consumerelectronic equipment, where it concerns the royalty rate). Because IPRs are incomplete,licensing agreement negotiations are one of the occasions (along with the patentoffice’s examination and infringement trials) during which the actual scope of patentsis discussed. If a potential user estimates that, given the patent’s actual contribution toan innovation, the patentee claimed too wide a protection, he can threaten him withlegal proceedings to contest his property rights. He can also negotiate favorable licens-ing conditions with him (low restrictions and low fees, among other conditions). In thatcase, the patentee’s property rights are de facto reduced, but he can prefer this secondsolution because of trial costs and delays, and because his title deed is publicly andunambiguously restrained or destroyed in case of unfavorable judgment. The negotia-tions of license contracts can therefore be close to the contradictory debates performedat the patent office or in courts. If all licensing negotiations were of that type, it wouldbe very costly and time consuming. That is why the two parties can agree to implementa clause in which the licensor agrees to grant all licensees the most favorable licenseconditions that he gives to any. Licensees ask for this clause because it enables them topotentially benefit from fair contractual arrangements, but to avoid costly negotiation.Indeed, each licensee, unless he is the most capable of contesting the patent claimbecause he intimately knows this technology, knows that he is not the best potentialnegotiator to reach the most favorable licensing conditions. On the other hand, thelicensor is incited to accept this type of clause because it greatly decreases both hisbargaining costs—most licensees sign contracts without negotiating—and the probabil-ity of contesting his title deed. Indeed, if there is no coordination between the licensees,
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even the most capable will not try to negotiate more favorable licensing conditionsbecause, first, the licensee is not necessarily aware that he is the best negotiator and,second, his individual costs can be superior to his expected individual gains.
As pointed out by North (1990), when property rights are incompletely set by publicinstitutions, transaction costs—i.e., “measurement” (specification) and “enforcement”costs—are higher. This is because the collective system involved in the management ofproperty rights and transactions benefits from economies of scale and of scope indefining and enforcing the uses right of economic agents. Moreover, when thesecollective systems fail, agents have to bear these costs directly by building specificgovernance structures. They can, however, develop strategies to reduce these costs.
This is particularly the case as regards supervision. Because property rights are weak,and because there are uncertainties about the possible uses of knowledge, licensorspotentially have to dedicate important resources to supervise licensees’ behaviors. Thatis why they will tend to implement contractual solutions that bind supervision require-ments. Three types of solutions are used:
Y Technological Barter Through Free Cross-Licensing: An important part of the su-pervision effort is often dedicated to appraising whether there is any cheating aboutthe evaluation of the basis of royalty assessment. Technological barter avoids such aneffort. The two companies exchange the right to use two technologies that areestimated as “equivalent,” without referring to any monetary value. Specialists in theprofession consider technical, industrial, and commercial arguments to estimate thatthe two technologies can be roughly considered as equivalent. To a large extent thissimplifies ex-ante negotiations.14 Also, the ex-post governance problems are simplifiedbecause the barter creates a situation in which each party is in a position to threatenthe other through unfair use of the licensed technology. The control of opportunisticbehaviors thus relies on a balance of credible threat. In our sample, cross-licensing isrequired from the licensee in 34.7% of the contracts. Moreover, it is positivelycorrelated to the absence of payment to the licensor (I7I1 3 I6C3) and to thenonimplementation of supervision mechanisms, renegotiation provision, and con-tractual safeguards (I6C1 3 I102, I172, RDO2). A possible degradation of the prin-ciple of technological barter (because it is not always possible) is to simply implementbarter between a patent and another type of resource. Indeed in our sample, thelicensor can demand reciprocity in terms of goods or service deliveries by the licensee(respectively, in 45.6% and in 43.4% of the cases). In such cases, there are no crediblethreats. However, the implementation enables simplification of the payment mech-anism. In our sample, reciprocity in terms of goods is also positively correlated to thenonimplementation of complex contractual and governance structures (I6P1 3 I102,I172, GEO2, RTE2).
Y Set Priced License. Again, to limit the required effort of supervision dedicated toestimating the actual intensity with which the licensee uses the technology, somelicensors give usage rights in exchange for a lump sum payment. However, this goesagainst the logic of royalties linked to uncertainty about the actual value of thetransferred technology (cf. the second subsection of the first part of Section III). Assuggested by Arora (1995), lump-sum payments could correspond to the remunera-tion of services (technical support and training, among other services). The license
14Our interviewees pointed out that these direct agreements between operational R&D or manufacturing specialistsare often easier to establish than arrangements involving lawyers and finance specialists.
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is then given free of charge. In Arora’s model, the payments are spread over twoperiods to solve the adverse selection problem. The licensee makes the secondpayment only when the licensor provides him with the required know-how to use thetechnology. In our sample, there are lump-sum payments in 59.4% of the cases inwhich payments are performed. However, in 83.4% of these cases, these lump-sumpayments are associated to royalties based on sales. This is also documented byDegnan and Horton (1997). As a result, there are only 10% of cases in which thereare, strictly speaking, lump-sump payments. The other cases are, in fact, two-parttariffs that enable firms to benefit from the advantages of both royalty payments(which solves the adverse selection problem) and lump-sum payments (that decreasesthe ability of licensees to cheat). Moreover, two-part tariffs are a good way to shareexploitation risks between the licensor and the licensee. This is probably why they areimplemented so often. This seems to reconcile Arora’s vision with ours.15
Y The Indexing of Royalties on Easily Observable Variables. If economic agents were inthe process of remunerating the actual contribution of a technology to a licensee’sresults, they would have to implement very complex basis of assessment and remu-neration formulas. Most of the significant variables would not be easily observableand verifiable, and the remuneration scheme would require intensive supervisionefforts. To avoid such efforts and to save costs, agents implement very rough, buteasily observable, basis of royalties assessments like total sales of the products incor-porating the licensed technology or even total sales of the company. In our sample,35.7% of the contracts implementing the payment of royalties base them on thegenerated sales, and royalties are based on total sales in 64.3% of the cases. This isalso documented by Caves et al. (1983, p. 258). This is another source of licensors’incomplete capture of innovation rents.
