Trade secrets vs Patents

BronwynH.HallUniversityofMaastrichtand

UniversityofCaliforniaatBerkeley

Acknowledgements and DisclaimerSomematerialbasedonjointworkwithChristianHelmers,VaniaSena,andthelateMarkRogers,conductedfortheUKIntellectualPropertyOffice.See

OxfordEconomicPapers(2013)JournalofEconomicLiterature(2014,forthcoming)

ThisworkcontainsstatisticaldatafromUKONSwhichisCrowncopyrightandreproducedwiththepermissionofthecontrollerofHMSOandQueen’sPrinterforScotland.TheuseoftheONSstatisticaldatainthisworkdoesnotimplytheendorsementoftheONSinrelationtotheinterpretationoranalysisofthestatisticaldata.

ThisworkusesresearchdatasetswhichmaynotexactlyreproduceNationalStatisticsaggregates.

May2014 2OECDWorkshop

Introduction• Firmsinvestingininnovationfacetheproblemofsecuringreturnstothatinvestmentinthefaceofimitationbycompetitors– the appropriabilityproblem

• Commonlyavailableoptions:1. IntellectualProperty— registeredandunregistered

(formal)2. Rangeof“alternative”protectionstrategies(informal)

• Thesemethodsoftenusedtogether– Theyarecomplements

• Inanimportantcase,theyaresubsitutes– patentvssecrecy

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Two contrasting views

• Tradesecretlawprovidesfarweakerprotectioninmanyrespectsthanthepatentlaw.[...]Thepossibilitythataninventorwhobelieveshisinventionmeetsthestandardsofpatentabilitywillsitback,relyontradesecretlaw,andafteroneyearofuseforfeitanyrighttopatentprotection[…]isremoteindeed.USSupremeCourt(KewaneeOilCo.v.BicronCorp.,416U.S.470,1974)

• Judgesandlawyershavesometimesthoughtthatbecausetradesecretlawprovideslessprotectiontotheinventorthanpatentlawdoes,norationalpersonwithapatentableinventionwouldfailtoseekapatent.[…]Thisreasoningisincorrect.Friedmanetal.(1991:62‐63)

May2014 OECDWorkshop 4

Valuable trade secrets• “MotorolasaidtheR&DcostsoftheinformationinMs.Jin’s[theallegedHuaweispy]possessionexceeded$600mandthecompanywouldlosesubstantialglobalrevenuesifitwasmadepublic.”FinancialTimesJuly222010

• “IBMhasagreedtopayCompuware$400moverfouryearstosettleclaimsthatitstoletradesecretsfromtheDetroit‐basedsoftwarecompany.[...]CompuwarefiledclaimsthreeyearsagothatIBMhadusedinformationobtainedimproperlyfromformeremployees[...]”FinancialTimesMarch222005

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The tradeoff

• PurposeofIPsystem:provideexanteincentivesforinventors

• Inexchange:explain&publishinnovationinspecific,standardizedtechnicalformat– Incentivesvs.disclosure

• Somequestions:– Howimportantaretheknowledgespilloversgeneratedbythepatentsystem?

– Whydofirmswithagiveninnovationthatcanbeprotectedbypatentschoosetorelyonsecrecytoprotectaninnovation?

May2014 6OECDWorkshop

Patents vs secrecy – the differences

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Patents SecrecyDisclosure(codifiableknowledge) Yes NoDisclosure(tacitknowledge) No NoEaseofdelimitinginvention Yes Not clearReverseengineeringallowed No YesSubjectmatter Statutory BroaderTiming After invention Work‐in‐progressProcessvs.product Both Easier for processLength 20 years Longer (potentially)Costtoobtain Higher NonzeroEnforcementcost Expensive Expensive

Partial answer to the spillover question

• Harhoff(2011):InnoS&TFP7projectwithBocconi,LMU,KULeuven,IESE (incooperationwithMITandRIETI)

• CoversEU,US,Japan• Askedinventorsaboutcost‐savingfromreadingpatents

– Highlyheterogeneousacrossandwithinsectors– Medianwas1.2hoursintelecommunications,alsolowinIT,audiovisual,electrotechnical

– 27.6hoursinorganicchemicals,alsohighinpharma,polymers,materialschemistry

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Importance of patent literature

