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California Management Review

Licensing Strategies of the New “Intellectual Property Vendors” Lee Davis

Licensing Strategies of the New “Intellectual Property Vendors”

Lee Davis

growing number of firms are specializing solely in the generation and licensing of intellectual property (IP). These “intellectual property vendors” are not traditional suppliers, since they do not engage in production or sales. Their business model is based on licensing out the rights to their inventions to other firms, who further develop the inventions commercially. Three examples provide a glimpse into the world they inhabit: ▪ Orbital Corporation of Perth, Australia, invented an environmentally friendly fuel injection system for 2-stroke engines in the 1970s. For nearly four decades, it has existed mainly by earning license fees. While the invention has not been commercialized in its original target market (the major automakers), Orbital identified new buyers, such as the manufacturers of marine and recreation vehicles, and has now morphed into a corporation that “provides research, design, development, and testing services to many of the world’s powertrain producers, regulatory authorities, and research institutions.”1 ▪ ARM (Advanced RISC Machines) Holdings Plc, founded by twelve Cambridge University engineers in 1990, invented the RISC chip, which enables computer hardware to interpret and carry out software commands. ARM, which calls itself a purely intellectual property licensing I would like to thank the Danish Social Sciences Research Council for supporting the research behind this article. An earlier version of this article was presented at the DRUID (Danish Research Unit for Industrial Dynamics) Conference held in Copenhagen, Denmark, in June 2005. I am also grateful to Jens Frøslev Christensen for pointing out some fruitful lines of inquiry and to Jerome D. Davis, Merete L. Drewsen, and two anonymous referees for reading through previous drafts and offering valuable comments for improvement.

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company, has broadly and successfully licensed its IP so as to establish the basis for an international standard.2 ▪ Virginia-based NTP Inc. leveraged its IP by suing Canada’s Research in Motion Inc. (RIM), manufacturer of the popular BlackBerry wireless communication devices, for patent infringement. RIM, threatened with a court-ordered shutdown of its operations in the U.S., home to more than 3 million BlackBerry users, finally settled the case in 2006 by paying NTP $612.5 million.3 This article investigates the special characteristics and choices of these IP vendors. How do they create value from their inventions? What problems arise, and how do they address them? As David Teece observed in 1998, firms are increasingly jostling for position in markets for know-how. A new dynamic to competition and competitive advantage has emerged, characterized by a rapid growth in arrangements for the exchange of new products or services (particularly in high-tech industries), including R&D joint ventures, licensing, and R&D contracting.4 As the costs of R&D soar, cooperation is becoming more central to successful global business strategies.5 However, while there is a large literature on firms’ licensing choices,6 and considerable anecdotal evidence about individual IP vendors, there has as yet been no systematic investigation of the licensing strategies they pursue. Several scholars touch on key features of firms that specialize in markets for ideas. Andrew B. Hargadon discusses how some companies, with access to a variety of industries, can serve as “knowledge brokers,” recognizing the value of an idea from one sector and transferring it to a firm in another sector in the form of a novel, innovative solution.7 Ashish Arora, Andrea Fosfuri, and Alfonso Gambardella describe how “markets for technology” can increase the strategy space for Lee N. Davis is an Associate Professor at the innovating firms, giving them the choice Department of Innovation and Organizational Economics, Copenhagen Business School, between producing the knowledge internally, Denmark. <ld.ino@cbs.dk> acquiring it from external sources, or licensing out their own knowledge to other firms.8 Joshua Gans and Scott Stern consider the challenges faced by small, start-up technology entrepreneurs who seek to profit from innovation through either the product market, or the market for ideas. Some of the latter are pure “ideas factories,” commercially developing their inventions through partnerships with downstream players.9 In all of this work, however, the strategies of IP vendors are analyzed in the context of the broader array of strategic choices available to innovating firms. Here, we investigate what makes IP providers unique, in order to contribute a new perspective to this ongoing theoretical discussion on the dynamics of markets for ideas in three manners. First, we shift the focus of analysis that is characteristic of virtually all studies on technology licensing, from the choices confronting the buyers of intellectual property to the choices confronting the sellers. For this reason, we have chosen to work with the term “IP vendor,” rather than vaguer concepts like “ideas factories” or “invention factories.”10

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Second, we are not interested in why firms choose between licensing, internalization, and hybrid organizational forms,11 but rather in how they use licensing for strategic advantage. The factors that drive firms to license out proprietary technology, and the role played by technology in corporate strategy, have as yet only been sparsely investigated.12 Third, since IP vendors do not engage in production, sales, or distribution, the problems associated with capturing value from their inventions alone become especially acute. This article presents a framework outlining four strategies that can be utilized by these creative and enterprising firms. Several recent trends have contributed to a fertile growth environment for IP vendors. First, many large companies have found it necessary to cut costs by reducing R&D staff and in-house laboratory capabilities. This creates an increased need to acquire intellectual property developed by other firms, particularly in science-based industries.13 Related to this has been the movement towards greater specialization, forcing companies to define where their core competencies lie and to find external partners for non-core technologies.14 Third, the patent system has been standardized and strengthened internationally, driven by the more “pro-patent” attitude of politicians and the courts in the industrialized countries, especially the United States.15 This has led to a proliferation of patent applications and the increasingly strategic use of patents and licenses by firms to win competitive advantage.16 Economists have traditionally viewed licensing and other forms of cooperation with some skepticism. The key early economic studies examined the reasons for the high transaction costs associated with technology licenses due to the complexity of the subject matter to be transferred, along with the risks attributable to small numbers bargaining, asymmetric information, the uncertainties of innovation, and the difficulties of contracting for knowledge given its “public good” characteristics.17 In his seminal 1986 article on how firms profit from their investments in R&D, Teece argues that in weak appropriability regimes, it is often the owners of specialized complementary assets that earn the lion’s share of the profits, not the original inventor. Only firms in strong appropriability regimes should contract for access.18 Other scholars view cooperation more positively.19 Work has explored how problems associated with licensing can be dealt with through the design of the contract.20 According to Arora, Fosfuri, and Gambardella, not only can markets for technology facilitate efforts by the individual firm to make more efficient use of its resources, they can potentially also lead to substantial industry-wide economies of specialization.21 Arora and Robert Merges investigate the relationship between the strength of intellectual property rights and firm boundaries. They contend that small technology specialist suppliers that possess important new information valuable to the potential buyer, and have strong patent protection, enjoy increased bargaining power in contractual negotiations with larger firms. Thus specialized suppliers with strong firm capabilities in innovation should be encouraged to invest in them.22

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Capturing Value from IP in the Market for Ideas Markets for ideas, as mentioned earlier, are characterized by numerous imperfections, rendering idea tradability difficult. One of the most important potential contractual hazards faced by an IP vendor is that the buyer might appropriate part of the value of its proprietary knowledge without paying for it.23 To interest a potential buyer, the inventor must reveal enough information to convince the buyer of the value of the IP. However, once the buyer possesses this information, it no longer needs to pay a fee to gain access to it. The buyer might, perhaps, use this knowledge to invent around the vendor’s patents. Not only would the IP vendor lose the opportunity to earn license fees, it might also create a competitor. These appropriability hazards can be illustrated by the story of Robert Kearns, who invented and patented the intermittent windshield wiper in the 1960s. Unable to commercialize this invention on his own, Kearns presented the idea to Ford Motor Company, disclosing to senior engineers not only the operating principles, but also the functionality of his invention. Ford ultimately rejected Kearns’ license proposal. Shortly thereafter, Ford began to feature a similar technology in its automobiles. Other automakers followed suit in the U.S. and Europe. Kearns sued them all for patent infringement. For over twenty years, neither Ford nor the other automakers paid Kearns any royalties. Finally, in the 1990s, the courts successfully upheld his patents, enabling him to extract a portion of the economic returns for himself.24 However, knowledge is not necessarily a public good. Most knowledge is context specific. This represents another source of market imperfections: the costs of transferring the technology from licensor to licensee. Generally speaking, the more codified and “observable in use” the knowledge is, the lower the costs of its transfer.25 The receiving company’s R&D lab must be able to assimilate and exploit the information in a productive way.26 One common problem is the “not invented here” syndrome. The licensee’s R&D, production, and marketing staff may not be interested in further developing the invention, since it is externally sourced and does not necessarily fit into their own plans or match their own competences. While the risk of imitation may be less for more complex inventions than for codifiable ones, it may be necessary to supplement the conventional license agreement with provisions covering the transfer of more sophisticated know-how or other forms of knowledge sharing. A third source of market imperfections is market and technical uncertainty. Market demand may change. The buyer’s demand for the invention in relation to its own technologies may change. The invention may not work properly after the buyer has assumed the rights. New technologies may emerge that make the invention outdated. Fourth, a range of agency problems can arise. The licensor has developed the invention and possesses the relevant experience; the would-be licensee lacks information needed to evaluate the expected pay-offs. An IP vendor may find that its licensee, contrary to expectations, is unable to work the invention