Incomplete IPRs also have an impact on the implementation of safeguards in con-tracts. Due to the incompleteness of the patent system, the transferred rights of use arealways imprecise and not easily enforceable. Ex-ante, a complete contract able to settleeach party’s rights and duties in every feasible situation cannot be designed. Ex-post it iscomplex to assess, for instance, whether a licensee’s behavior generates patent infringe-ments. In the previous section, we reviewed clauses—such as geographical restrictionsor a “technology flowback” principle—that are partly designed to solve this problem.We mention here other contractual solutions that are more directly linked to overcom-ing the incompleteness of IPRs:
Y The licensor’s technology can be misused by the licensee, thus reducing the paymentof royalties. This can be unintentional (management mistakes or inability to learn),but can also be the result of deliberate strategic behaviors (e.g., to neutralize atechnology in a competitive process among technologies). The point is that it is verydifficult for a third party to determine unambiguously whether a misuse is deliberateor not. However, such deliberate behaviors can be very harmful for the licensor,especially if he granted exclusive licenses. He then can implement a performanceclause that stipulates a minimum level of either sales or royalties for fear of contractbreach [cf. Caves et al. (1983)].
15In our sample there is no significant correlation between the implementation of dry lump sump payments (i.e.,those without royalties) and the provision of services or tangible resources. This seems to invalidate Arora’s assumption.per se. However, Arora’s arguments about lump-sump payments can be combined with ours on royalty payments toexplain why there is so often a combination of the two.
468 Technology licensing contracts
Y The licensor is also potentially the victim of an exorbitant appropriation of knowl-edge by the licensee. Indeed, because IPRs are fallible and incomplete, and becausethe licensee has access through know-how and material transfers to the cognitiveresources of the licensor, he can learn things that are not licensed. This explains whylicensors protect themselves against this type of knowledge extortion by providingtraining and support services rather than by opening the doors of their own facilitiesto the licensee’s employees. Small firms, however, are often unable to provide suchservices and are potentially victims of knowledge pillage [cf. Caves et al. (1983)].
To offset the incompleteness and the failures of the patent system, economic agentsdo not rely only on interindividual (contractual) devices. They also benefit fromcollective mechanisms that do not belong to the intellectual property or public insti-tutions category [cf. Brousseau (1999)], but that back up these institutions: The PrivateInstitutions. To coordinate, agents rely on informal rules (customs and conventions; (cf.Section II) see the second subsection of the first part of Section III) as well as on privatecollective organizations that offset the failures of public institutions. These informal orprivate institutions impact on measurement and enforcement costs and, thus, partici-pate in the characterization of an IPR system. Regarding the licensing of technology,two types of institutions play an important role.
Y Structured scientific and professional communities generate rules of behavior thatenable their members to benefit from the common interpretation of rules thatenable them to codify (or decodify) knowledge but also to state whether such a useof the transferred knowledge is fair or unfair. Moreover, these communities ensureinformation circulation (cf. the first part of Section IV). This reduces informationasymmetries and favors self-discipline [cf. Granovetter (1985)].
Y Private institutions dedicated to information asymmetries reduction. In some indus-tries, like consumer electronics or pharmaceutical products, commercial databaseson the sales of every type of product are permanently maintained and updated. Theseenable licensors to benefit from precise information on which royalties can be settledeasily. Such specialized information media severely bound the abilities of agents tocheat and manipulate information.
In either case, the existence of collective coordination resources enables agents tosimplify the governance structure they have to implement at a bilateral level. Obviously,these collective resources greatly differ from one industry to another and do not existin every industry. As a result, despite common features, license contracts can be verydifferent across industries. Moreover, this induces very different levels of transactioncosts. The more collective resources there are and the simpler the contracts andgovernance structures are, the lower the transaction costs. This will be developed inSection IV.
To sum up, given the specificity of knowledge transfers and the incompleteness of therelated institutional environment, TLAs tend be incomplete and relational contracts.This obliges agents to dedicate a quite extensive amount of resources to the ex-postgovernance of the transaction, because they have to negotiate and mutually adjust, andbecause supervision has to be exercised by the licensor. Moreover, because resourceshave to be dedicated to the actual transfer of knowledge, technology licensing opera-tion tend to be, all things equal, relatively costly.
To decrease these costs, patentees tend to implement contractual clauses that are
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robust to uncertainty and avoid complex supervision and interpretation. This concernsespecially payment mechanisms that tend to implement simple formulas that do notenable the innovator to be remunerated according to the actual use of its technology.In addition, because strong adverse selection problems occur with technology, licenseesfrequently ask for remuneration systems that share risks with the licensor (i.e., annualroyalties). All things being equal, licensing provides the licensor with a relatively lowremuneration in the sense that its remuneration is noticeably inferior to the valuegenerated by its innovation.
These high costs and low remuneration generate a low profitability of licensingoperations. Moreover, the combination of risk-sharing remuneration formulas andcontractual safeguards induces mutual interdependencies. The innovator must, there-fore, bear its client’s risks along with its innovator and producer risks. This is why firmsare so reluctant to license. In addition to increasing risks of being imitated andcompeted with, licensing does not generally generate such high net revenues. More-over, medium and small firms often do not have the (human) capacities and capabilitiesto efficiently perform and secure their knowledge transfers. Our investigation, there-fore, points out why TLAs differ from standard selling contracts and why, all thingsequal, their low profitability does not incite innovators to optimize the diffusion of atechnology.
At the same time, we pointed out several means that simplify licensing operations,and therefore favor a better remuneration of licensors, and, thus, a greater willingnessto license, which generates a wider diffusion of innovation:
Y First, the licensor can bundle the provision of knowledge with the provision of otherresources.
Y Second, the licensor can benefit from the existence of a specific institutional frame-work that provides him with collective resources that overcome the incompleteness ofboth the IPL and the available contractual solutions.
In Section IV, we will point out that although TLAs tend to be relational, theexistence of a specific environmental and relational situation enables patentees toimplement more transactional and therefore less costly governance structure to ex-change technology. This basically explains the concentration of TLAs in a specificindustry sub-segment and in specific relational situations. That also explains the diver-sity of TLAs.
IV. Explaining the Diversity of License Agreements
In the previous section we tried to point out the common features of TLAs. However,our discussion led to the mention of specific cases in which royalty payments are notimplemented and in which governance relies on sociotechnical networks rather than onbilateral governance structures, among other cases. Although they rely on commonsolution classes because they govern transactions that have identical features, TLAs arediverse. Everyone involved insists on this point [e.g., Contractor (1981); Anand andKhanna (1996)]. This is largely due to the variations of transaction features, but it is alsodue to variations in the institutional environment.
In our view, these two factors will influence licensing contracts that will resemble oneof the two contractual categories identified by MacNeil (1974):
Y “Transactional” or “classical” contracts as qualified by MacNeil are also qualified as“market” contracts by Williamson (1985). These are almost complete contracts that,
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in this case, essentially describe the conditions to which the rights to use a patent aretransferred between two economic units;
Y “Relational” contracts [MacNeil (1974)] or “hybrid forms” according to Williamson(1985, 1996) are relatively incomplete contracts that, first and foremost, design anegotiation structure both to perform an actual process of knowledge sharing andcreation and to complete industrial and commercial cooperation.
