We study how downstream market characteristics affect upstream technologymarket and innovation incentives. Main result is that the scope of technologylicenses chosen by patent holder falls as downstream product differentiation orspillover effect gets lower. This means that although both lower differentiationand higher spillover effect intensify downstream market competition, they exertopposing effects on technology use and dissemination. Using this result weshow that optimal patent protection may have to be weaker as higherdifferentiation intensifies competition.