38E00100Economics and Management of Intellectual Property

Lecture 12, Part VIII

“Basic Corporate IP Strategy: Patenting vs. Secrecy ”

Tuomas Takalo, 21.2.www.takalo.net

Lectures, the background material + Book

• The whole book except for chapter 8• So far we have more or less covered chapters 1-7,

9 and parts from 10-11. • The rest of the lectures relate less to the book

(besides chapter 10)

One question from the guest lectures

One question from Välimäki’s lectures

2-3 questions from my lectures + book

at least one will involve some algebra or game theory

Exam 5.3

Part I. Basic IP Law (V)

Part II. Use of IPRs (V)

Part III. Basic Economics of IP (T)

Part IV. Breadth and Duration of IP and Their Optimal Design (T)

Part V. Cumulative Innovation and IP (T)

Part VI. Competition Policy and IP (T+V)

Part VII. Litigation (Cases) (V)

Part VIII. Basic IP Corporate Strategy (T)

Part IX. Industry Studies 1. Financial Services (T)

Outline of Core Lectures

• The point is to embody in products as much as possible asset-specific human capital of the firms

• IPRs typically help, but…

• There are other appropriability stragies than IPRs • secrecy, lead-time, marketing, complementary

services and sales

• Holistic approach to IPRs

• Use many IP and complementary tools

Basic Corporate IP Strategy. Patenting vs. Secrecy

Intellectual property rights

Industrial Property CopyrightsTrade secret

(secrecy)

Patents and other forms of protection of inventions

Identification marks

Brief Overview of IPRs

Consider waiving IPRs

- Monitoring is not possible

- Not enough resources for monitoring and defending IPRs

- IPs would imply too much disclosure

- IP protection would be easy to “invent around”

- Invention becomes obsolete rapidly

- Other appropriability mechanism cheaper and more efficient

Basic Corporate IP Strategy

InventionProtect via IPRs

Publication

Monitoring rivals’patents

Contracts

Secrecy

Patent UtilityModel

Trademark

Design Protection ©Trade

markWidelyLocally© ,

Trademark

DisputesAgreementsCourt cases

Actions if contract breach/

unlawful employee communication

Monitoring Infringements

Monitoring contracts

1

2

4

3

DesignProtection

©

Two puzzling facts

1. Firms rely more on patent protection

E.g. Microsoft, Sun, HP, Nokia

E.g., Microsoft’s strategy change

• In 1976 software was not patentable and Microsoft relied on copyrights and trade secrets.

• Due to a reinterpretation of the US patent law (the S upreme Court decision (Diamond v. Diehr, 1981), software patenting became possible.

• Microsoft did not bothered to patent its software professionally, partly because of ideological reasons (Gates thought such patents are bad for industry and society)

• In the early 2000 Microsoft’s non-patent IP strategy became unsustainable:

- It was sued all the time and had to pay hundreds of millions dollars

- Antitrust authorities wanted Microsoft to disclose its trade secrets

- Open source software started to bite in its operating system market power

• Microsoft had basically three choices:

1) Patent and use patents defensively/strategically

2) Patent and use patents offensively (sue others)

3) Patent and use patents commercially (license)

• Microsoft’s choice: in 2003 they hired IBM’s former IPR boss and established IP licensing division and a new business unit

• Their purpose is to ensure that Microsoft’s technologies are patented and that it gets revenue out of the patents

• This is a fundamental change as not all IT firms regard their IP unit as a business unit

US patents

0200400600800

1000120014001600

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

Years

Pa

ten

tsMicrosoft

Nokia

Fact 2:

• In surveys, firms claim that other appropriability mechanism are superior (Cohen et al. 2000, Arundel, 2001, Byma and Leiponen, 2006)

• Anecdotal evidence: firms keep in secret what ever they can

• The puzzle: why do firms patent while claiming that patents are no good in protecting their inventions?

• An answer: arms race

• you need to acquire IPs because everybode else is doing so

• a patent thicket/minefield where you will certainly infringe the rivals’ patents and face law suits

• however, if you have a large patent portfolio, your rivals will most likely infringe your patents’ too settle the case via cross-licensing

• It can even be so that the firms were better off without IPs (and that shows up in the surveys)

Using game theory: The arms’ race as a prisoners’ dilemma game

• Cf. the consumer protection game in my previous lecture

• Consider two firms/players, 1 and 2, that have two strategies, Secrecy (S) and Patenting (P).

• a strategy: a complete contingent action plan fro a player in the game

• Let 1(i,j) be the payoff of firm 1 when it uses strategy i and firm 2 uses strategy j, i,j{S,P}

• Let 2(i,j) be the payoff of firm 2 when it uses strategy j and firm 1 uses strategy i, i,j{S,P}

• A pair of strategies is a Nash equilibrium

• if firm 1’s choice is optimal given firm 2’s choice

• and

• if firm 2’s choice is optimal given firm 1’s choice

• E.g., Secrecy (S,S) is a Nash equilibrium if 1(S,S) 1(P,S) and 2(S,S) 2(S,P)

• A dominant strategy is such that there is one optimal strategy for a firm no matter what the other firm is doing

• E.g., Secrecy (S,S) is a dominant strategy equilibrium if 1(S,j) 1(P,j) for i,j{S,P} and 2(i,S) 2(i,P) for i,{S,P}

• A dominant strategy equilibrium is a Nash equilibrium but it is much stronger equilibrium concept so we except it to be the equilibrium outcome of a game

• In a prisoners’ dilemma type game the dominant strategy equilibrium is not Pareto efficient, i.e., the firms were better off if they could commit to employ another pair of strategies.

