978-1259539060 Chapter 9 Lecture Notes

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Instructor’s Manual

CHAPTER 9

Protecting Innovation

SYNOPSIS OF CHAPTER

A firm’s ability to generate rents from innovation is a function of the ease with which

competitors can copy the innovation. This factor makes the choice to protect the innovation and

the choice of the protection mechanism an important part of the overall strategy. There are four

primary mechanisms used to protect innovations in most countries: patents, trademarks,

copyrights, and trade secrets. International agreements have simplified the process of applying

for and receiving protection in more than one country. Trade secrets can be a useful means of

protection when patent and copyright protection are not applicable. The effectiveness of these

legal mechanisms varies from one industry to another and one item to another.

Choosing whether to aggressively protect an innovation or to disseminate it freely varies with the

nature of the innovation and the industry. The choice and ability to protect a technology

generates greater rents, and enables the firm to maintain architectural control of the development

and compatibility with other goods. On the other hand, openly disseminating technology can

encourage its widespread adoption by consumers and encourage the development of

complementary goods. Choosing to treat a technology in an open manner is an important

consideration when the firm is unable to produce in quantities sufficient to meet demand or

demand for the item is affected by the availability of complementary goods.

TEACHING OBJECTIVES

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1. Develop an understanding of the mechanisms a firm has available to protect an

innovative technology, the means by which the mechanisms can be put into effect and

their limitations.

2. Provide a basis for evaluating the type of protection mechanism to use and the extent to

which the protections should be applied. To determine where on the continuum between

wholly proprietary and wholly open the firm the firm should place its technology.

LECTURE OUTLINE

Overview

a. Whether and how to protect technological innovation is an important aspect of a firm’s

technological innovation strategy (keeping in mind dispensing the technology freely may be the

most advantageous decision).

b. There is a range of protection mechanisms available, each with its advantages and

disadvantages.

c. Protection moves along a continuum ranging from wholly proprietary to wholly open.

d. Identify the factors a firm should consider when formulating a protection strategy.

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II. Appropriability

a. Appropriability is the degree to which firm is able to capture rents from its innovation

and is a function of how easily competitors can imitate the innovation (i.e. whether the

underlying knowledge is tacit or socially complex) and the strength of the chosen

protective mechanism.

Patents, Trademarks and Copyrights

b. Patents, trademarks and copyrights all protect intellectual property. Patents apply to

inventions, trademarks to words or symbols intended to distinguish the source of a good,

and copyrights protect original artistic or literary work.

c. Patents are a property right granted by a government to exclude others from producing,

using, or selling the invention in country the patent in which the patent is issued, for a limited

time. There are three types of patents:

i. Utility Patents protect a new and useful process, machine, manufactured item, or

combination of materials.

ii. Design Patents protect new, original and ornamental design for a manufactured

item.

iii. Plant Patents protect the invention or discovery and asexual reproduction of any

distinct and new variety of plant.

d. The three tests that must be passed before patent approval is granted are 1) usefulness, 2)

novelty and 3) obviousness (i.e. must not be obvious).

e. Not subject to patents are the following―the discovery of scientific principles

pertaining to natural laws, substitution of one material for another, changing the size of

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an existing device, making something more portable, substituting equivalent elements,

altering the shape of an item, and printed materials.

f. The process of applying for a patent requires the submission of drawings and/or

explanation of use and a description of the manufacture and differentiating element.

Submission of materials is followed by a review by a patent examiner and a publication

period that gives others the right to challenge the patent. If all tests are passed and the

request is unchallenged the patent is granted. The U.S. patent fee schedule is shown in

Figure 9.2.

