Licensing of Component Technologies

Citing the need for rapid product development, end-product manufacturers in a variety of industries license even core technologies from upstream technology provider firms while focusing primarily on efficient integration and/or assembly. In this paper we analyze the strategic introduction decisions of a technology provider firm who licenses new component technologies to such end-product manufacturers. Following Ulrich’s (1995) conceptualization of product architecture, we identify two distinct dimensions of a component what it does (i.e., the amount of different product functions fulfilled by the component) and how well it does it (i.e., the performance offered by the underlying technology) and examine their impact on the technology provider’s optimal licensing strategy. We develop a game theoretic model to account for the strategic interaction among the players and characterize the technology provider’s optimal introduction strategy (i.e., the number of licensees and the mode of licensing), contingent on the component and market characteristics. We find that offering a highly integrated component has a dual effect on the technology provider’s profits. On the positive side, the provider may be able to extract larger “ease-of-use” rent from the end-product manufacturers as such components are easier to integrate (lower integration costs/risks) into the end-products. On the negative side, such highly integrated components may curtail the end-product manufacturer’s ability to differentiate from competitors, and thus, render such components less preferable. In addition, we offer an interesting typology of technological uncertainty and demonstrate that much of the conventional wisdom relating to detrimental effects of uncertainty may be applicable only to certain forms of uncertainty and not to others.