Exploding the Supply Chain

This chapter describes the relationship between secure patent enforcement, the disaggregation of technology supply chains, and reduced entry barriers in three core segments of the modern innovation economy. The establishment of the Federal Circuit in 1982, coupled with the relaxation of antitrust restrictions on licensing starting in 1977, inaugurated a strong-IP regime that has enabled firms to mitigate the expropriation risk inherent to the transfer and exchange of informational assets. In the biotechnology market, secure patents have facilitated transactions between R&D-intensive start-ups and large pharmaceutical companies that specialize in the testing, production, and distribution functions required to reach market. In certain segments of the semiconductor market, secure patents have facilitated transactions between chip-design firms and “foundries” that specialize in chip production. In certain information-technology markets, secure patents have facilitated IP-licensing structures that promote informational dissemination among a broad population of producers and other intermediate users.

An Organizational History of the U.S. Patent System

This chapter presents a novel organizational history of the U.S. patent system during 1890–2006. Based on a division of U.S. patent history into two strong-patent/weak-antitrust periods (1890 to mid-1930s and 1980s to 2006) and one weak-patent/strong-antitrust period (late 1930s to 1970s), it describes evidence relating to concurrent changes in the mix of organizational forms used to structure the innovation and commercialization process. Both strong-IP periods are characterized by substantially disaggregated supply chains in which innovators enter into financing, licensing, and other contractual relationships with third parties to execute the commercialization process. By contrast, the weak-IP regime that prevailed during the postwar decades principally supported innovation by large integrated firms, often supplemented by extensive government funding. Historical organizational trends support the hypothesis that weak-IP regimes shift innovation and commercialization activities toward integrated firm structures, while strong-IP regimes sustain organizationally diverse innovation ecosystems that support a range of integrated and disintegrated structures.

Conclusion

For more than a decade, U.S. courts, legislators, and antitrust regulators have sought to weaken IP protections in technology markets. An organizational approach to IP analysis raises doubts about whether this policy trajectory is consistent with the public interest in supporting both the innovation and the implementation of new technologies. The economics, history, and politics of the U.S. patent system support the view that weak-IP regimes induce an organizational bias by favoring firms that operate under integrated and platform-based business models for monetizing R&D, which raises an implicit barrier to entry by smaller R&D-specialized entities that rely on patents to enter into contractual transactions to execute the commercialization functions required to reach market. Weakening IP protections can protect large incumbents against the competitive threat posed by smaller entrants that often produce the most dramatic forms of technological innovation.

Why Incumbents (Usually) Prefer Weak Intellectual-Property Rights

This chapter challenges the conventional assumption that incumbents in technology markets lobby for strong IP rights to erect entry barriers and capture market rents. In the railroad industry in the late nineteenth century, in the software industry in the 1960s and 1970s, and in patent-reform debates since the mid-2000s, large vertically and horizontally (systems-level) integrated firms outside the pharmaceutical industry have generally advocated for weaker patents or resisted the extension of IP protection to new technologies. By contrast, smaller R&D-intensive entities and venture-capital firms have generally expressed the opposite position. A comprehensive study of all amicus briefs filed in Supreme Court patent-related litigation during 2006–2016 confirms this entity-specific divergence in IP-policy preferences. Historical and contemporary evidence supports the hypothesis that in a significant number of industries, weak patents protect incumbents by impeding entry by smaller innovators that lack comparable non-IP complementary capacities by which to capture returns on innovation.

Constructing an Objective History of the U.S. Patent System

This chapter presents a history of the U.S. patent system based on quantitative and qualitative evidence relating to patentees’ expectations that courts will uphold the validity of contested patents, find infringement, and award injunctive relief against infringing parties. Additionally, this chapter describes historical changes in antitrust law that have impacted patentees’ ability to enter into licensing and other patent-dependent transactions. Based on these features of patent law and antitrust-related patent law, supplemented by background institutional developments, the history of the U.S. patent system during 1890–2006 consists of three periods: (i) a strong-patent, weak-antitrust period from 1890 through the mid-1930s; (ii) a weak-patent, strong-antitrust period from the late 1930s through the 1970s; and (iii) a strong-patent, weak-antitrust period from the early 1980s through 2006. Historical trends in the volume of patent applications by U.S. inventors are consistent with this division of U.S. patent history.

