Strategies of search and patenting under different IPR regimes

Cowan, Robin; Jonard, Nicolas; Samson, Ruth Working Paper Strategies of search and patenting under different IPR regimes UNU-MERIT Working Papers, No. 2024-008 Provided in Cooperation with: Maastricht Economic and Social Research Institute on Innovation and Technology (UNU-MERIT), United Nations University (UNU) Suggested Citation: Cowan, Robin; Jonard, Nicolas; Samson, Ruth (2024) : Strategies of search and patenting under different IPR regimes, UNU-MERIT Working Papers, No. 2024-008, United Nations University (UNU), Maastricht Economic and Social Research Institute on Innovation and Technology (UNU-MERIT), Maastricht This Version is available at: https://hdl.handle.net/10419/326904 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by-nc-sa/4.0/ #2024-008 Strategies of search and patenting under different IPR regimes Robin Cowan, Nicolas Jonard and Ruth Samson Published 24 April 2024 Maastricht Economic and social Research institute on Innovation and Technology (UNU-MERIT) email: [email protected] | website: http://www.merit.unu.edu Boschstraat 24, 6211 AX Maastricht, The Netherlands Tel: (31) (43) 388 44 00 UNU-MERIT Working Papers ISSN 1871-9872 Maastricht Economic and social Research Institute on Innovation and Technology UNU-MERIT UNU-MERIT Working Papers intend to disseminate preliminary results of research carried out at UNU-MERIT to stimulate discussion on the issues raised. Strategies of search and patenting under different IPR regimes Robin Cowan BETA, Universit´e de Strasbourg; 67085 Strasbourg, France UNU-MERIT, Maastricht University; 6221AX Maastricht, Netherlands [email protected] Nicolas Jonard DEM, University of Luxembourg; L1359 Luxembourg, Luxembourg [email protected] Ruth Samson BSE, Universit´e de Bordeaux; 33608 Pessac, France [email protected] Abstract Many scholars observed changes in the intellectual property rights systems in the 1980s and 1990s throughout the world. Patent systems in particular seemed to be expanding their scope, and the legal system seemed to be changing its attitudes towards intellectual property rights. At the same time, and probably in response, firms started to change their patenting behaviour — treating patents as tools of competition and bargaining rather than as a means to protect the fruits of intellectual labour. In this paper we present a simulation model that can be used to discuss that shift. Firms search for new technologies and patent what they find. But different firms have different strategies: one is to protect an invention; a second is to protect a technology space; the third is to attack others’ technology spaces. In the literature the latter two have been described as different types of blocking. We examine different IPR regimes, characterized by who is able to infringe whose patent rights. This is an extreme case of who is able to extract rents from a given configuration of patent rights. Keywords: Innovation, Patents, Knowledge network, Blocking strategies JEL numbers: O31; O34; C6; L5 This paper is also circulating as a BETA Working paper. 1 Introduction In March 2006, Research in Motion, maker of the Blackberry mobile phone and email device, paid 613 million dollars to NTP to settle a patent infringement case. NTP was a firm that had never made anything, and had no plans to do so in the future. It has been described as a patent troll. The case was settled and the payment made, in spite of the fact that during the litigation the patents were being re-examined on the basis of “overlooked prior art” and were in fact finally rejected as invalid. This case is often seen as one of the paradigm examples illustrating the problems emerging in US, and later worldwide, patent systems. And it was a general issue that exercised Paul David very much at the time. He was very concerned that the then current rapid evolution of patent systems was in the process of destroying the innovation systems they were designed to foster. He spent considerable energy during those years arguing about changes not only to the patent system but to systems of intellectual property rights more generally. He feared that the apparent broadening and strengthening of the system and attendant changes in patenting behaviour of firms in it, was threatening the ecosystem that supported innovation and thus economic growth. Paul David was not the only person thinking about these things; several people noticed an increase in patenting activity, and an increase in the ratio of patent applications to R&D expenditure (Blind et al. 2006, Hall and Ziedonis, 2001 for example) in the late 1980s and 1990s. While there are several candidate explanations for these trends, one in particular raised concerns. This is that firms move away from the traditional motivation for patenting, that is to secure temporary protection of their intellectual property, to strategic motives. Firms developing a product or technological line want to protect possible future technological developments, and so patent pre-emptively to permit continued development of a current trajectory. On the other hand, they may patent with competitors’ trajectories in mind, thus attempting to prevent