This article is provided by the Deloitte Institute of Innovation and Entrepreneurship.
The innovation-patent-investment path is a well-trodden one for organisations and lone inventors. Whether it is a new software programme, a novel communications technology, or a strange device built in an obscure R&D unit, the innovator legally protects their invention before investing heavily in its development.
However, as Jean-Pierre Benoit of London Business School, and co-authors Roberto Galbiati and Emeric Henry of Sciences-Po, Paris, point out in their paper, ‘Rational Parasites’, it has not always been this way. In medieval times, for example, social norms were sufficient to sustain long-distance trade even when contract enforcement was unavailable. Indeed, suggest the authors, perhaps bypassing legal protection might actually encourage greater investment and innovation.
Take open source software firm Red Hat. The firm generates millions of dollars of revenues from the sale of its operating system, Red Hat Enterprise Linux. Yet in its annual report it notes that “anyone can copy, modify and redistribute Red Hat Enterprise Linux,” (but not call it Red Hat). Furthermore, say the authors, regardless of lack of patent protection, Red Hat invests considerable sums in research.
The authors speculate that the companies that benefit from imitating Red Hat’s technologies – “the parasites” – choose not to be overly aggressive with their pricing and market share acquisition so as not to discourage Red Hat from investing in research. In doing so they are able to profit from Red Hat’s future innovation. At the same time, it might be prudent for Red Hat to innovate more than it might have done with a legal monopoly, in order to help keep “the parasites” co-operative and avoid a price war. Yet if Red Hat produces a particularly profitable innovation, imitators may be tempted to take as much value as possible now, rather than rely on the risk of lower profits from future innovation.
To test their idea, the authors create two different artificial institutional environments, one with patents and one without. With patents, an innovator can collect monopoly profits, without them, imitators can copy, price and sell the innovation as they wish.
To examine firm behaviour in these situations the authors theoretically model a game situation where a serial innovator first makes a capital investment in innovative capabilities, with the initial investment determining both the prospects of the firm successfully innovating in the future and the value of that innovation. They then tested the predictions of that theoretical model with a game-playing experiment involving 132 people playing a total of 1,756 games.
The games approximated an innovator choosing investments of different sizes, both in a patent and non-patent situation. The patent game was single player, the non-patent game two-player – to reflect the role of the imitators or parasites, with a sub-game assessing pricing and competition effects. The results confirmed the authors’ ideas. Levels of investment by the innovator were marginally greater without legal protection. This was more evident in low risk investment situations because, as the risk increases following a successful innovation, there is greater temptation for the parasites to deviate in their pricing choosing to be more competitive. This encourages the innovator to increase its investment to keep the parasites happy. In particular, to increase the chances of successful innovation – not just the value.
Thus refraining from patenting innovations may increase the prospects of future innovation and investment in that innovation. Some firms may take persuading, however, as proceeding along the no patent route would presumably preclude a firm engaging in patent litigation that can delay or crush emerging competition, and secure billions in damages.
Jean-Pierre Benoit, Roberto Galbiati and Emeric Henry, ‘Rational Parasites’, CEPR Discussion Paper (February 2013) Sharing the light: being overprotective of ideas could dampen creativity.