The Role of IP in Industry Structure

I've long been a fan of Peter Lee's (UC Davis) work at the intersection of IP and organizational theory. His latest article is another in a long line of interesting takes on how IP affects and is affected by the structure and culture of its creators. The latest draft, forthcoming in Vanderbilt Law Review, is titled Retheorizing the Impact of Intellectual Property Rights on Industry Structure. The draft is on SSRN, and the abstract is here:

Technological and creative industries are critical to economic and social welfare, and the forces that shape such industries are important subjects of legal and policy examination. These industries depend on patents and copyrights, and scholars have long debated whether exclusive rights promote industry consolidation (through shoring up barriers to entry) or fragmentation (by promoting entry of new firms). Much hangs in the balance, for the structure of these IP-intensive industries can determine the amount, variety, and quality of drugs, food, software, movies, music, and books available to society. This Article retheorizes the role of patents and copyrights in shaping industry structure by examining empirical profiles of six IP-intensive industries: biopharmaceuticals; agricultural biotechnology, seeds, and agrochemicals; software; film production and distribution; music recording; and book publishing. It makes two novel arguments that illuminate the impacts of patents and copyrights on industry structure. First, it distinguishes along time, arguing that patents and copyrights promote the initial entry of new firms and early-stage viability, but that over time industry incumbents wielding substantial IP portfolios often absorb such entrants, thus reconsolidating those industries. It also distinguishes along the value chain, arguing that exclusive rights most prominently promote entry in “upstream” creative functions—from creating biologic compounds to coordinating movie production—while tending to promote concentration in downstream functions related to commercialization, such as marketing and distribution of drugs and movies. This Article provides legal and policy decision makers with a more robust understanding of how patents and copyrights promote both fragmentation and concentration, depending on context. Drawing on these insights, it proposes calibrating the acquisition of exclusive rights based on the size and market position of a rights holder.

Professor Lee surveys six industries, looking for commonalities in how they are structured, and how IP fits in with entry and consolidation. This is not an empirical paper in the sense of, say Cockburn & MacGarvie, who found that patents reduced entry into the software industry unless the entrant had patent applications. Instead, it looks at the history of entry and consolidation in the different industries as a whole, using studies like Cockburn & MacGarvie (which is discussed in some detail) as the foundational base for the theoretical view that puts all the empirical findings together.

The result is a sort of two dimensional axis (though Prof. Lee provides no chart, which wouldn't have added much). He finds that, in general, IP leads to entry early in time, but as the industry (or product area) matures, then IP leads instead to consolidation, as companies find it easier to acquire IP than create it on its own in crowded areas. He also finds, however (and I think this is a key insight in the paper), that IP leads to more entry upstream (early creation stage) and more consolidation downstream (commercialization and marketing).

This second axis is the more interesting one (there are lots of articles about development of thickets over time), but it is also the harder one to prove, and it depends a lot on your definition. For example, Professor Lee discusses video streaming services such as Netflix and Hulu but doesn't discuss whether he views them as horizontally consolidated because there are so few of them. I've always thought of IP as fragmenting video streaming, because rights holders want to monetize their IP by holding on to it. Hence, we have to pay separately to get Star Trek: Discovery on CBS streaming, Hulu has many TV shows that Netflix doesn't, and soon Disney will pull out of its exclusive deal with Netflix to create its own service. That's 5 or more services I have to sign up with if I want to get all the shows (contrast this with the story he tells about music streaming, in which the music distributors all distribute all the music, and the distributor record labels consolidate to enhance market power against the distributor streamers). Indeed, this issue is so important that the services have (as Prof. Lee points out) vertically integrated by consolidating production with distribution (Netflix and Amazon making its own shows, Comcast and NBC/Universal, and AT&T buying Warner). Professor Lee discusses this as a penchant for consolidation, but it is not clear why IP drives it. I think it is consolidation caused by upstream entry (as he would predict) by the likes of Netflix and Amazon in the creation space, because they also happen to be distributors. But then why don't the record labels become streamers? Why does this fragmentation work for video and not music? I'd be interested in hearing how Professor Lee breaks this down.

As you can probably tell, this is a thoughtful and thought-provoking paper, and I recommend it, especially to those unfamiliar with the literature on the role of IP in industry organization and entry.