competitors’ future developments. Both of these strategies were considered troubling, as rather than protecting inventions and innovations, they are walling off pieces of the technological space. If successful, of course, this can impede innovation. A third motive, with less clear cut implications, is the acquisition of patents as bargaining chips, for use in case the firm is accused of infringement. A firm with a large patent portfolio is more likely to be able to defend such a suit by a counter-suit. Less litigiously, firms may simply be able to trade patents, if there is a double coincidence of wants. (See Blind et al. 2006 for further discussion of other patenting motives.) All of these motives raise concerns that the initial rationale for the IPR system has been lost, and that the IPR no longer supports but rather (in several important industries at least) impedes innovation. This paper takes up that concern, and presents a simple model of patenting behaviour, asking about the interaction between firm strategies and micro and macro performance 1 in the face of changes to the structures (and strengths) of the patent system. There is now considerable literature in Management on the implications of patent protection for innovation and R&D investment. Recent studies show that firms patent strategically with motives other than the classical goal of appropriating returns from R&D (Hall and Ziedonis, 2001; Blind et al., 2006; Harhoff et al., 2007; Holgersson, 2013; Holgersson and Granstrand, 2017; Blind et al., 2018). The implications of strategic patenting (for instance, on firms’ R&D investment and market value) have received much attention empirically (Grimpe and Hussinger, 2014; Clancy, 2018; Blind et al., 2009; Helmers and Rogers, 2011; Panagopoulos and Park, 2018) and theoretically (Schneider, 2008; Chu, 2009; Krasteva, 2014; Mihm et al., 2015). Yet, we are still without a nuanced understanding of how firms should search a technology landscape and how optimal search strategies may differ under different IPR regimes. This paper presents a simple model of firms discovering and patenting technologies in the development of different products. We model innovation as a process of building technological bridges, where new technological inventions are combined with existing technologies to advance existing products. This takes place under different IPR regimes, and with a population of firms having idiosyncratic R&D and patenting strategies. Essentially a “product” begins with a pioneering patent, and then is developed as new technologies are discovered, possibly patented, and added to the product (Cohen and Tripsas, 2018). Thus a product or technology evolves through the accretion of new, improvement discoveries. Using a network representation, we capture the structure and evolution of the technology landscape, while focusing on the search and patenting strategies firms might follow. 1.1 Patent protection and strategic patenting In principle the patent system has the primary goal of creating incentives for innovation, which it does by offering limited-time monopoly rights in exchange for full technological disclosure (Drivas et al., 2016; Erkal, 2005; Archibugi and Planta, 1996; Dunlavey, 1955; Crass et al., 2019). However, evidence on whether formal disclosure through patenting encourages or discourages idea generation and innovation is mixed (Boldrin and Levine, 2009; Suzuki, 2015; Ouellette, 2012). On the one hand, studies show that imperfect patent protection, allowing a certain level of imitation, stimulates investment in R&D and innovation Krasteva (2014); Hellmann and Perotti (2011); Klein (2020). On the other hand, there are numerous arguments against patents: disclosure through patents hurts innovation as it discourages agents from engaging in creative endeavours, and the requirements for patent grants involve so much disclosure that imitation is made too easy (Anton and Yao, 2004; Teece, 1986; Boldrin and Levine, 2013; Horstmann et al., 1985; Chu et al., 2012; Suzuki, 2015; Gans et al., 2017; Cockburn et al., 2010). 2 Despite weaknesses in the patent system, firms still do patent their inventions. Indeed, there has been a tremendous increase in patent applications and grants (especially in the US) since the 1980s (Gallini, 2002; Hall and Ziedonis, 2001; Hall, 2004). Many of these commentators have commented on a “regime change” taking place, starting in the US in the 1980s. Among others, Lerner and colleagues1observed a “pro-patent shift” in the legal environment, particularly with the establishment of the Court of Appeals for the Federal Circuit, which focused its attention on patent issues.2One might expect that such a regime change would induce a change in patenting behaviour and in particular a change in the strategic uses to which patents are put. In light of this increase in patenting (and in particular the ratio of patents to R&D expenditure), researchers have established that firms’ patenting decisions vary across industries and types of inventions and are not entirely motivated by the protection of proprietary know-how. Instead, firms’ decisions to file for a patent may encompass a combination of strategic acts to sustain a competitive