PINHEIRO-TORRES — Innovation, Patents and Competition Policy in Dynamic Industries (2013)

INNOVATION,

PATENTS AND

COMPETITION POLICY

IN DYNAMIC INDUSTRIES

CARLOS PINHEIRO-TORRES

2013

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To Isabel and Carlos—safeguarding pillars.


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CONTENTS

ACKNOWLEDGMENTS

PREFACE

1. INTRODUCTORY

1.1 The Austrian School

1.1.1 Subjectivity

1.1.2 Prediction

1.1.3 The Market Process

1.2 Patents and Competition Law

2. COMPETITION

2.1 Static Competition

2.2 Dynamic Industries

2.2.1 Large Fixed Costs and Low Marginal Costs

2.2.2 Highly Profitable Industry Leaders

2.2.3 Short Product Life Cycles

2.2.4 Quick and Frequent Entry and Exit

2.2.5 Network Effects

2.2.6 Low Price Elasticity of Demand

2.2.7 First-Mover Opportunities

2.2.8 Labor and Human Capital Intensity

2.2.9 Low Entry Costs

2.2.10 Winner-Take-All Races

2.3 Dynamic Competition

3. INNOVATION

3.1 Innovation? What Innovation?

3.2 Sustaining Technology

3.2.1 The Rise and Fall of a Technology – The S-Curve

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3.3 Disruptive Technology

3.4 Back to the Future: A Brief History of Innovation

4. THE PATENT SYSTEM

4.1 Property Rights

4.2 Profiting From Technological Innovation

4.3 Far From Perfect but Necessary Nonetheless

5. MARKET STRUCTURE, MARKET POWER

5.1 Perfect Competition

5.2 Market Structure and Innovation

5.3 Patents and Market Power

5.4 Nope, Size Does Not Matter

5.4.1 Too Big To Fail? – On The Contrary.

5.5 Technological Opportunities and Firm Capabilities

5.6 Firms Internal Factors that Drive Innovation and Beyond

6.COMPETITION POLICY

6.1 The Welfare Standards

6.2 Innovation and Competition Policy

6.3 Patents and Competition Policy

6.4. On the Use of Mathematical Models

CONCLUSIONS

BIBLIOGRAPHY

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ACKNOWLEDGMENTS

I wish to thank Peter Dirk Siemsen for the opportunity to write this dissertation.

There would be no Innovation, Patents and Competition Policy in Dynamic

Industries had he not urged and challenged me to try for the Jaques Lassier Prize.

I am also extremely grateful to my sister Francisca for revising the English

language of prior drafts and helping smooth some rough edges in the text.

My gratitude extends to Ivan Bacellar Ahlert and Joaquim Eugênio Goulart whose

invaluable insights on patents helped me achieve a better understanding on some

aspects of such complex subject.

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PREFACE

The following dissertation, although a monograph, is far from being one-

dimensioned. And although theoretical, is little technical. Such is due to the

crossroaded (not to say tangled) scenery of competition between firms and to the

eminent social drift that permeates it. In fact, the study of market competition

surely involves economics1 and business administration but—if one has the need

to observe and analyze the very nature of the social fabric that comprises it—

imperatively encompasses a myriad of other social subjects (namely, history,

psychology and philosophy). Actually, so as to properly address the process of

company rivalry, one has to learn the behavior of the agents involved and the

decision-making process per se, while such process its centered on human kind.

Put differently, there is no way to analyze the performance of such a complex

engine without understanding the underlying mechanics of its cogs.

The study of competition law2 focuses on the legal rationality of antitrust policy

and other social and political goals, but one cannot intend to embrace such subject

matter without reaching for all of the dimensions implicated in the process of

competition itself, namely the relationship between law and economic outcomes:

the issues of how the law shapes economic activity both through organizations

and individuals. With that in mind, our journey will not—as it could not—be

limited to a monolithically legal approach of the competition process, but will

encompass further relevant and interdependent subjects that are crucial to reach

the administrative objectives of antitrust policy.

1 “It is by using economics to ‘bridge’ legal rules with empirical phenomena that one can push the

antitrust and IP worlds to overlap. In other words, by using such a methodology, these two fields of law

succeed in speaking the same language, because the same economic principles and concepts are called upon

to shape them” – MAGGIOLINO, Mariateresa. The Economics of Antitrust and Intellectual Property Rights,

INTELLECTUAL PROPERTY AND COMPETITION LAW : NEW FRONTIERS, Oxford University Press, 2011, p.73, n.3. 2 Throughout this work, ‘competition law’ and ‘antitrust law’—or simply “antitrust”—will be used as

interchangeable terms.

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My attempt is to ask “what is going on” from the viewpoint of the dynamics of the

modern corporation and where we could trace all these complex threads from the

heart of the competition process. Although the human mind is underrated vis a vis

a systematic physical/visible/material world, one cannot neglect it as an essential

aspect to be considered. After all, a social science like Law cannot be considered

detached from the human factor—its very essence. Unfortunately, the human

factor is rarely considered on academic comments and analysis. And this can be

explained by the intricate thoroughness of those studies that may somehow

disconnect the observer from the rudimentary nature of the observed. Lost in

increasingly complex lucubrations, authors tend to forget that human knowledge

ultimately represents interpretations of human experience. Also authors

commonly disregard philosophy and philosophical grounds in their academic

approaches in legal and economical sciences. Such qualms, although

comprehensible, ought not to dismay a realistic attempt to analyze real human

phenomena.

While scholars, commentators and practitioners may have widely varying

opinions on the matter, one ought to regard all of the dimensions of human

existence. In my view, it just makes no sense analyzing a human environment if

not taking in deep consideration the mental factor of market-process participants:

society, firms and consumers.3 In essence, the compliance with formal academic

praxis cannot thwart an extensive and complete analysis of market competition

model. That is due to the fact that we cannot reduce the richness of the human

aspect of a social phenomenon that is a human-based process without the hazard

of failing to grasp it to the fullness.

3 This contradicts the merely individualistic approach of neoclassical theory: “Though Walras also

insisted that all social phenomena - religion, politics, economy, and spiritual life - are closely interrelated, this

interrelation imperative has not been realized in neoclassical theory. Despite all further achievements and

constant declarations about relations of the economy and different aspects of social life, the dominating

concepts are still individualistic. As before, such fundamental categories as 'need', 'utility', 'price' and

'equilibrium' are almost always treated by this theory in the context of methodological individualism, from the

standpoint of a separate person regardless of the socium to which he or she belongs.” – GRINGBERG,

Ruslan. Economic Sociodynamics, Springer, 2005, p.73.

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Surely enough, along my way I got so absorbed by social sciences’ approach on

market mechanics that I had a hard time not to be carried away by the seductive

appeal to enter detour paths—mea culpa if I caved. It is that the vast tree of

knowledge bears such enticing fruits that temptation to savor them all at sight is

not easily avoidable. Notwithstanding, I hope I was able to keep myself away at

least from those not hanging far from the branch I chose to study.

The literature on this subject is vast and complex. Yet, I strive for simplicity and

hope to be able to deliver a concise and understandable assessment of the matter

at hand.4

4 Structurally I try to follow the two components that alchemists had in their philosophy: Solve et

Coagula. Basically, Solve was the equivalent of analysis, i.e. taking things apart to see how they worked.

Coagula is basically synthesis, i.e. trying to put the disassembled pieces back together. In effect, these

principles can be applied to almost anything in culture—like the literary and philosophic deconstructionism

and constructionist waves.

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Innovation, Patents

and Competition Policy

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1. INTRODUCTORY

This work is divided in chapters that approach specific themes, however its

structure is not rigid and sections are not at all watertight. Instead, chapters

interconnect and complement each other. It is to say that readers will certainly

have trouble to fully grasp the intended idea unless they know the plot as a whole.

As such, this introductory chapter sets up the proper lenses through which this

work should be envisaged by giving a glimpse on the economic though of the

Austrian School and a succinct reflection on the interface between patent law and

antitrust law.

1.1 The Austrian School

The Austrian School of Economics—also called the Viennese School—was

founded by CARL MENGER (1840–1921) in Vienna during the last third of the 19th

century. In the 1930s, a substantial transformation of economic paradigms and the

emigration of many of the School’s proponents drove the ‘Austrians’ closer to the

sidelines of academia. This gash was further deepened by the expulsion of its last

remaining representatives that occurred when the National Socialists seized

power. Then, after World War II, the post-war political atmosphere did not enable

for its renovation. In essence, considered by many as too old-fashioned, the

Austrian School was no longer welcome in its homeland. However, by means of

their works and teaching, LUDWIG VON MISES (1981-1973) and FRIEDRICH HAYEK

(1899-1992) were relatively able to sustain the Viennese tradition in the United

States and from the 1970s—as the modern theory of the firm was taking shape—

the revival of the Austrian movement in economics was emerging.

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Back in the dusk of the 19th

century, and in contrast with his contemporaries

WILLIAM STANLEY JEVONS (1835-1882) and LÉON WALRAS (1834-1910),

MENGER emphasized the role of the individual as a value-imputing subject and as

an active agent in the economic process, thus being primarily interested in

explaining the real-world actions of real people, not in creating artificial, stylized

representations of reality. MENGER, in his Grundsätze der Volkswirtschaftslehre

(Principles of Economics), published in 18715, states that economics studies the

purposeful human choice:

All things are subject to the law of cause and effect. This great

principle knows no exception, and we would search in vain in the

realm of experience for an example to the contrary. Human

progress has no tendency to cast it in doubt, but rather the effect of

confirming it and of always further widening knowledge of the

scope of its validity. Its continued and growing recognition is

therefore closely linked to human progress.6

JEVONS and WALRAS disregarded this ‘cause and effect’ approach in favor of

simultaneous determination—the technique of modeling complex relations as

systems of simultaneous equations in which variables are independent from one

another, i.e. the value of any given variable having no impact on any other. Theirs

has become the standard approach in contemporary economics, accepted by nearly

all economists but the followers of MENGER. In fact, 60 years later, MISES, in his

“Human Action – A Treatise on Economics”, published in 1949, persevered that

economic analysis must always start from the basic idea that “human action is

purposeful behavior”7. In that sense, the procedures of the natural sciences cannot

5 According to Mises, this event marks the birth of the Austrian School: “What is known as the

Austrian School of Economics started in 1871 when Carl Menger published a slender volume under the title

Grundsätze der Volkswirtschaftslehre.” – MISES, Ludwig von. The Historical Setting of the Austrian School

of Economics, Arlington House, 1969, p.1. 6 MENGER, Carl. Principles of Economics, Ludwig von Mises Institute, 2007, p.51. 7 MISES, Ludwig von. Human Action – A Treatise on Economics, Fox & Wilkes, 1964, p.11.

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be applied to social interactions8—unlike natural laws, human behavior has no

underlying constants. In addition, in social affairs there is no way to conduct a

truly controlled experiment where the variables can be manipulated—let alone

excluded—so as to have a limited environment that enables to observe absolute

and definite truths.

But by neoclassical standards, economics is only "scientific" if it implements the

methods used by the natural scientists. Generally, neoclassicals feel that

economists should form hypotheses with testable implications and then collect

data to measure the accuracy of their predictions. Those tendencies that enjoy

most success in this sense are then considered to be better "laws" than conjectures

that do not fit the data so well.

1.1.1 Subjectivity

Unlike neoclassical mainstream economists, MENGER’s approach seeks to explain

real-world events caused by real-world market players whose interactions are not

always rationally-oriented. HAYEK, in its book “The Counter-revolution of

Science: Studies on the Abuse of Reason”, draws attention to the fact that social

studies—like economics—“deal, not with the relations between things, but with

the relations between men and things or the relations between man and man. They

are concerned with man’s actions (…)”9. Hence for Austrians, economics forms

part of a much wider and general science—a general theory of human action (and

not of human decision or choice). And if for this general science of human action

“a name is needed, the term praxeological sciences, (…) now clearly defined and

8 “This method of research, attaining universal acceptance in the natural sciences, led to very great

results, and on this account came mistakenly to be called the natural-scientific method. It is, in reality, a

method common to all fields of empirical knowledge, and should properly be called the empirical method.

The distinction is important because every method of investigation acquires its own specific character from

the nature of the field of knowledge to which it is applied. It would be improper, accordingly, to attempt a

natural-scientific orientation of our science.

Past attempts to carry over the peculiarities of the natural-scientific method of investigation uncritically into

economics have led to most serious methodological errors, and to idle play with external analogies between

the phenomena of economics and those of nature.” – MENGER, Carl. Principles of Economics, supra note 6,

p.47. 9 HAYEK, Friedrich. The Counter-Revolution of Science: Studies on the Abuse of Reason, The Free

Press, 1955, p.25.

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extensively used by L. v. Mises (Nationalökonomie, Geneva, 1940), would appear

to be most appropriate.”10

Austrian economics ‘humanistic’ approach is directly linked with their

subjectivist concept of economic theory, a matter of key significance to this

School of thought. This is just a natural consequence of a science founded on the

idea of flesh-and-blood human beings understood as direct participants of all

social processes and interactions. In that regard, MISES elucidates that “external

objects are as such only phenomena of the physical universe and the subject

matter of the natural sciences. It is human meaning and action which transform

them into means. (…) Economics is not about things and tangible material

objects; it is about men, their meanings and actions. Goods, commodities, and

wealth and all the other notions of conduct are not elements of nature; they are

elements of human meaning and conduct. He who wants to deal with them must

not look at the external world; he must search for them in the meaning of acting

men.”11

While it is inarguable that Reason brought many great benefits and was a

very necessary stage of our development unfortunately lead to materialism—

where the physical material world is seen as the be-all and end-all of existence.

Inevitably we are seen by neoclassic lenses as flat creatures that have no spiritual

dimensions, having no soul and living in a soulless society.12

Focused on human action, Austrian theory works with a subjective conception of

costs, which is based on personal valuation. Thus, prices of final consumer

goods—as an expression of that subjective valuation—are what determine the

costs that the agent is willing to incur to produce such goods, and not the other

way around—as commonly displayed in neoclassical models.

10 Id. at 209, footnote 20. 11 MISES, Ludwig von. Human Action, supra note 7, p.92. 12 Spiritualism was the natural state of human thinking up until the Renaissance and the subsequent

Age of Reason that grew out of it. Our original way of seeing the world was a place entirely inhabited by

spirits, where everything had its indwelling essence, where everything was in some sense sacred, including

ourselves. The Age of Reason changed all that.

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A well marked structural difference between neoclassicals and Austrians is their

methodology. While the former stresses quantitative empirical work to test

theories13

, the latter argues that mathematical formulation does not permit the

incorporation of the subjective reality of time and social interaction. HANS MAYER

(1879-1955) summed up the failure of empirical verification:

In essence, there is an immanent, more or less disguised, fiction at

the heart of mathematical equilibrium theories, that is, they bind

together, in simultaneous equations, non-simultaneous magnitudes

operative in genetic-causal sequence as if these existed together at

the same time. A state of affairs is synchronized in the “static”

approach, whereas in reality we are dealing with a process. But one

simply cannot consider a generative process “statically” as a state

of rest, without eliminating precisely that which makes it what it

is.14

For instance, if a given consumer prefers A to B and B to C, she may very well

prefer C to A15

. This kind of behavior may be understood as being objectively

irrational, but absolute rationality is not a feature of the real world16

. Exogenous

(e.g. paradigm shift, trends) as well as endogenous factors (e.g. change in taste or

13 “A more serious effect of the difficulty of testing economic hypotheses by their predictions is to

foster misunderstanding of the role of empirical evidence in theoretical work. Empirical evidence is vital at

two different, though closely related, stages: in constructing hypotheses and in testing their validity. Full and

comprehensive evidence on the phenomena to be generalized or "explained" by a hypothesis, besides its

obvious value in suggesting new hypotheses, is needed to assure that a hypothesis explains what it sets out to

explain - that its implications for such phenomena are not contradicted in advance by experience that has

already been observed” – FRIEDMAN, Milton. The Methodology of Positive Economics, ESSAYS IN POSITIVE

ECONOMICS, University of Chicago Press, 1966, p.12. 14 MAYER, Hans. The Cognitive Value of Functional Theories of Price, CLASSICS IN AUSTRIAN

ECONOMICS: A SAMPLING IN THE HISTORY OF A TRADITION, Pickering & Chatto Ltd, 1994, vol. 2, p.92. 15 Assuming that given the prior choices the agent would choose A over C in a subsequent event

would be just the same as inferring that, in a triangular tournament, if F.C. Porto wins over Manchester

United in the first game and Manchester wins over Juventus in the second, ergo F.C.Porto would win over

Juve in the third match—assumption which, in this author’s perspective, is universally true just for the fact

that it puts F.C. Porto as the tournament winner. All kidding aside, we can perceive that hardly probabilistic

nature of football results (like human actions) makes predictability a far from exact science. 16 “It is no less impermissible to differentiate between rational and allegedly irrational acting on the

basis of a comparison of real acting with earlier drafts and plans for future actions. It may be very interesting

that yesterday goals were set for today’s acting other than those really aimed at today. But yesterday’s plans

do not provide us with any more objective and non-arbitrary standard for the appraisal of today’s real acting

than any other ideas and norms.” – MISES, Ludwig von. Human Action, supra note 7, pp.102-3.

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simply the wrongful perception of basic assumptions) weight in the decision-

making process of market players and outcomes with a fair degree of certainty are

seldom predictable. And it may be the case that the consumer prefers C to A just

for a change.

According to MISES, the two acts (preferring A to B and B to C), once they are

acts from the same individual, can never be synchronous17

. However short the

interval between the two actions may be, there is no way to construct a uniform

scale of value from A to C just as it cannot be inferred that a later third action

coincides with the two previous actions. ‘Rationality’ and ‘constancy’ are not to

be confused:

If one’s valuations have changed, unremitting faithfulness to the

once espoused principles of action merely for the sake of constancy

would not be rational but simply stubborn. Only in one respect can

acting be constant: in preferring the more valuable to the less

valuable. If the valuations change, acting must change also.

Faithfulness, under changed conditions, to an old plan would be

nonsensical. (…) Acting must be suited to purpose, and

purposefulness requires adjustment to changing conditions.18

1.1.2 Prediction

For Austrians, the justification that empirical verification is theoretically

impossible in economics lies in the fact that the scientific observer is not able to

retrieve subjective information that is continually created and modified by the

protagonists of the social process of constant, innovative creation. More so, the

dynamic character of the consumerist process makes impossible to access

information which was not even generated.

17 “Two actions of an individual are never synchronous; their temporal relation is that of sooner and

later. Actions of various individuals can be considered as synchronous only in the light of the physical

methods for the measurement of time. Synchronism is a praxeological notion only with regard to the

concerted efforts of various acting men.” – MISES, Ludwig von. Id. 18 MISES, Ludwig von. Human Action, supra note 7 at 103.

