Entry of Innovator and License in Oligopoly

When an outside innovating firm has a cost-reducing technology, it can sell licenses of its technology to incumbent firms using a combination of royalty and fixed fee. Alternatively, the innovating firm can enter the market and at the same time sell licenses, or enter the market without license. We examine the credibility of the threat of entry by the innovating firm using a two-step auction under oligopoly with three firms, one outside innovating firm and two incumbent firms. With general demand function, we show that the credibility of the two-step auction depends on the form of the cost function of the new technology, whether it is concave or convex. Also we analyze the optimal strategy for the innovator in a case of linear demand and quadratic cost functions in which the two-step auction is credible.