Technology Licensing in a Dual‐Channel Supply Chain Under Network Effects

ABSTRACT Firms invest in technology development to secure proprietary innovations, which can be then monetized through licensing agreements with other entities. This, however, may erode the licensor's profitability due to diminished technological advantages and intensified market competition. In this paper, we examine a dual‐channel supply chain comprising a supplier that produces final products for a buyer while concurrently selling substitutable products directly to end customers. Our primary focus is on whether the supplier investing in quality‐enhancing technology should license this innovation to the buyer and, if so, how to select between per‐unit and ad valorem royalty contracts to maximize overall profits. For that purpose, we develop models for these licensing strategies, along with a benchmark no‐licensing model, and reveal that the licensing equilibrium depends critically on the buyer's initial product quality. Specifically, if the initial quality is low, licensing fails to occur because at least one party finds it unprofitable; if it is medium, per‐unit licensing emerges as the equilibrium; otherwise, the firms opt for ad valorem licensing. A crucial finding is that both per‐unit and ad valorem licensing can enhance consumer surplus and social welfare, provided that the initial quality exceeds certain levels within their respective feasible ranges. Furthermore, our sensitivity analysis shows that strengthened network effects increase the probability of a shift from ad valorem to per‐unit licensing, whereas heightened product competition across channels decreases the likelihood of licensing. Finally, we extend the model to a broader range of scenarios to verify that our key findings remain qualitatively robust. These findings offer actionable insights for innovative firms managing technology licensing decisions in co‐opetitive environments, particularly in markets characterized by network effects.