1. General Aspects
Technology is a resource of production. As any resource of production it should be subject to negotiation and commercialization. Nevertheless, because technology is basically knowledge, it has some characteristics that make its commercialization very complicated.
These characteristics hinder technology producers from participating in the profits other users obtain from their inventions. This is what doctrine calls problems of appropriability36. The problems of appropriability are caused by specific characteristics of a good which impede its creator from obtaining profit from its use in the market. Under these circumstances there are not enough mechanisms to motivate the market to pay for the benefits it obtains from these goods or services.
Appropriability problems are a specific case of “externalities”. Market value of a
36 Gerosky, Paul, Markets for Technology: Knowledge, Innovation and Appropriability, in Stoneman, Paul (ed.), Handbook of the Economics of Innovation and Technological Change, 1995, at 90, 91.
service or a good remains external to the market, because although the market is aware of the value of that service or good, it is not willing to reward it, and thus promote its creation.
As a result, a vicious circle is generated: appropriability problems hinder the commercialization of technology and thus, the creation of technology markets. As the existence of markets facilitate the process of production and commercialization of these goods, the absence of markets increases again the appropriability problems of inventors.
Without the support of an appropriate institutional framework, a technology developer will be interested in keeping his new technological developments secret.
Also, he may lack motivation to keep improving his technology, as long as he is unable to appropriate all the benefits that this improvement creates.
2. Characteristics of Technology that Create Appropriability Problems
The appropriability problems of inventors are the result of the following characteristics of technology:
a) Technology Can Be Reproduced Without Limitation
Technology is knowledge; it is not a material object but it is composed of intellectual ideas. These ideas may be embodied in different ways: crystallized in the machines that use them, in models, industrial designs, or any kind of recording material, for example, written documents, data bases and the human memory. The recording mechanism may not have a high market value in itself, when we considered each record or copy, since from a technology whose development was expensive, an infinite number of very inexpensive copies can be reproduced (a fotocopy is an example). The value is generated by the massive exploitation of the technology in the market, i.e., from the possibility of selling a large number of inexpensive copies in the market.
b) Technology is a Quintessential Public Good
Technology, being basically information, is a public good37. The characteristics that make technology a public good can be listed as follows:
1).- Technology is a non-rival good38. The use of technology by one agent does not preclude its use by another.
2).- Technology is a non-excludable good39. Normally the producer of a new technology cannot prevent non-payers from using it.
3).- Technology is a “non destructive good”. The act of consumption of technology, in contrast to ordinary commodities, is not destructive.
These characteristics complicate the sale of technology in a market. It is difficult for the inventor to control the use by others of his technology and to convince those using his technology to pay him for the use of the invention.
The fact that technology embodies the characteristics of a public good allows technology users to consume it as free riders, without paying for it. Thus, both the creation and diffusion of technology are hindered, since it is difficult for a developer to participate in the social profits that his invention brings society.
Within these circumstances, an inventor will not have suitable incentives either to invent, or to disclose this invention. For this reason, without a proper institutional framework, markets will normally not provide the right incentives to encourage production of these positive “externalities”40.
c) Through Technology Diffusion the Market Price of Technology Deteriorates The price an entrepreneur is ready to pay for certain technology depends on the competitive advantage it gives him over other producers. Consequently, with diffusion of technology, the market power of the first enterprises which implemented it deteriorates. For this reason, those who first implement new
37 Id. at 92.
38 Foray, Dominique, Knowledge Distribution and the Institutional Infrastructure: The Role of
Intellectual Property Rights, in Albach, H. (ed.), Intellectual Property Rights and Global Competition, Berlin, 1995 at 77, 80.
39 Id. at 81.
40 Gerosky, at92.
technologies will normally be interested in excluding their competitors from using that new technology.