edge. Firms use patents for strategic reasons, including building a shield around a particular technology to push away rivals, or pre-empting competitors on advances in a particular technology — fencing or offensive blocking (Walsh et al., 2016; Grimpe and Hussinger, 2014; Czarnitzki et al., 2020; Jell et al., 2017). Also, firms use patents to force entry into a particular technology or to block another firm’s downstream invention in a particular direction — defensive blocking (Blind et al., 2006; Hall et al., 2021; Harhoff et al., 2016). Phenomena such as “patent thickets” may arise from fragmentation of the technology landscape when an inventive entity holds several interlocking patents around a core invention to prevent rivals from designing around or developing substitutes (Shapiro, 2000; Cockburn et al., 2010; von Graevenitz et al., 2013). It is also a mechanism that inventors use to block competitors from entering a particular technology and(or) to avoid being blocked by competitors (Mihm et al., 2015; Desyllas et al., 2018). 1.2 The cumulative nature of innovation and product development The notion of “standing on the shoulders of giants” implies that a firm’s quest to innovate does require not only the firm’s “own” stock of knowledge but also the knowledge stock of “others” (Scotchmer, 1991). However, in the context of intellectual property protection, especially using patents, this also implies “standing on the shoulders of rights holders” 1Kortum and Lerner (1998) or Lerner (1995) for example. See Hall and Ziedonis (2001), page 105 for a discussion. 2There was also the discovery by, patent owners, of the Eastern District of Texas, which was particularly favourable towards plaintiffs in patent infringement suits, and especially so towards entities sometimes known as patent trolls. This stopped in 2017 when the US Supreme court limited the ability of plaintiffs to choose the jurisdiction in which they filed suit. See Mullin, 2017. 3 (Duffy, 2008; Ziedonis, 2004). The cumulative nature of innovation engendered the notion of core or pioneering inventions (protected by basic patents) and improvement inventions (protected by improvement patents) (Silverman, 1995; UpCounsel, 2020). Core or pioneering inventions are inventions upon which many other technological developments can be built. The US supreme court defines a basic patent (and invention) as “a patent covering a function never before performed, a wholly novel device, or one of such novelty and importance as to mark a distinct step in the progress of the art” (Merges and Nelson, 1990, pg. 854). In contrast, improvement inventions build directly over another invention, the core or pioneering invention. Without the latter, while the former may exist as a piece of knowledge (invention), it cannot be exploited or marketed (as an innovation). In principle improvements can be “original” if they provide the same functions but with technical modification to the core invention (Merges and Nelson, 1990; Silverman, 1995; Scotchmer, 1991). But, an improvement invention can also be additional, when it adds features, or value, to existing technology.3Inherently, an improvement patent (protecting an improvement invention that meets the patentability criteria) builds directly upon a basic patent (protecting the pioneering invention). In this paper we conceive of improvement patents as adding features to an existing product or technology. Such improvements could be (discovered or) made by the owner of the pioneering patent, or by other firms. Who discovers the improvement patent will have different effects under different IPR regimes. 1.3 Firm strategies The strategic use of patents must be coupled with a relevant search strategy. Where in the technological landscape should a firm focus its R& activities? For fencing, search around one’s own technologies would be appropriate; for defensive blocking, search around a rival’s. If the traditional patent motive is in play the search wherever there might be “good stuff”.4We model firms’ search on the landscape (movement on the landscape) as a deliberate decision to invest in research and development based on various search motives, which are as well the motives behind patenting the resulting inventions. Further, the unpatented inventions represent the uncharted territory of the landscape that no one knows about. In our model, the knowledge discovered and disclosed by other inventive entities act as streetlights illuminating the way. Thus, the landscape is uncharted unless a firm discovers something and discloses it through patenting (pioneer or improvement patent). 3The current technology landscape has evolved to the extent that most inventions seeking protection through patents are improvement technologies, providing meaningful novel, non-obvious, and useful improvements to existing technological inventions (Justia, 2022). 4We have obviously abstracted from issues of path dependence at the level of a firm’s knowledge or competence, so a richer discussion would ask for more nuance in these strategies. 