Mergers and Licensing With Horizontal Differentiation

ABSTRACT We consider a research laboratory that owns a patented process innovation and two firms producing differentiating goods in a Bertrand setting. The laboratory considers the possibility to license the innovation as an outsider patentee or to merge with one of the firms in the industry, becoming an incumbent patentee. Licensing takes place through observable two‐part tariff contracts. We show that the merger is profitable only for small innovations and increases social welfare for both small and large innovations. Even though we allow the royalty to be higher than the size of the innovation, and opposite to the result in a Cournot setting, we find a region where the merger is both profitable and welfare improving. This occurs only for small innovations and sufficiently differentiated goods. The same result arises for consumer surplus which allows us to derive the optimal merger policy: compared with Cournot competition, a Bertrand setting calls for a more lenient merger policy.