The problem connected with technology diffusion is accentuated by the fact that technology is basically information that can be recorded and transmitted easily and infinitely. Once technological knowledge is no longer secret it will remain in circulation, no matter how many people use it. As a result, it will tend to be an abundant good. The development of communication techniques has facilitated even more the process of technology recording and transmitting. Furthermore, because technology is a not destructive good, it very difficult to manipulate its price by creating an artificial scarcity. On the other hand, when a technology is wide-spread in a market, its possession might constitute a requisite for survival in that market.
Acquisition cost constitutes an indispensable factor for pricing technology. The competitive advantage provided by a certain technology depends not only on its ability to increase productivity, but also on its scarcity and on the cost of acquiring it. There are normally alternative ways of acquiring technology other than the producer. When an enterprise can acquire the technology more inexpensively from other sources, it will not pay its inventor.
d) Relatively Low Cost of Transmission of Codified Technology Transmission
The low cost of codified information recording and transmitting constitutes one of the largest difficulties in appropriating technology benefits. Anything which raises the transfer and reproduction costs of technology reduces the importance of problems associated with appropriability41.
The acquisition of technology generally occurs through a simple learning process, by understanding how it functions and how to apply it. This could be achieved unilaterally, simply by observing and analyzing the goods or services produced with this technology (reverse engineering), or by receiving a record of this technology. Acquiring the knowledge by reverse engineering implies costs and the risk of failure42, but can be less expensive than paying for it, if the sale or transfer price is too high. Thus, when the technology is not complicated, the possibilities of
41 Id. at 93.
42 Id. at 106-9.
reverse engineering can make the transfer of technology very inexpensive, especially when compared to the increase in productivity and, consequently, to the profit which it may generate.
Another factor which hinders the inventor from obtaining profits from the diffusion of his technology is that technology is a non-destructive good. As a result, it is very difficult to manipulate the price of technology by creating an artificial scarcity. Because of this, the developer of technology tends to keep it secret and to obstruct its diffusion.
Thus, an appropriate institutional framework is required to grant technology developers the possibility of having some control over the price of technology, in order to allow them to obtain a profit from the service of transmitting it.
On the other hand, even though knowledge transfer may be relatively inexpensive, it is rarely without cost. The cost of acquiring new technology normally includes more than the cost of the acquisition of information about the existence of a particular technology and the costs of obtaining a copy of it. Particular costs of technology mastering could partially reduce appropriability problems43. There may be certain conditions which hinder the diffusion of technology, allowing those who have invested heavily in Research and Development (R&D) to accrue the benefits of innovation44. For example, some technology may require its users to be well informed about other basic technologies; without that knowledge they will be unable to use the new technology. The cost of technology transmission offers the innovator the possibility of obtaining a certain control over the market and thereby, to obtain profits from the sale of certain services related to the transfer of technology. In these cases, technology transfer can be a profitable service, even when there is no protection for the inventor. As technology becomes more complicated, the learning process becomes more important: it is necessary that the acquirer has a basic knowledge to understand it and also that he has the ability to learn and find proper pedagogic ways of assimilating the information. Inventors may obtain profit from the special services required to organize and transfer all the information necessary to master the invention. Moreover, it might be necessary that the transferor adapt the technology to the necessities of the transferee.
43 Id. at 117-118.
44 Id. at 93.
As technology becomes more and more complicated, the costs of understanding and adapting it to the needs of the receiver become increasingly important.
Therefore, the service of transferring the information and assisting the acquirer to master technology are becoming a central element of technology transfer contracting. Consequently, technology transfer normally includes not only the authorization of using the protected technology, but also the service of transferring information. And this service itself may become more important than the information itself, when the market price of a particular technology could tend to decrease by technology diffusion45.
Thus, the definition of an appropriate framework for technology should include not only appropriability problems, but also the existence of opportunities of obtaining profits through technology transfer created by the costs of technology acquisition and master. In addition, the institutional framework should take into consideration the existence of market failures in the production and commercialization of technology in order to determine the level of protection and incentives given to inventors.