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effectively or fashion a successful marketing strategy. Alternatively, the licensee might try to create value from the invention in a way not agreeable to the IP vendor,27 possibly acquiring the rights not in order to commercialize the invention, but to prevent another firm from doing so.28 Finally, firms face the potential hazards associated with transaction-specific assets and small numbers bargaining.29 The potential number of both buyers and sellers of a new proprietary technology will typically be limited. Buyers considering trading with IP providers may fear being subjected to a “hold-up” situation. Once the buyer has sunk the costs of developing an innovation based on the vendor’s patent, the vendor might use its bargaining power to set the price of its invention so high that the buyer incurs a loss on its initial investment. In particular, buyers may hesitate to trade with IP vendors that are the sole suppliers on the market.

A Tale of Two Vendors While the sources of market imperfections described above render idea tradability difficult for all IP vendors, it is often possible to find workable solutions, either as part of the license contract or in some other manner. This can be illustrated by the strategies pursued by the two prominent IP vendors briefly introduced above: Orbital Corporation and ARM Holdings Ltd. Orbital Corporation, founded in 1970, initially patented an “orbital” engine (somewhat similar to the radial engine). However, it soon abandoned this, pursuing instead a novel fuel injection technology that was both environmentally friendly and cost-efficient. The company licensed out the rights to this technology, and a stream of related inventions, on a non-exclusive basis to major automakers and engine manufacturers. Orbital charged very high royalties to ensure that the licensees took the technology seriously—and to enhance its own earnings. By 1990, Orbital had generated so much royalty income on its test engines and license contracts that it became the largest company in Western Australia in terms of market capitalization, and it was hailed as the best performer on the Australian stock market. Orbital also found new outlets for its inventions in engines for motorcycles, motorboats, and lawnmowers, and it now offers a range of consultant services. In the fiscal year ending June 2007, Orbital earned $15.2 million in revenues, mainly from its license agreements along with prototype and component manufacturing.30 ARM Holdings Ltd., which generates revenue by widely licensing its RISC chip designs to semiconductor companies, has pursued quite a different strategy. Whenever ARM grants a license, it tries to build a reciprocal relationship with the licensee, giving ARM insights into the licensee’s process technology and access to new knowledge about emerging applications. This helps ARM design chips that best fit its partners’ future technologies and application needs. The more end applications that can be serviced by an ARM chip, the more both ARM and its partners can earn. ARM’s licensees add their own application-specific

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technology to the ARM chip designs, manufacture the chips in their wafer fabrication plants, and sell them to Original Equipment Manufacturers like Nokia or Hewlett Packard. As a result, the ARM design is now used in a vast range of consumer and industry products, from mobile phones to personal organizers to digital cameras. By 2001, the company had achieved a market share of 77% of the embedded RISC processor market and was accepted by industry leaders as the de facto global standard. In January 2007, the company won the European Business of the Year award.31 Each company faced the sources of market imperfections described in the previous section but addressed them differently. To deal with appropriability hazards, for example, Orbital took out hundreds of patents. Its policy of liberal licensing, high license fees, and tight control over its intellectual property rights secured a continuous income stream. It was mainly up to the buyer to absorb the technology into its own development and production activities. Like Orbital Corporation, ARM made extensive use of patents, thoroughly protecting its basic invention. However, ARM allowed its buyers to custom tailor its chips to their needs. In so doing, ARM ran the risk that its buyers might imitate its technology. However, by underlining that reciprocal knowledge sharing was in the interests of both parties, ARM aligned their incentives, creating strong alliances. ARM thereby also reduced the costs of technology transfer. Buyers were encouraged to learn as much as possible about how the ARM design could work for them. ARM benefited from its buyers’ experiences with the chip, spurring ARM to improve chip performance. Orbital seems to have been plagued by the “not invented here” syndrome. The scientists and engineers who worked for the automobile manufacturers were themselves experimenting with a variety of new technologies. Why should they favor Orbital’s process? The inventions pioneered by both Orbital and ARM faced considerable problems of technical and market uncertainty. Orbital’s primary approach was to improve the technical efficiency and reliability of the fuel injection process, while leaving the question of eventual market uncertainty up to the automobile manufacturers. ARM tried to reduce both types of uncertainties, by engaging buyers directly in the continuing development process, finding out what they wanted specifically, and learning how to fulfill these needs. A crucial factor for Orbital concerned the systemic nature of technologies in vertically integrated, capital-intensive industries like automobiles.32 No matter how good an invention is, it will only be valuable to potential buyers if it can be integrated into this larger system. Orbital’s fuel injection process, while technically and environmentally attractive, involved revamping existing engine technology. Car dealers and insurance agents would have to learn about it. Mechanics would have to be trained in its repair. A faulty engine leading to a rash of consumer lawsuits could be enormously costly. The automobile manufacturers had not been able to observe Orbital’s development process. Contracting with such an external agent could put them at considerable cost and risk.

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ARM, by contrast, worked in semiconductors, a “cumulative systems technology,” where new products are closely linked technically with previous innovations (and may as a result infringe previous patents).33 The parties ensure mutual compatibility by extensive knowledge sharing and cross-licensing, reducing information asymmetries and thus costs related to adverse selection and moral hazard. Finally, potential hazards associated with small numbers bargaining played out differently for the two companies. Orbital Corporation was the sole supplier of its fuel injection process. Because of its many patents, it effectively sealed off the area of technology to any other supplier, let alone the automobile companies. Empirical studies have shown that the greater the degree of asset specificity in transactions governing automobile components (and thus the higher the expected appropriable quasi-rents), the greater the tendency towards the vertical integration.34 The automobile manufacturers might well have felt vulnerable to “hold up.” ARM, the sole supplier of the RISC chip, also operated in an industry where the risk of hold-up can be acute. However, by engaging its buyers in mutually beneficial arrangements, it acted directly to ameliorate these fears.

Towards a Framework for Analysis While ARM and Orbital devised quite different strategies to capture rent from their license agreements, other approaches may be employed. Consider, for example, the story of NTP, the third case briefly mentioned in the introduction. NTP obtained five patents on inventions in e-mail systems with wireless networks, but did not develop the technology itself. Some time later, Research in Motion (RIM) realized that its already developed and commercialized Blackberry devices could not function without access to NTP’s technology. RIM claimed it had no idea it was infringing NTP’s patents and questioned their validity. However, faced with an injunction that would have closed its U.S. BlackBerry service, RIM settled out of court. NTP, like both Orbital and ARM, patented its technology to secure appropriability. Like ARM, it also worked in a cumulative systems technology. However, it did not engage in knowledge exchange. Nor did NTP make any effort to reduce the costs of technology transfer or ameliorate the technical and market uncertainties connected with its invention. All RIM wanted to do was to continue to produce BlackBerries. Thus NTP used its blocking patent position simply to extract rents. Subsequently, NTP has filed new patent infringement lawsuits against the four biggest wireless carriers in the U.S. Alternatively, consider the experiences of the early Genentech. In 1978, its researchers won a prize competition sponsored by Eli Lilly to successfully synthesize the human insulin gene. Genentech applied for a patent on the invention and entered into an exclusive license agreement with Eli Lilly for its further development.35 In this case, appropriability hazards were not really an issue, since the two sides had agreed on the division of the property rights.

