levin klevorick nelson winter gilbert griliches appropriability p&d bpea 1987

7/22/2019 Levin Klevorick Nelson Winter Gilbert Griliches Appropriability P&D BPEA 1987

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RICHARD C. LEVINYale UniversityALVIN K. KLEVORICKYale UniversityRICHARD R. NELSONColumbia UniversitySIDNEY G. WINTERYale University

Appropriatingh e R e t u r n sf r o m Industrial Research

a n d Development

To HAVE the incentive to undertakeresearch and development,a firmmust be able to appropriate eturns sufficientto make the investmentworthwhile.The benefits consumers derive from an innovation, how-ever, are increased if competitors can imitate and improve on theinnovation o ensure ts availability n favorable erms. Patent aw seekstoresolvethis tensionbetweenincentives or innovationandwidespreaddiffusionof benefits.A patentconfers, in theory, perfectappropriability(monopoly of the invention)for a limitedtime in returnfor a public

Weare grateful or the supportof the NationalScience Foundationand especially toRolfPiekarz f the NSF's Divisionof Policy Researchand Analysis.We also wish to thank he 650respondents o oursurveyandthe R&Dexecutiveswhohelpedus pretest t-especially RalphGomory,BruceHannay,andLowellSteele. DonaldDeLuca,WendyHorowitz,and othermembersof the RoperCenter or SurveyResearchhelpedmanage he survey. RobertW. Wilson, and MargaretBlair, MarcChupka,EmilyLawrance,ConstanceHelfat,AndrewJoskow, KathleenRodenrys,Somi Seong, AndreaShepard, ndHal Van Giesonalsoprovidedvaluableassistance.783

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784 Brookings Paper-s on Economic Activity, 3:1987disclosurethatensures, again ntheory,widespreaddiffusionof benefitswhen the patentexpires.Previous investigations of the system suggest that patents do notalways work in practice as they do in theory.' On the one hand,appropriabilitys notperfect. Manypatentscan becircumvented; thersprovide ittleprotectionbecauseof stringent egalrequirementsorproofthat they are validor thatthey arebeing infringed.Onthe otherhand,publicdisclosuredoes not alwaysensure ultimatediffusionof an inven-tion on competitive terms. For example, investmentsto establish thebrand name of a patentedproductmay outlive the patent itself.2 Andpatents may not always be necessary. Studies of the aircraft andsemiconductorndustrieshave shownthatgaining eadtime andexploit-inglearning urve advantagesare theprimarymethodsof appropriatingreturns.Otherstudies haveemphasized he importanceof complemen-taryinvestments n marketing ndcustomerservice.3Evidenceon the natureandstrengthof conditions orappropriabilityand on the working of the patent system is, however, scattered andunsystematic. Because imperfectappropriabilitymay lead to underin-vestment in new technology, and because technologicalprogressis aprimary ource of economicgrowth,it wouldbe usefulto have a morecomprehensive mpiricalunderstandingfappropriability,nparticular,to identify those industries and technologies in which patents areeffective npreventing ompetitive mitationofa newprocessorproduct.It would also be desirableto know where patents can be profitablylicensed. Wherepatentsare not effective, it would be useful to under-standwhy theyarenotand whetherothermechanismsare.

1. F. M. Scherer and others, Patents and the Coiporation: A Report on IndustrialTechnology under Changing Public Policy, 2d ed. (privately published, 1959); and C. T.Taylor and Z. A. Silberston, The Economic Impact of the Patent System: A Stludyof theBritish Exper-ience(Cambridge University Press, 1973).2. See, for example, Meir Statman, "The Effect of Patent Expiration on the MarketPosition of Drugs," in Robert B. Helms, ed., Drulgs and Health: Economic Issues anidPolicy Objectives (Washington, D.C.: American Enterprise Institute, 1981), pp. 140-51.3. The importance of lead time and learning curve advantages is documented inAlmarin Phillips, Technology and Market Structure: A Study of the Aircraft Indiustry(Lexington Books, 1971);and John E. Tilton, International Diffuision of Technology: TheCase of Semicondiuctors (Brookings, 1971). For the importance of marketing and customerservice, see Marie-Therese Flaherty, "Field Research on the Link between TechnologicalInnovation and Growth: Evidence from the International Semiconductor Industry,"working paper 84-83 (Harvard University, Graduate School of Business Administration,no date).



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R. C. Levin, A. K. Klevorick, R. R. Nelson, and S. G. Winter 785This paper describes the results of an inquiry into appropriabilityconditions in more than one hundredmanufacturingndustries. Wediscuss how thisinformationhas been and mightbe usedto cast light onimportant ssues in the economics of innovationandpublicpolicy. Ourdata,derived roma surveyof high-levelR&Dexecutives, areinformedopinionsaboutan industry'stechnologicalandeconomic environmentrather han quantitativemeasuresof inputsandoutputs.Although our use of semantic scales to assess, for example, theeffectiveness of alternativemeansof appropriationntroduces consid-erable measurementerror, more readily quantifiableproxies would

probablynot serveas well. Remarkableprogresshas beenmadetowarddevelopinga methodologyto estimate the economic value of patents.4But suitable data are as yet unavailablein the United States, andEuropeandata ack sufficiently eliabledetail o supportnferencesaboutinterindustry ifferences n the valueof patents.Ourjudgmentwas thataskingknowledgeablerespondents about the effectiveness of patentsandalternativemeans of appropriationwas at least as likely to produceuseful answers as asking for quantitativeestimates of the economicvalueof a typical patent.We have takenconsiderablecare to establishthe robustness of ourfindings n the presenceof possibly substantialmeasurementerror,butultimately the value of the data will depend on their contributiontobetterempiricalunderstanding f technologicalchange and more dis-criminating iscussion of publicpolicy. To view the empiricalcontribu-tion of the data from the simplestperspective, considertheirpotentialforimprovinghequalityof research hat uses patentcounts to measureinnovativeactivity.5This line of inquiryhasshown,amongotherresults,that industriesvary significantlyin the average number of patentsgeneratedby eachdollarof R&D investment.6Ourfindingson industry

4. See, especially, Ariel Pakes, "Patents as Options: Some Estimates of the Value ofHolding European Patent Stocks," Econometrica, vol. 54 (July 1986), pp. 755-84.5. For a summary of the best of this work, see Zvi Griliches, Ariel Pakes, and BronwynH. Hall, "The Value of Patents as Indicators of Inventive Activity," working paper 2083(Cambridge, Mass.: National Bureau of Economic Research, November 1986). For otherperspectives on the usefulness of patent data, see the special issue of Research Policy,vol. 16(August 1987).6. F. M. Scherer, "The Propensity to Patent," International Journal of IndustrialOrganization, vol. 1 (March 1983), pp. 107-28; and John Bound and others, "Who DoesR&D andWho Patents?" in Zvi Griliches, ed., R&D, Patents andPProductivity Universityof Chicago Press for National Bureau of Economic Research, 1984), pp. 21-54.



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786 Brookings Papers on Economic Activity, 3:1987differences n patenteffectiveness may help explainthis variation n theapparentproductivityof R&D.More undamentally, argeandpersistent nterindustry ifferences nR&D nvestmentand nnovativeperformancehave resisted satisfactoryexplanation, in part for lack of data that adequately represent thetheoretically importantconcepts of appropriability nd technologicalopportunity.Promisingbutultimatelyunsatisfactoryresults have beenobtained in exploratory work that used crude proxy variables andeconometric ingenuity to capture the influence of appropriability ndopportunityconditions.7Ourdesireto providea strongerbasis for thisline of inquiry was a prominentmotive for our survey research andhelped to shapeits design.Finally, gatheringbetter informationon the nature and strengthofappropriabilitys particularlyimely nview oftheprominenceof currentdebateson the adequacyof laws andinstitutions o protect intellectualproperty. One impetus for change has been the need to clarify andperhaps trengthenhesystemofproperty ightsatvariousnewfrontiersof technology. Thus, for example,recentlegislationhas adaptedcopy-right aw to protect the rights of the creatorof new computersoftware,a new legal framework has been constructed to protect intellectualpropertyembodied n semiconductor hip designs,andimportant ourtdecisions and administrative ctionshave shapedthe developmentof apropertyrightssysteminbiotechnology.8Anotherspur ochangehasbeen theneedto resolve conflictsbetweenthe aims of social regulationand the exercise of intellectualpropertyrights. For example, the Drug Price Competitionand Patent TermRestoration Act of 1984extended patent lives of pharmaceuticals ocompensatefor regulatoryrequirements hatdelay the introductionofnew drugs.

7. RichardC. Levin, "TowardanEmpiricalModelof SchumpeterianCompetition,"working paper 43 (Yale University, School of Organizationand Management,1981);RichardC. Levin and Peter C. Reiss, "Tests of a SchumpeterianModel of R&D andMarketStructure," n Griliches,ed., R&D, Patents andProductivity,pp. 175-204;andAriel Pakes andMarkSchankerman, AnExplorationnto the Determinants f ResearchIntensity," in Griliches, ed., R&D, Patents and Productivity, pp. 209-32.8. See ComputerSoftwareAct of 1980;SemiconductorChipProtectionAct of 1984;Diamond v. Chakrabarty, 47 U.S. 305 (1980), holdingthat plant and animallife ispatentableunder U.S. patent law; and D. J. Quigg, memorandum f April 7, 1987,explaining he policies of the U.S. Patentand TrademarkOfficeconcerningapplicationsto patent ifeforms.