• SharesofinventorsansweringaLikertscalequestiononimportancefortheirinvention,classifiedbymainpatentclass(Harhoffetal.2011)

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Maintechnologyarea Impt orveryimpt Not usedChemistry 61.4 9.1Processengineering 48.0 15.6Instruments 47.8 14.7Consumption&construction 45.8 16.7Mechanicalengineering 44.9 15.9Electricalengineering 34.1 21.7

Innovation and IP use

UK1998‐2006 Allfirms InnovatorsPatents 10 26Secrecy 21 45FromCIS3,4,5–sharesoffirms,populationweighted(38,760obs)

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US2008 Allfirms R&D‐doingfirmsPatents 5 41Secrecy 14 67FromNSFBRDIS,sharesoffirms,populationweighted

Shareoffirmsratingprotectionmechanismofhighormediumimportance

Theory: costs and benefits of patenting

• Costs– Directandindirectfinancialexpendituresforapplicationandmaintenance

– Disclosureofinformation(published18monthsafterpriority)– Grantuncertain– Enforcementuncertain

• Benefits– Excludecompetitorsfromusingtechnology– Licensingincome– Blockcompetitorsbyrestrictingtheirfreedom‐to‐operate– Signallingofqualityofinventiontopublicorpotentialresearchcollaborators

– Deterinfringementsuits– Increaseinbargainingpowerin(cross)‐licensingnegotiations

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Theory: costs and benefits of secrecy

• Costs– Directandindirectfinancialexpenditures– Activeknowledgemanagement(internalsecrecypolicy)

– Needtosignconfidentialityagreements– Enforcementuncertain&difficult

• Benefits– Protecttheinventionindefinitely– Notlimitedtocertaintechnologies– Broaderscope(example‐ customerlists)– Applicableto‘workinprogress’

May2014 OECDWorkshop 12

Theoretical literature• Horstmannetal.(1985):“[...]propensitytopatentwillbelowerthe

moreprofitable(exante)acompetingproductisexpectedtobe.”• AntonandYao(2004):ifpatentprotectionweak,onlysmall&medium

valueinventionsarepatented;highvalueinnovationskeptsecret.• Kulttietal.(2006):However,whenthereisastronglikelihoodof

simultaneousinvention,patentingtakesonadefensiverole:thechoiceisnownotbetweenpatentingandsecrecy,butbetweenpatentingorallowingacompetitortopatent.

• ScotchmerandGreen(1990):sequentialinnovation‐ loweringnoveltythresholdwillnotleadtomorepatentsiffirmsprefersecrecy

• Ponce(2007):sequentialinnovators– loweringthenoveltythresholdmayincreasetheuseofsecrecyifinnovationisverycumulative(addedassumptionthatpriorartmakespatentingmoredifficult)

• Schneider(2008);Zaby(2010):importanceofleadtime– iflarge,prefersecrecy

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Theoretical literature

• Resultsareverymixed– Dependonthenatureofcompetition– Whethertheleadinnovatorisfarahead– Informationassumptions– Largelybasedontheoneproduct‐onepatentmodel

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Empirical literature

• Surveyevidenceonpatent/secrecyuse• Crosscountrycomparisons• Impactonperformanceanddiffusion• Naturalhistoricalexperiments

May2014 15OECDWorkshop

Empirical evidence: surveys

• Fundamentalproblemis‘observability’‐ needforsurveydata

• Levinetal.1987 (YaleIsurvey)andCohenetal.2000(CarnegieMellonsurvey)– Firmsindifferentindustriesfavorsecrecyandleadtimeoverpatentstoprotectinnovation

– Firmspatentforstrategicreasons(blockcompetitors,improvereputation,gainbargainingpower)

• Largenumberofsimilarsurveys:CISinEurope,similarsurveysaroundtheworld...– Mostfindfirmssystematicallyregardlead‐timeandsecrecyasmoreimportanttoprotectinnovationthanpatents

May2014 16OECDWorkshop

CIS literature on IP protection

• BrouwerandKleinknecht(1999):DutchCIS1• Arundel(2001):CIS1datafor7Europeancountries

