The Journal of Legal Studies 2000 Lichtman

Property Rights in Emerging Platform Technologies Author(s): Douglas Lichtman Source: The Journal of Legal Studies, Vol.
29, No. 2 (Jun., 2000), pp. 615-648 Published by: The University of Chicago Press Stable URL: http://www.jstor.org/stable/724698 Accessed: 23/06/2010 08:21
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PROPERTYRIGHTS IN EMERGING PLATFORMTECHNOLOGIES

DOUGLAS LICHTMAN*
ABSTRACT
This article considers an externality thataffects a broadrange of markets,specifically markets where one set of firms sells some platform technology such as a computer, video game console, or operating system, while another possibly overlapping set of firms sells peripherals compatible with that platform, for example, computer software or video game cartridges. The externality causes certain peripheral sellers to charge prices that are unprofitably high. That is, these firms could earn greater profits if only they could coordinate to charge lower prices. In many markets, such coordination is possible; firms can contract, for example, or integrate. In markets based on relatively new platform technologies, however, coordination will typically be difficult. The article explains why and argues that intellectual property law can and should facilitate price coordination in these "emerging technology" settings. I. INTRODUCTION of emerging
EVER since Apple lost to IBM, technology firms have recognized the important role third-party innovation plays in the development
"platform" technologies.' The story is by now well known.2 Apple

* Assistant professor,University of Chicago Law School. E-mail: dgl@uchicago.edu. in Special thanksto Marshallvan Alstyne for numerousconversations which the natureof the externalitydescribedhere was first discoveredand to John Pfaff for excellent research assistance.Thanksalso to readersDouglasBaird,Scott Baker,Dan Fischel,WendyGordon, Deb Healy, Mark Janis, Bill Landes, Gene Lee, Saul Levmore, Anup Malani, Kimberly Moore,Casey Mulligan,RandyPicker,Eric Posner,RichardPosner,and Ingo Vogelsang;to at workshopparticipants Duke University, the University of Chicago, the University of SouthernCalifornia,the 1999 Social Science ResearchCouncilWorkshopin AppliedEconomics, and the 1999 Telecommunications Policy ResearchConference;and, finally, to a all helpful anonymousreferee.I regretthat I could not accommodate of the suggestionsI received, althoughmany are reflectedhere and othershave found their way into a related papercurrently underway. refersto any objecta consumercan 1 For the purposesof this paper,the term "platform" at of purchase a nonzeropriceto enhancethe valueof some number independently purchased refersto any purchased goods, andthe term"peripheral" good whose valueis in thatmanner increased.Desktop computers,VCRs, and operatingsystems are thus "platforms,"while softwareare all "peripherals." modems,videotapedmovies, and applications 2 This accountwas drawnfrom PeterNorton,In Praiseof an OpenLotus 1-2-3 Aftermarket, PC Wk., March 3, 1987, at 32; Steve Gibson, The Macintosh'sNubus Delivers on @ 2000 by The University Chicago.All rightsreserved. of 0047-2530/2000/2902-0002$01.50 615
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designed its first desktopcomputerswith easy-access hardware ports and an accessible operatingsystem, the purposebeing to facilitatethird-party and softwareaccessories.But when developmentof compatiblehardware IBM enteredthe home computermarket,Apple decidedthat its best strategy was to offer a more integrated product.Thus, the same year IBM unveiled the IBM PC, a machinewith built-inexpansionslots for hardware and well-publicized hardware softwarespecifications, and Appleintroduced the Macintosh,a unit thathad some advantages over the IBM PC out of the box but was markedlyless accessibleto third-party Withina development. few years,hundreds availablehardware softwareadd-ons(including of and dozens of applications accessoriesthatIBM itself had not anticipated) and made the IBM PC the dominanthome computingplatform. The IBM approach-what is todayreferred as "open architecture"to has been a popularone in recentyears.In the marketfor handheld computhave adoptedvariantsof the ers, for example,both Palm3and Handspring4 strategy,makingavailableat no chargeandto all comersthe interfacespecificationsfor theirrespectivecomputing The platforms.5 motivationin each of these instancesis the same: open-architecture strategiesallow platform developersto decentralizethe innovativeprocess. Firms like IBM, Palm, and Handspring not need to themselvesbear the full responsibilityof do both identifyingthe most compelling applicationsfor their platformsand then eitherdevelopingor contracting with othersto develop the necessary instead, under an open-architecture peripherals; approach,they can share thatresponsibility with third-party innovators. platform The developersearn their profits on sales of the platforms;the third-party earn entrepreneurs theirson sales of associatedhardware, software,and service peripherals. The open-architecture strategyhas a problem,however,in thatit creates a marketstructure Think,for example,aboutpefraughtwith externalities. of ripheral prices.Earlyin the development anyplatform/peripheral ecosysdiscretionto set theirpricesintem, peripheral developersenjoy significant
Promise,InfoWorld,June 22, 1987, at 10; Open Architecture: Apple's Open Architecture Room for Doubt, PC Wk., December10, 1985 at 20; and David Sanger,Will I.B.M. Shift N.Y. Times, March22, 1984, at D-2. Strategy? for Interfacespecifications Palm'sline of handheld are computers availableat no charge 3 from the companywebsite,http://www.palm.com visited October1, 1999). (last for 4 Interface specifications Handspring's recentlyunveiledhandheldunit are also available at no chargeand to all comers;see http://www.handspring.com visited October1, (last 1999). refersto any information firmsneed 5 In this paper,the phrase"interfacespecifications" in orderto developperipherals with a given platform. Thatinformation compatible mightbe information of aboutphysicalattributes the platform-for example,the preciselayoutof the more along the lines of a softpins in the platform'sserialport-or it mightbe information ware protocolfor the exchangeof encodedinstructions.
PLATFORM TECHNOLOGIES EMERGING
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to cost. This steadof being forcedby competitivepressures chargemarginal is truein largepartbecausethe firstfirmto identifyany add-oncategoryis a monopolistuntil other firms create comparablegoods. Such discretion alone would not be troublingexcept for the fact that each firm's pricing decision affects every other firm's sales. If a given firm were to charge a lower price, consumerswould be more likely to purchasethe relevantplatotherfirms'peripherals. This form and,hence, morelikely to then purchase it is an externality: is a consequenceof each firm'spricingdecision that is ignoredwhen each firm sets its price.6 Whatthis means-and here let us continueto focus on the pricingexternality althoughparallelargumentscan be made with respect to decisions regardingproductquality, advertisinginvestments,and so on-is that in basedon emergingplatformtechnologies,third-party markets developersas a group will charge prices that are too high. That is, if these firms could the internalize externality, they would (a) chargelower prices, a resultthat sense and also increase effiwould benefit consumersin a distributional ciency by lessening the gap betweenprice and marginalcost, and (b) earn greaterprofits, since under reasonableassumptionseach firm would lose money as a resultof its own price dropbut gain much more thanksto the increase in sales broughton by other firms' reciprocalprice reductions. Price coordination would also increasethe pace of innovation,since higher profitsex post would mean greaterincentivesto enterthe marketex ante, and, throughboth lower prices and fasterinnovation,it would increasethe rate of platformadoptionas well. is markets.Firmscan conPrice coordination possible in most peripheral is tract,for example,or integrate.But coordination virtuallyimpossiblein marketsbased on still-emerging technologies.The problemis thatthere is to never an opportunity bringall or nearlyall of the affectedfirmstogether to negotiate a mutuallybeneficialprice reduction.At these early stages, firmsare constantlyenteringand exiting the market.Obviouslya firmcurwith one thathas yet to enter;but in rentlyin the marketcannotcoordinate this setting such negotiationsare of criticalimportance since a consumer's decision as to whetherto purchasean emergingplatformtechnologyis often as muchbased on the consumer'sexpectations with respectto the price, as quality,and availabilityof futureperipherals it is based on the price and alreadyavailablefor purchase. qualityof peripherals Negotiationsamong the subset of firmsin the marketat any given time are still an option;but, by themselves,negotiationsof this sort will likely to prove ineffective. After all, currentfirmswill always be reluctant lower
6 Note that this is not a "pecuniary defined.See externality"as thattermis traditionally AndreuMas-Colellet al., Microeconomic Theory352 (1995).
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theirprices for fear that any price concessionsthey achieve will be offset itself at by price increasesfrom futurefirms.This is in fact the externality work:lower prices for current lead to increaseddemandfor the peripherals platform,which, in turn,leads to increaseddemandfor futureperipherals; that increaseddemandtempts futurefirms to raise their prices, and those the Note higherprices undermine benefitsof the originalprice reductions. that this same problem also makes vertical integrationunworkable.The sellersandlower peripheral platformownercould in theorybuy out current sellers would enter the prices of theirperipherals; when new peripheral but the market, those sellerswouldchargecorrespondingly higherprices,eliminatingor reducingthe benefitsof the originalintegration. combineto suggestthat Wheredoes this leave us? The above arguments in markets based on relatively new platform technologies, pure openarchitecture strategiesare decidedly second best. The best way for a platformownerto introduce new platform a technologymightindeedbe to make firmsto develop compatible it profitable a large numberof unidentified for that hardware softwareaccessories,'but accomplishing goal by making and publicly available the platform's technical specificationsinvites ineffihigh. ciency. Every time, consumerswill face prices that are unnecessarily low. sellers will earnprofitsthat are unnecessarily Every time, peripheral Platformowners choose the open-architecture approach,however, beInsteadof cause undercurrentlegal rules they have no better alternative. these firmsshouldbe using thatinformagiving awayinterfaceinformation, tion as leverage, sharingit with all interestedthird-party developers,but in only on the condition that the firms participate some sort of a pricereductionor profit-sharing program.But intellectualpropertylaw gets in the way. Completelyinsensitiveto the peculiardynamicsof the platform/ marketstructure, modem intellectualproperty the regimeunderperipheral firmsto reverse owners'influenceby allowingunauthorized mines platform engineer the platformand, in that way, develop compatibleperipherals withoutthe platformowner'spermission. Worse,every time platformowners attemptto compensate-say, requiringthat platformpurchasers agree with authorized to use the platform peripherals-courts only in conjunction doctrineso as to block the adintellectualproperty one interpret or another
(last visited October 1, 1999) 7 Accord, http://www.palm.com/devzone/business.html to developers']crucialrole in our success,we arecommitted sup("Recognizing[third-party ideas, developmentand marketingsupport.[Their] porting[their]efforts with information, businesssuccess will also be ours."; "Ourrole is to get devices into customer'shands,build and demandfor [our]platform, help createnew uses for the productthrough technologyand hardware software and innovation.";"[Third-party developers']role is to providethird-party and that accessoriesor otherproducts enhancethe platform the usabilsolutions,peripherals, ity of the devices.").
