Posted by Social Science Research Network
By Michael Mattioli (Indiana University)
Abstract: Individuals who decline to join cooperative groups—outsiders—raise concerns in many areas of law and policy. From trade policy to climate agreements to class action procedures, the fundamental concern is the same: a single member of the group who drops out could weaken the remaining union. This Article analyzes the outsider problem as it affects patents.
The outsider question has important bearing on patent and antitrust policy. By centralizing and simplifying complex patent licensing deals, patent pools conserve tremendous transaction costs. This allows for the widespread production and competitive sale of many useful technologies, particularly in the consumer electronics industry. Because these transaction cost savings appear to outweigh the most common competition-related concerns patent pools raise, antitrust authorities generally view these private pools favorably.
Others are less sanguine. Most patent pools are incomplete: for the technologies they cover, not all relevant patents are included. The reason for this is understandable: patent holders sometimes believe they can negotiate for higher royalties by declining to join an existing pool. Antitrust regulators are aware of this behavior, but do not worry much about it. A growing number of economists and legal scholars believe, however, that this outsider behavior may impose higher costs on pool licensees, detracting from the central benefit that patent pools offer—transaction cost savings. These commentators urge antitrust regulators to regard patent pools with greater caution and skepticism.
These calls for caution, however, are based mostly on theories about how patent pools should work, rather than empirical study. Remarkably, little research has been done to shed light on the actual impact of patent pool outsiders. Through an original ethnographic study, this Article seeks to remedy this gap. A set of the most notable and public episodes of outsider behavior were collected from industry press reports, case reports, and historical archives. Crucial new information was then gathered through interviews with lawyers and executives directly involved with the episodes studied.
The study reveals a characteristic of patent pools that has gone unappreciated until now: they subtly but powerfully influence bargains that take place “poolside”—i.e., deals between patent holders and licensees that take place “in the shadow” of the pool. This spill-over effect can beneficially limit the power that theorists have assumed outsiders to have. This is an unappreciated benefit of cooperation. The theorists, as it turns out, have not used the wrong approach, but rather, have been missing some important parameters.
To further aid regulators, this Article builds upon its qualitative findings by introducing a new quantitative technique for estimating the cost that a licensee either incurs or saves due to an outsider. Applying this technique to original financial and industry data gathered from research subjects, this Article shows that, counterintuitively, patent licensees are sometimes better-off where cooperation among licensors is partial, rather than complete. The inflection point lies where the royalty rate hike that a unified pool would need to charge to draw in an outsider is equal to the transaction costs that licensees would conserve by dealing with a single pool.
This study’s revelations have provocative implications that reach beyond patent law. Contrary to conventional wisdom, slightly fragmented property markets may sometimes be preferable to “grand coalitions.” There may exist in any given market for complementary patent rights (or other complementary property rights), an optimal level of diffusion of ownership that resides between total diffusion and total concentration. Some cooperation may not only be better than none, but also better than more.
Drawing upon this study, antitrust regulators who must evaluate patent pools can assemble a clearer and more complete understanding of their overall costs and benefits—a topic that Robert Merges and I recently wrote on in a related article. This Article is also helpful beyond patent law. The ethnographic methodology followed here reveals dynamics between outsiders and groups that theory alone has not captured. Scholars concerned with outsiders in other areas of law and policy can refine and build upon theory by applying a similar ethnographic approach.