Show Figure 9.2

g. Patent law around the world differs and protections are not reciprocal. Some of the

key differences are:

i. Outside the US, publication about the invention before applying for the patent

will bar the right to a patent. In the US, inventors have a 1year grace period

within which they can publish before applying for the patent.

ii. Many countries have a “working requirement” requiring the invention be

manufactured in the country within a certain time period (often 3 years) after the

patent is granted.

iii. Of several international treaties related to patent laws around the world, the two

most significant are the Paris Convention for the Protection of Industrial

Property (eliminates any differences in patent rights afforded a citizen versus a

foreign national, establishes the right of “priority”, eliminates barriers to patenting

inventions previously revealed by public disclosure) and the Patent Cooperation

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Treaty (single application valid in all countries and the inventor has 2 ½ years to

file in other signatory countries).

h. Inventors and firms may monetize patents through a range of different patent strategies.

1. Patent strategies may include blocking others from selling the product so that the firm can

be the sole provider, licensing the technology to others, or selling the patent rights to

another firm that can better utilize the technology.

2. Firms may also seek patents just to limit the options of competitors, or to earn

revenues through aggressive patent lawsuits. These actions are sometimes referred

to as “patent trolling.”

3. In industries with complex technologies such as computers, software, and

telecommunications, a dense web of overlapping patents known as “patent

thickets” can make it very difficult for firms to compete without falling prey to

patent suits by other firms in that technology domain. This can seriously stifle

innovation. Firms thus sometimes buy bundles of patents to create war chests that

they hope will deter the patent attacks of others.

i. Trademarks and Service Marks protect a word, phrase, symbol, design or other

indicator (perceived through the five senses) used to distinguish the source of goods from

one party from the goods of another and also prevent the use of similar marks that may be

confusing to the consumer. A service mark distinguishes the provider of a service instead of

a product. These marks do not expire as long as they are in use. Rights to marks are

established in the legitimate use (i.e., the trademark does not have to be registered) though

registration offers some advantages.

j. Trademark Protection Around the World varies as does patent protection. Residents

and citizens of countries participating in the World Intellectual Property Organization

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benefit from a System of International Registration of Marks that is governed by two

treaties: the Madrid Agreement and the Madrid Protocol.

k. Copyrights protect works of authorship (fixed in a tangible form of expression) for a

period of 70 years in the U.S. These works include literary, dramatic, musical, artistic and

certain intellectual works. A copyright is established by legitimate use of the work and

provides the exclusive rights to reproduce the work, prepare derivative works, distribute

copies by sale or other transfer of ownership, by rental, lease, or lending, perform the work

publicly (including digital audio transmission) and display the material publicly. Copyrights

provide for the “fair use” of the material for purposes such as criticism, comment, news

reporting, teaching, scholarship or research.

l. Copyright Protection Around the World. There is no international copyright law that

protects an individual’s works throughout the world. There are, however, a number of

international treaties that extend reciprocal copyright protection amongst signatories. The Berne

Union for the Protection of Literary and Artistic Property is among the most important.

Trade Secrets

m. Trade secrets consist of information that belongs to a business but is generally unknown

to others that confer a distinct advantage in the form of economic rents for as long as it

remains valuable and private. An advantage of classifying proprietary information as a trade

secret is they need not meet the stringent requirements of patent law and a broader class

of assets and activities can be protected.

n. The Uniform Trade Secret Act attempts to establish a consistency between trade secret

laws amongst the U.S. states. To be subject to the Uniform Trade Secret Act, information

must meet three criteria:

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i. The information must not be generally known or readily ascertainable through

legitimate means.

ii. The information must have economic importance contingent upon its secrecy

iii. The trade secret holder must exercise reasonable measures to protect the

secrecy of the information

o. For information meeting the above criteria, the Uniform Trade Secret Act prevents

others from copying, using or otherwise benefiting from the secret without the owner’s

approval if they are bound by a duty of confidentiality, they have signed a non-disclosure

agreement, they acquire the secret through improper means such as theft or bribery, they

acquire the information from someone unauthorized to disclose it, they learn the

information in error, but have reason to believe it is a protected trade secret.

