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Theoretical Perspectives on Patent Strategy
Deepak Somaya
Robert H. Smith School of Business
University of Maryland
College Park, MD 20742
Tel. 301 405 0333 Fax. 253 550 7736
Email: [email protected]
DRAFT
August 1, 2002
ABSTRACT
We seek to advance scholarship in patent strategy by presenting a set of organizing
theoretical perspectives to guide future research. The domain of patent strategy primarily
encompasses patenting, licensing, and enforcement decisions. Patent strategy also entails a set of
nested choices, where future opportunities are only available by building prior positions, which
thus become a source of dynamic capabilities. Three generic strategies are pursued by firms in
the patent domain – using patents to strategically “isolate” rent yielding organizational assets,
maximizing royalty revenues from patented technologies, and defending against patents owned
by others. In addition, patent strategy has an important organizational choice dimension, where
the organizational modes used in the commercialization of complex multi-invention products
have fundamental implications for the strategic use of patents by firms. I situate prior studies of
patent use in the context of broad theoretical framework presented in this paper, and suggest
avenues for further research into patent strategy.
Keywords: patents, intellectual property, licensing, firm strategy
JEL Classification: O3, K2, M2
1
Theoretical Perspectives on Patent Strategy
1. Introduction
In a knowledge economy, the knowledge assets built and owned by firms are vital for
commercial success. Intellectual property assets like patents constitute an important category of
these knowledge assets, and are therefore of substantial interest to modern corporations. Recent
books in the popular business press (Rivette and Kline, 2000; Davis and Harrison, 2001) also
reflect this growing managerial interest in patents and their role in building competitive
advantage. However, research on patent strategy has proceeded on a somewhat ad hoc basis, and
there is a pressing need for organizing theoretical perspectives to motivate and structure this
emerging field.
We address this need by presenting both an analysis of the patent domain, as well as two
sets of theoretical motivations that are central to patent strategy. The domain of patent strategy
primarily encompasses decisions about obtaining patent rights, licensing patents, and enforcing
them. In turn, these decisions have a nested structure, so that some choices are only available to
firms if specific prior choices were made. Thus decisions about patents can help firms build
“positions” that become sources of dynamic capabilities in the long run (Teece, Pisano and
Shuen, 1997). While actions in the patent domain are essentially of a “non market” type, they are
nonetheless closely connected to the market strategies of firms.
These very connections are at the heart of patent strategy. One such strategy is the use of
patents as isolating mechanisms (Lippman and Rumelt, 1982; Rumelt, 1984) to shield valuable
rent yielding commercial assets of the firm from imitation. A second important strategy is the
leveraging of patents to maximize licensing revenues from the firm’s inventions. Third, firms
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must often devise effective “defensive” strategies to ensure that they are free to innovate and
operate in the marketplace despite numerous patents owned by others. These three considerations
seem to pervade the patent domain, leading us to label them as “generic patent strategies”.
In addition to this first generic set of strategies, patents also play an important role in a
second level of strategic considerations in complex multi-invention industries. In such industries,
products typically incorporate a very large number of patented inventions, which in turn, may be
owned by a number of firms. Since end products in such contexts can be produced by using a
number of integrated and non-integrated organizational modes, firms must first determine their
organizational strategy for commercializing products based on the relative merits of these modes.
An effective patent strategy is an important complement to this organizational choice, and can
help both non-integrated technology specialists and large integrated firms enhance their
competitive advantage.
Our focus on patent strategy is somewhat unique when contrasted with the long history of
“patent research” in management. This substantial and successful body of research has employed
patent-based variables as proxies in the study of innovative performance (Ahuja, 2000a;
Sorensen and Stuart, 2000; Ahuja and Katila, 2001), capabilities (Mowery, Oxley and Silverman,
1996; Stuart and Podolny, 1996; Ahuja, 2000b) and learning (Jaffe, Trajtenberg and Henderson,
1993; Mowery, Oxley and Silverman, 1998; Ahuja and Katila, 2001). By contrast, in patent
strategy, the phenomena being studied are “the patents” themselves, and their use as intellectual
property (IP) assets (or knowledge assets) by firms.
The rest of this paper is organized as follows. Section two of this paper defines patent
strategy and discusses its main characteristics. Section three presents three generic theoretical
perspectives on patent strategy – strategic isolation, royalty harvesting, and defensive strategy.
3
Section four highlights the implications of patent rights for organizational choice in multi-
invention contexts. Section five discusses the implications of this paper for academic research in
patent strategy, and concludes.
2. Understanding Patent Strategy
Broadly, patent strategy can be defined as the pursuit of competitive advantage through
the acquisition and management of patents by firms. While a good understanding of patent law
would no doubt be useful in devising it,1 patent strategy is primarily a business responsibility that
is ultimately shouldered by the CEO. To clarify, patent strategy is not centered around the many
(clearly important) legal tactics and maneuvers practiced in patent law, but with the broader
strategic role played by patents in firms. A more detailed understanding of what I mean by this
can be obtained by focusing on three central features of patent strategy – its domain, its nested
choice structure, and its non-market character.
2.1 The Domain of Patent Strategy
The domain of patent strategy broadly encompasses three related phenomena – patenting,
licensing, and enforcement. Patenting refers to the gamut of actions whereby patent rights are
obtained, renewed and maintained around the world. While obtaining a patent typically involves
the “prosecution” of a patent application in the patent office, patents may also be obtained
through the market for patents, patent-owning firms, or exclusive licenses.2 The renewal and
maintenance of patent portfolios entails an active managerial process whereby the marginal costs
1 As a very brief primer, I note that patents are applied for at the patent office, where a technically informed patent examiner decides whether or not to allow the patent. Once the patent issues, it constitutes a (somewhat fuzzy) property right on the invention claimed in the patent for a fixed period of time (typically 20 years from the date of application). Patentees may exclude others from a wide range of actions – including, making, selling, and importing the invention – by enforcing the patent against such infringers in a court of law.