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In fact, tomorrow’s events cannot be scientifically known in advance. As such, in

economics only general predictions of trends are possible. In his study The Theory

of Complex Phenomena19

, HAYEK calls these ‘pattern predictions’. Hovering on

the above discussed notion of constancy, he notes that we start to wonder only

after we detect some recurring pattern or order in the events we observe. In the

path of ARISTOTLE (384–322 BC)20

and ADAM SMITH (1723–1790)21

, HAYEK

considered wonder to be the primary reason for scientific inquiry while “where we

wonder we have already a question to ask.”22

And it is to this thirst for knowledge

and to the curiosity of the human spirit “that we owe whatever understanding and

mastery of our environment we have achieved.”23

However wonderful our mental capacity for pattern recognition is, there are

several restrictions to be accounted for its own limitations, namely interpretation24

and exteriorization25

of research objects. Events in real-world are never objective

19 HAYEK, Friedrich. Studies in Philosophy, Politics and Economics, Routledge, 1967, pp.22-42 20 “For it is owing to their wonder that men both now begin and at first began to philosophize (…)

therefore since they philosophized in order to escape from ignorance, evidently they were pursuing science in

order to know, and not for any utilitarian end. Evidently then we do not seek it for the sake of any other

advantage; but as the man is free, we say, who exists for his own sake and not for another's, so we pursue this

as the only free science, for it alone exists for its own sake.” – ARISTOTLE. Metaphysics, Book I, Part 1. 21 “While the great objects of nature thus pass in review before them, many things occur in an order to

which they have not been accustomed. Their imagination, which accompanies with ease and delight the

regular progress of nature, is stopped and embarrassed by those seeming incoherences; they excite their

wonder, and seem to require some chain of intermediate events, which, by connecting them with something

that has gone before, may thus render the whole course of the universe consistent and of a piece. Wonder,

therefore, and not any expectation of advantage from its discoveries, is the first principle which prompts

mankind to the study of Philosophy, of that science which pretends to lay open the concealed connections that

unite the various appearances of nature; and they pursue this study for its own sake, as an original pleasure or

good in itself, without regarding its tendency to procure them the means of many other pleasures.” – SMITH,

Adam. The History of Astronomy, Section III, ESSAYS ON PHILOSOPHICAL SUBJECTS, Glasgow Edition of the

Works and Correspondence of Adam Smith, vol.3, Liberty Fund, 1982. 22 HAYEK, Friedrich. Studies in Philosophy, Politics and Economics, supra note 19 at 22. 23 Id. 24 In economic science, research is made on previous conceptions, notions and ideas others hold about

what they do and what ends they pursue. Such objects are never directly observable, but can only be

interpreted in historical terms. And while interpreting historical social reality one must first have a given

theory as much as to make a non-scientific judgment of relevance. This subjective judgment (as the personal

choice of the theory to work with) varies from one observer to the other, making interpretation a greatly

subjective process: “Two normal observers viewing the same object from the same place under the same

physical circumstances do not necessarily have identical visual experiences, even though the images on their

respective retinas may be virtually identical. There is an important sense in which two observers need not

"see" the same thing. As N. R. Hanson (1958) has put it, "there is more to seeing than meets the eyeball."” –

CHALMERS, Alan. What is this thing called Science?, Hackett Publishing, 1999, p.5. 25 We may be willing to be in unison with others that are in circumstances analogous to ours as we can

put ourselves—always, of course, in a slightly Pickwickian sense—in their places. But in most situations

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or directly observable and one has to bear in mind that personal accounts on the

interpretation of phenomena are biased by nature. The things and events to which

the symbols refer belong to mutually exclusive territories of personal experience.

Again—now on the realm of perception—subjectivity is a key issue.

On economic theory, JOSEPH SCHUMPETER (1883–1950) described that “the

economic life of a non-socialist society consists of millions of relations or flows

between individual firms and households. We can establish certain theorems about

them, but we can never observe all of them.”26

As such, the ideal of prediction and

control must largely remain beyond our reach and we may well give up on the

illusory thought that discovery can be made by extensively analyzing regular

connections between individual events. HAYEK adds that:

The very insight which theory provides, for example, that almost

any event in the course of a man's life may have some effect on

almost any of his future actions, makes it impossible that we

translate our theoretical knowledge into predictions of specific

events. There is no justification for the dogmatic belief that such

translation must be possible if a science of these subjects is to be

achieved, and that workers in these sciences have merely not yet

succeeded in what physics has done, namely to discover simple

relations between a few observables. If the theories which we have

yet achieved tell us anything, it is that no such simple regularities

are to be expected.27

As a result, economic theory is limited to describing kinds of patterns which will

appear if (and only if) certain general conditions are satisfied, and can seldom—if

ever—derive from this comprehension any predictions of specific phenomena:

communication between individual universes is incomplete or even nonexistent. The mind is its own place

insofar as there is limited common ground to serve as a basis for understanding or fellow feeling. 26 SCHUMPETER, Joseph. History of Economic Analysis, Taylor & Francis, 2006, p.231. 27 HAYEK, Friedrich. Studies in Philosophy, Politics and Economics, supra note 19 at 32.

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This is seen most clearly if we consider those systems of

simultaneous equations which since Léon Walras have been widely

used to represent the general relations between the prices and the

quantities of all commodities bought and sold. They are so framed

that if we were able to fill in all the blanks, i.e., if we knew all the

parameters of these equations, we could calculate the prices and

quantities of all the commodities. But, as at least the founders of

this theory clearly understood, its purpose is not 'to arrive at a

numerical calculation of prices', because it would be 'absurd' to

assume that we can ascertain all the data.28

Indeed, according to HAYEK, prediction-making is founded on broad-spectrum of

factual assumptions that determine the scope of the variables but not their

particular values. Such predictions are doomed to fail while they do not rely on

more particular circumstances which we would have to know in order to be able

to predict prices or quantities of given commodities. Ironically, while no

economist has ever made a fortune by buying or selling commodities on the basis

of his scientific prediction of future prices, many have certainly done so by selling

such forecasts.

According to HANS KELSEN, “a scientific law of nature is the rule by which two

phenomena are connected with each other according to the principle of causality,

that is to say, as cause and effect.”29

For HAYEK, however, such notion of ‘law’ is

hardly applicable to complex phenomena:

“If we assume that all the other parameters of such a system of

equations describing a complex structure are constant, we can of

course still call the dependence of one of the latter on the other a

'law' and describe a change in the one as 'the cause' and the change

28 Id. at 34. 29 KELSEN, Hans. The Natural-Law Doctrine before the Tribunal of Science, THE WESTERN

POLITICAL QUARTERLY, v. 2, n. 4, University of Utah, 1949, pp.482-3

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in the other as 'the effect'. But such a 'law' would be valid only for

one particular set of values of all the other parameters and would

change with every change in any one of them. This would evidently

not be a very useful conception of a 'law', and the only generally

valid statement about the regularities of the structure in question is

the whole set of simultaneous equations from which, if the values

of the parameters are continuously variable, an infinite number of

particular laws, showing the dependence of one variable upon

another, could be derived.”30

In that line, while we can achieve an useful and elaborated theory about a certain

complex phenomenon, we still have to admit that we are incapable of determining

a single law—in the ordinary sense of the word—to which that phenomenon

conforms. As such, HAYEK believed this to be to a great extent true about social

phenomena—though we possess theories of social structures, he rather doubted

whether we are able to learn of any 'laws' to which social phenomena obey.

In fact, HAYEK’s great contribution consisted of indicating that MISES’s original

idea about the impracticality of socialist economic calculation is a corollary of the

more general principle of logical impossibility of social engineering. HAYEK uses

the term “scientism”31

to refer to the unjustified application to social sciences of

the method typical of physics and the natural sciences32

.

1.1.3 The Market Process

When I think about markets the original concept conveys the idea of physical

retail markets—like local farmers markets—where the established network

structure allowed trade to happen. In ancient retail markets the transfer of

30 HAYEK, Friedrich. Studies in Philosophy, Politics and Economics, supra note 19 at 41. 31 HAYEK, Friedrich. The Counter-Revolution of Science, supra note 6 at 11-102. 32 Contrary to social sciences, in natural sciences from facts acquired through observation we can infer

laws and theories (inductive process) and from these we are able to explain phenomena and make educated

predictions (deductive process). For a deeper understanding of the modem views about the nature of science,

see CHALMERS, Alan. What is this thing called Science?, supra note 24.

11

ownership of goods and services from one person or entity to another—i.e.,

trade—was originally done by direct exchange. In this rudimentary notion,

transactions had a prominent distributional nature on communities: while Bill had

potatoes and chicken, Jason and Gloria had linen, and so on. Amidst the frenzy of

the marketplace, and privileged by the caring push of the invisible hand, all

profited from the barter process and exchanged goods naturally filled in the gaps.

On such, SMITH expressed that

When the division of labour has been once thoroughly established,

it is but a very small part of a man’s wants which the produce of his

own labour can supply. He supplies the far greater part of them by

exchanging that surplus part of the produce of his own labour,

which is over and above his own consumption, for such parts of the

produce of other men’s labour as he has occasion for. Every man

thus lives by exchanging, or becomes, in some measure, a

merchant, and the society itself grows to be what is properly a

commercial society.33

On MENGER‘s words,

An economizing individual, A, has a certain quantity of a good at his

disposal which has a smaller value to him than a given quantity of

another good in the possession of another economizing individual, B,

who estimates the values of the same quantities of goods in reverse

fashion, the given quantity of the second good having a smaller value

to him than the given quantity of the first good which is at the disposal

of A.34

Hence trade has a specific finality of enhancing the well-being of individuals; this

seems to be the ultimate reason for exchange as the needs of the actors involved

33 SMITH, Adam. An Inquiry into the Nature and Causes of the Wealth of Nations, University of

Chicago Press, 1977, p.41. 34 MENGER, Carl. Principles of Economics, supra note 6 at 179.

12

could be better satisfied than before. We can perceive that individuals, in the

market process, assess a particular situation (opportunity) that they became aware

of and actually they have the power to perform the transfer (capability).

Individuals are continually concerned over the betterment of their economic

positions and their efforts are expended in order to satisfy their needs as

completely as possible. The effort to satisfy their needs as completely as possible

is therefore the cause of all the phenomena of economic life through exchange35

.

In sum, “[t]he principle that leads men to exchange is the same principle that

guides them in their economic activity as a whole; it is the endeavor to ensure the

fullest possible satisfaction of their needs.”36

1.2 Patents and Competition Law

Simply put, a patent grants its holder the right to exclude others from using the

invention for any purpose and competition law concerns with the use of such

property right. Overly crude, in its reductionist form these two concepts pose a

natural contradiction: one encourages exclusion while the other restricts it.

However, “we are fortunately past the time when the patent laws were viewed as

rewarding an inventor with a ‘temporary monopoly’ and ‘an exception to the

general rule against monopolies’.”37

Actually, the often called ‘minefield’ between the patent-antitrust interface seems

nowhere to be found as the two sets of rules serve the same purpose of ensuring

innovation38

, facilitating and rewarding its process39

. Certainly, “competition can

35 It should be observed that “exchange” is used here in a special sense with a much wider application

than in popular or especially than in legal language. For in the economic sense it also includes purchase and

sale, and all partial transfers of economic goods (tenancy, rental, lending, etc.) for compensation. 36 MENGER, Carl. Principles of Economics, supra note 6 at 180. 37 MORSE, Howard. Statement before the Antitrust Modernization Commission hearing on Antitrust

and the New Economy, 2005, p.6. 38 Undoubtedly a principal factor in fostering a dynamic, growing economy, while promoting social

welfare and economic efficiency.

13

stimulate innovation. Competition among firms can spur the invention of new or

better products or more efficient processes. Firms may race to be the first to

market an innovative technology. Companies may invent lower-cost

manufacturing processes, thereby increasing their profits and enhancing their

ability to compete. Competition can prompt firms to identify consumers’ unmet

needs and develop new products or services to satisfy them.”40

Also, intellectual

property can be seen both as key input into and as byproduct of successful

innovation.

However, inevitable tensions do eventually occur between intellectual property

and antitrust41

. Whereas modern competition law is at ease with a monopoly

conquered through proper conduct42

or historic accident, the same result achieved

by exclusionary or predatory acts may raise antitrust concerns. Hence tension

between the two bodies of law only surfaces when patents are turned into a clever

manner to avoid competition law. Since patented inventions have the ability to

39 “Still, some regard the antitrust and patent laws as in conflict, at least when a patent gives a firm

market power, and they argue there is a need to keep competition and intellectual property in balance. The

better view, in my opinion, is that the laws are complementary, both aimed at encouraging innovation and

competition.” – MORSE, Howard. Statement before the Antitrust Modernization Commission, supra note 37;

“Indeed, both bodies of law share the same basic objective of promoting consumer welfare and an efficient

allocation of resources. Innovation constitutes an essential and dynamic component of an open and

competitive market economy. Intellectual property rights promote dynamic competition by encouraging

undertakings to invest in developing new or improved products and processes. So does competition by

putting pressure on undertakings to innovate. Therefore, both intellectual property rights and competition are

necessary to promote innovation and ensure a competitive exploitation thereof.” – EUROPEAN

COMISSION, Guidelines on the application of Article 81 [101 TFEU] of the EC Treaty to technology

transfer agreements, JOUE 2004/C 101/02.

“Over the past several decades, antitrust enforcers and the courts have come to recognize that

intellectual property laws and antitrust laws share the same fundamental goals of enhancing consumer welfare

and promoting innovation. This recognition signaled a significant shift from the view that prevailed earlier in

the twentieth century, when the goals of antitrust and intellectual property law were viewed as incompatible:

intellectual property law’s grant of exclusivity was seen as creating monopolies that were in tension with

antitrust law’s attack on monopoly power. Such generalizations are relegated to the past. Modern

understanding of these two disciplines is that intellectual property and antitrust laws work in tandem to bring

new and better technologies, products, and services to consumers at lower prices.” – U.S. DEPARTMENT

OF JUSTICE and THE FEDERAL TRADE COMMISSION, Antitrust Enforcement and Intellectual Property

Rights, 2007. 40 THE FEDERAL TRADE COMMISSION, To Promote Innovation: The Proper Balance Of

Competition And Patent Law And Policy, 2003. 41 “Although intellectual property rights and competition laws can indeed both be thought of as

stimulating innovation, it does not follow that tensions between the two regimes cannot and do not occur.

Much depends of right holders and on the scope and term of intellectual property rights”. – VINJE, Thomas;

VAN ROOIJEN, Ashwin. The Relationship Between Intellectual Property Rights and competition Law,

OVERLAPPING INTELLECTUAL PROPERTY RIGHTS, Oxford University Press, 2012, p.367. 42 Gaining or maintaining a leading position by superior products, innovation or business acumen.

14

raise price or exclude competitors, such anticompetitive effects of the conduct

may harm consumers and, more importantly, society43

.

But has the ‘exclusion’ possibility granted to patent owners the same meaning as

the ‘exclusionary’ conduct damned by competition law? First and foremost, it

should be noted that holding a patent right is simply the recognition by a patent

office that such technology deserves to be protected as it actively contributes to

advance the state of the art in benefit of community. Hence by owning a patent a

firm does not ipso facto engage in an exclusive conduct.

Exclusivity, in competition law, refers to the idea of a firm with significant and

durable market power casting existing competition out of its dominance field or

keeping would-be rivals from entering it. Typically, this is accomplished by

means of exclusive supply or purchase agreements, tying, predatory pricing or

refusal to deal. In reality, a patent grants the right to exclude others but does not

give an exclusive ability regarding its market. Besides the fact that a patent does

not imply monopoly leveraging44

even in the space defined in the patent itself

there might be others sharing that same sphere45

. Patent protection is invention-

specific and market-independent.

It is not unless the patent holder engages in a practice that aims to unlawfully

obstruct an actor from being able to compete—unfairly tending to destroy

43 On the ultimate antitrust goal see 6.1, below. 44 WHISH, Richard; BAILEY, David. Competition Law, Oxford University Press, 2012, p.769: “A

patent does not necessarily make the patentee a monopolist in a economic sense: there may be other products

that compete with the subject-matter of the patent.”; NIELS, Gunnar; JENKINS, Helen; KAVANAGH,

James. Economics for Competition Lawyers, Oxford University Press, 2011, p.172: “Designing a new type of

kitchen tap may be patent-protected, but because it competes with a wide range of other taps that are

sufficiently close substitutes, the patent may confer no pricing power.” 45 This is the case of overlapping patent rights which can occur, for instance, when an inventor finds a

new (non-obvious) use for a previously patented process or product. In that case, there are concentric circles

of patent rights where the old patent (larger circle) surrounds the new one (smaller circle). For a better

understanding of the subject implications see e.g. CHRISTIE, Andrew; DENT, Chris. Non-Overlapping

Rights: A Patent Misconception. EUROPEAN INTELLECTUAL PROPERTY REVIEW, v.32, n. 2, 2010; SHAPIRO,

Carl. Navigating the Patent Thicket: Cross Licenses, Patent Pools, and Standard-Setting, INNOVATION POLICY

AND THE ECONOMY, v. 1, National Bureau of Economic Research, Inc, 2001; MERGES, Robert. Intellectual

Property Rights and Bargaining Breakdown: The Case of Blocking Patents, TENNESSEE LAW REVIEW, v.62,

n.75, 1994.

15

competition itself—that antitrust concerns arise46

. The inability of a rival firm to

compete with the patent holder is not a per se indication that she has exercised an

illegally anti-competitive activity47

. As observed just above, no illegal character

emerges from merits on superior management or by having a better product or

process—those are the very rules of the marketplace. And competition law does

not aim to protect businesses from the ways of the market or out of solicitude for

private concerns; it aims to protect the public from some of its failures in the

concern for the social interest.

For example, if we were to apply the no economic sense48

test, we would have to

cumulate the ownership of a patent—which in turn is the result of the analysis and

validation as ‘able enough’ technical knowledge so as to be endorsed by the patent

authority to deserve legal protection—with an exclusionary practice as such. Put

another way, the use of patent rights would not be ‘exclusive’ in the antitrust

sense of the word insofar as costs by the owner would sensibly have been incurred

absent the tendency of the conduct to eliminate competition.

In fact, exclusionary conduct has often a predatory thrust associated with profit

sacrifice, meaning that a company wanting a monopoly position trades a part of its

monopoly profits—at least temporarily—for a larger market share by making it

unprofitable for rivals to compete. But even if the defendant’s conduct entails a

short-run profit sacrifice, the no economic sense test further asks where the

rational in making such sacrifice is. Never the sole tendency to eliminate

competition is sufficient to embody an exclusionary conduct as rebuked by

46 “As in other antitrust contexts, however, market power could be illegally acquired or maintained,

or, even if lawfully acquired and maintained, would be relevant to the ability of an intellectual property owner

to harm competition through unreasonable conduct in connection with such property.” – DEPARTMENT OF

JUSTICE and THE FEDERAL TRADE COMMISSION, Antitrust Guidelines for the Licensing of

Intellectual Property, 1995. 47 And even the mere fact that one competitor’s conduct injures another is far from a sufficient basis

for presuming that the conduct is improper. 48 “(…) conduct is exclusionary only if it would not make business or economic sense apart from its

tendency to reduce or eliminate competition.” – Brief of the Solicitor General for the United States and the

Federal Trade Commission as Amici Curiae Supporting Petitioner, Trinko, 540 U.S. 398 (2004) (No. 02-682).

