This Article is written by Avinash Bhargav ( National Law Institute University (NLIU) Bhopal)
Table of Contents
In an ideal scenario, an institutional framework for the assignment and enforcement of IP rights should satisfy, to large extent, the needs of firms to protect intangibles such as innovation, business models, and knowledge. However, as the two previous sections suggest, the existing IP institutional framework is overwhelmed by the volume and complexity of requests, as well as by the herculean effort needed to enforce existing rights. Although this problem impacts both local and multinational firms, it is especially acute for the latter, since global firms rely on intangible assets such as their know-how and reputation for overseas success (Vernon, 1973; Morck & Yeung, 1991).
Although changes in the global IP system, such as the introduction of global patents, trademarks, or industrial designs, or the establishment of a global court system for IP disputes, may be desirable, the likelihood of these changes is slim at best. Moreover, ongoing research suggests that some potential solutions, including patents that cover multiple countries, may negatively impact innovation (Alcacer, Beukel, and Luo, 2015). Without such a system, what steps can firms take to capture value from their investments in know-how and reputation globally?
To answer this question, we turn to the academic literature that has identified mechanisms to appropriate value when the IP system is lacking (Liebskind, 1996; Anand and Galetovic, 2004; Fisher & Oberholzer-Gee, 2013). We complement and illustrate these mechanisms with examples of global firms that have developed practices and routines to appropriate value in challenging environments. Although many of these mechanisms were conceptualized, developed, tested, and discussed in a single-country context, we emphasize the pros and cons of applying them in a global context. We have observed that firms that excel at appropriating value globally don’t favor one single mechanism, but are flexible enough to choose and apply multiple mechanisms depending on the characteristics of specific markets, the activities they perform there, and the products they sell. Most of these firms have moved from looking at IP as a legal issue to treating it as an integral part of their business model and competition strategy. We collect these mechanisms to capture value from IP into two groups: market and non-market.
Often firms design or change their business model to incorporate mechanisms that capture value under the existing IP institutional framework.While we have documented important differences in the effectiveness and cost of formal IP tools across regions and authorities, there are also important differences across industries in the effectiveness of different mechanisms for capturing value from IP Interestingly, formal IP tools are not systematically rated more effective compared to other mechanisms of protection, such as secrecy, superior lead time, or making an innovation more complex. In pharmaceuticals or research services, patents play a very important role in capturing value from IP, This corresponds to what Cohen et al. (2000) found for a large sample of U.S. R&D labs in the 1994 Carnegie Mellon survey, namely that secrecy and lead time are rated more effective in protecting and capturing value from innovations. In addition, they found that complementary manufacturing or service activities were highly effective for capturing value from product and process innovations.
Nevertheless, we need to interpret these results with caution. Formal IP tools might be a necessary, but not sufficient, condition for capturing value from firm innovations. In particular, secrecy is highly correlated with other IP tools. For example, in pharmaceuticals and research services, secrecy is rated very effective by more than 50% of the firms surveyed. Complexity, while important for research services, seems less relevant in an industry with a more discrete technology such as pharmaceuticals. Overall, complexity as a mechanism to protect innovations is less correlated with the other IP tools, but is (perhaps not surprisingly) very related to protection through superior lead time.
STRONG IP REGIMES
Exercising market power.
IP rights provide a mechanism to exclude others from appropriating value. Although previous sections uncover the problems of the global IP regime, applying for patents, trademarks, and industrial design is still an important building block to appropriate value globally and the main reason for applying for formal IP rights (Cohen et al. 2000). The big challenge for firms is to decide, given financial and managerial constraints, what to patent where.
This decision depends on a set of parameters: the potential decrease in revenue if infringement occurs, the probability of such event, the cost of obtaining IP rights, and the cost of enforcing those rights.
Markets, where the potential erosion of revenues from infringement is high, are good candidates to obtain an IP right, which explains why the majority of patents, trademarks, and industry designs are concentrated in a few larger markets. High application and enforcement costs and high probability of infringement make using IP rights less attractive. In the extreme, a high probability of infringement (e.g. in a very weak IP regime) will discourage firms from entering a market or force them to search for alternative mechanisms to capture value from their IP.