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and benefits of continuing to own the patents must be constantly evaluated. For example, Dow
Chemical saved over $ 40 million in maintenance costs when it eliminated roughly 25% of its
global patent portfolio that were not of business interest.3
Licensing encompasses both exclusive and non-exclusive licensing of a company’s
patents, as well as those arrangements for patent sharing that arise out of joint ventures or
strategic alliances. Within licensing, a distinction must be made between the instances in which
patent rights are licensed along with technology, and those in which only the patent rights are
licensed. The traditional licensing literature has tended to focus on the former “active” form of
licensing, however, it appears that the latter “passive” form has grown sharply in recent years. In
information technologies, firms like IBM have earned very substantial licensing revenues
primarily from this passive form of licensing ($ 580 Million a year over 1999-2001).4
Enforcement entails the use or threatened use of litigation to avail of the legal property
rights embodied in the patent. Since patents themselves are not very well demarcated as property
rights,5 patent litigation and its outcome is far from a routine matter. Indeed, most real
enforcement occurs in the shadow of litigation – in the detection of infringement, in notices and
other actions taken against alleged infringers, and the intensive negotiations and settlements that
occur both before and during patent suits.
Finally, as illustrated in Figure 1, patenting, licensing and enforcement are strongly inter-
connected, so that actions or opportunities in one area often affect firm behavior in others. For
2 An exclusive license would allow a firm to obtain a limited patent right (by product or geography), which can sometimes be very valuable. For example, Eli Lilly’s exclusive license to Genentech’s genetically engineered insulin (so-called Humulin) patents helped extend that firm’s franchise in the insulin market. 3 Davis and Harrison, 2001 (pp.145-46). 4 IBM 2001 annual report. IBM also makes very substantial income from sales and transfers of its intellectual property. 5 While patents issued by the patent office are generally assumed to be prima facie valid by the courts, evidence may be introduced at trial that undermines the validity or enforceability of the patent. Further, technical and legal
5
example, enforcement opportunities thrown up by a change in legal standards may imply the
need to obtain and maintain more patents, and also enable firms to resist licensing and use some
patents in a more exclusive manner instead. Similarly, the recent spurt in business method
patenting (Allison and Tiller, 2002) has led to enforcement actions by firms like Amazon and
Priceline, as well as substantial licensing activity in these patents.
[Figure 1 about here]
While past research has not always studied the patent domains discussed above from the
perspective of patent strategy, it has nonetheless shed light on each of them. For example,
research has demonstrated the deterrent impact of prior patenting on the allocation of innovative
resources by companies (Lerner, 1995), and the growth of “defensive” patenting in systems
product industries like semiconductors as a result of stronger patent enforcement (Hall and
Ziedonis, 2001) and institutionalized cross-licensing (Grindley and Teece, 1997). In turn,
licensing has been shown to be more common in the presence of strong and clear patent rights
(Arora, 1995, 1997), and in the presence of competing technologies (Arora and Fosfuri, 1998).
Patent enforcement through litigation has also been studied in past research (for an early review,
see Lanjouw and Lerner, 1998), with most studies focusing on the decisions to file, prolong, and
settle patent suits (Lanjouw and Schankerman, 2001a, b; Somaya, 2002a, b).
2.2 Nested Choices in Patent Strategy
Patent strategy can be thought of as consisting of a series of nested choices. For example,
firms choose whether to apply for a patent, and having obtained them, whether to renew them,
and in turn, whether to license or enforce them. This pattern of choices is pervasive, not only
across domains, but also within each domain – patenting, licensing, or enforcement. The choices
judgments are typically involved in determining if the patent has been infringed, adding an element of subjectivity to
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are “nested” in the sense that certain options are only available if the necessary prior choices
have been made. Obviously, one can only enforce or license patents that have been applied for,
granted, and kept alive through renewals.
Further, while each choice opens up some opportunities, it often closes others. Thus, if a
patent is granted (and therefore published), firms are generally unable to protect the same
invention as a trade secret. Similarly, if a firm has chosen to license a patent, the terms of the
license would circumscribe its ability to enforce the patent on the licensee. Thus, firms must
continually make current choices by anticipating their future needs, taking cognizance of both
the opportunities opened up and forgone by their actions.
Each nested choice in patent management not only has an associated set of opportunities,
but also costs. Thus, obtaining and litigating patents is costly, both in terms of legal expenses as
well as organizational resources like the time and effort of key inventors and managers.
Similarly, it takes resources to find potential licensees, and to negotiate and structure licensing
deals with them. In some instances, the impact of these costs can be very substantial – e.g.,
reduced productivity from a star scientist, or a top management distracted by patent litigation.
Along with the opportunities foregone when certain choices are made, these costs imply that
firms can not simply keep all their options open, but must carefully consider if the value of
making a given choice exceeds both its pecuniary and opportunity costs.
While the costs associated with patent choices are often quite clear, the benefits of
choosing one set of nested patent opportunities versus another are often difficult to assess due to
inherent uncertainties about patents and technologies. For example, it is often unclear, a priori, if
an invention will turn out to be commercially successful, and therefore worth building a patent
fence around. Thus, at each stage, firms must make judgments about the likely value of patent-
the boundaries of the patent, and thus making them “fuzzy”.
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related opportunities kept open up (or closed) in the face of substantial uncertainty. This suggests
that many patent decisions could be viewed as the buying of real options (Dixit and Pindyck,
1994), and some recent research has sought to extend real options thinking into the patent arena
(Marco, 2000). Analogously, in the language of dynamic capabilities (Teece, Pisano and Shuen,
1997), these prior choices can be viewed as the building of asset “positions” that enable firms to
access future strategic opportunities.
The presumption in a real options view of patent strategy is that when the option is “in
the money” – for example, when technological and commercial uncertainties are resolved and it
is clear that a patented product would be a success – patent owners will exercise the option.
Typically, this would mean enforcing the patent right against others. However, as I have noted
earlier, it is often unclear what the outcome of patent enforcement will be, lending an element of
uncertainty to the “exercise-ability” of the patent option. One upshot of this is that patents that
are of higher quality, usually implying clearer validity and scope, are more valuable than weak
and shaky patents (Sherry and Teece, 2002).