4 A firm’s ultimate payoff from innovation activities depends on its R&D strategy — deliberate movement in a particular direction on the technology landscape — contingent on different external and internal factors such as industry characteristics and appropriability regimes (Teece, 1986; Granstrand, 1999; Pisano, 2006; Laursen and Salter, 2014; Holgersson et al., 2018; Cohen et al., 2000). We follow Granstrand’s (1999) argument that firms’ R&D strategies and patenting strategies are tightly coupled. Mihm et al. (2015) separated firms’ patenting decision (strategy) from R&D strategy and found that firms’ R&D strategy (leader or follower) is the main determinant of patenting strategy (patent all, close competitor, high quality, or nothing). We do not focus on how or what firms decide to patent. Rather, our interest is in the the extent to which products are developed, and whether different patenting strategies pay off differently in different IPR regimes, and under different population ecologies. In what follows we develop a simple agent-based model in which firms explore a technological space in order to improve existing products. A product begins with a “pioneering” patent which can be further developed by technological discoveries. Thus firms explore the technology space, hoping to find a technology that can be linked to an existing product, patented and thus exploited (or to find a new pioneering patent). Different firms follow one of three different strategies, roughly speaking: the classic “appropriate rents from this discovery”; patent to protect my current products; and patent to stop competitors from developing their products. We use the model to explore the value of these different strategies under different IPR regimes and different distributions of the three strategies over the population of firms. 2 Ideas and products There are three parts to the basic structure of the model. We can think of this as a multiplex network of three layers, one lying above the other, and each layer being a reduction of the layer below. That is, the bottom layer represents the technology space, showing how technologies are located relative to each other. The middle layer connects technologies or groups of technologies into potential products. The top layer is a subgraph of the middle layer, showing which technologies have actually been discovered and which products are brought to market. 2.1 Ideas The most basic, foundational, part of the model are ideas or technologies. There are many ideas in the world which might or might not be discovered. Technologically or scientifically, ideas can be close to, or distant from, each other. Thus in the model we 5 ● ● ● ● ● ● ● ● ● ● ● ●● ● ● ● ● ● ● ● ● ● ● ● ● ●● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● 123 2 4 6 8 10 12 14 Strategy Performance Perfect IPR protection \ No trading Figure 2: The distribution of average performance of firms of each of the three behavioral types over 400 replications; perfect IP protection and hard blocking. IPR regime guaranteeing perfect protection, type 1 firms prevail, followed closely by type 2 firms, both far ahead of type 3 firms. A type 1 firm exploits its products through local search, but it also follows the most exploratory behaviour, therefore discovering more pioneering patents, and so controlling more products. A type 2 firms explores less than a type 1 firm, but by remaining in the vicinity of the pioneering patents it holds, also collects high revenues by developing the products it controls. Type 3 firms by contrast behave in a very unproductive way, only searching in the vicinity of other firms’ patents; patents they obtain they cannot exploit themselves, unless by pure luck they happen to he part of a product whose pioneering patent they control (and at the right position in the sequence of improvements). Without trading, they have no means to extract rents from other firms owning pioneering ideas. Given the behaviour of type 3 firms, which tends to block others, most products do not experience their full potential development: indeed, we find that only roughly 30% of the valuable ideas are exploited, which means that blocking occurs on average after the pioneering patent and the first 2 improvements have been found. Thus it is an advantage to own many pioneering patents, since when one product is blocked the firm can move to another. It is the strategy of type 1 firms that leads to the discovery of the most pioneering patents. 5.2 Trading IP Suppose now that if two firms block each other they could trade patent ownership. The idea is that if firm Rholds a blocking patent on a product of firm Gand vice versa, R 12 and Gcould trade those patents (one-for-one) and both firms would be better off. This implies a slight change in the strategy of type-3 firms: they should not search randomly among others’ technologies, but should concentrate search around firms that hold patents blocking their own products. That is, they search for patents that would be useful in making trades. Figure 3 illustrates a case of trading. 