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Problems related to the costs of technology transfer and asymmetric information were also more manageable, since the IP vendor’s invention was early on tailored to the buyer’s needs. While Genentech faced some technical uncertainty in developing the gene, Eli Lilly could help in finding a solution. The potential for hold-up, however, clearly existed. To generalize from the above cases, in the license negotiation process, the IP vendor and the would-be licensee strive to reach a contractual arrangement that can effectively deal with these sources of market imperfections. Moreover, as Oliver Hart has observed in his work on contractual governance,36 the ex post allocation of power (or control) in the contract—the position of each party if the other party does not perform—matters as well. At different times, both vendor and buyer will invest in the IP being traded. Both attempt to minimize their financial exposure inherent in such investments, and maximize their future returns. Both operate under the constraints imposed by the characteristics of the technology concerned. Based on the literature on firm appropriability choices and economic theories of organization (here the theory of incomplete contracts), along with anecdotal evidence of the experiences of IP vendors in practice, we suggest that vendor strategies can be differentiated along two main dimensions. The first concerns the nature of the contractual relations; the second concerns the degree of cumulativeness in the technology to be traded.

Stand Alone Licensing or “Licensing Plus”? In IP markets, the would-be buyer must be confident that its ex post investments in products, services, or processes arising from its purchasing the rights to an IP vendor’s invention will not lead to financial exposure due to the seller’s bad faith. The IP vendor, for its part, must be assured that it can procure sufficient returns to cover the ex ante costs of its initial investments in the invention. These mutual interests can give rise to a range of agreements, from straightforward licensing to complicated contractual relationships. In transaction costs economics, it is recognized that many problems can be associated with contracting for complex, unpredictable products, such as those involving research and development. Such contracts must be incomplete because it is difficult for the parties to think through and plan for any eventual contingencies that might arise, and to find a common language to guide the negotiation process. And even if the parties can overcome these problems, it can be very difficult to draw up the contract so that it can be effectively enforced by an outside authority.37 However, if both parties have an interest in increasing the returns from the invention, both will also be motivated to make the transaction as efficient as possible. “Hostages” or “hostage-like” mechanisms, where one firm offers a valuable asset to another that will be forfeit if the agreement is not honored, may be employed to align their incentives. The buyer can require the seller to post a cash bond, invest in specific capital, make bilateral investments, and the like.38 ARM’s use of reciprocal knowledge sharing can be seen as an “exchange of hostages” involving highly specific assets. The willingness of both

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ARM and its licensing partners to reveal knowledge to each other suggests that both valued the continuation of the relationship and did not want it to fail. As Peter Smith Ring and Andrew Van de Ven have pointed out, for transactions characterized not only by a high degree of risk (with moderate to high asset specificity), but also by a high degree of trust, relational contracting can provide an efficient solution.39 In such contracts, the terms of exchange are uncertain, open, and incomplete, and the parties enjoy close social relations. According to Jeffrey Dyer and Harbir Singh, strong partnerships of this type can create “relational rents,” supernormal profits that can only be generated through the joint idiosyncratic contributions of the two parties.40 This work on relational contracting and relational rents, which builds as well on insights from the knowledge-based and competence-based views of the firm, allows us to add a “strategic” perspective to the “efficiency” perspective of economic theories of organization, enabling us to link governance structure with the IP licensor’s strategic choices. Against this background, we suggest that IP vendors can employ two main approaches to licensing. In the first, the “stand-alone” licensing agreement, the license serves primarily to specify the legal basis for the transfer of rights and enable the IP vendor to earn royalties (or other forms of compensation like lump sum payments). The license fees can then finance the vendor’s ongoing inventive activities. In the second type of agreement, “licensing plus,” the vendor uses the license as a means not only to extract royalties, but also to support the longerterm relationship with the buyer. The license agreement can be supplemented by contracts covering other aspects of R&D collaboration and/or equity exchange. The inventive process is tailored to the evolving requirements of both parties. Scientists and engineers who work for such vendors must be willing to adjust their own research agendas to what buyers find important. Among the case studies explored above, Orbital Corporation and NTP seem to have viewed the license mainly as a means to earn royalties. ARM Holdings and the early Genentech, by contrast, employed a “licensing plus” approach.

The Degree of Technological Cumulativeness The second critical dimension of the IP provider’s licensing choice concerns the degree to which its research activities are mutually dependent on the innovative activities of other market players. If an innovation gives rise to a stream of interlinked improvement innovations, or lays the basis for improvements in related areas, the technology may be characterized as “cumulative.”41 In technological regimes of high cumulativeness, such as computers, semiconductors, electronic equipment—and, increasingly, biotechnology—manufacturers typically hold the patent rights to technologies to which other companies working in related technologies must be able to have access in order to continue with their own product development activities. The two parties, by cross-licensing their patent rights, avoid the possibility of mutually blocking patents. The

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license primarily confers the right to utilize someone else’s technology without being sued for patent infringement.42 Technological regimes of lower cumulativeness, like the pharmaceutical industry, have exhibited a different dynamic.43 Traditionally, after a pharmaceutical company had successfully developed one drug, it basically started all over again to search for promising new molecules. With the revolution in biotechnology, these conditions are changing, enabling companies to search more efficiently for new molecules, focusing on specific segments of the search space.44 However, the pharmaceutical companies have continued to specialize in particular therapeutic areas. They can either develop the needed inputs to their production process themselves, or contract with an external agent. When a pharmaceutical corporation enters into a license agreement with an external R&D supplier, the typical division of labor is for the supplier to conduct the initial screening up to Clinical Phase III, when the testing process becomes much more expensive. The vendor then contracts with a pharmaceutical company for the invention’s further commercial development.45 This distinction between technologies of low and high cumulativeness echoes the distinction made in the literature on firm patenting strategies between the use of patents to “block to fence” and “block to play.”46 In the fence strategy, a firm patents not only its core invention, but also numerous substitutes, generating a protective layer around this core, blocking rivals from imitating it. This strategy is leveraged mainly in technological regimes of low cumulativeness.47 Here, the IP vendor typically grants the licensee the right to use its invention as an input into the licensee’s own production process, linking the two parties in a vertical buyer-supplier partnership. Depending on the invention, the vendor may need to possess one or a few patents (as exemplified by Robert Kearns, with his intermittent windshield wiper) or many hundreds (as illustrated by Orbital Corporation). By contrast, the play strategy is frequently employed in technological regimes of high cumulativeness. Patents serve as “bargaining chips”, enabling the orderly division of rights among producers of complementary technologies where there is some technical relationship between the two inventions. Access to the one is necessary if the other is to be enjoyed. Often such licenses must be negotiated among many different producers (as shown by ARM Holdings). However, even a small firm can “block to play” if it possesses the patent rights to technologies to which another firm must have access.48 As regards the degree of technological cumulativeness, Orbital Corporation has a great deal in common with the early Genentech, since they worked as suppliers in markets characterized by relatively low cumulativeness. The technologies offered by ARM and NTP are characterized by relatively high cumulativeness.

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IP Vendors’ Licensing Strategies:A Suggested Typology Using these two dimensions to create a typology, we suggest that IP vendors can pursue four different strategies: ▪ the independent strategy (stand-alone licensing/technologies of low cumulativeness), ▪ the complementor strategy (stand-alone licensing/technologies of high cumulativeness), ▪ the directed strategy (licensing plus/technologies of low cumulativeness), and ▪ the reciprocal knowledge-sharing strategy (licensing plus/technologies of high cumulativeness). Figure 1 shows the main drivers of the four strategies, and examples of IP vendors that have implemented them. Orbital’s approach to licensing can be classified in this typology as the independent strategy, NTP as the complementor strategy, the early Genentech as the directed strategy, and ARM as the reciprocal knowledge-sharing strategy.