Applying and obtaining IP rights across markets has an extra advantage: they can be used as a negotiation chip when firms litigate in a given market and protect the firm from suits against them (Cohen et al. 2000). Moreover, using multimarket contact to deter and retaliate for actions in a given market may decrease the number of markets a firm needs to apply for IP rights.
Even in markets with strong IP regimes, firms might decide not to protect their IP formally. For a large sample of US R&D labs, the main reason for not patenting IP was because of the disclosure requirements and the ease of inventing around the invention. Especially when firms worry about the difficulty of demonstrating novelty, they might decide not to patent and not disclose information about their innovation efforts to potential rivals (Cohen et al. 2000).
Sale or licensing:
In a regime with strong IP protection IP can be traded. Either ownership is transferred or IP is licensed to other firms. Actually, Gans et al. (2002) argue that the stronger the IP regime, the more likely one should observe collaboration and licensing or sale of the technology as the incumbent has an incentive to buy out any potential contender for the market and avoid competition. Serrano (2010) studies the transfer of patents to different owners. On average 13.5% of all granted patents are traded at least once over their life cycle. For small firms this even goes up to 24% when patents weighted by patent citations received. Much less data is available on licensing agreements in technology, but similar patterns are discussed in the literature for example in the case of alliances between biotech firms and pharma companies (Lerner and Merges, 1998) or licensing agreements between specialized engineering firms and large chemical firms in the chemical processing industry (Arora et al. 2001). The overall conclusion is that strong IP rights and larger markets favor the use of the markets for technology in order to capture value from IP.
While IP trading and licensing or cross-licensing is a bilateral transaction, in recent years patent pools have started to flourish as a means to appropriate returns from IP by simplifying the transactional aspects of licensing by creating bundles of licenses to license to third parties. These licenses include the relevant IP to use a particular invention based on IP owned by different players.
Where selling and licensing IP is an ex-post opportunity for firms to capture value from their IP, firms can organize collaborative agreements to develop new (shared) IP based on their existing knowledge base. These agreements might involve the (cross-) licensing of existing IP, but with the explicit objective of exploiting existing IP and developing new IP. This new IP can be exploited by the partners individually or can be exploited by a different organization such as joint venture between the partners. Concerns about appropriation are more likely to arise when the partners are competitors, customers, or suppliers. Collaboration in early-stage projects with universities raises less concern (Cassiman and Veugelers 2002). Tesla Motors, a front-runner in electrical vehicle technologies, chose a different approach to collaboration based on strong IP. Tesla developed ground-breaking technology to minimize the time it takes to recharge batteries. Although these technologies are protected by a strong portfolio of over 400 patents, Elon Musk, Tesla’s CEO, announced on June 14th 2014 that “Tesla will not initiate patent lawsuits against anyone who, in good faith, wants to use our technology.” 16 Tesla believed that utilizing an open-source approach to their patents would help them in comparison with their competitors to speed the rapidly-evolving technology platform for electrical vehicles.
Litigation is a very expensive response to infringement. In countries with strong IP protection, firms can approach the party that infringed an IP and try to negotiate a settlement that includes either selling or licensing the IP that has been infringed. Although data on settlements that lead to licensing or transferring ownership of IP rights is practically impossible to obtain, there are clear indications of active licensing to solve, and even prevent, IP infringement. For example, a survey of 1,235 random Danish firms that hold IP revealed that settlement was the preferred action taken after the firm experienced piracy (see Exhibit 40).
Combining different IP tools:
As discussed earlier, companies can also combine IP tools, such as patents, industrial designs and trademarks to reinforce protection and their value capture from their innovations (Dernis et al. 2015). Apple combines trademarks, patents and industrial designs in their iPhone products.
WEAK IP REGIMES
- Owning or controlling complimentary assets:
A firm can appropriate value if a product/service that has weak IP rights or is easier to copy can only create value if it is bundled with another product/service that is either protected or hard to imitate. AKB48, a Japanese entertainment concept associated with the giant advertising firm Dentsu provides an example. AKB48 is a set of musical idol groups, each formed by 16 amateur young girls, which rotate to perform in a small theater in the Akihabara district in Tokyo. The concept, based on the idea of idols that you can meet, has been extremely successful and it could be easily replicated. However, most of the revenues come from advertising campaigns that Dentsu and its clients develop to leverage the notoriety of AKB48 members. Apple offers another example of using complimentary assets. Apple stores were introduced for many reasons; one of them was to guarantee consumers that they were buying an original product. Moreover, Apple is actively involved in the design of the equipment that will produce critical elements of their products and provides this equipment to their suppliers in order to guarantee the quality of their products. In industrial products it is common practice to link maintenance and repair services to proof of original equipment. For example, General Electric Medical Systems (GEMS) offers repair and maintenance services only to its medical devices and excludes third-parties from the market.