3. Market Failures in Production and Commercialization of Technology
Appropriability problems generate market failures in the production and commercialization of technology. Market failures are circumstances in which certain aspects of a good make it difficult for a market to take account of the benefits or disadvantages it produces, thus the market will not make a proper evaluation of it. Consequently market failures hinder the consolidation and development of markets.
One of these aspects is that technology is knowledge that may be very expensive to develop but very inexpensive to reproduce. The problems generated by this characteristic are aggravated by the way in which technology is produced.
Technology’s costs of production includes the risk of failure in one’s inventive
45 In fact business firms on average spend at least three times more on developing activities (i.e.
designing, building and testing prototypes and pilot plants), than on research activities (i.e.
developing, testing and refining scientific laws and models). See Patel, Pari, and Pavitt, Keith, Patterns of Technological Activity: Their Measurement and Interpretation, in Stoneman, Paul (ed.), Handbook of the Economics of Innovation and Technological Change, Blackwell Publishers Ltd.
Oxford, 1995, 17.
effort; and the risk of an invention not being economically exploitable46. Due to such risks, continued inventive activity depends on the expectations of recouping the necessary start-up cost as well as on earning a substantial profit to compensate for inherent risks47. However, once a technology is an abundant good, its market price tends to be zero, even though its contribution to productivity may be enormous48.
Market failures change from sector to sector, depending also on the technological capacities of the acquirers. The most important market failures are described in the following sections.
a) Market Uncertainties
There are two types of uncertainties that increase the cost of technology production and cause market failure. The first is related to the risk of realizing profitable results from inventive efforts. In fact, even if something new is discovered, only one out of ten inventions proves to be economically exploitable49. This relates to the problem of how to use technology to produce goods which succeed in the market. The second problem relates to the commercialization of technology, how to appropriate the benefits from a successful innovation. That is, there can be little relation between the commercial success of the new products or processes that a new technology makes possible and the benefits developers can appropriate from it. Once the inventor reveals his results, competitors may reproduce them as much as they like, taking away the potential profits from the original inventor. This situation undermines incentives for research and development (R&D) of technology and affects all the ways a researcher could have to finance his activity.
46 MacLaughlin, Richards & Kenny, The Economic Significance of Piracy, in Gadbaw, R. and Richards, T., (eds), Intellectual Property Rights: Global Consensus, Global Conflict?, London, 1988 at 89, 100-01.
47 See Emmert, Frank. Intellectual Property in the Uruguay Round- Negotiating Strategies of the Western Industrialized Countries, in 11 Michigan Journal of International Law 1317, 1318 (1990). See also Scherer, F.M. and Ross, D., Industrial Market Structure and Economic Performance, Boston, 1990, 615.
48 Foray, Knowledge Distribution , pat80-81.
49 See MacLaughlin, Richards & Kenny, pat 100-01.
For this reason R&D is especially promoted in activities where researchers can retain their results as secret and in which competitors do not have enough technological capacities to engage in reverse engineering to copy the technology.
A complementary way to cope with these uncertainties is to create a cooperative association of enterprises that allows them to share cost and benefits of technology production.
Uncertainty is also a problem in the commercialization of technology50. The creator of a technology confronts the dilemma that once the technology is created, the possibilities of commercializing it in order to obtain a profit are hampered by the appropriability problems of technology. Appropriability problems are complicated by the way technology should be negotiated. Sellers need to disclose certain information about the technology in order to allow potential acquirers to assess its value it properly. This negotiation phase implies a high risk for the seller and does not guarantee an income, as the potential buyer will generally not pay for this information. Therefore, sellers of an innovation are unlikely to obtain the full value that the buyers may give to the innovation. For this reason, technology developers generally do not assess the opportunities to produce technology for commercializing it. Instead, they tend to reserve that technology for their own use.
b) Economies of Scale in Production and Consumption of Technology
In contrast to the market failures related to uncertainty, there are other market failures that influence enterprises to find other ways of cooperation as alternatives to the market in order to exchange technology. Thus, the creation of cooperation agreements is chosen as a mechanism of technology transfer restricted to some participants.