In this sense, a conduct would be exclusionary where it would involve a sacrifice of short-term profits or

goodwill that would makes sense only insofar as it would help the defendant maintain or obtain monopoly

power.

16

antitrust law. And if the patent grants the owner an advantage over its rivals, that

is all the more desirable. After all, “[t]he successful competitor, having been urged

to compete, must not be turned upon when he wins.”49-50

49 United States v. Aluminum Co. of Am., 148 F.2d 416, 430 (2d Cir. 1945). 50 “(…) what may appear inefficient today, such as monopolies ad barriers to entry, may actually turn

out to be a necessary passage toward achieving efficiency tomorrow. In other words, they could recognize in

dominant positions and entry barriers that harm allocative efficiency the same appropriability function (…)

[of Intellectual Property Rights], which impair today’s allocative efficiency in order to guarantee tomorrow’s

innovation. Likewise, competition authorities could realize that, on the one hand, market power, barriers to

entry, and over-competitive prices are evidence that the firm in question has made a substantial contribution

to economic growth, by developing new products and processes (…) that better satisfy consumers. And, on

the other hand, they could acknowledge that firms unable to develop new products or processes (…) should

not be ‘saved’”. – MAGGIOLINO, Mariateresa. The Economics of Antitrust and Intellectual Property Rights,

supra note 1 at 85.

17

2. COMPETITION

“Invincibility lies in the defense;

the possibility of victory in the attack.”

—Sun Tzu

COMPETITION

In contrast with mainstream economics that conceptualize competition in terms of

consistency of maximizing decisions made by buyers and sellers alike, Austrian

economics sees the market process as active rivalry between players that behave

in unpredictable ways. Thus, competition is understood by Austrians in terms of

constant disequilibrium caused by the revolving motion of market interaction as

constant readapting is ever-occurring. Put differently, competition is an ongoing

dynamic rivalrous process. Since market equilibrium basically means a state of

rest, the neoclassical notion embraces a static perspective of competition as the

Austrians adopt a dynamic one.

2.1 Static Competition

Etymologically, ‘competition’ expresses a contest for something—a dispute, a

battle. Particularly in business, competition means rivalry in the marketplace.51

51 “Perhaps it is worth recalling that, according to Dr. Johnson, competition is ‘the action of

endeavouring to gain what another endeavours to gain at the same time.’” – HAYEK, Friedrich.

Individualism and Economic Order, The University of Chicago Press, 1948, p.96.

18

However, it is quite noticeable that the classic notion of competition among

economists is rather distant from the true meaning of the word.

In its textbook definition, competition has a static nature of being, almost like a

still life. The archetype of this ‘static’ competition is a marketplace where

unchanging—or barely unchanging—products are offered by numerous providers

at low prices. In markets like these, demand would have a quick response to an

increase in price by a particular supplier, as alternative products would be

available at a lower (market) value52

. Put differently, consumers could easily

satisfy the same needs to the same degree expending less money. Consequently,

competition between firms in such context occurs mainly through price—

competitors cut retail prices to gain market share. Not much of a battle here.

In order to be capable of reducing prices and/or increasing output companies have

to make all efforts to efficiently allocate resources and maximize their businesses’

productivity. Therefore, firms are pushed to improve management of production

factors in such a manner that, ultimately, there would be no way to reorganize

them without reducing total output and/or raising costs. Solely by better

employing their factors are companies able to reduce their marginal production

costs53

and gain the ability to charge a lower price to consumers in static

markets—thus naturally increasing market share54

. This conceptual framework

converges to the very notion of perfect competition55

—indeed, not much of a

vivid dispute for the marketplace.

Unfortunately, however, such academic model of static competition paradigm

permeates antitrust economics, haphazardly tainting governments’ policies and

authorities’ analysis. As we will see further ahead56

, antitrust authorities implicitly

52 Economists call this “elasticity”, that is, the responsiveness of the quantity demanded of a good or

service to a variation in its price. 53 That is, the change in total cost when the quantity produced increases by one unit of output. 54 Other (non-performance related) ways to increase market share in static markets would be by means

of marketing campaigns and trending efforts. 55 See 4.1, below. 56 Chapter 6, below.

19

accept a perfect competition approach to assess—and attempt to correct—eventual

market failures even on highly technological economies, a mindset that has no

good theoretical or practical evidence that enhances consumer welfare in the long

run57

.

2.2 Dynamic Industries

In ‘non-traditional’ industries58

, markets are inhabited by companies that invest

highly in R&D and intellectual property protection, hence competition occurring

mainly through innovation. In recent years, such companies have increasingly

acquired importance and influence in our daily lives. From smartphones59

to high-

performance engines, GM corn and precision drugs60

, innovation is undoubtedly

the cornerstone of much of the business activity nowadays. Dynamic industries

include those in which innovation, intellectual property and technological change

are central features. Those high-tech markets, which are very complex business

sectors that changes very rapidly, are sometimes called ‘new economy’ industries.

Companies in dynamic industries tend to have noticeable idiosyncrasies that

largely differ from traditional industries:

57 Even though consumer welfare was not always pursued by antitrust law, it is now quite clear that it

has become the central objective of competition policy, supra note 34. For a further discussion on the matter,

see infra 6.1 58 “The traditional industries are characterized by multiplant and multifirm production (indicating that

economies of scale are limited at both the plant level and the firm level, or in other words that average total

costs are rising at relatively modest output levels), stable markets, heavy capital investment, modest rates of

innovation, and slow and infrequent entry and exit.” – POSNER, Richard. Antitrust in the New Economy,

John M. Olin Law & Economics Working Paper n.106, University of Chicago Law School, 2000, p.2. 59 “Almost every complex electronics product sold to the final consumer today implicates scores of

technologies and inventions. Many of these inventions are likely covered by patents and/or other forms of

intellectual property rights. Smartphones and their use likely implicate hundreds—if not thousands—of

patents.” – SOMAYA, Deepak; TEECE, David; WAKEMAN, Simon. Innovation in Multi-Invention

Contexts: Mapping Solutions to Technological and Intellectual Property Complexity, CALIFORNIA

MANAGEMENT REVIEW, v.53, n.4, 2011, p.47. 60 “In biotechnology, innovators must assemble increasingly large portfolios of patented genomic

information, research tools and other inventions, and license rights from other innovators, in order to conduct

new research and to bring new medical solutions to market” – Id. at 49.

20

2.2.1 Large Fixed Costs and Low Marginal Costs

As intellectual property has critical importance, these industries generally have

large fixed costs (most of which are sunk R&D expenditures) and low marginal

costs, giving rise to economies of scale over a wide range of output. However,

after the initial investment it is rather inexpensive to produce additional units, i.e.

marginal production costs are quite low. Another copy of a video game is quite

cheap to produce once the source code is created or an additional unit of a pill

once the scientific formula is discovered. While millions of dollars are spent in

fixed costs—to research, develop, and put through testing—it may cost only a few

cents (marginal cost) to produce another unit of the good.

2.2.2 Highly Profitable Industry Leaders

As a consequence of the previous feature, for engaging in dynamic industries to

be rewarding, large upfront fixed costs shall return as high profits to investors. For

instance, as presented by M. HOWARD MORSE in its statement before the Antitrust

Modernization Commission, the “development of new pharmaceuticals is

notoriously expensive and risky, with many ‘dry wells’ and a few ‘gushers’, as

companies pour money into developing drugs that never succeed. New investment

will not occur in such industries unless firms anticipate earning a competitive

return in the long run.” 61

Sure enough, firms that would only be able to charge prices equal to their

marginal costs would certainly be dissuaded to spend on costly R&D since they

would not be able to recover their fixed and sunk costs. In any event, investment

in innovation is a risky business as the rate of success is rather small: “in

dynamically competitive industries, entrepreneurs and their backers recognize that

many will try and most will fail.” 62

In such inauspicious environment where the

61 MORSE, Howard. Statement before the Antitrust Modernization Commission hearing on Antitrust

and the New Economy, supra note 37 at 7. 62 EVANS, David; SCHMALENSEE, Richard. Some Economic Aspects of Antitrust Analysis in

Dynamically Competitive Industries, INNOVATION POLICY AND THE ECONOMY, v.2, MIT Press, 2002, p.14.

21

majority of enterprises fail, succeeding ventures yield tall revenues. Therefore the

tendency is for dynamic industries to “have a small number of relatively large

firms at any point in time.”63

2.2.3 Short Product Life Cycles

The rapid pace of change in such industries often makes future developments

difficult to predict and tends to challenge or erode pre-existing market power.

Once innovation competition is a major feature of new economy industries,

products seldom reach a maturity stage with new products64

replacing old ones

quite rapidly. For example, in little more than five years—from June 29, 2007

(release date of the initial models65

) to September 21, 2012 (release date of the

iPhone566

)—Apple already released six improved versions of its notorious

smartphone67

. Likewise, Samsung’s ‘Galaxy S’ series had its three major products

launched in little less than two years—from June 2010 (release date of Galaxy S)

to May 2012 (release date of Galaxy S III). 68

2.2.4 Quick and Frequent Entry and Exit

Disruption and discontinuity characterize the economic landscape of dynamic

industries, radically altering market structures. Whereas since the 1990s we are

well into what PETER DRUCKER calls the “Age of Discontinuity”69

, this stage has

been building up from earlier economic forces70

. In this environment, “incumbent

companies have unprecedented opportunity to take advantage of these times.”71

63 Id. at 15. 64 Meaning, either an improved version of the same product or an alternative creation that can best

satisfy consumer needs. For further considerations on different types of innovation, see 3.1 below. 65 Apple Press Info: Apple Reinvents the Phone with iPhone, January 9, 2007. 66 Apple Press Info: Apple introduces iPhone5, September 12, 2012. 67 Original (June 29, 2007), iPhone 3G (July 11, 2008), iPhone 3GS (June 19, 2009), iPhone 4 (June

24, 2010), iPhone 4S (October 14, 2011) and iPhone 5 (September 21, 2012). 68 Samsung Media Press Release: Samsung GALAXY S Series Surpasses 100 Million Unit Sales,

January 14, 2013. 69 DRUCKER, Peter. The Age of Discontinuity: Guidelines to Our Changing Society, Transaction

Publishers, 1992. 70 “Among these are:

22

Figure I – Average Lifetime of S&P 500 companies

Source: FOSTER and KAPLAN, Creative Destruction.

According to RICHARD FOSTER and SARAH KAPLAN, “if history is a guide, no

more than a third of today’s major corporations will survive in an economically

important way over the next twenty-five years. (…) To be blunt, most of these

companies will die or be bought out and absorbed because they are too damn slow

to keep pace with change in the market72

. By 2020, more than three quarters of the

S&P 500 will consist of companies we don’t know today (…).”73-74

The extent to

which quick and frequent entry and exit outlines dynamic industries is relevant to

establish whether the alleged market power possessed by a firm can be considered

durable.

• The increasing efficiency of business, due to dramatic declines in capital costs. As industry

shifted from goods to services, there was a concurrent decline in interaction and transaction costs. These costs

declined because of the advent of information technology and the steady rise in labor productivity due to

advances in technology and management methods.

• The increasing efficiency of capital markets, due to the increasing accuracy (and transparency) of

corporate performance data.” – FOSTER, Richard; KAPLAN, Sarah. Creative Destruction, Currency

Doubleday, 2001, p.13. 71 Id. at 14. 72 “In 2011, a total of 23 companies were removed from the list, either due to declines in market value

(…) or through an acquisition (…).” – INNOSIGHT Executive Briefing, Winter 2012, p.4. 73 FOSTER, Richard; KAPLAN, Sarah. Creative Destruction, supra note 70 at 14. 74 “On average, an S&P 500 company is now being replaced about once every two weeks. And the

churn rate of companies has been accelerating over time. According to the Innosight study of almost a

century’s worth of market data, corporations in the S&P 500 in 1958 lasted in the index for 61 years, on

average. By 1980, the average tenure had shrunk to about 25 years. Today, it stands at just 18 years based on

seven year rolling averages.” – INNOSIGHT Executive Briefing, supra note 66 at 4.

23

2.2.5 Network Effects

In many industries the value of products often increases with the number of

users—such complementary products grow stronger by forming systems. This

aspect corresponds to demand-side economies of scale, where products tend to be

more valuable to consumers the higher the number of people using them.

“Because the value of membership to one user is positively affected when another

user joins and enlarges the network, such markets are said to exhibit ‘network

effects’ or ‘network externalities’”75

. Such is the case, for example, of

communications network and hardware/software networks.

2.2.6 Low Price Elasticity of Demand

A particular repercussion of network effects is the cost consumers will have if

they decide to shift from a product to another. “Once a certain system is chosen,

switching suppliers is costly because new relation-specific investments have to be

made. In such a situation, systems that are expected to be popular—and thus have

widely available components—will be more popular for that very reason.”76

In fact, demand in network markets is relatively inelastic, not necessarily because

there are no close substitute products available, but as a result of the costs

consumers have to face if they decide to join (switch to) another network.

2.2.7 First-Mover Opportunities77

75 KATZ, Michael; SHAPIRO, Carl. Systems Competition and Network Effects, JOURNAL OF

ECONOMIC PERSPECTIVES, v.8, n.2, 1994, p.94. 76 Id. 77 Instead of the conventional terminology “first-mover advantages”, I prefer to use the concept of

‘opportunity’ instead of ‘advantage’. That is because being a pioneer does not grant an advantage per se,

rather opens the possibility for firms to benefit from the head-start they have. In fact, while some depend on

the strengths and weaknesses of the firm, virtually all of the advantages depend on costumers, whose

preferences have been shaped to favor the pioneer product. In any event, an opportunity is the door to the

advantage and firms may (or may not) seize it and take advantage, as they may (or may not) hold on to it for a

significant period of time. For further reading on the subject, see LIEBERMAN, Marvin; MONTGOMERY,

David. First-Mover Advantages, Research Paper, Stanford University, n.969, 1987; LIEBERMAN, Marvin;

MONTGOMERY, David. First-Mover (Dis)Advantages: Retrospective and Link with the Resource-Based

View, STRATEGIC MANAGEMENT JOURNAL, n.19, 1998.

24

This reality—also called ‘lead time’—defines a firm that has a head start, i.e. is

the first to enter a given market, acting early relative to peers. Being the pioneer

may establish a competitive advantage that enables the company to garner positive

economic profits.

In effect, to some extent due to intellectual property protection and network

effects, in a high-tech industry there may be advantages in pioneering

entrepreneurship, that is, by developing and introducing a new product or by

being the first to gain a significant market presence. This lead motivates firms to

race to be the first to market, enabling them to gain preemptive control of scarce

resources or enjoy a ‘blue ocean’78

paradigm that followers will not have access

to. Also, pioneers may benefit from consumers’ switching costs and from network

externalities that establish the original product as the industry standard.

2.2.8 Labor and Human Capital Intensity

Dynamic industries, while heavily relying on R&D and intellectual property,

make intensive use of labor. That is due to the fact that “in practice fifty per cent

or more of R&D spending is the wages and salaries of highly educated scientists

and engineers.” 79

Such innovative-driven industries lead to the creation of intangible (intellectual)

assets that form companies’ knowledge base, rooted on the workforce involved in

the developed R&D. This knowledge is roughly a firm’s greatest asset and,

consequently, one which they strongly seek to monetize—namely through

patenting.

78 ‘Blue ocean’ suggests the idea of a calm uncontested market space, as opposed to ‘red ocean’ where

firms fight with other suppliers in an existing industry. See KIM, W. Chan; MAUBORGNE, Renée. Blue

Ocean Strategy, Harvard Business Review Press, 2005. 79 HALL, Bronwyn; LERNER, Josh. The Financing of R&D and Innovation, HANDBOOK OF THE

ECONOMICS OF INNOVATION, North Holland, 2010.

25

2.2.9 Low Entry Costs

Particularly in internet-based industries, entry costs can be quite low. For instance,

Mark Zuckerberg co-created Facebook in his Harvard dorm room. Facebook was

publicly opened as a social network in 2006 and by the end of 2009 it had reached

a whopping 75% of market share.80

Figure II – Person of the Year 2010.

In December 2010, Time Magazine named Facebook CEO Mark Zuckerberg as person of the year.

Actually, “a wealth of low- or no-cost online tools, coupled with hyperconnected

markets, put innovation capabilities into the hands of the masses and allow ideas

to rapidly spread. For many start-ups, $25,000 is sufficient to launch a fully

formed business, as the incubator Y Combinator and its numerous copycats show.

These early-stage funders have helped launch promising new companies such as

Dropbox, Airbnb, Xobni, Scribd, Hipmunk, and many more.”81

80 Source: StatCounter Global Stats—http://stats.areppim.com/stats/stats_socmediaxtime.htm. 81 ANTONY, Scott, The New Corporate Garage, HARVARD BUSINESS REVIEW, n.87, Sep. 2012.

26

As a consequence, in such context threats from dangerous rivals are ever-lurking

and able to be sudden and unexpectedly unveiled.82

2.2.10 Winner-Take-All Races

In dynamic industries, firms compete for the market developing innovative

products and processes that greatly diminish or even eliminate actual or potential

rivals. Leadership is usually conquered not through slow-steady advances but

from a hard blow of progressive creation. In fact, “it is not atypical for a fringe

firm that invests heavily to displace the leader by leapfrogging the leader’s

technology.”83

2.3 Dynamic Competition

The ground from which neoclassical competition theory stems is covered by

assumed conditions that are far from having real-world application, such as

market equilibrium and that information is known beforehand to all market

actors84

. This kind of utopian assessment of the market process as a perfect

competition model85

most definitely leaves no room for trial-and-error, learning

and other marks of the discovery process. The reality of a perpetually-changing

market environment is seasoned with entrepreneurial activity and rivalry; with

attempts, errors and error corrections; with the never-ending road to unveiling the

82 “Consider the “daily deal” space. By some accounts, Groupon reached $1 billion in revenue faster

than any other company in history. But dozens of instant copycats put it on defensive—and lower fixed costs

today mean those contender can linger far longer. Groupon may succeed in spending its challengers into

retreat, but hypercompetition, coupled with shortening development cycles, makes it harder than ever for

start-ups to create enduring competitive advantage.” – Id. 83 EVANS, David; SCHMALENSEE, Richard. Some Economic Aspects, supra note 62 at 12. 84 “For instance, the question of how businessmen come to understand what consumer demand is

becomes, in the standard analysis, the assumption that such information is already known, and correctly

known, to all businessmen. How businessmen discover which factor combinations are the most efficient

becomes, in the orthodox model, the assumption that such combinations are already known and have already

been adopted by suppliers. How businessmen determine which products to produce with what degree of

differentiation, becomes the assumption that all the products are already homogenous. In short, the model

assumes the existence of information that a competitive process aims to discover.” – ARMENTANO,

Dominick. Antitrust and Monopoly : Anatomy of a Policy Failure, The Independent Institute, 1990, p.26. 85 See infra 5.1 for a better understanding of the concept (and deceit) of the perfect competition model.