• It may be that patenting (P,P) is such dominant strategy equilibrium!

• let profit of a player and c the cost of patenting

0

2 c

c2

0

c

c

Secrecy Patents

Secrecy

Patents

Firm 2

Firm 1

The Arm’s Race:Payoff Matrix

• If >c, then secrecy would offer higher payoffs but a firm is forced to patent since the other firm is doing so

Recall: The consumer protection game:

If 1-c/up c/u, then (not acting, not acting) a dominant strategy Nash equilibrium

cpu

pu

pu

cpu

0

0

cu

cu

Act Do not act

Act

Do not act

Consumer 2

Consumer 1

Consumers’ problem

Note 1) The patenting game arises because

- firms can and do make independently similar innovations

- the independent invention is not a defense against infringement in the patent system

- more relevant to the first-to-file system than first-to-invent

- however, the first-to-file is counterbalanced with prior-user-rights

Note 2) If patenting is indeed a Pareto inefficient dominant strategy Nash eq., it will justify disclosure/contract theory of patents

• even if patent system is weak and implies much disclosure, the firms will patent

• what happens to the incentives to innovate?

Note 3) The surge of patents may be caused by a shift in competitive advantage of the patent holder as against the firms’ resorting to secrecy but not in the appropriability capacity of secrecy

• E.g. the US legal changes since the early 1980s

• With a weaker competitive advantage of the patent holder there may be two Nash equilibria, Secrecy and Patenting

• If secrecy yields higher payoff to the firms, we may speculate that most firms are able to coordinate to that equilibrium over time

- Cf. the major work of Thomas Schelling, the Econ. Nobel Prize Winner 2005

0

c

c0

c

c

Secrecy Patents

Secrecy

Patents

Firm 2

Firm 1

Patenting game with a weaker competitive advantage of the patent holder

Note 4) The big question: Are R&D and patents/IP complementary competitive strategies or substitute?

• If substitute, an increase in patenting will mean less R&D

• If complementary, the patent system works as it should

• Max profit without R&D, 2 with R&D.

• Cost of investment R<

• If both firms in the market, each of them gets a share s1/2 of the max profit.

• s is a measure of competition s→0 = a lot of competition (Bertrand) s→1/2 = collusion

• If one firm in the market, it gets the whole market

• the patent holder can exclude the other from the market

• If both apply for a patent, Pr. of getting it 1/2

0

2 R

R2

0

R

R

s

s

No patents, No R&D Patents, R&D

No patents,No R&D

Patents, R&D

Firm 2

Firm 1

R&D and patents as complementary competitive strategies

R

R

2/

2/

Rs

Rs

2

2

No patents, R&D Patents, no R&D

No patents, R&D

Patents, no R&D

Firm 2

Firm 1

R&D and patents as substitute competitive strategies

38E00100Economics and Management of Intellectual Property

Part IX

“Innovation and IP in Financial Services Sector ”Tuomas Takalo, 21.2.

www.takalo.net

Tufano, Handbook of Corporate Finance, 2003, Frankel and White JEL-2004

• Financial service sector

• financial intermediaries (e.g., banks, mutual funds, venture capitalists),

• investment service providers

• stock market infrastructure (e.g., exchanges and clearing & settlement),

• payment media (e.g., credit card companies, interbank paymets)

Part IV. Innovation and IP in Financial Service Sector

• Innovation in financial services

• Product innovations. E.g., new derivatives, new mutual funds, new payment media

• Process innovations. E.g., new process for interbank payments, new methods for calculating the value of mutual funds

• Cumulative

• E.g., equally weighted market fund 1971, value-weighted fund 1973….exchange traded funds 1990…holding company depository receipts 1998

• Rapid innovation rapid diffusion

Financial services

Growth

Innovation in other sectors

Innovation in financial service sector

Welfare effects of financial innovation

Note: financial innovation can be harmful

- Any innovation can be harmful due to the (theoretical) possibility of overinvestment/duplication

- But there is an extra reason to worry in case of financial services sector: It is heavily regulated

• Transactions costs• Stability

a lot innovation to circumvent regulation

a concern for the stability

• Appropriating strategies in financial services traditionally:

• Patents were not available (in such a way as today)

• Secrecy does not work for product innovations

• Copyrights?

• do not prevent imitation

Imitation of product innovations rapid

Lead time & marketing the best means of appropriation

– Other mechanisms:• Reputation & Size• Complementary assets• Joint ventures• Regulatory barriers to entry

• However, the things have changed in the U.S & Asia

• Patents are not new to financial services• But today’s patents are rather different

• Europe?