12 2220 32 31 30 10 12 20 32 31 30 10 22 13 13 21 21 Figure 3: The current patent and product spaces before (left) and after (right) patent trading with 2 firms (red and green): vertex colors code for firm identity; circles indicate exploitation and squares indicate blockade; coloured edges have the same interpretation as in the potential product space; pioneering patents labeled in bold white font. Red originates a product with node 12, but is blocked by Green who owns node 22 (which renders 21 also unexploitable). Green originates a product with node 20, but is blocked by Red who owns 10. Green owns a second product, (31 −32). Idea 30 has been discovered by Green, but is valueless as it belongs to no potential product. In the right panel, Red and Green have traded patents (10 for 22), and so have both extended their products: Green now offers (20 −10) and Red offers (12 −22 −21). Red would like to include 13, currently owned by Green, but has at this point nothing to offer in trade, and thus (12 −22 −21) is blocked. In Figure 4, we present two boxplots. On the left we repeat the base case; on the right we show the outcomes for the different strategies when trading is possible. A first observation is that trading is beneficial to all, even if only slightly. This implies that more improvement patents are exploited, consumers enjoy better products with more features incorporated, and firms earn higher profits. In terms of relative performance, type 1 still prevails, but the benefits trading provides to type 3 behavior are clearly visible: trading is mostly beneficial to the firm that accumulated bargaining chips by searching where there are many products being developed by others. Nonetheless, accumulating trading opportunities (which might or might not be exploited) remains less profitable than the two other strategies which prioritize developing one’s own pioneering ideas. 13 ● ● ● ● ● ● ● ● ● ● ● ●● ● ● ● ● ● ● ● ● ● ● ● ● ●● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● 123 2 4 6 8 10 12 14 Strategy Performance Perfect IPR protection \ No trading ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ●● ●● ● ● ● ● ● ● ●● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● 123 4 6 8 10 12 14 Strategy Performance Perfect IPR protection \ Trading Figure 4: Box-plot representations of the average performance of the three behavioral types in the absence (left) and presence (right)) of patent trading over 400 replications. 5.3 Imperfect IP protection We consider two forms that imperfect IPR protection can take. The first corresponds to IP infringement that goes unsanctioned when performed by the owner of the pioneering patent. Whether courts are failing at properly defending prior IP, whether they consider IP violation to be less detrimental to innovation than blocking product development would be, or whether the owners of the violated IP do not take the case to court, control over the product is maintained by the incumbent (the owner of the first, pioneering patent in the potential product). In effect, the IPR regime is favoring incumbents. We model this probabilistically, as the outcome of a Bernoulli trial. With probability 1 −β, where βmeasures IP protection, when the owner of the latest improvement also owns the pioneering patent, the incumbent infringes the property rights of any other firm that owns a patent in that product sequence, and captures total product revenue, thereby appropriating the value created by the innovative efforts of others. Essentially, courts are reluctant to stop the development of a product because of a possible patent infringement.9 In the other outcome of the Bernoulli trial, occurring with probability β, strong property rights hold and a patent held by a non-incumbent firm blocks further development. The second form of IP imperfection has a different focus. While IP infringement was a prerogative of incumbent firms, it now becomes possible for firms that do not own 9Of course this is an extreme implementation. More generally what we consider is a case in which it is not very costly for an incumbent firm to infringe another firm’s patent. Or a case in which the holder of a single patent relevant to a product that involves many patents does not thereby have a large claim on rents that accrue to the overall product. 14 the pioneering patent. So in effect, the IPR regime here favours interlopers: the last firm to patent something in a product sequence extracts all the rents of that product, so effectively owns the product, and becomes the incumbent. But that firm can lose it all if another interloper (who might of course be the original pioneer, given the way we have modelled it) appears. With some probability, any firm holding the latest improvement patent infringes the IP of its predecessors in the product, and then behaves with subsequent improvements as if holding the pioneering idea — the owner of the latest improvement, when successful at infringing prior IP, controls the product. Again with probability 1 −β, where βmeasures IP protection, the owner of the latest improvement infringes the property of all the other firms involved in the product, and captures total product revenue, thereby appropriating the value created by the innovative efforts of others.10 Figure 5 presents the relative performance of the three patenting behaviours, when protection is perfect (top row), imperfect and favorable to incumbents (middle row) , and finally imperfect and favorable to interlopers (bottom row), in the absence (left