Don’t
Fence Me In:
Fragmented Markets for Technology and the Patent
Acquisition Strategies of Firms
forthcoming in Management Science
by Rosemarie Ham Ziedonis (University of Michigan)
FULL
TEXT
Introduction
Michael Polanyi noted long ago that “invention, especially modern invention, is a drama . . . enacted upon a crowded stage” (Polanyi, 1944). Decades later, scholars and policymakers still wrestle with the same vexing question: How do the rights of myriad actors shape this drama as it unfolds?
The proliferation of patents in the United States over the past few decades—in areas ranging from semiconductors and software to human gene sequences—has been well-publicized and widely discussed. Meanwhile, legal disputes over intellectual property have become more frequent and costly. Some suggest that increased acquisition and enforcement of patent rights is creating a problem in US technology markets similar to the “over-fencing” of land (David, 2001): when licenses from too many individual property owners are required to develop a new product, firms may under-invest in the commercialization of downstream technologies (Heller and Eisenberg, 1998). Others raise similar concerns about the emergence of “patent thickets” but predict that institutional solutions like patent pools or joint ventures will arise (Shapiro, 2001).
Defensive Patenting
In this paper, I examine the conditions under which defensive patenting offers firms an alternative to getting “fenced in” by owners of the technologies they use, perhaps unknowingly, in the design and manufacture of their products. Combining insights from transaction cost economics and “anti-commons” theories, I predict that firms will patent more aggressively than otherwise expected when rights to complementary patents—ones that would likely be infringed if the firm manufactures or sells its products without a license—are widely distributed among outside entities; this effect should be amplified for firms with large investments in technology-specific assets.
I argue that firms commercializing technologies that draw upon a concentrated pool of outside inventions can safeguard their investments most effectively through use of mechanisms like joint ventures or patent pools. But for firms building upon technologies held by a more disparate set of owners, the costs and delays associated with ex ante contracting make such an approach much less feasible, increasing the strategic value of patent portfolios. Laws governing the strength and enforceability of patents mediate these effects.
Evidence of the effects of fragmented rights
Identifying all technologies used in the development or manufacture of a firm’s products is an arduous if not impossible task, even without linking those technologies to patents and their respective owners. In line with a growing number of economics and management studies, I use linkages revealed in patent citations data to identify some organizational “shoulders” on which a firm’s inventions stand. More unique is my use and interpretation of these data. Relaxing the implicit assumption that knowledge flows freely across organizational borders, I use patent citations to identify a list of potential licensors and estimate the extent to which rights to a firm’s complementary patents are widely distributed. In doing so, I construct a time-varying “fragmentation index” that captures this dimension of a firm’s external market for technology that, while prominent in the theoretical literature, has not been examined in a large-scale empirical study. I test the effects of fragmented rights on incentives to patent using a sample of 67 semiconductor firms in periods that pre-date and follow reforms to the US patent system during the 1980s.
Management scholars have long recognized that some firms accumulate portfolios of patents for trading purposes—either to gain more favorable access to outside technologies or to cut down on licensing fees (e.g., von Hippel, 1988). Indeed, recent evidence suggests that the primary reasons firms patent in “complex” industries like electronics, semiconductors, and computing are to prevent rivals from patenting related inventions, to use these patents in negotiations with owners of outside patents and technologies, and to deter patent infringement lawsuits (Cohen et al., 2000). My paper builds upon this literature but suggests that these strategic use of patents may vary considerably even within an industry and is driven by both firm-specific and environmental factors.
The paper also provides new insights into the motives for patenting in semiconductors, a sector where innovation is a fluid, highly cumulative process. In an earlier study, Bronwyn Hall and I found that the “pro-patent” shift in US policies during the 1980s prompted specialized firms to enter the industry while triggering “patent portfolio races” between firms with large, complex manufacturing facilities (Hall and Ziedonis, 2001). Our interviews with executives suggested the latter “racing” effect was driven not only by the (observable) scale of these firms’ manufacturing investments but also by the (unobservable) likelihood of ex post licensing negotiations with outside patent owners. Drawing upon these qualitative insights, this paper develops the theoretical arguments more fully and devises a way to disentangle these two effects.
The results suggest that the “patent portfolio races” identified in Hall and Ziedonis (2001) were not driven by capital-intensive firms per se, but by the subset of these firms that builds upon a broad range of external technologies. In response to average levels of fragmented rights, I find that capital-intensive firms patent more than five times as aggressively as firms with fewer sunk costs in manufacturing assets, even after controlling for differences in R&D spending and size. However, these firms do not seem to patent more intensively than others in the sample unless they draw upon technologies owned by a disparate set of parties. I consider several competing explanations for this phenomenon: underlying shifts in technological opportunity, or the possibility that firms with a broader range of knowledge sources benefit from greater R&D efficiencies. However, I find little evidence in favor of these views.
Policy Implications
From a policy perspective, “mutually assured destruction” games among firms that develop and produce complex technologies exacerbate the problem: to avoid being held-up by others, firms file more patents and, in turn, contribute to the proliferation of patents that others face. The recent Federal Trade Commission (FTC) report (2003) makes important strides in identifying the features of US patent law and practice that exacerbate what already seems to be a zero-sum game. The greater challenge, of course, lies in reforming the system. The FTC/Department of Justice Hearings yielded a number of recommendations. These include reducing the costs of challenging “questionable” patents by adopting a post-grant opposition system and relaxing the evidentiary standards required to invalidate a patent and raising the overall quality of patents issued in the United States by improving the rigor of the patent examination process and raising the bar of non-obviousness. But even these straightforward solutions require non-trivial changes in the way that patents are examined, prosecuted, and enforced. Until such reforms are adopted, some firms may continue to form patent pools. Others may reduce R&D spending. Still others may flood the US Patent and Trademark Office for defensive purposes. Polanyi’s “drama of innovation” goes on. The question is, Who wants to clean up the stage?
References:
Cohen, W.M., R.R. Nelson, and J.P. Walsh (2000). “Protecting Their Intellectual Assets: Appropriability Conditions and Why U.S. Manufacturing Firms Patent (or Not),” NBER Working Paper no. 7552.
David, P.A. (2001). “Will Building ‘Good Fences’ Really Make ‘Good Neighbors’ in Science?”, Department of Economics working paper #01-005, Stanford University.
Hall, B.H. and R.H. Ziedonis (2001). “The Patent Paradox Revisited: An Empirical Study of Patenting in the US Semiconductor Industry, 1979-95.” RAND Journal of Economics, 32(1): 101-128.
Heller, M.A. and R.S. Eisenberg (1998). “Can Patents Deter Innovation? The Anticommons in Biomedical Research,” Science, 280: 698-701.
Polanyi, M. (1944). “Patent Reform,” Review of Economic Studies, XI.
Shapiro, C. (2001). “Navigating the Patent Thickets: Cross-Licenses, Patent Pools, and Standard-Setting,” in A.Jaffe, J. Lerner and S. Stern, eds., Innovation Policy and the Economy, v1 (Cambridge MA: NBER)
U.S. Federal Trade Commission (2003). To Promote Innovation: The Proper Balance of Competition and Patent Law and Policy, available for viewing at: http://www.ftc.gov/reports/index.htm
Von Hippel, E. (1988). The Sources of Innovation (Oxford, U.K.: Oxford University Press)
