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The Digital Music Distribution Revolutiona
Fraunhofer and MP3
In 1991, Fraunhofer IIS of Germany developed an algorithm that would set in
motion a revolution in how music was distributed, stored, and consumed. The algorithm
(commonly referred to as a codec) allowed compression of digital audio
to approximately one-tenth of its original size with minimal compromise in audible
quality. The format also enabled song information such as the song title and
artist to be embedded within the file. This format for compressed audio files was
later dubbed MPEG-1 layer 3—a.k.a. MP3. By 1995, software programs were
available that enabled consumers to convert tracks from compact discs to MP3
files. This technology transformed how music could be manipulated—a song was
now a file that could be kept on a hard drive, and the file was small enough to be
shared over the Internet. The MP3 format became wildly popular by users sharing
their music online, and software companies began releasing many variants
of MP3 encoders (utilities that compress files into MP3s) and decoders (utilities
that play back MP3s). Hardware manufacturers decided to capitalize on this new
trend and several hardware MP3 players began appearing on the market.
With the growing popularity of the file format, Fraunhofer was faced with a
dilemma—should it enforce its patent on the use of the MP3 algorithm and attempt
to collect royalties for its use, or should it allow users and software/hardware
manufacturers to make free use of the algorithm, allowing the momentum of
the format to build? If it was to limit the use of the algorithm, it faced the risk of
established rivals such as Microsoft and Sony developing competing formats, yet if
it allowed free use of the algorithm, it would be difficult to profit on its invention.
Fraunhofer decided to pursue a partially open licensing approach, partnering
with Thomson Multimedia as the exclusive licensing representative of MP3 patents
Thomson, in turn, negotiated agreements with several companies including
Apple, Adobe, Creative Labs, Microsoft, and many others. Such a broad base of
MP3 licensees (100 by April 2001) provided consumers with easy access to encoders,
decoders, and the format in general. Licensees generally opted to provide decoders
free of charge, while charging a nominal fee to those who wished to encode MP3s.
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178 Part Two Formulating Technological Innovation Strategy
Fraunhofer continued to innovate, introducing the mp3pro format and
working on the Advanced Audio Coding (AAC) format with Dolby that Apple
would later use. Many other companies also developed or adapted their own
audio compression codecs including Sony (ATRAC codec, originally developed in
1991 for use with Mini Discsc
) and Microsoft (WMA, launched in April 1999d
However, by 1996, MP3s could be found on computers worldwide, and it
appeared that MP3 had won the battle for dominant design in compressed
Napster Takes the Lead
In 1999, while a student at Northeastern University in Boston, Shawn Fanning
released Napster—a software program that allowed users with Internet access
to easily share MP3 files. Napster provided a user-friendly solution to music fans
wishing to share and find music online. Napster provided a user interface with a
search box that pointed individuals to other users with the files they wished to
download. The Napster servers did not host any MP3 files; rather they hosted a
database with information on which users had which files to share and whether
they were online, and connected one computer to another for downloading.
Napster was one of the first widely adopted “peer-to-peer” applications, and
helped popularize the term.
Napster was free, and as the growing number of people with Internet access
realized, so was the music that it allowed them to access. Users were increasingly
trading copyrighted material—commercial records and songs. In fact, the
great majority of music downloaded through Napster was copyrighted material.
By March 2000, 5 million copies of Napster had already been downloaded.e
its peak, there were 70 million Napster users.f
While “music pirates” around the world embraced Napster, the Recording
Industry Association of America (RIAA), the trade group that represents the leading
music business entities in the United States, grew increasingly alarmed. The
RIAA worried that the growing illegal trade of music would result in a loss of
profits for its constituents—record labels that owned the rights to much of the
popular commercial music that was being traded online. The RIAA initiated legal
action against Napster and Napster users in an effort to take the service offline
and curtail illegal file sharing. This move was controversial for several reasons.
Some analysts believed that it would be difficult to fight a technological advance
such as this by legal action alone, and that the RIAA would not be successful
unless it offered a legitimate alternative for users who wished to purchase music
online. Other analysts took an even stronger stance, arguing that the record
labels were not only fighting to protect the rights of artists, but to protect a
business model that had become outdated.g
They argued that the popularity of
Napster was partially due to the rigid and overpriced traditional music distribution
model, where fans were forced to buy albums for prices that some felt were
inflated, and did not have the choice to buy individual songs. This was not the
first time the entertainment industry had resisted a change in business models
and was reluctant to embrace a new technology. A 2001 article in The Economist
pointed out that “Phonographs were going to kill sheet music, the rise of radio
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Chapter 9 Protecting Innovation 179
threatened to undermine sales of phonograph discs, video recorders were going
to wipe out the film industry, and cassette recorders spelt doom for the music
business. . . . In each case, their fears proved unfounded. The new technologies
expanded the markets in unprecedented ways.”h
Some commentators believed
that the new technology could be beneficial for the recording industry.
If harnessed appropriately, it could enable an inexpensive distribution method,
as well as direct intimate interaction with consumers that allowed for targeted
In 2001 Napster offered the RIAA a partnership that included a legitimate digital
distribution model that would make online music available via a subscription
service. The RIAA declined, and instead continued to pursue a legal judgment
against Napster. In July 2001, the court ruled in the RIAA’s favor, and the Napster
service was taken offline. It was a blow to peer-to-peer fans worldwide.
Though the record labels had won the battle against Napster, they began to
realize the war was far from over. Services similar to Napster began to sprout
up online, offering “users in the know” the opportunity to continue pirating
music. The record labels continued to pursue legal action against peer-to-peer
services and users who engaged in illegal file trading, while coming to terms with
the need to offer a legitimate alternative service. Subsequently, Warner Music
teamed up with BMG, EMI, and RealNetworks to introduce MusicNet, and Sony
Entertainment and Universal created Pressplay, both of which were subscription
services that enabled individuals to download music legally from the Web.
However, in an attempt to control their music catalogs, the labels used proprietary
file formats and severely limiting digital rights management (DRM) schemes
that confused users. Furthermore, neither service offered the breadth of selection
offered by unauthorized peer-to-peer services such Kazaa or Gnutella. The
popularity of peer-to-peer music swapping continued to grow. The RIAA needed
a savior. Steve Jobs offered to be that guy.
iTunes Just in Time
On April 28, 2003, Apple opened its iTunes Music Store. After striking agreements
with the five major record labels (Sony, Universal, BMG, Warner Music
Group, and EMI), iTunes launched with an initial catalogs of 200,000 songs
for purchase at 99 cents per song.i
iTunes showed immediate signs of success,
boasting 50 million downloads within the first year, and quickly became the leading
distributor of music online.j
Apple got the blessing of the recording industry
after guaranteeing them that the files offered via the Music Store would allow
for protection against illegal sharing thanks to the “FairPlay” DRM scheme. In
essence, the iTunes Music Store offered audio in two file formats—Advanced
Audio Coding (AAC) and modified MP3s. With Apple’s Fairplay DRM, song files
could be loaded on up to five computers only, and could not be played on noniPod
MP3 players. In addition, the files could not be e-mailed or distributed over
the Web, and files were “hidden” on the iPod through a subdirectory structure
that made it difficult to copy songs from a friend’s iPod. All of these features
helped to prevent users from mass-distributing songs to others, helping to ease
the minds of record company executives.
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180 Part Two Formulating Technological Innovation Strategy
The success of iTunes was fueled by a number of factors. The company had a
“cool” image that was attractive to the recording industry and users alike. The
company also used the familiar MP3 format, offered an attractive price tag for
online music, and its licensing agreements with all five major labels enabled it to
offer a one-stop source for customers. In addition, the FairPlay DRM was not as
restrictive as other competing formats,k
and this was important to many users.
The success of iTunes was also accelerated by the success of Apple’s iPods. iPods
are hard-disk-based portable MP3 players that are well designed, well marketed,
and user-friendly. Though there had been some criticisms concerning their
dependability (chiefly related to battery life)l
and sound quality issues,m casual
music consumers took to these players in large numbers. To the appreciation of
the RIAA, the iPods required synchronization with one’s music collection via the
iTunes application, thereby making it difficult to share music stored on the iPod,
or purchased from iTunes.