2.3 Patent Strategy as Non-Market Strategy
The property rights embodied in patents are created by law and implemented by agencies
(e.g. patent offices) and the courts.6 Since the domain of industrial innovation and global
competition to which these rights are applied is both complex and constantly evolving, these
rights are often modified over time, as well as being applied in the specific context of each new
6 Within the U.S., in addition to Congress, the federal courts, and the USPTO, the Food and Drug Administration plays an important role in regulating patent extensions and generic entry in pharmaceuticals (an outcome of the Hatch Waxman Act). The International Trade Commission provides an alternative forum (to the courts) for the resolution of patent disputes relating to imports into the United States. In the international arena, patents are typically granted by national patent offices (with the exception of the European Patent Office) and enforced in national courts (even in Europe). However, several multilateral and bilateral treaties (the Paris Convention, the Patent Cooperation Treaty and the GATT TRIPS accord are the most important) and institutions like the World Intellectual Property Organization (WIPO) and the World Trade Organization (WTO) also govern these primarily national systems.
8
technological invention. Firms can attempt to strategically influence both the broad direction of
patent “policy” as well as application of existing policy in the instance of a specific patent. Thus,
there is a substantial element of “non-market” strategy (Baron, 1995) in patents. Firms that
understand this non-market dimension often find that it is an important ingredient for success in
the patent domain. For example, even a small Maryland start-up called Fusion Systems could
successfully to forestall attempts by the giant Mitsubishi Corporation to surround its patents in
Japan and force a license to Fusion’s pioneering patents in high intensity ulta-violet lamps by
strategically using pressure from the U.S. Trade Representative (Spero, 1990).
While at some level all patent strategy is non-market in nature, a conceptual distinction
can be drawn between strategies that seek to shape patent policies and institutions, and those that
primarily operate within an existing non-market environment in response to market imperatives.
While acknowledging the importance of the non-market perspective in patents generally, the rest
of this paper will focus primarily on patent strategies of the latter type – i.e. where the role
patents play in commercial market success is center stage, operating within a largely exogenous
non-market context.
3. Generic Patent Strategies
While there are no doubt specific issues that arise in each domain of patent strategy –
patenting, licensing or enforcement7 – some important commonalities cut across all of them.
Three such generic theoretical perspectives are presented below – namely, strategic isolation,
royalty harvesting, and defensive strategy.
7 For example, patenting decisions are subject at least in part to the need for motivating the firm’s researchers. Similarly, litigation includes the tactical considerations of using the costs and uncertainties of going to court to one’s advantage.
9
3.1 Strategic Use of Patents As Isolating Mechanisms
Patents and other forms of intellectual property have long been recognized as effective
tools to safeguard valuable organizational resources from imitation by rivals, or in other words,
as “isolating mechanisms” (Lippman and Rumelt, 1982; Rumelt, 1984). Similarly, in the recent
popular literature, the role of patents in enabling firms to “stake out and defend a proprietary
market advantage” has been characterized as “their most powerful benefit” (Rivette and Kline,
2000, p. 4). But how are we to understand patents as isolating mechanisms when at the same
time they are often licensed, which inherently implies (legal) imitation by other firms?
The central insight arises from the recognition that the technological exclusivity offered
by a patent can sometimes be far more valuable than the “technological value” accessible by
licensing the patent. Thus, patents over technologies at the core of a company’s business are
often relied upon for their ability to discourage competitive imitation, and even follow-on
innovation. Such patents could be used to protect related irreversible investments in (potentially
imitable) product development (Kitch, 1977), co-specialized complementary resources (Teece,
1986), and even follow-on innovations.
Patents are also often used by entrepreneurial innovative entrants, who are generally
lacking in other organizational resources, to keep better-endowed competitors from quickly
imitating them. In markets where a firm has established a proprietary standard, patents can be
used to prevent imitation (or reverse engineering) of the standard itself, and to deny rival
complements access to the virtual network built around the standard.8 In sum, the essence of
8 Patents on “connector” technologies that enable complementary products to work together are often critical to the execution of firm strategies in standards-driven markets. For example, Gillette has a number of patents on the interface between their blades and razor handles. Without these, Gillette would be hard-pressed to sustain its “cheap razor – expensive blades” business model, as other blade manufacturers would compete with Gillette in the blades market (even if their blades are not perfect substitutes for Gillette’s).
10
strategic isolation through patents is that the protection they provide from imitation is more
valuable than any returns available from licensing the patent.
Ultimately, the reliance on exclusivity in these patents rests on a contractual explanation
– it is very difficult to write and enforce contracts that allow rivals to license-in the patent, while
retaining the isolating benefits of the patent at the same time. These contractual problems arise
because of the enormous uncertainties in the future benefits over which the contracts must be
written. In essence, such a contract would have to guarantee the level of rents that the patentee
would have earned absent the license – a calculation that involves so many unknowns in the case
of isolating patents as to render it infeasible. In turn, any open-ended licensing contract can be
used opportunistically to ends not intended by the patentee. Thus, isolating patents function as
unique non-contractible firm-specific assets, or resources, which are considered a central source
of competitive advantage for firms in the resource-based view (Wernerfelt, 1984; Dierickx and
Cool, 1989; Barney, 1991; Barney, 1996).
When patents can serve a strategic isolating function, firms will be keen to build a strong
position in such patents (e.g. by creating a “patent thicket” that is difficult to invent around), they
will obviously prefer not to license these patents, and they will enforce the patents aggressively.
Conversely, some patents are less valuable as isolating mechanisms because they are not central
to the firm’s commercial advantage and do not protect a broader source of rents beyond the
patented technologies themselves. If these patents are of any value to their owners, it would often
be for their potential to yield royalties from licensing.