27

never-ending consumers’ needs. But such a constant disequilibrium process

cannot cope with the abridging assumptions of the static perspective. As HERBERT

HOVENKAMP sums it,

“Neoclassical competition is a little like watching the ocean when it

is calm, while Schumpeterian competition is like watching a raging

storm or perhaps even a tidal wave.”86

Actually, Austrian economists see competition “as a constant process of

disclosure were economic agents innovate when they discover (or uncover) pieces

of information and knowledge previously ignores. Firms that innovate enjoy a

competitive advantage in comparison to their rivals because they become the best

at coping with the uncertainty that ignorance generates. Yet, since information and

knowledge are supposed to be always incomplete, at any time any firm can

develop new products, new techniques, new management methods, new corporate

culture and new organizational processes to keep on competing with its rivals. In

this way, therefore, competition becomes an open-ended race between rivals.”87

These unstably dynamic88

markets denoted by successive waves of innovation are

the habitat for rivals that compete for them. Put differently, firms in dynamic

markets tend to struggle not for a market slice but for the market as a whole. That

concept is directly linked to the idea of winner-take-all races, a trait of dynamic

industries89

, and to the Schumpeterian concept of “creative destruction”90

. Indeed,

86 HOVENKAMP, Herbert. Schumpeterian Competition and Antitrust, Legal Studies Research

Papers, n.08-43, University of Iowa, 2008, p.1. 87 MAGGIOLINO, Mariateresa. The Economics of Antitrust and Intellectual Property Rights, supra

note 1 at 83-4. 88 “The adjective ‘dynamic’ is a shorthand descriptor for a variety of rigorously competitive activities

such as significant product differentiation and rapid response to change, whether from innovation or simply

from new market opportunities ensuing from changes in taste or other forces of disequilibrium.” – SIDAK,

Gregory; TEECE, David. Dynamic Competition in Antitrust Law, JOURNAL OF COMPETITION LAW &

ECONOMICS, 5(4), 2009, p. 603. 89 See 2.2.10, supra. 90 “The history of the productive apparatus of a typical farm, from the beginnings of the

rationalization of crop rotation, plowing and fattening to the mechanized thing of today—linking up with

elevators and railroads—is a history of revolutions. So is the history of the productive apparatus of the iron

and steel industry from the charcoal furnace to our own type of furnace, or the history of the apparatus of

power production from the overshot water wheel to the modern power plant, or the history of transportation

from the mailcoach to the airplane. The opening up of new markets, foreign or domestic, and the

28

dynamic markets have sudden convulsions and unexpected revolutionary changes

that take the form of unbalancing technological maelstroms.91

Time and again

innovation-driven competition overturns the state of affairs in an industry, greatly

benefiting society as a whole, and many are the cases of industries illustrating that

gains from dynamic competition far outshine those where competition is not

innovation-driven.92

The essence of competition is an ever-changing reality generated by the rivalry

process, not equilibrium itself. The neoclassical “competitive equilibrium”

implicates that data—from a number of individuals pursuing their own separate

interests—is the same for all those planning minds. And it assumes that data

remains unchanged while individual objectives are chased, even disregarding

environmental adaptations and reactions to the action of others. However, HAYEK

reminds us that “the causal factor enters here in the form of acquisition of new

knowledge by the different individuals or of changes in their data brought about

by the contacts between them.”93

In fact, we cannot simply assume that

consumer’s preferences and desires is information that producers possess ab

initio, instead of being the quest for those desires revealed precisely in the

competitive process itself. HAYEK concludes that

organizational development from the craft shop and factory to such concerns as U.S. Steel illustrate the same

process of industrial mutation—if I may use that biological term—that incessantly revolutionizes the

economic structure from within, incessantly destroying the old one, incessantly creating a new one. This

process of Creative Destruction is the essential fact about capitalism.” – SCHUMPETER, Joseph. Capitalism,

Socialism and Democracy (1942), Routledge, London, 2003, p.83. 91 “Those revolutions are not strictly incessant; they occur in discrete rushes which are separated from

each other by spans of comparative quiet. The process as a whole works incessantly however, in the sense

that there always is either revolution or absorption of the results of revolution, both together forming what are

known as business cycles.” – Id. footnote 2. 92 “The steamship brought enhanced competition to the sailing ship and to ocean transportation. Steam

and sail competed side by side for decades. The great days of sail—the era of the clipper ships—occurred

partly in response to competitive pressures from steam ships. Likewise, vacuum tubes got better with

competition from the transistor. Competition from refrigeration destroyed the ice-harvesting industry but

brought massive cost savings and convenience to consumers. Technological innovation in aircraft jet engines

marginalized internal combustion engines and destroyed many of the traditional aircraft manufacturers that

were wedded to internal combustion engines. Electronics destroyed the typewriter.” – SIDAK, Gregory.

TEECE, David. Dynamic Competition in Antitrust Law, supra note 88 at 603. 93 HAYEK, Friedrich. Individualism and Economic Order, supra note 51 at 94.

29

competition is by its nature a dynamic process whose essential

characteristics are assumed away by the assumptions underlying

static analysis.94

Innovation-driven competition, as opposed to price-competition, require

incumbents and entrants alike to adjust to changes in product and process

industrial development in order to survive. In the pursuit of the competitive

advantage that will bring high profits95

—as leaders are able to charge prices well

above the marginal cost—many firms enter the battlefield.96

Amidst the

bloodshed, the dominant firms emerge among the carcasses of the losers.

Competition in dynamic markets is indeed a ruthless confrontation that will

naturally determine which firms played better the innovation game and thus

yielded high profits in return. And, as attackers may benefit from some inherent

advantages97

, “(…) incumbents must master discontinuities as well as incremental

change and improvement”98

if they want to stand a chance in the race.

94 Id. 95 “A very high percentage of innovation programs fail, but the ones that succeed frequently provide

enormous payoffs.” – HOVENKAMP, Herbert. Schumpeterian Competition and Antitrust, supra note 86 at 2. 96 “Entrants introduce a large fraction of radical technologies into an industry. (…) The advent of new

technological ensembles or paradigms is usually marked by a wave of new competitors entering an industry

to sustain success.” – SIDAK, Gregory. TEECE, David. Dynamic Competition in Antitrust Law, supra note

88 at 604-5. 97 For instance, novelty is a difficult issue to deal with when firms have already consolidated its

procedural structure. More on managerial advantages of entrant firms on 3.4, below. 98 SIDAK, Gregory. TEECE, David. Dynamic Competition in Antitrust Law, supra note 88 at 605.

30

3. INNOVATION

“If I have seen further it is by standing on ye sholders of Giants”

—Isaac Newton

INNOVATION

In their attempt to escape the substitution effect firms struggle to differentiate

their goods from those of competitors. Otherwise, their products would be put side

by side with those from rival companies. From a consumer standpoint, failure

from firms to set apart their products would make choices indifferent as

fulfillment of needs could be similarly achieved whether choosing X or Y.

While distinction is made between the concepts of invention and innovation99

, a

patent is surely an invention that innovates100

. Once it is considered by authorities

(namely, patent offices) to be an onward movement unfolding a change from the

status quo—sometimes even a truly technological paradigm shift—and an active

99 See e.g. PERITZ, Rudolph. Competition Within Intellectual Property Regimes: The Instance of

Patent Rights, INTELLECTUAL PROPERTY AND COMPETITION LAW : NEW FRONTIERS, Oxford, 2011, p.39.

Accordingly, innovation includes the process of commercializing inventions. See also

BRANDENBURGUER, Rachel, Promoting Innovation through competition, 2nd BRICS INTERNATIONAL

COMPETITION CONFERENCE, China, 2011.

In fact, David Teece defines ‘innovators’ as those “which are first to commercialize a new product

or process in the market” – TEECE, David. Profiting from technological innovation: implications for

integration, collaboration, licensing and public policy, RESEARCH POLICY, n.15, 1986, p.285. 100 Slightly different is the vision of FRITZ MACHLUP, while he sees innovation as the development

and introduction of inventions already made and patented. See MACHLUP, Fritz, An Economic Review of the

Patent System, STUDY OF THE SUBCOMMITTEE ON PATENTS, TRADEMARKS, AND COPYRIGHTS OF THE

COMMITTEE ON THE JUDICIARY, US Government Printing Office, 1958.

31

way to monetize creative design, “profiting from technological innovation”101

, a

patented invention is innovation102

.

3.1 Innovation? What Innovation?

The concept of innovation is understood by many as synonyms for creativity

and/or proactivity103

. This is the case of firms doing their best to include

innovation on a list of core values while exhorting employees to think ‘outside the

box’ and try new things, offer ideas, exude positive energy, cooperate with their

colleagues—hoping that this inspires people to come up with new ideas that will

transform the strategic and financial scenario of the company. However, for all the

talk about innovation, surely most executives don't really look auspiciously to the

prospect of their people generating new ways to do things, favoring that they

simply do what they are asked to do but in the most enthusiastic, professional way

possible. And so it is no surprise that when firms talk about innovation they are

not really talking about the true meaning of the word.

Innovation is a corollary of development and productivity since advances in

science and technology contribute to better life conditions and improve general

human well being. The creation of new technologies and the development of new

methods and processes have huge impact on the population, providing for a wider

satisfaction of needs and serving as an inclusive mean to households. As

innovation enables incremental changes on products, past versions of those

products become more affordable for low and medium-income households. Also,

101 TEECE, David. Profiting from technological innovation, supra note 99; TEECE, David. Reflections

on “Profiting From Innovation”, RESEARCH POLICY, n.35, 2006. 102 Consequently, both terms will be used in this work as synonym concept referring to knowledge on

industrial technology that advances prior or background art. 103 See e.g. O’REILLY, Charles; CHATMAN, Jennifer ; CALDWELL, David. People and

Organizational Culture: a Profile Comparison Aproach to Assessing Person-Organization Fit, ACADEMY OF

MANAGEMENT JOURNAL, v.34, n.3, 1991; CHATMAN, Jennifer; JEHN, Karen. Assessing the Relationship

Between Industry Characteristics and Organizational Culture: How Different Can You Be?, ACADEMY OF

MANAGEMENT JOURNAL, v.37, n.3, 1994; ROBBINS, Stephen. Essentials of Organizational Behavior,

Prentice Hall, 2005.

32

innovation allows the poor to modernize this often “informal” and low-producing

business.

For example, the development of a better paintbrush will make earlier models of

that item to become obsolete to big and wealthy firms that usually own cutting-

edge technology. This will improve those firms’ productivity, as they will be able

to paint more efficiently with the newly enhanced brush. On the other hand, in a

domino-like effect, the poor will have access to the “old” paintbrush as its price

will significantly drop. This will improve those individuals productivity, as they

will be able to paint more efficiently with a brush that is an enhancement vis-à-vis

their former tool.

Market actors promote competitive dynamics either by stimulating subsequent

innovation, or by expanding access to knowledge and information. Thus

innovation, while pushing the state-of-the-art further, effectively improves the

lives of citizens, ultimately enhancing regional and global HDI.

3.2 Sustaining Technology

In most cases technology improves the performance of established products,

increasing the satisfaction of existing consumers, and therefore sustaining the

established trajectory of constantly improving the performance of established

products. Such improvements are made “along the dimensions of performance

that mainstream customers in major markets have historically valued.” 104

3.2.1 The Rise and Fall of a Technology – The S-Curve

In December, 1907, the corporate sailing ship Thomas W. Lawson—the largest

pure sailing vessel (i.e., with no auxiliary engine) ever built—sank off the

uninhabited island of Annet, in the Isles of Scilly, killing all but two of her 18

104 CHRISTENSEN, Clayton, The Innovator’s Dilemma, Harper Business, 2011, p.xviii.

33

men crew. Her cargo of more than 50,000 barrels of light paraffin oil caused a

tremendous spill, probably the first large oil spill in modern history.

The design and purpose of Thomas Lawson was an ultimately unsuccessful bid to

keep sailing ships competitive with the steam ships that were becoming more

common for freight transport purposes. But to gain speed there was need to

sacrifice maneuverability: she was an imposing 7-masted behemoth unwieldy and

difficult to handle. The Lawson’s seven masts crowded as much sail above her

decks as the limits of space and windflow would allow. She was the last breath of

a declining sailing ship industry. No attempt was ever made to design a faster

cargo-carrying sailing ship and steamships began to rule the seas.

Figure III – The Thomas W. Lawson (1902-1907)

The Thomas Lawson story gives us the notion of limits in technological

innovation, as beyond certain point there cannot be any progress. This happens

when developing a new product: first, the rate of progress is relatively slow as

R&D starts putting the wheel in motion; then, extensive progress is quickly made

while the technology is mastered; finally, while approaching maturity state it is

increasingly costly to progress even a little and greater effort will be required to

achieve improvements. And then sailing ships don’t sail any faster. This is the

limit at the top of the S-curve.

34

Figure IV – The S-Curve

Source: FOSTER, The Attacker’s Advantage

The core of essence of strategic technology management, then, is to identify when

the inflexion of the S-curve is reached. “The operative trigger is the slope of the

curve of the established technology. If the curve has passed its point of inflexion,

so that its second derivative is negative (the technology is improving at a

decreasing rate), then a new technology may emerge to supplant the established

one.”105

Being able to correctly assess this stage will ultimately give firms a

chance to timely (i.e., before the current technology reaches maturity) develop the

technology that will take the former one’s place.

When talking about sustaining innovation, we might be talking about either of two

kinds of technology: incremental and radical (or discontinuous). The first type is

a gradual and continuous development of a given product, like the sailing ship. In

the pursuit of satisfying consumers’ needs, there is an enhancement on the older

version of the product so as to upgrade its performance levels. Same product, but

better. On the other hand, when we talk about the steamship, we are talking about

a radical change on technology. The market is still the same, and so are the

consumers, but it is not the same product. It serves the same needs, but the nature

105 Id. at 57.

35

of the product—i.e. its technology—is different. In virtually any given industry

we are able to see a framework of intersecting s-curves that conceptualize

sustaining technology, as illustrated in Figure V.

Figure V – The Conventional Technology S-Curve

Source: CHRISTENSEN, The Innovator’s Dilemma.

We can perceive that both incremental (intra-products) and radical (inter-

products) technology continually sustain industrial innovation and product cycles

form a chain that progressively upgrades products so as to meet current

costumers’ needs and expectations. In fact, while some were straightforward

technology improvements and others radical departures, all had the same impact

on the music industry: they helped manufactures to maintain the rate of historical

performance improvement that their customers had come to expect.

3.3 Disruptive Technology

In some situations, however, innovation results in worse short run product

performance but that ultimately creates a new market segment and value network,

36

and eventually goes on to disrupt an existing market and value network—over

time—displacing the prior technology. Typically, such innovation is initially

designed for consumers of emerging or insignificant markets but move upmarket

wiping out established firms. In his book The Innovator’ Dilemma (1997),

CLAYTON CHRISTENSEN coined this type of innovation as disruptive

technology and explains that

disrupted technologies bring to a market a very different value

proposition than had been available previously. Generally,

disruptive technologies underperform established products in

mainstream markets. But they have other features that a few fringe

(and generally new) customer value.106

An important fact to be recognized is that technologies can advance more rapidly

than consumer demand. Put differently, while attempting to offer better products

than their rivals and earn higher prices and margins, suppliers often ‘overshoot’

their market. This is particularly hazardous to non-obsolescence technologies. For

instance, in the past you had to replace your computer every few years. But as

explained by Moore’s Law107

average PC’s processing power now exceeds most

people’s daily needs by a healthy margin. That, added to the fact that in these days

much computing is done on smartphones and tablets, PC market suffered the

106 CHRISTENSEN, Clayton, The Innovator’s Dilemma, supra note 104 at xviii. 107 The law is named after Gordon Moore while he described in 1965 that components in integrated

circuits had doubled every year from the invention of the integrated circuit in 1958 until 1965 and predicted

that “there is no reason to believe it will not remain nearly constant for at least 10 years” (MOORE, Gordon,

Cramming more components onto integrated circuits, ELECTRONICS, v.38, n.8, 1965, p.145). “This prediction

has come true so beautifully, that nowadays we speak of ‘Moore’s Law’ as if it were a law of Nature. The

validity of this law cannot be understood from the technical procedures by which the chips are made. The fact

that the law holds so well is an effect of the way actors (in industry, in science and in government) judge their

own and each other’ accomplishments with respect to what Moore’s Law predicts. They direct their efforts

towards achieving the predicated values. Laboratories evaluate and plan their efforts in terms of Moore’s

Law; when there is danger of expectations falling short at the predicted moment, extra effort is expended.

Firms use the law to guide investment decisions in specific technologies; for example whether or not to

develop products that need chips with the predicted capacity—such as calculators or compact disc players.

Governments are willing to provide subsidies in order to help firms avert danger of not meeting the predicted

value. All actors exert themselves to measure up the predicted competition and to stay in the race. Moore’s

Law is the yardstick for the behavior of chip producers and governments in Japan, the United States and

Europe, and it shapes their mutual dependency in the strategic game they play with one another.” – VAN

LENTE, Harro; RIP, Arie. Expectations in Technological Developments, GETTING NEW TECHNOLOGIES

TOGETHER : STUDIES IN MAKING SOCIOTECHNICAL ORDER, de Gruyer, 1998, pp.206-7.

37

steepest decline ever in the first quarter of 2013 (Figure VI). In fact, the PC

industry continues to suffer from the rise of smartphones and tablets as the

disruptive technology that is gradually replacing PCs as the primary computing

device for many consumers:

Figure VI – Worldwide PC shipments by the Top 5 vendors (in million units)

Source: statista.com

This shows that disruptive technologies that result in worse short run product

performance in a given market may be totally competitive in that same market in

the future.

Figure VI – Impact of Disruptive Technological Change


38

“Many who once needed mainframe computers for their data processing

requirements, for example, no longer need or buy mainframes. Mainframe o

performance has surpassed the requirements of many original consumers, who

today find that much of what they need to do can de done on desktop machines

linked to file servers. In other words, the needs of many computer users have

increased more slowly than the rate of improvement provided by computer

designers.”108

Disruptive technologies start from an emerging value network and progress on

their own, in a uniquely defined trajectory, and are able to progress to the point

that they can satisfy the performance demand levels of another (high end) value

network. If so, the disruptive technology invades the established network.

Figure VII – Disruptive Technology S-Curve


Once the vertical axis for a disruptive innovation figure must measure other

performance aspects than just those relevant in established networks, it has to be

plotted in a figure like Figure VII.

108 CHRISTENSEN, Clayton, The Innovator’s Dilemma, supra note 104 at xix.

39

In any event, it is important to recognize that “disruption is less a single event

than a process that plays out over time, sometimes quickly and completely, but

others slowly and incompletely.”109

3.4 Back to the Future: A Brief History of Innovation

Recapitulating the history of innovation, the first era was that of the lone inventor.

