les Nouvelles July 2020 Article of the Month:
Does Asymmetry Cause Anti-Competitive Practices?
Assistant Professor of Innovation Management
Mälardalen University, School of Innovation, Design and Engineering
Former President LES Benelux
European, British and German Patent and Trademark Attorney and LLM Professor University of Brussels (ULB)
Typically the licensing of IP such as patents or trademarks is controlled by a license agreement. Although in western democracies there is great freedom to determine the clauses of such a contract, basic contract law and anti-trust or unfair competition law may restrict the details of such a contract. There is, however, a concern that anti-trust or unfair competition law is complex and inadequate to deal with certain business practices, particularly, relating to the negotiation and enforcement of terms of licensing contracts resulting from a gross economic imbalance between contractual partners. This can happen particularly in asymmetric partnerships/ negotiations involving small and/or young firms (e.g. spin-offs, spin-outs, start-ups, SMEs), and larger organizations (e.g. multinationals). In such interorganisational interactions tensions to co-create and capture value are interlinked between players of greatly different resources and market power. And though more often the smaller, younger firms are at disadvantage in such interactions, larger incumbents are not always ones to profit. The latter situation can occur for two possible reasons: either the larger incumbents' smaller contract partners do not reveal anything related to their IP due to fear of misappropriation, or large incumbents interact with even larger organizations that hold the upper hand in terms of bargaining power. The present paper attempts an overview of such issues with some suggestions for improvements.
Do Davids And Goliaths Profit Unequally From Innovation? Evidence From The Media
There are scarce examples of failed negotiations between asymmetric partners in the media. In these examples of business interactions between so-called Davids and Goliaths it is rather an unwritten rule that the smaller organizations profit less (or not at all) compared to their larger counterparts. Such small and/or young organizations seldom have the resources to file lawsuits against their larger, more resourceful partners. Suing their partner can result in "bet your company" litigation.
One reported exception is the case of a start-up called Infoflows and a large digital library, Corbis. The case is described in detail in an article in The New York Times by Lohr (2010). Infoflows was started by Microsoft 'veterans' who came up with an idea for a technology to track digital objects. Corbis was interested in this idea and thus the two companies signed a collaboration agreement in mid-2006. It is said that the two parties agreed not to patent the technology before jointly developing it further in the collaboration. Some months later, once Infoflows had disclosed more about the new technology, it is reported that Corbis suddenly announced the cancellation of the collaboration agreement. A few months later Infoflows launched a new website, presenting the previously developed technology of tracking digital objects. At this point Corbis sued, claiming the technology belonged to them and that Infoflows was infringing their IP. Infoflows sued back. Some three years passed before a U.S. court found Corbis guilty of having infringed upon Infoflows' trade secrets. It is assumed that verdicts involving misappropriation of trade secrets are rare because, a) it is a matter that can be very difficult to prove in court (Lohr, 2010), and b) litigating will only worsen the relationship between the parties which may be a poor long term strategy, and presenting arguments and evidence in open court might make loss of trade secrets even worse.
Another example found in the media, this time an on-going lawsuit, is the case of a Swedish start-up and Swedish banks (see Björk, 2018). Stefan Hultberg is a Swedish inventor who presented his idea about secure bank identification in 2007. It turned out that it was rather early for his idea, as the concepts of mobile apps and security did not yet go together. In 2010 Stefan made a new attempt. His idea was different, as it built mainly on software development, while the technologies banks were using at the time included sim-cards and sms communications. Stefan's company, Accumulate, started a pilot project together with the banks' jointly owned company, Finansiell id-teknik. Accumulate received some compensation for this pilot project but this was not even sufficient to cover the firm's own costs—they had no less than 15 patents registered for this solution. Stefan Hultberg suggested a licensing model which entailed that each user pay some sort of royalty fee for using the app. The banks did not agree. During this time, Accumulate had had meetings with the banks where details about how the solution worked had been revealed—including details about the source code under the protection of non-disclosure agreements. In autumn 2010 Finansiell id-teknik announced they were not interested in Accumulate's idea and that they would build their own
system. Stefan Hultberg claims that this is an identical copy of the system suggested by Accumulate. In 2017 the Swedish Patent and Market Court accused Finansiell id-teknik of patent infringement. The lawsuit is on-going (Björk, 2018).
