Topic 15:Antitrust and Intellectual property rights

TOPIC 15: ANTITRUST AND INTELLECTUAL PROPERTY RIGHTS

Topic 15| Part 1 26 November 2013Date

ANTITRUST ECONOMICS 2013David S. EvansUniversity of Chicago, Global Economics Group

Elisa MariscalCIDE, Global Economics Group

2Overview

Part 1

Overview of IP Rights

Economics of Intellectual

Property

Tension Between

Antitrust and IP Protection

Licensing of IP

Part 2

Purpose and Effect of Vertical

Restraints

Bundling and Tying

Loyalty Rebates

3 Overview of IP Rights

4Simple Economics of Property Rights

• Power to exclude others from using a resource: others can’t trespass for instance.

• Ability to control the property: the property can be used and improved however the holder sees fit.

• Ability to benefit from the property: the owner keeps whatever profit or other benefits come from the property.

• Power to transfer property: all of these rights can be transferred to someone else and thus the property hold can realize the capital value of the property.

Property Right is a Legally Enforceable:

5Property Rights Provide Key Economic Incentives

Incentive to maximize the value of the property.

Incentive to limit access to depletable property to those who value the property most highly.

Incentive to transfer property to highest valued user.

6

Property Rights Solve the “Problem of the Commons”

No one owns the town commons. Therefore farmers use it for grazing so much that the commons is depleted. Individual action harms the collective good and makes every individual worse off.

To solve the problem of the commons there has to be the ability to charge for use and therefore to exclude. Moreover, with no ownership, property isn’t in the hands of those who can do the most with it.

Most environmental problems including global warming result from lack of ownership and ability to exclude. If only someone owned the ozone layer ….

7Social Benefits of Property Rights

Assume property can be used for production of goods and services that provide value to consumers.

• Incur cost of creating property.• Bear risk that future value may not materialize.

Property rights provide incentives to create property in the first place (why build a factory if you can’t realize the economic return from it?)

Property rights provide incentives to maintain property.

Property rights provide incentives to make sure property moves to its highest valued social use (I have the ability to get some of the surplus from the highest valued user and therefore have an incentive to transfer the property).

8Social Cost of Property Rights

Owner may not have incentive to take into account positive or negative externalities of its property; results from transactions costs being high so, e.g., beneficiaries of property can’t negotiate a sale.

People may spend too many resources “grabbing” property—e.g. consider domain names on the internet.

Owner may sub-optimally restrict access to property—this is the typical situation when the owner has market power.

9The Tradeoff Decided by Market Economies

Strong protection of property rights—many rights assigned so owners can exclude others and appropriate the gains.

But not complete—some rights are unassigned (e.g. Internet) and others are taken on by the government (waterways). Many more incomplete rights when we discuss products of the mind.

Protection not absolute—government can “take” property under some conditions even in very market-oriented economies.

Market economies have all decided that strong property rights promote investment incentives that significantly benefit society in the long run.

10 Economics of Intellectual Property

11

Intellectual Creations Can Lead to Immense Social Value

Mathematical and scientific theorems (Special Theory of Relativity).

Music (Ode to Joy).

Written works (Harry Potter).

New products (iPhone).

Technologies that lower costs (Google Search).

12

But Should the Creators be Given Property Rights to the Products of Their Minds?

The economic analysis is actually very complicated as we will see.

But in fact society doesn’t give any property rights to many creations of the mind (Einstein could patent his refrigerator inventions but couldn’t exclude anyone from using the special theory of relativity).

And when it does give property rights it often limits those property rights much more severely than it does rights to tangible creations (patents and copyrights are limited).

13

The Economics of “Creations of the Mind”—Support for Protection.

Once you have created something it is essentially costless to reproduce.

Once you disclose a mental creation, exclusion is very difficult.

Ex post it is socially efficient to make it available to everyone, since marginal cost is zero.

Ex ante people may have little (if any ) incentive to incur the cost and risk of creation, if they can’t exclude and charge.

Forward looking rules should of course focus on ex ante and therefore provide incentives to create.

14

The Economics of “Creations of the Mind”— Further Support for Protection

New products immensely valuable and vastly outweigh any loss from monopoly pricing.

Most entrepreneurs fail and earn no return (e.g. dotcom bust).

• Most efforts to develop new drugs fail; only a small fraction of efforts lead to drugs that makes it to market.

• Most movies don’t recover costs.• Most graduates of prestigious music schools never earn a

living in music.

Examples from particular industries:

Evidence that society under-invests in research and development.

15Economics of “New Products”:

Q

P

MC

Value of New Product (increases from zero to this value (minus perhaps value of products it has displaced)

Demand

16Economics of “New Products”:

For the United States the annual consumers’ surplus is approximately $78.1 million from the introduction of a new brand of cereal (Apple Cinnamon

Cherrios).

17

The Economics of “Creations of the Mind”— Support for Limiting Protection

Costs of creation might be very low—some things might be just sitting there ripe for discovery with no effort and may be very obvious; others were close to discovering the theory of relativity.

People might require very minimal incentives to create things—fame and social prestige (more below). Tim Berners-Lee created many of the key innovations for the Internet for no reward but fame. Likewise Linus Torvalds who invented Linux the leading open source operating system.

Therefore granting property rights may not encourage production of creative things but will limit the dissemination sub-optimally as the first creators exercise their property rights. Consider charging “calculus” invented by Newton and Leibniz (a pence a derivative).

People may waste time in a “land grab” for creations.

