We study optimal linear licensing and its social welfare implications when the innovator (patentee) is an insider that can make capacity/output commitment so as to act as a Stackelberg leader in the output market. We show that (i) the patentee's profit-maximizing licensing contract is a royalty; (ii) the optimal royalty rate is greater than the cost reduction attained by the licensed technology and is increasing in the number of competitors; (iii) optimal licensing maximizes the likelihood of technology transfer, may reduce social welfare and always makes consumers worse off; and (iv) the innovator benefits from capacity commitment, and the more competitive the output market, the greater the gains it makes by licensing. The opposite holds for consumers.

This paper analyses an optimal two‐part licensing scheme based on ad valorem royalties within a differentiated Bertrand duopoly where the innovator is also the downstream producer, and compares it with the optimal two‐part per‐unit royalty mechanism. After showing that the optimal two‐part ad valorem licensing scheme reduces to a pure ad valorem royalty scheme, we show that per‐unit contracts are typically preferred to ad valorem contracts by the patentee, as, under price competition, the per‐unit royalty has a stronger strategic effect than the ad valorem royalty. In contrast, welfare is higher under the ad valorem contract than under the per‐unit mechanism.

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