This is the image of Leonardo da Vinci, Gutenberg, Edison, Ford, et alia. In fact,

while some first-era innovators “occasionally formed or latched on to companies

to exploit the full potential of their ideas, (…) most seminal innovations

developed before about 1915 are closely associated with the individuals behind

them.”110

Whilst innovation became increasingly expensive and complex,

individuals were less and less able to pursue their projects, companies took over

the innovation efforts. At the time, a slower-paced industrial environment entailed

longer-term perspectives, willingly allowing experimental efforts. In this sense,

inventors on this second era were corporate labs workers, turning firms from mere

exploiters into creators.

“The seeds of the third era were planted in the late 1950s and the 1960s, as

companies started to become too big and bureaucratic to handle at-the-fringe

exploration.”111

In effect, when stifling hierarchical organizations started to clash

with the individualistic nature of the inventive process, innovators began to leave

established companies. In response to the funding requirement for innovation,

venture capital (VC)112

backed start-ups began to emerge. And “life became even

109 WESSEL, Maxwell; CHRISTENSEN, Clayton, Surviving Disruption, HARVARD BUSINESS REVIEW,

n.90, Dec. 2012. 110 ANTONY, Scott. The New Corporate Garage, supra note 81. 111 Id. 112 VC is money provided to early-stage startup companies and small businesses with perceived long-

term growth potential. The venture capital fund makes money by owning equity in the companies it invests

in, which usually have a novel technology or business model in high technology industries. It is a crucial

source of funding for startups that do not have access to capital markets and while typically entailing high risk

for the investor it has the potential for above-average returns.

40

harder for innovators in big companies as the capital markets’ expectations for

short-term performance grew.”113

But the pace of progress gained momentum and technologies born in this

globalization and world markets age accelerated the pace of change:

Over the past 50 years corporate life spans by some measures have

decreased by close to 50%. Back in 2000, Microsoft was an

unstoppable monopoly, Apple was playing at the fringes of the

computer market, Facebook founder Mark Zuckerberg was a student

at Phillips Exeter Academy, and Google was a technology in search of

a business model.114

This furiously innovative pace brought us to a fourth era, where innovations—

rather than being characterized by technological breakthroughs—are likely to

involve business models.115-116

And in a time of hyperconnected markets and low-

cost online tools, entry costs are small117

. But the ease and pace of innovation that

propels start-ups may turn against them in the not-so-long run. Formerly,

competition was milder and entrants had time—often years—to develop difficult-

to-replicate assets. In these days, however, start-ups barely have the time to savor

their success before imitators and copycats start to replicate their creations:

Consider the “daily deal” space. By some accounts, Groupon reached

$1 billion in revenue faster than any other company in history. But

dozens of instant copycats put it on defensive—and lower fixed costs

today mean those contender can linger far longer. Groupon may

succeed in spending its challengers into retreat, but hypercompetition,

113 ANTONY, Scott. The New Corporate Garage, supra note 81. 114 Id. 115 “(…) from 1997 to 2007 more than half the companies that made it onto Fortune 500 before their

25th birthdays—including Amazon, Starbucks, and AutoNation—were business model innovators.” –

ANTONY, Scott. The New Corporate Garage, supra note 81. 116 Once the World Trade Organization’s Agreement on Trade-Related Aspects of Intellectual Property

(TRIPS) does not specifically address business method patents, patentability of such models varies from

jurisdiction to jurisdiction. 117 See supra 2.2.9.

41

coupled with shortening development cycles, makes it harder than

ever for start-ups to create enduring competitive advantage.118

As a consequence, entrant firms are prone to suffer the very same capital-market

pressures that haunted second-era incumbent firms, only that they have not the

time to develop lasting hard-to-replicate corporate assets. And the answer for this

conundrum is this new era that mixes the entrepreneurial approach of a third-era

VC-backed start-up with the unique capabilities once housed in second-era

corporate labs.119

118 ANTONY, Scott, The New Corporate Garage, supra note 81. 119 Such as a strong brand reputation, good partnerships, solid scientific knowledge, business acumen,

process experience, established distribution networks, etc.

42

4. THE PATENT SYSTEM

“Let me in, let me in" cried the wolf

"Or I'll huff and I'll puff till I blow your house in"

"Not by the hair of my chinny chin chin" said the little pig.

“Then I’ll huff, and I’ll puff, and I’ll blow your house in” the wolf growled.

Well, he huffed, and he puffed, and he huffed and he puffed, and he puffed and huffed;

but he could not get the house down.

—The Three Little Pigs

THE PATENT SYSTEM120

Progress, development, prosperity: we can point out these to be some hot words

when the patent system is the subject. In fact, a social dynamic reality underlies a

model that intends to satisfy the interests of individuals, their various aggregates

and interests of an aggregation of people as a whole.

The patent system is design to protect human creations which—although in the

highest degree advantageous to a society—are of such a nature that a regular

profit could never repay the expense to any individual or small number of

individuals unless protection would guarantee compensating returns:

The funds supporting invention and the commercial development

of inventions are front-end “sunk” investments; once they have

been spent, they are irretrievable bygone. To warrant making such

investments, an individual inventor or corporation must expect that

120 After all, in the words of Walton Hamilton, “the best patent lawyers always slip into their briefs a

few paragraphs concerned with economics and public policy.” – HAMILTON, Walton. The Politics of

Industry, Knopf, 1957, p.72.

43

once commercialization occurs, product prices can be held above

postinvention production and marketing costs long enough so that

the discounted present value of the profits (or more accurately,

quasi rents) will exceed the value of the front-end investment. In

other words, the investor must expect some degree of protection

from competition, or some monopoly power. The patent holder’s

right to exclude imitating users is intended to create or strengthen

that expectation.121

In short, the role of the patent system is ensuring suitable appropriability. Indeed,

“without legal protection, the creator of intellectual property may be unable to

recoup his investment, because competitors can free ride on it; and so legal

protection can expand output rather than, as in the usual case of monopoly, reduce

it.”122

In sum, “a patent confers the right to secure the enforcement power of the

state in excluding unauthorized persons from making commercial use of a clearly

identified, novel, and useful invention."123

Concerning patents and the patent system, an invention is the intellectual creation

that represents “a new contrivance, device, or technical art newly created, in

contrast to a discovery of a principle or law of nature that has already ‘existed’

though unknown to man.”124

A more useful invention will give the inventor a

larger economic return than a less useful one. To maximize their reward, inventors

will seek to create inventions that they believe the market will find useful, and so

society benefits overall from the encouragement for inventors to direct their

talents towards creating useful inventions125

. In any event, the institutional

121 SCHERER, Frederic; ROSS, David. Industrial Market Structure and Economic Performance,

Houghton Mifflin, 1990, p.622. 122 POSNER, Richard. Antitrust in the New Economy, supra note 57 at 3. 123 MACHLUP, Fritz. An Economic Review of the Patent System, supra note 100 at 6. 124 Id. 125 “(…) inventors are for the most part trained salaried professionals, hired to learn and to work in the

great laboratories provided by those who can afford them. Patents are automatically assigned to the

corporation which pays the salaries and provides the facilities. Because it takes the risks, the business takes

the speculative reward. Because invention is consciously cooperative, the individual inventor cannot readily

be isolated as the just patentee, so that all patents are held by the collectivity—the corporation. Because the

process of invention is more than ever a complex process of minute accretion, the individual patent is seldom

44

mission of the patent system is not easy to fathom and many grounds have been

considered as arguments for its conception.

Generally speaking, patent law seeks to encourage creation and innovation126

while enabling public access to the disclosed invention.127-128

By guarantying an

exclusive right for a limited period of time, patent law addresses these two

problems successively. Firstly, the legal mechanism of protection makes the good

excludable. Subsequently, when the work passes into the public domain, all

consumers can benefit from free-of-charge public access. The patent system

strikes a balance between the incentive to create and innovate, and the diffusion of

the results achieved. A muscular patent system will persuade inventors to disclose

their inventions as it provides them stronger guard from infringement than trade

secret protection129

. The disclosure of advances in knowledge is beneficial to

society while making public new knowledge which would otherwise be hidden

under the blanket of trade secrecy.

Ultimately, patents are powerful tools for companies to profit from inventive

activity and thrive. After all, in the words of ALFRED MARSHALL, “many giant

large enough to exploit by itself; therefore patents are pooled as a basis of exploitation by the firm which

acquires them.” – KAHN, Alfred. Deficiencies of American Patent Law, AMERICAN ECONOMIC REVIEW,

v.XXX, 1940, p.481.

For the inventors in the laboratories, the modern incentive is probably preferable to the old. These men are

specialists, professionals who like their work. Where society, accords scientists and inventors steady income,

respect, a career, and a laboratory, it is safe to assume that most prefer these emoluments, facilities, and

associations to the uncertainties of isolated research and business adventure. 126 “The patent system, for example, sometimes confers temporary monopolies on inventors to

encourage technological progress and sacrifices competition for the sake of innovation.” – KATZ, Michael;

SHELANSKI, Howard. Mergers and Innovation, ANTITRUST LAW JOURNAL, v.74, n.1, 2007, p.3. 127 “Patents stimulate improvement, and the general practice of the nations indicates their recognition

of this fact.” – CLARK, John. Essentials of Economic Theory, Macmillan, 1915, p.360. 128 “A patent system, if properly guarded, seems to be thoroughly justified by its results. In the absence

of such protection few new inventions would be developed. The risk attending the introduction of a new

process is always great. Even when it works thoroughly well in the laboratory or model room, it may not

work well in public. The man who first develops a new invention loses his whole capital if it fails. If he is

immediately exposed to free competition in case of success, he can enjoy exceptional profits for a short time

only. The risk of loss, under such circumstances, outweighs the possibility of gain. No man (…) will take the

lead in a hazardous experiment when those who follow him have practically equal chance of gain and almost

no chance of loss. The patent (…) makes it safe for a capitalist to develop a new process. This is the real

justification of the system.” – HADLEY, Arthur. Economics, G.P.Putnam's sons, pp.133-34. 129 See BENTLY, Lionel. Patents and Trade Secrets, OVERLAPPING INTELLECTUAL PROPERTY RIGHTS,

Oxford University Press, 2012, pp.63-5.

45

businesses have owed their first successes to the possession of important

patents.”130

4.1 Property Rights

Patent law—as intellectual property law in general—grants exclusive, transferable

rights. From an economic point of view, transferability is just as important as

exclusivity because it ensures that the asset can be used a valuable tool for firms

to capture profits from innovation. And it is only when ownership is clearly

defined that trade becomes legally viable131

.

A clear and precise definition of patent rights is essential as if the content of a

license is not properly set, price will not be properly established. And it is not just

the fact that the outline of ideas is not clear-cut; also the definition of the scope of

inventions is left up to inventors and applicants must append a list of claims to the

description of their inventions. “For example, in his patent on the telegraph,

Samuel Morse laid claim not only to the specific device that he had developed, but

to all uses of electromagnetic power for transmitting signs or letters at any

distance. In the space of works of the mind, the American inventor attempted to

stake out a concession that would include not only the telegraph, but also

semaphore, the fax and even television!”132

Surely patent law requirements of

novelty133

, nonobviousness134

and technical feasibility135

limit the possibilities of

making claims, but boundaries still stay very imprecise.136

130 MARSHALL, Alfred. Industry and Trade: a study of industrial technique and business

organization and of their influences on the condition of various classes and nations, Overstone Press, 1919,

p.534. 131 “While the idea of property in an invention is not taken seriously by modern economists, a

‘property right’ in a patent and in the limited monopoly which it grants is of course an accepted legal

institution.” – Id. at 26. 132 LÉVÊQUE, François; MÉNIÈRE, Yann. The Economics of Patents and Copyright, The Berkeley

Electronic Press, 2004, p.14. 133 The invention must not have existed previously. 134 The invention must not be readily apparent to a person skilled in the relevant field. 135 The invention must be technically applicable. 136 This uncertainty over the limits of a patent can discourage more efficient companies from

purchasing the right. Conversely, it can prompt the acquisition of a license as a precautionary measure, since

the purchaser does not know whether his process infringes the competitor's patent or not.

46

Crucial to property rights is the enforcement possibility. As such, the cornerstone

of the patent system is the effective assurance that rules and judicial institutions

are able to exclude unauthorized parties from deriving profit from a patented

invention:

With respect to a great number of inventions in the arts, an

exclusive privilege is absolutely necessary, in order that what is

sown may be reaped. In new inventions, protection against

imitators is not less necessary than in established manufactures

protection against thieves. He who has no hope that he shall reap,

will not take the trouble to sow. But that which one man has

invented, all the world can imitate. Without the assistance of the

laws, the inventor would almost always be driven out of the market

by his rival, who finding himself, without any expense, in

possession of a discovery which has cost the inventor much time

and expense, would be able to deprive him of all his deserved

advantages, by selling at a lower price. An exclusive privilege is of

all rewards the best proportioned, the most natural, and the least

burthensome.137

As a matter of fact, it is important to acknowledge the basic notion that lies

beneath modern legal systems: the certainty that the individual has its private

property protected. Indeed, why would we spend our resources on something

unless we were guaranteed its property?138

Property rights, if not a sine qua non

condition for innovative creation, are at least a powerful catalyst.

137 BENTHAM, Jeremy. Manual of Political Economy, THE WORKS OF JEREMY BENTHAM, William

Tait, v.3, 1843, p. 71. 138 “Imagine a society with no real property law or land tenure rules. A farmer clears a plot of land,

fertilizes it and sows it, only to have a neighbor take the crop when it is ripe for harvest. Since the farmer has

no title, either to the land or to the harvest, he has no possibility of seeking redress. After several thwarted

attempts to farm, he will give up and switch to a different activity with a shorter investment cycle.” –

LÉVÊQUE, François; MÉNIÈRE, Yann. The Economics of Patents and Copyright, supra note 132 at 11.

47

According to FRITZ MACHLUP, “while the idea of property in an invention is not

taken seriously by modern economists, a ‘property right’ in a patent and in the

limited monopoly which it grants is of course an accepted legal institution.”139

Symptomatically, the U.S. Department of Justice and the Federal Trade

Commission expressly acknowledge that “for the purpose of antitrust analysis, the

Agencies regard intellectual property as being essentially comparable to any other

form of property.”140

Hence, infringing a patent is actually much like trespassing.

4.2 Profiting From Technological Innovation

As patents increase the returns for R&D, there is innovative development that

otherwise would not—or not as quickly. Surely, the patent system serves to

enhance social welfare, making supplementary—or even less expensive—choices

available to consumers.141

According to ARTHUR PIGOU, the patent system’s

resulting profits direct the inventor’s activity into channels of general

usefulness.142

As the patent system fulfills its purpose, it promotes invention, and

thereby intensifies those effects which are attributable to invention.143

Regarded by MACHLUP as “the fundamental economic justification of patents”144

,

the patent system may produce effective profit incentives for inventive activity145

139 MACHLUP, Fritz. An Economic Review of the Patent System, supra note 100 at 26. 140 U.S. DEPARTMENT OF JUSTICE and THE FEDERAL TRADE COMMISSION, Antitrust

Guidelines for the Licensing of Intellectual Property, 1995, p.2. 141 See ANDEWELT, Roger. Basic Principles to Apply at the Patent-Antitrust Interface, REMARKS

BEFORE HOUSTON PATENT LAW ASSOCIATION, 1981. 142 PIGOU, Arthur. The Economics of Welfare, Macmillan, 1932, p.185. 143 “When technological advantage is largely a function of R&D expenditures, pioneers can gain

advantage if technology can be patented (…). This has been formalized in the theoretical economics literature

in the form of R&D or patent races where advantages are often enjoyed by the first-mover firm.” –

LIEBERMAN, Marvin; MONTGOMERY, David. First-Mover Advantages, STANFORD UNIVERSITY

RESEARCH PAPERS, n.969, 1987.

“An erosion of intellectual property rights would be extremely shortsighted. There is a strong

consensus today that a strong intellectual property regime is needed to provide an incentive to undertake

costly and risky investment in innovative activities (…) and the entire thrust of the IPR laws is to use that

incentive to encourage innovation.” – ABBOTT, Alden. The Harmonization of Intellectual Property Rights

and Competition Policy: A Unified Approach to Economic Progress, remarks before the APEC High-Level

Symposium on IPR, China, 2005. 144 MACHLUP, Fritz. An Economic Review of the Patent System, supra note 100 at 33.

48

and promote progress in the technical arts. If an invention became public property

the moment that it was made, there would be small profit accruing to anyone from

the use of it and smaller ones from making it.146

From firms’ perspective, who wins from innovation: those that are first to

commercialize a new product or process in the market or their followers? In June

1986—in perhaps the first and most influential article to converge innovation and

strategic management to this date—DAVID TEECE tried to explain why innovating

firms often fail to obtain significant economic returns from an innovation while

costumers, imitators and other industry participants benefit.147

In this day and age,

the question asked therein continues to capture the interest of scholars and

managers as there is a never-ending struggle against competitors/imitators that

profit more from the innovation that the incumbent firm, outperforming the

innovator.

145 Rather than rewards, patents are incentives: “A popular fallacy considers entrepreneurial profit a

reward for risk-taking. It looks upon the entrepreneur as a gambler who invests in a lottery after having

weighed the favorable chances of winning a prize against the unfavorable chances of losing his stake. (…)The

owner of capital does not choose between more risky, less risky, and safe investments. He is forced, by the

very operation of the market economy, to invest his funds in such a way as to supply the most urgent needs of

the consumers to the best possible extent. (…)

For the capitalist there is no means of evading the law of the market that makes it imperative for the investor

to comply with the wishes of the consumers and to produce all that can be produced under the given state of

capital supply, technological knowledge, and the valuations of the consumers. A capitalist never chooses that

investment in which, according to his understanding of the future, the danger of losing his input is smallest.

He chooses that investment in which he expects to make the highest possible profit. (…)

Nobody embarks upon any investment if he does not expect to make a good investment. Nobody deliberately

chooses a malinvestment. It is only the emergence of conditions not properly anticipated by the investor that

turns an investment into a malinvestment.”. – MISES, Ludwig von. Human Action, supra note 7 at 809-10. 146 “Why should one entrepreneur incur the cost and risk of experimenting with a new machine if

another can look on, ascertain whether the device works well or not, and duplicate it if it is successful? Under

such conditions the man who watches others, avoids their losses, and shares their gains is the one who makes

money; and the system which gave a mart no control over the use of his inventions would result in a rivalry in

waiting for others rather than an effort to distance others in originating improvements. This fact affords a

justification for one variety of monopoly. The inventor in any civilized state is given an exclusive right to

make and sell an economical appliance for a term of years that is long enough to pay him for perfecting it and

to pay others for introducing it.” – CLARK, John. Essentials of Economic Theory, supra note 127 at 360.

“It can be very expensive to conduct the research and development that is necessary to come up

with new products and technologies, and there can be many failures before a successful innovation is

achieved. There would be little incentive for firms to make such a risky investment in research and

development if others could freely copy or use a successful innovation and prevent the inventor from

realizing well-earned rewards. Strong intellectual property rights are one of the most important means for

providing those incentives.” – Abbott, Alden. The Harmonization, supra note 143. 147 TEECE, David. Profiting from innovation, supra note 99 at 285-305.

