Protecting Intermediate Innovations When Ideas Are Scarce: Patents or Secrecy?

Patenting an intermediate research innovation can lead to competition for the development of a final commercial innovation and potentially induce wasteful duplicative R&D efforts. This study examines the effects of different protection strategies and patent life on the incentives to protect an intermediate innovation by considering a two‐stage sequential innovation model. In this model, the success of a patentable final innovation depends on information about prior intermediate innovations and on complementary inspiration received by innovators. Protecting an intermediate innovation through secrecy can be socially superior if the final innovation involves a high cost and the idea essential to its implementation is common. Acquisition of specialized assets under patenting may increase duplication of resources, and secrecy can act as a social control to limit the entry by many firms. If the idea for the final innovation is scarce, on the other hand, patenting can be optimal for both the innovator of an intermediate innovation and society, and the innovator's incentive is well aligned with social welfare. A broad patent scope can facilitate the adjustment of patent life to align private incentives with the social optimum when the idea for the final innovation is scarce.