III. The Effectiveness and Use of Protection Mechanisms

a. Protection mechanisms their effectiveness are industry specific. Where patents offer little

protection, the firm may choose to rely on trade secrets, but the effectiveness of trade secrets

also varies with the type of technology and the industry.

i. In 1980 IBM was anxious to pursue a share of what they perceived would be a

valuable personal computer market. Although IBM used off the shelf

components, they felt confident their product would not be easily duplicated

because the computer code used to link the hardware to the software (BIOS) was

protected by copyright. The weakness in their thinking was that the written lines

of code were protected, but the functions the code produced were not.

Through a very carefully engineered process to circumvent the law Compaq

deconstructed the code and had engineers write their own code to duplicate the

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functions. The result was that Compaq was able to produce and sell a record

number of IBM-compatible computers without infringing on IBM’s copyright.

b. There are some situations where a company might decide they are better served by

disseminating technological secrets in order to establish their technology as the dominant

design. The downside of this strategy is that the firm may lose the opportunity to capture

monopoly rents and may not be able to regain control of the technology in the future.

Liberal diffusion of the technology can also result in the fragmentation of the technology

platform and the “standard” may cease to exist.

c. Wholly Proprietary Systems versus Open Systems

i. Wholly proprietary systems are based on company-owned technology protected

by patents or some other means. The technology is generally not compatible

with other manufacturers’ products and the developer is usually able to

appropriate rents from the technology. Customers may resist adopting these

technologies because of their higher costs and lack of compatibility with other

products.

ii. Wholly open systems are not protected and may be based on freely distributed

technology, are quickly commoditized and offer little opportunity to

appropriate rents.

iii. Most technologies are offered somewhere between wholly open and wholly

proprietary and are protected by a range of control mechanisms. This range is

exhibited by the control continuum exhibited in Figure 9.3.

Show Figure 9.3

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1. Video game consoles are an example of technology controlled at the wholly

proprietary end of the continuum. On the other hand, rights to produce

games for the consoles are usually licensed to third party developers in

order to generate a profusion of games.

2. Licensing policies for Microsoft’s Windows are more open in that

Microsoft retains all rights to augment the software, but licenses

complementary goods providers in order to promote the development of

such products and licenses equipment manufacturers to distribute the

software with their hardware.

3. Sun’s “Community Source” policy for Java moves a bit further in the

direction of wholly open. While Sun allows developers to augment the

source code and does not collect a licensing fee, all changes to the code

require approval by the “Java Community Process”, managed by Sun.

This allows Sun to disseminate the technology while maintaining control

over the integrity of the core platform.

d. Advantages of Protection include great rent appropriability, giving developers greater

incentives to invest in technological development, promotion and distribution.

i. A sponsor of proprietary technology may offer the technology at an especially

competitive price, advertise aggressively or subsidize the production of

complementary goods in order to promote the technology and secure its

position as the single producer of the standard.

ii. Another advantage of protecting a technology is to retain architectural control

(i.e. meaning the ability to determine the structure and operation of the technology

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and its compatibility with other goods and services). This is an especially

important feature of control when the manufacture and sale of complementary

technologies are a key part of the firm’s strategy.

e. Advantages of Diffusion

i. Diffusion encourages rapid adoption, resulting in a large installed base and a

strong market for complementary goods.

ii. Open technologies may also benefit from the additional development efforts of

other parties without additional cost to the original developer.

f. The following factors should be considered when deciding whether and to what degree

a firm should protect its innovation:

i. Production and marketing capabilities, and capital–if unable to produce or

market the technology (and complementary goods) at sufficient volume or quality,

protecting the technology may hinder its adoption.

ii. Industry opposition against sole source technology–other industry members

may jointly be able to exert enough pressure so that a firm will offer the

technology with fewer restrictions.

iii. Resources for internal development–a firm lacking in sufficient resources to

invest in the technology’s functionality and ongoing improvements may not be

able to compete in the market.

iv. Control over fragmentation–is important when standardization and

compatibility are important.

v. Incentives for architectural control–are especially high when the firm is a

significant producer of complementary products.

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