column) and presence (right column) of patent trading. Weakening patents to favour incumbents increases overall payoffs generally. It becomes harder to block an incumbent, so more improvement patents are exploited and more products are more fully developed. Aggregate “output” increases. Additionally, though, the dominant strategy changes: type 2 now dominates types 1 and 3, in this order. By acquiring patents in the neighbourhood of its own patents (which include pioneering patents), the type 2 firm is ideally placed to build up long sequences of improvement patents when infringement is “sucessful”. This applies to other firm types, but with less pronounced effect because they spend more time either exploring away from existing patents (type 1) or searching the neighbourhood of other firms’ patents (type 3). All firms thus perform better, but the increase in performance is maximal for type 2 firms. When the weakening of patents favours interlopers, the performance ordering of type 2 and type 3 firms is reversed, while type 1 firms maintain a intermediate position. When infringement is possible half of the time, searching around the patents held by others rather than seeking to develop one’s own product pays off — type 3 firms are ideally placed to take advantage of imperfect IP protection. Other types also benefit from the failure of IP (profits are larger for all firms than they are under incumbent-favourable weakening), but to a lesser extent. It is quite remarkable that although at first sight the third patenting motive is somewhat unreasonable — rather than trying to develop 10Again this is an extreme. In principle the idea is that the holder of a single patent has “hold-up” power and can extract an unseemly proportion of the rents that accrue to the entire product (see the example of Research in Motion in the introductory paragraphs of this paper). 15 ● ● ● ● ● ● ● ● ● ● ● ●● ● ● ● ● ● ● ● ● ● ● ● ● ●● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● 123 2 4 6 8 10 12 14 Strategy Performance Perfect IPR protection \ No trading ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ●● ●● ● ● ● ● ● ● ●● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● 123 4 6 8 10 12 14 Strategy Performance Perfect IPR protection \ Trading ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ●● ● ● ● ● ● ● ● ●● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● 123 5 10 15 20 Strategy Performance Imperfect IPR protection \ No trading Incumbent−friendly ●● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● 123 5 10 15 20 25 Strategy Performance Imperfect IPR protection \ Trading Incumbent−friendly ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ●● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● 123 10 15 20 25 30 35 Strategy Performance Imperfect IPR protection \ No trading Interloper−friendly ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ●● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ●● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● 123 10 15 20 25 30 35 40 Strategy Performance Imperfect IPR protection \ Trading Interloper−friendly Figure 5: Box-plot representations of the average performance outcomes of the three behavioral types over 400 replications. Note that different panels have different scales on the ordinate axis. its own product, the firm will only try block other firms in the industry — imperfect IP protection will make it most profitable. It is worth pointing out that the dominant strategies do not emerge immediately.11 Regardless of the regime, in the short run type 1 firms report the highest payoffs. They patent the most and exploit the highest number of patented technologies. The discussion above of the long run results of the base case of perfect IPR applies as well in the short run: when blocking is abrupt, it is advantageous to have a strategy that finds many pioneering patents. In the second and third regimes, all firms, but those of types two 11We observed the system after 10 innovative attempts per firm. 16 and three in particular, can gain value by taking over products of other firms. This adds value most clearly to type three firms in the third regime, but also to type two firms in the second (even if someone has “stolen” their product, by continuing to search around their own patents, they can “steal it back”). This sort of theft results in the thieving firm acquiring all the value of the product. But the value of any product will increase with time, so the value of these thefts will also increase with time. Thus early on, developing one’s own products is of more value than stealing others’. So again type one firms dominate in the short run. So in both regimes of imperfect protection, it takes time for the dominant strategy to bear fruit. 