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justment,again withouteven consideringthe possibilitythatbroaderintellectual propertyrights might facilitatea beneficialform of price coordination. The argumentin this article, then, is not that intellectualpropertylaw shouldrecognizein all platformowners absolutecontrolover which firms, if any, develop peripherals compatiblewith theirrespectiveplatforms.Nor is it thatplatformownersshouldalwaysenjoy absolutecontrolwith respect to emergingplatformtechnologies-that is, absolutecontrolover the first generationof some handheldcomputeror the first release of a new opthe eratingsystem.The point, instead,is thatwhen courtsinterpret intellectual propertyrights recognizedin platformtechnologies,they should consider the possibility that broader readings would facilitate price coordinationthat, in turn, might lead to lower prices for consumersand For higherprofitsfor producers. the reasonssketchedabove, thatpossibility is especially strongin marketsbased on emergingplatformtechnologiesalthoughthere are surely exceptions to that rule and, conversely, settings involving more establishedtechnologieswhere this same logic might hold. This argument implications a numberof specificpatentandcopyhas for those are consideredlaterin the article.As readersfamiliar rightdoctrines; will recognize,however,it also has with the intellectualpropertyliterature debatein intellectualpropertylaw, a debate implicationsfor an important that began with a famous articleby EdmundKitch8and concernsthe wisdom of allowingoriginalinventorsto coordinate processthroughwhich the laterfirmsimproveand develop theirinventions.9 Thatdebatehas, up until coordination now, focused on only one type of coordination: designed to reducethe resourceswastedwhen rival firmseitherinadvertently duplicate one another's researchor race to be firstto completesome incremental step. This paperintroduces the debatea secondtype of coordination: to coordination designed to capturedemand-sideinterdependencies. shift in emThe phasis is importantsince, as others have pointed out,'"given transaction costs and uncertainty, downstream coordinationas it is traditionally conceived is virtuallyimpossiblefor an originalinventorto bringabout.After all, original inventorshoping to lessen the risk of duplicativefollow-on
8 EdmundKitch,The Natureand Functionof the PatentSystem, 20 J. Law & Econ. 265 (1977). 9 For a sense of the debate,see RobertMerges & RichardNelson, On the ComplexEconomics of PatentScope, 90 Colum. L. Rev. 839 (1990); MarkLemley, The Economicsof in Improvement IntellectualPropertyLaw, 75 Tex. L. Rev. 989 (1997); Donald McFetridge & Douglas Smith, Patents, Prospects,and Economic Surplus:A Comment,23 J. Law & Econ. 197 (1980); SuzanneScotchmer, ShouldSecondProtecting EarlyInnovators: Generation ProductsBe Patentable? RandJ. Econ. 322 (1996). 27 10 The point was firstmade explicit in Merges& Nelson, supra note 9, at 874-75.
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investmentface the Herculeantask of negotiatingdetailedcontractswith innovator,avoidingoverlapby specifyingexactly which every incremental research path each is authorizedto pursue. The type of coordination consideredhere, by contrast,can be significantlyachieved throughmore manageablemeans. For example, the originalinnovatorcan impose price caps keyed to roughperipheral categoriesor develop a profit-sharing plan where the percentageeach firm contributesis constant across all firms. Thus, the argumentpresentedhere supportswhat was Kitch's original claim: intellectualpropertylaw should,in certaincases, empoweroriginal inventorsto coordinate behaviorof follow-on inventors. the The paperproceedsas follows. Section II characterizes basic exterthe in platform/peripheral that can cause prices to be unprofitably high nality markets.This part shows that while the effect can obtain in a variety of it circumstances, is particularly likely in marketsbased on emergingplatformtechnologies.The sectionalso confirmsthatthe externality be sigcan nificant, thus justifying the possible recognition of additionalproperty rights. Section III plays out the implicationsfor intellectualpropertylaw, and consideringin some detail how patent,copyright,trademark, tradesebetween platformowners and peripheral cret law mediatethe relationship to developersand how minoradjustments severalspecificpatentand copyand coordination therebybenefit doctrines facilitatedownstream might right not only platformownersbut also third-party developersand consumersas well.
II. THE NEED FORCOORDINATION
This sectionbegins with a somewhatstylizedexampledesignedto introThe section then presentsa interaction. duce the basic platform/peripheral discussionof relatedwork and sets up the more formalmodel that appears in the Appendix.The section concludeswith some estimatesas to the size causedby the demandexternality. of the price and profitdistortions
A. How Peripheral Prices Relate
Considera single peripheral/platform pair-say, a word processorand To the associateddesktopcomputer. keep thingssimple,let us supposethat the computerhas no intrinsicvalue, so consumerspurchaseit only if they also plan to purchasethe word processor.Assume the computeris sold at a price, P, and the word processoris sold at a price,Pwp. into threegroupsbased Figure 1 is a numberline thatdivides consumers on how much they value the word processor.Group1 is made up of consumerswho value the wordprocessorbelow its retailprice.These consumers would not purchasethe word processoreven if they alreadyowned the
TECHNOLOGIES PLATFORM EMERGING GROUP1 2 GROUP GROUP3
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0
PwP PwP + P on FIGURE 1.-Consumer valuationsfor a hypotheticalword processor,represented a numberline that increasesfrom left to right and startsat zero.
computersince, to them, the software'sprice exceeds its value. Group2 is composedof consumerswho value the word processorabove its cost, but not enough to warrant purchasingthe computer.Unlike the consumersin group 1, these consumerswould purchasethe word processorif they already owned the computer.Group3 consists of consumerswho value the wordprocessorso much that,for this reasonalone, they are willing to purchase both the computerand the word processor. a to this Now introduce secondperipheral the market, time a spreadsheet. event. True, the To the seller of the word processor,this is an important introduction a second peripheral of does nothingto change the behaviorof consumersin the firstand thirdgroups;'" formerwill refuseto purchase the the word processorregardless,and the latter were ready to buy both the and becameavailcomputer the wordprocessoreven beforethe spreadsheet able. For some consumersin the second group, however, the spreadsheet with the wordprocessorwill be enoughof a reason alone or in combination to purchasea computer.In otherwords,for some consumersin this group, will tip the balance,leading them to purchasethe spreadthe spreadsheet sheet, the computer,and the word processor. This is the externalitythat motivatesthe paper.Thinkof a randomconsumerdrawnfromgroup2. Holdingconstantthe pricesof the wordprocessor and the computer,this consumer'sdecision as to whetherto purchase the word processorturns entirely on the price of the spreadsheet.If the is spreadsheet cheaprelativeto the consumer'svaluationof the spreadsheet, the consumermight decide to purchasethe computer,the spreadsheet, and the word processor.If, by contrast,the spreadsheet sold at a price too is close to or above the consumer'svaluation,the consumerwill forgo all three components.This is an externalityin that it is a consequenceof the seller's pricingdecision thathas no directeffect on the spreadspreadsheet
" This is a bit of a The existence of the spreadsheet could increaseconsimplification. sumerdemandfor the wordprocessorif wordprocessorsand spreadsheets complements, are andcould decreasedemandfor wordprocessorsif wordprocessors spreadsheets suband are stitutes.These effects are consideredin the next two subsections.
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sheet seller's profit;in the absenceof coordination, is thereforea conseit he will ignore when choosinghis price. quence B. WhyProfitsMightRise Thatthereis an externality this marketis of courseonly half the story; in the externalityhas interestingpropertiesonly if it also turns out that the firms can earn greaterprofits by accountingfor it. Thus, what we really want to know is whether,were the spreadsheetseller to lower its price, profitsfromwordprocessorsales would increaseby more thanprofitsfrom sales would diminish.To answerthis question,we need to despreadsheet velop a more formalmodel; that is the task of the next subsection.Here, we can use a simpleranalysisto previewthe results. The peripheral/peripheral arisesbecauseconsumersare in esexternality sence amortizing cost of a platformacrossseveralpurchasing the decisions. This is why lower peripheral prices are so helpful:a lower peripheral price allows consumersto retainextra surplusfrom a particular and transaction, that surplusmakesthe platformseem cheaperwhen consumersare considering every otherpossible purchase.The cheaperplatformmakes consumers more willing to buy, and the effect propagatesacross all peripherals. The fact that severalperipherals compatiblewith the same platformis are thereforeenough to set up the possibility of a profitableprice reduction: loweringprice by a small amountwould have a negligible effect on each firm's profits but, overall, those small price reductionswould add up to what consumerswould perceive to be a substantial reductionin the platform's total cost. Whetherthatpossibilitycan be realizedin any given case, however,defactors.First,when a given periphpends on the strengthof two additional eral firmlowers its price, some of the otherfirmsare madeworse off. Suppose, for example, that Microsoft were to lower the price of its popular wordprocessor.Makersof competingwordprocessors would surelyexperience a drop in sales; even thoughMicrosoft'slower price would increase demandfor most peripherals makingdesktopcomputersseem less exby pensive, it would decrease demandfor these substitutegoods. True, the otherfirmscould lower theirprices as well, but that still would not change the key result:these firmswould be worse, not better,off by virtueof Microsoft's hypothetical price reduction. Second, and workingin the oppositedirection,when a given peripheral firm lowers its price, some of the other firms are made betteroff in ways thathave nothingto do with the increasein platformsales. To stay with the above example,for some consumersowning a wordprocessormakesownmore desirablesince, together,the programs ing an electronicspreadsheet
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createbetterdocumentsthaneitherprogramcan alone. Thus, a lower price above and for wordprocessorswould increasethe demandfor spreadsheets increase caused by the increase in platformsales. Firms that beyond any would thereforebe even betteroff thanour inisell electronicspreadsheets tial analysissuggested. Whetherfirms overall can lower prices and increase aggregateprofits, then, dependson the numberof firms in each of the above categories,on the strengthof each effect, and on the numberof firmsin neithercategory and thus subjectto just the basic analysis.This makesgeneralobservations somewhatcomplex. Nevertheless,a few general statementscan be made. For example,in marketswhere consumerstend to have strongpreferences a for particular will peripherals, lower pricefor any one peripheral typically not significantlyreducedemandfor any otherperipheral, so therewill and for almost always be some opportunity profitableprice reductions.Examples here might include the marketfor trendyvideo games or the market for popularmusic. By contrast,in marketswhereperipherals all almost are perfect substitutes, mutuallybeneficialprice reductionsare unlikely.Lowering the price of a given brandof ink cartridgeor blank videotape,for instance, would probablydecreaseoverall profits,since a lower price for one brandwould force competingbrandsto eitherlose sales or lower their prices as well. Of particular interesthere:therewill typicallybe an opportunity mufor tually beneficialprice reductionsin any marketbased on an emergingplatform technology.Thereare two reasons.First,early in the developmentof a peripheral marketonly a small numberof peripherals available.These are are peripherals in most cases unique,and so loweringthe price of one will in rarelymuch diminishsales of any other.Second,peripherals these markets tend to be unique for anotherreason:at these early stages peripheral firmsare identifyingentirelynew types of hardware softwareadd-ons. and The whole purposeof open-architecture developmentis to set third-party developersfree to identify new applicationsfor a given platformtechnology.12 Every time a third-party developerdoes so, that firm will create a will be unique as peripheraltailoredto the new use, and that peripheral to at adcompared all availableperipherals least untilthe firm'sfirst-mover vantagesdissipate.13
12 That is how Palm Computingexplains its open architecture program.See http:// (last www.palm.com/devzone/business.html visited October1, 1999) ("As we focus on the we're relyingon [ourthird-party extendexisting platform, developers]to reachnew markets, to applications the handheld,and work with real-life users to find entirelynew ways to use this platform."). 13 Sometimesintellectual is propertyrightsfurtherensurethat a given peripheral unique, as where a firmis grantedcopyrightor patentprotectionfor its peripheral. a discussion For
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C. A Formal Model
The formalmodel thatfollows buildson a foundation firstset out by Auin notedthatindependent gustinCournot 1838.14 monopolisticsellCournot ers of complementary goods earn maximalprofitsif each chargesa price below its individually rational price.Sellersof complementary goods face a sellers:by definition,a lower problemsimilarto the one facedby peripheral increasessalesof all complementary but priceforone product products; those benefitsare ignoredwhen complementary goods are pricedindependently. case whereproducts directcomare provedthisresultforthe narrow Cournot andareusefulonly as directcomplements,15 he framed was and but plements unableto solve the more complicatedcase wherethe productshave uses in additionto theiruse as partof the complementary combination.16 have extended and recast Cournot'swork;"of particular Many papers relevance here is a series of recent papers applying it to the platform/ These papersassumethatone or severalfirmssell some peripheral setting.18 at a supracompetitive set platform price while another,nonoverlapping of firmssell peripherals also at supracompetitive show thatif the prices.They sellers, prices would platformsellers were to integratewith the peripheral decreaseand profitswould rise. The currentpapertakes the next step by showingthat a similardynamictakes hold even in marketswhere the relevant platformis sold at a competitiveprice. The priorpapersfocus on a price distortioncaused by verticallystackedmonopolies:the platformmoand each nopolists are upstream,peripheral monopolistsare downstream, chooses its price withoutconsideringimplicationsfor firms in monopolist
of the implications layeredintellectual of property rightsof this sort,see Lemley,supranote 9; and Scotchmer, supra note 9. 14 Augustin of Researches the Mathematical into Cournot, Principles the Theoryof Wealth 1838 (Nathaniel Bacon trans.,OxfordPress 1897).