Obviously, there is a continuum of solutions between these two polar cases. Theexistence of diverse categories of TLAs is documented in Table 4, in which the resultsof a hierarchical clustering of our sample are given. Five classes of contracts emerged.The five categories can be ranked on a relational-transactional axis, on which contractstend to be increasingly complete and simple. The relational class groups TLAs thatresemble those described in Section II. They are designed to cover the exchange ofmany types of resources in addition to the patent by itself, are incomplete, implementmany safeguards and a specific governance structure. On the other hand, although theyare not as simple as a selling contract for a commodity, transactional TLAs tend to becomplete and to not implement complex governance structures. Intermediary classesshare features of both categories.16
Basically, our idea is that, given the characteristics of the institutional environment,the ability to rely on collective mechanisms to govern technology and knowledgetransfers vary. This leads agents to implement more or less complete contracts, the costsof which vary considerably. The institutional framework, therefore, plays a major role inthe explanation of interindustry differences in licensing practice.
A certain amount of research has already documented this influence of the institu-tional framework. However, our own study differs on two points. First, most of thesestudies insist on the quantitative impact of the institutional environment, which leads toa very heterogeneous propensity to license [e.g., Caves et al. (1983) on intercountrycomparisons; Anand and Khanna (1996) on interindustry comparisons]. We choose topoint out qualitative impacts (to explain the quantitative ones). Below, we will demon-strate the types of possible contractual arrangements given the various institutionalenvironment features. Second, most of these studies rely on a very narrow vision of theinstitutional environment. Most of the time it is reduced to the legal (formal) frame-work. As pointed out in the first section, such a characterization is insufficient. More-
16The five classes are:
Y “Relational TLAs”: These long-term agreements govern the exchanges of many resources along with the right to usea patent. These contracts implement many safeguards, specific negotiation supervision and arbitration structures,and two-part tariffs, “Development TLAs”: This groups agreements through which a licensor gives a licensee a rightto develop his technology. They do not implement payments but are a renegotiation structure aimed at discussingthe conditions of the exploitation of the result of the R&D process when completed, “Relational Commercial TLAs”:These short-term agreements are linked to commercial agreements. The licensor transfers to the licensee a right touse a patent and the necessary resources to exploit it. Geographical restrictions and other safeguards are imple-mented to avoid competition between the licensor and his licensees. In turn, the licensor bears the risks (paymentsbased on royalties), “One-Shot Complete Transfer”: These contracts are designed to transfer the right to use a patentfor its whole life in exchange for a lump-sum payment. The absence of restrictions and royalties avoids any ex-postsupervision and renegotiation needs. As a result, these contracts do not implement governance structures. Theytypically govern the exchange of a technology that is not a key one for the patentee, “Transactional TLAs”: Thesecorrespond to a simple transfer of the right to use a patent and, therefore, do not cover the exchange of additionalresources. They generally do not implement strong safeguards and do not anticipate ex-post renegotiation. They arerelatively short term and tend to implement uniform royalties payments.
over, it cannot explain interindustry differences within a country. Anand and Khanna(1996) try to overcome this limitation by linking the strength of property rights to thecharacteristics of technology and knowledge (through its degree of codification). Webelieve, however, that this characterization needs refining. On the one hand, the verynature of the diverse types of organization and rule that characterize an institutionalenvironment has to be pointed out. On the other hand, even if the strength of IPRs isan essential characteristic, it cannot summarize all the determining characteristics thatinfluence TLAs and cannot explain the differences.
In our view, there is a great difference between horizontal and vertical TLAs:
Y In horizontal agreements between competing firms, a logic of market sharing dom-inates. Therefore, the competitive features of the industry largely influence thenature of license contracts (the first part of Section IV). However, horizontal TLAsshare a common feature. They tend to be “transactional contracts” because their aimis essentially to organize the transfer of rights of use among similar firms. Moreover,there are often many collective resources that can be used to support these agree-ments. Their degree of completeness is then strongly influenced by the basic featuresof the industry.
Y Vertical agreements are usually intended to organize actual transfers between com-plementary companies that have a common interest in an industrial or commercialproject. These agreements are most often based on “relational contracts” becauseactual knowledge transfers have to be performed, and because very few collectiveresources can back up private governance efforts. The degree of privacy of coordi-nation and the degree of incompleteness of the contract is, however, strongly depen-dent on relational specificities. Indeed, certain situations enable agents to simplifythe design of these hybrid governance structures and, thus, to bring transaction costsdown (the second part of Section IV).
Horizontal Relations: Knowledge Commonality and Technological Interdependencies
The logic of market sharing dominates in horizontal agreements between effective orpotential competitors. Indeed, there are no other reasons to explain why a firm choosesto give up a monopoly right. If a firm licenses its own competitors, it is either becauseit would be impossible (lack of resources) or too costly to directly exploit its technologyon a specific market (or market segment), or because it wants to capture rents gener-ated by diffusion (imitation) that it cannot prevent (or it has no interest in preventing).The propensity to license and the available contractual solutions will principally dependon two factors:
Y The degree of knowledge commonality that influences both the ease (and thegovernability) of technology transfers and the completeness of IPRs (the first sub-section of the first part of Section IV);
Y The technological interdependencies among firms that incite technology transfersand the construction of collective governance resources to manage them (the secondsubsection of the first part of Section IV).
Common Knowledge and Completeness of IPRs. The features of licensing contracts greatlydepend on each industry’s institutional environment, which can be characterized by thefact that knowledge is common (as opposed to specific) and that IPRs are relativelycomplete (as opposed to incomplete), these two elements being strongly correlated:
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Y A high degree of commonality of knowledge17means that an industry’s membersshare the same type of knowledge. Put another way, they do not own specificcompetencies (in the sense of evolutionary theory) because they are on the same“technological frontier” and serve the same types of markets thanks to similar pro-duction processes.18 In that context, all the industry members are able to interpretthe wording of a patent in the same way, and a patentee does not really need totransfer knowledge and other resources when he wants to transfer his technologies toanother economic unit.
Y When knowledge is common, IPRs are, everything remaining equal, stronger (or lessweak), because all the protagonists involved in their management share commonrules of interpretation. As a result, patent claims and patentees’ rights are lessambiguous, and patent infringements are more easily verifiable [cf. Bessy and Brous-seau (1987a)].