The recording industry had found a new channel of distribution that earned
significant revenues (about $.70 of every $.99 sale on iTunes is delivered directly
to the record labelsn
), and Apple had licensing agreements with all the major
labels, which afforded Apple access to a huge catalogs. Apple leveraged this
catalogs to entice users to buy music through its iTunes Music Store, and this in
turn helped drive sales of the Apple iPod, since files bought on iTunes could not
be played on rival MP3 players. Apple was well positioned, but threats loomed
on the horizon.
In March 2006, the French National Assembly approved a bill requiring Apple
to open its FairPlay DRM technology to industry rivals in France.o
This meant that
Apple would have to allow songs downloaded from the French iTunes Music
Store to be played on non-iPod MP3 players, and that iPods would need to play
competing file formats, such as Sony’s ATRAC3 files purchased through the
Sony Connect online music store. Many users could appreciate this interoperability,
yet it would challenge the “single operator license model” that had eased
the minds of the recording industry and created a large and loyal customer base
for Apple. Initially analysts speculated that Apple would withdraw from the
French market, but instead Apple began working on negotiating fewer DRM
restrictions from the record labels. By March of 2009 Apple had convinced all
the major labels to permit their songs to be sold through iTunes without DRM.
In return, Apple adopted the tiered pricing model that the major labels had long
The rise of smartphones that could hold users’ music digital libraries in addition
to offering a host of other useful functions helped to fuel the growth
of digital music sales, and in 2011, sales of digital music surpassed the sale
of physical music for the first time ever, capturing 50.3% of the total market
for music. However, analysts speculated that the near future of music might
involve a transition away from sales of music completely. Rapidly growing
services such as Pandora and Spotify offered streaming of music over the internet,
enabling listeners to hear whatever music they wanted, whenever they
wanted, on a wide range of devices without the user ever taking ownership
of the music.
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Chapter 9 Protecting Innovation 181
1. What industry conditions led to the revolution in audio distribution described
above? Which stakeholders stand to benefit most (or least) from this
2. Why did the music stores created by the record labels fail to attract many subscribers?
What, if anything, should the record labels have done differently?
3. What will determine how long the success of services like iTunes endures?
Adapte d from a New York University teaching case by Shachar Gilad, Christopher Preston, and Melissa
A. Schilling. b
“Thomson Multimedia Signs 100th mp3 Licensee,” press release (PR Newswire), April 18, 2001.
Junko Yoshida, “Sony Sounds Off about Mini Disc,” Electronic World News, no. 41 (June 3, 1991), p.15.
d Jack Schofield, “Music Definitions,” The Guardian, October 5, 2000, p. 3. e
Karl Taro Greenfeld, “The Free Juke Box: College Kids Are Using New, Simple Software Like Napster to
Help Themselves to Pirated Music,” Time, March 27, 2000, p. 82.
Michael Gowan, “Easy as MP3,” PC World 19, no. 11 (November 2001), p. 110. g
“The Same Old Song,” The Economist 358, no. 8210 (January 24, 2002), pp. 19, 20.
Michael Amicone, “Apple Took a Big Bite Out of the Market,” Billboard 116, no. 16 (April 17, 2004), p. 2.
“Tunes Music Store Downloads Top 50 Million Songs,” press release, March 15, 2004.
“Apple Faces Class Action Suits on iPod Battery,” Reuters, February 10, 2004. m Randall Stross, “From a High-Tech System, Low-Fi Music,” New York Times, July 4, 2004, p. 3. n
Alex Veiga, “Recording Labels, Apple Split over Pricing,” Associated Press, April 2, 2006. o
Rob Pegoraro, “France Takes a Shot at iTunes,” WashingtonPost.com, March 26, 2006, p. F06.
A crucial element of formulating a firm’s technological innovation strategy is
determining whether and how to protect its technological innovation. Traditionally,
economics and strategy have emphasized the importance of vigorously protecting
an innovation in order to be the primary beneficiary of the innovation’s
rewards, but the decision about whether and to what degree to protect an innovation
is actually complex. Sometimes not vigorously protecting a technology is to the firm’s
advantage—encouraging other producers (and complementary goods providers) to
support the technology may increase its rate of diffusion and its likelihood of rising to
the position of dominant design. In this chapter, we first will review the factors that
shape the degree to which a firm is likely to appropriate the returns from its innovation,
and the mechanisms available to the firm to protect its innovation. We then will consider
the continuum between a wholly proprietary strategy and a wholly open strategy,
examining the trade-offs inherent in decisions about whether (and to what degree) to
protect or diffuse a technological innovation. The chapter concludes by listing factors
the firm should consider in formulating its protection strategy.
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182 Part Two Formulating Technological Innovation Strategy
The degree to which a firm can capture the rents from its innovation is termed
appropriability. In general, the appropriability of an innovation is determined by
how easily or quickly competitors can imitate the innovation. The ease with which
competitors can imitate the innovation is, in turn, a function of both the nature of the
technology itself and the strength of the mechanisms used to protect the innovation.
Some technological innovations are inherently difficult for competitors to copy; the
knowledge underlying the technology may be rare and difficult to replicate. A firm’s
unique prior experience or talent pool may give it a foundation of technical know-how
that its competitors do not possess. If this knowledge base is tacit (i.e., it cannot be
readily codified into documents or procedures) or socially complex (i.e., it arises
through complex interactions between people), competitors will typically find it very
difficult to duplicate.1
For example, a firm that has a team of uniquely talented research
scientists may have a rare and difficult-to-imitate knowledge base. While some
of the skill of the research scientists may be due to imitable training procedures, talent
typically implies that an individual (or group) has a natural endowment or ability that
is very difficult, if not impossible, to replicate through training. Furthermore, if the
unique capabilities of the research team arise in part from the nature of the interactions
between the scientists, their performance will be socially complex. Interactions
between individuals can significantly shape what each individual perceives, and thus
what each individual—and the collective group—discovers or learns. The outcomes
of these interactions are path dependent, and thus are idiosyncratic to the combination
of individuals, the moment of the interaction, and the nature of the interaction. This
means that knowledge can emerge from the interaction of a group that could not be
replicated by any individual or any different group.
Many innovations, however, are relatively easy for competitors to imitate.
Individuals and firms often employ legal mechanisms to attempt to protect their innovations.
Most countries offer legal protection for intellectual property in the form
of patent, trademark, copyright, and trade secret laws.
PATENTS, TRADEMARKS, AND COPYRIGHTS
While patents, copyrights, and trademarks are all ways of protecting intellectual property,
they are each designed to protect different things. A patent protects an invention,
and a trademark protects words or symbols intended to distinguish the source
of a good. A copyright protects an original artistic or literary work. Thus, a typical
computer might have components whose designs are protected by patents, logos such
as “IBM Thinkpad” that are protected by trademark law, and software that is protected
by copyright (though as discussed later in the section on patents, many types of software
are now also eligible for patent protection).
Most sources attribute the origin of formalized protection of intellectual property to
15th-century England, when the English monarchy began granting certain privileges
to manufacturers and traders as signified by “letters patent,” which were marked with
the king’s great seal. The first known of these was granted by Henry VI to John of
The degree to
which a firm is
able to capture
the rents from its
cannot be readily
codified or transferred
that arises from
design for manufactured
variety of plant.
used to distinguish
of a good.
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Chapter 9 Protecting Innovation 183
Utynam in 1449. This patent gave John a 20-year monopoly on a method of producing
stained glass that had not been previously known in England.2
did not arrive until 1710, when an Act of Parliament gave protection to books
and other written works. While the use of trademarks (or, more generally, marks of
ownership) can be traced back as early as 3500 bc, trademark protection laws did not
begin to emerge until the late 1700s. In 1791, Thomas Jefferson supported the requests
of sailcloth makers by recommending the establishment of trademark protection
based on the commerce clause of the Constitution. Trademark laws were later
enacted in France (1857) and the United Kingdom (1862).3
The first international
trademark agreement was reached in 1883 at the Paris Convention for the Protection
of Industrial Property.