The Independent Strategy (Stand-Alone Licensing/Technologies of Low Cumulativeness) IP vendors that pursue this strategy, like Orbital Corporation, develop a new product or process to the point where they can demonstrate its potential commercial value, and then license it out. Ultra-Scan of Amherst, New York, also adopted this approach. Ultra-Scan introduced the world’s first ultrasonic fingerprint scanner in 1996. It holds an extensive portfolio of patents on its techniques utilizing ultrasound in reading, matching and identifying fingerprints. The technology can be widely applied in uses ranging from airport security systems and fraud protection to biometric smart cards and online account access.49 The independent licensing strategy can be illustrated by a time line (see Figure 2), where “t” represents the time at which an action is undertaken. It should be emphasized that Figure 2 and the other time lines (Figures 3-5, below) are diagrammatic. Thus the term “t” does not represent “year 1,” or any other absolute figure, but provides a way of indicating the relative chronology of the strategic moves of the respective parties. The vendor invests in its invention at t=1, and patents it at t=2. Often, such vendors can amass large patent portfolios covering different aspects of the invention (patents on related products, processes, and uses), enabling a “block to fence” strategy. The vendor then seeks to license out the invention. If another firm is interested in using the invention as an input to its own development program, they enter into a license agreement. Because the technology is of low cumulativeness, the prospective buyer can choose not to license, attempting instead to “invent around” the vendor’s patent(s) (t=3). As can be seen, the prospective buyer does not commit resources until t=4, when the two parties sign a simple licensing contract. Such a contract can

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FIGURE 1. A Suggested Typology of IP Vendors Nature of the Contractual Agreement

Stand-Alone Licensing

Licensing-Plus

The Independent Strategy

The Directed Strategy

Main Drivers

The license provides the legal basis for the transfer of rights, enabling the IP vendor to earn royalties (or other compensation).

The license is part of a larger package of cooperative R&D agreements between vendor and buyer.

Degree of Technological Cumulativeness Low

Patents to prevent imitation “Block to fence” (if large patent portfolio)

Patents to prevent imitation “Block to fence” (if large patent portfolio) Examples of Companies

Examples of Companies

Mojave Aerospace Ventures Orbital Corporation’s collaboration with Jaguar Ultra-Scan’s collaboration with US Biometrics Corp The early Genentech NeuroSearch

Orbital Corporation Robert Kearns Ultra-Scan Jerome Lemelson

High

The Complementor Strategy

The Reciprocal Knowledge-Sharing Strategy

Main Drivers The license provides the legal basis for the transfer of rights, enabling the IP vendor to earn royalties (or other compensation).

Main Drivers

Patents as “bargaining chips” Non-trolls:“Block to play” Trolls: Block to force compensation

Patents as “bargaining chips” “Block to play”

The license is part of a larger package of cooperative R&D agreements between vendor and buyer.

Examples of Companies Examples of Companies Systemonic and other young university spin-offs in cumulative technologies NTP Eolas MercExchange

ARM Cambridge Display Technologies CombiMatrix and Benitec Qualcomm

include the background IP, the IP to be shared (including a specification of components), the transfer of the license, sublicensing rights, lump sum and/or royalty payments, secrecy, termination of licensing rights, and (future) dispute resolution. The vendor continues to perform independent R&D; the buyer may

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FIGURE 2. Time Line One:The Independent Strategy

IP Vendor

Invests in invention

t=0

t=1

Prospective Buyer

Patents invention(s) (if large patent portfolio, block to fence) Seeks to license out invention

t=2

t=3

If prospective buyer decides to license, enters into license contract with buyer

License either continued or terminated Continues own R&D

t=4

Decides whether to license or ìi nvent around” If decides to license vendor’s enters into patent(s) license contract with vendor

t=5

t=6

Either develops the technology License either commercially continued or (incurring major terminated financial exposure) – or does not

or may not develop the technology commercially (t=5). If the buyer goes ahead with commercialization, it must commit further resources, risking major financial exposure if the technology fails. If the contract is later terminated (t=6), both parties lose their contract-specific investments. This strategy may also be leveraged by the so-called “patent trolls,” companies that patent potentially valuable inventions and then wait until another firm develops a technology that infringes its patents. The troll then brings suit, demanding license fees or some other compensation. An example is Jerome Lemelson’s invention of a toy race car track including vertical loops. Lemelson later claimed that Mattel Inc.’s Hot Wheels toy car racing system violated his patent. In 1989, a U.S. federal jury ordered Mattel to compensate Lemelson for patent infringement.50

The Complementor Strategy (Stand-Alone Licensing/Technologies of High Cumulativeness) In this case (see Figure 3), the vendor develops an invention (t=1) that is complementary to the prospective buyer’s technology (if unbeknownst to the buyer) and patents it (t=2). In the meantime, this prospective buyer has been investing in the complementary technology (t=2), patenting its inventions, engaging in cross-licensing agreements with other producers (t=3) (“block to play”), and, possibly, commercializing the technology (t=4). The vendor may or may not be interested in cross-licensing. At some point, the buyer becomes

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FIGURE 3. Time Line Two:The Complementor Strategy

IP Vendor

Invests in invention complementary to the buyer’s technology

t=0

Prospective Buyer

t=1

Asks buyer to license the rights to the invention or pay other compensation

Patents invention(s); non-trolls: block to play

t=2

t=3

t=4

t=5

Develops (and possibly Invests in commercializes) technology invention(s) complementary to the Patents invention(s) vendor’s invention (block to play); engages in crosslicensing with other producers of complementary technologies

Licenses out the invention or receives other compensation

t=6

Realizes it faces major financial exposure by not dealing with the vendor. Licenses the rights to the invention or gives the vendor other compensation

t=7

Continues with R&D and manufacturing agenda

aware that the vendor’s patent covers an invention to which it must have access if it is to continue with its own development and production activities—perhaps when the vendor approaches it and asks for a license (t=5). The buyer realizes it faces major financial exposure by not dealing with the vendor. It enters into a license agreement or compensates the vendor in some other way (t=6). After settling with the vendor, the buyer continues with its R&D and manufacturing agenda (t=7). In this case, the IP provider leverages its patent(s) to create value because other firms working in the area of the patented technology cannot proceed without licensing. This is different from Strategy 1, where the buyer may or may not decide to license. IP vendors that pursue the complementor licensing strategy typically work in the areas of software and electronics. Many are small, entrepreneurial ventures, including university spin-offs. Systemonic, a wireless chip company, provides a good illustration. The company was founded in 1999 by Gerhard Fettweis, professor of mobile telecommunications at the Technical University of Dresden. Fettweis was an expert in digital signal processors (DSPs), a special chip critical to communications applications. Systemonic later licensed its intellectual property to the large telecommunications and consumer electronics companies.51 This category also includes numerous patent trolls. If the vendor is a troll, t=5 may well take the form of a lawsuit, threatening the producer of the

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FIGURE 4. Time Line Three: The Directed Strategy Enters set of contracts that: include both license plus joint R&D contract with milestones, etc.

Invests in invention

Patents invention(s) (if large patent portfolio, block to fence)

IP Vendor

t=0

Prospective Buyer

t=1

t=2

Success or failure in achieving milestones

Further development

t=3

Enters set of contracts that: include both license plus joint R&D contract with milestones, etc.*

Contractual relationship either continued or terminated. Possibly new licenses and development contracts

t=4

t=5

t=6

Either develops the technology commercially (incurring major financial exposure) – or does not

Investments supporting vendor’s further development

Reviews results

t=7

Contractual relationship either continued or terminated. Possibly new licenses and development contracts

*These can include possible equity purchase of IP vendor shares, establishment of management committees, etc.

complementary technology with an injunction, forbidding it to sell the technology until the courts can decide if patent infringement has occurred. The buyer has no choice but to reach agreement with the troll—unless the costs of settlement are greater than the costs of revamping its entire business. Recent instances of trolls in action include Eolas, which won $520 million from Microsoft after a jury found that certain aspects of Microsoft’s Internet Explorer browser had infringed Eolas’ patent on a method for displaying browser plug-ins.52 Similarly, MercExchange, a small online vendor with three patents related to the process of online auctions and shopping, sued eBay for patent infringement. An important reason why such trolls have been able to flourish concerns the poor quality of the patents concerned, where examiners have not insisted on high enough standards defining two key criteria of patentability, “novelty” and “non-obviousness.”53