Such cases are not frequently mediatized merely because they seldom end in lawsuits and most often are settled behind closed doors. However, small and/ or young firms are crucial for employment and growth in many economies. Hence, unfair business practices may have severe consequences for economy, innovation growth and more.
Possible Consequences of Unfair Business Practices
Employment and Growth Stomped When Young Firms Cannot Profit from Their IP– OECD Evidence
If negotiations between organisations fail and end in misappropriation or infringement of IP, one of the partners is most likely to be deprived of the rightful share of profits. In the case of smaller organizations, such as SMEs or start-ups, not reaping benefits from an idea might result in them not surviving. Young firms and their survival are crucial for employment and growth (Criscuolo et al., 2014; Haltiwanger et al., 2013) and may need nurturing to survive. For instance, in the U.S., firms that are more than 10 years old and have more than 500 employees provide about 45 percent of employment, while young firms account for only three percent employment in the private sector. While the former group accounts for about 40 percent of job creation and destruction, the latter explains approximately 20 percent of job creation (Haltiwanger et al., 2013).
A recent report of the OECD—Organisation for Economic Co-operation and Development—(by Calvino et al., 2016) provides cross-country evidence about ties between country policies and regulations and start-up growth. The catalyst of this analysis is the assumption that policies provide unequal advantages and benefits to incumbent firms, to the detriment of smaller and/or younger firms. One of the key findings by Calvino et al. (2016) is that strong contract enforcement is essential for creating a dynamic environment for young firms such as start-ups. Moreover, start-ups in sectors with greater growth and sectors which are more unstable are more vulnerable to national policies:
"start-ups in volatile sectors and in sectors that exhibit higher growth dispersion are significantly more exposed to national policies and framework conditions— i.e., their entry and growth performance appear to be more correlated to the policy environment— than those of start-ups in other sectors. This highlights the importance on the one hand of promoting policies explicitly aimed at lowering risk (e.g. improving access to finance), and on the other hand of tackling policy failures that are implicitly imposing an extra cost on risk (such as poor contract enforcement)." (Calvino et al., 2016; p. 6)
Goliaths Are Also Affected by Unfair Practices—Evidence from the European Commission
Nevertheless, misappropriation is also a threat beyond the domain of small and/ or young organisations, such as start-ups. A report from a European Commission conference emphasizes possible severe consequences of misappropriation that also affect large organisations (EC, 2012). For instance, in this European Commission conference, delegates of Alstom, DuPont and Michelin among others, illustrated several cases where their companies had been victims of misappropriation of trade secrets. Some of the above-mentioned delegates pinpointed that misappropriation may have negative effects on organizations' profits but also on overall growth and development of technology and economy.
Furthermore, misappropriation not only relates to trade secrets, but also to patents, patent licenses, patented knowledge and IP in general (e.g. Autio & Acs, 2010; Besen & Raskind, 1991; Robinson, 2012). In some cases, although misappropriation does not occur, even fear and anticipation of misappropriation could have a demotivating effect and result in loss of incentive to innovate. Prior studies have shown that firms that experienced misappropriation of unprotected IP (e.g. trade secrets) were less prone to collaborate/negotiate with external partners (Lorenz and Veer, 2017). Thus prior misappropriation may hamper present and/ or future co-creation of value or the willingness to enter into IP licensing contracts..
The above-mentioned examples like the Infoflows- Corbis collaboration (Lohr, 2010), the Accumulate and Finansiell id-teknik case (Björk, 2018) or the cases of misappropriation reported at the European Comission conference (EC, 2012) indicate that practitioners and policy makers alike struggle to identify solutions for managing tensions in negotiations/collaboration. Resolving such tensions could enable technological progress and economic growth.
Technology-Related Licensing and R&D Agreements and Top Sources of Disputes—Evidence from a WIOP Report
Another useful source of disputes with more focus on IP licensing is "Results of the WIPO Arbitration and Mediation Center International Survey on Dispute Resolution in Technology Transactions," March 2013 WIPO Arbitration and Mediation Center (WIPO, 2013). This report emphasizes the following:
"While, overall, disputes occurred in relation to some 2 percent of Respondents' technology-related agreements, more than half of Respondents stated that out of the agreements listed in the Survey less than 1 percent of licenses, R&D agreements, NDAs, settlement agreements, assignments and M&A agreements led to disputes.