In many countries, inventors can apply for patent protection for their inventions. In
the United States, a patent is a property right granted by the federal government that
excludes others from producing, using, or selling the invention in the United States,
or from importing the invention into the United States, for a limited time in exchange
for public disclosure of the nature of the invention at the time the patent is granted.4
Patents are often categorized into different types. In the United States, a utility patent
may be granted to an inventor who creates or discovers a new and useful process,
machine, manufactured item, or combination of materials. A design patent may be
granted to the inventor of an original and ornamental design for a manufactured item.
A plant patent may be granted to an inventor who invents or discovers and asexually
reproduces any distinct and new variety of plant. Under U.S. patent law, an invention
must pass three tests to be patentable:
1. It must be useful (i.e., it must produce a desirable result, solve a problem,
improve on or propose a new use for an existing development or show potential of
2. It must be novel (i.e., it must not already be patented or described in public literature,
or be in public use for more than a year).
3. It must not be obvious (i.e., a person with experience or skill in the particular art
of the patent would not be expected to achieve the same invention with a normal
amount of effort).
Discovery of scientific principles that pertain to natural laws (e.g., gravity) cannot
be patented because they are considered to have always existed. Specifically, the
following are not typically patentable:
• Substituting one material for another (e.g., plastic for metal).
• Merely changing the size of an already existing device.
• Making something more portable.
• Substituting an element for an equivalent element.
• Altering an item’s shape.
Printed materials are not typically patentable, but it may be possible to protect them by
copyright, as discussed in the next section.
A property right
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184 Part Two Formulating Technological Innovation Strategy
Before 1998, most software algorithms were not eligible for patent protection—
they were eligible only for copyright protection. However, when a Supreme Court
case in 1998 upheld a patent on a computerized method of managing mutual funds
that relied on software algorithms, it unleashed a flood of patent applications for software
algorithms. From 1997 to 2000, patent filings for software-enabled methods of
doing business increased more than 700 percent.5
For example, Amazon patented its
“1-click” system that streamlines the process by which customers place orders.6
Patenting an invention is a serious undertaking. To apply for a patent, the inventor
must explain how to make and use the invention, and make claims about what it does
that makes it a new invention. Drawings of the new invention are also often required.
In the United States, this application is reviewed by a patent examiner who may modify
the scope of the claims made by the patent. The patent is then published for a time
in which other inventors can challenge the patent grant (if, for example, they believe
that the patent infringes on previously granted patents). If the standards for patentability
are met, the patent is then granted. The entire process from application to granting
of the patent can take between 2 and 5 years, with an average time of 33 months in
2011. These delays in patent granting grew substantially over the last two decades,
in large part due to rapid growth in both U.S. origin and non-U.S. origin patent
applications that was not matched by growth in resources for patent examination. In
industries in which product lifecycles are short, such delays significantly diminish the
usefulness of patenting. This has led to a number of proposals for how the patenting
system might be reformed to make it more efficient. (see Figure 9.1).
A number of costs are also involved in filing and maintaining a patent. The
U.S. Patent and Trademark Office has two fee schedules—one for “small entities”
(independent inventors and companies with less than 500 employees) and one for
larger entities (see Figure 9.2). The entire patenting process in the United States
typically costs a small entity around $1,500 in filing fees and $5,000–$10,000 in
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Chapter 9 Protecting Innovation 185
Utility patents are typically granted more protection than other types of patents.
Before 1995, the United States granted patent owners a term of 17 years of protection;
however, in 1995, that term was extended to 20 years. While patent law varies considerably
by country (as discussed in more detail below), almost every country assigns a
protection term of 20 years to utility patents.
Patent Law around the World
Almost every country has its own laws governing patent protection. A patent granted
in one country does not provide protection in other countries. People or firms seeking
patent protection in multiple countries must apply in each of the countries in accordance
with those countries’ requirements.
Significant differences exist in national patent laws, and U.S. patent law is one of
the more unusual. For example, in most other countries, publication of information
about the invention before applying for a patent will bar the right to a patent, but the
United States allows a 1-year grace period (that is, an inventor can publish an invention
up to a year before applying for the patent). Thus, if international patent protection
will eventually be sought, inventors must uphold the stricter standard of applying
for patent before publishing information about the patent, even if they plan to first patent
the invention in the United States. Many countries also require that the invention
be manufactured in the country in which a patent was granted within a certain time
frame (often 3 years) from the time the patent is granted. This is called the “working
requirement,” and it effectively prevents inventors from patenting inventions in countries
in which they have no intention of setting up production.
Several international treaties seek to harmonize the patent laws around the world.
Two of the most significant are the Paris Convention for the Protection of Industrial
Property and the Patent Cooperation Treaty.
Fee Types Regular Fee Small Entity Fee
Patent Filing Fees
Basic patent filing fee—utility $ 380 $ 190
Search fee—utility 620 310
Examination fee—utility 250 125
Basic patent filing fee—design 250 125
Search fee—design 120 60
Examination fee—design 160 80
Patent filing fee—plant 250 125
Search fee—plant 380 190
Examination fee—plant 200 100
Patent Post-Allowance Fees (paid after Patent Office approves patent)
Utility patent issue fee $1,740 $ 870
Design patent issue fee 990 495
Plant patent issue fee 1,370 685
Publication fee 300 300
Patent Maintenance Fees (to keep patent in force)
Due at 3.5 years after issuance of patent $1,130 $ 565
Due at 7.5 years after issuance of patent 2,850 1,425
Due at 11.5 years after issuance of patent 4,730 2,365
U.S. Patent and
Schedule as of
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186 Part Two Formulating Technological Innovation Strategy
Paris Convention for the Protection of Industrial Property
The Paris Convention for the Protection of Industrial Property (also known as the Paris
Convention Priority) is an international intellectual property treaty adhered to by 174
countries as of December 2011. Under the Paris Convention, a citizen of any member
country may patent an invention in any of the member countries and enjoy the same
benefits of patent protection as if the inventor were a citizen of those countries. That
is, the Paris Convention eliminates (for its member countries) any differential patent
rights afforded to citizens of the country versus foreign nationals. Furthermore, the
treaty also provides the right of “priority” for patents and trademarks. Once an inventor
has applied for patent protection in one of the member countries, the inventor may
(within a certain time period) apply for protection in all the other member countries.
The time period is 12 months for utility patents and 6 months for design patents and
trademarks. Most important, the applications to these later countries will be treated as
if they were made on the same date as the first application. This enables the inventor to
establish priority over any other patents applied for in those countries after the inventor
made the first application. For example, if an inventor applied for a utility patent for an
invention in Madagascar in January 2003, and another inventor applied for a patent for
a very similar invention in France in June 2003, the Madagascar inventor could have
applied for patent protection in France in December 2003 and claim priority over the
French invention. The French inventor would have to prove that his or her invention
was substantively different from the Madagascar invention, or the French inventor’s
patent would be denied.
As mentioned previously, in many countries, public disclosure of an invention
makes it impossible to subsequently patent that invention. However, with the priority
rights established under the Paris Convention, an inventor who patents an invention
in one of the member countries can then publicly disclose information about that invention
without losing the right to patent the invention in the other countries—each
patent application will be treated as if it were applied for at the same time as the first
application, and thus as if it were applied for before public disclosure. Without this
treaty, it would be nearly impossible for an inventor to patent an invention first in the
United States and then in other countries because U.S. patent applications are made
available to the public.