The Directed Strategy (Licensing Plus/Technologies of Low Cumulativeness) Here, the IP firm invests in an invention (t=1) and patents it (t=2), as illustrated in Figure 4, employing a “block to fence” approach if it possesses a sufficiently large patent portfolio. At t=3, vendor and buyer enter into a contract that includes the license as well as other R&D agreements. The vendor continues

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to devote resources to developing the invention (t=4). Contractual milestones indicate whether the arrangement is proceeding satisfactorily (t=5). The buyer either develops the technology commercially (incurring financial exposure), or does not (perhaps waiting for a resolution of technical or market uncertainty) (t=6). The parties may also expand their contractual relationship. If the original agreement is discontinued (t=7), the parties lose their contract-specific investments, but can go their separate ways. This approach can be illustrated by the California-based Mojave Aerospace Ventures (MAV), which won the Ansari X prize for the development of a reusable rocket to carry passengers to the edge of the earth’s atmosphere and back. In 2004, MAV and Sir Richard Branson’s new company, Virgin Galactic, entered into a licensing and joint venture agreement to develop a commercially viable suborbital spacecraft, launching a new era of space tourism.54 The directed strategy may also be pursued by independent vendors (Strategy 1) interested in a more relational contract. For example, in May 1992, Orbital announced that it would develop a high performance, two-stroke V6 engine in cooperation with the British carmaker Jaguar. In May 2005, Ultra-Scan announced the formation of a joint venture with the computer security company US Biometrics Corp., to further elaborate Ultra-Scan’s fingerprinting technology to provide health professionals with secure access to hospital computer workstations.55 Strategy 3 is particularly suitable for small biotech IP vendors. For example, in December 2003, the Danish biotechnology firm NeuroSearch and the British pharmaceutical corporation GlaxoSmithKline (GSK), announced a fiveyear research and development alliance covering a number of programs on the treatment of diseases of the central nervous system, and ion channel drug discovery and development. GSK obtained access to new drug candidates in NeuroSearch’s pipeline, and the option to license them. NeuroSearch received EUR 82 billion in guaranteed payments (in the form of upfront payments and shares to be issued to GSK). NeuroSearch could receive further milestone payments based on the successful development of its drug candidates, and royalties on sales of successfully launched compounds. If GSK did not exercise its license options, NeuroSearch would be free to further develop the drugs as they wished. In November 2006, the two companies agreed to expand the scope of this agreement (t=7). Since drug discovery programs sometimes run into problems concerning safety or lack of efficacy, it may be necessary to discontinue the cooperation. A case in point is NeuroSearch’s development contract in December 2000 with the Spanish pharmaceutical company Grupo Ferrer for a drug targeted to treat anxiety (NS 2710). NeuroSearch’s early clinical trials had indicated that the drug might cause skin rashes. Grupo Ferrer completed a clinical safety study, confirming that there was a serious problem with skin rashes. As a result, the two companies decided not to continue, terminating the contract (t=6).56

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FIGURE 5. Time Line Four: The Reciprocal Knowledge-Sharing Strategy Invests in further reciprocal innovation, incurring major financial exposure

Develops and patents invention(s) complementary to the buyer’s invention (block to play) Searches for potential partners for crosslicensee(s)

IP Vendor

t=0

t=1

t=2

Invests in improvements

Enters crosslicensing/ R&D contracts

Provides new ideas/receives feedback

t=4

t=3

t=5

Enters Prospective Invests in and patents invention(s) crossBuyer licensing/ complementary to the vendor’s invention (block to play) engages in crosslicensing with other producers of complementary technologies

R&D contract

Further feedback

Contractual relationship continued, expanded or contested

t=7

t=8

t=6

Invests in improvements Provides new ideas/receives feedback

Contractual relationship continued, expanded or contested

Further feedback

Invests in further reciprocal innovation, incurring major financial exposure

The Reciprocal Knowledge-Sharing Strategy (Licensing Plus/Technologies of High Cumulativeness) Finally, in the reciprocal knowledge-sharing strategy, as illustrated by ARM Holdings, the inventor enters into a complex licensing and product development agreement with several or many market participants. These can potentially include suppliers, competitors, and customers. The vendor develops and patents the invention at t=1 (see Figure 5) and searches for potential partners with whom to cross-license at t=2. In the meantime, the would-be buyer has been developing and patenting a complementary technology. Both parties use patents to “block to play.” The goal is the rapid diffusion of the technology. Both enter into a cross-licensing contract or contracts, supplemented by other forms of R&D collaboration, at t=3. Both invest in the further elaboration of their technologies (t=4), both incur major financial exposure in relation to the joint effort, and both engage in extensive mutual feedback (t=5). Moving along the time line to t=8, reciprocal knowledge-sharing enables further cross-licensing and continuous improvements to the technology.

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A second instance of this approach is Cambridge Display Technologies (CDT), launched in 1992 as a Cambridge University spin-off. CDT specializes in the innovation of light-emitting polymers, which can be applied in a variety of products, including calculators, cellular phones, and laptop computer screen displays. The company soon became the global leader in this technology. However, when CDT tried to manufacture and market products incorporating its technology, it nearly went bankrupt. As a result, CDT changed its business model, entering into licensing and co-development and manufacturing deals with established companies such as Philips Electronics, Seiko-Epson, Hoechst, and DuPont. CDT’s partners could then apply their complementary skills to the technology to develop specific products for their own markets.57 While these examples are from the electronics industry, reciprocal knowledge-sharing agreements are also increasingly seen in biotechnology, in areas where webs of interlocking technologies necessitate complex forms of contracting. For example, in February 2005, the Australian biotech company Benitec, Ltd., a leading RNA interference (virus-destroying) therapeutics company, and the CombiMatrix Group, a Seattle-based biotechnology company specializing in electrochemical manufacturing, signed a broad cross-licensing and collaboration agreement. Benitec received the right to use certain therapeutic agents against viral diseases, along with genetic treatments for HIV, developed by CombiMatrix. In return, Benitec granted CombiMatrix the license rights to its IP portfolio of ten issued and sixty pending patents covering the treatment or prevention of illnesses caused when human beings are exposed to biological, chemical, radioactive, and other weapons. Other collaborative projects were included in the deal.58 Strategy 4 agreements are often continued and expanded—but they may also be violently contested in huge legal battles if the parties fall out. Consider the story of Qualcomm, founded in 1985 in San Diego, California by seven industry veterans. Four years later, Qualcomm introduced its basic Code Division Multiple Access (CDMA) technology for wireless and data products. Qualcomm’s current licensing program enables third parties to design, manufacture, and sell products based on this technology. By 2007, over 130 telecommunications equipment manufacturers around the world had cross-licensed the rights to the company’s essential CDMA patents.59 However, extensive cross-licensing agreements provide no guarantee of continued success—or of harmonious relationships between the parties. For example, Qualcomm’s CDMA technology was initially used in all Nokia cell phones. However, Nokia then sought a reduction in the license fees it was paying. In 2005, Qualcomm filed a patent infringement suit against Nokia. In 2007, Nokia hit back, filing its own infringement suit against Qualcomm. Both asked the U.S. International Trade Commission to ban the import of the other company’s products.60

