The recent interest in traditional knowledge systems within health care and biodiversity sectors is directly related to the profitable innovations that traditional knowledge can generate. This paper seeks to examine the nature of economic incentives required for protecting and sustainably using traditional knowledge. The paper asks two key questions: (a) under what conditions do communities and pharmaceutical companies enter into contracts to develop traditional knowledge-based innovations? And, (b) what factors influence the benefit-shares of the two parties from commercial use of traditional knowledge? Adapting a bargaining model, this paper shows that the actual sharing of the revenues depends on a number of issues, most importantly, the relative bargaining strengths of the two parties. Factors that affect profits and relative bargaining strengths include the contributions of the parties in developing the innovation, the availability of alternative sources and options, differences in expectations over future revenues and costs, and the involvement of a third party in the negotiations. Such factors need to be taken into account in designing incentive schemes that can help communities benefit from the use of their traditional knowledge.