Cross-licensing or not: The optimal choices of competing ICT firms in a duopoly market

Abstract

Cross-licensing, which grants each party the right to produce products using the other's patents, is a prevalent strategy for information and communications technology (ICT) firms to improve product quality and respond to intense competition. This study focuses on the cross-licensing choices of two competing ICT firms that engage in price competition with substitutable products of different quality levels. Using a game-theoretical model, we find that each firm will have a higher (lower) profit as its competitor's product quality improves in a price-sensitive (quality-sensitive) market. Signing a cross-licensing agreement is profitable for the two firms when their quality improvements are roughly symmetric or when customers are sensitive to the price difference but less sensitive to the quality difference. Furthermore, we examine the quality-to-price ratio, which reflects customer perceived value, and find that cross-licensing may achieve a win–win–win situation for both firms and customers when there is no significant difference in quality improvements between the two firms or when the competition intensity is moderate. The rationale behind these results hinges on the integration of the quality improvement effect and the quality differentiation effect. The results explain the observations of ICT firms' cross-licensing practices and provide managerial implications for ICT firms and policymakers.