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38E00100 Economics and Management of Intellectual Property Lecture 8


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Title: 38E00100 Economics and Management of Intellectual Property Lecture 8

38E00100Economics and Management of Intellectual
PropertyLecture 8 Competition Policy and
Intellectual PropertyTuomas Takalo,
7.2.www.takalo.netScotchmer, Chapter 6
Outline of Core Lectures
Part I. Basic IP Law Part II. Use of IPRs Part
III. Basic Economics of IP Part IV. Breadth and
Duration of IP and Their Optimal Design Part V.
Cumulative Innovation and IP Part VI.
Competition Policy and IP Cases, Basic IP
Corporate Strategy, Industry studies, 2 Guest
  • Recapping the last lecture
  • The basic tradeoff of IP in cumulative
    innovation ensuring that the first innovation is
    made may put the later ones in jeopardy and vice
  • If ex ante licensing is infeasible, the second
    innovators fears hold-up and has lower incentive
    to invest
  • If it is feasible, the second innovation will be
    made but the first innovator now fears hold-up
    and has lower incentive to invest

  • Ex ante license would nonetheless typically be
    beneficial for society
  • Yet, various problems make it typically
    infeasible in practice
  • Asymmetric information about the licensees costs
  • Fragmentation
  • Ex ante is not always beneficial for licensors
  • Hiding and waiting until the later inventors are
    successful in commercialization gives hold-up
  • ? The rise of patent trolls

  • 4) Fragmentation problem, anticommons
  • - suppose three essential patent/IP holders
  • - it costs c to make the application, profits
  • The ex ante cake P-c.
  • - The inventor of the application negotiates with
    each holder separately
  • - Assume equal bargaining power.
  • The inventor of the application should pay
    (P-c)/2 to each IP holder ? impossible!
  • ? The IP holders should form a (patent) pool,
    collude or merge ? antirust problems

Problem of fragmentation
Basic innovation 1
Basic innovation 2
Basic innovation 3
Part VI. Competition Policy and IP
  • The need for competition policy
  • People of the same trade seldom meet together,
    even for merriment and diversion, but the
    conversation ends in a conspiracy against the
    public, or in some contrivance to raise prices.
    It is impossible indeed to prevent such meetings,
    by any law which either could be executed, or
    would be consistent with liberty and justice. But
    though the law cannot hinder people of the same
    trade from sometimes assembling together, it
    ought to do nothing to facilitate such
    assemblies much less to render them necessary
  • - Adam Smith. Wealth of Nations 1.10.82. -

  • Competition laws guard consumer surplus by
    promoting competition
  • competition not competitors, as inefficient firms
    will be wiped out by competition
  • IP creates the incentive to innovate by enforcing
    temporary market power over innovations
  • ? IP needs to reduce at least temporarily
    competition ? DWL
  • There seems to be almost by definition a tension
    between antitrust/competition and IP laws
  • IPRs convey market power, antitrust constrains it

  • Notes
  • - market/monopoly power is used in my
    lectures as an economic concept A firm has
    market power if it can price above its MC.
  • - legal concept is different
  • market power itself is not necessarily a
    violation of competition laws but its abuse
    certainly is

  • The tension is caused by the fundamental
    trade-off between ex ante and ex post
  • ex ante need to stimulate innovation (IP laws)
  • ex post information is public good, no reason to
    restrict its use, because it does not wear out
    (competition laws)
  • The tension is not new but the balance has
    shifted E.g. in the US supremacy of antitrust
    laws around 1930-1980, supremacy of IPR laws
    around 1890-1920 1980-present
  • The tension has shown up over the past 25 years
    when IP and its management have become the core
    competitive assets of firms
  • leveraging IPRs is key to success but can violate
    competition laws

  • The innovation has become the core competitive
    asset of nations, too
  • Alain Greenspan 27.2.2004 conceptualization (of
    GDP) is irreversibly increasing the emphasis on
    the protection of IPRs
  • competition laws have become more tolerant
  • Yet, the tension is here, cf. Microsoft in US and
    Europe, MasterCard-Visa

  • Political economy of IP and competition policy
  • Competition (consumer) laws and authorities are
    needed to protect consumers because consumers are
    a dispersed group
  • consumers face a public good production problem
    in protection of their interest
  • difficult to coordinate joint action to protect
    the interests of consumers as a whole

Consumers problem
Consumer 2
Do not act

Consumer 1
Do not act
  • Lobbying often based on the static/ex post
  • In the static context strong IPRs are good for
    producers/innovators and bad for consumers
  • - Countries that produce/innovate lobby for
    strong IPRs and countries that consume/imitate
    lobby for weaker IPRs
  • IPRs tend to be strong because
  • a) producer side is typically more concentrated
    than consumer side ? easier to organize lobby
  • b) countries that produce/are technologically
    advanced have more political power

  • But...
  • Governments incentive to cheat ex post tends to
    make IPRs weaker
  • In more dynamic context strong IPRs are not
    necessarily bad for consumers