The pharmaceutical industry in the United States and Europe provide an example of usingcomplimentary assets that are not owned by firms that hold the IP. In Europe, most drugs are bought in bulk by government agencies—agencies that would not buy from unknown distributors that may carry counterfeit drugs. In the U.S. sales of drugs to consumers is in the hands of a few pharmacy chains (like CVS or Walgreens) that would hesitate to buy from obscure providers. By controlling the most common (and legal) distribution channel, pharmaceutical firms prevent fake drugs from taking hold in the marketplace.
- Imposing secrecy.
Secrecy is an alternative to public IP rights when intangibles can’t be patented, trademarked, or protected through industrial design. Apple is again a good example. Although some of their designs and technology are patented in advance, every product launch is shrouded in high-secrecy to protect the company’s lead time and make imitation less likely.
- Secrecy as a tool to protect IP
Secrecy as a tool to protect IPis commonly used with the workers of a given firm, using hierarchical structures or cultural norms that limit opportunistic behavior. It can also be extended to suppliers and buyers by using “carrots” in the form of higher prices paid, or “sticks” in the forms of strict confidentiality and exclusivity rules in contracts, the threat of reputational losses, and the loss of future contracts. In order to keep new products secret, industry sources report that Apple pays a premium to Foxconn to keep exclusive production lines and workforce that can’t be used for other customers.
Non-compete clauses are part of contracts under which one party, usually an employee, agrees not to enter into or start a similar business in competition against another party, usually the employer. Although these contractual clauses are not valid in all jurisdictions, they offer a way for firms to keep the IP resident in employees within the boundaries of the firms.
While secrecy and the restriction of mobility of inventors can be leveraged as a protection mechanism for IP, Cassiman et al. (2015) show that this mobility of researchers and inventors is actually critical to capture value from formal IP in collaborative agreements the semiconductor industry. Inventions from researchers that have interacted actively with other research environments lead to more valuable IP for the firm and are an essential step in capturing value from this knowledge.
- Using complexity as protection.
IP that is inherently complex is harder to infringe on since it requires a higher level of resources and knowledge, as well as more capable human capital.
Complexity also allows firms to use another tool to protect IP: dividing knowledge and skills across the organization so that, even if some IP is leaked, it cannot be replicated due to missing pieces. Zhao (2006) finds that multinational firms are more likely to conduct R&D in China when the local project requires inputs from projects in other locations. Alcacer and Zhao (2012) documented the same principle in the semiconductor industry: fragmenting innovation across locations, even in countries with strong IP, to prevent anyone from seeing the whole picture. Consistent with this idea Cassiman (2009) documents the fact that firms that combine different innovation activities such as internal R&D, external R&D contracting and licensing, rate the effectiveness of protection through strategic measures such as complexity, secrecy and lead time much higher. Firms combine internal and external knowledge into more complex innovations. Access to the external knowledge allows them to move faster and create lead time, while integrating and using internal knowledge improves secrecy about the innovation and enhances protection.
- Using speed and lead time.
To the extent that infringement requires time, firms can enjoy periods of protection by staying ahead of potential copycats. Bilir (2014) shows that multinational firms are more likely to locate in countries with weak IP regimes in industries with short-life cycles because “offshore imitation is less likely to succeed before obsolescence” of the technology. Nokia was an example of this approach. By bringing its design-production cycle for new cell phones under the two-year industry standard in the late 1990s early 2000s, Nokia was able to stay ahead of competitors and imitators for a few months.
- Deploying outdated IP.
In environments where imitation, IP leakage, and piracy are common, it may be worthwhile to enter with technology that is outdated, thus reducing the potential loss if technology or knowledge is pirated. For example, when Intel opened its plants in China, it decided to use semiconductor technologies that were two generations older.