6 Dominant strategies in heterogeneous populations In this section, we relax the assumption of an equal number of firms following each type of behaviour, and ask how relative performance changes in population of firms characterized by different prevalence of each behavioral type. We consider a total of 30 firms, and vary the number of firms of each type by increments of 2. To represent the results, we use ternary plots. A ternary, or simplex plot depicts the ratios of three variables that sum to a constant (the shares of each type of behaviour sum to 1) as positions in a triangle. Each point in the triangle represents one population of firms defined by its distribution over the three strategies. At each position then, one reports the value of a 4th variable which is related to the three others. This way, one is able to represent 4 variables (the 3 variables summing to a constant, and the response variable) in a two-dimensional graph. Reading a ternary plot requires a little practice. To illustrate, label the corners {1,2,3}. In any corner, all firms have the same strategy, strategy 1 in corner 1, strategy 2 in corner 2 and so on. Moving away from that corner (corner 1 for example), the proportion of firms using strategy 1 falls linearly, until reaching the edge (between the corners 2 and 3) opposite corner 1. Along that edge no firms use strategy 1, and are thus split between strategies 2 and 3. On any locus of points parallel to edge (2,3), all populations have the same share of firms adopting strategy 1. The outcome variable we report is the identity of the type that most often maximizes performance (over the set of replications run for a given population mix). Each type has a color (blue, green, red). Color opacity increases with the difference between the best performing strategy and the second best performing strategy (in a way, this constitutes a 5th variable). Figure 6 presents 6 panels corresponding to three different IP regimes, crossed with the (im)possibility of trade. Several things are apparent from this figure. The first is to observe the corners of the plot. Here there is little insight: when all firms are of the same type, then naturally this type is recorded as the dominant strategy. That said, on the interior of the simplex, we observe a clear dominant strategy that depends on the IPR regime: in the base, strong 17 Strategy 1 Strategy 2 Strategy 3 Perfect IPR protection \ No trading 1 2 3 Strategy 1 Strategy 2 Strategy 3 Perfect IPR protection \ Trading 1 2 3 Strategy 1 Strategy 2 Strategy 3 Imperfect IPR protection \ No trading Incumbent−friendly 1 2 3 Strategy 1 Strategy 2 Strategy 3 Imperfect IPR protection \ Trading Incumbent−friendly 1 2 3 Strategy 1 Strategy 2 Strategy 3 Imperfect IPR protection \ No trading Interloper−friendly 1 2 3 Strategy 1 Strategy 2 Strategy 3 Imperfect IPR protection \ Trading Interloper−friendly 1 2 3 Figure 6: Ternary representations. Each triangle plot presents the simplex of proportions of firms of each type — a point defines three values that sum to 1. Colours indicate which strategy has the highest payoff, averaged over 100 replications; the opacity indicates the ratio of best to second best payoff, lighter shades being closer to one. blocking case, strategy one dominates; when patent imperfections favour the incumbent strategy two is dominant; and when imperfections favour interlopers it is strategy three. Not only are the different strategies dominant in these cases, but, though we did not structure the experiment specifically to get at it, we can make a strong conjecture that they are also evolutionarily stable. In the middle row, for example, to look at the clearest case, even starting from zero firms of type two, if even one firm changes strategy to type one, it will have the highest payoffs. Assuming firms (eventually) imitate good 18 performers, in time all firms will switch to strategy one. Similarly, though sometimes not quite as stark, in the other cases the dominant strategy yields the highest payoff even if there are very few firms of that type in the population, leading us to conclude that the dominant strategy is also evolutionarily stable. As discussed above, when incumbents can ignore patents that might block the development of their products, it is effective to search near one’s own patents, thereby discovering more improvement patents. Searching around others’ patents may prove futile if the incumbent is “lucky” and can ignore a potentially blocking patent. By contrast in the third regime, where an interloper can grab (in our case) all the rents, an easy way to make large profits is to find a technology that improves an existing product (your rivals having done all the previous hard work, you swoop in at the last minute and grab everything). We can also observe that trading makes little difference to which strategy dominates in general. The one possible exception is in the base case with strong blocking and trading, where if there are few firms of types one and two, type three can still be attractive. This follows from the discussion of trading in section 5.2. A final observation regarding the two imperfect protection regimes: when the dominant firm-type is absent (type 2 in the middle row; type 3 in the bottom row), type one firms achieve the highest payoffs (see the 1 – 3 edge in the middle row; the 1 – 2 edge in the bottom row). The difference between the type-one strategy and the others is that type one firms explore the space much more than the other types do. Thus here we observe that in the absence of the strategy that is finely tuned to the regime, exploration, which is effective in discovering new pioneering patents and thus new products, is particularly valuable. 