Patent Cooperation Treaty (PCT)
Another very significant international patent treaty is the Patent Cooperation Treaty,
or PCT. This treaty facilitates the application for a patent in multiple countries. An
inventor can apply for a patent to a single PCT governmental receiving office, and
that application reserves the inventor’s right to file for patent protection in more than
100 countries for up to 2½ years. Once the inventor has filed the application, a PCT
governmental searching office will perform the patent search for the application (this
search verifies that the invention is not already subject to a prior claim). Once the
search is completed, the inventor can choose to enter Chapter II of the process wherein
the PCT governmental office assesses the patentability of the invention subject to the
standards of the Patent Cooperation Treaty. Eventually, the inventor must have the
PCT application filed in each of the national patent offices in which the inventor is
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Chapter 9 Protecting Innovation 187
Filing a single PCT application offers numerous advantages. First, applying for
the PCT patent buys the inventor the option to apply to multiple nations later without
committing the inventor to the expense of those multiple applications. With a PCT
application, the inventor can establish a date of application in multiple countries
(protecting the inventor’s priority over later claims), while paying only the single
PCT application fee rather than the numerous national application fees. Though the
inventor will eventually have to pay for national applications in the countries in which
protection is sought, the inventor can delay those costs. Thus, the inventor has time
to assess the likelihood of the patent being granted and the potential profitability of
the invention. If the PCT process suggests that the patent will not be granted or if it
appears the invention has limited potential for earning returns, the inventor can forgo
the expense of applying to the national offices.
Another advantage of the PCT process is that it helps make the results of patent
applications more uniform. Though individual countries are not required to grant a
patent to those inventions that are granted a patent by the PCT governing office, the
granting of the patent by the PCT provides persuasive evidence in favor of granting
the patent in the individual national offices. As of April 2012, there were 144 member
states of the Patent Cooperation Treaty.
Trademarks and Service Marks
A trademark is a word, phrase, symbol, design, or other indicator that is used to distinguish
the source of goods from one party from the goods of others. The “Intel
Inside” logo on many computers is one example of a trademark, as is the familiar
Nike “swoosh” symbol. A service mark is basically the same as a trademark, but distinguishes
the provider of a service rather than a product. Often the term trademark is
used to refer to both trademarks and service marks.
Trademarks and service marks can be embodied in any indicator that can be perceived
through one of the five senses. Most marks are embodied in visual indicators,
such as words, pictures, and slogans. However, marks are also registered that use other
senses such as sound (e.g., tones that are associated with a particular company or brand)
or smells (as in fragrance). Trademark rights may be used to prevent others from using a
mark that is similar enough to be confusing, but they may not be used to prevent others
from producing or selling the same goods or services under a clearly different mark.
The rights to a trademark or service mark are established in the legitimate use of the
mark and do not require registration; however, registration provides several advantages.
First, registering the mark provides public notice of the registrant’s claim of ownership
over the mark. Second, marks must be registered before a suit can be brought in federal
court against an infringement of the mark. Third, registration can be used to establish
international rights over the trademark, as when the U.S. registration is used to establish
registration in other countries, and to protect the mark against infringement from imported
products. As of April 2012, the U.S. Patent and Trademark Office charged a $375
application fee for trademark registration using paper filing, and $325 using electronic
filing. It normally takes from 10 to 16 months to receive certification from the U.S.
Patent and Trademark Office, but the protection offered by the registration of the trademark
begins from the date of filing. Unlike patents and copyrights, trademark protection
can last as long as the trademark is in use, but the registration requires periodic renewal.
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188 Part Two Formulating Technological Innovation Strategy
Trademark Protection around the World
Nearly all countries offer some form of trademark registration and protection. National
or regional offices maintain a Register of Trademarks that contains information on
all trademark registrations and renewals. To eliminate the need to register separately
in each country (or region), the World Intellectual Property Organization administers
a System of International Registration of Marks governed by two treaties: the
Madrid Agreement Concerning the International Registration of Marks and the Madrid
Protocol. Countries that adhere to either (or both) the Madrid Agreement or Madrid
Protocol are part of the Madrid Union. Any individual that lives in, is a citizen of, or
maintains an establishment in a Madrid Union country can register with the trademark
office of that country and obtain an international registration that provides protection
in as many other Madrid Union countries as the applicant chooses. As of April 2012,
there were 85 member countries of the Madrid Union.
Copyright is a form of protection granted to works of authorship. In the United States,
the authors of original literary, dramatic, musical, artistic, and certain other intellectual
works can obtain copyright protection.7
Like trademarks, the rights of copyright
protection are established by legitimate use of the work. This protection is available
whether or not the work is published and prevents others from producing or distributing
that work. Under section 106 of the 1976 Copyright Act, the owner of the copyright
has the exclusive right to do (or authorize others to do) the following:
• Reproduce the work in copies or phonorecords.
• Prepare derivative works based upon the work.
• Distribute copies or phonorecords of the work to the public by sale or other transfer
of ownership, or by rental, lease, or lending.
• Perform the work publicly, in the case of literary, musical, dramatic, and choreographic
works, pantomimes, and motion pictures and other audiovisual works.
• Display the copyrighted work publicly, in the case of literary, musical, dramatic,
and choreographic works, pantomimes, and pictorial, graphic, or sculptural works,
including the individual images of a motion picture or other audiovisual work.
• Perform the work publicly by means of a digital audio transmission (in the case of
There are, however, limitations to these rights. In particular, the doctrine of fair
use stipulates that in most circumstances it is not a violation of copyright for others
to use copyrighted material for purposes such as criticism, comment, news reporting,
teaching, scholarship, or research. Furthermore, some types of work cannot be
protected by copyright. For example, work that has not been fixed in a tangible form
of expression (for example, a choreographed dance or improvisational speech that
was not notated or recorded) is not eligible for copyright protection. Titles, names,
short phrases, slogans, familiar symbols, and lists of ingredients also cannot be
Unlike patent protection, copyright protection is secured automatically when an
eligible work is created and fixed in a copy or phonorecord for the first time. No
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Chapter 9 Protecting Innovation 189
publication or registration with the Copyright Office is necessary to establish this
copyright, though registering the copyright is advantageous in that it establishes a
public record of the copyright claim and is required before filing an infringement
suit in court. As of April 2012 basic online registration of copyright with the U.S.
Copyright Office cost $35, and it took about 3–10 months to receive a certificate of
Before 1978, copyright protection lasted only 28 years from the time it was secured
(though during the last year the author could opt to renew the protection for
an additional term). Revisions to U.S. copyright law, however, give copyright protection
to works created after 1978 that lasts for the author’s life plus an additional
Copyright Protection around the World
As with patents and trademarks, no international copyright law automatically protects
an author’s work throughout the world. Copyright protection varies from country to
country. However, most countries do offer copyright protection to both domestic and
foreign works, and there are international copyright treaties for simplifying the process
of securing such protection. One of the most significant is the Berne Union for the
Protection of Literary and Artistic Property (known as the Berne Convention). The
Berne Convention specifies a minimum level of copyright protection for all member
countries, and it requires member countries to offer the same protection to both
its own citizens and foreign nationals. Other treaties include the Universal Copyright
Convention (UCC); the Rome Convention for the Protection of Performers, Producers
of Phonograms and Broadcasting Organizations; the Brussels Convention Relating to
the Distribution of Program-Carrying Signals Transmitted by Satellite; and the World
Intellectual Property Organization Copyright Treaty.