15 Id. at 99-107.
16
Id. at 107-108.
for examsee industries. an overview of the literature, Dennis For ple, the automobileand newspaper 523-33 (2d ed. 1999). Carlton& JeffreyPerloff,Modem Industrial Organization New Features & Integrating 18 See Steven J. Davis, JackMacCrisken, Kevin M. Murphy, 27-31 (unpubinto the PC Operating System:Benefits,Timing,and Effects on Innovation on lished manuscript, file with author,1998);NicholasEconomides,The Incentivefor Nonprice Discrimination an InputMonopolist,16 Int'l J. Indus.Org. 271 (1998); Nicholas by The Incentivefor VerticalIntegration Economides, (DiscussionPaperNo. EC-94-05,N.Y.U., ComplemenSternSchool of Business 1997); NicholasEconomides,NetworkExternalities, tarities,and Invitationsto Enter, 12 Eur. J. Pol. Econ. 211 (1996); Nicholas Economides, 17 QualityChoice and VerticalIntegration, Int'l J. Indus.Org. 903 (1999); Nicholas Ecoand and nomides & Steven Salop, Competition Integration Among Complements, Network and MarketStructure, J. Indus.Econ. 105 (1992); RandallHeeb, Innovation VerticalInte40 Ph.D. dissertation, Univ. Chicago SoftwareMarkets(unpublished grationin Complementary 1999).
17 These papersshow how Cournot'soriginalinsightexplainscore featuresof,
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the othergroup.This paper,by contrast,focuses on the Cournotdistortion causedby independent horizontally arrayed monopolists.Whetherthe platform developerhas marketpower is irrelevant; externalityhere is an the externalityamongperipherals. For the purposesof the model, let us now formallydefinethe term "platform" to mean any object a consumercan purchaseat a nonzeroprice, or nontrivial investany stateof the worlda consumercan bringaboutthrough ment, to enhance the value of some numberof independently purchased goods; and the term "peripheral"to refer to any purchasedgood whose value is in thatmannerincreased.This is a broader definitionthanthatpreand viously adopted,'9 the model thus has relevanceto a broaderclass of musttravelto a shopproductsandactivities.For example,since consumers ping mall before they can make purchasesat the individualstores in the mall, travelingto the mall is in some sense a "platform"whose price can be measured termsof bothtime andinconvenience, the variousitems in and sold in the mall are in some sense "peripherals"to that initial platform expense.20In this paper,however,the primary focus will remainon physical technologyplatformspurchased throughfinancialinvestmentsand the peripheralsassociatedwith those platforms. Because of theirrelationship with the platform,the price of any one peAs ripheralaffects sales of every other peripheral. was pointedout in the intuitivediscussion,however,peripherals often linkedin otherways as are well. To be precise:peripherals "substitutes"if, were the relevantplatare form availableat zero cost, a decreasein the price of one would lead to a decreasein demandfor the others;and peripherals "complements"if, are were the relevantplatformavailableat zero cost, a decreasein the price of one would lead to an increasein demandfor the others. The model assumes that each peripheral sold by only one firm, that is each firm sells only one peripheral, that firms that sell peripherals and do not also sell the platform.More complicatedcases follow the same general patterns.The model also assumes that peripheralfirms are independent, meaningthat each makesits own decision with respectto price. One could easily extend this work to addressdecisions with respectto other product features, for example, product quality or service support.21Using these definitionsand underthese conditions,the following propositionand two relatedcorollariesare provenin the Appendix. PROPOSITION. settingswhere two or more firms sell peripherals In and
The termswere originallydefinedin note 1 supra. Similarly,before a consumercan shop on-line,the consumermustinstallandconfigure an Internet connectivitypackage.This installation process is also a "platform"investment, at that an expensive one for consumerswho are not yet computerliterate. 21 The paperscited in note 18 supramake this point with respectto theirmodels as well.
19
20
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those peripherals neithercomplements substitutes, are nor each firmwould earngreaterprofitif each chargeda price lower thanits individuallyrational price. 1. are COROLLARY In settings where some fractionof the peripherals the proposition continuesto hold for all firms. complements, 2. COROLLARY In settings where some fractionof the peripherals are the continuesto hold for firmsthatdo not sell subsubstitutes, proposition stitutes,and the proposition may or may not hold for firmsthat sell substitutes. The commentsin the priorsubsectionshouldhelp to makeclearthe relevance and implicationsof these more formal statements.Note that while confers the proposition referencesonly the benefitsthat price coordination in coordination fact also benefitsconsumersand on peripheral developers, the platformowner.For consumers,the rewardis lower prices, greaterefficiency from closer-to-marginal-cost pricing,and an increasein the rateof innovation. the platform For owner,the primary payoff is greater peripheral consumerdemand,an increasethat comes aboutthanksto both the lower innovation. peripheral prices and the increasedrate of peripheral D. The Size of the Effect The work of the previous subsectionwas to develop the article's core firmswill charge economicclaim:that,undercertainconditions,peripheral high. The Appendixpresentssome additional prices that are unprofitably detailhow peripheral interaboutthis effect, showingin greater information This secdependenceshifts and distortsdemandfor any given peripheral. tion uses the model presentedin the Appendixto estimatethe size of the cases. The purposeis to for price andprofitdistortions some representative confirmthatthese distortionsare sizeable and, hence, that it is worthwhile to consider at least some minor modificationsto the currentintellectual propertyregime. we To keep the mathematics manageable, considerhere only cases with that and two peripherals a platform has no intrinsicvalue.Demandfor each is peripheral assumedto be uniformon [0, V] (thatis, lineardemand),and are for consumervaluations the two peripherals assumedto be uncorrelated. cause the two firmsto behaveidentically,allowingus to These restrictions focus on just one of them in the graphsthat follow. peripheralprices as a Figure 2 shows coordinatedand uncoordinated function of platformprice. The top line representsthe prices each firm while the lowerline represents wouldchargein the absenceof coordination, Platthe lower prices the firms would chargeif the two could coordinate. form price is markedon the horizontalaxis, and it increasesfrom left to
EMERGING PLATFORM TECHNOLOGIES 0.5 Peripheral Price 0.3 V V
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V Platform Price
2V
FIGURE 2.-Uncoordinated (top line) and coordinated (bottom line) prices for the two-firm setting with consumer demand uniformly and independently distributed on [0, V]. Platform price increases left to right.
right. The axis is labeled as a functionof V in orderto give it meaningful context.For example,a pricegreater thanV meansthatconsumers purchase the platformonly if they are willing to purchaseboth peripherals. Platform is cappedat 2V since, at higherprices,no consumervalues the periphprice erals enoughto purchasethe platform. Severalfeaturesof the graphwarrant brief comment.First,at a platform of zero, the uncoordinated price and the coordinated price are identiprice cal. This makes sense since, in cases where the platformis free, the price of one peripheral does not affect demandfor the other, so each firm will set its price appropriately. Second, as platform pricerises, peripheral prices fall. Again, this follows intuition.Since consumersconsider the platform how much they are willing to pay for any given price when determining peripheral,a higher platformprice eats away at consumerwillingness to firms, leading the firms to compensatewith pay as seen by the peripheral lower prices. Third,both lines are kinkedbecause, above a certainplatformprice, no consumersare in "group 3" with respect to either peripheral. That is, at some point, no consumersare willing to purchasethe platformsimply because they value one of the peripherals highly. In this example,a platform price of V is the absolutehighest platformprice for which any consumer could conceivablyvalue one peripheral enough to purchaseboth that peand The ripheral the platform. kinksfall slightlybelow V since the peripherals themselvesare sold at nonzeroprices, andthus group3 is emptiedeven before the platformreachesa price of V. This also explainswhy the kinks are not aligned.The lower line represents lower prices, so at a given plat-
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33%
Percentage
Drop
20%
V Platform FIGURE 3.-Price of platform price. Price
2V
distortion as a percentage of uncoordinated price, graphed as a function
form price, there are always more consumersin group 3 when prices are coordinated than there are when prices are not coordinated. This naturally that group3 is emptiedin the uncoordinated before it is empcase implies one. tied in the coordinated 3 comparesthe coordinatedand uncoordinated Figure prices shown in 2. The verticalaxis depicts the price distortionas a percentageof Figure the uncoordinated price. Thus, at a platformprice of V in this example,if the firmscould coordinate, they would choose prices 33 percentlower than their uncoordinated prices. The kinks in the line are caused by the kinks is shown in the previousfigure.The percentage constantonce the platform who purchase areconsumers it who is so expensivethatthe only consumers both peripherals. purchase Figure4 comparably depicts the profitdistortion,again as a functionof This time, the vertical axis representsthe profit loss as a platformprice. functionof uncoordinated profits.Again, and for the same reasonsas exis above,the line is kinkedandthe distortion constantonce the platplained form exceeds a certainprice. As with any presentation this sort, the graphs shown here are only of is The representative. price distortion a functionof manyfactors,andit can The be madeto look worse or betterby varyingany of severalassumptions. used to generatethese graphs,however, were chosen because assumptions were assumedto be of comparathe they seem reasonable: two peripherals ble popularity,the distortionis shown under the full range of platform are prices, and so on. If the assumptions indeed fair, then the graphsconfirmthatthe effect can be sizeable.