Thus, the more that knowledge is common, the more “transactional” [MacNeil(1974)] contracts will be. If knowledge is common, the license contract does not haveto organize a knowledge or even a technology transfer. It just has to define what rightsof use are given to the licensee. Moreover, the more that knowledge is common, themore precise the contractual specification of transferred property rights and the greaterthe ability to involve (public and private, formal and informal) collective systems.Licensing contracts are, therefore, relatively simple and complete. They give (generallyrestrictive) exploitation authorization in exchange for royalty payments.19 On the otherhand, in industries where firms have very specific competencies, agents have to transferknowledge and cannot rely on collective resources to make the governance of theirtransaction easier. More “relational” contracts are necessary to organize a successfultransfer and to secure the interests of both parties (cf. Section III).
In the cases we studied we observed such a difference between TLAs, given thecharacteristic of the industry in terms of commonality of knowledge. For instance, in the
17Anand and Khanna (1996) have a very similar argument to ours. However, according to them, the essential factorin contract differentiation is the degree of knowledge codification. The less ambiguous the link between a text and theeconomic and technical properties of a technical realization, and the stronger the industrial property rights, then themore complete the license contracts will be. We think, however, that their focus on codification is too restrictive.
Y First, technology licensing does not only cause problems in property rights protection; it also causes problems ofknowledge circulation. Now, the problem of knowledge transmission cannot be reduced to the question of codifi-ability. As pointed out in Section III, knowledge is embodied in different support and is, therefore, transferredthrough the circulation of various resources. Moreover, sociotechnical networks [Callon (1993)] and professionalcommunities [Nelson (1993)] convey knowledge, even if tacit, second, the strength of IPRs surely depends on thecodifiability of knowledge, but this is far from being the sole factor. We have pointed out [in Bessy and Brousseau(1997)] that it also depends on the conventions that are specific to each industry and that precisely determine fairand unfair uses of licensees’ rights.
Moreover, our data seem to invalidate the interpretation of Anand and Khanna (1996) in terms of knowledgecodification. Indeed, if they were right, one should observe a greater propensity to exchange codified knowledge intransactional contracts, and noncodified knowledge in relational contracts. As can be seen in Table 4 (Lines I5I1 toI5J3), this is not the case. Indeed, the propensities to exchange codified and uncodified knowledge follow the sametrend between transactional and relational contracts. Much codified and uncodified knowledge is exchanged inrelational contracts and much less in transactional ones.
18That is why imitation occurs. Mansfield et al. (1981) and Mansfield (1985) document that imitation is very rapidin many industries because knowledge is common, but also that there are strong interindustry differences.
19The literature on license contracts based on the incentive framework [e.g., Gallini and Wright (1991); Shepard(1987)] typically corresponds to this type and this context of licensing agreements. It is, however, not well designed todeal with the other types of contract.
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organic chemical industry, in which scientific rules, industrial principles, and techno-marketing properties of molecules are well known by the whole industrial and scientificcommunity, TLAs tend to simply (and completely) define the types of rights of use thatare transferred to the licensee. Indeed, it is not useful to organize a transfer ofknowledge, and a judge, with the assistance of experts, can easily arbitrate conflictsbecause patentee’s rights are quite unambiguous. This is quite different in the biotech-nology industry, for instance, in which research has been largely performed by smallunits (university laboratories and start-up companies) on very specific subfields. Thescientific community is not already well organized, and all the researchers in the fielddo not share the same basic knowledge. The industrial community is highly scatteredand does not share common views about the principles governing the manufacturing ofproducts and the market. As a result, knowledge is not only largely tacit, but also isincomplete and spread among many small entities that do not maintain strong rela-tionships with each other. The consequence is that when two units want to exchangetechnology, they have to exchange many resources besides the wording of the patent.They also have to implement specific means of supervision and arbitration to make theircomplex and specific agreement self-enforceable. Beyond our case studies, our corre-lation table also documents this. In Table 3, columns I5I1, I5I3, I5J1, and I5J3, whichrefer to the intensity of exchanges of knowledge in addition to the wording of thepatent, show that the more additional resources are exchanged, the more safeguardsand renegotiation provisions are implemented. This confirms that when both parties donot have to actually transfer knowledge, they are able to implement more transactionalagreements.
All the applied studies confirm the polarization of license contracts according to sucha framework (even if theoretical categorization varies). Caves et al. (1983), for instance,point out that 25% of their contracts are of the “transactional” type. Moreover, bothAnand and Khanna (1996) and our own studies point out that these “transactionalcontracts” are concentrated in specific industries. According to our investigation, theyare concentrated in the chemical, pharmaceutical, and electronics industries. Anandand Khanna (1996) state that they are more frequent than other types of agreement inthe chemical (one third of the contracts in their database), electronic (24%), andcomputer (18%) industries. This confirms that the characteristics of an industrystrongly impact on the ability to design and run certain types of contracts.
To a large extent, the degree of commonality of knowledge itself depends on the ageof the industry. Indeed, all the collective resources [knowledge codification, conven-tions, associations and societies, social networks, etc.; cf. Nelson (1993)] that favorknowledge circulation and IPR security have to be built over time. Although there areother necessary conditions, older industries are, therefore, more likely to be character-ized by a high level of commonality.
Technological Interdependencies Between Industry Members. The second factor thatstrongly influences license agreements does not impact on the transfer and governancecosts, but rather on the incentives to transfer knowledge and technologies to compe-titors. Indeed, the very nature of technology creates more or less strong technologicalinterdependencies among industry members that influence the density of technologylicense agreements, and, in the end, their capacity to govern such transfers.
There are three different causes of technological interdependencies:
475C. BESSY AND E. BROUSSEAU
1. There are technological spillovers due to the boundedness of the cognitive re-sources of each industry protagonist. Consequently, each protagonist cannot realizeall the potential developments of a technique, especially when a core technologycan engender many applications or when highly complex technological systems aredesigned. This is a frequent situation in the chemical and biotechnology industries.Cumulative developments increase the value of the initial invention, and the diverseinnovations are linked because the use of a marginal innovation implies the use ofall its mother inventions.
2. There are increasing returns of adoption that are due to network externalitiesamong technologies or among users of a technology. They favor the setting up ofa unique technological standard [cf. David (1985); Cowan (1990); Antonelli(1994)]. The electronics industry provides the best example of this phenomenon,because one can observe the combination of physical network externalities (toensure interoperability) and technical externalities (among the diverse technicalcomponents of these network-provided services).
3. Regulation or standardization constraints can also lead to the adoption of commontechnologies. Most of the time these standards or regulations are created to over-come negative externalities. This is, for instance, the case either in network serviceswhere interoperability requirements are high (e.g., telecommunications) or inindustries that can generate strong negative externalities in terms of environmentor health.