3.2 Harvesting Licensing Revenue from Patents
The licensing of technologies is a much-studied phenomenon in the management and
economics literatures. For example, prior research has focused on such issues as the crafting of
11
incentive compatible licensing contracts (Katz and Shapiro, 1986; Gallini and Wright, 1990), the
licensing of know how along with patents (Arora, 1995), and the design of appropriate
governance structures for technology transactions (Teece, 1986, 1988, 1989; Anand and Khanna,
1997; Oxley, 1999). However, the decision to license the patents, and the leveraging of patents to
maximize licensing revenues has received less attention in this licensing literature. Since leading
technology firms like IBM have, in the 1990s, transformed their licensing operations into major
income generators precisely through their proactive management of intellectual property, this is
an important lacuna.
Based on the discussion in the previous section, patents that do not serve a strategic
isolating function are natural candidates for licensing.9 However, to accurately assess the
isolation available from patents, one must not only consider whether rent yielding resources are
being protected by the patents, but also how effective the protection is. Thus, strategic isolation
would not be very effective when competing technologies are available for licensing from other
firms (Arora and Fosfuri, 1998). Similarly, if multiple technologies are competing to become a
standard (or dominant design) in the “preparadigmatic” stage of technological evolution, it may
be necessary to encourage adoption through licensing (Teece, 1986). Further, if the patent
position of the firm is itself not very strong, and can not be improved, rivals may be able to
circumvent the patent by inventing around or exposing the patent’s legal weaknesses.
Another instance where licensing is often used is if patentees need access to the unique
resources of other firms to successfully commercialize their patented inventions. For example,
early biotechnology start-ups lacked the marketing, financial, and regulatory resources needed to
commercialize their inventions, and often licensed them to established pharmaceutical firms as a
12
result.10 Ultimately however, firms must evaluate if they are better off using the protective
umbrella of patents to develop their own capabilities, or licensing out the patents.
Having decided to license, either the patents alone or the patents with the associated
know-how (i.e. in passive or active form), firms can typically use their patent rights to maximize
revenues from these licenses. Clearly, such royalty harvesting will only be helped by the diligent
detection and pursuit of patent licensing opportunities – either where patent infringement is
already occurring or where there is interest in commercializing the patented technology. More
importantly however, the share of rents appropriated by the patentee depends in large part on
convincing the licensee of the value of the license. Two main metrics of value are of relevance
here – the alternatives available in the (licensing) market, and the expected returns if the patent is
enforced.
For example, if the potential licensee is already infringing the patent(s) and has invested
substantially in the patented technologies, there are few practical alternatives to licensing the
patent(s). Otherwise, firms could consider inventing around or licensing similar technologies
from other sources (and in some cases even abandoning the technological opportunity entirely),
which can substantially undermine the patentee’s bargaining position. Thus, royalties can be
maximized if the patents are obtained on alternative technologies, and by making it difficult for
firms to invent around the patent. In complex products, firms often patent extensively so that
even if any one patent can be circumvented, it is difficult to circumvent all the patents taken
together.
9 Sometimes, patents may be valued for strategic isolation in some applications (products) and not others. In these instances, firms may be willing to provide limited licenses to encourage other firms to pursue these other opportunities. 10 Genentech’s recombinant insulin patents were thus licensed to Eli Lilly, an established pharmaceutical firm in the insulin market.
13
If alternatives to the patent(s) are not the binding condition, the expected returns to the
two firms from litigation constitute the relevant reference points in bargaining. Thus, the threat
of litigation, if credible, plays a central role in royalty harvesting strategies. At the same time,
patent litigation itself is so costly and disruptive for firms that a significant fraction of the
potential benefits can be dissipated in the process. Thus, the goal of patentees should be to
enhance their own bargaining position, and to convince potential licensees of the default
litigation outcome without actually incurring the full costs of litigation. In particular, firms can
demonstrate the seriousness of the litigation threat by taking concrete actions like filing a suit or
obtaining a preliminary injunction (without going to full trial), as well as by building a reputation
for aggressive enforcement.
In addition, firms should be aware that the outcome of licensing negotiations or litigation
with one firm often produces spillovers in other licensing opportunities. Just as a reputation for
enforcement or a positive court decision can help with royalty harvesting against other potential
licensees, a negative outcome in court (or in any given licensing negotiation) can be harmful.
Therefore, a clear and dispassionate appreciation of the patent’s legal enforceability is critical –
it would be prudent to accept less generous licensing terms if the patent itself is weak, and could
end up getting exposed in litigation.
3.3 Defensive Strategies with Patents
Thus far, I have focused on the strategic considerations of firms that seek to assert their
patents against others. But, how should firms respond when they are “on defense”, i.e. when their
rivals assert patents against them? In certain industries, the firm’s patents themselves can be used
as shields against patent litigation. The effectiveness of, and need for, such “defensive patents”
14
stems inherently from the technological character of these industries, which involves the use of
large numbers of patented inventions in marketable products (and potentially, services).
In fast-paced high-technology industries, firms may have made substantial irreversible
investments dedicated to a specific technological opportunity even before it is known who owns
the relevant patents (due to patent issuance lags and confidentiality in patent applications). In
other contexts, like semiconductor manufacturing, highly capital intensive fabrication facilities
that use thousands of patented inventions could easily be held hostage by a single patent suit.
Since the captive investments and associated commercial opportunities in these cases can be very
large, the ex post willingness to pay and therefore the firms’ vulnerability to patent litigation is
also large.
The primary defensive strategy available to firms in such contexts can be described as
“mutual hold-up.” If threatened by another firm with patent enforcement, firms in these
industries will typically threaten to sue back with their own patents, thus preventing their rival
from operating in the marketplace as well. One fallout of using a mutual hold-up strategy is a so-
called “arms race” to obtain large portfolios of patents with which to threaten potential patent
enforcers (Hall and Ziedonis, 2001). Since it may be possible to invent around a single blocking
patent, the emphasis in such industries is typically on building a large arsenal of patents with
overlapping and complementary coverage. Often, firms with defensive portfolios will
preemptively obtain access to each others’ patents en masse through cross-licenses to mitigate
the uncertainties of future litigation (Grindley and Teece, 1997). In sum, defensive patents serve
the purpose of foiling attempts by others to use their own patents as strategic isolating
mechanisms or to extract exorbitant royalties, thus giving their owners the freedom to invent and
operate in the marketplace.