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R. C. Levin, A. K. Klevorick, R. R. Nelson, and S. G. Winter 787Intellectualproperty rights also figureprominentlyamong policyissues milling under the banner of competitiveness. Recent annualreportsof the U.S. traderepresentativehave focused on the difficultiesU.S. manufacturers ncounter n protecting ntellectualpropertyrightsin foreign markets. The trade bill passed in 1987 by the House ofRepresentativescontainsseveralprovisionsthat increase the scope ofprotectionand theopportunities or reliefavailable o U.S. manufactur-ersconfrontedwith mports hat nfringe heserights.9Proposedantitrustlegislation,motivatedbya concern that courtshavekeptinventors romreaping ewards hatpatent aws areintended o provide, stipulates hat

patent license agreements and similar contracts relating to use ofintellectualproperty"shallnot be deemedillegalperse underanyof theantitrust laws." 10To the extent thatall this activityattemptsto rectifyobvious inade-quaciesin existinginstitutions,the case for reformappearsstrongandstraightforward.t is easy to deplorethe blatantcopyingof innovativeintegratedcircuit designs, the importationof "knock off" copies oftrademarked r patentedU.S. products,and the piracyof copyrightedwrittenmatter and audio and video cassettes. But reformsmay yieldunintended onsequences. In its simplest form,this concern translatesinto wariness aboutTrojanhorses: provisionsbrought nto the law bythe rhetoricalugof "competitiveness"and"intellectualproperty"mayharbor nstrumentsof protectionismand price fixing. Otherpotentialconsequencesare subtlerbutno less important.Forexample,seeminglyuniformadjustments f intellectualproperty,antitrust,or trade awmayaffect someindustriesquitedifferently hanothers.And it should not be takenfor grantedthat more appropriabilitysbetter, hatbetterprotectionnecessarily eads tomore nnovation,whichyieldsbettereconomicperformance-higher standardsof living, bettercompetitiveness,andsoon. Betterprotectionmay yieldmore nnovationat the cost of incrementallyncreasingresourcesdevoted to producingthe nnovation: helargerprizemaymerelyencourageduplicativeprivateeffort to capture t."IAlternatively,betterprotectionmayinduceinno-

9. SeeH.R. 3, theOmnibusTradeandCompetitivenessReformActof 1987,which scurrently nderconsideration y a House-Senateconferencecommittee.10. H.R.557 andS. 438, 100Cong., 1sess.11. This s the "freeaccess" externality, irstemphasizednthe context of innovationin Yoram Barzel, "Optimal Timing of Innovations," Review of Economics and Statistics,vol. 50 (1968),pp. 348-55. For a surveyof the literatureon patentraces, see Jennifer



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R. C. Levin, A. K. Klevorick, R. R. Nelson, and S. G. Winiter 789the economic impact of the patent system, the work of Mansfieldandhis associates on imitationcosts, and numerouscase studies.14 Thequestionnairewas aimedat high-levelR&D managerswith knowledgeof both the relevanttechnology and marketconditions. To check theinterpretability f the questions andthe likely validityandreliabilityofthe responses, we pretested the questionnairewith twelve managersrepresentingdiverse businesses.'5Tounderstand owappropriabilityiffersacross industries,we askedeach respondentto report typical experiences or central tendencieswithinaparticularndustry.Respondentswere thus treatedas informedobserversof a line of business rather han as representativesof a singlefirm,anapproach hatencouragedcooperation theywere notplacedinthe positionofpossiblydivulgingpracticesorpoliciesof theirownfirms),but led inevitably to heterogeneity in the responses within a givenindustry.The questionnairecontained four parts. Parts 1 and 2 concernedappropriability; arts3 and4 concernedtechnologicalopportunityandtechnologicaladvance.Questions npart1asked about heeffectivenessof alternativemeans of protecting he competitiveadvantagesof R&D,limits on the effectiveness of patents,andways of acquiringknowledgeof a competitors' technology. Part 2 asked about the cost and timerequired o imitate nnovationsof rivals;we distinguishedprocessfrom

14. Among the sources of ideas for the questionsare Paul Allan David, TechniicalChoice, Innovation and Economic Growith:Essays on Americatnand British Experiencein the NineteenthCentuty(CambridgeUniversity Press, 1975);RichardR. Nelson andSidneyG. Winter,"InSearchof UsefulTheoryof Innovation,"Research Policy, vol. 6(Winter 977),pp. 36-76;NathanRosenberg,"Science,Invention ndEconomicGrowth,"Econiomic Jolurnal, vol. 84 (March 1974),pp. 90-108; and DevandraSahal, Patterns ofTechnological nnovation Addison-Wesley,1981).For empirical iteratureon the eco-nomiceffects of the patentsystem, see Schererand others,Patents and the Coi-poration;and Taylor and Silberston, The Economic Impact of the Patent System. For imitationcosts, see EdwinMansfield,MarkSchwartz,and SamuelWagner,"ImitationCosts andPatents:An Empirical tudy," EconomicJournal, vol. 91 (December1981),pp. 907-18.15. Thesemanagers adexperiencencommunicationsquipment,ndustrialnorganicchemicals,metalcuttingmachine ools, shoe machinery,householdelectricalappliances,processed oods, computing quipment,semiconductors, opper smeltingand refining,radioand TV sets, and industrialorganicchemicals. They were asked to complete thequestionnaireor a specific line of business, but to keep in mindthe suitabilityof thequestions or other ines of business with which they were familiar.Aftercompleting hequestionnaire,hey were interviewed ace-to-faceor by telephone.Interviews ypicallylastedone-halfhour or more, and each question was discussed to eliminatesourcesofambiguity.



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790 Brookings Papers on Economic Activity, 3:1987product innovations, major from typical, and patented from unpa-tented. 6Part3exploredthe links between anindustry's echnologyandother sources of technologicalcontribution.Weasked about the impor-tance of scientificresearch n general anduniversity-based esearch inparticular. We also asked about the extent to which interindustryspillovers are an important ource of technologicalopportunity.Part 4asked some broadquestionsabout the pace and characterof techno-logical advance.17This paper analyzes responses to the questions inparts 1and 2.18

SAMPLE CONSTRUCTIONAs a sampling rame, we used the lines of business definedby theFederalTradeCommission.In the manufacturingector, these chieflycorrespondto four-digitSIC industries,althoughsome are defined asgroupsof four-digit r eventhree-digitndustries.TheFTC inesprovidethe most disaggregated evel at which data on R&D expendituresareavailable. An additionalconsiderationwas that F. M. Scherer's tech-nology flow matrix,which classifies patents by industryof originandindustryof use, was also constructedat this level of aggregation. 9Ultimately,we receivedresponsesfrom 650individuals epresenting130 ines ofbusiness,withten or moreresponses romeighteen ndustriesand five to ninefromtwenty-sevenindustries.The samplewas reason-16. Thequestionswere similar o those in Mansfield,Schwartz,andWagner,"Imita-tionCosts andPatents,"butcovered ypicalratherhanspecific nnovations.Our ndustrysamplewasalsobroader.17. One objective was to examine "natural rajectories"of the sort describedinNelson andWinter,"In Searchof Useful Theory," p. 56.18. Data fromresponsesto questions n parts3 and4 have been used in RichardC.Levin, WesleyM. Cohen, and David C. Mowery,"R&DAppropriability,Opportunity,and MarketStructure:New Evidenceon SomeSchumpeterianHypotheses,"AmericanEconomic Review, vol. 75 (May1985, Papers and Proceedings, 1984), pp. 20-24;Cohen,Levin, and Mowery, "FirmSize and R&D Intensity:A Re-examination," ournal ofIndustrial Economics, vol. 35 (June1987),pp. 543-65;andRichardC. Levinand PeterC.Reiss,"Cost-Reducing ndDemand-Creating &DwithSpillovers"(Stanford niversity,GraduateSchool of Business, 1986).See RichardR. Nelson, "InstitutionsSupportingTechnicalAdvance nIndustry,"American Economic Review, vol. 76(May 1986,Papersand Proceedings, 1985), pp. 186-89,forfindingson theimportance f externalsourcesoftechnological nowledge.19. F. M.Scherer,"Inter-industry echnologyFlows in theUnitedStates,"ResearclPolicy, vol. 11(August1982),pp.227-45.



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R. C. Levin, A. K. Klevorick, R. R. Nelson, and S. G. Winter 791ably representativeof firms performingR&D, though the exclusion ofthose without publiclytraded securities undoubtedlymeans that smallstart-upventures, importantsources of innovation, were underrepre-sented.The numberof respondents n a line of business was positivelycorrelated with the line's R&D spending, sales volume, and R&Dintensity.The number frespondentsdidnot increase nstrictproportionto the level of industryR&D or sales, but the rate of response within aline of business was not significantlycorrelatedwith industry R&Dspending, ales,or R&D ntensity.TheAppendixpresents urtherdetailsof sampleconstruction.