When technological interdependencies are high, it is either a quasi-obligation [(1)and (2)], or an obligation (3) for a patentee to license his technology to any potentiallicensee, even if it is a direct competitor. In the first two cases, it is the competitionamong technologies that forces a patentee to try to develop his “market share” either toinitiate additional development or to increase the relative number of users of histechnology. In either case, licensing is essential because the technology market sharedirectly impacts on the short-term generated revenues and on the long-term viability ofthe technology. In such competitive games, license agreements play an essentialrole.20In the latter case, one is often in a compulsory license regime, either through theantitrust law (like in the telecommunications industry, where a patentee cannot use itsintellectual property monopoly power to create entry barriers), or through the specificlaw linked to the various domains of public policy (like in the healthcare industry, inwhich it is obligatory to license a basic technology to those who want to developtherapeutic applications).
Whatever the situation, when there are strong technological interdependencies,there will be many licensing agreements that, everything being equal, impact on theability to manage those agreements. Three phenomena are in question.
First, these interdependencies imply intense exchanges of information through in-dustrial and commercial relationships, the circulation of employees’, etc. [e.g., Hyde(1997)]. These exchanges reduce information asymmetries. This has consequences ontechnology transfers and governance:
20This refers, for instance, to the famous VHS versus Betamax and V 2000 competition where JVC (VHS) wonagainst Phillips (V 2000) and Sony (Betamax) because it agreed to license its technology at a low cost.
476 Technology licensing contracts
Y A reduction of adverse selection problems: everything remaining equal, uncertaintiesabout the actual value of an innovation decrease for the potential licensee because hehas access to many information sources;
Y A lowering of moral hazard because, for the same reasons, licensor and licenseesupervision is easy;
Y Easier enforcement, because, as pointed out by Granovetter (1985) or Milgrom et al.(1990), reputation effects, which are the foundation of collective retaliations againstopportunists, greatly depend on dense links among the members of a community.When there is a tight relationship and a fluid information circulation, cooperativebehaviors and, therefore, the enforcement of agreements are guaranteed.
Second, technological interdependencies favor the emergence of collective governancemechanisms. Some of these are deliberately built, whereas others spontaneouslyemerge. In both cases, the large number of intraindustry relationships and the similar-ities among them explain the emergence of these collective mechanisms that mutualizeand bring transaction costs down [cf. Brousseau (forthcoming); Bessy and Brousseau(1997b)]. Two types of mechanism have to be identified:
Y On the one hand, economic agents favor the development of efficient supervisionsystems that enable a clear statement of the basis of the royalties settlement. Becausemost industry members are both licensors and licensees, they have a common interestin building such mechanisms;
Y On the other hand, the dense network of transfers among industry members, thehuge amount of cross-licensing increases retaliation capabilities. This enables trans-actors to simplify governance structures because it is not necessary to implementcomplex safeguards.
Third, learning effects also bring governance costs down. Because firms design andmanage many TLAs, they can conceive cost-saving solutions:
Y First, agents standardize license contracts to economize on negotiations and themanagement of contracts [cf. Brousseau (forthcoming)]. Learning is the key to thisstandardization because it enables agents to fix the efficient contractual solutionsgiven the industry and the legal environment.
Y Second, at a collective level, the large number and the multilateral nature of tech-nology transfers tend to favor the commonality of knowledge and, therefore, thesimplification of technology transfers (cf. the first subsection of the first part ofSection IV).21
21One might, therefore, think that the commonality of knowledge and technological interdependencies are linked.This is not the case, as illustrated by the computer and professional electronic equipment industries where thecommonality of knowledge is considerably less than in the chemical industry [cf. Taylor and Silbertson (1973); Levinet al. (1987); Mansfield (1986); Cohen et al. (1996); Anand and Khanna (1996)]. One notices, however, numerouslicensing agreements [e.g., Anand and Khanna (1996)]. One could add that in these two industries knowledge is notyet easily codified. Thus some industries are characterized by strong technological interdependencies and others bycommon knowledge, in the long run, technological interdependencies favor commonality of knowledge and knowl-edge codification. However, in the short term, there are industries, especially emerging industries, in which there arestrong interdependencies without common knowledge (e.g., biotechnology). Moreover, commonality of knowledgedoes not generate technological interdependencies (e.g., mechanical construction). It is, therefore, important todiscriminate between the two characteristics.
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Thus, the stronger the technological interdependencies, the more “transactional”that licensing agreements will be. Indeed, these complete and simple contracts can besupported by collective devices. Moreover, technological transfers are simplified.
Our case studies confirm this strong influence of technological interdependencies onthe emergence of collective governance devices that enable agents to implementsimpler contracts and, therefore, to decrease transaction costs. It can be pointed out bycontrasting the cases of the electronic consumer industry and engineering services. Inthe electronic consumer industry worldwide standards tend to be implemented in mostproduct sectors [cf. (2)]. Indeed, a television system, for instance, requires compatibilitybetween the broadcasting network and the television set, and the development ofdigitized high-definition television increases these requirements because interoperabil-ity has to be implemented at the service level (e.g., encryption, payment management,programming, interactivity management, etc.). As a result, all the manufacturers areimplementing the same technology in their television sets and television peripherals.This means that the owner of a patented technology that became the de facto standard(like VHS for the video recorder) sells licenses to all the manufacturers in the world.Because most big firms own patents that cover a part of the de facto worldwide techno-logical standard, there is a tremendous amount of multilateral licensing. This stimu-lated the development of a community of licensing executives, of frequent intercom-pany exchanges of information about licensing behaviors, of service companiesspecialized in the gathering and publication of data about the intensity of use of thevarious technologies, etc. These induced the development of conventions about what isfair and unfair regarding the use of a licensed technology, about the adequate level ofroyalty rates, and provided the industry members with the means to enforce agree-ments. In that industry, a TLA is quite standardized and simple. It does not implementdetailed restrictions and does not design a specific governance device. It often refers tothe “practices that are considered to be fair by the profession” and implements paymentmechanisms based on information that is made public by industry unions or by privatemarketing companies. In the engineering service industry, on the other hand, mostcompanies do not want to either license or patent their technical knowledge becausethey consider it to be their major source of competitive advantage, and because they sellnot technology but services produced with highly idiosyncratic technologies. As a result,intercompany exchanges of technology and knowledge are quite scarce, and there areno occasions for and no incentives to develop collective means to govern them. In thisindustry, TLAs are quite complex, in the sense that they describe in detail what thelicensee is authorized to do with the technology. The licensor requires many auditrights to check whether the licensee enforces the agreement. These types of agreementsare highly specific and create a situation of mutual dependency. There are, therefore,no references at all, for example, to common practices or royalty rate conventions.Although TLAs tend to be frequent and multilateral in the consumer electronicsindustry, they are exceptional and monolateral in the engineering services industry.