15
Mutual hold-up is not the only defensive strategy available to firms however, nor is it
always effective. In particular, mutual hold-up is a weak defensive strategy against patents
owned by individual inventors or universities, who typically have no commercial operations of
their own that can be held up. An alternative defensive strategy that firms can use to overcome
this “asymmetric threat” is to invent around the patent, thus restricting the patentee’s claim to
past infringement alone. In other instances, they can preemptively make public their own
inventions, either through scientific publications or by filing an “invention disclosure” at the
patent office,11 so as to prevent others from patenting it later.
Firms will also often respond to patent enforcement by trying to render the patent invalid
or unenforceable. Patents can be invalidated by uncovering relevant “prior art”, or by proving
that the invention would have been obvious to anyone skilled in that field of knowledge. Even
valid patents can be made unenforceable if it can be shown that they were obtained through fraud
at the patent office, or were used for anticompetitive purposes in violation of the antitrust laws.
Finally, firms can also defend themselves against unwelcome patent litigation by credibly
threatening to cause financial damage to the patentee – by making the litigation extremely
expensive and inconvenient, by exposing flaws in the patent to other (potential or actual)
licensees, or by taking other retaliatory actions in the marketplace.12
4. Patents and Organizational Choice in Multi-Invention Contexts
The defensive strategy of mutual hold-up relates to a more general challenge in many
industries where multi-invention contexts are becoming increasingly common, i.e. where very
large numbers of inventions are typically combined in end-products. In semiconductors for
11 The advantage of preemptive disclosure through these mechanisms is that they are generally much cheaper than obtaining a patent.
16
example, increasing miniaturization has made it feasible to manufacture massive electronics
systems on a single chip (so-called systems-on-a-chip or SOC), but this implies that very large
numbers of patented inventions must be combined in any single product (Linden and Somaya,
2002). Similarly, even as software products are becoming large and extremely complex, the
patenting of software inventions – hundreds of which may be combined in contemporary
software programs – continues apace. In biotechnology, too, an outpouring of innovation in
genomics, research tools, and other areas needs to be combined to bring new healthcare solutions
to fruition.
In practice, innovation in these industries comes from multiple sources – from within
large firms, from start-ups and specialized players, from firms outside the industry, and even
from universities and other research establishments – creating a tangled web of patent rights that
must be navigated for commercial success. The central challenge for firms in such multi-
invention contexts is two-fold. First, they must determine how the production of end products in
their industry can be most effectively organized, given the need to combine these large numbers
of inventions. Second, they must examine their own capabilities and patent assets to ascertain
what role they must play within this emerging industrial organization. Patent strategy will be an
important complement to the firm’s chosen role in the organization of production in the industry,
and must therefore be closely coordinated with it.
4.1 Organizational Modes for Multi-Invention Products
The combination of technologically separable inventions in multi-invention contexts can
be accomplished in a number of ways. Broadly however, these organizational alternatives can be
12 For example, Intel’s threat to withhold information about the next x86 generation from Intergraph when Intergraph filed a patent suit against Intel in 1998.
17
divided to into integrated and non-integrated modes,13 where the essence of being integrated is
that internally available technologies are used within the firm to produce the final product. Note
however, that the firm need not own the patents on these technologies, so that there may be a
need for “passive” licensing even in integrated modes.
4.1.1 Integrated Modes
Integrated production of multi-invention products may be pursued using a number of
different approaches. A priori, given the nature of innovation in these industries, it would be
highly unlikely that a single firm can invent and patent all the technologies necessary to
commercialize the end-product. Integrated modes therefore entail alternative approaches to
obtaining both the technologies and the access to patents needed for commercialization. One
alternative is to use the markets for mergers and acquisitions to agglomerate the technologies and
patents available in other firms. Firms like Cisco Systems have championed this approach,
typically acquiring smaller innovative firms with technologies (and patents) that the company
wants access to. Similarly, in the agricultural biotechnology industry, a number of firms have
consolidated to bring together germplasm, genomic, and plant variety patents relating to specific
crops.
Integrated firms can also choose to develop all the technologies they need in-house. For
those technologies patented by other firms, in-house development may occur through
independent near-simultaneous invention with the patent holder, or even through reverse
engineering of the patented invention. If the in-house technologies have not successfully
invented around the patents owned by others, integrated firms will need to obtain access to these
patents. This could be accomplished in a number of ways – through patent pools, cross-licenses,
13 Intermediate modes like joint ventures and strategic alliances are also possible, but analytically these can be
18
and other patent sharing arrangements. Note however, that these licensing arrangements are
passive licenses, involving only the patent right. Indeed, managers in industries like
semiconductors, where cross-licensing is rampant, primarily think of licensing as patent-trading,
rather than the transfer of technology or know-how. Importantly, reliance on such licensing
assumes a willingness to license on the part of others, an assumption that will be strongly
challenged if those patentees intend using a non-integrated mode for commercialization.
4.1.2 Non-Integrated Modes
Non-integrated modes primarily use licensing and component markets through which
specialized “niche” firms offer their patent protected technologies to integrating firms, who
combine them with others to make multi-invention end-products. Thus, non-integrated modes do
involve firms that integrate technologies into a final product, but the key distinction is that some
of these technologies are obtained across an organizational boundary either through licenses or in
“embodied” component form. In both cases, the relevant patent rights owned by the licensor or
component supplier also convey with the license or component.
In semiconductors, new “chip-less” firms are creating a market for integrated circuit
design modules that other firms can license and integrate into their own system-on-a-chip
designs. Similarly, a fledgling market in software components has also grown, where program
components written by third-parties are increasingly being used when developing software. In
turn, such markets often foster specialization in the industry, with technologically focused firms
populating these specialized niches. While such specialization removes the need for widespread
access to patent rights across the industry, it doesn’t remove it entirely. In particular, firms in the
accommodated as hybrid forms that combine some features of integrated and non-integrated approaches.
19
integrating “center” of the industry, as well as competing firms within each specialized niche,
would probably still need access to each others’ patents.14
4.2 Organizational Effectiveness and Choice
Ultimately, end products in multi-invention industries compete against each other in the
marketplace, and using a superior organizational mode can be critical for commercial success.