• Pajak(2009):FrenchCIS4• HegerandZaby(2010):GermanCIS2005• Hussinger(2006):GermanCIS3• Halletal(2013):UKCIS3,4,5• Mainlimitations:

– Cross‐sectionaldata– Firm‐level;actualusegenerallynotobserved

May2014 17OECDWorkshop

CIS Literature – Main Findings• Patentingpropensity

+Size+Salesofinnovativeproducts+R&Dcollaborationagreements+High‐tech+Inventionscharacterizedbyasmallerinventivestep+Technologicalleadwherereverseengineeringeasy

• Propensitytousesecrecyrelativetopatents– Firmsizeforproductinnovations+– CooperationinR&D/innovation+Processinnovation– High‐tech– PartofMNCs

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Cross country evidence

• Moser(2005):innovationspresentedattwo19Cworldfairsinthe19thcentury,fromcountrieswithandwithoutpatentsystems– Patentprotectionnotcriticaltoinnovation– Doesaffecttheindustrialdistributionofinnovativeactivity‐ countrieswithoutpatentprotectionconcentrateinindustrieswheresecrecyeffectivesuchastextiles,foodprocessingandwatchmaking

May2014 OECDWorkshop 19

Empirical evidence: performance

• Impactofprotectionmethodonfirmperformanceandknowledgediffusion– Hanel(2002)– increasedprofitsfromallformsofIP

– Hussinger(2006) – patentsassocwithinnovsales,butsecrecyisnot

– Halletal.(2013)– bothpatentsandsecrecyassociatedwithhigherinnovativesalesshare

• Verylittleworkonthistopicduetothedatachallenges(useofsecrecynotobserved)

May2014 20OECDWorkshop

Evidence on value to the firm

• Litigationdata– highlyselectivesodifficulttodrawstrongconclusions– Lerner(2006)– mostcasesinsectorswherepatentsarelessimportant;damagesrelativelylowcomparedtopatents

– Almelingetal.(2010a,b)– federalandstateappealscourtcases.Mostareagainstformeremployees

– Bothstudiesfindwinrateslessthan50%

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Natural experiments• Png(2011):impactofsecrecyonR&Dandpatenting

– UniformTradeSecretsAct(UTSA)inUS‐ exploitvariationovertimeandacrossstatesinenactment(strengthening)

– Associatedwithaveragedropof2.4%inR&DinUSmanufacturing(1976‐2006)

– Differentialimpactacrosssectors:dropof4.2%inmedicinalchemicals&4.7%incomputerterminals,butnoimpactinpharmaceuticalsandcomputercommunicationsequipment

– negativeimpactonpatentinginsectorsinwhichpatentingofprocessinnovationsrelativelymoreimportant/effective

• CarrandGorman(2001):EconomicEspionageAct(1996)– Criminalizedtheftoftradesecrets– Impactonstockmarketvalueoffirmsaffectedbytheft– Rangedfrom$0.04to$20million,withanaverageof$5million.– Muchlargerthanactualvalueoftradesecrets(fromcourtrecords)

May2014 22OECDWorkshop

Natural experiments• YoungeandMarx(2013)– lookatchangetoMichiganlaw– Madenon‐competesenforceable(strengtheningoftradesecrecy)

– Immediatepositiveimpactonmarketvalueofaffectedfirms,especiallythoseinsectorsknowntorelymoreonsecrecy(fromYale/CMsurvey)

• ContrastwiththesectoraldevelopmentargumentofSaxenian,Gilsonetal.:– SiliconValleygrewrelativetoroute128becausenon‐competeswerenotasenforceableinCaliforniaasinMassachusetts

– Allowedmigrationofknowledgetonewstartups,i.e.,morespillovers

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Some key findings• Theoreticalliteratureisinconclusive• Empiricalliteraturesuffersfromfocusatfirmlevel,ratherthaninventionlevel(verycoarse)

• Sectorswherepatentsareimportantarealsothosewherereadingpatentssavestime,suggestingspilloversareenhanced

• Tradesecretenforcementlargelydirectedatformeremployees

• Strengtheningtradesecretprotectionisgenerallypositiveforincumbentfirms,butmaynotenhanceinnovationanddevelopmentintheaggregate

• Weakeningpatentprotectionpushesfirmstowardssecrecy

May2014 OECDWorkshop 24