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Implications and Conclusion Managers of IP vendors can use this typology to guide them in deciding what licensing strategy would be best for them. Does it make more sense to use the license to extract royalties, or to see it more as a building block in establishing in a longer-term relationship with the licensee? Managerial choices are also constrained by the nature of the technology (the degree of cumulativeness). Success will depend on how effectively managers deal with the five sources of market imperfections described earlier (appropriability hazards, the costs of technology transfer, market and technical uncertainty, agency problems, and small numbers bargaining) through the contractual agreement(s)—and at what cost. For example, managers that pursue the independent strategy (Strategy 1) can reduce appropriability hazards by securing tight proprietary control. However, this approach will also raise the costs the licensee must bear in integrating the vendor’s technology into its own production. Technical and market uncertainty may well be high, with a risk of incurring the “not invented here” syndrome. The buyer might also hesitate to trade given the possibility of opportunistic vendor behavior due to non-observability of the vendor’s inventive process, and small numbers bargaining. Such vendors preserve their independence but run the risk that no one will further develop the invention. The vendor can help to reduce these costs by being willing to share information with the buyer about its product development and test procedures and its own understanding of the market, and/or organizational arrangements such as personnel exchanges, giving the would-be buyer direct access to its operations. Managers of complementor patent trolls (Strategy 2) stand to hit the jackpot if they succeed. However, if no one infringes their patent, or if their patent infringement suit fails, they get nothing, not even license royalties. Ironically, there may even be costs to winning. Recently, NTP was itself sued by a software developer who claims that he did much of the work behind NTP’s patents, and so claimed to deserve a share of the RIM settlement.61 Managers of vendors that employ the directed strategy (Strategy 3) can reduce appropriability hazards by using patents to specify the division of property rights with the buyer in the broader product development process. Vendor and buyer share the costs related to technical uncertainty and technology transfer. Because the license supports a continuing relationship, agency costs are relatively low. However, if the relationship breaks down, the vendor will incur high transaction costs in switching to an alternative buyer. “Hostage-like” arrangements such as bilateral investments, along with personnel exchanges, might decrease these hazards. The reciprocal knowledge-sharing strategy (Strategy 4) offers the greatest potential to reduce all five sources of market imperfections, since vendor and buyer will be closely cooperating throughout the development process, aligning their incentives. The parties can observe each other’s behavior relatively easily. However, managers of Strategy 4 (and Strategy 3) vendors also risk being locked into outdated technologies to the degree that their customers miss emerging

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market opportunities.62 Where the technology succeeds, they risk costly lawsuits and damages if the parties fall out. The nature of the IP vendor’s investment at t=1 can vary. This investment might be substantial (as in biotech) or minimal (as in toy race car tracks). The specificity of the property rights being licensed may be clear or somewhat fuzzy. Many patents, for example, lack a demonstration of “prior knowledge.” In some areas, particularly software, patents are relatively non-specific as to the invention’s design and specification. This can create problems for licensing contracts— and fertile conditions for patent trolls. The number of patents required for successful vending can be phenomenal. By 2007, for example, Qualcomm’s patent portfolio included some 6,100 United States patents and patent applications for CDMA and related technologies. Such patenting costs can seem exorbitant. Yet without an impregnable patent position, the vendor’s bargaining stance will be too weak. Since the typology used here is at the level of the individual license transaction, and not the firm, vendors may also pursue two or more different licensing strategies, depending on the characteristics of the invention concerned. Thus Orbital Corporation and Ultra-Scan, as described above, have pursued both independent and directed approaches to licensing. Some vendors have moved out of our framework altogether. Genentech now engages in production and commercialization, as well as invention—even licensing in inventions from its own IP vendors. Systemonic became a semiconductor manufacturer. An alternative to trading with an IP vendor is to acquire it. As emphasized by transaction cost economists, for transactions with high levels of asset specificity, frequency, and uncertainty (IP vendors’ inventions typically rank high on all three counts), the most efficient governance structure should be internalization. Further benefits of internalization include reducing the risk of imitation, and the costs of technology transfer. Philips, for example, exercised this option when it bought Systemonic in 2003.63 IP vendors can provide an efficient way for society to expand the sum total of inventions available for commercial exploitation, reaping the benefits of increased specialization. Yet it might also mean that valuable ideas are not effectively exploited. Orbital Corporation, for example, has earned handsomely from its investments in IP. However, because the environmentally friendly fuel injection system was never actually used commercially by the major automakers, an important societal benefit may have been lost. Instead of using nonexclusive licensing to maximize royalty earnings, Orbital could have entered into an exclusive license agreement with a single automobile manufacturer. However, Orbital may have rejected this approach precisely because it wished to continue to be an independent IP vendor. Ironically, its insistence on non-exclusive licenses might have ensured that no automobile manufacturer would ultimately be interested, since no one could earn the high rents made possible by an exclusive license. Managers can effectively deal with lurking patent trolls by searching patent databases in the area of their technological trajectory early on. If they

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unmask a troll, they can try to invent around its patents before their investment costs have been sunk. Possibly this enhanced risk of discovery might even encourage trolls to move to one of the “relational” boxes in the matrix—in which case, they would cease to be trolls.64 As with any model, which by definition must simplify to identify the essence of a strategy, the typology used here is not absolute. Some strategies do not easily fit into a given category. The pharmaceutical industry, for example, has traditionally specialized in discrete technologies (technologies of low cumulativeness). With the recent developments in biotechnology, however, crosslicensing deals have become more prevalent. Thus the Dutch biotechnology company Crucell N.V. and the pharmaceutical giant Merck & Co. signed a crosslicensing agreement giving Merck access to several of Crucell’s inventions in vaccine technology, and giving Crucell access to Merck’s large-scale manufacturing technology for vaccines.65 This arguably represents a hybrid of Strategies 3 and 4. Most IP vendors start out on the left side of our matrix. However, “relational rents” can only be earned by vendors on the right hand side. Many of the IP vendors discussed above, including ARM and Cambridge Display Technologies, began as university spin-offs, and their very early licensing strategies fall under Strategy 2. As they grew in size and experience, they moved towards more ambitious goals (Strategy 4). Had they become “stuck” in the complementor strategy, they might never have achieved their full potential. Relational rents, nevertheless, depend on the continued strength of the relationship. As our Qualcomm case demonstrates, extensive cross-licensing agreements can also lead to considerable acrimony and efforts on the part of both companies to extract rents via lawsuits. Finally, managers of IP vendors must understand that while they face some risk of financial exposure after contracting for the commercial development of their inventions, the real risk is faced by the buyer. After signing the contract, the relationship between the two parties becomes asymmetrical. The vendor continues to earn license fees, even if the invention is not developed commercially. However, the buyer needs to be assured, as far as possible, that its future investments will not be compromised due to vendor opportunism or other uncertainties. Notes 1. See <www.orbeng.com.au>, accessed on October 15, 2007; Andre Morkel and Kelvin Willoughby, “Orbital Engine Corporation,” teaching case, 1992. The company changed its name to Orbital Corporation in October 2004. 2. In addition to RISC chips, ARM’s product offering currently includes processors, physical IP, cache and SoC designs, application-specific standard products (ASSPs), and related software and development tools. Its technology is used in digital applications ranging from wireless, networking, and consumer entertainment solutions to imaging, automotive, security, and storage devices. See <www.arm.com>, accessed on October 15, 2007; Eleanor O’Keeffe, “ARM Holdings Plc.,” teaching case, INSEAD-EAC, Singapore, 2002. 3. RIM agreed to pay even though the U.S. Patent and Trademark Office, in a preliminary ruling, had found all five of NTP’s patents invalid. Nor did NTP provide e-mail service or

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4. 5. 6.

7. 8.

10. 11.

12. 13.

14. 15.

16.

17.

18. 19.