Therefore, firms are deeply interested in knowing which of the many integrated and non-
integrated organizational alternatives are the most effective in any given context. I have
discussed the advantages and costs of different organizational modes in greater depth in a
separate paper on multi-invention contexts (Somaya and Teece, 2000). The focus here therefore
is on the main conclusions of that analysis.
It is well recognized that integrated modes of organization are more effective when the
transaction costs of using markets are high (Williamson, 1991). Coordinated adaptation made
possible through managerial direction and the weaker incentives within firms help to overcome
the adaptation problems created by transaction costs in the market. In the non-integrated modes
discussed above, at least some transaction costs are Williamsonian in nature, arising out of the
need for specific investments and uncertainty in contracting. However, others can more easily be
understood as arising out of the systemic nature of technology, where technological
interconnectedness between different parts of the system creates the need for close cooperation
and coordination that is difficult to sustain in incentive laden markets (Teece, 1996). Sometimes,
these can be overcome by the widespread use of clear interface standards that facilitate the inter-
operability of different parts of the systems product despite the use of non integrated modes.
Thus, the absence of such standards is often an impetus to a more integrated approach.
14 Thus non-integrated forms do not supplant the structures of integrated production entirely, but merely break it
20
Although I have lumped licensing and components together as “non-integrated modes”,
there are obviously important differences between the two. In particular, components allow
inventors to more precisely control and monitor the use of their technology, which in turn lowers
transaction costs in the component market. However, in many contexts, the lack of clear and
robust interface standards between components and the integrated product (in other words, a high
level of technological interconnectedness) may mean that licensing – which allows integrators
some flexibility in modifying the licensed technologies or designs – is more effective than
component contracts.15
Another critical difference between licensing and components contracts is the extent to
which the transfer of tacit know-how is necessary. If a lot of tacit knowledge is associated with
an invention, it typically makes it more difficult to transfer the technology across organizational
boundaries and implement in a new organizational context. In addition, firms are hesitant to
share tacit knowledge with others if they feel that the knowledge may be expropriated. Thus tacit
know how, to the extent it is present in any licensing context, can add further impediments to
licensing transactions.
Thus far, I have focused on the advantages of integrated modes in building multi-
invention products. However, it is well known that integrated modes also carry the heavy costs
of internal bureaucracy and the burden of equity (Williamson, 1985). In other words, the
advantage of non-integrated modes is that market-based incentives spur efficiency within each
specialized component or licensing niche. By contrast, in integrated modes, market competition,
down to more manageable fragments. 15 Although I describe components and licensing markets as two distinct alternatives, in practice, the distinction is a often a matter of degree rather than absolutes. For example, in digital component markets like those for software components or semiconductor designs, the distinction blurs because the “components” are already information goods. However, even there, degrees of componentization and licensing are visible in the extent to which the underlying code or know-how (and the accompanying flexibility to modify and adapt) is transferred between firms in any given contract.
21
and thus incentives, operate only at the overall end-product level, which can subsume many
inefficiencies in components or technologies. Integrated modes can mitigate this drawback to
some extent by incorporating new market-driven technologies through mergers and acquisitions,
but these markets (for corporate control) are also generally quite inefficient.
The increasing size and complexity of products in many multi-invention contexts also
implies some other advantages for non-integrated innovation, in addition to raw incentives.
Integrated firms are typically less effective at experimenting with alternative technological
solutions than a heterogeneous market consisting of technology specialists. In other words,
integrated modes may have a disadvantage vis-à-vis non-integrated modes in the exploration for
path breaking technologies, even though they may be quite adept at the exploitation of defined
technological trajectories (Winter, 198x). When innovation in non-integrated modes is well
coordinated around effective compatibility interfaces, the external economies generated by
widespread experimentation can be formidable. Further, in multi-invention contexts, internal
production implies that organizations are constantly reinventing the wheel – reproducing
inventions that other firms have already made. It follows that substantial economies are available
by accessing external inventions through component and licensing markets.
Throughout this discussion, I have set aside the role patents play in determining
organizational effectiveness in multi-invention contexts. While the transaction costs in licensing
markets have often been studied (for a review, see Fosfuri, Arora and Gambardella, 1999), this
inquiry has tended to focus on the costs of licensing technology or know-how. In this literature,
patents generally ameliorate the transaction costs of licensing. Licensors are less concerned
about expropriation since they can rely on patent protection as a fall back, and this makes them
more willing to license their know-how.
22
However, other licensing costs that stem directly from patent protection also need to be
considered, which I have examined in recent research (Somaya and Teece, 2000). The upshot of
my analysis is that a lack of ex ante clarity about who owns the relevant patents, disagreements
over the value of patented technologies, and the patentee’s own desire to use patents as
instruments of strategic isolation can sometimes make non-integrated modes more cumbersome
than integrated modes. The passive licensing that typically accompanies integrated production is
often more efficient because access to patents are typically negotiated en masse and facilitated by
mutual hold-up. At the same time, patents can be critical to component and licensing specialists
attempting to establish themselves in the face of entrenched integrated firms.16 Thus, patents play
an important role in determining organizational success in multi-invention contexts, to which I
turn next.
4.3 Patent Strategies in Multi-Invention Contexts
In multi-inventions contexts, patent strategy functions as an important complement to the
organizational approach taken in commercializing end products. Thus, firms must first evaluate
organizational modes dispassionately and prospectively to determine which ones have the best
chances of success. In this analysis, it is important to recognize that non-integrated modes often
require inter-firm cooperation in building markets and standards institutions, and that sometimes
such cooperation may be difficult to achieve. Ultimately, firm strategy should be oriented along
an organizational mode that appears promising, with contingency plans for a few others.
For example, a firm could broadly pursue an integrated mode, with the knowledge that it
may need to open itself later to components markets in some specific technologies. If efficient
components markets do become a reality, it would generally be advisable to loosen the firm’s
16 In semiconductors, interview evidence suggests that niche players have relied heavily on patents to protect their
23
ties to the relevant internal technologies and make them compete in the components market, or
even spin them out as separate firms. Alternatively, if the firm determines that an integrated
approach continues to be promising, it can seek to boost its own technological capabilities
through the acquisition of specialized technology leaders.
