Specialization through Cross-licensing in a Multi-product Stackelberg Duopoly

We argue that cross-licensing is a device to establish specialization in a multi-product Stackelberg duopoly under process innovation. The optimum licensing contracts are royalty contracts. These are designed so as to implement the joint-profit maximization (monopoly) outcome as the unique Nash equilibrium of the competition game. The monopoly-First-Best optimum is attained: each firm produces solely the good for which it has a technological advantage, firms' joint profits attain the First Best optimum. We study the implications of limitations to contract enforceability and find that this may reduce the attained degree of specialization, but social welfare may increase.