EMERGING PLATFORM TECHNOLOGIES
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18% Possible Increase Profit
10%
2V
Platform
FIGURE 4.-Profit of platform price.
Price
distortion as a percentage of uncoordinated profit, graphed as a function
III. IMPLICATIONS The externalityidentifiedin the precedingsection likely affects a wide markets.It probablyaffects marketswhere variety of platform/peripheral consumerspurchasevideo game consoles separatelyfrom compatiblecartridges and marketswhere consumerspurchasecomputerhardwareseparately from niche or locked-in software.In cases like these, however, affected firms can mitigate the externality'simplicationsby coordinating or contract, pricesthrough integration, some otherformalor informalmechanism. This, for example, might be one reason why Microsoftbundles a word processor,spreadsheet,and databasetogetherin its Office product and, further,why Microsoftthen tries to sell the Office producttogether with the Windows operatingsystem. Marketsof this generalform are not of particular interesthere, then, because,even if it is significant,any externality in these marketscan be addressed throughconventionalmeans. In markets based on emergingplatform technologies,however,voluntary coordinationis likely unworkable.As was explainedin the Introduction, this is because of the dynamicnatureof still-maturing markets.With firms and exiting the market,it is almostimpossibleto bring constantlyentering all affectedfirmstogetherfor a single negotiation. And negotiationsamong subsetof the firmsare unlikelyto resultin a significant any pricereduction since involved firmswill be hesitantto lower theirprices for fear that any price concessions they achieve will be offset by corresponding price increases from uninvolvedfirms.Of course, the platformowner itself might be able to partiallysolve the problemby, for example,paying subsidiesto firmsthat lower theirprices;but any such solutionis significantlylimited.
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When new peripheral sellers enterthe market,afterall, those sellers either will chargecorrespondingly higherprices or will themselvesdemanda significantsubsidy,in both cases significantly eitherthe platform undermining owner's objectivesor its profitability. In emergingtechnologycases, then, the most promisingway to internalize the peripheral/peripheral is externality to empowerone party-the obvious choice being the platformowner-to coordinate behaviorof all the the otherfirms.The issue is thus an issue for intellectualproperty law. Patent, and trademark, tradesecretprotectioncombineto give platform copyright, owners a certaindegreeof influenceover every would-beperipheral develBut that influencehas traditionally been constrained; courts have in oper. generalbeen unwillingto recognizetoo much influencefor fear that platform owners would use it to exclude firms from the peripheral market.22 That, of course, misses the insight of open-architecture strategies:many innovationboth to develop their platformownersin fact rely on third-party Theseplatform owners platforms quicklyandto identifynew applications.23 would use additionalinfluence not to exclude peripheralfirms from the marketbut instead to make the peripheral marketmore profitable.Thus, thereis anotherfactorfor courtsto considerwhen applyingany of the various doctrinesthat determinethe scope of a platformowner's intellectual rights:the possibilitythat broader rights will be used to facilitate property downstream coordination the benefitof consumers,third-party to developers, and also the platformowner. The first subsectionbelow sketchesthe basic rights intellectualproperty law recognizesin platformowners as a matterof course. This providesa baselinefor the analysisthatfollows. The second subsectionconsidersdisrights courts at their option recognize on a case-by-casebasis. cretionary The subsectionis organizedaroundfour maininquiries-in patentlaw, the and distinctionbetween repairand reconstruction, the doctrineof patent misuse;and,in copyrightlaw, the definitionof the term "derivativework" and the doctrineof fair use-and arguesthateach of these inquiriesshould
Ltd. v. Accolade, Inc., 977 F.2d 1510, 1526 (9th 22See, for example, Sega Enterprises Cir. 1993) ("If disassemblyof copyrighted objectcode is per se an unfairuse, the ownerof the copyrightgains a de facto monopolyover [the sale of add-ongoods]"); Sage Products, Inc. v. Devon Industries, Inc., 45 F.3d 1575, 1579 (Fed. Cir. 1995) ("[The platformowner] thus seeks to keep for itself a marketin parts which are intendedto be periodicallyre[add-on] placed-this is no more than an attemptto expandpatentrights to an unpatented product."). mechanism. Conin peripherals 23 An open market mightalso be a crediblecommitment sumerswould hesitateto purchasea platformif they thoughtthatthe platformownerwould On laterhave monopolisticpowerin the marketfor peripherals. a relatedtheme, see Joesph as Farrell& NancyGallini,Second-Sourcing a Commitment: MonopolyIncentivesto Attract Competition,103 Q. J. Econ. 673 (1988).
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be guidedin partby the arguments presentedearlierin the paper.The third and final subsectionconsiderstwo possible objectionsto this proposal:that courts might not have the expertiserequiredto engage in the analysisendorsed here and that, even with broaderrights, as a practicalmatterplatform owners will not be able to coordinatefollow-on innovation. A. The IntellectualPropertyBaseline If platformowners were able to patentinterfaceinformation--say, assertingrights in the precise layout of the pins that make up the platform's serial port or the specific dimensionsof the diskettesacceptedby the platform's disk drive-platform owners would fully controlthe associatedpedeveloperusing the patenteddetail withripheralmarkets.Any peripheral holder'spermissionwould be an infringer,vulnerableto an out the patent actionfor damagesas well as injunctiverelief. This is rarelythe case, however, because interfacedetails are for the most part "obvious" given the Dell, for example,did not and probablycould not claim the parpriorart.24 add-onsto interfacewith the that ticularportconfigurations allow hardware DimensionXPS desktopcomputersince, no matterhow originalother aspects of the machinemight have been, the serial connectionsthemselves were commonplaceat the time Dell filed its patentclaims.25 For similarreasons,copyright,too, rarelygives platformowners significant influenceover peripheral developers.The main limitationhere is that interface specificationsconceivably eligible for copyright-for example, the specific patternof Os and Is necessaryto cause an operatingsystem to read data from a diskette-typically do not satisfy Section 102(a)'s origiof nality requirement.26 According to the SupremeCourt's interpretation that provisionin Feist, to be eligible for copyrightprotectiona work not
24 35 U.S.C. ? 103(a) ("A patentmay not be obtained.., .if the differencesbetweenthe subjectmattersought to be patentedand the priorart are such that the subjectmatteras a whole wouldhave been obviousat the time the inventionwas madeto a personhavingordidetailsdo naryskill in the artto which said subjectmatter pertains.").Some interconnection qualify for patentprotection.For example, Nintendoearneda patentfor the design of the interfaceon one of its early video game consoles. See U.S. PatentNo. cartridge/console cassetteis a patented meansof bringinginforma4,799,635 (1989). Similarly,the eight-track tion to the compatiblecassetteplayer.See U.S. PatentNo. 3,403,868 (1968). Even in cases where a patentissues, however,protectionis not airtight.In Hewlett-Packard Companyv. Stencil Manuf., 123 F.3d 1445 (Fed. Cir. 1997), Hewlett-Packard's Repeat-O-Type patents on a particular were held not to be infringedby a competitor's cartridge ink-jetprinter practice of purchasing on cartridges the open market,modifyingthem so as to makethem refillfor able, and, without Hewlett-Packard's consent, selling the modifiedcartridges use with Hewlett-Packard printers. 25 Among the relevant patentsare U.S. PatentNos. 5,291,585 (1994) (softwarefor accessing I/O devices) and 5,668,696 (1997) (system for heat dissipation). 26 17 U.S.C. ? 102(a).