We approach patent strategy in multi-invention contexts by examining, in turn, the
implications for technology specialists and integrating firms. If technology specialists expect that
a non-integrated organizational mode will succeed, their patents can play a critical role in
commercial success within their own technology niche. Patents are not only instrumental in
keeping integrated firms from replicating the niche firm’s technology and undermining its
business model, but also in helping the specialist build a strong position vis-à-vis all innovators
in that technology. Thus, the non-integrated firm should expect to use patents substantially as
instruments of strategic isolation, even though a limited amount of cross-licensing with other
patentees within the same niche may be unavoidable.
Sometimes however, it may become apparent that non-integrated modes will fail due to
the high level of transaction costs, and technology specialists must be willing to adapt by
consolidating with others or letting themselves be acquired to become part of an integrated
organization. Patents play an important role in transforming specialists into attractive acquisition
targets. A strong patent position can convince acquirers that it is not easy to imitate the
specialist’s inventions or obtain the technology from other sources. Thus the general lesson for
patent strategy among technology specialists is to build a strong isolating patent position.
By contrast, the patent strategy of integrated firms tends to emphasize the building of
portfolios, where quantity rather than “bullet-proof” protection is the watchword. If the
market position (Hall and Ziedonis, 2001). For a persuasive argument in favor of patents to enable a market in software components, see Lemley and O'Brien (1997).
24
integrated mode continues to be successful for these firms, their patent portfolios are valuable
defensive tools that help provide access to external patents. Of course, we can expect that these
defensive patent portfolios will not be very effective against isolation-minded technology
specialists. Therefore, a concerted strategy is needed to obtain leverage against such specialists
by targeted patenting within their technology niches. Similarly, if integrated firms are
considering the acquisition of a technology specialist, they should pay special attention to ensure
that their resulting patent position will at the very least prove adequate to obtain access to the
patents of other firms in that niche.
If an integrating firm decides to move towards a less integrated approach however, the
challenge lies in adapting its patent strategy to a more strategic isolating approach. Such a shift
would be critical for the new specialist businesses that the firm may now pursue, either through
spin-outs or through licensing and components markets. Strong isolation from patents can also be
valuable if the firm is able to define important interface standards for the industry using its own
technology, and retain exclusive use of its patents over those interfaces.
5. Discussion and Conclusion
In this paper, I have laid out a broad set of theoretical perspectives that are central to a
firm’s use of patents from a strategic managerial viewpoint. In many instances, I have
emphasized the strategic implications for firms that arise out of the theory, and thus, my
approach has been sometimes been somewhat normative. However, I am also interested in
setting out a positive description of firm behavior, which can in turn serve as a template for
research on patent strategy. I now turn my attention to these research implications.
25
5.1 A Framework for Research
The theoretical perspectives presented in this paper help provide a framework with which
to chart and build research within the emerging field of patent strategy. Although much past
research on patent use has not taken an expressly strategic approach, their strategic implications
are nonetheless palpable. As a first step, I attempt to classify this existing body of research using
the theoretical perspective(s) that they shed light on and the domain(s) of patent strategy
(patenting, licensing or enforcement) that they based in (Table 1).
[Table 1 about here]
It is evident from Table 1 that separate research projects have often shed light on the
same theoretical perspective in different domains of patent strategy. For example, five papers
have covered the use of mutual hold-up based defensive strategies in complex multi-invention
industries. One of these examined the patenting behavior of semiconductor firms (Hall and
Ziedonis, 2001), another studied the widespread cross-licensing prevalent in the same industry
(Grindley and Teece, 1997), while three others have researched the implication of these
strategies for counter-suits and other aspects of litigation behavior in computers (Somaya, 2002a,
b) and semiconductors (Ziedonis, 2002). Similarly, the strategic isolation perspective is informed
both by Lerner (1995), which looks at its consequences for patenting behavior in the shadow of
competitors’ patents, and by Somaya (2002 a, b), which study the resulting litigation outcomes.
The framework in Table 1 also helps to identify research using other theoretical
perspectives than those presented in this paper. One important set of studies fit broadly into the
realm of non-market strategy, although the emphasis of these papers has primarily been on the
influence of existing institutional features on firm behavior, rather than the shaping of patent
policies and institutions by firms. For example, one study focuses on the implications of
26
differences between patent examiners (Cockburn, Kortum and Stern, 2002), while another looks
at the use of reexamination (in the U.S.) and opposition procedures (in Europe) in patent offices
(Graham, Hall, Harhoff, and Mowery, 2002), and yet another examines the impact of preliminary
injunctions in patent litigation (Lanjouw and Lerner, 2001).
As Figure 1 illustrates, patent strategy is not only situated within an institutional and legal
context, but also seeks to influence this regulatory environment. However, with the exception of
two studies (Kortum and Lerner, 1999; de Figueiredo, 2002), which examine the pro-patent
changes in the 1980s and the passage of an electronic database protection law in the United
States respectively, research investigating how this regulatory environment is created has been
relatively scarce.
Table 1 also suggests a number of other areas where research has been lacking, and needs
to be pursued. Particularly glaring is the paucity of research that attempts to capture the
implications of particular strategies across different domains of patent strategy, although some
recent papers have attempted to bridge the patenting and litigation domains (Cockburn, Kortum
and Stern, 2002; Graham, Hall, Harhoff, and Mowery, 2002). Research focusing on the licensing
implications of isolating patents, and on the royalty harvesting perspective in both patenting and
litigation has also been somewhat sparse. In addition, more studies that examine the specific
challenges for patent strategy created by organizational choice in multi-invention contexts are
needed. Overall, my conclusion is that while research in patent strategy has made a promising
start, much still remains to be done. In particular, research that adopts a specifically managerial
perspective and puts patent strategy center-stage would be especially valuable.