49

The most important dimensions of an effective regime of appropriability148

are the

nature of the technology, and the efficacy of legal mechanisms of protection. The

nature of technology affects the ease of imitation whether knowledge is tacit or

codified.149

“Codified knowledge is easier to transmit and receive, and is more

exposed to industrial espionage and the like. Tacit knowledge by definition is

difficult to articulate and so transfer is hard unless those who possess the know

how in question can demonstrate it to others. Survey research indicates that

methods of appropriability vary markedly across industries, and probably within

industries as well.”150

Disclaiming about his gross simplification, TEECE draws a dichotomy between

environments in which the appropriability regime is ‘tight’ (technology is

relatively easy to protect) and ‘weak’ (technology is almost impossible to protect).

Regarding tight appropriability regimes—where the innovator has a muscular

patent protection— “the innovator is almost assured of translating its innovation

into market value for some period of time. Even if the innovator does not possess

the desirable endowment of complementary costs, iron clad protection of

intellectual property will afford the innovator the time to access these assets.”151-

152

148 “A regime of appropriability refers to the environmental factors, excluding firm and market

structure, that govern an innovator’s ability to capture profits generated by an innovation.” – Id. at 287. 149 “Uncodified or tacit knowledge is slow and costly to transmit. Ambiguities abound and can only de

overcome when communications take place in face to face situations. Errors of interpretation can be corrected

by a prompt use of personal feedback. Consider the apprenticeship system as an example. (…) It is the scope

provided for the development of a personal style that defines a craft as something that goes beyond the

routine and hence programmable application of a skill.

The transmission of codified knowledge, on the other hand, does not necessarily require face to face

contact and can often be carried out largely by impersonal means, such as when one computer ‘talks’ to

another, or when a technical manual in passed from one individual to another. Messages are better structured

and less ambiguous if they can be transmitted in codified form.” – TEECE, David, The Market for Knowhow

and the Efficient International Transfer of Technology, THE ANNALS OF THE AMERICAN ACADEMY OF

POLITICAL AND SOCIAL SCIENCE, v.458, n.1, 1981, p.82. 150 TEECE, David, Profiting from innovation, supra note 99 at 287. 151 Id. at 290. 152 “If these assets are generic, contractual relation may well suffice, and the innovator may simply

license its technology. Specialized R&D firms are viable in such an environment.” – TEECE, David,

Profiting from innovation, Id.

50

Intellectual property typically is both a key input into and a

byproduct of successful innovation, which is a principal factor in

fostering a dynamic, growing economy. Innovation promotes

consumer welfare and economic efficiency in a number of ways. It

drives down costs through the development of more efficient

production and distribution techniques. It stimulates economic

growth by bringing to market new products desired by consumers

and the business community. And it can limit the creation and

exercise of market power by fostering the development of new

technologies that permit new entrants to leapfrog the advantages

and entry barriers enjoyed by entrenched dominant firms.

Intellectual property, therefore, is a highly valued asset, and it has

been granted substantial legal protection by the nations of the

world. It is important that we preserve those protections.153

4.3 Far From Perfect but Necessary Nonetheless

One cannot be naïve so to consider that the patent system is flawless but while

there are quite a few imperfections criticism mainly focuses on the alleged

neglecting of the string-of-inventions that preceded a particular creation.154

MISES

153 ABBOTT, Alden, The Harmonization, supra note 143. 154 “I believe the [patent] law is essentially deficient, because it aims at a purpose which cannot be

rationally achieved. It tries to parcel up a stream of creative thought into a series of distinct claims, each of

which is to constitute the basis of a separately owned monopoly. But the growth of human knowledge cannot

be divided up into such sharply circumscribed phases. Ideas usually develop gradually by shades of emphasis,

and even when, from time to time, sparks of discovery flare up and suddenly reveal a new understanding, it

usually appears on closer scrutiny that the new idea had been at least partly foreshadowed in previous

speculations. Moreover, discovery and invention do not progress only along one sequence of thought, which

perhaps could somehow be divided up into consecutive segments. Mental progress interacts at every stage

with the whole network of human knowledge and draws at every moment on the most varied and dispersed

stimuli. Invention, and particularly modern invention which relies more and more on a systematic process of

trial and error, is a drama enacted on a crowded stage. It may be possible to analyze its various scenes and

acts, and to ascribe different degrees of merit to the participants; but it is not possible, in general, to attribute

to any of them one decisive self-contained mental operation which can be formulated in a definite claim.” –

POLANYI, Michael. Patent Reform, REVIEW OF ECONOMIC STUDIES, v.XI, 1944, pp.70-1.

“Each novel element arises inevitably from the past and itself sets up a complex interplay of causes

and effects which in turn induce still further change. These novel elements are what we call inventions. They

51

sums it up by stating that “the fairness of patent laws is contested on the ground

that they reward only those who put the finishing touch leading to practical

utilization of achievements of many predecessors. These precursors go empty-

handed although their contribution to the final result was often much more

weighty than that of the patentee.”155

Such claims although not unreasonable cannot stand in face of the role of the

patent system as innovation backer and certainly are by far outweighed by the fact

that society has much to gain from the disclosure of inventions. In the same sense

MARSHALL stated that “the large manufacturer prefers to keep his improvements

[in technology] to himself and get what benefit he can using it [without patenting

it]” but “it is generally in the public interest that an improvement should be

published, even though it is at the same time patented”.156

It is indisputable that an invention is the result of a process rather than an isolated

act detached from earlier technique. But it was the inventor that assembled all the

pieces together. Much like the car manufacturer that buys components from

several sources but, in the end, has the legitimate property of the final good. The

components sources profit from the market’s natural mechanism and so do

inventors, who may profit from their creation through patent licensing or may

have profited in the past from other ways of exploiting its patent—like using the

protected technology for own competitive advantage and enforcing its rights

against competitors. After all,

are, of course, created by individuals; but these individuals merely make explicit what was already implicit in

the technological organism which conditions their thought and effort and within which they must work.

Strictly speaking, no individual makes an invention, in the usual connotation of the term. For the object

which, for linguistic convenience, we call an automobile, a telephone, as if it were an entity, is, as a matter of

fact, the aggregate of an almost infinite number of individual units of invention, each of them the contribution

of a separate person. It is little short of absurdity to call any one of the interrelated units the invention, and its

“creator” the inventor.” – KAHN, Alfred. Deficiencies of American Patent Law, supra note 125 at 479. 155 MISES, Ludwig von. Human Action, supra note 7 at 662. 156 MARSHALL, Alfred. Principles of Economics, Macmillan, 1920, p.281, footnote 1.

52

a patent is merely a passport to another journey down the road to

enforcement and possible licensing fees.157

The state of the art is there to be invented upon by whoever is inclined to. Put

differently, there are no subjective limitations as to resorting to disclosed

knowledge. Like the egg of Columbus, once the feat has been done, anyone

knows how to do it. And deserved exaltation must be given to those who achieve

innovative results that foster human progress and provide social welfare even if

those gains were build upon previous knowledge—as always is. In turn, that new

creation will allow and drive further inventions as it will settle a new technology

paradigm and innovation will evolve from there on and so forth.

157 SIDAK, Gregory; TEECE, David. Dynamic Competition in Antitrust Law, supra note 88 at 594.

53

5. MARKET STRUCTURE, MARKET POWER

“Nothing lasts forever.

Even the longest, the most glittering reign must come to an end someday.”

—Francis Urquhart

MARKET STRUCTURE, MARKET POWER

Antitrust law is aimed at collusion, not concentration. It would be aimed at

concentration if only it determined some sort of collusion—which it does not.

Hence, there is no point in resorting to the concentration-profit correlation 158

as

that there is no association between concentration and collusion. For instance, it is

only natural for a firm to attract a large share of costumers and be profitable if it

continually innovates and improves efficiency faster than its competitors. Greater

profitability of leading firms and they large sales share, then, is a demonstration of

outstanding performance. And, as Judge LEARNED HAND has so well put it,

“the successful competitor, having been urged to compete, must not be turned

upon when he wins.”159

Further, “collusion occurs most frequently in low-profit

industries (…) because profitable industries attract entry and cartels cannot

survive in face of entry.”160

A similar observation can be made about innovation while it has no nexus with

market structure. Big firms have idiosyncratic aspects that give them advantages

158 “The efficiency view of the well-known industrial concentration–profits relation postulates that

efficient firms achieve both high market share and high profits, incidentally creating a positive correlation

between concentration and profit levels.” – ECKARD, Woodrow. A note on the profit-concentration relation,

APPLIED ECONOMICS, v.27, n.2, 1995, p.219. 159 US v Aluminium Company of America, 148 F2d 416 (2d Cir. 1945). 160 BROZEN, Yale. Concentration, Mergers, and Public Policy, Macmillan, 1982, p.11-2.

54

over smaller companies. But the inverse is also true and entrant firms can have

competitive advantages over bigger ones. “Moreover, numerous variables

complicate any simple relationship between the generation of monopolistic rents

and the allocation of resources to develop new products and processes.”161

“Economists do not appear to have found much evidence that

market concentration has a statistically significant impact on

innovation. This relationship probably is not a useful framing of the

problem, because market concentration alone is neither

theoretically nor empirically a major determinant of innovation. In

short, framing competition issues in terms of monopoly versus

competition appears to have been unhelpful. At a minimum, doing

so has been inconclusive.”162

How to assess market power in R&D-intensive industries where investment is

risky but potentially yielding high profits when successful is one of the most

difficult tradeoffs for competition law. Highly innovative markets are the prime

example of such conundrum. “Innovation—finding new things to do or new ways

to do existing things—is a strong driver of long-run economic welfare. (…)

Competition law is seen as an important tool to support and facilitate innovation,

and there is a continuing debate about which type of market structure is most

conducive to innovation.”163

161 SIDAK, Gregory; TEECE, David. Dynamic Competition in Antitrust Law, supra note 88 at 587. 162 Id. at 588. 163 NIELS, Gunnar; JENKINS, Helen; KAVANAGH, James. Economics for Competition Lawyers,

supra note 44 at 171-2.

55

5.1 Perfect Competition

The model of perfect competition it sets up a total unrealistic unachievable

utopian ideal of a ‘perfect’ world.164-165

And as the name itself gives up, it is only

a model. The circumstances for perfect competition to be observed are extremely

unlikely to be observed in practice:

Perfect competition requires that on any particular market there is an

infinite number of buyers and sellers, all producing identical (or

‘homogeneous’) products; consumers have perfect information about

market conditions; resources can flow freely from one area of economic

activity to another: there are no ‘barriers to entry’ which might prevent the

emergence of new competition, and there are no ‘barriers to exit’ which

might hinder firms wishing to leave the industry.166

Truth be told, there is no competition in perfect competition.167

That is why there

is a pulverized market on the perfect competition model: firms that succeed and

grow tend to push contenders off the market wagon. Competition is about the

survival of the fittest and the demand and supply set the rules and firms have to

work hard to win and keep costumers. On the other hand, perfectly competitive

markets fail by discouraging inventors to invent. “Vigorous competition between

firms is the lifeblood of strong and effective markets. Competition helps

164 “If we lived in a world of perfect information, zero transaction costs, infinite number of buyers and

sellers, then perhaps the core model of neoclassical economics would depict our social plight. But we

obviously do not live in that world, our general situation is one filled with imperfections, misperceptions,

costly transactions, and utter ignorance of lurking opportunities.” – BOETTKE, Peter. What Is Wrong With

Neoclassical Economics, BEYOND NEOCLASSICAL ECONOMICS, Edward Elgar Publishing, 1996, p.28. 165 Such model totally detached from reality has no use for practical purposes. “With fiction, with art,

with writing, it’s important that—even if you’re dealing with areas of complete outrageous fantasy—a story

ring true upon a human level.” – MOORE, Alan. The Mindscape of Alan Moore, Directed by Dez Vylenz,

Moritz Winkler; Produced by Shadowsnake Films, Tale Filmproduktion, 2005. 166 WHISH, Richard; BAILEY, David. Competition Law, supra note 44 at 7-8. 167 “What the theory of perfect competition discusses has little claim to be called ‘competition’ at all

and that its conclusions are of little use as guides to policy. The reason for this seems to me to be that theory

throughout assumes that state of affairs already to exist which, according to the truer view of the older theory,

the process of competition tends to bring about (or to approximate) and that, if the state of affairs assumed by

the theory of perfect competition ever existed, it would not only deprive of their scope all the activities which

the verb "to compete" describes but would make them virtually impossible.” – HAYEK, Friedrich.

Individualism and Economic Order, supra note 51 at 92.

56

consumers get a good deal. It encourages firms to innovate by reducing slack,

putting downward pressure on costs and providing incentives for the efficient

organisation of production.”168

There are few—if any—perfectly competitive markets. At best, atomistic (perfect)

competition serves as a benchmark against which to measure real-life and

imperfectly competitive markets.169

The misallocation of resources is a dominant problem in economic theory. It

means that scarce economic resources are not being properly managed in order to

achieve their greatest economic advantage. This entails that alternative allocations

could improve overall economic performance. “It happens that resource allocation

under atomistic competition might well be efficient if perfect information existed

or if tastes and preferences never changed, but it is difficult to understand the

relevance of such a theory in a real world of differentiated preferences, economic

uncertainty, and dynamic change. To assume away divergent expectations and

change (…) is to assume away all the real problems associated with competition

and the resource-allocation process. Thus, although the standard efficiency criteria

may be technically correct for a static world, they are irrelevant to actual market

situations.”170

168 DEPARTMENT OF TRADE AND INDUSTRY, Productivity and Enterprise : A World Class

Competition Regime, 2001, p.1. 169 “(…) known as the perfect competition model, a label that seems misleading to me. The model

really says little about competitive activities except insofar as entry and exit into a market is thought of as a

competitive activity; that is, the model says nothing about altering price, improving technology, investing in

advertising and so on. Its real contribution is to offer an analytically coherent view of the workings of a

highly decentralized, unplanned economic system, and it should have been labeled, and in this essay is

labeled, ‘perfect decentralization.’” – DEMSETZ, Harold. The Problem of Social Cost: What Problem?,

REVIEW OF LAW & ECONOMICS, n. 7, 2011, pp.1-2. 170 ARMENTANO, Dominick. Antitrust : The Case for Repeal, Ludwig von Mises Institute, 2007,

p.33.

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5.2 Market Structure and Innovation

A central topic in industrial economics is how (and if) market structure impacts

innovation. But problems arise when trying to define a market, as concentration

analysis is based around the products that are at the time in the market. But that

approach may not take into account if there is a possibility that those products will

be substantially modified, or even replaced, over the following one or two years

(the time frame over which a market is usually defined).171

When market power is

evaluated, subject firms that may have a very high market share—or even being a

monopolist—today may not even be in the same position in a year’s time. That is

due to the fact that strong market positions can quickly erode. Additionally, firms

often compete aggressively in the attempt to develop new products and services

that are not even in the marketplace yet. This shows that the evaluation of future

developments in dynamic industries is rather complex and extreme caution should

be exercised when assessing dominance based on current market positions.

Paradigmatic of the complexity of accessing market power in high-tech industries

is the 1995 report by the UK Monopolies and Mergers Commission (MMC)

regarding the video game industry.172

In result of their investigations on the video

games market in UK between July 1993 and June 1994 the MMC found that it

was dominated by Nintendo and Sega, which held a combined market share of

more that 98% for consoles (hardware).173

From their assessment MMC

expressed: “We believe that Nintendo and Sega remain well placed to retain their

dominant position in the market and to derive continuing profit from it.”174

Ironically, in the exact same year the report was published (1995) Sony launched

171 NIELS, Gunnar; JENKINS, Helen; KAVANAGH, James. Economics for Competition Lawyers,

supra note 44 at 173. 172 MONOPOLIES AND MERGERS COMMISSION, Video Games : A report on the supply of video

games in the UK, 1995. 173 Sega had 60.1% and Nintendo 38.6% – Id. at 70. 174 Id. at 3.

58

PlayStation in the western market: it was the first video game console to sell over

100 million units worldwide.175

Launched in 1999 in the western market Sega’s Dreamcast had an extremely

expensive marketing campaign176

and was initially well received. However sales

plummeted when Sony announced the eagerly awaited PlayStation2. Sony’s

second console quickly became tremendously popular upon release and the

Dreamcast lost much of its momentum, later forcing Sega to the realization that it

did not have a real chance to compete. The company discontinued the production

of the Dreamcast early in 2001, withdrawing from the console hardware business

altogether and restructuring itself as a third-party developer. During its short

lifespan, Sega’s last console sold less than 11 million units worldwide, while

Sony’s PlayStation2 reached the astounding figure of 150 million units sold

globally.177

This is the archetypal case of how temporary market power can be

mistaken for a more durable kind, where innovation involves the Schumpeterian

concept of ‘creative destruction’, with a successful new product making an

existing—and also dominant—one obsolete.

As we have seen, in highly technological and innovation-driven industries, market

power can quickly erode while fast-pace innovation, together with increasingly

small product life cycles, enables creative innovation that can quickly lead

consumers to find in another product a better way to fulfill their needs:

Like a river, technology can completely reverse its course. When

an easier and simpler route presents itself, it can move in a

direction opposite to what had been true of the past and would

logically be expected for the future.178

175 NIELS, Gunnar; JENKINS, Helen; KAVANAGH, James. Economics for Competition Lawyers,

supra note 44 at174. 176 LAPLANTE, Alice. Playing for Profit : How Digital Entertainment is Making Big Business Out of

Child's Play, Wiley, 1999, p.152. 177 Source: Sony Computer Entertainment Inc—http://www.scei.co.jp/corporate/release/110214_e.html 178 BLAIR, John. Economic Concentration, Harcourt Brace Jovanovich, Inc., 1975, p.95.

59

Actually, there is little evidence of a positive relationship between R&D intensity

and concentration in general and even less of a positive impact of concentration

on innovative output.179

“Turbulent technology (...) creates many opportunities for

innovative new entrants, and new entry can powerfully erode concentrated market

structures”.180

Further, long-term benefits of dynamic efficiency can easily

outweigh any short-term losses of allocative efficiency from high prices—pretty

much the same principle regarding patent rights.

5.3 Patents and Market Power

Price above marginal cost, by itself, does not necessarily suggest that a firm has

market power that should be relevant in an antitrust matter or is operating

anticompetitively in a relevant antitrust market. As seen earlier in 2.2.1, firms in

innovative industries—in which intellectual property assets are key—may have

large, up front fixed costs for research and development, and relatively small

marginal costs of production. For instance, in the pharmaceutical industry a pill

that has a negligible cost to produce may cost a lot of money to research, develop,

and put through clinical testing. Over the long run, the pharmaceutical company

must set a competitive price that will cover its up-front fixed costs, including a

risk-adjusted cost of capital. In addition, firms in innovative industries also must

cover the costs of innovation failures.