METHODOLOGICAL ISSUESGiven our interest in identifyingdifferences n the appropriability fR&D, it is reassuring hatanalysisof variance confirmed he presenceof significantnterindustry ariation n the responsesto most question-naire tems.20There was, however, also substantial ntraindustry aria-tion inthe responses.There are several potentialsourcesof intraindustry eterogeneity ntheresponsestoany givenquestion.First,the lines ofbusinessas definedby the FTC may be objectively heterogeneousin their products andtechnologies.For example, if two firmsclassified as manufacturers findustrialnorganic hemicalsproducedifferentproductsusingdifferenttechnologies, they might differ markedlyin their perception of theeffectiveness of patents or the time requiredfor imitation in their"industry. To eliminate his source of heterogeneity,we askedrespon-

dents to identify two majorinnovations-a process and a product-within their industries duringthe past ten to fifteen years. For mostindustrieswith ten or morerespondents,morethanhalf therespondentsagreedon at least one such innovation.We thus believe it unlikelythatoverlyaggregatedndustrydefinitionwas amajor ourceof intraindustryheterogeneity.21

20. Interindustry ifferences are significantat the 0.05 level for approximately60percent f thequestions n parts1and2 of thequestionnaire.f ahigher evel ofaggregationis used to measure ndustryeffects, such as the level at which the National ScienceFoundation eports R&D spending(a hybridof two- and three-digit evel industries),interindustryifferencesaresignificant t the 0.05 level for 70percentof the questions.21. Heterogeneity, santhropologists avelong nsisted, s, however, n theeye of the



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792 Brookings Papers oni Economic Activity, 3:1987Arespondent'sperceptionof the central endencieswithinanindustry

may also be affected by his firm'spolicies or strategies.Respondents nthe same line of business may thus have differentperceptions of thecommontechnologicalenvironment hatthey were asked to character-ize. A two-wayanalysisof varianceof theresponsesonthe effectivenessof patents,forexample,revealedthat bothfirmandindustryeffects arestatisticallysignificant.A representativemulti-industry irm, however,tends to be involvedintechnologicallyrelated ndustries,and thuswhatappear o be effects attributableo thefirm n the datamay simplyreflectthe correlationnresponsesfrom related ndustries.The third, and probablymost important,source of intraindustryheterogeneity s the inherentlysubjectivenatureof the semanticscalesused in thesurvey. Mostanswers werereportedon a seven-pointLikertscale. The effectiveness of patents in preventingduplicationwas, forinstance, evaluated on a scale ranging rom "not at all effective" to''very effective." There is no naturalor objective anchor for suchevaluativeratings.Individualsmay perceivethe same environmentbutsimply use the scale differently.Some might systematically avor highscores; others mightconcentrateresponses in the center of the scale;still othersmight requentlyuse extremevalues.The numerous echniquesavailable o controlfor differencesamongrespondents n meansand variancesgenerally requireabandoningoneor more dimensionsalong which the data might be informative.Forexample,we wereinterested ninterindustry omparisonsof answerstoa singlequestion;controlling or fixed effectsamongrespondentswouldvitiate suchcomparisons,since we expecteda respondent'smeanscoreover allquestionsto dependon his industry.Standardizinghevarianceof each respondent'sanswers raised similarproblems: he distributionof "correct" responses was unknown and it almost certainlydifferedsystematicallyamong ndustries.Ratherthanimposeanarbitrary tan-dardization,therefore, we examined the results for each group ofquestions usinga varietyof techniquesandperspectivesto assess the

beholder. One R&D manager,asked to inform us about the air and gas compressorindustry, nquiredwhetherwe wereinterestednlarge,medium,orsmallcompressors. nhis view the technologies were fundamentally ifferent.We asked him to note on hisquestionnairewhere the answersto ourquestionsdifferedacross these size categories.The booklethe returned ontainedno such notation.



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R. C. Levin, A. K. Klevorick, R. R. Nelson, and S. G. Winter 793robustness of our principalconclusions. There was undeniablymuchnoise in the data, butseveral mportant ignalswere robust o alternativeweightingsof theobservations,alternativepartitionsof the sample, andtheuse of alternative ummary tatistics.22Wesidesteppedonemethodological ifficultybytreating atingsalonga seven-pointsemanticcontinuumas iftheywereintervaldata. Thedatawere, of course, moreproperly o be regardedas ordinal.Itwouldhavebeen straightforwardo treat them as ordinal f we hadbeen interestedonly in interindustryomparisonsof responsesto a single question.Wealso sought, however, to make comparisons among questions (forexample,are patentsmore or less effective than secrecy in protectingprocess innovationsfrom duplication?),and we therefore treatedthedataas if theywere interval.23One additionalmethodologicalconcern was whether our level ofindustryaggregationwas appropriate or the problems being studied.The FTCline-of-businessevel waschosen to facilitatemerging he datawith disaggregatedR&D data and Scherer'sclassificationof patents byindustriesof originand use. Ouranalysis indicated,however,thatmostof the interesting nterindustrydistinctionsamongthe 130 ines definedat the FTC level were robust to an aggregationof the data into the 25industrygroups used by the NationalScience Foundation n its annualsurveyof R&Dspendingandemploymentpatterns.

Patents and Other Means of AppropriationTable1shows thepatternof responses,based ona seven-pointscale,to questions on the effectiveness of alternativemeans of capturingandprotecting he competitiveadvantagesof new or improved processesandproducts.The first two columnsreportthe meanresponse for the22. One notableconsequencearising rom he measurement rror nthe datawas thatindustrymeanresponses rom ines of business with onlyone ortwo respondents endedto be disproportionatelyocatednear the extremesof the distribution f meanresponsesto anygivenquestion.Mostconclusionsbasedon thefullsampleof 130 ines,andvirtuallyall thoseemphasized n thispaper, were replicated n the smallersampleof 75 linesthathadmore han wo respondents.23. We designed he questionnaire o ensure thatcross-question omparisonswouldarisenaturallyn the mindsof the respondents.The items werearrangedn blocks, witheachitem n a blockratedon the samesemantic cale.



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794 Brookings Papers on Economic Activity, 3:1987Table 1. Effectiveness of Alternative Means of Protecting the Competitive Advantagesof New or Improved Processes and Productsa

Distribution ofOverall sample means industmymeansbMethod of appropriation Processes Products Processes Products

Patents to prevent duplication 3.52 4.33 2.6-4.Oc 3.0-5.Oc(0.06) (0.07)Patentsto secure royalty income 3.31 3.75 2.3-4.0c 2.7-4.8c(0.06) (0.07)Secrecy 4.31 3.57 3.3-5.0 2.7-4.1(0.07) (0.06)Lead time 5.11 5.41 4.3-5.9c 4.8-6.0c(0.05) (0.05)Moving quickly down the 5.02 5.09 4.5-5.7 4.4-5.8learning curve (0.05) (0.05)Sales or service efforts 4.55 5.59 3.7-5.5 5.0-6.1(0.07) (0.05)

Source: Authors' calculations.a. Range: I = not at all effective; 7 = very effective. Standard errors in parentheses.b. From the upper bound of the lowest quintile of industries to the lower bound of the highest quintile.c. Differences in means significant at the .01 level.

entiresampleof 650respondents o each question,aswellasthe standarderrorof each estimated mean. These statistics, of course, give equalweight to each respondentand consequently weight each industry inproportion to its number of respondents.The overall pattern acrossquestions,however, isrobust o theuseof alternative ummary tatistics,such as the mean of industrymeans or the median of industrymeans.This is apparent n columns 3 and 4, which summarize he distributionof industry mean responses to each question. Each pair of numbersrepresents the range of industry means from the upper bound of thelowest quintileto the lower bound of the highestquintileof industries:20 percent of the 130 industries had mean responses at or below thebottom of the range indicated for each question, and 20 percent hadmeanresponsesatorabove thetopof therange.Meanresponsesfor theremaining 0 percent (or 78 industries) ell within thereportedrange.Thepicture s striking.For newprocesses (columns1and3), patentswere generallyratedthe least effective of the mechanismsof appropri-ation:only 20 percentof the lines of business surveyedratedprocesspatenteffectiveness in excess of 4.0. Eighty percent scored the effec-tiveness of lead time andlearning urveadvantageson newprocesses in