27
5.2 Empirical Considerations in Patent Strategy Research
Empirical researchers face a number of challenges in crafting viable research projects that
examine patent strategy considerations. Here, I focus on three central issues, and based on the
theoretical framework presented in this paper and past empirical research, suggest some
approaches to addressing them.
First, patent strategies need to be translated into empirical questions that can be tested
using available data, which are typically from patenting, licensing, or litigation. Fortunately, pre-
existing theoretical and empirical models of firm behavior in each of these domains provide
valuable tools for this task. For example, Hall and Ziedonis (2001) use a traditional empirical
model of patent counts (Hausman, Hall, and Grilliches, 1987) as the base on which they build a
robust empirical test of patenting differences. Similarly, hypotheses about strategic isolation and
mutual hold-up were translated in the patent litigation context (Somaya, 2002a, b) by linking
these strategies to so-called asymmetric stakes theories of non-settlement in litigation from the
law and economics literature (Meurer, 1989; Lanjouw and Lerner, 1998).
A second concern that arises in empirical studies relates to the nature of the data typically
found in the patent strategy domain. Recall that patent strategy itself consists of a number of
nested choices that firms make sequentially. It follows therefore that the data available for
empirical work is itself a result of such choices, creating potential sample selection biases. For
example, patenting data is an outcome of firm choices on whether to patent or not, so that we
typically do not observe those inventions that the firms choose not to patent. Similar selection
processes operate on licensing and litigation data as well.
Making inferences based on such selected data is additionally complicated because firm
choices are typically made from a real options perspective, in the face of substantial uncertainty.
28
Thus, a simple fact like “more inventions in industry X are patented than in industry Y” can have
multiple interpretations. It would be tempting to conclude that patent protection is more effective
in X, but it could also be that more inventions exceed a threshold option value in X. Intriguingly,
this difference in option value may simply reflect the fact that more uncertainties are associated
with inventions at the time of patenting in X, making it sensible to retain the patent option there.
Ultimately, the solutions to working with such data lie in devising careful empirical tests that
account for the selection processes, and in interpreting the results with care.
Finally, another important challenge for empirical research is to craft appropriate
measures for the theoretical constructs presented in this paper. In many cases, the theories
themselves often suggest plausible measures that could be used in empirical tests. In past
research, the extent to which firms cite their own patent, which can be seen as a measure of the
firm’s commercial interest in building on the patented technology (and even patent fence
building), has been used as a measure of strategic isolation (Somaya, 2002a, b). Hall and
Ziedonis (2001) use the capital investment of semiconductor firms as a measure of their
vulnerability to hold-up, which would encourage them to engage in defensive patenting. In
patent litigation, the use of defensive mutual hold-up has been measured by the patentee’s
citations to the defendant’s patents17 as well as the existence of counter-suits (Somaya, 2002 a,
b).
5.3 Conclusion
This paper has presented a set of theoretical perspectives to understand patent strategy
from a managerial perspective. However, it clearly does not address all possible strategic issues
in this domain. For example, I have already pointed out that a non-market perspective would be a
29
valuable complement. In addition, I have approached firm strategy mainly from a decision-
making perspective, and consequently there is no discussion of the process by which these
strategies are developed and implemented. Finally, there is also little discussion of specific legal
tactics or institutional features. Although these are no doubt important in specific contexts, my
impression is that they are by and large secondary from a managerial viewpoint.
Another feature of this paper is that it examines patent strategy in isolation, without much
reference to other strategies that firms use to appropriate returns from their innovations. This
omission is intentional, and made in the interest of simplification. However, as illustrated in
Figure 1, I recognize that patent strategy must be situated within the broader appropriability
strategies of firms, where past research has shown that alternatives like secrecy, time to market,
and complementary commercial assets are also important (Levin, Klevorick, Nelson, and Winter,
1987; Cohen, Nelson, and Walsh, 2001). In addition, although I do not develop a theory of firm
strategy vis-à-vis intellectual property rights in general, the broad theoretical thrust I use with
patents is likely to transfer, albeit somewhat imperfectly, to other forms of intellectual property
as well.
In conclusion, I reiterate the importance of firm knowledge and knowledge-based
capabilities for competitive success in the new economy. Hitherto, the managerial literature has
placed much of its focus on the creation and recombination of knowledge, but strategies to
capture value from knowledge are also vital for firm success. Patents comprise an important
element of these appropriability strategies, particularly since the issuance and use of patents has
been growing rapidly in recent years, both within the U.S. and globally. Research in patent
strategy is thus an important and timely addition to our understanding of the sources of
17 These can be seen as a measure of the extent to which the defendant’s patent portfolio “reads” on the patentee’s own business activities, thus creating the need for reciprocal access.
31
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34
Figure 1: Domains of Patent Strategy
Enforcement Domain
Licensing Domain
Patenting Domain
OTH
ER A
PPR
OPR
IAB
ILIT
Y
STR
ATE
GIE
S
INST
ITU
TIO
NA
L A
ND
LE
GA
L EN
VIR
ON
MEN
T
35
Patenting Licensing Enforcement
Strategic Isolation Lerner (1995)Lanjouw and
Schankerman (2001a, b), Somaya (2002a, b)
Royalty HarvestingArora and Fosfuri (1998), Anand and
Khanna (1997)
Lanjouw and Lerner (1996)
Defensive Strategy Hall and Ziedonis (2001)
Grindley and Teece (1997)
Somaya (2002a, b), Ziedonis (2002)
Organizational Choice / Multi-invention Contexts
Lemley and O'Brien (1997), Linden and
Somaya (2002), Somaya and Teece
(2000)
Arora (1997), Somaya and Teece (2000)
Other Perspectives
Cockburn, Kortum, and Stern (2002),
Graham, Hall, Harhoff, and Mowery (2002), Kortum and
Lerner (1997)
Cockburn, Kortum, and Stern (2002),
Graham, Hall, Harhoff, and Mowery (2002), Lanjouw and
Lerner (1996)
Table 1: Classification of Prior Research in a Framework of Patent Strategy
Patent Strategy Domain:
Theo
retic
al A
ppro
ach:
Theoretical Perspectives