Licensing and Price Competition in Tied-Goods Markets: An Application to the Single-Serve Coffee System Industry

The authors develop a structural model of demand and supply for tied goods, which they estimate using aggregate data from the single-serve coffee system industry. The authors use the parameter estimates to quantify the impact of licensing on equilibrium prices and profits for firms in the industry. In particular, the authors look at the decision to allow other firms to sell components (coffee pods) that are compatible with a firm’s primary good (coffee machines) by licensing the use of its patents. The authors solve for the counterfactual market equilibrium in which one of the market leaders enters a licensing agreement with one of the competitor brands - with the latter brand only selling compatible coffee pods and not the machines. The authors show the existence of a range of royalty rates under which firms could potentially reach a beneficial licensing agreement. In addition, the authors find that the relationship between the licensee’s profits and the royalty rate is not always decreasing. Finally, the authors find that, within the set of royalty rates in which licensing benefits both brands, the licensing agreement is associated with less price dispersion in the aftermarket (coffee pods), and with lower prices of the primary good (coffee machines) relative to the nonlicensing scenario.