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R. C. Levin, A. K. Klevorick, R. R. Nelson, and S. G. Winter 795excess of 4.3. Secrecy, thoughnot considered as effective as lead timeand earningadvantages,wasstillconsideredmoreeffective thanpatentsinprotectingprocesses.Patents for products were typically consideredmore effective thanthose for processes, and secrecy was considered less effective inprotecting products than processes. Generally, lead time, learningcurves,and sales or service efforts wereregardedas substantiallymoreeffective than patents in protecting products. Eighty percent of thesample businesses ratedthe effectiveness of sales and service effortsabove5.0, butonly 20percentconsideredproductpatents hiseffective.24Thetendency oregard ecrecy as moreeffective thanprocesspatentsbutless effective thanproductpatentsprobablyreflectsthegreatereaseanddesirability f maintaining ecrecyaboutprocesstechnology. Firmsmay sometimes refrainfrom patentingprocesses to avoid disclosingeither the fact or the details of an innovation.25But firmshave everyincentive to advertisethe advantagesof new or improvedproductsandto get them into the hands of customers, thereby facilitating directobservationof theproductand thetechnologyit embodies.Maintainingsecrecy aboutproduct nnovations s thuslikelyto be bothdifficultandundesirable.Respondentsalso tended to regardpatents to preventduplicationasmoreeffective than patents to secureroyaltyincome. This findingwasconsistent with the view that licensing arrangementsare beset withtransactional ifficulties.Only3 of 130 ines of business ratedprocess patentshigherthan fiveon a seven-pointscale of effectiveness in preventingduplication.Twoof these were concrete andprimarycopper;the otherhadonly a singlerespondent.26Only5 of 130 industriesratedproductpatents to prevent

24. Thisview of the efficacyof sales andserviceefforts s consistentwiththeemphasisgiven to investment n "cospecializedassets" as a means of appropriationn David J.Teece, "ProfitingromTechnological nnovation: mplications or Integration,Collabo-ration,LicensingandPublicPolicy,"ResearchPolicy, vol. 15(December1986),pp. 285-305.25. See IgnatiusHorstmann,Glenn M. MacDonald,and AlanSlivinski,"PatentsasInformationTransferMechanisms:To Patent or (Maybe) Not to Patent," Journal ofPoliticalEconomy,vol. 93 (October1985),pp. 837-58, for a theoretical reatmentof theissue.26. To preserveconfidentiality,we do not identifyany industry n which there wasonly one response.Hereafter,we refer o such cases as singletons.



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796 Brookings Papers on Economic Activity, 3:1987duplicationhigherthan six points. Two of these were singletons;theother three were drugs, pesticides, and industrialorganicchemicals.Twenty other ines ratedproductpatents between five and six. Of thosewith more than two responses, almost all fell neatly into chemicalproducts (including inorganic chemicals, plastic materials, syntheticfibers, syntheticrubber,and glass) or relativelyuncomplicatedmechan-ical equipment airandgas compressors,power-drivenhandtools, andoilfieldmachinery).Theonlyanomalieswereroastedcoffee andproductsof steel rollingandfinishingmills.Table2 shows additional ndustry-leveldetail-the meanratinggivenfor the effectiveness of patents in preventing duplication n eighteenindustries with ten or more respondents. These industries tend to bemuch more research-intensive han the sample average, yet the patternof interindustry ariationwas similar o thatin the full sample. Exceptforpetroleumrefining,productpatentswere considered moreeffectivethan process patents. Only four chemical industries (drugs, plasticmaterials, inorganicchemicals, and organic chemicals) and petroleumrefiningratedprocess patenteffectiveness higherthan four on a seven-point scale, andonlythese fourchemical ndustriesand steel mills ratedproductpatentshigher han five.27The data on these eighteen most heavily sampled industrieshelp toestablish he robustnessof ourconclusionabout he limitedeffectivenessof patents as a means of appropriation.In none did a majorityofrespondents rate patents-either to prevent duplicationor to secureroyalty income-as more effective than the most highly rated of theotherfour means of appropriatingeturns rom newprocesses, althoughin drugs and petroleumrefininga majorityregardedprocess patents asat least the equalof the most effective alternativemechanismof appro-priation.Inonly one industry,drugs,wereproductpatents regardedbya majorityof respondentsas strictlymoreeffective than other meansofappropriation.28n threeothers-organic chemicals, plastic materials,

27. The same patternappearswhen the surveydataare aggregatedup to the level(roughly wo andone-halfdigit)at which he NationalScience Foundation eportsdetaileddata on the extent and compositionof researchand developmentexpenditures.Of thetwenty-five ndustries nto which the manufacturing ector is divided, only industrialchemicals, drugs, andpetroleumrefining atedprocess patents higher hanfourpoints,andonly industrial hemicalsanddrugsratedproductpatentshigher hanfive.28. Ourresultswere reinforcedby Edwin Mansfield's inding hatamongthe twelvebroadlydefined ndustrieshe studiedonly in the drug ndustrywere patents considered



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R. C. Levin, A. K. Klevorick, R. R. Nelson, and S. G. Winter 797Table 2. Effectiveness of Process and Product Patents in Industries with Ten or MoreSurvey Responses

Process patents Prodluct atentsStandard StandardIndustry Mean error Mean error

Pulp, paper, and paperboard 2.6 0.3 3.3 0.4Cosmetics 2.9 0.3 4.1 0.4Inorganicchemicals 4.6 0.4 5.2 0.3Organicchemicals 4.1 0.3 6.1 0.2Drugs 4.9 0.3 6.5 0.1Plastic materials 4.6 0.3 5.4 0.3Plastic products 3.2 0.3 4.9 0.3Petroleum efining 4.9 0.4 4.3 0.4Steel mill products 3.5 0.7 5.1 0.6Pumpsand pumping quipment 3.2 0.4 4.4 0.5Motors, generators,and controls 2.7 0.3 3.5 0.5Computers 3.3 0.4 3.4 0.4Communications quipment 3.1 0.3 3.6 0.3Semiconductors 3.2 0.4 4.5 0.4Motorvehicle parts 3.7 0.4 4.5 0.4Aircraftand parts 3.1 0.5 3.8 0.4Measuringdevices 3.6 0.3 3.9 0.3Medical nstruments 3.2 0.4 4.7 0.4Full sample 3.5 0.06 4.3 0.07

Source: Authors' calculations. Mean score on a scale of I to 7.

and steel mill products-most respondentsrated patents as no lesseffective than the best alternative.The exclusionfromour sampleof firms hatofferednopublicly radedsecuritiesmay have biased our findings.For small, start-upventures,patents may be a relatively effective means of appropriatingR&Dreturns, in part because some other means, such as investment incomplementarysales and service efforts, may not be feasible. Thepatentsheldby a small, technologicallyorientedfirmmay be its mostmarketable sset. Althoughourrespondentswere askedto describethetypical experience of firms in their industries, they may well haveoverlookedaspects of appropriabilityhatare particularly elevantfornewfirms.essentialto developingand marketingmost inventions.Chemicalswas the only otherindustry hat consideredpatents essential for as many as 30 percent of inventions. See"PatentsandInnovation:An Empirical tudy," ManagementScience, vol. 32 (February1986),pp. 173-81.



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798 Brookings Papers on Economic Activity, 3:1987The most probableexplanation or the robustfinding hatpatents are

particularly ffective in chemical industries s thatcomparativelyclearstandardscan be appliedto assess a chemicalpatent's validity and todefend against infringement.The uniqueness of a specificmolecule ismore easily demonstratedthan the novelty of, for example, a newcomponentof a complexelectricalor mechanical ystem. Similarly, t iseasy to determinewhetheranallegedly nfringingmolecule s physicallyidentical o a patentedmolecule; t is moredifficult o determinewhethercomparable omponentsof two complex systems "do the sameworkinsubstantially he sameway." To the extentthatvery simplemechanicalinventionsapproximatemolecules in their discreteness and easy differ-entiability, tis understandablehat ndustriesproducing uch machineryrank just after chemical industriesin the perceived effectiveness ofpatentprotection.Theperceivedineffectivenessof patents n mostindustriesraisesthequestion of why firms use them. Furtherwork is needed here, but weoffersomespeculationsnformedbythecommentsofourpretestsubjectsand by several survey respondentsat a conference we held to reportpreliminary indings.These executives identifiedtwo motives for pat-enting that have little connection with appropriating eturns from in-vestment. One is to measure heperformance f R&Demployees,whichis a significantproblembecause these workersaretypicallyengagedinteam production.Legal standards or identifying nventors on a patentapplicationare, however, reasonablyrigorous.The second motive is togain access to certain foreign markets. Some developing countriesrequire,as a conditionof entry, that U.S. firms icense technology to ahost-country irm,and some patentsare filedprimarily o permitsuchlicensing.29

29. Yet another motive discussed in the literature s to gain strategicadvantage nnegotiation.In the semiconductor ndustry,for instance, the cumulativenature of thetechnologymakes t difficult o participateegallywithoutaccessto thepatentsof numerousfirms.In consequence, there is widespread ross-licensing.Established irms,however,rarely icensea new entrantuntil thas establisheda significant osition nthemarket.Asa defenseagainst nfringement uits, a prudentnew entrantwill establisha patentportfolioof its own, thus compellingestablished irms o negotiatecross-licenseagreements.SeeEric von Hippel, "Appropriability f InnovationBenefit as a Predictorof the SourceofInnovation,"ResearchPolicy, vol. 11(January 982),pp. 95-115;and Levin, "Semicon-ductor ndustry,"pp. 80-81.