compete with RIM. See Keith E. Maskus, “Reforming U.S. Patent Policy: Getting the Incentives Right,” Council on Foreign Relations Report, CSR No. 19, November 2006, p. 5. David J. Teece. “Capturing Value from Knowledge Assets: The New Economy, Markets for Know-How, and Intangible Assets,” California Management Review, 40/3 (Spring 1998): 55-79. Andrew B. Hargadon, “Firms as Knowledge Brokers: Lessons in Pursuing Continuous Innovation,” California Management Review, 40/3 (Spring 1998): 209-227. See, for example, Ulrich Lichtenthaler, “The Drivers of Technology Licensing: An Industry Comparison,” California Management Review, 49/4 (Summer 2007): 67-89; Ashish Arora and Andrea Fosfuri, “Licensing the Market for Technology,” Journal of Economic Behavior & Organization, 52/2 (October 2003): 277-295; Bernard Guilhon, Raja Attia, and Roland Rizoulieres, “Markets for Technology and Firms’ Strategies: The Case of the Semiconductor Industry,” International Journal of Technology Management, 27/2-3 (2004): 123-142; Tamara Nanayakkara, “Negotiating Technology Licensing Agreements,” International Trade Forum, 4 (2002): 13. A wide variety of license arrangements may be negotiated. Some licenses are restricted to particular markets, for example. Some contain provisions that obligate the licensee to share information regarding any improvements made in the licensed technology, often free of charge. Hargadon, op. cit. Ashish Arora, Andrea Fosfuri, and Alfonso Gambardella, “Markets for Technology and Their Implications for Corporate Strategy,” Industrial and Corporate Change, 10/2 (June 2001): 419451. Joshua S. Gans and Scott Stern, “The Product Market and the Market for “Ideas”: Commercialization Strategies for Technology Entrepreneurs,” Research Policy, 32/2 (February 2003): 333-350. It might be noted that the concept “market for ideas” is not new; it was used over thirty years ago by Ronald H. Coase, in “The Economics of the First Amendment: The Market for Goods and the Market for Ideas,” American Economic Review, 64/2 (1974): 384-391. However, Coase was analyzing the economics of the First Amendment of the U.S. constitution, not the tradability of ideas among firms. The term “invention factories” was coined by Hargadon, op. cit. See for example Arora, Fosfuri, and Gambardella, op. cit.; Oliver Williamson, The Economic Institutions of Capitalism (New York, NY: The Free Press, 1985); Oliver Williamson, “Comparative Economic Organization: The Analysis of Discrete Structural Alternatives,” Administrative Science Quarterly, 36/2 (June 1991): 269-296; Kwaku Atuahene-Gima, “Inward Technology Licensing as an Alternative to Internal R&D in New Product Development: A Conceptual Framework,” The Journal of Product Innovation Management, 9/2 (June 1992): 156-167; Toru Yoshikawa, “Technology Development and Acquisition Strategy,” International Journal of Technology, 25/6-7 (2003): 666-674. Lichtenthaler, op. cit. Alvin K. Klevorick, Richard C. Levin, Richard R. Nelson, and Sidney G. Winter, “On the Sources and Significance of Inter-Industry Differences in Technological Opportunities,” Research Policy, 24/2 (March 1995): 185-205. Dorothy Leonard-Barton, “Core Capabilities and Core Rigidities: A Paradox in Managing New Product Development,” Strategic Management Journal, 13/5 (Summer 1992): 111-125. See, for example, Adam B. Jaffe and Josh Lerner, Innovation and its Discontents (Princeton, NJ: Princeton University Press, 2004); Carlos A. Primo Braga, “Trade-Related Intellectual Property Issues: The Uruguay Round Agreement and Its Economic Implications,” in Will Martin and L. Alan Winters, ed., “The Uruguay Round and the Developing Economies,” World Bank Discussion Papers, Washington, D.C., 1995, pp. 381-411. See, for example, Peter C. Grindley and David J. Teece, “Managing Intellectual Capital: Licensing and Cross-Licensing in Semiconductors and Electronics,” California Management Review, 39/2 (Winter 1997): 8-41; Kevin G. Rivette and David Kline, Rembrandts in the Attic: Unlocking the Hidden Value of Patents (Boston, MA: Harvard University Press, 2000). Farok Contractor, International Technology Licensing: Compensation, Costs, and Negotiation (Lexington, MA: Lexington Books, 1981); Richard Caves, H. Crookel, and J.P. Killing, “The Imperfect Market for Technology Licensing,” Oxford Bulletin of Economics and Statistics, 45/3 (1983): 249-267. David J. Teece, “Profiting from Technological Innovation: Implications for Integration, Collaboration, Licensing and Public Policy,” Research Policy, 15/6 (1986): 285-305. John Hagedoorn, “Sharing Intellectual Property Rights—An Exploratory Study of Joint Patenting Amongst Companies,” Industrial and Corporate Change, 12/5 (October 2003): 1035-

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20.

21. 22. 23.

24.

25. 26.

27. 28.

29. 30.

31. 32.

33. 34.

1050; Holger Kollmer and Michael Dowling, “Licensing as a Commercialization Strategy for New Technology-Based Firms,” Research Policy, 33/8 (2004): 1141-1151; Klevorick et al., op. cit. Teece himself, in his 1998 contribution [op. cit.], argues that when firms compete in markets for know-how, there can be advantages to R&D collaborations (though he emphasizes that idea tradability is still difficult). See for example, Ashish Arora, “Licensing Tacit Knowledge: Intellectual Property Rights and the Market of Know-How,” Economics of Innovation and New Technology, 4 (1995): 41-79; Jay Pil Choi, “Technology Transfer with Moral Hazard,” International Journal of Industrial Organization, 19/1-2 (January 2000): 241-267; Bruce A. Larson and Margot Anderson, “Technology Transfer, Licensing Contracts, and Incentives for Further Innovation,” American Journal of Agricultural Economics, 76/3 (August 1994): 547-556; Ines Macho-Stadler, Xavier MartinezGiralt, and David Perez-Castrillo, “The Role of Information in Licensing Contract Design,” Research Policy, 25 (1996): 43-57. Arora, Fosfuri, and Gambardella, op. cit. Ashish Arora and Robert P. Merges, “Specialized Supply Firms, Property Rights and Firm Boundaries,” Industrial and Corporate Change, 13/3 (2004): 451-475. Gary P. Pisano, “The R&D Boundaries of the Firm: An Empirical Analysis,” Administrative Science Quarterly, 35/1 (March 1990): 153-176. This conundrum was first explored by Kenneth A. Arrow, “Economic Welfare and the Allocation of Resources for Invention,” in Universities-National Bureau of Economic Research, The Rate and Direction of Inventive Activity: Economic and Social Factors, Conference No. 13 (Princeton, NJ: Princeton University Press 1962). Gans and Stern, op. cit. While Kearns is often seen as the victim here, he in fact could have done much more to position himself more favorably in relation to Ford and the other automakers, saving himself (and everyone else) the stress of decades of lawsuits. See Jerome Davis and Lee Davis, “The ‘Mad Max Puzzle’: Positioning and the Lone Inventor,” in Lars Fuglsang, ed., Innovation and the Creative Process (London: Edward Elgar, 2007). Teece (1998), op. cit. Wesley M. Cohen and Daniel A. Levinthal, “Innovation and Learning: The Two Faces of R&D,” Economic Journal, 99/397 (1989): 569-596. Information may also be “sticky,” to the degree that it is costly to transfer from one place to another. See Eric Von Hippel, “‘Sticky Information’ and the Locus of Problem Solving: Implications for Innovation,” Management Science, 40/4 (April 1994): 429-439. Klaus Kultti and Thomas Takalo, T. “Hold-Ups and Asymmetric Information in a Technology Transfer: The Micronas Case,” Journal of Technology Transfer, 27/3 (June 2002): 233-243. Thursby has analyzed the risk that a licensee might shelve an invention by a university researcher, and what contractual solutions exist. This logic can readily be extended to IP firms. See Marie Thursby, “Shirking, Sharing Risk, and Shelving: The Role of University License Contracts,” Paper presented to the Summer Conference of the Danish Research Unit for Industrial Dynamics, Copenhagen, June 27-29, 2005. Available via the DRUID homepage, <www.druid.dk>. See Williamson (1985) and (1991), op. cit. The automakers had to pay 30-40 Australian dollars per engine, as opposed to the industry rate of about 1 Australian dollar. See Morkel and Willoughby, op. cit. For recent developments, see <www.orbeng.com.au>, accessed on October 15, 2007. O’Keeffe, op. cit.; Maija Palmer, “Arm Bolstered by Royalty Revenues,” Financial Times, April 20, 2006, p. 21; <www.arm.com>, accessed on October 15, 2007. J. Stanley Metcalfe and Michael Gibbons, “Technology, Variety, and Organization: A Systematic Perspective on the Competitive Process,” in R.S. Rosenbloom and R.A. Burgelman, Research on Technological Innovation, Management, and Policy (London: 1989), pp. 153-173; Nathan Rosenberg, “Why Technology Forecasts often Fail,” The Futurist, 29/4 (July/August 1995): 16-21. Grindley and Teece, op. cit.; James E. Bessen, “Holdup and Licensing of Cumulative Innovations with Private Information,” Economics Letters, 82/3 (March 2004): 321-326. Kirk Monteverde and David J. Teece, “Appropriable Rents and Quasi-Vertical Integration,” Journal of Law and Economics, 25/2 (October 1982): 321-328. This was demonstrated empirically by Klein et al. in their analysis of General Motor’s decision to buy out Fisher Body in the 1920s. Benjamin Klein, Robert G. Crawford, and Armen A. Alchian, “Vertical Integration, Appropriable Rents, and the Competitive Contracting Process,” Journal of Law and Economics, 21/2 (October 1978): 297-326.