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only must be originalto the author(literally,"not copied") but also must Protocols for the demonstratesome modicum of creative achievement.27 that most partfail to demonstrate modicumof creativeachievementsince patterns.28 many are in fact arbitrary Even where protocolsdo evidence sufficientoriginality,copyrightprotection is still typically denied. The courtsare inconsistentas to how this pointis framed,with some courtsinvokingthe mergerdoctrinewhile others invoke the doctrine of scenes a faire, Section 102(b), or the somewhat but test blurredabstraction-filtration-comparison from Altai;29 the various all emphasizethe same fundamental copyrightprinciple:copyapproaches extendsonly to the expressiveelementsof a work,andeven rightprotection creativeprotocolsare more functionalthanthey are expressive. law Trademark gives platform developerssome influenceover peripheral in most cases this is likely but a modestfactor.Even unausellers,although are thorizedfirms can advertisethat their peripherals compatiblewith the since thatis a truthful crafted,it would claim, and,if appropriately platform Whatunauthonot lead to any confusionas to the sourceof the peripheral.30 rized firms cannot do is claim that their peripheralsare "officially licensed" or, as the above implies, use platformbrandnames or logos in source.31 ways that would misleadconsumersas to the peripheral's A platformowner's most significantinfluence, however, likely comes firmsaccess from the fact that the platformownercan deny uncooperative
27 v. Feist Publications RuralTel. Serv. Co., 499 U.S. 340, 345 (1991) ("Original,as the createdby the author meansonly thatthe workwas independently termis used in copyright, ... and thatit possesses at least some minimaldegreeof creativity"). 28 See, for example,Mitel, Inc. v. Iqtel, Inc., 124 F.3d 1366, 1373 (10th Cir. 1997). 29 The cases apply and intermix these four basic inquiries.Some cases pursuethem sepaAssocs. Int'l, ratelyand explicitly;otherspursuethem in the contextof the Altai (Computer Inc. v. Altai, Inc., 982 F.2d 693, 709-10 (2d Cir. 1992)) abstraction-filtration-comparison framework.See, for example, Mitel, Inc. v. Iqtel, Inc., 124 F.3d (withinAltai framework relyingon ?? 102(a) and 102(b) and scenes a faire);GatesRubberv. BandoChem. Indus., Ltd., 9 F.3d 823 (10th Cir. 1993) (withinAltai framework relyingon ?? 102(a)and 102(b), merger,and scenes a faire); Batemanv. Mnemonics,Inc., 79 F.3d 1532 (11th Cir. 1996) in of application Altai framework this context).Menell discussesthe historyof (questioning for to Altai andits application the abovecases in PeterMenell,An Epitaph Traditional CopyBull. 651 (1998). of of Software,43 Antitrust rightProtection NetworkFeatures Computer or to firm'strademark marketproducts ser30 As a generalrule, one firmcan use another vices providedthat the use is truthfuland there is no likelihoodof confusionas to source. tradeSee, for example,Smith v. Chanel,Inc., 402 F.2d 562 (9th Cir. 1968) (competitor's This is especially true in cases where the markis markused in comparative advertising). essentiallythe only meansof informingconsumersas to the truenatureof the product. 31 Some anecdotalevidence as to the marketvalue of this type of trademark protection: for a fee of $500, Palm allows peripheral developersto use the official Palm logo, the only tests. The detailsare available conditionbeing thatthe peripheral pass certaincompatibility at http://www.qpqa.com/palm/base-pr.html visited on October1, 1999). (last
TECHNOLOGIES PLATFORM EMERGING
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to private informationabout the platforminterface.As a formal matter, tradesecretlaw helps platformownerskeep this information privateby, for former employees from divulging technical details; example, forbidding but, truthbe told, this is more a practicalremedythanit is a legal one. The firmthatdesigns a platformquite obviouslyhas special expertiseaboutthe platform'sinnerworkingsandcan choose when andwhetherto divulgethat information. of The value of this privateinformation course varies with the costs of reverse engineering.In instanceswhere it is difficult for an unauthorized from both the platformand authorized firmto extractprotocolinformation ownerwill findthatits privateinformation quite is the peripherals, platform valuable, and, hence, the platformowner will enjoy significantinfluence over every would-be peripheral developer.By contrast,where technology the makes it easy to extractspecification information, platformowner's inand fluencewill be significantly not constrained, the ownermight therefore be able to bringaboutmeaningful These lattercases might pricereductions. be more commonthat intuitionwould at first suggest. After all, peripheral firmsare not simplybeing askedto lower theirpricesin a staticsetting,but are insteadbeing askedto lower theirpriceseven as demandfor theirproducts is increasingthanksto otherfirms'pricereductions; thus,when we say the thatthe platformownerwill find it difficultto coordinate marketin settings wherethe costs of reverseengineeringare low, we mean low relative to the requested price drop,which in manycases can turnout to be a rather number. large B. DiscretionaryDoctrines The baselinerightsoutlinedabove-mainly tradesecretprotectionof interface information-will in many instancesnot give the platformowner sufficientleverage to coordinatedownstream innovators.The cases introduced below bear evidence to that fact; if the simple act of keeping interface information secret was enoughto give platformowners significantinfluenceover would-beperipheral developers,platformownerswould never have resortedto the licensingandrelatedschemessummarized below. That tradesecretprotectionmight be too weak, however,is only one of two argumentsin favor of the recognitionof broaderrights.The other argument applieseven in cases where tradesecretprotectionis sufficient. In cases wherereverseengineeringis expensive, a platformowner gains significantinfluence by threateningto withhold interfaceinformation.In these cases, the platformowneralreadyenjoys significantinfluence,so it is hardto see any harmin recognizingthatinfluenceexplicitly.Yet such recognition would likely increasesocietal efficiency since it would eliminate
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several bad incentives that trade secret law today creates. For example, firms attempting keep the costs of reverseengineeringhigh will, at the to be temptedto design awkward, cumbersome margin, protocols.Simpleprotocols are somethingof a liability to a firm relying on the expense of reverse engineering; are handshakes moredifficultto reverseencomplicated gineer. In other words, by not recognizing broaderrights, the current intellectualproperty regime createsa perverseincentivefor platformowners to design unwieldy interfacespecifications.And, more troubling,in a the betweentwo otherwiseequivalent competition platforms, morecumbermore developersthroughthe some technologywill prevail-first attracting promise of coordination,then attractingmore consumersthanks to the higheravailabilityof peripherals. Similarly,a firm relying exclusively on trade secret protectionwill be developersby temptedto increase its influenceover would-be peripheral of delayingthe introduction its platformto market.Reverseengineeringis impossibleso long as the platformnever leaves its owner's physical control;thus, to a firmrelyingon the expense of reverseengineeringas a substitute for explicit intellectualpropertyprotection,delay is at the margin attractive. that protecConsidering one of the goals of intellectualproperty tion is to promotethe promptdisclosureof innovativeideas, this sort of behaviorseems undesirable.32 The text below surveysfour discretionary inquiriesin intellectualproperty law that,in differentsettings,determinethe relativerightsof platform ownersandperipheral developers.It is in the contextof these inquiriesthat the analysispresentedin this articlecould most easily be broughtto bear. The purposehere is not to offer detailedexplanationsof the variousdocbut trinesand interpretations, insteadsimply to point out thatthese are the key inquiriesaffectedby the article. 1. Repair/Reconstruction (Patent Law). Plaintiff in Sage Products v. Devon Industries33 developed and sold a disposal system designedfor use medicalmaterials.One componentof the system was a rewith hazardous thatwould actuallymake contactwith the hazardmovableinnercontainer ous waste. This componentwas designed to be used once and then discarded.Plaintiffheld a patenton the completedisposal system-the inner with the rest of the apparatus-but its patas container used in combination ent did not, and on obviousness grounds probablycould not, explicitly
32Compare WilliamLandes& Richard Law, Posner,An EconomicAnalysisof Copyright 18 J. Legal Stud. 325, 331 (1989) (arguingthatcopyrightlaw shouldrecognizebroadrights authorswould at the margin in derivativeworksbecause,in the absenceof such protection, derivativeworksthemselves). in delay publication orderto firstprepare 33 45 F.3d 1575 (Fed. Cir.1995).
PLATFORM EMERGING TECHNOLOGIES
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claim the inner containeritself. When a competitorbegan selling replacement containers,plaintiff-patentee sued, arguingthatevery time one of its customersused a containermade by its competitor,the consumerwas imthe permissibly "reconstructing" patentedcombinationand thereforethe or was liable for eithercontributory inducedinfringement. competitor The distinctionraisedin a case like Sage is the distinctionbetween the of The repairand reconstruction a patentedcombination.34 issue arises in is instanceswhere a peripheral listed as an elementof a patentclaim. The patentholderarguesthat,by replacingthe listed element,users infringethe combinationpatent-and note that this is a plausibleargument given that law frequentlyrecognizes exclusive rights in particularcombinapatent of tions, for example,the combination unpatentable glue and unpatentable to form the fully patentable Post-Itnote.35 Alleged infringers respond paper shouldbe excused,in essence on thatthis type of hyperliteral infringement an impliedlicense theory. The distinctionbetween repairand reconstruction thus a questionof is thatin this contextdetermines whetherperipheral patentscope-a question need the platformowner's permissionto sell compatible developers periphis erals. To the extent that replacingthe peripheral deemedreconstruction, it is underthe patentholder's exclusive purview;to the extent that those are replacements deemed repair,the patentholder has no exclusive right. Thisis ajudiciallydevelopeddistinction, courtstodayconsider "totaland the when determining whethera given act infringes.36 ity of the circumstances" One implication the current of paperis thusto suggestthatone factorcourts should consideras partof this inquiryis how each result would affect the and for structure existenceof the market replaceable components. 2. PatentMisuse. Platformownershave fromtime to time attempted to controlperipheral licenses on purchasers developersby imposingrestrictive of the platform.For example,in MotionPicture Patents Companyv. Universal Film Manufacturing conditionedeach Company,37 plaintiff-patentee sale of its patentedfilm projector the stipulation on that the purchaser rent films only fromdistributors approved the patentee.Whenthreeunauthoby rized film distributors startedto offer films for sale, the patenteesued, arof could use unauthorized guing that(1) becauseno purchaser the projector
Co. v. Convertible Co., 365 U.S. 336 (1961) Top Replacement 34 See Aro Manufacturing Co. (Aro I); and Aro Manufacturing v. ConvertibleTop ReplacementCo., 377 U.S. 476 (1964) (Aro II). Additionalcases are collected and analyzedin MarkJanis,A Tale of the and ApocryphalAxe: Repair,Reconstruction, the ImpliedLicense in IntellectualProperty Law, 58 Md. L. Rev. 423 (1999). 35U.S. PatentNo. 5,153,041 (1992). 36 Aktiebolagv. E. J. Company,121 F.3d 669 (Fed. Cir. 1997).