Merges (1996) shares common views with us and gives many historical examples ofthis correlations among the existence of technological interdependencies, the emer-gence of collective devices that make the governance of technological transactionseasier, and the willingness to license. Callon (1997) also documents this in the specificcase of technology transfer between universities and firms.
In sum, when one speaks of horizontal TLAs, contracts tend to be transactional.Moreover, they are strongly dependent on the nature of the industry. Managerial
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discretion is weak because the institutional framework and the technology characteris-tics impose both the licensing policy and the main features of TLAs. The more oftenthat knowledge is common and that technology is interdependent, the more often“transactional” contracts are used to manage simple rights of use transfers (rather thantechnology and knowledge transfers).22 Because “transactional” contracts are less costlythan “relational” ones, there is a strong propensity to license in those industries whereknowledge is common and technological interdependencies are strong.
Vertical Relations and Relational Specificities
When it is a question of vertical licensing, the industry characteristics impact less oncontractual agreements than on specific relational situations. Compared to horizontalTLAs, vertical TLAs are more intensively dedicated to the actual transfer of knowledge.Moreover, they are often set in the framework of cooperative R&D processes. As a result,licensing agreements are not set up to share a market but rather to cooperate, in thesense of Richardson (1972). In this context, the two parties have little likelihood ofbelonging to the same industries and sharing common knowledge. Nor do they benefitfrom collective coordination resources. As a result, they have to rely on “relationalcontracts” to perform their technology and knowledge transfers.
Because relational contract governance costs are quite high, economic agents nec-essarily limit the number of such transfers. These types of arrangements are, therefore,less frequent than transactional horizontal licenses. Moreover, these high governancecosts lead economic agents to balance out the “hybrid” governance mode with thehierarchical one (i.e., vertical integration). In some cases, this tradeoff can enablecontract designers to simplify the “relational” contract because the threat of takeovercan be used as a safeguard.
In sum, vertical relations favor the implementation of relational contracts, but spe-cific situations can lead to less relational and more transactional agreements. This islinked both to the type of technological transaction that is performed (the first subsec-tion of the second part of Section IV) and to the existence of alternative modes ofgovernance (the second subsection of the second part of Section IV).
Uses Right Transfers Versus Technology and Knowledge Co-development. As pointed outabove, vertical agreements generally are oriented more toward technology transfer thanhorizontal agreements. One can, however, establish means of discrimination amongvarious situations in which the transfer of technology does not play the same role as inthe interfirm cooperation process. On the one hand, a codevelopment process ismanaged through the implementation of TLAs, whereas, on the other hand, technol-ogy is just used as a counter-bargaining tool. Former agreements are more relationalthan later ones.
LICENSE AGREEMENTS AND TECHNOLOGICAL COOPERATION. As documented by Jordeand Teece (1990), the management of cooperative processes of (incremental) innova-
22Because economic entities are almost obliged to license (and to license according to the industry’s conventions),managerial discretion essentially lies in the choice of the partners, especially to manage technological spillover andstandardization processes. This explains the importance of the literature on core competencies and complementaryalliances in the analysis of technological and standards competition [e.g., Hagedoorn (1990); Teece et al. (1994)].
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tions requires the implementation of complex governance structures that are open tobargaining.
If innovation processes were linear, the management of those cooperative situationswould be relatively simple because technology and knowledge transfer would be uni-lateral at each stage of the innovation process. As regards property rights, it would besufficient at least to organize a cascade transfer among the diverse protagonists in theprocess. Because many innovation processes are incremental [concerning an increasingnumber of technologies, according to Jorde and Teece (1990)], the management ofIPRs and of cooperation as a whole is much more complex because transfers are madeback and forth between the entities involved in the process.
Moreover, because IPRs are incomplete, and because knowledge and technology areembodied in many supports, the management and the security of such types of coop-erative processes cannot be reduced to simple transactional license contracts.
Jorde and Teece (1990) insist on the idea that these processes require the imple-mentation of long-term exclusive agreements. They quote the example of partnershipsbetween automobile makers and providers of automobile components. These are not,however, sufficient because of the incompleteness of IPRs, which will not be able tosecure the side or ex-post uses of the shared knowledge and technology. Jorde and Teeceinsist on the idea that to secure these types of cooperative processes, and, therefore, toincite agents to make risky investments in cooperative development processes, collectivetangible resources are built. Moreover, these tangible resources enable partners toconsolidate their competitive position vis-a-vis their competitors by reducing the abilityof competitors to imitate the innovation and to bring a similar innovation to the market.As a result, the licensing process by itself tends to be a part of a broader, cooperativelong-term agreement in which many types of transfers are performed and many types oflinks are created between the two entities. In our data there is a positive correlationbetween the fact that the TLAs tend to be relational and their inclusion in a jointventure process (Table 3, Column I3V3). Moreover, relational contracts tend to bemore corelated than the other types of contracts to joint-venture settlement (Table 4,Line I3V3).
It should, however, be pointed out that license contracts, strictly speaking, play animportant role in reducing the complexity of such cooperative agreements. In fact, whatwe called in this paper “relational” license agreements enables the implementation ofa simpler governance structure than, for instance, JVs or consortia. In some papers sucha tradeoff is presented through a moral hazard approach in which the question is toincite parties to the optimal level of R&D effort. Given specific conditions, Katz andShapiro (1986) or Morasch (1995), for instance, show how cross-licensing is moreefficient than JVs. There are, however, other arguments in favor of cross-licensing. Forinstance, the JV settlement obliges a costly reorganization of R&D and even of industrialand commercial capacities. Cross-licensing avoids this. We even observed cases where aone-way TLA can substitute for quasi-integration.23
Our data confirm this possible partial substitution between quasi-integration andrelational contracts. In our data, even if relational TLAs can be associated with thesettlement of formal JVs, this is not the case in the majority of the contracts belonging
23For instance, to accelerate the development of a specific category of therapeutic applications, S, a pharmaceuticalcompany, licensed to B, a leader in the field, the development of specialties. The two companies are the copatenteesof B’s innovations and exploit them on their own side. A coordination committee, however, is intended to manage thecontinuance of the R&D process and to set possible financial compensation (if needed).
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to the relational class (Table 4, Line I3V3). Indeed, as argued here, relational TLAsenable the performance and security of the exchange of many resources withoutsystematically leading parties to implement a more specific governance structure thana relational TLA. That is why there is a positive correlation between the fact that manyresources are transferred and the basic features of a relational contract (length of term,mutual safeguards, and renegotiation provisions) but not with the fact that a JV isimplemented (Table 3, Columns I5I3 and I5J3).