Rather than disclose detailed information about a proprietary product or process in
exchange for the grant of a patent, inventors or firms often will choose to protect their
intellectual property by holding it as a trade secret. A trade secret is information that
belongs to a business that is generally unknown to others. Trade secrets need not meet
many of the stringent requirements of patent law, enabling a broader class of assets
and activities to be protectable. For example, while the formula for a beverage is not
patentable, it can be considered a trade secret. Trade secret law traces its history back
to Roman law punishing individuals who induced someone to reveal the details of their
employer’s commercial affairs.8
Information is typically considered to be a trade secret only if it (a) offers a distinctive
advantage to the company in the form of economic rents, and (b) remains valuable
only as long as the information remains private. Examples of trade secrets might
include information about a firm’s customers, its marketing strategies, or its manufacturing
processes. Trade secret law protects such information from being wrongfully
taken by another party. In the United States, trade secret law is implemented at the
state level, but the Uniform Trade Secret Act attempts to make these laws consistent
from state to state.
belongs to a
business that is
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190 Part Two Formulating Technological Innovation Strategy
For information to qualify as a trade secret under the Uniform Trade Secret Act, the
information must meet the following three criteria:
• The information must not be generally known or readily ascertainable through
• The information must have economic importance that is contingent upon its
• The trade secret holder must exercise reasonable measures to protect the secrecy of
If information meets these criteria, the Uniform Trade Secret Act stipulates that its
owner can prevent others from benefiting from this information without the owner’s
permission. In particular, the act states that no individual or group can copy, use, or
otherwise benefit from a trade secret without the owner’s authorization if they meet
any of the following conditions:
1. They are bound by a duty of confidentiality (e.g., employees, lawyers).
2. They have signed a nondisclosure agreement.
3. They acquire the secret through improper means such as theft or bribery.
4. They acquire the information from someone who did not have the right to
5. They learn about the secret by mistake but have reason to know that the information
was a protected trade secret.
In most U.S. states, if owners of a trade secret believe that another party has stolen
or improperly disclosed their trade secret, they can ask a court to issue an injunction
against further use of the secrets, and they may also be able to collect damages for
any economic harm suffered by the improper use of the trade secret. For example, in
November 2002, Procter & Gamble sued Potlatch Corporation, claiming that Potlatch
had stolen trade secret methods used to produce Bounty paper towels and Charmin
bath tissue by hiring away two of Procter & Gamble’s paper manufacturing experts.
Potlatch is a large, private-label tissue manufacturer that produces toilet paper, facial
tissues, napkins, and paper towels for grocery store chains such as Albertsons and
Safeway. By March 2003, the two companies had reached an agreement to settle out
of court, keeping the terms of the settlement confidential.9
THE EFFECTIVENESS AND USE OF PROTECTION MECHANISMS
The methods used to protect innovation—and their effectiveness—vary significantly
both within and across industries.10 In some industries, such as pharmaceuticals, legal
protection mechanisms such as patents are very effective. In other industries, such
as electronics, patents and copyright provide relatively little protection because other
firms can often invent around the patent without infringing on it (as IBM discovered
with its personal computer design as described in the accompanying Theory in Action).
It is also notoriously difficult to enforce patents protecting industrial processes such
as manufacturing techniques. If patents provide little protection, the firm may rely
more heavily on trade secrets; however, the ability to protect trade secrets also varies
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Chapter 9 Protecting Innovation 191
with the nature of the technology and the industry context. To protect a trade secret, a
firm must be able to expose its product to the public without revealing the underlying
technology, but in many cases, revealing the product reveals all.
For some competitive situations, protecting a technology may not be as desirable
as liberally diffusing it. In industries characterized by increasing returns, firms
sometimes choose to liberally diffuse their technologies to increase their likelihood
of rising to the position of dominant design. As discussed in Chapter Four, learningcurve
effects and network externalities can cause some industries to demonstrate
increasing returns to adoption: The more a technology is adopted, the more valuable
it becomes.11 This dynamic can lead to winner-take-all markets that create natural
monopolies. A firm that controls the standard can reap monopoly rents and can exert
significant architectural control over both its own industry and related industries.12
This enviable position can be so lucrative that firms may be willing to lose money
in the short term to improve their technology’s chance of rising to the position of
dominant design. Thus, firms may liberally diffuse their technologies (through, for
example, open source software or liberal licensing arrangements) to accelerate
the technology’s proliferation and thereby jump-start the self-reinforcing feedback
effect that can lead to the technology’s dominance. However, the firm often faces a
dilemma: If it liberally diffuses the technology to would-be competitors, it relinquishes
the opportunity to capture monopoly rents when and if the technology emerges as a
dominant design. Furthermore, once control of a technology is relinquished, it can
be very hard to regain; thus, such diffusion may result in the firm losing all hope of
controlling the technology. Finally, liberal diffusion of the technology can result in the
fragmentation of the technology platform: As different producers add improvements
to the technology that make it better fit their needs, the “standard” may be split into
many nonstandardized versions (as with UNIX, as described in more detail later in the
chapter). To resolve these trade-offs, firms often adopt a strategy of partial protection
for their innovations, falling somewhere on the continuum between wholly proprietary
systems and wholly open systems.
Wholly Proprietary Systems versus Wholly Open Systems
Wholly proprietary systems are those based on technology that is companyowned
and protected through patents, copyrights, secrecy, or other mechanisms. Such
technologies may be legally produced or augmented only by their developers. Wholly
proprietary systems are often not compatible with the products offered by other manufacturers.
Because their operation is based on protected technology, other manufacturers
are often unable to develop components that may interact with the proprietary
system. Proprietary systems typically provide their developers with the opportunity to
appropriate rents from the technology. However, they might also be less likely to be
adopted readily by customers as a result of their higher costs and the inability to mix
and match components.
In wholly open systems, the technology used in a product or process is not protected
by secrecy or patents; it may be based on available standards or it may be new
technology that is openly diffused to other producers. Wholly open technologies may
be freely accessed, augmented, and distributed by anyone. Such technologies are usually
quickly commoditized and provide little appropriability of rents to their developers.
code is made
to others for use,
Goods based on
is owned and
or other mechanisms.
only by their
Goods based on
is not protected
and that is freely
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192 Part Two Formulating Technological Innovation Strategy
Many technologies are neither wholly proprietary nor wholly open—they are
partially open, utilizing varying degrees of control mechanisms to protect their
technologies. It is useful to think of a control continuum that stretches from wholly
proprietary to wholly open (see Figure 9.3). For instance, most of the major video
game console producers (Nintendo, Sony, and Microsoft) utilize a wholly proprietary
strategy for their consoles, but a limited licensing policy for their games. The licensing
policies are designed to encourage developers to produce games for the systems,
while simultaneously enabling the console producers to retain a great deal of control
over the games produced. All games developed for the consoles must be approved by
the console producer before they can be made commercially available. For example,
in the case of Microsoft, would-be Xbox games developers must first apply to the
Xbox Registered Developer Program (for established games developers) or the Xbox
Incubator Program (for smaller or newer games developers). If accepted into one of
these two programs, the developer will receive access to development tools, but this
does not guarantee the approval of any resulting game titles. The games are subjected
to a separate, rigorous approval process.
By contrast, the licensing policies for Microsoft’s Windows are more open.
Windows is protected by copyright, and Microsoft defends its exclusive right to
augment the software; however, it also permits complementary goods providers to
access portions of the source code to facilitate development of complementary goods,
licenses the rights to such providers to produce complementary applications, and
licenses original equipment manufacturers (OEMs) to distribute the software
by bundling it with hardware. Those who purchase a license for the software can
execute and bundle the software with other goods but may not augment the software.
For example, software applications developers may produce and distribute valueadded
applications for use with Windows as long as those applications do not affect
the functionality of the Windows program itself.
As described in the Theory in Action section later in the chapter, Sun’s “community
source” (as opposed to “open source”) policy for Java is even more open.
Limited Licensing Moderate
Xbox video game
January 1999 to
Sun’s Java Glyphosate
Firms that assemble
made by other
also called valueadded
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Theory in Action IBM and the Attack of the Clones
In 1980, IBM was in a hurry to introduce a personal
computer. When personal computers first began to
emerge at the end of the 1970s, most of the major
computer manufacturers considered it no more than
a peculiar product for a hobbyist market. The idea
that individuals would want personal computers
on their desks seemed ludicrous. However, as total
U.S. personal computer sales reached $1 billion, IBM
began to worry that the personal computer market
could actually turn out to be a significant computer
market in which IBM had no share. To bring a
personal computer to market quickly, IBM decided
to use many off-the-shelf components from other
vendors, including Intel’s 8088 microprocessor and
Microsoft’s software. However, IBM was not worried
about imitators because IBM’s proprietary basic
input/output system (BIOS), the computer code
that linked the computer’s hardware to its software,
was protected by copyright. While other firms could
copy the BIOS code, doing so would violate IBM’s
copyright and incur the legendary wrath of IBM’s
However, getting around IBM’s copyright turned
out not to be difficult. Copyright protected the written
lines of code, but not the functions those codes
produced. Compaq was able to reverse-engineer the
BIOS in a matter of months without violating IBM’s
copyright. First, a team of Compaq programmers
documented every function the IBM computer would
perform in response to a given command, without
recording the code that performed the function. This
list of functions was then given to another team of
“virgin” programmers (programmers who were able to
prove that they had never been exposed to IBM’s BIOS
These programmers went through the list of
functions and wrote code to create identical functions.
