Don’t Fence Me In: Fragmented Markets for Technology and The Patent Acquisition Strategies of Firms Rosemarie Ham Ziedonis Management Science, 2004 Presented by – Amit Darekar

Objective and Research Question Identify the conditions under which an aggressive patenting strategy is an alternate mechanism that firms use to avoid being “fenced in” Research Question How do firms avoid being “fenced in” by owners of patented technologies in the design or manufacture of their products? Cumulative Innovation – important phenomenon for firm performance and economic growth. So earlier scholars have studied mechanisms that helps transfer technologies and know-how across organizations, such as – internal R&D programs, alliances, participation in professional communities, and hiring of employees. Literal meaning of “fenced in” is “being completely surrounded”. Reasons firms patent in complex industries include – Patent Blocking; improved capabilities to negotiate with owners of external patents; To deter patent infringement lawsuits Don't Fence Me In

Theory cont’d… Does strengthening patent rights promote or hinder cumulative innovation process? Pro – Optimal patent design literature – to induce sufficient R&D investments (Scothmer, 1991) Against – difficulties in IP-related transaction (Merges & Nelson, 1990) Recent literature on firm’s contracting problem in markets for technology Hold-up  TCE (Williamson, 1985) – Asset specificity. “Make-and-buy” vs. “Make-or-buy” decision Patent thickets – Solution? Invent around. Timing is crucial. E.g., Intel Vs S3 Hold ups – when one party is able to expropriate rents from another. Asset Specificity – costly to redeploy assets to alternative uses or users. TCE says that in Hold-ups, 2 things may happen, 1. Firms internalize transactions that involve highly specific assets; 2. Firms underinvest in areas where risks of expropriation are high. A valid patent gives its owner “exclusionary rights”, but not “affirmatory rights”. Simultaneous use and Duplicative inventions  Make-and Buy Vs Make-or-buy choice Patent Thickets – multiple, fragmentary patent owners, i.e. Diffuse entitlements Don't Fence Me In

Theory Societal welfare - Resource may be underutilized in case too many individual exclusionary rights (of too small a scale) are granted (“anti-commons” theory) Example Scenario 1 – Firm uses 1000 patents from same external patent owner Scenario 2 – Firm uses 1000 patents from 100 different owners Implications? Expropriation risks are higher for firms with asset specificity Ex-ante contractual solutions more costly / less feasible for firms that draw on pools of external technologies Don't Fence Me In

Hypotheses H1 – The more fragmented the external technology markets, the more aggressively firms will patent (beyond what is otherwise predicted). H2 – The effect of fragmented external rights on incentives to patent will be more pronounced among capital-intensive firms (all else equal). H3A – The effect of fragmented external rights on incentives to patent will be stronger following the “pro-patent” shift in the US legal environment (all else equal). H3B – The interaction effect between fragmented rights and capital-intensity will be greater in magnitude following the “pro-patent” shift in the US legal environment (all else equal). H1 – If fragmented rights to patents render ex-ante contracting less feasible, one should expect firms that draw widely distributed technologies to patent more aggressively. H2 – When external technology market is fragmented and cost associated with potential held-ups are large, firms will invest heavily to forgo the potential costs and delays in negotiating with patent owners. H3A – “Pro-patent” shift in US legal environment will act mediate Don't Fence Me In

Construct Existing literature lacks reliable measure for firm’s technological use, hence suggested new measure Fragmentation Index NBCITES (Number of backward citations) is the total number of citations listed in patents assigned to each firm (on an annual basis). j refers to each unique entity that is cited by patents issued to firm i in a given year. F Hat - To correct for statistical bias towards firms with few patents as suggested by Hall(2002), normalized index Don't Fence Me In

Methodology Population – US firms having business in semiconductor and related devices (SIC3674) Sample – 110 publicly traded US firms and are included in Compustat Final sample – 72 firms Estimation sample – 67 firms, 1980 - 1994 Period – 1975 to 1996 Estimation Sample – To test H31 and H3b, sample is divided into years before and after the strengthened US enforcement regime. Although new appellate court was established in 1982, until 1985-86 when Texas instrument and Polaroid won large patent suit, the impact was not felt in industry. Further as suggested by literature, this paper has considered the year 1985 as the benchmark to split the period into pre and post “propatent” regime Don't Fence Me In

Model and Variables Expected number of patents applied for during a year CV Size of firm R&D spending Capital-intensity Dummy variable for Texas Instruments (an outlier) Annual time dummies DV – # of successful patent applications made by firm in a given year IV Firm-specific annual Fragmentation Index Interaction – Fragmentation Index and Capital-intensity DV – Propensity to patent Don't Fence Me In

“Qualified” support to H1 Results(I) Robustness: Fragmented index is simply an indirect proxy Omitted variable bias Some firms “better” at assimilating external technologies  Internal decisions of firms to acquire patents is affected by external distribution of patent rights surrounding technologies H2 H1 Fragmented Index Omitted variable bias: Firms “better” at assimilating external tech Qualified support to H1  suggests relation bet fragmented rights and incentive to patent is more complex “Qualified” support to H1 Don't Fence Me In

Results(II) Supports H2 the total slope coefficient for capital-intensity in Column 3 switches signs within the sample and is positive only for above-mean values of fragmentation (at values ≥075). Capital-intensive firms do not patent more intensively than other firms in the sample (again, controlling for other factors) unless they build on fragmented pools of outside technologies. Don't Fence Me In

Results(III) Column 1a and 2a  semiconductor firms’ decision to patent became less responsive to changes in their R&D investments during the era of strong patent rights; and capital-intensity emerges as a strong, significant predictor of these firms’ patenting behavior only under the “propatent” regime (supportive of the hypothesis that capital-intensive firms responded strategically to the legal reforms by amassing portfolios of patents). Don't Fence Me In

Conclusion Contribution Deepens understanding on broader, strategic motives for patenting Isolates dimensions of a firm’s contracting problem in markets for technology Shows how firm-specific and environmental factors interact with shape incentives to patent New empirical evidence on determinants of patenting in semiconductors Explores trade-off among mechanisms and identify conditions under which an aggressive patent acquisition strategy represents alternative organizational response. Suggests role of complimentary assets, apart from patents, that a firm can earn rents from (inspiration to - Arora & Ceccagnoli, 2006) Don't Fence Me In