By IESE Insight
When you think of video technology, do you think of Ampex, the company that invented the first commercially viable VCR? Probably not. Despite its innovation, Ampex was edged out of the digital recording market — and it’s all to do with licensing.
Ampex licensed its cutting-edge technology to rival firms like Sony, who improved on the Ampex VCRs, dominated the market, and finally made the original technology obsolete.
This is a classic case of what researchers call the “boomerang” effect: the risk that a new technology’s licensee will develop it further to the point that they can overtake the licensor. Clearly, companies that license their technology need to protect themselves from potentially getting left behind. But given the complexity of technology innovation, and the uncertainty of the market, it’s impossible to design a licensing contract that protects for every eventuality.
That’s why some companies use a “grant-back clause” in their licensing contracts — a requirement that any improvements made to the licensed technology must be shared with the licensor. While a grant-back clause protects the licensor, it can make the licensee less invested in developing the technology.
Balancing potential gains and prudent protections in contracts isn’t easy. So how do firms decide whether it’s a good idea to include a grant-back clause? Research by Keld Laursen, IESE’s Solon Moreira, Toke Richstein and Maria Isabella Leone, published in Organization Science, homes in on two key factors that have a significant influence on the decision:
- whether the innovation is a core technology for the company, and
- whether the technology’s future is uncertain or secure.
They test the significance of these factors by analyzing 397 patented and licensed technologies in the pharmaceutical industry.
So, what’s the managerial take-away? The results of this study suggest that including a grant-back clause is most desirable when a licensor is trading a core technology and when there are high levels of uncertainty about the technology’s future.
Managers looking to increase rents from technology innovation must understand not only the opportunities and risks of licensing, but also how to design effective licensing contracts with provisions like the grant-back clause. The insights from this research may help guide the decision to use a grant-back clause or not.
When a Grant-back Clause Is Desirable
A firm’s core technologies are central to its ability to create value, and so these assets need to be protected. A company must retain control of its core technologies with patents and careful contract provisions so that it can use its innovative knowledge and experience effectively and create future innovations.
For the potential licensee of a licensor’s core technology, the grant-back clause can reduce potential future benefits from the technology contract. But the benefits of accessing this technology may outweigh these disadvantages, especially if it is an unfamiliar technology (say, a gene therapy innovation licensed by a more traditional drug company).
When a firm is uncertain about the future of a technology — for instance, when a patented breakthrough is still far from being commercialized — this effect is intensified. Licensors are most likely to add a grant-back clause in the case of technology that is both core to their business and uncertain.
When Companies Avoid the Grant-back Clause
A licensee also needs to protect its future rents in the licensing agreement. If the technology traded is closely related to the licensee’s own core patents, that company is unlikely to agree to a grant-back clause, as it will want to use its core experience and expertise to develop the technology. In this case, it will not want to share future property rights with the inventor.
So, the patent-holder may forgo a grant-back clause in these circumstances, especially if the technology is not core to their own business. If the licensor considers the licensee’s potential developments predictable and low-risk, the grant-back clause is also likely to be deemed unnecessary.
In sum, contracts matter. Licensing arrangements should strike a delicate balance between protecting innovation and allowing both companies involved to maximize their gains. Knowing when to include a grant-back clause can allow companies to strike this delicate balance and better create joint value.
Methodology, Very Briefly:
To test the authors’ hypotheses re: the likelihood of using grant-back clauses, they analyze a sample of 397 patented and licensed technologies in the pharmaceutical industry over the period 1984-2004, while controlling for many firm- and market-level variables (such as patent value and firm size). The data offered significant support for all the hypotheses.