We have seen in Chapter 4 that patents are a way to monetize inventions so as for

firms to recoup their investments. However, there is no foundation in the

presumption that mere ownership of a patent creates market power.181

Although a

179 SYRNEONIDIS, George. Innovation, Firm Size and Market Structure: Schumpeterian Hypotheses

and Some New Themes, OECD Economic Studies, n.27, 1996, p.41. 180 SHERER, Frederic. «Market Structure», THE NEW PALGRAVE: A DICTIONARY OF ECONOMICS,

Palgrave Macmillan, 1987, p.344 181 “The denial that ownership per se of a patent can be tantamount – not even presumptively – to

market power that is relevant for antitrust purposes, thus affirming a duty to grant access thereto to (paying)

third parties, must hold true also in cases where the patented invention happens to be quite superior to the

prior art and hence becomes de facto dominant (think of a new drug dramatically improving the cure of

60

patent creates an exclusive right, there may be economically viable substitutes that

can accomplish the same functional purpose as the invention. But even if it does

create market power, that market power does not by itself offend the antitrust

laws. In fact,

as with any other tangible or intangible asset that enables its owner

to obtain significant supracompetitive profits, market power (or

even a monopoly) that is solely "a consequence of a superior

product, business acumen, or historic accident" does not violate the

antitrust laws.182

Cited by MORSE in his statement to Antitrust Modernization Commission 183

,

HERBERT HOVENKAMP, MARK LEMLEY and MARK JANIS184

also concluded that

price-cost relationships on a particular patent do not provide useful evidence about

market power. However, in some R&D-intensive industries a high level of

concentration is inevitable, chiefly because of the existence of indivisibilities in

R&D and the fact that R&D projects may involve large fixed costs.

5.4 Nope, Size Does Not Matter

The size of a company is not a determinant of the rate of innovation it produces.

Bigger firms are usually linked with a higher degree of innovative output, but

such views are mainly based on the assumption that R&D fixed costs are high and perilous diseases). Should we in such case – in the absence of further circumstances that multiply the force of

the patent’s exclusionary power to the point of hindering competition by others or making it more arduous –

compel the patentee to waive its exclusive right solely because it invented too well and successfully? Let us

not forget that brilliant innovation does not per se impede entrance in the market for other competitors. These

will try to produce a better cure for the same disease, based on the application of other molecules and if they

eventually come up with it they will break into the market with their more advanced product.” –

CAGGIANO, Giandonato; MUSCOLO, Gabriella; TAVASSI, Marina. Competition Law and Intellectual

Property, Kluwer, 2012, p.38. 182 DEPARTMENT OF JUSTICE and THE FEDERAL TRADE COMMISSION, Antitrust Guidelines

for the Licensing of Intellectual Property, 1995. 183 MORSE, Howard. Statement before the Antitrust Modernization Commission hearing on Antitrust

and the New Economy, supra note 37 at 7. 184 HOVENKAMP, Herbert; LEMLEY, Mark; JANIS, Mark. IP and Antitrust: An Analysis of

Antitrust Principles Applied to Intellectual Property Law, Aspen Publishers, 2002.

61

that only big companies have the infrastructure to be able to develop new

technology. That stems from the fact that, given the gross rate of return, their

expected sales are not sufficiently large to allow them to cover these costs.

As a matter of fact, firm size—as market structure—has no direct relation with

innovation output. For instance, WESLEY COHEN, RICHARD LEVIN and

DAVID MOWERY—using data from the U.S. Federal Trade Commission and

survey measures of technological opportunity and appropriability conditions—

found that overall firm size has a very small, statistically insignificant effect on

business unit R&D intensity when either fixed industry effects or measured

industry characteristics are taken into account.185

Also, KEITH PAVITT, MICHAEL ROBSON and JOE TOWNSEND186

found

that smaller firms were important innovators in machinery, instruments and

construction, larger firms in food products, chemicals, metals, electrical

engineering and aerospace. Both machinery and instruments, on the one hand, and

chemicals and electrical engineering, on the other, are sectors of high

technological opportunity. This is the reflection of the fact that there are large

differences regarding the costs of R&D projects across industries and possibly

within the same industry.

5.4.1 Too Big To Fail? – On The Contrary.

A common misconception is that bigger, established firms, have a decisive

advantage against entrant competitors. But, as regards dynamic industries, big

companies may not be as successful as a start-up in innovating.

Big companies ware once small entrant firms. In their infancy, small firms are

designed to add value to the market, to bring something fresh and new. These

young firms are opportunity-seekers, hungry for a chance to thrive. Indeed—and

185 COHEN, Wesley, LEVIN, Richard; MOWERY, David. Firm Size and R&D Intensity: a Re-

Examination, JOURNAL OF INDUSTRIAL ECONOMICS, v.XXXV, n.4, 1987. 186 PAVITT, Keith; ROBSON, Michael; TOWNSEND, Joe. The Size Distribution of Innovating Firms

in the UK: 1945-1983, JOURNAL OF INDUSTRIAL ECONOMICS, v.XXXV, n.3, 1987.

62

contrary to big companies—start-ups’ success is not gauged by earnings or

quarterly reports, but by how well they address a problem in the market, finding

the right solution. Once a business figures out how to solve its costumer’

problems, they enter a maturity phase where organizational structures and

processes emerge to guide the firm towards efficient operation. While their

measure of success shifts to profit, seasoned managers steer employees from

pursuing the art of discovery to en route for engaging in the science of competent

deliver. Staff is indoctrinated to seek efficiencies, leverage existing assets and

distribution channels, and listen to their best clients.

This ossification of a business structure when maturity is reached ensures that

executives deliver meaningful earnings that appease shareholders187

. Efficiency is

established as the determined motto and “how can we do what we do but better

and cheaper?” is the constant challenge. This is just a natural step of the

evolutionary pattern of business firms: the ascent to the relentless pursuit of profit.

And, in the process, R&D tends to be limited to sustaining innovation188

.

In short, big firms listen to and try to give their customers what they want,

targeting at large markets so as to generate the necessary sales and profit for

maintaining growth. Although often involving greater development expense, such

sustaining investments appear less risky than investments in the disruptive

technology: clients exist and their needs were known.

It is in disruptive innovations, where we know least about the

market, that there are such strong first-mover advantages. (…)

Companies whose investments demand quantification of market

sizes and financial returns before they can enter a market get

paralyzed or make serious mistakes when faced with disruptive

technologies. (…) Using planning and marketing techniques that

187 This constraint is linked to the fact that the heads of companies usually have bonus money tied to

profits. This ‘if-then’ approach to compensating management is likely to put a damper on creativity. 188 See 3.2, above.

63

were developed to manage sustaining technologies in the very

different context of disruptive ones is an exercise in flapping

wings.189

There is a risk aversion when a business enters a mature (bureaucratic) phase

where practices and policies that address the need of the firms’ best clients almost

always preempt resources from disrupted technologies with small markets and

poorly defined customer needs. In this context, we can see that organizations are

design to do something very well, namely what they are already doing.190

While they focus mainly on operational efficiency, structurally, big companies are

complex systems that are more resistant to change and, consequent, innovate.191

This lead us to conclude that “(..) despite the established firms’ technological

prowess in leading sustaining innovations, from the simplest to the most radical,

the firms that led the industry in every instance of developing and adopting

disruptive technologies were entrants to the industry, not its incumbent

leaders.”192

5.5 Technological Opportunities and Firm Capabilities

A key issue within the economics of technological change concerns the trade-offs

between the nature and organization of innovation and the broader context

wherein firms innovate. In theoretical jargon this translates into a discussion of the

189 CHRISTENSEN, Clayton. The Innovator’s Dilemma, supra note 104 at xxvi. 190 In fact, investing heavily in disruptive technologies is not a rational financial decision: “First,

disruptive products are simpler and cheaper; they generally promise lower margins, not greater profits.

Second disruptive technologies typically are first commercialized in emerging or insignificant markets. And

third, leading firms’ most profitable customers generally don’t want, and indeed initially can’t use, products

based on disrupted technologies. By and large, a disruptive technology is initially embraced by the least

profitable customers in a market. Hence, most companies with a practiced discipline of listening to their best

customers and identifying new products that promise greater profitability and growth are rarely able to build a

case for investing in disruptive technologies until it is too late.” – Id. at xx. 191 “(…) large integrated structures may become excessively hierarchical and less responsive to market

needs. Accordingly, at least for some aspects of innovative activity, smaller organizations are often superior.”

– JORDE, Thomas; TEECE, David. Innovation, Dynamic Competition, and Antitrust Policy, REGULATION,

v.13, n.3, 1990, p.40. 192 CHRISTENSEN, Clayton. The Innovator’s Dilemma, supra note 104 at.26.

64

relationships between technological regimes, opportunities and related

capabilities.

A crucial aspect within the economics of technological change concerns the trade-

offs between the nature and organization of innovation and the broader context

wherein firms innovate. To properly understand the sources of sustained

competitive advantages, one has to adopt a suitable approach that places primary

emphasis on the relationships between technological regimes and opportunities,

and the firm’s endowment of capabilities.

The nature and differences of technological opportunities largely determine to

what degree firms can extend their knowledge base and turn creative ideas into

profitable innovations.193

The intermediating factor, turning opportunities into

different types of innovations is often referred to as capabilities. Every firm works

under certain limits—laws of organizational nature—that powerfully define what

the company can and cannot do. Hence capabilities correspond to the

organization’s collective capacity for undertaking a specific type of activity.

According to CHRISTENSEN,

an organization’s capabilities reside in two places. The first is in its

processes—the methods by which people have learned to transform

inputs of labor, energy, materials, information, cash, and technology

into outputs of higher value. The second is in the organization’s

values, which are the criteria that managers and employees in the

organization use when making prioritization decisions.194

Although people can as individuals be rather flexible, being able to quickly adapt

to change, collective processes and values tend to be rigid. A process that has

193 The extent that technological opportunities can be appropriated through innovations depends on

market conditions. These are some combinations of market size and growth, the income elasticity of various

products, as well as the levels and changes in relative prices—in particular on the market for labor and capital

goods. Technological opportunities related to customers might be associated with both incremental and

radical innovation, depending on the nature of different products and industries. 194 CHRISTENSEN, Clayton, The Innovator’s Dilemma, supra note 104 at xxvi-ii.

65

been constantly perfected by a firm as to achieve a near-optimum performance

level for a determined task can be ineffective for any other. Likewise, company

values that prioritize projects of certain nature cannot consist with the

prioritization of projects of any other nature. “The very processes and values that

constitute an organization’s capabilities in one context, defines its disabilities in

another context.”195

We can further understand that there is no innovation pattern that can be linked to

a specific industry while technological opportunities are not only confined to

technological advances and R&D within the sector or market in question. Apart

from internally generated opportunities, firms frequently develop close ties to

universities and research institutes. In addition, suppliers of machinery and

equipment from other industries might provide major sources of opportunities in

supplier-oriented industries. Moreover, the content of technological opportunities

and their interrelationships with competence requirements and growth will also

depend on institutional contexts in specific areas where regulations and standards,

for example, largely will shape the direction and dynamics of innovation.196

Dynamic capabilities enable business enterprises to create, deploy, and protect the

intangible assets that support superior long- run business performance. In order to

sustain superior enterprise performance in an open economy with rapid innovation

and globally dispersed sources of invention, innovation, and manufacturing

capability, a company is required to have distinct skills, processes, procedures,

organizational structures, decision rules, and disciplines.197

This gives us an idea

that the competitive process does not depend on market peculiarities—and hence

is not controllable by competition policy—but rather to companies’ internal

aspects.

195 Id. at xxvii. 196 PALMBERG, Christopher. Tracing technological opportunities, patterns of innovation and

competence requirements through micro data, Nelson & Winter Conference, 2001. 197 TEECE, David. Explicating Dynamic Capabilities: The Nature and Microfoundations of

(Sustainable) Enterprise Performance, STRATEGIC MANAGEMENT JOURNAL, n.28, 2007.

66

5.6 Firms Internal Factors that Drive Innovation and Beyond

As we approach the end of this work, we are already able to realize that in

dynamic industries market features do not play a significant role in determining

innovation output. Instead, it is the internal idiosyncrasies of each firm and their

strategies that determine if they do or do not innovate:

A field study of top management teams and knowledge workers

from 72 technology firms demonstrated that the rate of new

product and service introduction was a function of organization

members' ability to combine and exchange knowledge. We tested

the following as bases of that ability: the existing knowledge of

employees (their education levels and functional heterogeneity),

knowledge from member ego networks (number of direct contacts

and strength of ties), and organizational climates for risk taking

and teamwork.198

For example, a strong determinant of firm innovation is the financial choices it

makes. Consider, first, single-product firms. As SIDAK and TEECE point out,

actual cash flows need not be the source of funding while firms with high-yield

projects will be able to signal their profit opportunities to the capital market:

Significant innovative efforts almost always involve expenditures

in a particular year that may be many multiples of available cash

flows. So the availability of marginally higher cash flows

occasioned by monopoly power is unlikely to change the sources of

funds very much, except in unusual circumstances. Furthermore,

198 SMITH, Ken; COLLINS, Christopher; CLARK, Kevin. Existing Knowledge, Knowledge Creation

Capability, and the Rate of New Product Introduction in High-Technology Firms, ACADEMY OF

MANAGEMENT JOURNAL, v. 48, 2005, p.346.

67

even in the absence of adequate internal cash flow, firms may

access the capital markets to obtain the requisite financing.199

Alternatively, products can be developed with resource to collaborative

organizational arrangements, such as research joint ventures, co-production, and

co-marketing agreements. The capital requirements for innovation can be

drastically reduced by such interfirm arrangements.

If innovation is detached from market characteristics and dependent on firm’s

internal aspects concerning single-product companies, the inexistence of such

nexus is all the more evident when considering multiproduct firms. That is due to

the fact that the structure of such companies allow the allocation of cash generated

everywhere to be directed to high-yield purposes anywhere inside the firm. “The

fungibility of cash inside the multiproduct firm thus unlocks any causal

relationship between market structure and innovation.”200

Put differently, if a multiproduct firm sells products in markets A to Z,

then the cash generated by virtue of any market power in market A

can fund innovation relevant to market A; but that cash can equally

well fund innovative activity for products in market Z.201

Either way, it is natural that even great companies stumble due to bureaucracy,

poor planning, tired executive blood, or just sheer incompetence. But while this

may come as no surprise—after all it is expected that, in a dynamic industry, bad

management may lead to fatal inefficiencies—perfectly good and sound

management may succumb to the forces of disruptive technologies202

. This is an

even more compelling demonstration that market characteristics and structure are

not directly related to innovation output.

199 SIDAK, Gregory; TEECE, David. Dynamic Competition in Antitrust Law, supra note 88 at 590. 200 Id. at 591. 201 Id. 202 See 3.3, above.

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6. COMPETITION POLICY

Antitrust remedies are beset by the central problem faced by a dog chasing a car:

what does the dog do with it when it catches it?

—Randal C. Picker

COMPETITION POLICY

In the broadest sense, competition policy is rooted in the assumption that a free

market—provided that property and contract rights are adequately defined—will

work by itself, contributing to the efficient use of existing resources and

encourage development of new technologies and new products that increase

market performance and social welfare. In this sense, the promotion of innovation

is crucial.203

But it is as important that authorities that foster innovation

distinguish between price (static) competition and innovation (dynamic)

competition, as both types have peculiarities that require different approaches.204

203 “Policy makers and economists strongly agree that innovation is a critical component of a sustained,

healthy economy. It is no accident that policy makers’ concern with fostering innovation grew over the course

of the 1980s and 1990s, a period during which those industrial sectors typically defined as “high

technology”—such as aerospace, telecommunications, biotechnology, software, and computers—increased

their combined share of manufacturing output by more than 50 percent. (…) Antitrust authorities have

themselves shared the critics’ recognition of innovation as an important driver of national economic welfare.

Enforcement officials have identified investment in research and the diffusion of new technology as being

among the most important dimensions of market performance.” – KATZ, Michael; SHELANSKI, Howard.

Mergers and Innovation, supra note 126 at 1-3. 204 “To the extent there are significant instances in which greater concentration is conducive to

innovation, innovative industries pose another central problem for antitrust enforcement because there can be

tradeoffs between static and dynamic objectives. Consumers benefit from competition because, when

producers face rivalry, they seek to attract customers through lower prices and higher quality. Consumers also

benefit from technological innovation because, when firms invest in research and development (R&D), they

can create valuable new products and reduce the costs of producing existing products. Product-market

competition and innovation are both, therefore, natural objectives of public policies designed to further

consumer welfare. But policies designed to pursue one of these objectives cannot always be implemented

without costs for the other.” – Id. at 2-3.

69

The correct assessment of how to weigh the single firm conducts is far from easy

as “there is little consensus among scholars, policy makers, or practitioners about

the appropriate degree of governmental intervention in markets with significant

actual or potential innovation.”205

In effect, innovation depends more closely on

factual inquiries specific to a given case and less on systematic presumptions

applied to static, product-market competition. But while antitrust enforcement

should not be pushed away from highly dynamic markets, decisions should be

made with extreme caution so as to not hinder the same innovation they

theoretically foster. 206

6.1 The Welfare Standards

Competition, in itself, is not a goal of competition policy. Competition—or at

least some degree of it—is needed for consumers to have the possibility of choice,

to have the ability to choose which products or services better satisfy their

needs.207

Actually, the protection of the competition process by antitrust

enforcement is done as a means to maximize economic welfare.

In his notable Manual of Political Economy, JEREMY BENTHAM wrote that,

“according to the principle of utility in every branch of the art of legislation, the

object or end in view should he the production of the maximum of happiness in a

given time in the community in question.”208

This was true then as it is true now

205 Id. at 4. 206 “Dynamic competition to develop new products and to improve existing products can have much

greater impacts on consumer welfare than static price competition, and antitrust policy should take dynamic

competition into account when evaluating (…) conduct in innovation-intensive industries.” – GILBERT,

Richard. New Antitrust Laws for the “New Economy”?, TESTIMONY BEFORE THE ANTITRUST MODERNIZATION

COMMISSION, 2005. 207 “In actual life the fact that our inadequate knowledge of the available commodities or services is

made up for by our experience with the persons or firms supplying them—that competition is in a large

measure competition for reputation or good will—is one of the most important facts which enables us to solve

our daily problems. The function of competition is here precisely to teach us who will serve us well: which

grocer or travel agency, which department store or hotel, which doctor or solicitor, we can expect to provide

the most satisfactory solution for whatever particular personal problem we may have to face.” – HAYEK,

Friedrich. Individualism and Economic Order, supra note 51 at 97. 208 BENTHAM, Jeremy. Manual of Political Economy, supra note 137 at 33.

70

and indeed utterly relevant as regards competition policy. In fact, the core concept

of competition policy is about promoting economic welfare209

and economic

freedom210

. Actually, seeking these economic objectives will advance the social

and political results intended by the law.

Essentially, antitrust laws are directed towards the promotion of allocative

efficiency by guaranteeing that companies have the opportunity to reach their

highest degree of productive efficiency211

, involving both cost minimization and

innovative activity. This will result in an increase of market output, whether

quantitatively or qualitatively speaking.