6.1 Aggregate performance of heterogeneous populations Above we observed that each IPR regime has a different dominant strategy. In Figure 7 we show a measure of aggregate payoofs in a similar ternary representation as in Figure 6. Each point in the simplex represents one population distribution, and the grey scales indicate aggregate payoffs, with darker shades representing higher payoffs. As a measure of performance we use the total number of patents exploited at the end of the simulation, that is, when all technologies have been found. One striking pattern stands out: the more type three firms there are in the population, the lower the aggregate payoffs. The reason is clear: the type three strategy is to block others’ product development. Unless this can be circumvented by trading or IP violation, the more of this activity, the less product development there will be.12. While it appears that overall, the third IPR regime has highest payoffs (and even the worst population there has higher payoffs than the best 12Recall that even in the second and third regime, β= 50% percent of the time patents are enforced, and an interloping patent blocks product development rather than permitting it through IPR violation. 19 population under other regimes), this should be treated with caution. The extent to which patents block depends heavily on the parameter β, the strength of the IPR enforcement regime. We have set β= 0.5 for the second and third regimes, implying that patent rights can be violated very frequently. These violations are what permits further product development. If violations were less common (higher β) this would happen less frequently, and more products would be blocked, lowering payoffs in the second and especially the third, regime. In essence what we observe here is a conflict between optimal and evolutionarily stable individual strategies on the one hand, and social welfare on the other. Again this must be interpreted carefully, because in some sense this is a static model. Firms change neither their search strategies nor their R&D strategies. Considered more generally, blocking is a failure of two firms to come to some licensing agreement, and our regimes represent different distributions of bargaining power over the terms of that agreement. In principle, provided property rights are well established, a bargain should always be struck (even if it leaves the original owner with epsilon). However the predicted nature of these bargains will have an impact on the incentives for firms to become product originators (incumbents in our terms), and clearly the more power held by the interlopers, the less incentive there is to become an incumbent. This will slow down innovation overall, and points to the concerns held by Paul David at the time. 7 Discussion and Conclusion We have presented a simple model in which firms search a technology space for innovations that could create new products or add value to existing products. Search strategies, where in the technology space firms look, are linked to underlying patenting strategies. In the model we have three types of firms: those who simply search for interesting technologies; those who protect their own piece of the space; and those who attack the space of other firms. the first type of firm is simply engaged in non-strategic search for good, that is to say patentable, ideas. In the literature the second type of firm is described as engaged in offensive blocking — its aim is to prevent other firms from encroaching on its activities; the third type of firm employs defensive blocking — it uses patents as bargaining chips either to extract rents from others’ existing products, or for use in patent trading. In a population ecology where all firm types are present, which is the preferred strategy depends on structures of the IPR system. If the system is very strong, and rigid, meaning that a single “interloping” patent will block all further development of a product, type 1 firms dominate. They acquire the largest number of exploitable patents. The introduction of patent trading (so firms who block each other can swap ownership of the critical patents) improves performance of all types, but most dramatically type three firms. Nonetheless, even with trading, simple search for good ideas is the dominant 20 388 241 94 Perfect IPR protection \ No trading 1 2 3 446 322 198 Perfect IPR protection \ Trading 1 2 3 561 379 197 Imperfect IPR protection \ No trading Incumbent−friendly 1 2 3 575 416 256 Imperfect IPR protection \ Trading Incumbent−friendly 1 2 3 750 703 656 Imperfect IPR protection \ No trading Interloper−friendly 1 2 3 755 714 673 Imperfect IPR protection \ Trading Interloper−friendly 1 2 3 Figure 7: Ternary representations. Each triangle plot presents the simplex of proportions of firms of each type — the gray hue indicates aggregate performance (total payoff). strategy. Which strategy dominates, however, changes in response to changes in the patent system. We have avoided discussion of weak and strong patents and instead returned to basics, focusing on how the system rewards patent holders. 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