Economics of Patent Pools When Some (but not all) Patents are Essential

Patent pools are agreements by multiple patent owners to license certain patents to third parties as a package, and often form in conjunction with the development of a technological standard. A key distinction made by regulators - between patents which are essential to a standard and patents for which suitable substitutes exist - has not been captured in existing economic models. I present a model of competition among differentiated technologies, in which some patents are essential and some are not. I show that pools of essential patents are Pareto-improving whenever they occur, while pools of nonessential patents can be welfare-negative, even when the included patents are all complements. I discuss conditions under which certain pools are likely to form, the "outsider problem" which makes some pools inefficiently small, and the effects of compulsory individual licensing.