37
243 U.S. 502 (1917).
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films without violating the license and (2) because after violating the license purchasers would be using the patentedinventionwithoutthe patent holder's permission,that (3) by selling unauthorized films the distributors were illegally inducingpatentinfringement. of Undermodem law, patentholdersand purchasers patentedgoods are free to "contract as they choose, provided that no law is violated in Thatis, the inquiryin a case like this is phrased the negative: thereby.'"38 restrictivelicenses are to be upheld so long as otherbodies of law do not prohibitthat result. Contractlaw, for example, precludesenforcementof "unconscionable" conditions,39and specificpatentdoctrinescondemncertain conditions,for example,conditionsthatserve to extendthe patentterm duration.40 What is troublingaboutthis analyticalapbeyond its statutory emphasizedin the proachas appliedhere is that one of the legal barriers negativeinquiryis the doctrineof patentmisuse. defense to a chargeof patent Patentmisuse is traditionally affirmative an It infringement. is an equitabledoctrine,the notionbeing thata courtshould not use its powerto assist a patentholderwhere,in this or any otherinteraction, the patentholder is exercising its rights in a manneragainstpublic The policy.41 defense can be invokedin any case. An alleged infringer,for example,can arguethat a given patentshouldnot be enforcedbecause,in used its some entirely unrelatedinstance, the patenteehas impermissibly patentpower.A patentholderwhose actionsare foundto constitutemisuse and loses all rightsvis-a-vis all partiesuntil the practiceis discontinued its effects on the marketare "fully dissipated."42 As Why is this troubling? a practicalmatter,bringingthis interpretation of patentmisuse into the negativeinquirymeansthatpatentholderscannot even attemptto use restrictivelicenses for this purpose.The stakes are too high;one misstepandthe patentholderin essence forfeitspatentprotection on the platformentirely.43 Because the arguments presentedin this paper
v. Inc., 976 F.2d 700, 703 (Fed. Cir. 1992). Accord B. Braun 38Mallinckrodt Medipart, 124 Medical,Inc. v. AbbottLaboratories, F.3d 1419 (Fed. Cir. 1997). Contracts See E. Allan Farnsworth, 4.28, at 307-17 (3d ed. 1999). 39 40 Brulottev. Thys Co., 379 U.S. 29, 32 (1964) ("patentee'suse of a royaltyagreement thatprojects dateof the patentis unlawful se"); Boggildv. Kenner per beyondthe expiration Prods.,776 F.2d 1315, 1320-21 (6th Cir. 1985), cert. denied,477 U.S. 908 (1986) (where is and royaltiesare identical,agreement unlawfulper se). preexpiration postexpiration 41 See MortonSalt Co. v. G. S. SuppigerCo., 314 U.S. 488 (1942). 42 B. B. Chem.Co. v. Ellis, 314 U.S. 495, 498 (1942) (aftera findingof patentmisuse, a patentholder'srightsshouldnot be enforceduntil the patentholder "is able to show thatit its has fully abandoned presentmethodof restraining competitionin the sale of unpatented articlesand thatthe consequencesof thatpracticehave been fully dissipated"). to to evidencethatpatentholdersarereluctant risk vulnerability the 43For some anecdotal An defense, see RichardH. Stem, Post-salePatentRestrictionsafterMallinckrodt: Idea in
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would favor, in certain circumstances,the enforcementof restrictivelicenses of this sort, the draconian penaltiesof patentmisuse seem unnecesCourtswould betterserve equity by in these instancesnarsarily chilling. rowing the maximumpatent misuse penalty and thus enabling firms to attemptwhatmightturnout to be permissibleand sociallybeneficiallicensing regimes. 3. Fair Use (Copyright). Platformowners have also tried to control peripheral developersby using copyrightto limit the reverse engineering Ltd. Forexample,in Sega Enterprises v. Accolade,Inc.," Accolade process. from Sega video game cartridges compatiblewith Sega's video purchased in console and proceededto reverseengineerthe cartridges orderto game Intermediate the relevantinterfacespecifications. steps in thatproidentify cess requiredAccolade to duplicate and manipulateSega's copyrighted video game code. (Among otherthings, Accoladehad to translate code the from machinelanguageto a form more accessible to humanreaders.)So Sega sued, not arguingthatAccoladehad illegally used the interfacespecifications-an argument availableto Sega because,as noted previously, not interfaceinformationitself is generally not eligible for copyrightprotecAccotion-but arguinginsteadthat,in the processof reverseengineering, lade had infringedSega's rightsin the validly copyrighted video games. of Two prominent cases evaluatearguments this sort:the Ninth Circuit's Federal Circuit case, Sega case summarizedabove and a contemporary Atari Games v. Nintendo.45Both courtsagreedthat any such infringement could in theorybe excused underthe doctrineof fair use.46Fair use is an affirmative that defenseto copyrightinfringement mustbe raisedon a casewherepublic polby-case basis.47It is meantto excuse literalinfringement icy favors that result. A book reviewer,for example, can invoke the doctrine to defend an infringement use chargearisingout of his unauthorized of a book excerpt,and a comediancan similarlyuse it to defend an unauSearchof Definition,5 Alb. L. J. Sci. & Tech. 1 (1994). For a relatedcriticismof the doctrine of patentmisuse, see MarkLemley, The EconomicIrrationality the PatentMisuse Docof trine,78 Cal. L. Rev. 1599 (1990). by 44977 F.2d 1510 (9thCir. 1992),as amended 1993U.S. App.LEXIS78 (9thCir. 1993). 45 975 F.2d 832 (Fed. Cir. 1992). The two cases have been the subjectof extensive legal and See, for example,Julie Cohen,ReverseEngineering the Rise of Electronic commentary. Intellectual of 68 Vigilantism: Implications "Lock-Out"Programs, S. Cal. L. Rev. Property 1091 (1995); Dennis Karjala, Protectionof Computer Documents,ReverseEngiCopyright neering,and ProfessorMiller, 19 U. DaytonL. Rev. 975 (1994). 46 This sentenceis somewhatcarefullyphrasedbecause, while both courtsagreedon the roughcontoursof the fair use analysis,the FederalCircuitin Atariultimatelyrefusedto recfacts of thatcase. ognize the defense on the particular 47 17 U.S.C. ? 107. For a generalintroduction, Marshall see Leaffer,Understanding Copyright Law 427-76 (3rd ed. 1999).
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thorizedparody.The defense is codified at Section 107 of the Copyright the Act, but codificationhas not significantlyconstrained doctrine'sscope. This is still, as it originallywas, an all-inclusive,equitableinquiry.48 The courtsin Sega and Nintendoconsidereda numberof factorsin dethatcopyrightinfringement termining necessaryto the creationof compatible peripherals could be excused on this public policy exception;but, as it was in patentlaw with the distinctionbetween repairand reconstruction, the fair use inquirypursuedin these cases did not weigh in the possibility that a findingof infringement would have forced would-beperipheral developers to negotiate with the relevantplatformowners and thus would have empoweredthose platformowners to coordinateperipheralprices. This is not to say thatthis factorwill always be determinative even that or it shouldhave been determinative these particular in cases; but it shouldin the futurebe consideredsince, as this articleargues,public policy will in some cases be better served by rejectingthe fair use defense and thereby develexpandingplatformowners' influenceover downstream peripheral opers. 4. DerivativeWork(Copyright). A last application the analysisprefor sentedin this articleis in the interpretation Section 106(2) of the Copyof rightAct, which grantsto copyrightholdersthe exclusiveright "to prepare derivativeworks" based on a copyrighted work.49 In Micro Star v. Formgen, Inc.,5" Formgenheld copyrightin a popularvideo game that,in addition to 29 playablelevels of monstersand scenery,came with a utilitythat allowed users to createadditional game levels. Micro Star,an independent levels and sold them on a single compact firm, collected 300 user-created disc as an accessoryto Formgen'sgame. The disc did not replacethe original game;it only containeddatathatwould allow userswho alreadyowned the game to play the additionallevels createdby other users. Micro Star then sued for a declaratory judgmentthatits productdid not infringeFormfor gen's copyright,and Formgencounterclaimed a preliminary injunction of barringfurtherdistribution Micro Star'sproduct. In a case like this, the analysisturnson the questionof whetherthe accessory at issue is a derivativework, which Section 101 defines to mean "a work based upon one or more preexistingworks."" Read literally,of ever created course,thatdefinitionwould includeevery work of authorship
48 The House Act Reporton the Copyright of 1976 makesthis point explicitly,H.R. Rep. Court interpreted 107 accordhas No. 1476,94thCong.,2d Sess. 65 (1975), andtheSupreme ? Inc. & 471 ingly;see Harper Row Publishers, v. NationEnterprises, U.S. 539, 560 (1985). 49 17 U.S.C. ? 106(2). 50 154 F.3d 1107 (9th Cir. 1998). 51 17 U.S.C. ? 101.
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science and art, borrows since, to some extent, "every book in literature, and mustnecessarilyborrow"from thatwhich came before.52 Courtstherefore must applythe statutory languagenarrowly,althoughexactly how narconcontinuesto be an open questionin boththe platform/peripheral rowly and text53 more generally.54 This definitional indirectinquiryinto the scope of the issue is yet another in a given platform.If add-onvideo intellectualproperty rights underlying game levels are deemedto be derivativework, the platformowner's copyright in essence expandsto include control over the marketfor this additional product.If not, that marketremainsopen to any firmcapableof rein verse engineeringthe relevantprotocols.Again, the arguments presented shouldbe consequenthis papersuggestthatpartof this definitional inquiry tialist:in additionto consideringthe trade-offbetweenincreasedincentives works on the one handand increasedpublic access to createcopyrightable workson the other,courtsshouldconsider to alreadyexistingcopyrightable of whetherbroaderrights might make possible beneficialcoordination the earlierthe article. sort introduced C. Judicial Competence Implementation and Problems Therearetwo primary objectionsthatmightbe raisedagainstthe proposals sketchedabove: first, that courtsdo not have the expertiserequiredto engagein the suggestedmarketanalysisand,second,thateven with broader rights,as a practicalmatterplatformowners will not be able to coordinate and follow-on innovationbecause of various informational logistical constraints.These are admittedlyimportantobjections;each is consideredin turnbelow. To evaluatejudicial competencein the currentsetting, it is helpful to drawan analogyto antitrust law. Practicessubjectto reviewunderthe Sherman and ClaytonActs are either evaluatedcase by case underthe rule of reasonor deemedillegal withoutregardto the specific facts at handunder a per se rule. Sometimesthe choice betweenrule-of-reason review and per is se prohibition straightforward; these are cases whereexperiencesuggests
52 Micro Star, 154 F.3d at 1110 (quotingEmerson v. Davies, 8 F. Cas. 615, 619 (C.C.D. Mass. 1845) (No. 4436)). 53 Compare, example,Lewis GaloobToys, Inc. v. Nintendoof Am., Inc., 964 F.2d 965 for add-onthat alteredvideo game performance derivativework) not (9th Cir. 1992) (hardware with MicroStar, 154 F.3d 1107 (softwareadd-onthatalteredvideo gameperformance found to be derivativework). 54 Compare, for example,MirageEditions,Inc. v. Albuquerque A.R.T.Co., 856 F.2d 1341 of art (9th Cir. 1988) (purchaser copyrighted book createdderivativeworkby removingand framingparticular pages) with Lee v. A.R.T. Co., 125 F.3d 580 (7th Cir. 1997) (opposite resultfor note cardsmountedon ceramictiles).