- Changing the business model.
Often small changes in a business model can help to protect IP. AKB48 is an example. Sales of CDs and DVDs are the second source of revenue from AKB48 after advertising. Although media piracy is low in Japan, it is very high in other places in Asia where the concept has expanded, such as China and Indonesia. To avoid having value from media appropriated by other firms, the creators behind the concept tried to change the perception of value that a CD would bring to a consumer. Beyond providing music or videos from AKB48 and its sister groups, purchasing a CD or DVD will give fans voting rights in the annual contest that chooses the top performers that will be part of the all-star AKB48 team. The desire to influence the outcome leads extreme fans to buy multiple CDs or DVDs to get more voting rights and regular fans to prefer the original copies to the pirated ones. Verifying that a CD or DVD is legitimate is easier as the whole system is in Dentsu’s control. As a result, media sales of AKB48 music and movies are significantly higher even in countries with rampant piracy.
The business model can be adjusted by country to adapt it to the IP risks in a given country or to adopt the best model to capture value from their IP. In 2015 Barco, a Belgian technology company, had a leading global market share in digital cinema systems for movie theatres. Since the late 1990s, Barco had been working on the technology for digital projection based on digital light processing technology licensed from Texas Instruments (TI). Only two other players in the market, NEC and Christies, were developing similar systems based on the same technology. Most players in the value system agreed that digital cinema was an innovation that could create tremendous value for the movie business. In particular, digital transmission of movies would eliminate the very costly transport and shipping of movie reels and allow worldwide releases of movies on the same day. The industry calculated that, on a yearly basis, about $1.5 billion could be saved on distribution alone, not to mention all the advantages of digital filming, editing, and special effects development. It nevertheless took until 2009 for this innovation to take hold in the movie business and for firms to be able to capture value from their innovation.
Movie theatres were not at all excited about replacing their analog equipment. The movie theatre business had very slim margins and the new equipment was expensive and reputably less durable than analog projectors. While the technological innovation for digital cinema systems was in place, it wasn’t until the United States instituted a virtual print fee that U.S. movie theatres began replacing their analog machines. Movie producers and equipment manufacturers created a fund that paid a fee-per-viewing of a movie in digital format. The fund would buy the digital projection equipment with these proceeds and lease the equipment to the movie theatres. This reduced the upfront investment that theatres had to make to switch to digital. As a result, it was not the technological innovation of digital projection that revolutionized the movie business, but rather a financial innovation instituted by the studios and equipment manufacturers. Based on this experience in the United States, Barco decided to provide direct vendor leasing opportunities for movie theatres in Europe in order to overcome the same bottleneck. In China, meanwhile, many of the medium-sized movie theatres were run by the China Film Group. Only after Barco instituted a joint venture with China Film Group did movie theatres in China begin to convert their analog systems, allowing Barco to capture value from its IP.
The original technology was patent-protected by TI and licensed by Barco. Barco developed a digital cinema projector based on its signal processing capabilities and gradually patent-protected this technology worldwide. However, it was only able to capture value from its innovation after it developed complementary activities to incentivize movie theatres into converting their systems: the virtual print fee in the U.S., direct vendor leasing arrangements in Europe, and a joint venture in China. These complementary activities were tailored to the specifics of the region where they intended to sell their systems.
Sometimes firms attempt to change the IP environment they face by changing rules, norms, and procedures that affect more than one firm. Often these actions, e.g. non-market mechanisms, imply some sort of collaboration with other firms to gain leverage that a single firm could not achieve.
Participating in patent pools and common-standards organizations.
Facing hyper-fragmented IP rights, acquiring critical mass in patent portfolios, and minimizing the probability of litigation are the main drivers that motivate firms to pool their patents. Although patent pools have been around for years—the patent pool for sewing machines in the United States, for example, was formed in 1856—they have gained notoriety since the mid-1990s, when they became more common and well known, with examples such as the pool for MPEG-2 technology created in 1997 and the pool for DVD technology enacted in 1999.More recently, the same concept has been used as a business model to solve imperfections in the IP market. For example, Intellectual Ventures, a firm created in 2000, has aggregated patents through purchases and agreements with other firms to become one of the top five patent-holders in the United States, without any innovative activity of its own. The IV business model consists of selling “insurance” against litigation to firms that either contribute with their patents or pay a fee to use the patents in IV’s stock in case of litigation.