The market failures that motivate enterprises to collaborate are related to the economies of scales both in production and utilization of technology51. Economies of scale, or returs to scale are present when greater efficiency is obtained as the firm moves from small -to large-scale operations. A proportional increase in all resources increase the output by a greater proportion.
50 See Stoneman, at 6.
51 Gerosky, pat 92-93.
R&D programs often involve substantial fixed set-up costs and display economies of scale arising from an extensive division of highly specialized labor. In addition, as technology consumption is non-destructive, the same investment in technology can be used for any amount of output. In this case, the cost of information per unit of output declines as the scale of production rises.
Economies of scale give large enterprises and cartels special advantages not only in the production but also in the commercialization of technology. They contribute to make technology transfer profitable through networks and technology markets.
Therefore, the size of the market plays a very important role in the creation and development of technology markets, as it increases the possibilities to take advantage of the economies of scale. For this reason, every attempt to integrate technology markets will strongly benefit the development and diffusion of technology through commercialization.
Technology also presents economies of scope across a wide range of uses. Greater efficiency is obtained as firms or R&D unit moves from small to larger wide range of different applications of a determined technology. Knowledge can be used to generate more knowledge. The broader a firm’s technological base is, the more likely it is to do basic research, since the research path could move to several directions, generating more valuable results52.
4. Practical Solutions to Appropriability Problem
Innovators can reduce their appropriability problems by implementing the following policies at the management level.
a) Maintaining Secrecy of Innovation and Integration of R&D with Production Appropriability problems let innovators to keep their inventions secret.
Consequently, rather than innovators selling their inventions to other firms, they have been inclined to hinder the diffusion of technology to competitors. As a result, R&D activities have tended to be financed not through commercialization of technology but through the integration of R&D with its direct exploitation for
52 See Nelson, R. The Simple Economics of Basic Research, in 67 Journal of Political Economy 297 (1959), 302.
production of new commodities. Therefore, technology tends to remain under-exploited, in relation to the social optimum processes of using that knowledge to manufacture new products.
Maintaining the information in secret presents at least the advantage of motivating other firms to create their own R&D departments, which increases the global technical capacities, but implies higher social costs because firms are forced to duplicate technology. Because imitation requires time and involves costs, developers may also obtain benefits even when the technology is subject to discovery by reverse engineering. R&D normally offers its developer lead time in industry and learning curve advantages for the acquisition and development of new technologies. Additionally, the developer of technology can obtain advantages from the foreknowledge of innovations. For example, he can obtain benefits from releasing, speculating or realizing new information53. The imitation time will allow him to take advantages of being the first developer through sales or marketing efforts. Therefore, a suitable institutional framework should motivate firms to share their knowledge instead of keeping it secret.
b) Increasing Scope of Firm and Cooperation Among Enterprises
Patent protection itself have scored quite poorly as an device for taking profit of the invention. Large enterprises are more readily able to exploit alternative means of reaping the benefits of R&D such as reliance on product differentiation, advertising and effective sales forces54. This firms have traditionally preferred to appropriate the benefits on investment in R&D excluding competitors and taking profit of the advantages created by beeing the inventor, i.e., being the first to use the invention (lead time), having better abilities to use the invention (learning curves); and the advantages generated by their economy scales (sales and service efforts. In this case, patent protection may play an important rule as an instrument for creating and preserving effective barriers to direct competition in commodity and resource markets worldwide.
Patent protection itself have scored quite poorly as an device for taking profit of the invention. Large enterprises are more readily able to exploit alternative means of reaping the benefits of R&D such as reliance on product differentiation, advertising and effective sales forces54. This firms have traditionally preferred to appropriate the benefits on investment in R&D excluding competitors and taking profit of the advantages created by beeing the inventor, i.e., being the first to use the invention (lead time), having better abilities to use the invention (learning curves); and the advantages generated by their economy scales (sales and service efforts. In this case, patent protection may play an important rule as an instrument for creating and preserving effective barriers to direct competition in commodity and resource markets worldwide.