Technology Licensing Versus Cannibalization, and Consumers' Welfare in Vertical Product Quality Market

ABSTRACT This paper investigates the strategy choice of a high‐quality firm confronted with the entry of a low‐quality competitor in vertical product‐quality difference markets. We find that due to asymmetric market power, the high‐quality firm may prefer quality licensing over cannibalization as its optimal strategy. Fixed‐fee licensing contract has the potential to enhance consumer surplus and boost the profits of both firms, making it a potentially optimal choice for the high‐quality firm to license its technology to the low‐quality firm. Our study offers insights on the optimal strategy for a high‐quality firm when confronted with the presence of a low‐quality competitor.