Organizational Perspectives on Intellectual-Property Reform

This chapter presents a novel organizational perspective on “patent reform” in the U.S. Supreme Court, Congress, and the federal courts during 2006–2020. Debates between proponents of strong and weaker patents can be understood as a conflict between entities that rely on integrated business models for monetizing R&D, which deploy non-IP complementary assets to capture returns on innovation, and entities that rely on non-integrated business models, which monetize R&D through licensing and other IP-dependent contractual relationships. Weak-IP regimes induce an organizational bias that favors integrated and platform-based firms that capture returns on innovation within internal capital and information markets while impeding entry by smaller, R&D-specialized entities that capture returns on innovation through external capital and informational markets. By contrast, strong-IP regimes enable firms and other entities to select from the full range of more and less integrated structures for executing the innovation and commercialization process.

Organizational Effects of Intellectual Property (Macro Level)

This chapter describes how the level of IP protection impacts firms’ choices in organizing the innovation and commercialization process, which in turn influences the structure of the innovation market as a whole. Weak-IP regimes induce firms to adopt “hierarchical” structures that mitigate expropriation risk by locating innovation and commercialization activities within substantially integrated supply chains. Strong-IP regimes restore organizational choice and enable innovators to adopt “entrepreneurial” structures that rely on contractual relationships among firms that specialize in particular innovation or commercialization functions. If hierarchical structures cannot sufficiently mitigate expropriation risk, then innovation markets will adopt “bureaucratic” structures that rely on tax-based or philanthropic funding. Even when markets adapt to weak-IP regimes by adopting hierarchical structures, or hybrid hierarchical and semi-bureaucratic structures, that support robust R&D investment, efficiency losses will arise to the extent that entry by entrepreneurial innovators is suppressed and the selected mix of innovation projects is distorted.

Organizational Effects of Intellectual Property (Micro Level)

This chapter identifies real-world circumstances in which secure IP rights are a precondition for innovation specialists to extract value from R&D investments, given the ability of large integrated firms to imitate any successful innovation and capture the market through financing, production, and distribution efficiencies. Survey evidence and other evidence on patent application, issuance, and enforcement indicate that smaller firms tend to place a higher value on patents than larger firms as a mechanism for capturing returns on innovation. A secure IP regime enables firms to select from the full range of monetization structures in order to assemble the maximally efficient mix of organizational forms for executing the innovation and commercialization process.

Dynamic Analysis of Intellectual Property

This chapter proposes a dynamic approach to IP analysis that assesses the effects of changes in the strength of IP rights by anticipating firms’ ability to adopt alternative non-IP mechanisms for capturing returns on innovation. Some of the most powerful non-IP alternatives are the economies of scale, financing capacities, and accumulated goodwill that are inherent to older, larger, and more integrated entities. By contrast, these non-IP alternatives are generally unavailable to younger, smaller, and less integrated entities. These entity-specific differences in adopting non-IP alternatives imply that changes in the strength of IP rights can have significantly different effects on different entity types as a function of age, size, and level of integration. Critically, weak- or zero-IP regimes can advantage large incumbents by compelling exit or deterring entry by smaller and less integrated firms that cannot sufficiently monetize R&D investments in the absence of reasonably secure IP protections.

Introduction

This introduction describes how the book examines the relationships between IP rights, organizational form, and market structure, using a combination of theoretical analysis and empirical evidence drawn from almost 120 years of U.S. patent policy and associated technology markets. This analysis deploys a “dynamic” approach to IP analysis, which anticipates that the effects of changes in IP protections differ depending on firms’ ability to adopt non-IP alternative mechanisms for capturing returns on innovation. In general, larger and more integrated firms will be able to do so at a significantly lower cost than smaller and less integrated firms. The entity-specific effects of IP rights imply that stronger and weaker IP regimes will impact the range of viable organizational forms for structuring the innovation and commercialization process, which in turn impacts the structure of innovation markets and the allocation of resources across different types of innovation projects.