THE IMPERFECT MARKET FOR TECHNOLOGY LICENSES*
| Published date | 01 August 1983 |
| Date | 01 August 1983 |
| DOI | http://doi.org/10.1111/j.1468-0084.1983.mp45003002.x |
| Author | Harold Crookell,Richard E. Caves,J. Peter Killing |
THE IMPERFECT MARKET FOR TECHNOLOGY
LICENSES*
Richard E. Caves, Harold Croo kell and J. Peter Killing
International transfers of technology between independent firms have
stirred a good deal of discussion as an issue of economic policy. In the
United States fears are voiced that American companies sell their tech-
nology too cheaply, or undervalue the chances that transferred tech-
nology will escape into unauthorized, hands (Baranson, l978b).
Technology-receiving countries symmetrically feel that they pay too
much and that the transferred technology may be ill-suited to the
factor endowments of developing countries (Contractor and Sagafi-
nejad, 1981). Missing from this dialogue is an understanding of the
behaviour and efficiency of the arm's-length market for technology
licenses. We know that, like any market for intangible assets or infor-
mation, it is prone to failure. But we do not know what sorts of deals
are struck, how their terms reflect the parties' preferences, and how
incomplete the market turns out to be.
This paper contributes to our analytical knowledge of how imperfect
is the market for technology licenses. It reports the results of two
surveys of licensors and licensees participating in this market. The
evidence follows after a review of concepts that explain why the market
is imperfect and predict the specific appearance of imperfection.
I. SOURCES OF MARKET IMPERFECTION
The concepts needed to analyse licensing agreements lie in the literature
of institutional economics, with its emphasis on the costs and uncertain-
ties of contractual agreements between opportunistic parties. Williamson
(1 975) and Klein, Crawford and Alchian (1978) have emphasized the
ways in which contractual failures can dispose economic agents to
choose integration as a substitute for unsatisfactory arm's-length
relations. We know less about the arm's-length relations that do persist
in settings where we expect them to work imperfectly. The analysis
that follows rests on several assumptions, some needing empirical
defence, some not.
* Leonard Wrigley, now at the University of Cork, Ireland, was an important contributor to
the study in which the data for this paper were gathered.
249
250 BULLETIN
Small-numbers bargaining. A technology that remains under
proprietary control and ripe for licensing not fully embodied in
equipment and not diffused into general knowledge -- is typically
possessed by only a few firms (Contractor, 1981, p. 112). The number
of willing sellers of a technology is further limited by the alternative of
foreign direct investment, which often holds the potential for extract-
ing more of the available rents, and tends to become the choice of the
larger and more successful firms in a market. One might expect poten-
tial licensees to be numerous. However, competent licensees are clearly
scarce in some markets (Contractor, 1981, ch. 2), and in any case small-
numbers bargaining conditions set in once the potential licensor and
licensee begin to negotiate.
Impacted information and opportunism. Technical knowledge
possesses the classical property of asymmetrical access by the
potential parties to a transaction to knowledge about its expected pay-
out. The licensor has the relevant experience. If the licensee could fully
evaluate the proffered technology, the license agreement would dwindle
to a right to infringe the licensor's patents - not a rare outcome, as we
shall see. That licensors and licensees may both behave opportunistically
is apparent to all and discourages the use of guarantees to get around
impacted information.
Uncertainty. A technology's economic performance is uncertain.
The technology may not work properly in the new location; the
demand for the product that embodies it may change; newer tech-
nologies may displace it. As the obverse of the same coin, information
about foreign companies and markets, necessary to assess the probable
return to a technology transaction, is costly to secure. It is acquired and
processed only in limited amounts, therefore, and the potential returns
to the technology licensed abroad are accordingly uncertain.
Risk aversion. The parties to licensing transactions are assumed to
be risk averse. Licensing decisions may involve major discontinuous
choices for both licensor and licensee, thereby threatening the parti-
cipants in their respective organizations. The licensor risks the escape
of his technology from proprietary control, the opportunity-loss of
profits foregone from foreign investment when the alternative strategy
of licensing works out badly, and the emergence of a new competitor
when it works too well. The licensee may make a substantial investment
in physical facilities and marketing outlays on the uncertain prospect
that a licensed technology will in fact perform as promised.
Transaction costs. The preparation and contact costs involved in
transferring technology are not trivial, and they strongly qualify the
public-good character that economists assign to technological knowledge.
Teece (1976) (also see Lovell, 1969, and Derakhshani, 1980, ch. 5),
puts the resource cost of transferring technology at between 2 and 59
per cent of the recipient's project total cost (average 19 per cent).
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