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Patenting vs. Secrecy for Startups and the Trade of Patents as Negotiating Assets

Author

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  • Andreas Panagopoulos

    () (Department of Economics, University of Crete, Greece)

  • In-Uck Park

Abstract

The term “patent paradox” refers to the increased use of patents, despite being perceived as having limited stand-alone value as incentives to innovate (Hall et al., 2012). This phenomenon can be attributed to the array of roles patents may play. One role particularly relevant in this context is their use as bargaining chips by firms who employ many patents bundled into patent portfolios to gain a better hand in licensing negotiations, especially in industries where technology is cumulative (Hall and Ziedonis, 2001). As argued by Lanjouw and Schankerman (2004), patent portfolios endow such uses because patents confer “enforcement spillovers” that allow firms to exploit economies of scale, making it less costly to protect a patent when it is part of a bundle, in which case small firms like startups, that hold few patents, are at a disadvantage. In fact, for startup firms patents may even be a “liability” as they can invite infringement allegations from dominant firms with a portfolio of patents. Fear of evoking such highly costly legal disputes is known to force startups to redirect their research (Lerner, 1995) and may well have contributed to the tendency of startups to prefer trade secrecy over patenting as found in some studies, e.g., Graham et al. (2009). In a world of dominant firms and patent portfolios, is there a role for patents as incentives to innovate for tech-startups, or should these innovative firms, which play an outsized role in US net job creation (Hathaway, 2013), prefer secrecy instead? This is an important question because patents, unlike trade secrets, promote welfare enhancing diffusion and knowledge spillovers. The use of patents as leverage in licensing negotiations stems from ownership contentions that arise due to the inherent difficulty (especially in cumulative innovation) of confining bordering technologies. Due to such contentions, when licensing or trading a patent whose ownership is potentially disputed by the prospective licensee, a startup may not be able to reap the full value of its patented technology because the negotiations take place in the shadow of infringement litigation (Shapiro, 2003). Nevertheless, we argue that trade secrecy may not be the best resort. Instead, we show that overt ownership of technology through patenting, together with appropriate channels for ownership trading, can work better to incentivize startups’ innovation activities. Specifically, we present an equilibrium analysis of a dynamic model that clarifies when and how patents may outperform trade secrets in promoting startup innovations. In the process, we also provide some policy implications. Our main thesis is that when trading a patent its owner is potentially selling more than a monopoly right. Specifically, insofar as patents’ enforcing capacity spills over as mentioned above, when a patent is added to a patent portfolio it enhances the portfolio’s muscle in enforcing the rights of any given patent in the bundle. Such additional leverage correspondingly increases the portfolio’s ability to favourably barter a future technology transfer agreement against potential infringers. Thus, a transfer of patent rights does not only convey monopoly profits on the technology embodied in the patents’ claims (as trade secrets do), but also extra surplus from the patents’ capacity to affect future technology transfer negotiations. Therefore, when an innovator transfers a patent, even though its transfer price may not be able to capture the full monopoly profits (because of the risk of infringement), it may merit a markup reflecting the prospect of such extra future surplus. When a sequence of startups are expected to patent and transfer their technology to an incumbent, gradually increasing its future bargaining power, the dynamic feedback effects on this markup can be large enough so that the patent’s transfer price exceeds the value of a trade secret. In short, since patent portfolios do not only engender the threat

Suggested Citation

  • Andreas Panagopoulos & In-Uck Park, 2016. "Patenting vs. Secrecy for Startups and the Trade of Patents as Negotiating Assets," Working Papers 1610, University of Crete, Department of Economics.
  • Handle: RePEc:crt:wpaper:1610
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    File URL: http://economics.soc.uoc.gr/wpa/docs/1610.pdf
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    References listed on IDEAS

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    1. Ashish Arora & Sharon Belenzon & Andrea Patacconi, 2015. "Killing the Golden Goose? The Decline of Science in Corporate R&D," NBER Working Papers 20902, National Bureau of Economic Research, Inc.
    2. Iain M. Cockburn & Megan J. MacGarvie & Elisabeth Müller, 2010. "Patent thickets, licensing and innovative performance," Industrial and Corporate Change, Oxford University Press, vol. 19(3), pages 899-925, June.
    3. Iain M. Cockburn & Megan J. MacGarvie, 2009. "Patents, Thickets and the Financing of Early-Stage Firms: Evidence from the Software Industry," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 18(3), pages 729-773, September.
    4. Shapiro, Carl, 2003. " Antitrust Limits to Patent Settlements," RAND Journal of Economics, The RAND Corporation, vol. 34(2), pages 391-411, Summer.
    5. Henry, Emeric & Ruiz-Aliseda, Francisco, 2012. "Innovation Beyond Patents: Technological Complexity as a Protection against Imitation," CEPR Discussion Papers 8870, C.E.P.R. Discussion Papers.
    6. Illoong Kwon, 2012. "Patent Races with Secrecy," Journal of Industrial Economics, Wiley Blackwell, vol. 60(3), pages 499-516, September.
    7. Horstmann, Ignatius & MacDonald, Glenn M & Slivinski, Alan, 1985. "Patents as Information Transfer Mechanisms: To Patent or (Maybe) Not to Patent," Journal of Political Economy, University of Chicago Press, vol. 93(5), pages 837-858, October.
    8. Vincenzo Denicolo & Luigi Alberto Franzoni, 2004. "Patents, Secrets, and the First-Inventor Defense," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 13(3), pages 517-538, September.
    9. Claude Crampes & Corinne Langinier, 2002. "Litigation and Settlement in Patent Infringement Cases," RAND Journal of Economics, The RAND Corporation, vol. 33(2), pages 258-274, Summer.
    10. Lanjouw, Jean O & Schankerman, Mark, 2004. "Protecting Intellectual Property Rights: Are Small Firms Handicapped?," Journal of Law and Economics, University of Chicago Press, vol. 47(1), pages 45-74, April.
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    Cited by:

    1. Crass, Dirk & Garcia Valero, Francisco & Pitton, Francesco & Rammer, Christian, 2016. "Protecting innovation through patents and trade secrets: Determinants and performance impacts for firms with a single innovation," ZEW Discussion Papers 16-061, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.

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    Keywords

    Patents; trade secrets; startups; takeovers;

    JEL classification:

    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure
    • L10 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - General
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection

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