640
thatthe practiceat issue has virtuallyno pro-competitive and application so In the per se rule is obviously appropriate."5 the remainingcases, however, the choice turnsin large parton the questionof judicialcompetence.That is, practices that have some pro-competitiveapplicationmight still be deemedillegal per se, the logic being that,as appliedto these practices,the expected benefits of case-by-casereview are outweighedby the expected costs-costs that include the directcosts of litigation,the costs associated with uncertainty,and, most important, costs associated with judicial the error.56 antitrust Thus,in formulating policy with respectto per se rules,courtsin essence ask a questionsimilarto the one being posed here:is the judiciary so sufficientlyskilled at analyzingmarketstructure as to justify case-bycase consideration the specific practiceat issue, or are courts so likely of to errin theiranalysisof this practicethata discretionary inquiryis unwise? This questionwas recentlyaddressed the SupremeCourtwith respectto by a practicethat bears strongsimilaritiesto the coordination underconsiderationin this paper:pricecoordination the use of verticalmaximum through price agreements. For nearly 50 years, vertical maximum price agreements-contracts or throughwhich an upstreammanufacturer supplierimposes a price cap on relateddownstream retailersor resellers-were prohibited undera per se rule.57 in 1997, the SupremeCourtoverruled those earliercases and But, held that verticalmaximumprice agreementsare rightlyjudged underthe rule of reason.58 Truthbe told, this most recentcase does not offer significant insight into the Court'slogic. The opinion makes only a few vague referencesto the possible harmsthat might obtainif verticalprice agreements are approvedin error,59 in the end the opinion seems to simply and
v. Engineers UnitedStates,435 U.S. 679, 688-92 (1978) 55NationalSoc'y of Professional whose natureandnecessaryeffect when appliedto "agreements (per se rulesare appropriate are so plainly anticompetitive no elaboratestudy of the industryis needed to establish that theirillegality"). 56 and FrankH. Easterbrook, VerticalArrangements the Rule of Reason,53 AnCompare in titrustL. J. 135, 157 (1984) (the per se rule is appropriate instanceswhere "case-by-case . adjudication . . would permittoo many deleteriouspracticesto escape condemnation"); FrankEasterbrook, MaximumPrice Fixing, 48 U. Chi. L. Rev. 886, 909-10 (1981) ("The . costs of tryingto separate beneficialagreements amongcompetitors .. arelarge;one particular cost is the chance of error";"[a]t some point, though,the [possiblebenefits]become so large in relationto the costs of inquiry(includingthe costs of error)... thatthereis no
longer . . . justification for using per se rules.").
Co. 57Kiefer-Stewart v. JosephE. Seagram& Sons, Inc., 340 U.S. 211 (1951); Albrecht v. HeraldCo., 390 U.S. 145 (1968). 58 State Oil v. Khan,522 U.S. 3 (1997), overruling Albrecht,390 U.S. at 145. 59 522 U.S. at 8.
641
behavior "can be appropriately assertthat anticompetitive recognizedand case by case.60 punished" however, this recent decision is consistent Despite these shortcomings, law with a broadtrendin antitrust away from per se prohibitions.61Indeed, firms with this most recentruling,almostall restraints imposedby upstream on theirdownstream are now evaluatedunderthe rule of reacounterparts son.62The courts considerthe facts when ruling on the legality of restricor tions on, say, sales territories customerlists.63A manufacturer refuse can to deal with an affiliateof long standing-perhaps even replacethatretailer with anotheror a wholly owned subsidiary-and at worst still be subject This is not becausethere only to the case-by-case,rule-of-reason inquiry.64 is no chance that courts will err in their evaluationof these complicated marketrelationships.This is not because these practicespose no risk of anticompetitive application,nor because the costs of litigationand uncerhave been shown to be trivialin these instances.The prominence of tainty the rule of reasoninsteadreflectsa gradualconsensuswithinthe judiciary and also the academythat, when it comes to analyzingmarketstructure, courtscan be trustedwith at least some degree of discretion. Would analysisunderthe four intellectualpropertydoctrinesintroduced in the previous subsectiondiffer from the analysis requiredin traditional antitrust cases? Absolutely.The antitrust is approach passive, the law simcases to coordinate ply allowing firmsin appropriate prices withoutfear of antitrust liability. The proposedapproach, contrast,contemplatesaffirby mativeintervention, namely,the recognitionof broader property rights.But in the choice between bright-linerules and case-by-case analysis, that seems to be a distinctionwithouta difference.The current intellectual propThat erty regime functions as a per se denial of affirmativeintervention. stands in obvious contrastwith both the recent decision with respect to
60
Id. at 7-9.
This trendhas been well documented elsewhere.See, for example,AlanJ. Meese, Tying Meets the New Institutional Economics:Farewellto the Chimeraof Forcing, 146 U. Penn. L. Rev. 1 (1997); ThomasA. Piraino,Jr.,MakingSense of the Rule of Reason,47 Vand.L. Rev. 1753, 1753-60 (1994); EarnestGellhorn& TeresaTatham,MakingSense Out of the Rule of Reason,35 Case W. Res. L. Rev. 155 (1985). 62 The lone holdout is the per se prohibition on minimumprice agreements,a doctrine with roots all the way back to Dr. Miles MedicalCo. v. JohnD. Park& Sons Co., 220 U.S. 373 (1911). Even thatper se ruleknowslimitations; example,underthe Colgatedoctrine, for minimumprice agreementsenforcedby purely unilateralaction never fall underantitrust law's purview.See United Statesv. Colgate& Co., 250 U.S. 300 (1919). 63 These and otherexamplesare discussedin Herbert FederalAntitrust PolHovenkamp, and icy: The Law of Competition Its Practice392-440 (1994).
61 64
Id.
642
and trendof whichthatdecimaximumresaleprice agreements the broader sionis a part.65 As for the second concern raised above-the worry that, even with broader rights,as a practicalmatterplatformownerswill not be able to coordinatethird-party developers-it is certainly true that propertyrights solve only partof the problemfacing platformowners.Broader rightsobligate would-be developers to identify themselves to the platformowner a owneris able to authorize firmto market since only the platform peripherownfirmsto complywith the platform als. They further obligateperipheral networksubjectto those er's requests,at least so long as the coordinated thansome competing,uncoordinated option. requestsis still more attractive What these rights do not do, however, is help the platformowner know how to wield this influencein the face of unknownproductsand uncertain demand. This is a significantproblem;however, experiencein other industries that firmscan often developmechanisms effectively suggeststhatupstream firms and can do this constrainthe prices chargedby relateddownstream limitations.For example,newspaperpublisherstypidespite informational in cally grantnewspapercarriersexclusive sales territories orderto make possible certaineconomies of scale in the delivery process. Having done in are so, however,publishers then interested limitingdeliveryprices in order to ensurethat carriers not abuse theirexclusive positions.So newsdo maxipaper publishershave devised a mechanism-the aforementioned mum price agreements-to constraincarrierdiscretion,keeping delivery choose these maxisales up.66 Publishers pricesdown andhence newspaper with rehave privateinformation mum prices despite the fact that carriers spect to local demandconditions,the qualityof theirdeliveryservice, and so on. Automobilemanufacturers A similardifficultyarisesin the autoindustry. this dealersexclusive sales territories, time as a also typically assign their with respectto dealerservices.(As a free-rider problem way of eliminating Dennis CarltonandJeffreyPerloffexplain,if car dealerswere not assigned a exclusive sales territories, cunningdealerwould open shop next door to anotherdealer,keep prices low by skimpingon d6corand service, and put a sign in the window advising consumersto "test drive there and buy in here.")67 Exclusive sales territories this context again create a situation
65 See also United Statesv. JerroldElectronicsCorp., 187 F. Supp.545 (E.D. Pa. 1960), aff'd per curiam,365 U.S. 567 (1961) (refusingto applyper se rule where technologyfirm of linked sales of new technologyto service and maintenance that technologyon grounds thatnew technologyshouldbe treateddifferentlyfrom establishedones).
66 Albrecht, 390 U.S. 145.
67Adaptedfrom Carlton& Perloff,supranote 17, at 528.
PLATFORM EMERGING TECHNOLOGIES
643
where retailershave marketpower;but, perhapsbecause the informational and monitoring difficultiesare more severe in the automobileindustrythan have been are in the newspaperindustry,automobilemanufacturers they offer sales reluctantto set price caps directly.Instead,car manufacturers rewardsto dealers and salesmen.The lower the price dealers charge,the morecarsthey sell, andhence the greater theircorresponding sales rewards. Sales rewardsthus give dealers an incentive to choose lower prices than they otherwisewould, reducingthe price distortion. Thereare otherexamplesof mechanismsthathelp to constrainprices in situationscharacterized at least some degree of imperfectinformation. by For instance,certainmalls use profit-sharing programsto tie store profits andin thatway encourageindividualstoreownersto chargeprices together thataccountboth for the directeffects on theirown profitsandfor the indiThe pointhere is only that,armedwith rect effects on overallmall traffic.68 the appropriate intellectualproperty rights,platformowners, too, might be able to use these or relatedmechanismsto mitigatethe price andprofitdistortions discussed in this article.69This seems especially likely in cases where prices are considerablyhigher than optimal since, in those cases, even an imperfectcoordination mechanism could still yield significantly increasedprofits. IV. CONCLUSION The externalityidentifiedin this papercan arise wheneverthree conditions are met: (1) consumersmake an initial investmentthat increasesthe value of some numberof products,(2) those productsare sold by independent firms, and (3) a subset of those firms have at least limited market these conditionscan be satipower.As was pointedout in the Introduction, sfied in a varietyof settings,althoughthis paperhas focused almostexclusively on varioustechnologyapplications. In theory, the resultingprice distortioncan be eliminatedby contract, vertical integration,or merger;but, in the context of emerging platform The technologies,coordination problemsmake these solutionsimplausible. natureof marketsbased on emergingtechnologiesmakes it diffidynamic
68 This same resultcould in theorybe achievedby adjustments each store's rent;howto for with respectto ever, rent seems to be keyed to otherexternalities, example,externalities the decision to open a particular see shop in a given mall. On these externalities, B. Peter The Externalities: Pricingof Spacein ShoppingMalls, Pashigian& EricGould,Internalizing 41 J. L. Econ. 115 (1998). ownerscouldrequirewould-beperipheral 69 TO play out one example:platform developers to pay a licensingfee up front;the platform ownercould thenuse those fees to funda system of sales incentivessimilarto those used in the automotiveindustry.
644
cult to gather all affected firms for a single negotiation, and the externality itself undermines the benefits of any negotiation conducted among a subset of the affected firms. These problems can be solved by property rights. Thus, the paper has argued that intellectual property law should take stock of these issues, offering the possibility of stronger rights in cases where coordination would otherwise be implausible. Recent enthusiasm for legal rules that constrain the behavior of platform
owners has to some degree crowdedout conversations regardinglegal reform of the sort discussed here. That is unfortunate. Just as traditional network economics related to lock-in and network effects suggest that legal intervention limiting platform owner control might in some cases improve societal welfare, the network economics introduced in this paper suggest conversely that legal intervention supportive of owner control can at times increase societal welfare as well. APPENDIX SupposethatN firmseach produceone peripheral compatiblewith a given platform.Each firmi E [1, N] sells its peripheral pricepi, and the platform availat is able at pricep, which for the purposesof this model is exogenous.Assume thatthe platformhas no intrinsicvalue, which is to say that consumerspurchaseit only becauseit enablesthem to use peripherals. If the platformwere free, a given consumerwould be willing to pay up to bi for the peripheral Becausethe platform not free, however,the consumeris willing i. is to pay only up to bei, wherebe, is the consumer's"effective" valuationof the ith and the platformprice,p. peripheral given all prices, Define N = {1, 2, 3, . . .p-i, and N, = N - {i}. The term be,iis therefore ,N
pp= 0 (bj - pj) ifbj<3 if :Ji pVje Ni Ni; such that j E J satisfies
5
bei
bi -_ p- p
L
pj
and V k E (Ni - Ji), bk <--Pk;
- bj
(pj
+ p), p, Z(bj pj) < j Ji
if 3 Ji g Ni such thatj Ji satisfiespj < bj and (b- pj) p; jE Ji
(Al) the wherethe bracketed given this portionrepresents effectivepriceof the platform consumer'svaluationsand the variousperipheral prices. Since the effective platform price varies from consumerto consumer,let us definePe, to be the expected effective platformprice with respectto the ith peripheral given all prices p-i.