The result was a new BIOS that acted just like an IBM
BIOS but did not violate its copyright. Compaq sold a
record-breaking 47,000 IBM-compatible computers in
its first year, and other clones were quick to follow.
R. Cringely, Accidental Empires (New York: HarperCollins,
This policy grants anyone immediate access to the complete source code for Java and
allows users to develop commercial applications based on the code, or to augment
the code for their own implementations. These developers pay no license fee to Sun.
However, any augmentation to the core structure of Java must be approved by the Java
Community Process, which is managed by Sun. Sun’s “community source” principle
is meant to encourage the broader software community to improve Java and develop
complementary applications, but it allows Sun to retain some control over the core
platform to ensure that the platform does not become fragmented through unmanaged
development by the software community.
Many technologies that were once wholly proprietary or partially open become
wholly open once their patents or copyrights expire. For instance, Monsanto’s
highly profitable Roundup herbicide is based on a patented chemical ingredient
called glyphosate. This extremely potent herbicide was adopted by farmers in
more than 100 countries and accounted for a substantial portion of Monsanto’s
sales.13 However, facing impending expiration of its patents, Monsanto began to
license the rights to glyphosate production to a few other companies (including
Dow Agrosciences, DuPont, and Novartis) in 1999. In September 2000, the U.S.
patent on glyphosate expired, and any chemical company was free to produce and
sell glyphosate-based herbicides in the United States, making glyphosate a wholly
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194 Part Two Formulating Technological Innovation Strategy
ADVANTAGES OF PROTECTION
Because proprietary systems offer greater rent appropriability, their developers often
have more money and incentive to invest in technological development, promotion,
and distribution. If a single firm is the primary beneficiary of its technology’s success,
it has much greater incentive to invest in further developing the technology. The
profits from the technology may be directly reinvested in further improvements in the
technology. The sponsor of a proprietary technology might also adopt a penetration
pricing strategy (that is, it may offer the technology at a low price or free) to rapidly
build its installed base, it may spend aggressively on advertising to increase awareness
of the technology, and it may even subsidize the production of complementary goods
to increase the desirability of its technology to customers. A firm may be willing to
lose money in the short term to secure the technology’s position as the standard, because
once the technology has emerged as a standard, the payoff can be substantial and
enduring. By contrast, when multiple firms can produce a technology, losing money
on the technology in the short term to promote it as a standard is highly risky because
the long-term distribution of the payoffs is uncertain. While the technology’s developer
may have borne the bulk of the cost in developing the technology, multiple firms
may vie for the profits to be made on the technology.
Protecting the technology also gives the developing firm architectural control over
the technology. Architectural control refers to the firm’s ability to determine the
structure and operation of the technology, and its compatibility with other goods and
services. It also refers to the firm’s ability to direct the future development path of the
technology. Architectural control can be very valuable, especially for technologies in
which compatibility with other goods and services is important. By controlling the
technology’s architecture, the firm can ensure that the technology is compatible with
its own complements, while also restricting its compatibility with the complements
produced by others.14 The firm can also control the rate at which the technology is
upgraded or refined, the path it follows in its evolution, and its compatibility with
previous generations. If the technology is chosen as a dominant design, the firm with
architectural control over the technology can have great influence over the entire industry.
Through selective compatibility, it can influence which other firms do well and
which do not, and it can ensure that it has a number of different avenues from which
to profit from the platform.
Microsoft’s Windows is the quintessential embodiment of this strategy. Because
Windows is the dominant operating system in the personal computing market and because
it serves as the interface between a computer’s hardware and software, Microsoft
has considerable market power and architectural control over the evolution of the personal
computer system. Among other things, Microsoft has been able to incorporate
ever more utility programs into the core program, thereby expanding and taking over
the roles of many other software components. Once a user purchased an operating
system, uninstaller programs, disk-compression programs, and memory management
programs separately, but Windows 95 and 98 integrated all these products and more
into the operating system. This “feature creep” had a major impact on competition in
the industry; many utility producers such as Qualitas, Stac Electronics, Microhelp,
Quarterdeck, and others were forced to abandon their once-profitable products.
The ability of a
firm (or group of
firms) to determine
of a technology.
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Chapter 9 Protecting Innovation 195
Advantages of Diffusion
The primary argument for diffusing a technology instead of protecting it is that open
technologies may accrue more rapid adoptions. If multiple firms are producing, distributing,
and promoting the technology, the technology’s installed base may accumulate
much more rapidly than if one firm alone is responsible for such activities. Competition
among producers may drive the price of the technology down, making it more attractive
to customers. Both customers and complementary goods providers may also perceive
the technology as better (or its future more certain) if there are multiple companies
backing the technology. This perception can lead to much more rapid adoption of the
technology by customers and complementary goods providers, which further stimulates
more companies to back the technology. Thus, a liberal diffusion strategy can stimulate
the growth of the installed base and availability of complementary goods.15
Open technologies can also benefit from the collective development efforts of
parties external to the sponsoring firm. For instance, Netscape Navigator, UNIX, and
Linux are all technologies that have benefited significantly from external development.
By making the source code freely available to the vast world of developers who
could benefit from the technology, the technologies reaped the advantages of having
a much larger pool of talent and resources directed at improving the technologies than
could have been rallied by the original developers.
External development, however, poses some costs and risks. First, external development
efforts typically lack the coordination of internal development. External
developers may have very diverse objectives for the technology; rather than work together
toward some unified vision of what the technology could achieve in the future,
they might work in different, possibly even conflicting, directions.16 Much of their
effort may be redundant, as different external developers work on solving the same
problems without communicating with each other. Finally, whether and how these
improvements get incorporated into the technology and disseminated to other users of
the technology can prove very problematic. UNIX provides a stark example of this.
UNIX was an operating system first developed by AT&T’s Bell Laboratories in
1969. Though a Department of Justice injunction forbade AT&T from selling software
commercially, it made the source code for the product available through licensing
arrangements. Early licensees (notably, University of California—Berkeley) began
using and adapting the software for their purposes, causing many incompatible
versions of the software to emerge. Though the software community made several
attempts to standardize the UNIX operating language, their efforts failed. AT&T
also challenged the commercialization of several UNIX variants, but to no avail.
Ultimately, AT&T sold the division responsible for UNIX to Novell, and Novell
handed over the rights to the UNIX trademark to the X/Open standards-setting body.17
Given the range of advantages (and risks) of protecting versus diffusing a technology,
a firm must carefully consider the following factors in deciding whether, and to
what degree, it should protect its innovation.
Production Capabilities, Marketing Capabilities, and Capital
If the firm is unable to produce the technology at sufficient volume or quality levels (or
market the technology with sufficient intensity), then protecting the technology so that
the firm is its sole provider may significantly hinder its adoption. For example, when
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196 Part Two Formulating Technological Innovation Strategy
JVC was promoting its VHS standard for video recorders, its management knew JVC
was at a disadvantage in both manufacturing and marketing capabilities compared to
Sony (which was promoting the Beta technology). JVC chose to vigorously pursue
both licensing and OEM agreements, lining up Hitachi, Matsushita, Mitsubishi, and
Sharp to boost the technology’s production rate.
