Product innovation and vertical integration: private and social incentives

We study the licensing incentives of an independent input producer owning a patented product innovation which allows the downstream fi…rms to improve the quality of their fi…nal goods. We consider a general two-part tariff contract for both outside and incumbent innovators. We …find that technology diffusion critically depends on the nature of market competition (Cournot vs. Bertrand). Moreover, the vertical merger with either downstream …firm is always privately pro…fitable and it is welfare improving for large innovations: this implies that not all pro…table mergers should be rejected. We contribute to the literature on optimal licensing of product innovations as well as to the literature on the competitive effects of vertical integration.