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R. C. Levin, A. K. Klevorick, R. R. Nelson, and S. G. Winter 799

ConditionsAffectingAppropriabilityThus farwe have focusedon the overallstrengthof variousmecha-nisms of appropriation nd on interindustry ariations n the effective-ness of patents.Thepatternsof covariation n the responses, however,suggestedthat interindustrydifferencesin conditionsaffectingappro-priabilitymightbe summarized ya limitednumberoffactors.Moreover,

the clear indicationsthat patentsare effective in only a few industriessuggestedthat it might be fruitful to classify industries into clustersdistinguishable y a primarymeans of appropriationndperhapsby theoverallease of appropriatingeturns.Such clusters couldprove usefulin examining inks betweenappropriabilityonditions andmeasures ofR&D, innovation,and productivitygrowth.Correlationsamong responses to questions on the effectiveness ofalternativemeans of appropriationevealedsomeinterestingpatterns.30When patents effectively prevent competitors from duplicatingpro-cesses andproducts, they tend also to be effective in securing royaltyincome.Butneitherformof effectiveness was stronglycorrelatedwiththe effectiveness of other means of appropriation.Forprocesses, therewas a strong connection amongthree other mechanisms:lead time,learningcurve advantages,and secrecy. For products, superiorsalesand service efforts were strongly linked to lead time and learningadvantages, houghnot to secrecy.Thecorrelations uggested hatthemechanismsof appropriationmaybe reducedto two dimensions:one associatedwith the use of patents,the otherrelatedto secrecy, lead time, and learningcurveadvantages.Forproduct nnovations, sales and service efforts may be involved inthe second of these dimensions. We investigatedthis possibility byreducing he data to principalcomponentsand employinga variety offactor-analyticechniques.Principalactoranalysisandseveralmethods

30. Simplecorrelation oefficientswere calculatedusing the individualrespondentand industrymean responses as the units of observation.Correlations mong industrymeansfor the entire sampleof 130 lines of business were qualitatively imilar o thoseobtainedwhen the samplewas restricted o those with morethantwo responses.Theseandothercorrelationmatricesdiscussed n this paperare available rom he authorsuponrequest.



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800 Brookings Papers on Economic Activity, 3:1987Table 3. Principal Components Analysis of Methods of Appropriation

Processes and produicts Processes and productsseparately togetherCoefficients Coefficients Coefficients Coefficientsof 1st of 2d of 1st of 2dprincipal principal principal principalMethod of appropriation component component component component

New ProcessesPatentsto preventduplication .04 .86 .01 .73Patentsto secureroyalties .12 .86 .08 .78Secrecy .59 - .12 .54 .04Lead time .84 -.09 .79 -.04Moving down the learning curve .84 - .05 .80 - .04Sales and service efforts .51 .11 .45 -.06Cumulativevarianceexplained .34 .59 n.a. n.a.

New ProductsPatentsto preventduplication .06 .87 .06 .73Patentsto secureroyalties .06 .87 .07 .80Secrecy .51 .01 .51 .06Lead time .84 .00 .79 -.03Movingdownthelearningurve .84 - .07 .82 - .04Sales and service efforts .69 -.09 .62 -.11Cumulativevarianceexplained .36 .61 .31 .50Source: Authors' calculations.

of rotation did little to alter the picture presented by the principalcomponents,whichareshownintable3.31The first two columns of the table show the weights associated withthe first two principalcomponentswhen the six questions relating toprocess appropriability re analyzed separately romthe six questionsrelating to productappropriability.The next two columns report theresults of a principalcomponents analysis on the entire set of twelvequestions. With both approaches,the firstprincipalcomponent givesnear-zeroweightto the two patent-relatedmethodsof appropriation ndheavy weight to the other mechanisms.The weighting s reversedforthe second principal omponent.Thusthefirst woprincipal omponents(and,in thefactor analysis,the firsttwo factors)arereadily nterpreted,respectively, as nonpatent-andpatent-relateddimensions of appropri-ability. Despite this clear interpretation, he data do not reduce very31. The results reported n table 3 are based on a principalcomponents analysisundertaken t the level of individual esponses.Ananalysisat the level of industrymeanresponsesproduced imilar esults.



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R. C. Levin, A. K. Klevorick, R. R. Nelson, and S. G. Winter 801Table 4. Cluster Analysis of Mechanisms of Appropriation

ClusterMethodof appropriation 1 2 3New ProcessesNumberof industries 38 67 25MeanscorePatents to preventduplication 3.1 3.0 4.7Patents to secureroyalties 2.9 2.9 4.8Secrecy 2.8 4.6 4.7Lead time 4.2 5.4 5.6Learningcurves 4.3 5.3 5.1

Superior ales or service 4.7 4.5 4.9New ProductsNumberof industries 20 68 42MeanscorePatentsto preventduplication 3.1 3.8 5.3Patents to secureroyalties 3.2 3.1 5.0Secrecy 2.6 3.5 4.0Leadtime 4.0 5.6 5.7Learning urves 4.2 5.3 5.2Superior ales or service 5.2 5.7 5.6Source: Authors' calculations.

satisfactorily o just two dimensions. As table 3 indicates, when theprocess and productquestions are analyzed separately, the first twocomponentsexplainonly 60percentof the variance n the responsestosix questions, and when the two sets of questionsare combined,twocomponentsexplainonly 50percentof the variance.Ourinterpretation hat the means of appropriation an be groupedintopatentandnonpatentmechanismswas nonetheless reinforcedby aclusteranalysisthat classifiedindustriesaccordingto meanresponsesto the relevantquestions.The best clusteringresults were achievedbydividing he industries nto threegroups,as shownin table 4. Industriesassigned to cluster 1 tended to have relatively low scores for allmechanismsof appropriation.Sales and service effort was the mosthighly atedmechanism ndwas, infact, regarded sreasonably ffectiveincapturing eturns romnewproducts.Industriesncluster2rated eadtimeand earning urvesas relativelyeffective, butnotpatents.Secrecywas importantn appropriating rocess returns,and sales and serviceeffortscomplementedead time andlearningadvantages or products.Onlyfor cluster 3 were productandprocess patentsdeemedeffective,



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802 Brookings Papers on Economic Activity, 3:1987but still the effectivenessof lead time and earningwas no lower thanforthe industries n cluster2. Those few industries n which patents wererated as more effective than other mechanismswere all in the thirdcluster.The cluster analysissuggestedthat therewas a groupof industries nwhich no appropriationmechanismwas particularlyeffective. As analternativeapproach o identifying ettingswith low appropriability,weconsideredthe maximumscore an industry assignedto any of the sixmechanismson the questionnaire.Only 11of the 130failed to rate atleast one meansof appropriatingeturns romproduct nnovationhigherthanfive on the seven-pointscale.The industries nthisgroupwithmorethan two responseswere all drawnfromthe food productsand metal-working sectors: milk, meat products, iron and steel foundries, boilershops, and screw machineproducts (nuts, bolts, and screws). Manymore industries(34 of 130)rated no means of appropriating rocessreturnshigher hanfive. Thisgroupcontainedall the industries exceptmilk)that ranked ow on product appropriability ut was otherwise adiverse lot. The heaviest concentrationwas in fabricated metals andmachinery. But several chemical industries were also represented,including he threeindustries n whichproductpatents were viewed asmosteffective-organic chemicals, pesticides,anddrugs.The urgeto findpatterns n thedata shouldnot be carried oo far. Theassociationsamongmechanismsof appropriation evealedby the cor-relation,principal omponents,andclusteranalysesaresuggestive,butthere is substantialheterogeneity n the underlyingdata.As noted, thefirst two principalcomponents, thoughreadily nterpretable, xplainedanunsatisfactoryractionof the overallvariance.A similar ack of goodfit characterized he cluster analysesof process andproductappropria-bility. Despite thefairlyclearinterpretationhat couldbe givento eachcluster, the variancewithinthe clusterswas almost twice that betweenclusters.

Limitations on Effectivenessof PatentsTo understandwhy patent protection mightbe weak in some indus-tries, we askedrespondents o ratethe importance f possible limitationson patenteffectiveness. Table5 summarizes he responses. The ability



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R. C. Levin, A. K. Klevorick, R. R. Nelson, and S. G. Winter 803Table 5. Limitations on Effectiveness of Patents for New or Improved Processesand Productsa

Distribution ofOverall sample means industry meansbLimitation Processes Products Processes Products

New processes or products 4.32 3.75 3.6-5.4c 2.8-4.8patentable (0.07) (0.07)Patentsunlikelyto be valid if 4.18 3.92 3.5_5.Oc 3.05. 0cchallenged (0.06) (0.07)Firmsdo not enforcepatents 4.29 3.84 3.5_5.0c 3.0-4.8c(0.06) (0.07)Competitors legally "invent 5.49 5.09 4.9-6.0 4.4-5.9daround"patents (0.05) (0.06)Technology moving so fast that 3.40 3.34 2.0-4.3d 2.0-4.0dpatentsare irrelevant (0.07) (0.07)Patentdocumentsdisclose too 4.19 3.65 3.2-5.0 2.8-4.5cmuchinformation (0.07) (0.07)Licensingrequiredby court 2.96 2.79 2.0-3.8 2.0-3.3decisions (0.06) (0.06)Firms participate in cross-licensing 3.08 2.93 2.2-3.9d 2.1-3.9dagreementswithcompetitors (0.06) (0.06)

Source: Authors' calculations.a. Range: 1 = not an important limitation; 7 very important limitation. Standard errors in parentheses.b. From the upper bound of the lowest quintile of industries to the lower bound of the highest quintile.c. Interindustry differences significant at the .10 level.d. Interindustry differences significant at the .01 level.

of competitors to "invent around" both process and product patentswas ratedhigher than five on a seven-point scale of importanceby 60percent of the responding ndustries.Only one other constraint-thelack of readypatentabilityor newprocesses-was ratedthisimportantby more than 20percent.Limitationson patentsweregenerallyconsid-ered more severe forprocesses thanforproducts,which was consistentwith our findingthat product patents tend to be more effective thanprocess patents. Inparticular,he lack ofpatentabilitywasmore seriousforprocessesthan orproducts,and so was thedisclosureof informationthroughpatentdocuments.32

32. Additionalvidenceof theinternal onsistencyof the surveyresultswas providedbythepattern f negativecorrelation etweenresponsesconcerning imitations npatenteffectiveness ndresponses oncerningheeffectivenessof patents.Usingeither ndividualrespondents rindustrymeansas the unitof observation,allsuch correlation oefficientswerenegative xcept nthecase ofcompulsory icensing.Mostcorrelationsweresignificantatthe .01 evel.