Similarly, if complementary goods influence the value of the technology to users,
then the firm must (a) be able to produce the complements in sufficient range and
quantity, (b) sponsor their production by other firms, or (c) encourage collective
production of the complements through a more open technology strategy. The only
firms that have been successful in the U.S. video game industry were those that were
able to produce games in-house (ensuring that a wide range of games would be available
at the console’s launch) and that encouraged third-party development of games
(to ensure that the number of game titles grew quickly). Both Nintendo and Sega
had previous arcade experience, and thus possessed considerable game development
expertise. Microsoft had long been a producer of PC-based video games, so it had
some game developing experience, and it also acquired a few small game developers
(e.g., Bungie) to expand its expertise in developing console-type games.18 Sony had
no prior game experience, but aggressively acquired in-house developers, licensed
external developers, and set up a program with Metrowerks to provide developer
tools that would make it easier for external developers to produce PlayStation games.
If a firm lacks the production capability or expertise to produce a sufficient range of
complementary goods, or the capital to acquire such capabilities quickly, it should
encourage collective production of complements through a more open technology
strategy and utilize forms of sponsorship.
Industry Opposition against Sole-Source Technology
Sometimes other industry members are able to exert strong pressure against the adoption
of a technology that would give one (or a few) producer(s) undue control and
power, causing a technology that is restricted to such production to be rejected or
more hotly contested than a more open technology. This was the case with Sony
and Philips’ Super Audio CD (SACD) audio format. Sony and Philips had jointly
created the original compact disc (CD) format and split the royalties on every CD
player sold, totaling hundreds of millions of dollars. The rest of the world’s leading
consumer electronics producers (including Hitachi, JVC, Matsushita, Mitsubishi, and
Toshiba) and record producers (including Time Warner and Seagram’s Universal
Music group) banded together to form the Digital Video Disk (DVD) Audio consortium.
This consortium’s purpose is to promote the DVD Audio standard that is
intended to displace the CD and enable royalties to be split among the 10 companies
that control the patents.19 Industry observers note that a driving force underlying the
formation of the consortium was to prevent Sony and Philips from controlling yet
another generation of audio formats. The degree of industry opposition to a solesource
technology needs to be considered when the firm formulates its technology
strategy. If the industry is able to pose significant opposition, the firm may need to
consider a more open technology strategy to improve the technology’s likelihood of
being chosen as a dominant design.
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Sun Microsystems was founded in 1982 in Mountain
View, California, as a manufacturer of high-end
computer workstations. Since its inception, Sun believed
that the power of the computer was in the
network, not the individual personal computer (PC).
A PC-centered approach to computing constrained
a user’s processing power and software applications
to that contained within a single PC, but a networkcentered
approach enabled users to share processing
power and applications that were distributed across
a network. Sun believed that a network-centered
approach would become increasingly powerful
as computers (and their users) became more and
more interconnected via advances in information
technologies. Sun’s motto was “The network is the
computer.” Following this belief, Sun produced
workstations and servers with the greatest amount
of intercommunication ability technology allowed.
Sun also preferred to use technology based on
shared standards rather than proprietary standards
to ensure compatibility between Sun’s products and
those of other producers. By 1995, Sun had earned
$7 billion in revenues and had grown to 20,000
INTRODUCING JAVA: A UNIVERSAL
In May 1995, Sun developed a new Web-oriented
software programming language called Java with
the aim of revolutionizing the computing industry.
Unlike other programs, Java-based software
was capable of being run on any computer, using
any operating system. A program created in the
Java language could be “written once, and run
anywhere.” It could even work on small electronic
devices such as personal digital assistants and
Sun believed that the combination
of Java and the rapidly growing Internet
could shift the computer industry away from its
“PC-centric” focus to a “network-centric” focus.
Because Java enabled applications to run on any
type of operating system, users would be able to
share applications easily across different computing
platforms. This would lessen the pressure to
have a single operating system standard (and thus
lessen the importance of Microsoft’s Windows),
while increasing the demand for products that encouraged
interconnectivity (such as Sun’s networkbased
Sun distributed Java through an extensive licensing
agreement. Initially, Sun’s licensing agreement
allowed users to obtain and use Java for a small licensing
fee. Sun required all licensees to submit their
Java-based programs to Sun for compatibility tests,
and limited the amount of changes licensees could
make to the standard. Sun also retained control over
all Java-related intellectual property, meaning that
any changes, additions, or improvements that licensees
made to Java were owned by Sun.
However, as the number of software engineers
using Java grew to 900,000 by the end of 1998,
many industry leaders thought that Java had outgrown
Sun’s control. Furthermore, some members
of the computing industry resented Sun’s restrictive
licensing policy and argued that the policy contradicted
Sun’s open standards mantra. Even IBM, Sun’s
most loyal Java ally, believed Sun should have relinquished
control of Java to independent standards
bodies. Patricia Sueltz, then general manager for
IBM’s Java software, stated, “Java is bigger than any
Scott McNealy, chief executive officer, Sun Microsystems,
however, feared that if Java were released
to standards bodies, it would suffer the same fate
as UNIX. In the early 1990s, the software community
tried to standardize the UNIX operating language,
but the effort failed. Though many companies
adopted UNIX, each company customized the program
to suit their purposes, causing fragmentation
of the standard. Instead of a single unifying UNIX,
many incompatible versions of UNIX emerged. “The
problem with UNIX is that nobody protected the
brand to mean something and the brand lost value,”
A CHANGE IN POLICY
Under heavy pressure from the computing industry,
Sun gradually made Java more open. By 2003, Sun
was freely distributing the Java source code under
its “community source” program and had eliminated
Theory in Action Sun Microsystems and Javaa
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Resources for Internal Development
If a firm does not have significant resources (capital, technological expertise) to invest
in the technology’s functionality, it may have difficulty producing a technology that has
an initial performance level, and rate of improvement, that the market finds attractive.
In such instances, it can be valuable to tap the external development efforts of other
firms (or individuals) through utilizing a more open technology strategy. For example,
when Netscape found itself in a race to match browser capabilities with Microsoft, it
was at a tremendous disadvantage in both human resources and capital. Microsoft had
legions of internal developers and a lot of money to invest in Explorer; there was no
way that Netscape could match those resources internally. Instead, Netscape tapped
the external development community by giving them access to its source code and
incorporating their improvements into the Navigator product.
Control over Fragmentation
For technologies in which standardization and compatibility are important, maintaining
the integrity of the core product is absolutely essential, and external development
can put it at risk. As the UNIX example illustrates, if the developing firm relinquishes
all control over the development of the technology, the technology will have no shepherd
with the ability and authority to direct its trajectory and ensure that a single standard
remains intact. This suggests that the developer of any technology that requires
standardization and compatibility should retain some degree of control over the technology,
or find/establish another governing body with the authority to do so.
Incentives for Architectural Control
Architectural control over the evolution of a technology is always valuable; however,
it becomes particularly valuable if a firm is a significant producer of complements to
the technology in question. A firm with architectural control can typically design the
technology to be compatible with its own complements and incompatible with those
of competitors. If the technology is chosen as the dominant design, this architectural
control allows the firm to ensure that it reaps the lion’s share of the rewards in complements
production. Furthermore, by making the technology selectively compatible with
some competitors and not others, the firm can exert great influence over the competitive
all royalty fees. However, Sun still required all Javabased
software to be subjected to compatibility
tests and retained all control over the intellectual
Sun also created its own standards body
for Java, called the Java Community Process (JCP).
This group consisted of leading Java programmers
and, under the supervision of Sun, was in charge
of managing Java. The JCP was responsible for all
changes, updates, and regulations of the Java language.
Sun believed that allowing companies to participate
in the JCP would satisfy their demands for
standardization, while at the same time retaining
Sun’s ultimate control over Java.
Robert D. Hof, “Sun Power,” BusinessWeek, January 18,
1999, p. 78. c
“Why Java Won’t Repeat the Mistakes of UNIX,” Byte,
January 1997, p. 40. d
Antone Gonsalves and Scot Petersen, “Sun Pulls Plug on
Java Standardization Efforts,” PC Week, December 12, 1999. e
M. Cusumano, Y. Mylonadis, and R. Rosenbloom,
“Strategic Maneuvering and Mass Market Dynamics: VHS
over Beta,” Business History Review, Spring 1992.