  • Is there a problem and what might it be?
  • 1) Are competition laws outdated?
  • If innovation is key to prosperity and innovative
    industries ubiquitous
  • ? Competition laws should be restricted to
    traditional industries such as asphalt,
    paperpulp or auction houses
  • Competition laws too static as they do not
    recognize the Schumpeterian competition in
    innovative industries
  • creative destruction where todays monopolies
    are bankrupt tomorrow unless they do not innovate
  • the competition for the market vs. competition
    within the market

  • Monopolies can stimulate innovation (Schumpeter)
    The case of nondrastic innovation
  • Consider a monopoly and a potential entrant. The
    entrant can enter if it innovates first, the
    monopoly can deter the entry by innovating first
  • The monopoly earns ?m
  • If the entrant enters, both firms earn duopoly
    profits ?d
  • The monopolys incentive to innovate ?m- ?d
  • The entrants incentive to innovate ?d
  • ?m - ?d ? ?d ? ?m ? 2?d
  • The monopolys incentive to stay a monopoly
    larger than the entrants incentive to become a

  • The actual competition laws
  • - In the US competition policy governed by the
    Sherman Act of 1890 and the Clayton Act of 1914.
    Concerned with horizontal competition.
  • - In the EU competition policy governed by the
    Articles 81 and 82 of the EC Treaty (as well as
    the Articles 87-89 concerning the state aid) from
    1957 (the Rome Treaty) and 1992 (the Maastricht
  • Article 81(1) Prohibition of agreements/decisions
    /practices that restrict competition
  • Provision contrary to 81(1) automatically void ?
    cannot be enforced

  • Article 82 Abuse of dominant position
  • Any abuse ...of a dominant position within the
    common market....shall be prohibited...insofar as
    it may affect trade between Member States
  • e.g.
  • imposing unfair purchase/selling prices
  • limiting production to the prejudice of consumers

  • Looks bad but
  • In the US
  • implementation based on case law where the
    enforcers are ultimately the courts
  • ? this offers flexibility
  • the Department of Justice and the Federal Trade
    Commission can act in behalf of consumers and
    bring the cases to the courts
  • These agencies notify firms on the actions that
    may cause competition policy concerns
  • In 1995 they issued Antitrust Guidelines for
    Licensing Intellectual Property

  • In the EU
  • Article 81(3) give a block exemption to
    agreements that promote technological progress
  • e.g. RD cooperation, technology transfers (TTBE)
  • The European Commission issues regulations and
    guidelines on how to apply the Treaty
  • Regulation (EC No.772/2004) on the Application of
    Article 81(3) to Technology Transfer Agreements
    associated Guidelines

  • Existence of IP not such indication of
    dominance/abuse of it
  • Article 82 typically is not a concern for small
    firms if they leverage on IPs
  • But IP one of the factors enabling the abuse of
    dominant position. E.g.
  • preventing competitors from entering the market
  • preventing the use of necessary production

  • Both the US and EU Guidelines Regulation take
    the view that IP is not intrinsically
  • e.g., the EC IPRs promote dynamic
    competitionthere is no inherent conflict
    between IPRs and Community competition rules
  • Both, nonetheless, impose a number of market
    share and other restrictions
  • e.g., the EC IPRs are not immune from
    competition law intervention

  • Summing up suggestion 1) Are competition laws
  • Competition laws seem to be up-to date
  • Modern (official) view
  • There is no inherent tension between the IP and
    competition laws (cf. the EC opinion above).
  • Both promote welfare of consumers IP law
    fosters competition for markets and competition
    law competition within markets
  • The problem is to seek a proper balance between
    the two bodies of law
  • However, how can there be a problem of seeking a
    balance if there is no tension in the first place

  • 2) Does the tension arise because firms leverage
    IPRs more aggressively and more sophisticated
  • Innovation a costly way to deter entry.
  • IPRs facilitate tying, bundling, predatory and
    exclusive behavior that aim at preserving market
    power, and do not necessarily stimulate
  • are IP and innovation substitute competitive

  • Monopolies can be bad for innovation (Arrow) the
    case of drastic innovation
  • Consider a monopoly and a competitive industry.
  • The monopoly earns ?m in pre innovation market
    and ?m ?? in post innovation market
  • ? the incentive to innovate ?m ?? - ?m ??
  • Competitive firms earn 0 before innovation but
    the innovator earns ?m ?? after the innovation
  • The incentive to innovate ?m ?? gt ??
  • ? In the competitive industry the incentive to
    become a monopoly larger than the monopolys
    incentive to replace himself, the best of all
    monopoly profits is a quiet life


Incentives to innovate
Degree of Competition Inverse strength of IP
  • 3) Competitive industry can generate too much
    innovation from welfare point of view
  • Consider n firms trying to innovate in a winner
    takes all patent race
  • The cost of innovation I, welfare from innovation
  • It may be the case that IltWm?nI and certainly,
    Wm-I? Wm-nI
  • Too much innovation can be bad as the costs of
    innovation should be taken into account!
  • - Not a politically correct observation

  • Network effects vs. predatory behavior
  • Predatory pricing
  • In an initial stage a firm charges unprofitable
    price to foreclose rivals from the market and
    then can charge a high prices that compensates
    the losses of the first stage
  • More generally, predatory behavior
  • A firm incurs short-run losses so as to eliminate
    competition and gain larger profits in the