Indeed, among technology-related agreements, licenses most frequently give rise to disputes (25 percent of Respondents). R&D agreements rank second (18 percent of Respondents), followed by NDAs (16 percent), settlement agreements (15 percent), assignments (13 percent), and M&A agreements (13 percent)." (WIPO, 2013; p. 4)
"41 percent of Respondents estimated that less than 1 percent of license agreements led to disputes. 7 percent of Respondents stated that more than 10 percent of the licenses led to disputes.
Respondent replies suggest that disputes in licensing agreements arise more frequently where parties are based in different jurisdictions than when they are based in the same jurisdiction.
In interviews, Respondents specified that disputes involving licensing agreements tended to concern issues such as scope and existence of the license, products, quality standards, profits, and determination and payment of royalty rates."(WIPO, 2013; p. 18)
Thus a quarter of licensing agreements and almost a fifth of R&D agreements are linked to disputes. Such numbers are rather high and point to general issues related to capturing rents from innovation.
Strategic Indeterminacy or Creative or Constructive Ambiguity
"Strategic indeterminacy" or "creative or constructive ambiguity" entails deliberately writing a contract with the aim to have it contain an uncertainty, vagueness or lack of clarity.
Two categories of Ambiguities are recognised:
- Textual or Internal Ambiguity which relates to problems with the language of the contract itself.
- Transactional or External Ambiguity which refers to the contract being clear and enforceable as written but essential transactional terms are missing, placing the benefits of the transaction at risk.
This is another way of manipulating a contract situation so as to inject a deliberate lack of clarity. That might happen because the one party—SME—does not have good representation. Vagueness in a contract could be a deliberate attempt to make the litigation of the contract difficult and expensive. But it is not easy to determine for certain whether vagueness is deliberate or accidental. Very often contracts contain some indeterminacy or ambiguity because not everything may be known perfectly at the time of drafting the contract and events in the future can render a statement in a contract to be unclear.
Emphasizing the Gravity of the Matter—the Austrian Federal Cartel Authority's Guidelines for Good Conduct of Entrepreneurs
It is of interest that the Austrian Federal Cartel Authority (FCA) has published for consultation draft guidelines for the good conduct of entrepreneurs (BWB, 2018). The draft guidelines identify various kinds of unfair trading practice and divide them into obstructive and exploitative practices, as follows:
Obstructive unfair trading practices:
- boycotts and denial of business;
- obstruction of sales;
- predatory pricing;
- market blockage;
- use of rebates and bonuses by dominant undertakings;
- unusual contractual restrictions; and
- most favoured treatment clauses.
Exploitative unfair trading practices:
- requests for unreasonable low purchase prices;
- requests for unjustified rebates and special conditions;
- abuse of market power;
- undue transfer of risks;
- discriminating contractual clauses and ambiguous contractual clauses or retroactive abuse of certain contractual clauses;
- intentional creation of legal uncertainty by way of refusing written contracts; and
- withholding of information.
One interesting aspect of the Austrian initiative is that the bullet points could perhaps become "heads of tort" each with an associated case law resulting in clearer definitions of misconduct. If the Austrian Federal Cartel Authority has prepared this list we assume that the list is based on realistic issues, i.e. actually what can happen or has happened even if such problems usually remain undisclosed. If that is true then the isolated cases which hit the courts and the media like Infoflows versus Corbis (see Lohr, 2010) or the WIPO report on disputes (WIPO, 2018), would be just the tip of a dark iceberg of misconduct.
This is not the first time this issue has been raised. For example, see the following comments by Howard Yale Lederman with respect to franchising in the U.S.A. (Lederman 2014):
"As Justice Holmes recognized, "[t]he life of the law...has been experience," including the "felt necessities of the time" and "intuitions of public policy." Historical experience has proven that almost unrestricted freedom of contract is destructive because it has become freedom to defraud. During the 1920s the securities markets were full of fraud, leading to the Great Depression and federal and state securities laws. During the 1960s, the franchise markets were full of fraud, almost destroying franchising and leading to the FTC rule, the MFIL, and other state franchising laws. Thousands of franchisees lost their life savings and hundreds of franchisors went broke. Franchisor representatives admitted rampant abuses and fraud and urged responsive government action. Even then California Gov. Ronald Reagan, not known for supporting government regulation, signed the California Franchise Investment Law, the MFIL's model. Thus, almost unrestricted freedom of contract in franchising became almost unrestricted freedom to defraud."
