Optimal pricing policy design for selling cost-reducing innovation in Cournot games

Abstract

In a marketplace where a number of firms produce and sell a homogeneous product, an innovator develops cost-cutting manufacturing technology and decides to sell it to various firms in the form of a license for profit. Given the innovator's license pricing policy, each firm independently decides whether to purchase the innovation license and how many products to produce. To put it simply, the firms are then in a Cournot market in which the product price is a decreasing function of the total amount of the product on the market. Both the innovator and the firms are acting out of self-interest and look to maximize their utilities. We consider the problem of designing optimal pricing policies for the innovator. A pricing policy could be in the form of a one-off upfront fee, a per-unit royalty fee, or a hybrid of both. Building upon the results of Segal [1], we first show that in a properly designed pricing policy, it is a strictly dominant strategy for the firms to accept the pricing policy, and that this constitutes the unique Nash equilibrium of the game. For the hybrid-fee policy, we devise an algorithm that computes the optimal price in time O(n ³), where n is the number of firms. For the royalty-fee policy, we show that the problem is captured by convex quadratic programming and can be solved in time O(n ⁶L ²), where L is the number of input bits. For the upfront-fee policy, we show the optimal policy problem is NP-complete and we devise an FPTAS algorithm. Moreover, we compare the revenue achievable through the above three pricing policies when all firms are identical.

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