  • Network effects a consumers utility from a
    product depends on the number of other users of
    the product.
  • Direct network effects the utility depends
    directly on the number of other users.
  • E.g., e-mail a camera phone.
  • Indirect network effects the utility depends on
    a feature of a product. The quality of the
    feature depends on the number of other users.
  • E.g., The utility from an OS depends the number
    of software applications written on the OS. The
    number of applications depends on the number of

  • Network effects create a chicken-and-egg problem
  • Nobody is willing to buy a product unless it is
  • The product cannot be popular unless many are
    willing to buy
  • ? With network effects, a business strategy that
    prices products below marginal costs can be vital
    for the success of the products even without any
    need to deter entry
  • Very difficult to isolate anticompetitive
    conducts from competitive business strategies in
    network industries
  • Applies more generally hard to distinguish
    predatory pricing from competitive pricing (e.g.
    Finnair vs. Flying Finn/Blue 1)

  • An Illustration the Microsoft vs. US
  • U.S. Government (Department of Justice) asserted
    that Microsoft engaged in anticompetitive conduct
    to maintain its operating system monopoly to the
    detriment of consumers
  • Microsoft asserted that the company has benefited
    and benefits consumers by supplying high quality,
    innovative products
  • According to the government, antitrust action
    against Microsoft would stimulate competition and
    innovation in the software industry
  • According to Microsoft, the action would reduce
    competition and innovation in the software

  • Microsoft hired Richard Schmalensee, (an MIT
    econ. prof. of IO), as their chief adviser for
  • Schmalensee the competition in the software
    market was not between operating systems but
    between platforms on which the software
    programmers could write on
  • ? Windows was facing significant actual and
    potential competition from other operating
    systems such as Linux, OS/2, Mac OS, Sun Solaris
    but also Java, Lotus notes and other middleware
  • Moreover, significant potential competition from
    future platforms (E.g. Nokia)
  • ? vigorous competition for the markets

  • Governments chief economists was Daniel
    Rubinfeld (a UC Berkeley econ. prof of law and
    economics and public economics) and they hired
    Franklin Fisher (an MIT econ. prof of IO) as
    their chief adviser
  • Rubinfeld Fisher Microsofts prices were in
    the long-run monopoly level even taking into
    account of potential competition
  • Because of network effects, Microsoft had
    substantial market power
  • Mircrosoft used market power so as to increase
    entry barriers and exclude Netscape Java, not
    stimulate competition
  • Microsoft engaged in predatory behavior offered
    Explorer free and even paid Apple to use it

  • On surface a valid business model in the network
    industry giving Explorer free makes Windows more
  • However, the argument should apply equally for
    distributing Netscape
  • judged to be anticompetitive

  • Licensing of IP and competition policy
  • One can sell IP, like any other property, via
    negotiation, auction, and posted price/fixed fee.
  • All IPs can and do get licensed, even trade
    secrets (e.g., Coca-cola)
  • In theory, auction is usually the best way to
    sell an object. In practice, however, other ways
    are more popular. The same applies to IP.
  • A popular method output royalty with or without
    a fixed
  • Licensee pays according to what he sells, e.g.,
    of final price per unit sold or x euros per unit

  • A license can include a variety clauses.
  • It can be exclusive only to one or restricted
    number of licensees
  • non-exclusive the licensor reserves the right to
    license the technology to any number of firms he
  • exclusive license via auction in theory the best
  • Some licensing clauses/restrictions can cause
    antitrust problems (despite TTBE in the EU)
  • E.g., exclusive dealing requires that the
    licensee only
  • resorts the licensor as sole supplier

  • TTBE includes a black list of prohibited
    agreement clauses. e.g.,
  • Price fixing, limitation production/sales,
    division of markets/customer, limiting licensees
    ability to use own technology and engage in RD
  • Probably the most tedious competition policy
    problems deal with standardization and IP
    policies of standard-setting organizations

  • Summary
  • The tension between IPR and competition laws make
    antitrust issues in innovative industries
  • If IPR laws work, firms have market power, if
    competition laws work, firms cant use the market
  • Political economy aspects tend to support strong
    IPRs, the Governments incentive to cheat ex post
    weak IPRs
  • Licensing of IP a major source of competition
    policy problems
  • ? The 1995 US Guidelines and the 2004 EU
    regulation try to incorporate IP issues in
    competition policy

  • Nonetheless, the tension will remain
  • on the one hand, the competition in the network
    industries so complicated that it will be very
    difficult to make precise antitrust assessments
  • on the other hand, the potential welfare effects
    so large that one cannot ignore the tension
  • ? cautious approach wise

  • but if an action is taken it should be effective
  • Remedies should stop a firm engaged in
    anticompetitive conduct from continuing to do so
    and should deter others from doing so
  • Microsoft has been found guilty in
    anticompetitive conduct many times over the past
    10 years but
  • Will MSN be integrated in Microsoft Vista?
  • 29.3. 2006 the Commission warns Microsoft a about
    antitrust concerns if Vista is prepacked with a
    search engine
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