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Chapter 9 Protecting Innovation 199
1. The degree to which a firm can capture the rents from its innovation efforts is
largely determined by the degree to which competitors can quickly and easily imitate
the innovation. Some innovations are inherently difficult to copy; others are
difficult to copy because of the mechanisms the firm uses to protect its innovation.
2. The three primary legal mechanisms used to protect innovation in most countries
are patents, trademarks, and copyrights. Each mechanism is designed to protect a
different type of work or good.
3. International treaties have helped to harmonize patent, trademark, and copyright
laws around the world. Most countries now have patent, trademark, and copyright
laws of some form, and in some instances protection can be applied for in multiple
4. Trade secrets provide another mechanism of protecting innovation. Firms that
protect their intellectual property as a trade secret often have legal recourse if
another party wrongfully takes and uses such property.
5. Legal mechanisms for protecting innovation are more effective in some industries
than others; in some industries, inventing around a patent or copyright is relatively
easy. Similarly, in some industries it is nearly impossible to protect an innovation
by using trade secrets because commercializing the innovation reveals its underlying
6. Sometimes the choice between protecting versus diffusing a technology is not
obvious. Both strategies offer potential advantages. Many firms use neither a
wholly open nor wholly proprietary strategy, but rather a partially open strategy.
7. Protecting an innovation helps ensure that the firm earns the lion’s share of the
returns from the innovation. These returns can then be reinvested in further developing
the technology, promoting the technology, and producing complementary
8. Protecting an innovation also preserves the firm’s architectural control, enabling
it to direct the technology’s development, determine its compatibility with other
goods, and prevent multiple incompatible versions of the technology from being
produced by other firms.
9. Diffusing a technological innovation can encourage multiple firms to produce,
distribute, and promote the technology, possibly accelerating its development and
diffusion. Diffusion can be particularly useful in industries that accrue increasing
returns to adoption. It is also useful when the firm has inadequate resources to be
the sole developer, producer, distributor, and marketer of a good.
Architectural control can also enable the firm to direct the development efforts
put into the technology so that it exploits the firm’s core competencies. Technology
trajectories are path dependent; minor events in their evolution can set them careening
off into unexpected directions. A firm that has a significant stake in a particular
evolution path (because, for example, it has technological competencies that are much
more amenable to one path of evolution than other potential paths) may place a high
value on architectural control, which can enable it to co-opt or destroy less favorable
development paths by denying their progenitors access to the market.
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200 Part Two Formulating Technological Innovation Strategy
1. What are the differences between patents, copyrights, and trademarks?
2. What factors should a firm considering marketing its innovation in multiple countries
use in formulating its protection strategy?
3. When are trade secrets more useful than patents, copyrights, or trademarks?
4. Identify a situation in which none of the legal protection mechanisms discussed
(patents, copyrights, trademarks, trade secrets) will prove useful.
5. Describe a technological innovation not discussed in the chapter, and identify
where you think it lies on the control continuum between wholly proprietary and
6. What factors do you believe influenced the choice of protection strategy used for
the innovation identified above? Do you think the strategy was a good choice?
Levin, R., A. Klevorick, R. Nelson, and S. Winter, “Appropriating the returns
from industrial research and development,” Brookings Papers on Economic Activity,
Microeconomics 3 (1987), pp. 783–820.
Bound, J., C. Cummins, Z. Griliches, B. H. Hall, and A. Jaffe, “Who does R&D and
who patents? in R&D, Patents, and Productivity, ed. Z. Griliches (Chicago: University
of Chicago Press for the National Bureau of Economic Research, 1984).
Teece, D. J., “Profiting from technological innovation—Implications for integration,
collaboration, licensing and public-policy,” Research Policy 15, no. 6 (1986), pp.
Astebro, T. B., and K. B. Dahlin, “Opportunity knocks,” Research Policy 34 (2005),
de Laat, P. B., “Copyright or copyleft? An analysis of property regimes for software
development,” Research Policy 34 (2005), pp. 1511–32.
Boldrin, M., and Levine, D. K., Against Intellectual Monopoly (Cambridge, UK:
Cambridge University Press, 2008).
Jaffe, A. B., and J. Lerner, Innovation and Its Discontents: How Our Broken Patent
System Is Endangering Innovation and Progress, and What to Do about It (Princeton, NJ:
Princeton University Press, 2004).
Lecocq, X., and B. Demil, “Strategizing industry structure: The case of open systems
in a low-tech industry,” Strategic Management Journal 27 (2006), pp. 891–98.
Ziedonis, R. H., “Don’t fence me in: Fragmented markets for technology and the
patent acquisition strategies of firms,” Management Science 50 (2004), pp. 804–20.
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Chapter 9 Protecting Innovation 201
Endnotes 1. J. B. Barney, “Firm Resources and Sustained Competitive Advantage,” Journal of Management
17 (1991), p. 990.
2. U.K. Patent Office.
3. U.S. Trademark History Timeline at www.lib.utexas.edu/engin/trademark/timeline/tmindex .html.
4. Definition from the United States Patent and Trademark Office.
5. “Software Patent,” Bank Technology News 14, no. 3 (2001), p. 25.
6. A. B. Silverman, “Software Patents for Methods of Doing Business—A Second Class Citizen
No More,” Journal of Management 52, no. 19 (2000), p. 64.
7. U.S. Copyright Office.
8. The Trade Secrets home page.
9. S. Decker, “Procter & Gamble, Potlatch Resolve Trade Secrets Suit,” Seattle Post Intelligencer,
March 14, 2003.
10. R. Levin, A. Klevorick, R. Nelson, and S. Winter, “Appropriating the Returns from Industrial
Research and Development,” Brookings Papers on Economic Activity, Microeconomics 3
(1987), pp. 783–820; and J. Bound, C. Cummins, Z. Griliches, B. H. Hall, and A. Jaffe, “Who
Does R&D and Who Patents?” in R&D, Patents, and Productivity, ed. Z. Griliches (Chicago:
University of Chicago Press for the National Bureau of Economic Research, 1984).
11. W. B. Arthur, Increasing Returns and Path Dependency in the Economy (Ann Arbor: The
University of Michigan Press, 1994).
12. C. H. Ferguson and C. R. Morris, Computer Wars (New York: Random House, 1993); and R.
Henderson and K. Clark, “Architectural Innovation: The Reconfiguration of Existing Product
Technologies and the Failure of Established Firms,” Administrative Science Quarterly 35
(1990), pp. 9–30.
13. S. Brooks, M. A. Schilling, and J. Scrofani, “Monsanto: Better Living through Genetic
Engineering?” in Strategic Management, Competitiveness and Globalization, 5th ed., eds. M.
Hitt, R. Hoskisson, and R. D. Ireland (Minneapolis/St. Paul: West Publishing, 2001).
14. M. A. Schilling, “Toward a General Modular Systems Theory and Its Application to Interfirm
Product Modularity,” Academy of Management Review 25 (2000), pp. 312–34.
15. C. W. L. Hill, “Establishing a Standard: Competitive Strategy and Technological Standards in
Winner-Take-All Industries,” Academy of Management Executive 11, no. 2 (1997), pp. 7–25;
and M. A. Schilling, “Winning the Standards Race: Building Installed Base and the Availability
of Complementary Goods,” European Management Journal 17 (1999), pp. 265–74.
16. R. Garud, S. Jain, and A. Kumaraswamy, “Institutional Entrepreneurship in the Sponsorship
of Common Technological Standards: The Case of Sun Microsystems and Java,” Academy of
Management Journal 45 (2002), pp. 196–214.
17. D. Essner, P. Liao, and M. A. Schilling, “Sun Microsystems: Establishing the Java Standard,”
Boston University teaching case no. 2001–02, 2001.
18. J. Kittner, M. A. Schilling, and S. Karl, “Microsoft’s Xbox,” New York University teaching
case, 2002. 45.
19. J. Brinkley, “Disk versus Disk: The Fight for the Ears of America,” New York Times, August
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