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Cooperation in R&D: The Case
of Patent Infringement Agreements Sugata Marjit, Arijit Mukherjee and
Heling Shi ABSTRACT: The paper attempts to provide
a strategic rationale behind patent infringement agreements (PIA).
PIA is to be viewed as a form of ¡§coopera-tion¡¨
in an otherwise non-cooperative environment. In this paper, we develop
a symmetric duopolistic structure where firms initially hold certain
patents and invest for further R&D. In the process of R&D,
firms face a positive probabil-ity of infringing the patents held
by the other. Once infringement takes place, the infringing firm has
to pay a compensation to the patent holder. The PIA scheme generates
a binding contract suggesting that such infringements would go unpunished.
We prove that (a) If the infringement probability is not too ¡§low¡¨,
firms would have incentives to sign a PIA and sacrifice the monopoly
option. In case the infringement occurs with certainty, PIA dominates
the non-cooperative outcome; (b) For relatively low and high probabilities
of in-fringement, PIA dominates state-contingent PIA; and (c) The
likelihood of signing PIA will also increase with the probability
of failure in R&D. JEL classification: L1 Key Words: Patent Infringement Agreement,
Cross-licensing This paper is about patent infringement agreements
(PIA hereafter), a term commonly used in the circuit of software specialists.
Companies such as IBM and Apple have some PIA agree-ments in practice1.
These agreements are drawn to make such that the software developers
in course of developing new software programs can utilize the existing
knowledge of the competing specialists. Interviews with self-employed
programmers reveal that they are interested in accumulating a reasonable
number of patents so that other big companies are willing to write
such agreements with them. In fact this is perceived to be a mean
of recogni-tion for the entrepreneurship in the business. This paper
provides a theoretical rationale behind PIAs. We view PIA as a cooperative
agreement in the sphere of R&D in the absence of explicit or implicit
collusion in the product market. This immediately relates our work
to the growing literature on cooperation in R&D2. More Specifically, PIA is an arrangement that:
i) is designed to deal with the acciden-tal infringement of other
party's patents. An infringement is said to be accidental if the infringement
or non-infringement does not significantly alter infringing party¡¦s
investment costs in R&D, nor does it substantially influence the
returns in marketing the final product3. Under such definition, infringement
of patents is not a strategic choice; and ii) is usually signed before
any R&D activities would be undertaken [like research joint ventures
(RJV)]. Patents laws assign monopoly rights to the
patent holder and it is usually expected that such rights will be
exercised in the event of a patent violation. Apparently close competitors
in a particular product market should be enthusiastic about enforcing
their patent rights to protect their market share from their rivals.
However, such aggressive behavior might be unsound when firms, in
their bids to innovate a new process or product, are likely to overstep
into each other's existing territory. In a world where innovations
are extremely frequent and technological progress is intense, like
information technology Industry, competing firms might find it costly
to exercise their patent rights all the time. Apart from such "transaction" costs,
there is also a reciprocal infringement problem. Intuitively, if two
firms operate in an industry where innovations are extremely frequent,
though the protection of one's patents could enhance its market power
by prohibiting rivals imitating the new technology and new product,
it is equally possible that he would infringe other party's patents,
be prohibited to use the new technology and new product, be forced
to pay compensation, and therefore suffer the lose of market power.
PIA works like risk-pooling: it scarifies the possibility of gaining
market power to avoid the possibility of losing market power. success
of these two operation systems are mainly lying on their own merits.
In IT industry, technology innovation is converging and some level
of overlapping seems inevitable. 4 Cross-licensing of patents is a well known
phenomenon4 and recent papers by Fershtman and Kamien (1992) and Eswaran
(1994) explain in detail the strategic motivation underlying such
arrangements. Cross-licensing, as explained in these works differs
from a PIA. Under cross-licensing firms can actually market the knowledge
brand of the competitor. Fershtman and Kamien (1992) show how complementary
technologies would be cross-licensed while Eswaran (1994) explains
how cross-licensing of competing brands can facili-tate implicit collusion
in the product market. With PIA firms are not supposed to market competing
brands and in fact we would show that they do not have any such incentives.
Even a absolutely non-cooperative product market can give enough incentive
for the parties to write a PIA. A PIA is required simply because accidental
patent-violation can be very costly. The right to utilise the existing
technology of the purpose of R&D, however, does not allow the
rivals to market each other¡¦s brand. This is a crucial
difference from the pure cross-licensing phenomenon. It is assumed
of generality that IBM packages can not be marketed by the Apple or
vice verse. Under PIA, firms may not be observed to utilize the technologies
of their rivals. In what follows, we develop a symmetric duopolistic
structure where firms initially hold certain patents and invest for
further R&D. In the process of R&D, firms face a positive
probability of accidentally infringing the patents held by the other.
Without an agreement, once infringement takes place, the infringing
firm has to pay a compensation to the patent holder, and the new technology
can not be marketed. The PIA scheme, on the other hand, generates
a binding contract suggesting that such infringement would go unpunished.
PIA confers the benefit that if the R&D is succeeded the firms
has utilized the rivals patented information, one does not have to
worry about the legal problem in marketing the new technology. The
implicit cost of writing a PIA is that one has to sacrifice the monopoly
option which is there without the PIA, ie. non-infringing successful
innovator can emerge as a monopolist when other player¡¦s
success depends on the infringement. Trade-off between these incentives
would generate a PIA provided the infringement probability is not
too low. We show this in section II. We introduce the problem of a self-enforcing
PIA in section III, dropping the assump-tion that a PIA as developed
in section II is enforceable in the court of law. We derive alternative
contractual form called ¡§state-contingent PIA¡¨
or SPIA. We prove that SPIA will always dominate non-cooperative R&D.
With monitoring costs, it is likely that PIA will dominate SPIA when
the probability of infringement is relatively high or relatively low. Both section II and III assume that there
is no failure in R&D. Section IV extends the simple model of PIA
into a model with a positive probability of failure and argue that
chance are even higher that a PIA would be contracted relative to
the ¡§no-failure¡¨ case in section II and III.
Section V concludes the paper. We can prove that: a) If the infringement probability is not too ¡§low¡¨, firms would have incentives to sign PIA. In case the infringement occurs with certainty, PIA dominates the non-cooperative outcome (In a simplified model with a Cournot-Nash example of cost-reducing drastic innovation, an infringement probability as low as 20% could induce firms to sign PIA); b) For relatively low and high probabilities of infringement, PIA dominates SPIA; for a moderate probability of infringement, SPIA dominates PIA; c) The likelihood of signing PIA will also increase with the probability of failure in R&D. Inframarginal Econimics Society www.inframarginal.com
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