But should antitrust policy adopt a distributive ‘consumer welfare’ principle or a

‘total welfare’212

principle?213

HOVENKAMP defines that, “formally, consumer

welfare looks only at the surplus that goes to consumers, ignoring what goes to

sellers. The consumer welfare principle must therefore be counted as ‘distributive’

to the extent that it produces outcomes that shift wealth or resources in favor of

consumers even though an alternative outcome would produce greater total

wealth.”214

On the other hand, “total welfare refers to the aggregate value that an

economy produces, without regard for the way that gains or losses are distributed.

209 BORK, Robert, The Antitrust Paradox : A Policy at War with Itself, Simon & Schuster , 1978. 210 “Antitrust laws . . . are the Magna Carta of free enterprise. They are as important to the preservation

of economic freedom and our free-enterprise system as the Bill of Rights is to the protection of our

fundamental personal freedoms.” – U.S. v. Topco Associates, 405 U.S. 596, 610 (1972). Same conclusion on

ADAMS, Walter; BROCK, James. Antitrust and Efficiency: A Comment, NEW YORK UNIVERSITY LAW

REVIEW, n.1116, 1987. 211 “(…) the overarching principle of free competition – the latter to be of course construed in tune

with other ‘social welfare’ objectives, also of constitutional rank, such as, e.g., the promotion of science,

research, culture.” – GHIDINI, Gustavo. The Bride and the Groom. On the Intersection between Intellectual

Property and Antitrust Law, COMPETITION LAW AND INTELLECTUAL PROPERTY—INTERNATIONAL COMPETITION

LAW SERIES, v.50, Kluwer Law International, 2012, p.27. 212 Also addressed to as ‘general’, ‘social’ or ‘citizen welfare’. 213 “Unfortunately, the term consumer welfare, which naturally denotes the welfare of consumers, is

often used to refer to total welfare, specifically including producers’ surplus, largely as a consequence of

Robert Bork’s usage in The Antitrust Paradox: A Policy at War with Itself (1978). (…) Others use the term

consumer welfare to denote a general endorsement of some welfare standard without committing either to

consumer or total welfare. (…) A possible explanaition is that, for external audiences, the term consumer

welfare seems both more comprehensible and more appealing than total welfare, even though total welfare

may be thought to be a more sensible objective.” – KAPLOW, Louis. On the choice of welfare standards in

competition law, THE GOALS OF COMPETITION LAW, Edward Elgar Publishing, 2012, p.4, n.2. 214 HOVENKAMP, Herbert. Implementing Antitrust’s Welfare Goals, University of Iowa, Legal

Studies Research Paper, n.12-39, 2013, p.2.

71

The gains to the firms are described as ‘productive’ efficiency gains because they

result from economies in producing and distributing. The losses to consumers are

described as ‘allocative’ efficiency losses because they result from a decrease in

market competitiveness.”215

It is manifest that reducing the object of a policy that globally affects society to

the protection of specific agents is counterproductive, to say the least, if one has

the public interest in mind. In my opinion, the welfare standard is considered by

much of economic theory216

by a consumer-sided perspective mainly due to the

central role that consumer choice has on the marketplace. In fact, it is buyers—

voting their preferences through purchases—that determine the presence, price

and quality of products and services. “If consumers are harmed (either by reduced

output or product quality, or by higher prices resulting from the exercise of market

power), then this fact trumps any amount of offsetting gains to producers, and

presumably to others. Theoretically, even a minor injury to consumers outweighs

significant efficiency gains.”217

Another downside to the consumer welfare principle is that—even inside the same

‘consumption group’—consumers are not all alike as things in the real world are

not that simple, as

many practices affect different consumers in different ways. They

may injure some, benefit others, and leave still others indifferent.

As a result, net consumer harm may be exceedingly difficult to

measure. Measuring net consumer harm in such cases requires

identifying those consumers who gain and those who lose, and then

quantifying their gains and losses. In some cases, such as where

output increases under the challenged practice, we would also have

215 Id. at 1-2. 216 For instance, Richard Whish’s seminal work Competition Law starts with: “As a general proposition

competition law consists of rules that are intended to protect the process of competition in order to maximize

consumer welfare.” – WHISH, Richard; BAILEY, David. Competition Law, supra note 44 at 1. 217 HOVENKAMP, Herbert. Implementing Antitrust’s Welfare Goals, supra note 214 at 3.

72

to identify consumers that were not in the market at all until the

practice brought them in. This group is always benefitted by the

practice.218

There is no doubt that consumers are central to the issue, but that should not imply

that antitrust policy should only aim at their welfare. I tend to think that a view

like the one adopted by environmental policy—where social interest prevails over

the individual interest—is altogether more adequate to ‘produce the maximum of

happiness to the community’.

Consumers are defined by the product or service they consume and are hence

divided by groups according to their consumption choices. But the choices of

some that affect not only them but other groups or even the entire community

should not be just analyzed regarding the impact that they have in that former

restricted group.219

This is even more obvious if we think that consumers benefit from the goods and

services they choose. Thus, if negative externalities—resulting from the utility

those consumers derive from the choices they made—affect society in some way

it is only natural that general welfare should be the ultimate welfare antitrust goal.

6.2 Innovation and Competition Policy

As have seen in Chapter 3, the relationship between competition and innovation is

essential to the execution of the antitrust enterprise in our modern economy. But

rather than advocate a reform of antitrust laws applicable to industries where

218 Id. at 11. 219 “It is important to remember that, over a long enough time horizon, everything is variable. This fact

suggests that the tension between the consumer-surplus and total-surplus standards is somewhat attenuated

when one takes a long-run view; consumers also have a strong long-run interest in firms’ having incentives to

invest in innovation, as well as production and distribution, in order to supply goods and services that

consumers desire.” – KATZ, Michael; SHELANSKI, Howard. Mergers and Innovation, supra note 126 at 55.

73

innovation, intellectual property220

and technological change are essential

components of the competitive process, dynamic efficiencies should be

incorporated into the established framework by accounting the idiosyncrasies of

those industries.

In fact, “an antitrust regime that ignores dynamic efficiencies and innovation and

focus solely on static product market competition is unlikely to improve consumer

or total welfare.”221

Accordingly, “the fundamental principles of antitrust should

be applicable to the ‘New Economy’, but government enforcers and the courts

should recognize that there are important characteristics of the high-tech sector

that may impact the antitrust analysis.”222

Everyone should understand that small increases in productivity

from innovation dwarf even significant reductions in static

efficiency over time. Thus in high-tech industries, at least,

anticompetitive effects on innovation can have much greater impact

than effects on price. This reality can be grasped by considering

Moore’s law – which teaches that computer chip capabilities

double every 18 months. Slowing the introduction of new and

improved products in that environment can harm consumers far

more than even a significant price increase.223

There is no doubt that competition encourages innovation by providing an

incentive for competitors to profit from the appropriable gains resulting from

inventions. Hence market competition pushes competitors to innovate in order to

face less competition and earn greater profits. In fact, “the relationship between

competition and innovation is complex and neither economic theory nor empirical

220 “(…) intellectual property has a critical role in furthering economic progress and the welfare of the

world’s citizens.” – ABBOTT, Alden. The Harmonization, supra note 143. 221 WRIGHT, Joshua. Antitrust, Multi-Dimensional Competition, and Innovation: Do We Have an

Antitrust-Relevant Theory of Competition Now?, George Mason Law & Economics Research Paper, n.09-44,

2009, p.4. 222 MORSE, Howard. Statement before the Antitrust Modernization Commission, supra note 37. 223 Id.

74

evidence supports a general conclusion that competition always increases or

always decreases incentives for innovation.”224

This leads to the conclusion that

eventual lawfully acquired market power derived by the exclusive rights over a

patented invention can incentive innovation as much as a higher degree of

competition.225

The main difference between price competition and innovation competition is that

the latter has a lot more impact on the market. We may say that innovation

competition is a lot more damaging than price competition. The reason is that

potential competition from new technologies can destroy a firm’s position in a

particular market and its underlying competences.226

Price competition, on the

other hand, may erode profit margins but is less likely to completely destroy the

value of a firm’s underlying assets. “Accordingly, potential competition from new

products and processes is the more powerful form of competition.”227

Competition

in dynamic industries is a harsh way of life and failure to keep up with the fast-

pacing technical environment is the seppuku of the modern business company.

An important topic of future research for industrial organization

economists will be what a firm’s being ‘too big to fail’ implies for

the evolutionary process by which the firm diagnoses and responds

to change. A conscious policy decision to interrupt the evolutionary

process that weeds out failing firms and strategies may have short-

term appeal because it may appear to be an onramp to a turnpike

that promises to speed one past market failure. But policymakers

need to be mindful of two caveats. First, the protection of failed

entities will influence the future formulation of strategy, most

likely introducing over the intermediate term a new variety of

moral hazard. Second, over the longer term, evolutionary processes

224 GILBERT, Richard. New Antitrust Laws for the “New Economy”?, supra note 206. 225 Such conclusion was anticipated earlier, in 5.2, above. 226 This is a ‘winner takes all’ situation, as referred in 2.2.10, above. 227 JORDE, Thomas; TEECE, David. Innovation, Dynamic Competition, and Antitrust Policy, supra

191 at 38.

75

will continue to operate, such that it would be naïve to suppose that

the industrial planning inherent in nationalization necessarily can

insulate the firm from the imperative to evolve in response to new

exogenous forces or face new threats of extinction.228

Antitrust policy ought to ensure that enforcement is neither an obstacle to

technological progress that results in desirable innovation229

nor permits the

exercise of market power to unlawfully hinder innovation230

. Either way, an

important thing to have in mind—especially in high-tech industries—is that “an

antitrust rule that cannot be administered effectively is worse than no rule at

all.”231-232

Surely, although the market power associated with innovation is often

transitory, standard entry barrier analysis—with the usual two year time fuse for

entry—will often not undo a finding of monopolistic-like power for an innovator.

The danger of such assessment would be that “innovators may need to constrain

their business conduct severely to avoid violating antitrust laws.”233

As a practical matter that means that firms with market power face some

uncertainty about how their conduct will be evaluated. Ultimately, such

uncertainty dampens the incentives to innovate and market new technologies. As

brilliantly put by THOMAS JORDE and TEECE,

228 SIDAK, Gregory; TEECE, David. Dynamic Competition in Antitrust Law, supra note 88 at 606-7. 229 “In order not to reduce dynamic competition and to maintain the incentive to innovate, the

innovator must not be unduly restricted in the exploitation of intellectual property rights that turn out to be

valuable. For these reasons the innovator should normally be free to seek compensation for successful

projects that is sufficient to maintain investment incentives, taking failed projects into account.” –

EUROPEAN COMISSION, Guidelines on the application of Article 81 [101 TFEU] of the EC Treaty to

technology transfer agreements, JOUE 2004/C 101/02 230 “(…) anticompetitive conduct – i.e., conduct that is neither competition on the merits nor

efficiency-enhancing, that tends to exclude competitors or potential competitors from the market and enables

the IPR holder to create, maintain, or extend its market power.” ABBOTT, Alden, The Harmonization, supra

note 143. 231 HOVENKAMP, Herbert. The Antitrust Enterprise: Principle and Execution, Harvard University

Press, 2005, pp.53-4. 232 This idea is linked to the concepts of over-enforcement (Type I errors) and under-enforcement

(Type I errors) and to the conclusion that there are greater social costs with Type I errors than Type II errors,

as the natural market process should self correct the latter more readily than the former. 233 JORDE, Thomas; TEECE, David. Innovation, Dynamic Competition, and Antitrust Policy, supra

note 191 at 36.

76

we should not be concerned if innovating firms gain market

dominance. If their technological contribution is significant, we

should applaud the firm's ability to commercialize its technology

successfully.234

6.3 Patents and Competition Policy

A patent that enables its owner to obtain significant supracompetitive profits,

lawfully acquires meritorious market power, hence not violating competition laws.

But we have had the opportunity to perceive that innovation may sometimes open

new markets.235

Actually, to some extent due to intellectual property protection

and network effects, in a high-tech industry there may be advantages in pioneering

entrepreneurship.236

Usually the market power granted by the patent enables its owner to restrict output

to a certain extent. This is the trade-off usually associated with the patent system:

consumers endure a temporary restricted output (or increase in price) in exchange

for the technological improvement that businesses firms develop. But if we are

talking about the opening of a new market that did not exist pre-invention,

restriction of output can only be understood as the actual output versus possible

output of that particular company. That is because there was no market at all

before the pioneering entrepreneurship. And whichever output there might be is

always higher than the no output that existed before.

Additionally, while the patent owner excludes competitors from using its

invention, there is no adverse effect on competition itself. 237

In fact, competitors

234 Id. at 37. 235 See 2.2.7. 236 That is, by developing and introducing a new product or by being the first to gain a significant

market presence. 237 “(…) the inventor-patentee has a legal right to exclude others from using that invention. As a

necessary corollary, antitrust liability for unilateral, unconditional refusals to license patents will not play a

meaningful role in the interface between IP rights and antitrust protections.” – Abbott, Alden, The

77

will strive to find a way to invent around the patent and, collaterally, to find new

ways to satisfy consumers’ new needs, which were born with the pioneering

invention.

6.4. On the Use of Mathematical Models

Although the construction of economic science trough mathematical models

consists in simplifying assumptions that excludes most of the richness and

complexity of real market processes, empirical verification is currently seen by

most as the ‘science’ in “economic science”. Mathematical formalism became the

standard language of economics at the expense of the semantic content of rich

economic analyses, even to the point that the scientific status of most realistic

theories and of literary economics is denied238

.

Mathematics drains the life out of economic science to the point that the

formalism of the discipline wins over its substance—and market processes

become mere freeze-frames of real-world interactions. The obsession with the

mathematical language has divorced economics from the world of everyday

life.239

As beautifully summarized by PAUL KRUGMAN, in his paradigmatic article “How

Did Economists Get So Wrong?” for The New York Times,

Harmonization, supra note 143. More generally, Abbot emphasizes that the Supreme Court confirmed that

unilateral refusals to deal are rarely, if ever, anticompetitive in nature, whether or not they involve patents. 238 “Economics would be far poorer as an intellectual discipline if it erects permanent barriers to

practitioners who possess the skills of an historian or philosopher, but do not possess either the background,

inclination, or aptitude in mathematical analysis necessarily to master the modern menu of models that

currently represents the discipline of economics. Economics has historically been much broader in scope than

what is currently fashionable in terms of formal technique and it has in its history attracted brilliant

individuals that were neither mathematically gifted nor statistically enamored.” – BOETTKE, Peter. What Is

Wrong With Neoclassical Economics, supra note 164 at 26. 239 “In the modern text-book, the individual is assumed to possess all the relevant information

necessary to maximize his utility subject to given constraints, the prices observed in the market are assumed

to contain all the relevant information about relative scarcities, and reflect equilibrium values, and through

price mediation profit maximizing producers perfectly coordinate their decisions with utility maximizing

consumers to generate an optimal allocation of resources.” – Id. at 27.

78

the economics profession went astray because economists, as a

group, mistook beauty, clad in impressive-looking mathematics, for

truth.240

240 KRUGMAN, Paul. How Did Economists Get So Wrong?, THE NEW YORK TIMES, September 6,

2009.

79

CONCLUSION

Innovation fuels the progress of mankind while it pushes human knowledge

further. Innovation is the progressive development of knowledge, outcome of

ingenious human labor, directed towards the design and use of production

methods and means. Thus, innovation is simultaneously a starting point and a

finish line as it broadens the very basis of knowledge and information upon which

rose. Knowledge that is applied to processes which enables us to enjoy an

increasingly better life, helping us to satisfy our daily needs. Necessity is the

mother of invention, or so they say.

But how do we incentive creation? How do we promote and stimulate people to

invent? As simple as making it profitable. And business firms will invest in

whichever projects that can yield profits. Especially if exclusivity—and

consequent market power—is assured. A more useful invention will give the

patent owner a larger economic return than a less useful one. To maximize their

reward, inventors will seek to create inventions that they believe the market will

find useful, and so society benefits overall from the encouragement for inventors

to direct their talents towards creating useful inventions.

In dynamic industries, fueled by innovation, appropriability is key. While it comes

as no surprise that a property system like the patent system has defects, it is

probably the best mechanism to encourage firms to accelerate progress, since the

profit is conditional on success. As patents increase the returns for investment on

R&D, there is innovative development that otherwise would not—or not as

quickly. Hence, the patent system’s resulting profits direct the inventor’s activity

into channels of general usefulness.

Patents provide protection from copy and imitation—the free access to innovative

processes would certainly discourage inventors from inventing. The recoil of

society if such incentives to invent were absent would be but expected. Patent

80

rights, allowing inventor to personally profit and society to generally benefit,

encourage innovation.

Additionally, the patent system strikes a balance between the incentive to create

and innovate, and the diffusion of the results achieved. A muscular patent system

will persuade inventors to disclose their inventions as it provides them stronger

guard from infringement than trade secret protection. The disclosure of advances

in knowledge is beneficial to society while making public new knowledge which

would otherwise be hidden under the blanket of trade secrecy.

Concerning the market power that the owner of the patent can have, that should be

of no concern to antitrust authorities. If their technological contribution is

significant, we should applaud the firm's ability to commercialize its technology

successfully. Competition policy regarding dynamic industries should specifically

target hardcore anticompetitive practices like price-fixing and cartelization.

Otherwise innovation incentives will greatly diminish and progress hindered.

A firms’ management, rather than market structure, is the crucial factor that drives

it to innovate. Hence, the rate of innovation on a given industry depends more on

its companies’ internal capabilities than on the degree of competition within the

marketplace. Surely, overly aggressive competition law sometimes privileges

static efficiency over innovation and therefore reduces long-term welfare.

Temporary market power on dynamic industries basically is nothing more than the

result of efficiency in the marketplace.

Market structure and R&D intensity are jointly determined by technology,

demand characteristics, the institutional framework, strategic interaction and

chance. A major policy implication of that fact is there are limits to what can be

achieved through competition policies, since there is only a restricted range of

sustainable market structures in any given industry. Antitrust enforcement must be

episodic and applied only when good reason exists for thinking that antitrust will

make a market perform more efficiently to the benefit of citizens.

81

Also, for a better interface between antitrust and intellectual property law,

competition authorities should collaborate with patent agencies to improve the

patent process. In fact, there are a number of ways for competition authorities to

assist intellectual property agencies in taking steps to improve patent granting

process. These include holding interdisciplinary dialogues with patent agencies to

encourage greater mutual understanding of each other’s field, commissioning

expert reports that study a country’s patent system to determine whether and how

it is causing any harm to innovation, and holding seminars or hearings in which

academics, public and private sector practitioners, and industry participants come

together to discuss problems and possible improvements to intellectual property

policies.

Competition authorities have a core competency in examining the effects of

restraints, market conduct, and rules on economic welfare, especially when this

analysis is performed through empirical research and the use of economists.

Because competition authorities have experience in an effects-based method of

inquiry, they can play a meaningful role in advising patent policy makers on the

impact of current laws and on recommended reforms.

82

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Documents

PINHEIRO-TORRES — Innovation, Patents and Competition Policy in Dynamic Industries (2013)