The problem of the antitcommons—people’s ownership rights create transactions costs which makes it hard to combine products of the minds into something useful.

18

Most Market Economies Have Developed Devices for Stimulating Creativity that Balance These Trade-offs: Social Incentives

• Prizes—e.g. famous English competition for development of device to measure longitude; see Dana Sobel Longitude; Nobel Prizes; etc.

• Social prestige (a “Sir” goes a long way).• Academic competitions for stature—most highly successful

academics earn little but get satisfaction from gaining accolades from their peers.

• Government subsidies for innovation such as to academic research.

• Government production of innovation such as CERN collider.

Society has developed many incentives for innovations that don’t depend on property rights.

19

Most Market Economies Have Developed Devices for Stimulating Creativity that Balance These Trade-offs: IP Rights

Incentives that rely on limited property rights:

Patents are time-limited property right in return for disclosure of knowledge. Patent holder receives monopoly over e.g. 20 years but in return for telling the world what the invention is.

Copyrights are time-limited property rights over writings, music, etc. Note that the length of copyright protection has increased over time (see Mickey Mouse debate in the US.)

Trade secrets give the right to keep knowledge a secret and prevent theft. But the holder has no rights if someone figures it out on their own (through reverse engineering for example).

20 Tension Between Antitrust and IP Protection

21

Intellectual Property Grants “Monopoly” over Creation

Owner restricts output to bid up price for creation or products or services based on the creation; particularly a problem since marginal cost of intellectual property ex post is zero.

• Whether an IP right grants market power depends on facts; most IP in fact is either worthless or isn’t sufficiently unique to generate more than a competitive return even ex post.

A few notes:

The important question is ex ante: has society set the rules for intellectual property in such a way that ex ante investors can only expect a risk-adjusted rate of return on average?

22Antitrust Limits the Abuse of Market Power

• EC: Article 102 prohibits firms from “abusing” a domination position through exclusionary and exploitative practice. Aside from merger clearance it does not limit firms from obtaining a dominant position or increasing their degree of dominance.

• US: Section 2 of the Sherman Act prohibits the acquisition or maintenance of monopoly power. US antitrust law does not limit the use of monopoly power to charge high prices and therefore does not have the corresponding notion of exploitative abuse.

Antitrust is designed to limit the ability of dominant firms to harm competitive process.

Possible tension between antirust and IP law: antitrust law limits monopoly power while IP law bestows market power. How can this be

reconciled?

23

The Benefits of Monopoly Recognized in Antitrust Jurisprudence

Advocate General Jacobs tells us in Bronner that “… if access to a production, purchasing or distribution facility were allowed too easily there would be no incentive for a competitor to develop competing facilities. Thus, while competition was increased in the short term it would be reduced in the long term.”

Judge Learned Hand’s decision in Alcoa : “the successful competitor, having been urged to compete, must not be turned upon when he wins.”

Justice Scalia’s “monopoly is good” view in the 2004 Trinko: monopoly is “not only not unlawful; it is an important element of the free-market system.”

24

Still Lots of Conflicts between Antitrust and IP that Need to be Resolved

Have firms unlawfully obtained a monopoly by abusing the intellectual property rights system? (e.g. abuse of the patent process, patent misuse, patent walls, etc.)

Does an intellectual property right create an essential facility? (No obvious reason to treat physical and intellectual property differently.)

Is an intellectual property right being used as part of an anticompetitive strategy? (e.g. tying, bundling, predatory pricing, exclusive dealing, price fixing, etc.).

25 Licensing of IP

26When and Why Do Firms License

• The willingness to pay of a potential licensee exceeds.• The willingness to accept patent by a potential licensor.

Economics of business decisions says a patent is licensed when

• Another firm can make sales it can’t and it can set license fee to more than offset the cost of possible cannibalization of its own sales.

• Another firm can make sales using the patent more efficiently than it can. Then there is more profit to be made be letting the other firm license and taking a piece of the profits in the form of a license fee.

Why would patent owner want to license

• Worries about creating another competitor.• Cannibalization of sales.• In principle these are just a question of whether the licensee is willing

to pay enough to offset these costs.

Other considerations on why a licensor doesn’t license

27Compulsory licensing of IP

What determines contract between willing licensee and licensor (between licensor’s minimum price and licensee’s maximum price)?Is it surprising that licensor and licensee don’t come to an agreement? (no—this happens all the time in competitive markets.)

• Economics focuses on vertical foreclosure theories and looks at whether firm has incentive and ability to prevent competition in adjacent market by refusing to grant access to IP.

When is refusal to license anticompetitive?

EC law has adopted a weak per se legality rule for refusing to license. Refusal to license ok, but for exceptional circumstances. Not so clear after CFI’s decision in Microsoft.

28

Bronner/Magill/IMS “Exceptional Circumstances Test”

Property is indispensable to compete.

Refusal will (risk) elimination of competition in market.

Will prevent the emergence of new product for which there is demand.

Is not objectively justified.

29

Key Issue in Microsoft Case Was Whether Licensing Would Increase or Decrease Innovative Efforts

Commission argued that by making protocols for interoperability more widely available competitors would innovate more and that Microsoft didn't need to protect these protocols to have an incentive to innovate.

Microsoft argued that forcing it to give competitors intellectual property would reduce its incentives to create and improve protocols.

30Overview

Part 1

Overview of IP Rights

Economics of Intellectual

Property

Tension Between

Antitrust and IP Protection

Licensing of IP

Part 2

Purpose and Effect of Vertical

Restraints

Bundling and Tying

Loyalty Rebates