1. NEW PRODUCT LICENSING: Why do companies license their IP?
Feryal Erhun
Enis Kayis
Management Science and Engineering
Stanford University
Mark Wilkinson
Intel Corporation
MSOM Conference 2005

2. The Transformation of the Computer Industry (80’s and 90’s)
Sales and
distribution
Application
software
Operating
system
Computer
Chips
IBM
DEC
Sperry
Univac
Wang
Sales and
distribution
Application
software
Operating
system
Computer
Chips
Intel Architecture
DOS and Windows
Word
Perfect
Etc.
OS/2
Mac
UNIX
Dell
Compaq
Packard
Bell HP
IBM
Superstores
Retail
Stores
Dealers
Mail
Order
Motorola
Source: A.S. Grove (1999) Only The Paranoid Survive: How to Exploit the Crisis Points That
Challenge Every Company, Currency-Doubleday, New York, NY. 2

3. Motivation: The Tale of Three Companies (The Story of IBM, Intel, and AMD)
IBM adopted x86 chips for its first computers in 1982
As part of the deal, Intel had to license the x86 architecture to AMD so that IBM could have a second source of chips
Intel, as a new player in the arena, did not have enough capacity to satisfy all the demand and needed the extra respectability that second sourcing provides
Licensing helped Intel by encouraging other producers to push the Intel product while discouraging their own future generations of chips
Source: 3

4. Motivation: Moving R&D to High Volume (R&D Labs)
Lack of production capacity to produce output at a level necessary to satisfy total market demand
Manufacturing costs at R&D facilities are usually higher than at high-volume manufacturing facilities
Outsource/license the product to reach a bigger market at lower costs 4

5. Research Questions
Why/when would a company license its intellectual property (IP)?
What is the role of an inventor’s capacity in the market equilibrium?
What is the role of manufacturing cost in product licensing? 5

6. Agenda
Model Definition
Analysis of the Model
Conclusion 6

7. Model Definition-I CS OEM CS2 End consumers Price p Wholesale price,
Literature Review
Model Definition
Analysis of the
Model
Extensions
Conclusion 7

8. Outsource the production to CS2 License the component to CS2
Model Definition-II
CS2
OEM CS
Wholesale price, w1
End consumers
Price p
CS2
OEM CS
Wholesale price, w1
End consumers
Price p
Royalty Fee, α
Wholesale price, w2
Outsource the production to CS2
Transfer Price, t2
License the component to CS2
Literature Review
Model Definition
Analysis of the
Model
Extensions
Conclusion 8

9. Modeling Demand
CS develops a component, which will be embedded within OEM’s new product
The potential number of customers attracted by OEM’s product is N
The probability that any customer purchases OEM’s product at price p with price sensitivity b is:
The aggregate demand is therefore:
Literature Review
Model Definition
Analysis of the
Model
Extensions
Conclusion 9

10. Modeling Supply
CS may produce her proprietary component at unit production cost c and sell it to OEM at a wholesale price w1
CS has limited production capacity K
CS can subcontract the production to CS2, who has “virtually unlimited capacity” and lower production cost c
Literature Review
Model Definition
Analysis of the
Model
Extensions
Conclusion 10

11. Agenda
Model Definition
Analysis of the Model
Licensing
Conclusion 11

12. Analysis Case III Case II Case I NO YES NO YES Produce capacity,
LICENSING
Analysis
License
the product? NO
YES
Participate in
production? NO
YES
Case II
Produce all
(D,0)
Condition: D<K
Case I
License all
(0,D)
Case III
Produce capacity,
license the rest
(K,D-K)
Condition: D>K
Literature Review
Model Definition
Analysis of the
Model
Extensions
Conclusion 12

13. LICENSING
Results
CASE II
(D,0)
CASE I
(0,D)
CASE III
(K,D-K) 13

14. Summary of the Results - Licensing
Royalty fee is independent of CS’s capacity
It depends only on price sensitivity and CS2’s cost
Even when CS has “virtually unlimited capacity,” she may still want to license
When the capacity is limited, licensing creates competition for CS2
CS2 produces more than he wants
More capacity is not always good for CS
Literature Review
Model Definition
Analysis of the
Model
Extensions
Conclusion 14

15. Agenda Model Definition Analysis of the Model Licensing Outsourcing
Conclusion 15

16. Analysis Similar to licensing contracts, three cases to analyze:
OUTSOURCING
Analysis
Similar to licensing contracts, three cases to analyze:
CASE A: CS2 sets transfer price t2<c, hence CS outsource all her production - (0,D)
CASE B: CS2 sets transfer price t2=c, hence CS is indifferent between in-house production and outsourcing - (0,D)
CASE C: CS2 sets transfer price t2>c, hence CS outsource the residual demand – (K, D-K)
Literature Review
Model Definition
Analysis of the
Model
Extensions
Conclusion 16

17. Results CASE B CASE A (0,D) (0,D) CASE C (K,D-K) OUTSOURCING
Literature Review
Model Definition
Analysis of the
Model
Extensions
Conclusion 17

18. Summary of the Results - Outsourcing
CS2 has “virtually” moved up in the supply chain Hence it is:
Driving the supply chain
Getting most out of the relation
Always participates in production
CS’s capacity can be used strategically when she does not have “virtually unlimited capacity”
CS does not participate in production even if she has too much capacity
Literature Review
Model Definition
Analysis of the
Model
Extensions
Conclusion 18

19. Agenda Model Definition Analysis of the Model Licensing Outsourcing
Comparison
Conclusion 19

20. Licensing vs. Outsourcing (CS’s profit)
Licensing is weakly preferred for almost all of the K-c region:
Better outcome is sustainable with licensing
Royalty fee is higher than profit margin from outsourcing
Literature Review
Model Definition
Analysis of the
Model
Extensions
Conclusion 20

21. Conclusion
Licensing is a reasonable alternative to outsourcing for a low cost, under-capacity supplier
Capacity can be used strategically by both suppliers to achieve higher profits, especially when CS’s capacity is low
Even when building capacity is free, it is not always in CS’s best interest to increase her capacity, especially when her supply chain partners know her exact capacity
CS does not always produce more when her capacity increases
Literature Review
Model Definition
Analysis of the
Model
Extensions
Conclusion 21

22. THANK YOU! QUESTIONS? Service & Repair Concept Functioning Design
Strategic Sourcing
2nd Source Manufacturing
Mechanical Design Services
Procure Components
Plastics
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Testing
Final Packaging
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Chip Packaging
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