Fighting counterfeiting by cooperating with governments.
Governments play an important role in developing legislation that enables IP owners to operate effectively against the spread of counterfeit products, especially in countries where the IP regime still isn’t sound. Although, firms may want to cooperate with governments to improve local institutions, the actions of one firm may not be enough to change the system. Moreover, governments may not be willing, or even able, to engage cooperatively with multiple individual firms.
To build a bridge between individual companies and governments in countries with weak IP regimes, firms have started to organize themselves in communities, to raise a single strong ‘IP voice’. One example is the Quality Brands Protection Committee in China, where 190 firms, representing many of the world’s most famous brands, collectively aim for the common goal of enhancing the IPR legal framework in China. They do so through interaction with the Chinese government at various levels, as well as through discussions with the judicial and administrative enforcement agencies.
Boosting market surveillance.
Multinational firms have limited resources to track counterfeits and infringements globally, and might not always be in a position where they can access this knowledge. At the same time, a limited understanding of the scope and scale of infringers may lead to poor enforcement strategies. A solution to imperfect knowledge access is engaging stakeholders, both downstream and upstream in the value chain, to identify infringements. For example, when Danfoss, a global leader in compressors and thermostats, learned in 2013 that counterfeit compressors had overtaken 7% of its market volume in China; it initiated an awareness campaign to boost surveillance and to minimize the damages caused by the fake products. In a series of seminars in both urban and rural areas in China, Danfoss informed their OEMs, distributors, project contractors, installers, and other local stakeholders of the risks of counterfeit compressors in terms of safety, efficiency, and performance, while also giving them technical instructions on how to identify a counterfeit Danfoss compressor, and information about whom to contact when a counterfeit is detected.
CONCLUSION AND IMPLICATIONS FOR MANAGEMENT PRACTICE
The overall picture that emerges from our analysis —a growing number of applications and grants, fragmented rights, and IP of questionable quality that is difficult and expensive to enforce—leaves plenty to be desired. At the same time, what is clear is that the challenges to capturing value from know-how and reputation through the use of different IP tools will be an increasingly important matter of strategy for global enterprises. This has important implications for management practice in this area.
As argued, global enterprises will need to combine different institutional, market and non-market mechanisms to capture value from a company’s know-how and reputation. Moreover, the precise combination of tools will depend on the local and regional institutional and market conditions. As a result, these organizations need to reconsider their innovation, IP and business structures to optimally adjust.
Such an environment requires early involvement by a value capture (VC) team. Global companies will need to organize globally-oriented cross-functional teams focused on capturing value from their know-how and reputation by combining different institutional, market and non-market tools depending on the business environment in the particular region. These teams will combine business development staff with IP experts (e.g. R&D, operations and production, sales and marketing, finance and accounting, legal staff with a business background).
To understand the role the VC team plays in firms, we suggest three central principles for managing the process of value capturing. First, the VC team should move beyond case handling to include strategic thinking. Clearly, it is not sufficient to think about IP protection without considering the overall IP portfolio and positioning of the business in the region.
Second, the VC team of the firm should not only be reactive, but pursue proactive engagement in innovation processes in the firm. Early on in the innovation process of the company, a VC plan is developed. Some innovations might provide better value capture opportunities though they might not be breakthrough innovations. Changing the business model or considering complementary assets at this stagecan radically change the value capture opportunities and might even change the technology development trajectory.
Third, a VC team’s frame of mind goes beyond thinking about IP registrations as a process linked to institutional demands; it should also include a frame of mind in which mechanisms for value capturing are developed creatively in cooperation with the traditional firm teams. Currently, many IP teams are only concerned about the institutional demands about the IP (registration, fees, search reports, revisions, etc.). However, in terms of patents for example, the VC team should offer an in-depth understanding of the technological landscape from a patenting perspective to be leveraged in brainstorming and design thinking processes. In addition, the VC team is active in scouting for market and product opportunities in the IP landscape to provide valuable insights to R&D.
Creating a VC team is an important impending issue for global enterprise dealing with the complexities of global IP in order to make sure that the opportunities presented by the failures of the institutional tools in some regions are exploited by different mechanisms.
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