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804 Brookings Papers on Economic Activity, 3.1987The responses concerning imitson patenteffectiveness may illumi-nate and focus policydiscussion.Inrecent yearsthere has been consid-erable nterest nmakingpatentprotectionmoreeffective. One initiativehas been to make the legal requirements or a valid patent claim lessstringent.33Another has been to vacate court decrees that compellicensing. Ourdata dentified ndustries nwhichstringent equirementsforpatentvalidityorcompulsory icensingwereperceivedas importantlimitationson the usefulness ofpatents nappropriating eturns.Respondentsfrom twenty-two lines of business, mostly in the food

processingandfabricatedmetalssectors, consideredthelikely inabilityto withstandchallengesto validityas significantlyimiting heeffective-ness of process patents (scoring the importancehigherthan five on aseven-point scale); for fourteen of these industriesthe meanresponsewas six or higheron the scale. This groupand the nineteenindustriesciting invalidityas a constrainton the effectiveness of productpatents(again assigning a score higher than five) overlapped considerably.Furthernvestigationwouldbe required o determinejustwhythesetwosectors appear to have difficultyestablishingvalid claims. Perhapsbecause they are matureindustries,opportunitiesmay be limited ornovelty maybe difficult o achieve or simplydifficult o prove.Compulsory icensing was rarelyjudged a significant imit on theeffectiveness of patents. Onlyone industrywith one respondentratedthis constrainthigher than five on the scale for products,and only sixcited compulsory icensingof process patentsas of comparable mpor-tance. Two of these industrieswere not singletons-metal containersand electron tubes. Compulsory icensingdecrees were thusperceivedas importantn only a small subsetof the industries hat F. M. Schererindicatedweresubject o such decrees.34The overall ack of impact romcompulsory icensingrequirementswasconsistentwithScherer' findingthatthey did notdiscourageR&Dspending.

33. Forexample,P.L. 98-622, passed n 1984,modified hepreviousrequirementhateachcoinventor isted n a patentapplication lsohadto be a coinventoron every claimofthe patent.The new lawallows inventors o apply ointly,even though hey maynothavephysicallyworked ogether,made the samelevel of contribution, rcontributedndivid-ually to the subjectmatterof each claim.For a thoroughdiscussion,see PatrickKelley,"RecentChanges n the PatentLaw WhichAffect Inventorshipandthe OwnershipofPatents,"unpublishedmanuscript 1985).34. F. M. Scherer, The Economic Effects of Coinpllsoty Patent Licensing (New YorkUniversity,Graduate chool of BusinessAdministration, 977).



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R. C. Levin, A. K. Klevorick, R. R. Nelson, and S. G. Winter 805The choice between obtaininga patent andmaintaining ecrecy may

be influencedby the extent to whichthe disclosures madein the patentdocument acilitate nventingaround hepatent.Ourdataprovidedsomesupport for this theory. The effectiveness of secrecy was positivelycorrelatedwith the extentto which disclosures imited heeffectivenessof patents. The link was stronger or product patents thanfor processpatents. But patent disclosuresrepresenteda substantial imitationonthe effectiveness of product patents for only 4 of the 130 industries(scoring as high as six on the scale), and only 16 regarded processdisclosuresas comparably mportant.In only one line of business ofthose with five or morerespondents-metal cuttingmachinetools-diddisclosuresconstrainso substantially he effectivenessof bothprocessand productpatents.

Channelsof InformationSpillover

To the extent that a rival can learn easily about an innovator'stechnology, the incentive to invest in R&D is attenuated.But to theextent thatlearning s easy, wastefulduplicationor nearduplicationofR&D effort by rival firms may be avoided. Also, knowledge of aninnovator's new technology may complement rival R&D effort byenhancingtsproductivity.RichardNelson andSidney Winter,MichaelSpence, andRichardLevin andPeterC. Reiss have developedmodelsthatbeginto disentangle hese offsetting effects, called by Spence theincentive and efficiency effects of interfirmspillovers.35A sharpercharacterization f interindustrydifferencesin the natureand strengthof the mechanismsby which firms earnabouttheircompetitors'tech-nology shouldadvancethese modelingefforts.Table6summarizes heresponsestoquestionsabout heeffectivenessof alternativeways of learning.There is little differencebetween thepatternof responsesforprocesses and forproducts, except that,as onewouldexpect,reverseengineerings markedlymoreeffectiveinyielding

35. Richard R. Nelson and Sidney G. Winter, "The Schumpeterian Tradeoff Revis-ited," American Economic Review, vol. 72 (March 1982), pp. 114-32; Michael Spence,"Cost Reduction, Competition, and Industry Performance," Econometrica, vol. 52(January 1984), pp. 101-21; and Levin and Reiss, "Tests of a Schumpeterian Model," and"Demand-Creating and Cost-Reducing R&D."



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806 Brookings Paper s on Economic Activity, 3:1987Table 6. Effectiveness of Alternative Methods of Learning about New Processesand Productsa Distribution ofOverall sample means industry rneansb

Method of learning Processes Products Processes ProduictsLicensing technology 4.58 4.62 3.4_5.6c 3.5_5.5c(0.07) (0.07)Patent disclosures 3.88 4.01 3.0-4.6c 3.0-4.8c(0.05) (0.06)Publications or technical meetings 4.07 4.07 3.4-4.7 3.3_4.6d(0.05) (0.05)Conversations with employees of 3.64 3.64 2.9-4.7d 2.9_4.5dinnovating firm (0.06) (0.06)Hiring R&D employees from 4.02 4.08 2.7-5.0c 2.8-5.0cinnovating firm (0.07) (0.07)Reverse engineering of product 4.07 4.83 3.0-5.0c 4.0_5.7d(0.07) (0.06)Independent R&D 4.76 5.00 4.0-5.5 4.4-5.6c(0.06) (0.05)

Source: Authors' calculations.a. Range: I = not at all effective; 7 = very effective. Standard errors in parentheses.b. From the upper bound of the lowest quintile of industries to the lower bound of the highest quintile.c. Interindustry differences in means significant at the .01 level.d. Interindustry differences in means significant at the .05 level.

informationabout producttechnology. On average, independentR&Dwas rated as the most effective means of learningaboutrival technol-ogy. 36This may appearto be wastefulduplication,but it need not be.OnepretestsubjectsaidthatR&Deffort devoted to determiningwhat acompetitorhas done may have strong complementaritieswith a firm'sown researchprogram n areas not directlyimitativeof the innovatingcompetitor.Licensingwas also rated,on average,an importantway ofgainingaccess to a rival'snewtechnology.The correlationsamong ndividual nd ndustrymeanresponsesshowthatmechanismsrelyingon interpersonal ommunication publicationsand technical meetings, informalconversations, and hiringaway em-ployees) are strongly ntercorrelated.Learning hrough icensingtech-nologyis uncorrelatedwithnearlyallotherlearningmechanismsexceptdisclosure throughpatentdocuments.There are two possible interpre-

36. WesleyCohenandDanielLevinthalhave studied heincentives o engage n R&Dthat s directed owarddeveloping bsorptive apacity, heability o makeuse of technologydevelopedbyothers.See "Innovation ndLearning:The TwoFaces ofR&D"(Carnegie-MellonUniversity,Department f Social and DecisionSciences,March1987).