A franchise agreement is typically a contract over the licensing of trademarks. The franchisee is almost by definition an unequal partner to the franchisor. The historical evidence is therefore that under certain circumstances, an almost unrestricted freedom of contract in IP licenses can be destructive because it can result in a freedom to defraud.
Actions to be Taken/Possible 'Best Practices'…
If these forms of misconduct mentioned above mean a real problem in licensing IP then there are some actions which can be taken.
Ten Steps/Moves Towards Fairer Collaboration/ Negotiations
The following 10 moves may foster honesty in a contract counterpart (Schonk, 2018) PON: Deceptive Tactics in Negotiation: How to Ward Them Off):
- Assure your counterparts that they will meet their goals. When you express optimism that you will both meet your goals, you convey that you view negotiation as a problem-solving (rather than winner-take-all) enterprise and reduce the likely of competitive—and unethical—moves.
- Convince your counterparts that they are making progress. It is easy to lose sight of how far we have come in the thick of a negotiation. Pointing out the progress that counterparts have made will help increase their satisfaction, reduce their frustration, and help maintain a collaborative atmosphere.
- Point out how your goals and your counterpart's are linked. Our goals are often more closely intertwined than we might expect, and it can be wise to suggest that if they try to take advantage of you, they may harm themselves in the process.
- Suggest that your counterpart has limited alternatives to the current deal. If you truly believe that your counterpart cannot get a better deal elsewhere, it can be useful to highlight this fact. The more committed the other party is to doing a deal with you, the more ethically they are likely to behave.
- Imply that you have strong outside alternatives. Hinting that you have a strong BATNA (best alternative to a negotiated agreement) conveys to your counterpart that perhaps you need them less than they need you. If this is indeed the case, the warning should further deter the other party from lying and other deceptive behavior.
- Point out shared social identities (age, job history, marital status, etc.). Bonding over your similarities will bring you closer together and may deter unethical behavior.
- Encourage counterparts to identify with an ethical organization, such as their trade group. Reminding negotiators that they are accountable to certain industry standards should also help promote honesty.
- Note your connections to your counterpart's social network. They are less likely to try to deceive you if the news could get back to their friends and colleagues.
- Remind your counterpart of the legal implications of unethical behavior. You might also make a joint commitment upfront to negotiate openly and honestly.
- Mention the prospect of future personal or social support. Consider proposing becoming a gateway to valued social or business networks.
How effective is each move at curbing deceptive tactics in negotiation? That may remain to be seen. In a lab experiment, the team found that when participants used these moves in their negotiations, they did so too late in the game to effectively deter deception. Moreover, they sometimes combined these tactics with their own unethical behaviour.
Further research is needed to test the effectiveness of these 10 moves at reducing deceptive tactics in negotiation. Given the benefits of negotiation in business, you have strong incentives to try to promote more honest behaviour and avoid failed negotiation by using these strategies proactively throughout the negotiation process."
There can be a fear, however, with such an initiative that some of the conveyed information may be seen as representations and if the licensing deal goes bad, there can be litigation in which an attempt is made to show that the representations were misleading. As with a greedy counterpart why should they stop at a reasonable negotiated situation—why not ask for more, and then more and so on?
Increased IP Training and Awareness for All
A recent doctoral thesis by Stefan (2018) also suggests some possible 'remedies' of potential misappropriation of IP and misconduct in interorganisational interactions. According to Stefan (2018) these relate in part to the lack of knowledge and awareness about IP disclosure and protection. Small and/or young firms such as SMEs or start-ups often have insufficient knowledge about IP protection and about what information to disclose in IP negotiations. Nevertheless, this is of vital importance to achieve balance between co-creating and capturing value. Possible solutions to achieving said balance relate to increasing awareness about IP issues and disclosure through IP training in the form of lectures, workshops, etc. (Stefan, 2018). This would make small and/or young firms more equipped to manage tensions of co-creating and capturing value.
According to Stefan (2018), training staff about IP protection and disclosure and creating cross-functional roles and/or teams that might handle innovation partnerships are factors that are likely to resolve tensions between co-creating and capturing value. Transparency and building trust are also essential in collaborations, because fear of misappropriation from one partner's side may translate into lack of willingness to share IP and thus could hinder co-creation and capture of value for both or all partners involved in an innovation partnership. However, transparency (simplifying collaboration routines or sharing details about internal advancements and progress) should be combined with the above-mentioned increased awareness about IP protection and disclosure.