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41.

42. 43.

44.

45.

46.

47. 48. 49. 50.

51.

52. 53.

Gans and Stern, op. cit. Oliver Hart, Firms, Contracts, and Financial Structure (Oxford: Clarendon Press, 1995). Williamson, op. cit. See P.H. Rubin, Managing Business Transactions (New York, NY: The Free Press, 1990). Peter Smith Ring and Andrew Y. Van de Ven, “Structuring Cooperative Relationships between Organizations,” Strategic Management Journal, 13/7 (October 1992): 483-498. Jeffrey H. Dyer and Harbir Singh, “The Relational View: Cooperative Strategy and Sources of Interorganizational Competitive Advantage,” Academy of Management Review, 23/4 (October 1998): 660-679. Suzanne Scotchmer, “Standing on the Shoulders of Giants: Cumulative Research and the Patent Law,” Journal of Economic Perspectives, 5/1 (Winter 1991): 29-41; Stefano Breschi, Franco Malerba and Luigi Orsenigo, “Technological Regimes and Schumpeterian Patterns of Innovation,” Economic Journal, 110/463 (April 2000): 388-410; Robert P. Merges and Richard R. Nelson, “On Limiting or Encouraging Rivalry in Technical Progress: The Effect of Patent Scope Decisions,” Journal of Economic Behavior and Organization, 25/1 (September 1994): 1-24. Royalty payments are adjusted to reflect the overall contributions of the different parties to the agreement. See Grindley and Teece, op. cit. Franco Malerba and Luigi Orsenigo, “Innovation and Market Structure in the Dynamics of the Pharmaceutical Industry and Biotechnology: Towards a History-Friendly Model,” Industrial and Corporate Change, 11/4 (August 2002): 667-703. Biotech firms may experience difficulties in contracting for access to specific research tools. Some scholars have expressed concerns that this situation has led to an “anti-commons” problem. See especially Rebecca S. Eisenberg, “Bargaining Over the Transfer of Proprietary Research Tools: Is this Market Failing or Emerging?” in Rochelle C. Dreyfuss, Diane L. Zimmerman, and Harry First, Expanding the Boundaries of Intellectual Property (Oxford: Oxford University Press, 2001), pp. 223-249. Other scholars find only limited evidence of an anticommons problem in practice, though problems of hold-up may well exist between particular buyers and sellers. See John P. Walsh, Ashish Arora, and Wesley M. Cohen, “Research Tool Patenting and Licensing and Biomedical Innovation,” in W.M. Cohen and S.A. Merrill, eds., Patents in the Knowledge-Based Economy (Washington, D.C. National Academies Press, 2003). In Phase I clinical trials, the new drug or treatment is tested on a small group of people (2080) for the first time to evaluate its safety, determine the safe dosage, and see what side effects exist. In Phase II, it is given to a larger group (100-300), and in Phase III, to an even larger group (1,000-3,000) to further evaluate its safety and effectiveness. See <www.clinicaltrials.gov>, accessed on October 15, 2007. See especially Wesley M. Cohen, Richard R. Nelson, and John P. Walsh, “Protecting their Intellectual Assets: Appropriability Conditions and Why U.S. Manufacturing Firms Patent (or Not),” NBER Working Paper, Cambridge, MA, 2000; Wesley Cohen, Akira Goto, Akiya Nagata, Richard R. Nelson, and John P. Walsh, “R&D Spillovers, Patents and the Incentives to Innovate in Japan and the United States,” Research Policy, 31/8-9 (December 2002): 13491367. Malerba and Orsenigo, op. cit. Grindley and Teece, op. cit. Fred O. Williams, “Amherst, N.Y-Based Ultra-Scan Considers IPO,” Knight Ridder Tribune Business News, October 4, 2002, p. 1; <http://ultra-scan.com>, accessed on October 15, 2007. Sarah Chapin Columbia and Stacy L. Blasberg, “Beware Patent Trolls,” Risk Management Magazine, 53/4 (April 2006): 22-27. All in all, Lemelson received 562 U.S. patents on technologies ranging from automated manufacturing systems to bar code readers, video cameras, and facsimile machines. Beginning in the 1970s, he brought patent infringement suits against numerous major U.S. corporations including General Motors, IBM, General Electric, and Zenith, reportedly reaping hundreds of millions of dollars in royalties and court awards. See also William F. Heinze and Harry Goldstein, “Dead Patents Walking,” IEEE Spectrum, 39/5 (May 2002): 52-54. Katherine Campbell, “A Chip Spun off the US Block: Venture Capital: Katharine Campbell Looks at a German University’s Pioneering Spin-Off,” Financial Times, December 7, 2000, p. 18. See Patricia S. Abril and Robert Plant, “The Patent Holder’s Dilemma: Buy, Sell, or Troll?” Communications of the ACM, 50/1 (January 2007): 37-44. Jaffe and Lerner, op. cit.

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54. MAV also made an agreement with Scaled Composites, which had been central to the development of the craft, to utilize the technology to build new spaceships to carry passengers into space. “One small step for space tourism . . . “, The Economist, December 18, 2004, pp. 141-142, <www.scaled.com>, accessed on October 15, 2007. 55. See <ultra-scan.com>, accessed on October 15, 2007. 56. These details are based on press releases from the companies concerned. For further information, see <www.neurosearch.com>, accessed on October 15, 2007. 57. Arora, Fosfuri, and Gambardella, op. cit.; <www.cdtltd.co.uk>, accessed on October 15, 2007. 58. “CombiMatrix and Benitec Enter Cross-Licensing and Collaboration Agreement,” Nanotechwire, February 22, 2005, available at <http://nanotechwire.com/news.asp?nid=1655>, accessed on October 8, 2007. See also <www.benitec.com.au/> and <www.combimatrix.com/>. 59. Arora, Fosfuri and Gambardella, op. cit.; <www.qualcomm.com>, accessed on October 17, 2007. 60. See Nancy Gohring, “Qualcomm Files Patent Infringement Suit Against Nokia,” IDG News Service, November 7, 2005, available at <www.infoworld.com/article/05/11/07>, accessed on October 17, 2007; Mark Halper, “Nokia vs. Qualcomm,” Fortune, December 25, 2006, pp. 2324; “Nokia Hits Back at Qualcomm in Patent Row,” Computer Business Review, May 25, 2007, available at <www.cbronline.com/article_news>, accessed on October 17, 1007; “Telecoms: Industry Update,” Datamonitor, 6/10 (October 2007): 217-218. 61. Arik Hesseldahl, “NTP: A Taste of Its Own Medicine,” Business Week Online, November 8, 2006, p. 29. Subsequently, the U.S. Patent and Trademark Office has rejected all five patents that formed the basis of NTP’s case against RIM. NTP is appealing the ruling. 62. See Clayton M. Christensen, The Innovator’s Dilemma (Cambridge, MA: Harvard Business School Press, 1997). 63. Alternately, they may make their own acquisitions. In November 2006, for example, Qualcomm bought nPhase LLC, which provides machine-to-machine solutions, helping to reinforce Qualcomm’s position in this market. <www.qualcomm.com/press/index.html>, accessed on October 15, 2007. 64. There are also indications that patent trolls are facing a more precarious existence. While RIM felt compelled to settle, another would-be troll, MercExchange, was less successful in its suit against eBay. In 2006, the U.S. Supreme Court reversed a lower court’s ruling supporting MercExchange and tightened the standards for granting injunctions made at the behest of patent trolls. William R. Overend, “Patent Injunctions after eBay: The Bidding is Open on Who Really Benefits,” The Corporate Counselor 21/3 (August 2006): 1-2, 7-8. 65. “Merck & Co., Inc. and Crucell Sign Cross-Licensing Agreement on Vaccine Production and Technology,” Marketwire, December 27, 2006. Available at <www.genengnews.com/news/bnitem.aspx?name=10841302>, accessed October 8, 2007.

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