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808 Brookinigs Papers on Economic Activity, 3:1987Table 7. Cluster Analysis of Channels of Learning

ClusterLearningmechanism 1 2 3New ProcessesNumber of industries 68 43 19Mean scoreLicensing technology 5.0 4.3 2.5Patent disclosures 4.0 4.0 3.2Publications or technical meetings 3.8 4.6 3.9Conversations with employees ofinnovating firm 3.2 4.8 3.0

Hiring R&D employees frominnovating firm 3.7 5.1 2.4Reverse engineering of product 3.8 4.6 4.0Independent R&D 5.0 4.6 4.3New productsNumber of industries 68 10 52Mean scoreLicensing technology 4.7 2.5 4.5Patent disclosures 3.9 2.9 4.3Publications or technical meetings 3.7 5.1 4.3Conversations with employeesof innovating firm 3.0 4.6 4.5Hiring R&D employees frominnovating firm 3.2 4.4 4.9Reverse engineering of product 4.7 3.0 5.2Independent R&D 5.1 3.7 5.0

Source: Authors' calculations.

they were developed by a competitor. For each category, respondentswere asked to identify (within a range) the cost of duplication as apercentageof the innovator'sR&Dcost. Intervalsmeasured n monthsoryearswere used to classifythe timerequired. n lightof evidence thatthere s a time-costtrade-off n certain ndustries,we asked respondentsto estimate the cost and time required"to have a significant mpact onthe market." 9Tables 8 and 9 show frequency distributions of industry medianresponses.40The dispersion of industry medians suggests substantialvariations mong ndustries n boththe cost and imerequired o duplicate

39. See Edwin Mansfield, Industrial Research and Technological Innovation: AnEconometricAnalysis Norton, 1968), orevidence on the time-cost rade-off.40. Qualitatively dentical resultsand interpretations re obtained from frequencydistributions f individual esponsesandfromthedistribution f industrymeans.



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R. C. Levin, A. K. Klevorick, R. R. Nelson, and S. G. Winter 809Table 8. Cost of Duplicating an Innovation as a Percentage of Innovator's R&D Cost,Frequency Distribution of Median Responses

More TimelyLess than 26 to 50 51 to 75 76 to 100 thani100 dluplicationtType of inniovationt 25 percenit percent percenit percentt percent niotpossibleNew process

Major patented newprocess 1 5 19 66 26 10Major unpatented newprocess 5 10 55 49 6 2

Typical patented newprocess 2 15 61 41 6 2Typical unpatented newprocess 8 43 58 14 4 0

New productMajor patented newproduct 1 4 17 63 30 12Major unpatented newproduct 5 13 58 40 7 4Typical patented newproduct 2 18 64 32 9 2Typical unpatented newproduct 9 58 40 15 5 0

Source: Surveyof 127 ines of business.

all categories of innovation. If, however, individualresponses to thequestionson cost arecoded on a six-point nterval cale, there s sufficientintraindustry ariation o render nterindustrydifferences insignificantat the 0.01 level. Interindustrydifferences in the time required forduplication re, by contrast,significant t the 0.01 level inevery instanceexcept the time required o duplicatea typical patentednew process.Severalconclusionsareapparent.First,duplicatingmajorinnovationstends to cost more and takelongerthanduplicating ypicalinnovations.(In a sense, this confirmsthat respondents correctly interpretedthedistinctionbetweentypicalandmajor nnovations.)Second, fora givencategory of innovation, the cost and time requiredto duplicate aredistributed ery similarly or productsandprocesses. Productstendtobe slightlycheaperandquicker o duplicate hanprocesses, thoughthisgeneralizationdoes not hold for major patentedinnovations. Finally,patents tend to raise imitation costs and time for each category ofinnovation.These increases canbe regardedas alternative ndicatorsoftherelativeeffectivenessof patents ndifferent ndustries.To explore this point further,we coded the individualresponses tothe imitationcosts and time questions on a six-point interval scale,



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810 Brookings Papers on Economic Activity, 3:1987Table 9. time Required to Duplicate an Innovation, Frequency Distributionof Median Responses

Less Timelythan 6 6 months I to 3 3 to 5 More thzant dluplicationtType of innovation months to I year years years 5 years not possibleNew processMajor patented new

process 0 4 72 37 9 7Major unpatented newprocess 2 20 84 17 2 4Typical patented newprocess 0 40 73 13 0 3Typical unpatented newprocess 8 66 47 6 1 1

New productMajor patented newproduct 2 6 64 40 8 9Major unpatented newproduct 3 22 89 12 1 2Typical patented newproduct 5 39 72 6 4 3Typical unpatented newproduct 18 67 39 4 1 0

Source: Survey of 129 lines of business.

calculated he individualandindustrymean increasesin costs and timeassociatedwith the presence of patents, andcorrelatedthese, respec-tively, with individualandindustrymeanresponsesto ourquestionsonthe effectivenessof patents npreventingduplication.For eachcategoryof innovation, the reported effectiveness of patents was positivelycorrelatedwith the increase in duplicationcosts and time associatedwithpatents,although hecorrelationsendedtobestrongerorproductsthanfor processes. We also found some evidence, at the level of theindividual espondent, hatpatenteffectiveness was associatedwith theabsolutelevel of duplication osts forpatentedprocessesandproducts.We found a much stronger association, however, between reportedpatenteffectiveness and the amountof timerequired o duplicatebothpatentedprocessandproduct nnovations.These broad-brushpatterns of association conceal some strikinganomalies. For particular ategoriesof innovation,at least two and asmanyas fourteen industriesreported hatpatentsactually reducedthecosts or time required or duplication.A partial explanation s that adisproportionate umberof these industriesalsoreported hatdisclosure



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R. C. Levin, A. K. Klevor-ick, R. R. Nelso,i, anid S. G. Winter 811of informationhroughpatentdocumentswas a significantimitationonpatenteffectiveness.A second anomaly s that, despite the positive correlationbetweenpatent effectiveness and the costs of imitatingpatentedproducts, inseveral industriespatents were relatively ineffective and duplicationcosts were nonethelessvery high, whetheror not the innovationwaspatented. Among these were guided missiles and several types ofindustrialmachinery food productsmachinery,electric welding appa-ratus, and speed changers, drives, and gears). In these instances therelative complexity of the products presumably makes reverse engi-neering nherentlycostly despiterelativelyweakpatentprotection.Itis interestingocompareourfindingswiththose of EdwinMansfield,MarkSchwartz,andSamuelWagner,who studiedtheeffects of patentson imitation costs in three industries.41They concluded that patentsgenerally raised imitation costs by 30 percentage points in drugs, 20points in chemicals, and 7 points in electronics. To renderour datacomparable,we evaluatedeach respondent'sanswer at the meanof therelevantrangeandcomputedcrudeindustryaverage mitationcosts foreach type of innovation.42Our results were consistent with those ofMansfield,Schwartz,andWagner.Wefoundthatpatentsraise mitationcosts by 40 percentagepointsfor bothmajorandtypicalnew drugs, by30pointsfor majornew chemicalproducts,andby 25 pointsfortypicalchemicalproducts. In electronics, our results differed somewhat forsemiconductors,computers,and communicationsequipment,but therangewas 7 to 15percentagepointsfor majorproductsand 7 to 10fortypicalproducts.43

41. Mansfield,Schwartz,and Wagner,"ImitationCosts and Patents."42. Therangesareshown n the headings f table8. Thefifthandsixthcolumnheadingsare not readilyquantified.To permit he comparisondiscussed in the text, we assignedthese categories the values of 112.5 percentand 137.5percent, respectively, therebymaintaining constantspacingof 25percentagepointsbetweeneachpairof categories.43. Ourresultson the timerequired o duplicatea rival's new productsor processeswere alsoroughly onsistentwith recentfindings f EdwinMansfield. nallbut one of theten industrieshe surveyed,the medianrespondent ndicatedthat six to twelve monthsusuallyelapsedbefore thenatureand operationof a new productwere knownto a firm'srivals.Effectiveduplication, swe have definedt, should akeaslongorlonger,andtable9 shows that t typicallydoes. Themedianandmodal ndustries equireone to threeyearsto duplicatea major nnovationor a typicalpatented nnovation.A typicalunpatentedinnovation,however, is more often duplicatedwithinsix to twelve months. See "HowRapidlyDoes New IndustrialTechnologyLeak Out?"Jolurnalof IndustrialEconomics,vol. 34 (December1985),pp.217-24.



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812 Brookings Paper-s on Economic Activity, 3.1987Although hecosts and timerequired orduplicationare related o the

effectiveness of patents, they do not seem to be linkedstronglyto anyother mechanismof appropriability.n particular,most imitationtimeand cost measuresare uncorrelatedwith lead time andlearningcurveadvantages,and where such correlationsare statisticallysignificant atthe level of the individual respondent), the correlationcoefficient isinvariablybelow .15. These resultsmake sense. Lead timeand learningadvantagesmaypermitappropriation f returnseven when duplicationis relativelyquickand nexpensive. Effective patents, however, presum-ably requireconsiderable ime andexpense to be inventedaround.Finally, most of our respondentsbelieved only a few firms werecapableof duplicatingnew processes andproducts.As table 10shows,the median andmodalnumberof firms udgedcapableof duplicatingamajorprocess or product nnovationwas three to five. The medianandmodal number of firms regardedas capable of duplicatinga typicalprocess or product nnovationwas six to ten. Thedatarevealedonlytheslightest tendencytoward a smallernumberof capable duplicators orprocesses thanfor products.