TECHNOLOGY AS A BARGAINING COUNTER. On the other hand, patents are sometimesconsidered by licensors only as bargaining counters that enable them to access otherresources. The desired resources can be other technologies or any other type ofresource. Whatever it is, the patent is a simple counterpart in a barter exchange. Thereare even situations where the patent is only used as a hostage that guarantees anothertransaction. In these cases, licensing agreements increasingly resemble a simple trans-actional contract.
In the first two cases, the license agreement is essentially aimed at ensuring thetransfer of a resource—e.g., technology—against another resource. In the case ofbilateral technology transfer, one observes cross-licensing agreements that have toorganize the transfer of knowledge, and, therefore, tend to be “relational,” but that canavoid implementing strong safeguards because there is mutual dependence and oftenthere are no royalty payments (because of the barter situation); they, therefore, tend tobe “transactional.” Cross-licensing agreements, therefore, are hybrid between these twoextremes. This is also the case of the barter of technology against, for example,financial, human, tangible, and commercial resources. In these cases, there is often afree license in exchange for a tangible transfer or access to a market or to industrialcapacities. In our sample there is a positive correlation between the fact that thecontract tends to be transactional and the implementation of reciprocity throughcross-licensing or goods purchasing by the licensor. Table 3 points out that cross-licensing is positively correlated to the absence of payment to the licensor (I6C3 3 I7I1)and is negatively correlated to the implementation of safeguards, renegotiation provi-sion and specific governance structure (Column I6C1). This is the same when barteringrelies on goods and not on technology (Columns I6P1 and I6P3). This thereforeconfirms the ability of bartering to avoid the implementation of complex and costlygovernance structures.
But the patent can even be used in a more generic way. In that case, patents are usedas simple title deeds that are exchanged by the parties to make their commitmentcredible. A patentee then gives a free license to a partner to signal his cooperativebehavior. For instance, in the framework of an alliance, one can give one’s partner afree license to a technology, although he will not directly use the technology. Itpotentially enables him to use the technology for free or to perform competingdevelopments. The license is therefore a credible licensor’s commitment [Williamson(1985)] because it gives the licensee a means of retaliation. Through this type oflicensing agreement, the licensor expresses his trust in his partner. As pointed out inBrousseau (1996), this type of signal is often necessary to implement trust and mutualconfidence in bilateral relationships. Indeed, to overcome some aspects of contractualincompleteness, rational trust based on the idea that the two parties share commongoals and have common interests is essential [Menard (1994)]. In practice, one canobserve this type of strategy both in bilateral alliances (in which case only one or a small
481C. BESSY AND E. BROUSSEAU
number of patents are generally licensed) and in multilateral alliances (in which caselicenses cover packages of patents related to a wide technical domain). Whatever thecase, such types of licenses do not really organize technology transfer, moreover theyare free. As a result, they tend to be transactional TLAs.
Integration as a Credible Threat. Because licensing agreements are complex and costlyand do not have a high level of profitability, licensing strategies essentially result fromthe fact that in some cases an inventor is not able to exploit an invention alone or tobring it to the market due to a shortage of, for instance, financial, R&D, industrial, ormarketing capabilities. This situation will lead the inventor to license his technology toa partner who will exploit it generally in a specific niche or geographical market. In thiscase, the logic of “relational” contracts prevails. However, in some specific situations,the implemented contracts can be less relational because the governance structure canbe simplified. This is essentially due to the ability of one party to take over the other,which gives it considerable means of retaliation, or, to the contrary, make contractualsafeguards ineffective. Two main cases arise: small versus large company relationships;and international license agreements.
LARGE AND SMALL FIRMS. A large firm can generally take over a small firm (even ifit is depending on the small firm’s equity distribution). Large firms can, therefore,acquire a technology either by license agreements or by taking over the small firm. Inthat context, the former have several advantages. First, TLAs are a good way to test thetechnology before a possible integration of the small and medium business (SMB).Second, TLAs enable the licensee to maintain the autonomy of the innovator and thusits potential inventiveness. Third, the threat of possible integration weakens the paten-tee’s bargaining position. The agreement then becomes “transactional” because thesmall business is unable to implement safeguards. Moreover, it is often poorly remu-nerated, because standardized rates of royalties can be imposed by the large firm.24
Licensing agreements are, therefore, likely to be favored by the large firm because theyare potentially less costly and at least as efficient as integration.
The contract features essentially depend on the strength of the bargaining powerasymmetry between the two parties. This asymmetry first increases with the equitydissipation of the SMB. Second, it also depends on the IPR system. In French law, forinstance, the damages for patent infringements are based solely on the exploitationlosses supported by the patentee. This makes the cost of counterfeiting a small firm bya large one very low. This is not the case in the United States. Third, bargainingasymmetries depend strongly on the inventiveness of small firms. Indeed, if the smallfirm has a strong ability to innovate, the integration threat becomes less crediblebecause large firms can consider that this ability to invent is linked to the independenceof the small firm [e.g., Wolff (1996)]. Moreover, if it is very inventive, it can organizecompetition among several large firms.
TLAs among small and large firms are thus generally less “relational” than theaverage agreements governing actual transfer of knowledge. If the small firm has astrong ability to innovate, cooperative governance mechanisms and profit-sharingschemes are, nevertheless, implemented.
24In addition, Caves et al. (1983) document that small firms are unable to protect their stock of knowledge againstpillaging, because they cannot prevent access to their R&D facilities by engineers of large firms.
482 Technology licensing contracts
Although our data set does not enable us to document this point, our case studies do.We observed a major player in the consumer electronic industry that tries to evaluatethe defense potential of innovative SMBs before proposing them agreements. Whenthose firms have a weak financial structure, when they do not have strong industrialpartners, or when their patent portfolio can be contested, this firm chooses to negotiatelicensing contracts that do not implement many safeguards for the licensor even if thelarge firm claims exclusiveness. To the opposite, when the SMB benefits from a strongbargaining position, the same large firm establishes a partnership with the innovativefirm to benefit from priority access to its technological developments. We documentedsuch behavior in several other cases.
PENETRATING FOREIGN MARKETS. Considerable literature [e.g., Caves (1982); Hen-nart (1988)] is devoted to the trade-off among diverse alternatives to penetratingforeign markets and performing international technology transfers. Imitation risks canlead the firm to make direct investments. On the other hand, the difficulty and the costof creating and managing an efficient local subsidiary can lead the firm to license itstechnology. Ex-ante it has to patent it in the target country, and the nature of IPL is astrong determinant of the possibility to adopt this policy. Caves et al. (1983) list thefactors that favor licensing versus direct investment: the small market size as comparedto the minimum efficient size of the activity; the absence of required additional assets;the quickness of technological obsolescence; and expropriation risks.