It is further crucial to be aware about the costs and limitations (e.g. territorial limitations) of so-called formal IPR such as patents (Stefan, 2018). Moreover, it is important to understand and, if possible, delineate between a new product's solution and its characteristics. This further relates to understanding whether an entire new product could be formally protected (e.g. via patent application) or whether only parts of it are protectable. The extent of formal protection applicable to an entire or parts of a novel product would subsequently determine the potential of disclosing the product (Stefan, 2018).
The above-mentioned costs and limitations of formal IP protection such as patents, as well as of contractual agreements are important aspects that policy makers should also consider. According to Stefan (2018) policy makers might also take into account the overall lack of awareness about IP protection and disclosure (in both smaller and larger organisations) and the fact that such lack of awareness enhances risks of misappropriation. Therefore, trainings, workshops, etc. related to IP issues should be organized for small and large organizations alike in order to increase awareness.
Aside from IP disclosure issues, small and/or young firms should be aware of the reputation of potential partners in innovation. Innovation intermediaries or other types of neutral partners might be able to help balance asymmetries and tensions (Stefan, 2018).
According to Stefan (2018), uncertainty about IP outcomes in collaborations, as well as collaboration projects with time constraints should be viewed as red flags by managers, as they increase risks of tensions and ultimately of misappropriation in innovation collaboration.
Over-focusing on either co-creating or on capturing value could also damage innovation partnerships. An example would be overprotecting a company's IP: on one hand this would be an efficient measure to make sure leaks and misappropriation of own IP are avoided; on the other hand too much IP protection might hamper new collaboration opportunities (Stefan, 2018).
A crucial question remains to be answered: How can small and/or young firms, or firms with limited resources protect their IP, although formal IP protection mechanisms such as patents are costly to enforce and limited territorially? Of course, this depends on the nature of the knowledge that is to be protected, and formal IP protection mechanisms are easier to enforce for codified knowledge (Stefan, 2018).
The Next Capitalist Revolution?
A recent article from The Economist (2018) points to the need for a revolution that would stimulate competition and abolish disparate profits. According to said article:
"A tenth of the [U.S.] economy is made up of industries in which four firms control more than two thirds of the market."
Similar figures can be observed across European industries. The Economist article further draws attention to a decline in new entrants' numbers and productivity growth, whose main underlying cause is the "lack of competitive pressure to innovate" (The Economist, 2018).
For this to change a so-called next capitalist revolution is needed according to The Economist.
"Data and intellectual- property regimes should be used to fuel innovation, not protect incumbent […] Patents should be rarer, shorter and easier to challenge in court.
[…] Governments should tear down barriers to entry, such as non-compete clauses, occupational licensing requirements and complex regulations written by industry lobbyists.
[…] antitrust laws must be made fit for the 21st century."
In comparison with the Austrian initiative, which attempts to focus on particular problems, the suggestion presented in The Economist requires global changes in legal and commercial thinking. It seems unlikely that there will be sufficient consensus for this to be implemented in one fell swoop.
The grey zone of abuse of financial or market dominance or other asymmetric factors in IP licensing is a matter of concern, but is difficult to investigate and quantify as many negotiations of IP licensing agreements remain secret. Unfair competition law or the law of misappropriation of IP can be complex, costly and time-consuming to litigate. This places smaller companies or companies with limited resources or poor representation at a disadvantage. It is, however, exactly these companies that can provide dynamic and technology-rich solutions to modern problems.
Evidence has been presented in the past that, under certain circumstances, an almost unrestricted freedom of contract in IP licenses can be destructive because it can result in a freedom to defraud, as well as to exploit weaknesses in the contract partner. In this situation laws which are quick, economical, efficient and cost-effective are preferred in combination with an increased awareness of IP laws and ancillary laws, thereto such as anti-trust or unfair competition and unfair business practice laws. There are some individual proposals from a limited number of countries such as Austria as to how the relevant laws may be made more comprehensive and effective. However, given the increasingly global nature of licensing or R&D agreements and other types of interorganisational interactions with the scope of buying/selling or co-creating innovations, improvements in laws and regulations in isolated national settings might not suffice. Hence, there could be a need for a harmonisation of such laws internationally in order for things to change for the better. ■
Available at Social Science Research Network (SSRN): https://ssrn.com/abstract=3317073.
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Stefan, I. (2018). "Knowing the Ropes in Open Innovation: Understanding Tensions through a Paradox Lens," (Doctoral dissertation, KTH Royal Institute of Technology).
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