R&D and InnovationIn this section, we summarizehowdataderived romoursurveyhavebeen employedto understandbetter the sources of interindustry iffer-ences in R&D spendingand the rate of technologicaladvance. In thefirstsuch effortRichardLevin, Wesley Cohen,and DavidMoweryused

several survey-basedmeasuresto explain variationsin the publishedFederal Trade Commissiondata on industry-levelR&Dspendingas apercentageof sales.44They also soughtto explaininterindustrydiffer-ences in the rate at which new processes and new products wereintroducedduring he 1970s,as reportedby our survey respondents.4544. The ratio of company-financed R&D to sales (R&D intensity) varies considerablyamong industries defined at the FTC line-of-business level of aggregation. In the 1976 data

used by Levin, Cohen, and Mowery, R&D intensity ranged from 0.08 percent to 8.5percent; both the mean and standard deviation were 1.7 percent. See "R&D Appropria-bility, Opportunity, and Market Structure."45. Respondents were asked to identify, on a seven-point Likert scale ranging from"very slowly" to "very rapidly," the rate at which new processes and products had been



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R. C. Levin, A. K. Klevorick, R. R. Nelson, and S. G. Winter 813Table 10. Number of Firms Capable of Duplicating an Innovation, FrequencyDistribution of Median Responses

More tliantType of intntovation None I or 2 3 to 5 6 to 10 10Major new or improved process 2 32 75 18 2Typical new or improved process 1 7 41 58 22Major new or improved product 2 25 73 25 4Typical new or improved product 1 5 33 63 26

Source: Survey of 129 lines of business.

In a subsequentpaper,Cohen, Levin, andMowerystudied heextent towhich thesame survey-basedmeasuresexplained hepowerful ndustryeffects in the confidentialFTC dataon R&Dintensity at the level of thebusiness unit.46The firstpaperfocused on the Schumpeterianhypothesisthat R&Dintensityandinnovationrates aresignificantly nfluencedby thelevel ofindustryconcentration. One common rationalefor this hypothesis isthatindustryconcentrationenhances the potentialfor appropriation fR&D returns.A differentview is that, in the long run, concentrationtends to be a consequence of industryevolution in a regimeof abundanttechnologicalopportunityand a high degreeof uncertaintyassociatedwith investmentin R&D. Both perspectives suggest that there is nosimple, causal relationshipbetween concentrationper se and R&D.Concentrationmaybe statisticallysignificantn simpleregressionspec-ificationsbecause it reflects the influenceof the unobservedappropria-bilityandopportunity onditionsthatdirectlyaffect R&Dspendingandthe rate of innovation.In ordinary east squaresand two-stageleast squaresspecificationsthat includedonly the four-firmconcentrationratio and its square as

introduced in their industries since 1970. Industry mean responses were highly correlatedwith total factor productivity growth, and the plausibility of the responses was reinforcedby the identity of the highest and lowest industries in the sample. Excluding singletons,the lines of business reporting the slowest rates of product introduction were concrete,cement, boiler shops, milk, gypsum, primary copper, grain mill products, and sawmills.Those reporting the most rapid rates of product introduction were electrical equipment forinternal combusion engines, radio and TV sets, computers, semiconductors, communi-cations equipment, photographic equipment and supplies, engineering and scientificinstruments, andguided missiles. Levin, Cohen, and Mowery used as a dependent variablethe average of each industry's reported rates of process and product introduction.46. Cohen, Levin, and Mowery, "Firm Size and R&D Intensity."



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814 Br-ookinigsPaper-s on Economic Activity, 3:1987regressors, Levin, Cohen, and Mowery replicatedwith the industry-level FTC data thefamiliar nverted-Urelationshipbetweenconcentra-tion andR&D ntensity,and they founda strongrelationship f the sameform between concentrationand the rateof innovation.47Adding two-digit ndustry ixedeffects weakenedslightlythe effect of concentrationon R&D,but the innovation-rate quationwas unaffected.The results changeddramaticallywith the addition of measures ofappropriabilityndtechnologicalopportunityderived rom hesurvey.48Whether or not two-digit industry fixed effects were included, thecoefficientson concentrationand ts square ellbyan orderof magnitudein the R&D equation, and the effect of concentrationwas no longerstatisticallysignificantat the .05level in either the R&Dintensityor theinnovation-rate quation.The vector of survey-basedopportunityvari-ables was significantat the .05 level in all specifications, and theopportunityand appropriability ariableswerejointly significant.Theappropriability ariables, however, were not individuallysignificant ntheR&Dequation,although he rateof innovationwas positivelyrelatedto the effectiveness of an industry'smost effective means of appro-priation.49The paperby Cohen, Levin,and Moweryused the disaggregatedFTCdata at the level of the business unit to investigatethe Schumpeterianhypothesis inkingsize andR&D ntensity.Theauthors oundthatwheneither ixed ndustry ffects(atthe level of the lineofbusiness)or survey-basedindustrycharacteristicswere taken into account, firm size hadavery small and statistically insignificant ffect on R&D intensity. Thesize of the businessunit did have a significant ffect on the probability

47. All coefficients in the R&D and innovation-rate equations were statisticallysignificant at the .01 level.48. To represent appropriability conditions, Levin, Cohen, and Mowery used twosurvey-based measures: the maximum of the mean scores an industry's respondentsassigned to the effectiveness of the six methods of appropriation and the time required toduplicate effectively a patented major product innovation. To represent opportunityconditions, they used a measure of an industry's closeness to science as well as variablessummarizing the importance of four other external sources of knowledge for an industry'stechnological advance: material suppliers, equipment suppliers, users of the industry'sproducts, and government agencies and research labs.49. It may seem anomalous that the effectiveness of appropriation was positivelyrelated to innovation but not to R&D, but the relationship was observed at the level of theindustry. Better appropriability may discourage R&D directed toward imitation to anextent that more than compensates for its stimulus to innovative R&D. Such a reallocationof effort would be entirely consistent with the observed positive relationship betweenappropriability and the rate of innovation.



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R. C. Levin, A. K. Klevorick, R. R. Nelson, acndS. G. Winter 815of engaging n R&D, but there was no perceptibletendency for R&Dintensity o increasewith size withinthe groupof R&Dperformers.Sizeeffects, however, explainedonly two-tenthsof 1percentof the variancein R&D intensity, while industryeffects at the line-of-businesslevelexplainedhalfthis variance.Cohen, Levin, and Mowery found that industry-levelmeasuresofappropriability, pportunity,and demandconditionswere consistentlysignificantnordinary eastsquares,GLS,andTobitregressionsexplain-ing business unit R&Dintensity. Moreover, these industrycharacteris-tics explainedapproximatelyhalf the variancein R&D intensity ex-plainedby fixedindustryeffects. Whenattentionwas focused on thoselines for whichthere were at least three survey respondents,measuredindustrycharacteristicsexplained 56 percent of the variation n R&Dintensityamong ndustries.Withinparticularwo-digit ndustries chem-icals, machinery, and electrical equipment), measuredcharacteristicsexplained78 to 86 percentof the varianceexplainedby fixedeffects.The results obtainedin the two papersindicatedthat survey-basedmeasurescan contribute ubstantiallyo anexplanationof interindustrydifferencesin R&D intensity and innovative performance.Measuresderived from the survey, despite their imperfections,have also beenfoundusefulfor variousotherpurposes.50

Remarks on PolicyOurfindingssuggestedsome general principlesrelevant to policies

thataffectthe incentivesto engagein innovativeactivity.A firstprinciple s that the patent system and relatedinstitutionsto50. Levin and Reiss have used survey-based measures of appropriability and oppor-tunity in a simultaneous equation model of R&D spending and market structure that buildson their work in "Tests of a Schumpeterian Model." Cohen and Levinthal use survey-based variables in their work on R&D as investment in absorptive capacity; see "Innova-tion and Learning." lain Cockburn and Zvi Griliches are studying the usefulness of oursurvey measures in estimating the value of patents from stock market data; see "IndustryEffects and Appropriability Measures in the Stock Market's Valuation of R&D andPatents," American Economic Review (forthcoming, May 1988). Meryl Finkel, "OverseasResearch and Development by U.S. Multinationals: Ownership Structure Decisions"(Ph.D. dissertation, Harvard University, 1986), explored the effect of our appropriabilityvariables on the investment decisions of multinational corporations. Franco Malerba isusing the survey data to explain interindustry differences in the extent and effectivenessof learning mechanisms.



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816 Br-ookings Papers oniEconomic Activity, 3:1987protect intellectualpropertyshould be understoodas social structuresthat improve the appropriability f returnsfrom innovation. They arenot the only nor necessarily the primarybarriers hat prevent generalaccess to whatwould otherwisebepurepublicgoods. Lead time accruesnaturally o the innovator,even in the absence of any deliberateeffortto enhance ts protectiveeffect. Secrecy, learningadvantages,and salesandservice effortscanprovideadditional rotection, hough hey requirethe innovator'sdeliberateeffort. The survey confirmed hat these othermeans of appropriation re typically more important han the patentsystem. Henceinexaminingaproposedadjustment f thepatentsystemor related nstitutions, t is important o recognizethat the incrementaleffect of thepolicy changedependson theprotectionother mechanismsprovide.The surveyresultsalso confirmed ubstanti

levin klevorick nelson winter gilbert griliches appropriability p&d bpea 1987

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