Because there are often effective technology and knowledge transfers, these TLAstend to be relational. However, the contract is in fine strongly dependent on therelational situation. The licensee brings to the partnership its own resources: localindustrial facilities; commercial networks; specific brand name reputation; and knowl-edge of local consumers. The more specific its resources [in the sense of evolutionarytheory, see Teece et al. (1994)], the less substitutable it is for the licensor, and the morerelational the contract will be (because the relationship tend to be a partnership).There are, however, cases in which the local licensee does not own really specificresources. In these cases the threat of contract breach or integration is credible and thegovernance structure can be lightened and oriented more to serve the interests of thelicensor. Such possibilities also depend obviously on the local law on foreign invest-ments. Generally speaking, North-South technology transfers correspond to this lattersituation. Local firms are generally not gifted with many decisive advantages comparedto a local subsidiary of a foreign firm (which can hire local employees and buy specificcapacities), and the IPL is often weaker than local corporate law. As a result, takeoversand direct investments are very credible threats that enable licensing agreements to besimplified. These factors that favor less “relational” contracts have to be balancedagainst the fact that the weaknesses of IPRs and the effectiveness of knowledge transferscall for “relational” agreements [cf. Arora (1985) and the first subsection of the firstpart of Section III).
In sum, TLAs can sometimes be substituted by other governance modes, especially ahierarchy. This enables the potential integrator to implement less relational TLAs thanthey should. The threat of integration is, however, greatly dependent on the corecompetencies of the potentially integrated firm and of the institutional environment.
To sum up, license agreements tend to be “transactional” or “relational” according towhether they manage, respectively, a horizontal or vertical transfer. However:
483C. BESSY AND E. BROUSSEAU
Y To really observe “transactional” contracts in the case of a “horizontal” license, theindustry has to be characterized by a great deal of common knowledge and by strongtechnological interdependencies. If one of these two conditions does not hold, anda fortiori if the two do not hold, contracts tend to be less “transactional” and more“relational”; that is, less complete and less supported by collective governance.
Y The actual “relationality” of vertical agreements is linked to the fact that they reallyconcern a process of technology codevelopment, and to the fact that there are noalternative means of governance. In simple technology transfers, or when one partycan integrate the other, the governance structure can be simplified and contracts areless relational.
Figure 1 tries to summarize these elements. It shows the causes of TLA distributionalong the continuum between purely transactional and purely relational contracts. Thisfigure has to be understood, however, as a heuristic representation of our previousreasoning. It is not a schematization of a predictive structural model.
V. Conclusion
In this article we have tried to point out how the new-institutional framework can beused to clarify the complexity and diversity of TLAs. In our view, there are two polartypes of such contracts that can be related to MacNeil’s categorization of “transactional”and “relational” contracts [MacNeil [1974)].
Relational contracts are often linked to strategies that consist of maintaining theexclusiveness of knowledge and technology within a small circle of partners controllingcomplementary assets. Ex-post they tend to create strong interdependencies between the
FIG. 1. Causes of TLA differentiation.
484 Technology licensing contracts
parties because the licensees have to invest in specific assets or development processes,and the licensor irremediably transfers a part of his cognitive patrimony. These inter-dependencies require the implementation of ex-post negotiation mechanisms and con-tractual safeguards.
On the other hand, “transactional” contracts are primarily devoted to spreading thetechnology over the maximum number of users. In such situations, there are no realknowledge transfers and specific investments. Moreover, there are multilateral horizon-tal exchanges that by themselves secure each transfer. As a result, contractual safeguardsare useless and specific governance structures are not required.
The continuum from relational contracts to transactional ones is linked to twocorrelated phenomena:
Y An increasing collectivization of governance. This collective governance obviouslyrelies on public institutions (especially on the IPR system and antitrust regulation),but also on private institutions and informal conventions.
Y A decrease in technology transfer costs. According to North (1990), the institutionalgovernance of transaction governance enables firms to benefit from economies ofscale and scope as well as from learning effects. As a result, transactional licenses aremore frequent than relational ones.
These enable us to go back over the public policy problems mentioned in ourintroduction (cf. Section I). Compared to other research work, we insisted on theessential role of private and informal institutions and on the contrast between verydifferent types of TLAs.
Y As concerns scientific and technological policies, it must also be pointed out that theintermediary governance structures play a fundamental role in the generation ofincentives to innovate and diffuse knowledge and technology. As a result, publicinstitutions and the law are not the only tools to manage and stimulate technologicaland economic dynamics.
Y Concerning IPRs, our contribution prolongs those of Contractor (1981) and Caves etal. (1983), which insist on bad capture through licensing of innovation rents. This ismainly due to the weakness of IPRs. However, as pointed out here and in Bessy andBrousseau (1997a, 1997b), public policies cannot be reduced to changing the word-ing of the law. The strengthening of IPRs is also a question of the organization of thejudicial system. Indeed, when complex knowledge and technology cases are man-aged, more specialized courts and judges can better protect property rights. But, aspointed out in this paper, strong IPRs also depend on the existence of privateinstitutions and informal rules. Public authorities can support these institutions andfavor their emergence.
Y Concerning antitrust and (pro)-competition policies, our contribution points outthat the efficient transfer of knowledge requires contractual arrangements that haveanticompetitive properties (exclusivity clauses, long-term commitments, bundling,etc.). This does not mean that these arrangements should automatically be autho-rized. When there are private institutions to support the governance of technologytransfer, contracts that are too “relational” should not be permitted. When theseprivate institutions do not exist, they should be temporarily permitted according tothe gestation period of the technology [Krafft (1996)]. Moreover, antitrust authori-ties should authorize the development of those private arrangements and institutionsthat enable a technology market to emerge.
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From a theoretical point of view, the cases we studied pointed out two interestingphenomena used by economic agents to decrease transaction costs when transactionswould be expected to be costly because they are uncertain and complex, and becauseproperty rights are incompletely defined.
Y First, agents have recourse to informal and private collective means of governancelike conventions (informal rules) and private institutions (private supervisor, arbitra-tors, or standardization committees, among others). The important point, here, isthat these institutions do not only partially take charge of the enforcement ofcontracts [cf. Menard (1997)], but they also simplify their design by setting upcommon rules that avoid negotiations and provide agents with predesigned solutionsto their coordination problems [cf. Brousseau (forthcoming)].
Y Second, the securing of such transactions is preferentially performed through solu-tions that create mutual interdependencies (bundling, barter, and mutual safe-guards, for example) that, ultimately, strongly decrease the incentives to cheatbecause both parties share some common interest.
In both cases, TLA practices are highly suggestive because they suggest strategies foreconomizing transaction costs, the consequences of which should be better docu-mented to better advise economic agents and policymakers when they have to deal withtechnology and other intangible transfers.
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