TECHNOLOGIES PLATFORM EMERGING
645
Price
100
0 Quantity
FIGURE A1.-Demand as reshapedby the prices of, and demandfor, two additionalpeThe threelines are interpreted the text. in ripherals. Figure Al interprets equation (Al) in the context of a specific example. The rightmost line represents demand for one peripheral under the assumption that consumer valuations are uniformly distributed on [0, 100] and the relevant platform is available at no charge. The leftmost line shows how demand shifts when the platform price is nonzero; in this example, price was set to 80. The middle line shows how demand is then reshaped by the introduction of two additional peripherals. This particular line shows demand under the assumptions that consumer valuations for the other two peripherals are independent and uniformly distributed on [0, 100] and that the two additional peripherals are each sold at a price of 30. The introduction of the two additional peripherals not only shifts demand up and to the right, it also bends it. The upward shift is easy to understand: the effective price of the platform has diminished, so demand partially recovers the loss represented by the leftmost line. The bending at the top is more complicated. The intuition is that consumers who value at the highest extreme are especially rare since such consumers not only must value the peripheral highly to begin with, but also must happen to value the other peripherals so much that the platform's effective price is nearly zero. The confluence of these events is rare, and so, at the top of the curve, a given price reduction lures fewer new purchasers than would a corresponding change elsewhere in the curve. Denote the demand faced by firm i E N by Di(p, Pi, P-i), which means that the demand for firm i's peripheral is a function of the price of the platform (p), the price of the peripheral (pi), and the prices of all other peripherals (p-i). Note that does not affect Di directly, but instead influences Di through its effect on the p-i effective price of the platform. Firm i thus chooses pi to maximize its profit, ti, where r7i = piDi(p, pi, with both p and taken as given. Firm i's first-order condition to this maximization problem is p-i p_-) (A2) X/iapi -= Di(p, Pi, P-i) + piD'(p, Pi, P-i). Denote aDi/lap as DI. Let pUbe firm i's uncoordinated price in equilibrium. We assume that the firms settle on a Nash equilibrium for ease of discussion; in cases
646
where there is no equilibrium, prices would churn and our claim would instead be that they churn at levels that are unprofitably high. At pU the first-order condition in equation (A2) equals zero, so we get that ((p, pU, (A3) pU = Di(p, pU, pUi)/D pUg). Define pU = (p, . , p). The various claims made in the paper all assert that p... p" is unprofitably high, in other words, that lowering prices would raise aggregate profits. To see this, define total network profit, ItN, to be
N
piDi(p, P, P-i).
(A4)
For a given pi, the first-order condition to this maximization problem is

a7N/aPi =
Di(p, pi, p-i)
piD'(p, pi, p-i)
+
j#i
pj(aDj/ap).
(A5)
The critical point is this: any price for which this derivative is negative is, by definition, a price that is unprofitably high. A lower price increases aggregate profits. It is helpful to rewrite equation (A5) as equation (A5) = equation (A2) + (A5') pj(aD/api).
j#i
We know that equation (A2) = 0 for all i whenever prices are at the levels given by p". We also know that pj > 0 for all j (since these are prices). Thus, at pU, the claim (weakly) holds whenever BRuapi =
j#i
pj(Dj1/api) < O.
(A6)
In PROPOSITION. settings where two or more firms sell peripherals and those peripherals are neither complements nor substitutes, each firm would earn greater profit if each charged a price lower than its individually rational price. We prove the proposition in two steps. First, we show that absent coordination every firm will charge too high a price relative to the prices that would maximize aggregate profit. Then we show that whenever every firm is charging too high a price relative to the prices that would maximize aggregate profit, there exists a set of coordinated prices such that each firm individually earns greater profit than it would under uncoordinated conditions. Consider equation (A1). We know from equation (Al) that changes in the other firms' prices shift demand for any given peripheral, and in predictable ways. Lower prices for the other peripherals mean increased demand for the original one. Conversely, higher prices for the other peripherals mean lesser demand for the original one. We defined the bracketed term to be the "effective" platform price and further defined Pe, to be the expected effective platform price. We thus know that JDiap,ei 0 (that is, demand for the ith peripheral decreases as the effective platform price increases) and Japiapj > 0 (an increase in firm j's price increases the effective price of the platform as perceived by consumers thinking of purchasing any other peripheral). The sign of equation (A6) is determined by the sign of JD/lkpifor all pairs (i, j) e N where i ? j. Since the peripherals are neither complements nor substitutes,
EMERGING TECHNOLOGIES PLATFORM
647
the only relationship between their demand and other firms' prices is the relationship through the platform. Thus, for any pair, we know (A7) ~Dj/lpi = ~Djl/pej X aPejlapi, which is less than or equal to zero. Thus the inequality in equation (A6) holds, and we know that every firm can lower its price and (weakly) increase its profits. Now we want to show that individual profits also rise-that is, if at the uncoordinated prices equation (A6) is negative, then there exists some set of prices (p* = [p* ... .5 p*]) such that p* -- p1 and for which individual firm profits rise even without side payments between the firms. This proof proceeds as a proof by induction. First we show that the result holds for the two-firm case, then we show that if it holds for N firms, it also holds for (N + 1) firms. Define ntr to be cnr/iapjevaluated at price vector p". From the previous proof, we know that at the uncoordinated prices, a marginal price reduction by either firm increases overall profits. A price reduction lowers a firm's own profits, so it must be true that a price reduction by the first firm lowers its profits by less than it increases the second firm's profits, and vice versa. Thus, nII< I1 I , 1, (A8)
< 17tn2117t121.
Accounting for the signs, this implies (which will be useful below)
22 7t'117 < 7t127t21.
(A9)
(A10)
Let us now assume that we have a small downward deviation in prices from p". Differentiating each firm's profit function, we get = t11idp1 + (All) tl12dp2, dItl + (A12) dit2 = It21dP1 -r22dp2. If both equations (All) and (A12) are greater than zero, then the price reduction will have increased profit for both firms and the corollary would immediately be true. If both are less than zero, then the reduction will have decreased aggregate profits, which we know to be impossible. Thus, the case of interest is the case where one is positive and the other is negative. Without loss of generality, let us assume, then, that equation (All) > 0 and equation (A12) < 0. Let us define firm 2's "break-even" price change, dpb, to be the change in P2 such that, for a given change in din2equals zero. In other words, pl, (A13) dpb(dpl) = -(1(n21/i22) X dp. If firm 2 selects this price change, then firm l's change in profit due to a given change in pi is = [111 X dp. (A14)
< 0. This follows Since dp1 < 0, firm l's profit rises only if (l2i721)/i722] make one firm strictly better off and directly from equation (A10). Thus, we can[71 another weakly so by lowering prices. In fact, if the profit functions are everywhere continuous and then we can lower firm l's price by E;firm l's profit will tij O0, still be greater than nru, and firm 2's will now be greater than Rtu well. as That was the two-firm case. Now, imagine that the property holds for N firms. This means that each firm can lower its price some appropriateamount and, because
dIrt
(i121r21)/122]
648
THEJOURNAL LEGAL OF STUDIES
the other firmshave also loweredtheir prices, experiencea net increasein profit. will hold for an additional firm.That firm,after It is easy to see thatthis property all, benefitsfrom the price drop negotiatedby the N firms.If it lowers its price enoughto give back almostall of that gain, it will benefitthe otherfirmsand still itself be betteroff. Therefore, induction,the two-firmcase expandsto show that by the property holds more generally.Q.E.D. are 1. COROLLARY In settingswhere some fractionof the peripherals complecontinuesto hold for all firms. ments,the proposition are Assume some set J c N of the peripherals (direct)complements,meaning the these periphthatin additionto being complements indirectly through platform, erals have directsynergiessuch that,even if the platformwere free, a lower price for one would increasedemandfor the others. were neithercomplementsnor substiIn equation(A7), becausethe peripherals between peripherals, term becomes more complicated.Define Fj this relationship to be Dj evaluatedwhenp equalszero. Thatis, Fj is the demandfor thejth peripheral assumingthatthe platformis free. Equation(A7) thus becomes
DOj/api= DOj/lpejX Pej/lPi + tutes, we knew that aDj/api =
JDjl/pej X aPejlapi. Now, because there is a direct
and is where Fj/Flap negativefor complements zero for all otherperipherals. Thus, in the aggregate,equation(A15) is negative.Q.E.D. are substiCOROLLARY2. In settings where some fractionof the peripherals and continuesto hold for firmsthatdo not sell substitutes, the tutes,the proposition or may not hold for firmsthat sell substitutes. propositionmay Assume some set J c N of the firmsare (direct)substitutes, meaninga decrease in the price of one decreasessales of the othersor, more precisely,that for these is firms Fj/lapi positive. As in the above corollary,
=
Fj/c1pi,
(A15)
but this time Fj/lapiis either zero or positive. The aggregateeffect on network profitsfor a given firm'sprice changeis thus
= Di(p, pi, p-i) + piD/I(p, pi, p-i) + rtN/daPi p(aDj1api),
jii
Dj]/api
Dj]/pej X
PejlaPi
Fj/lapi,
(A16)
(A17)
which at the uncoordinated prices simplifiesto

atNapi =
j J,Ji J,j#i
+ pj(cDj/pi)
>
jeJ,iN/J,ji
pj(cDj/1pi).
(A18)
The derivativesin the second term are negative,just as they were in the proof of in As the proposition. per equation(A16), the derivatives the firsttermcan be either to as of positive or negativedependingon the relativemagnitude Fj/lapi compared
the magnitude of JDlaPei X aPe/iaPj. The overall effect depends on the number of
All as firmsin each summation well as the relativemagnitudes. else equal, as the numberof firms in the first summation rises, or the magnitudeof Fj/lap,grows, the derivativebecome more positive, and vice versa. Q.E.D.

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Property Rights in Emerging Platform Technologies Author(s): Douglas Lichtman Source: The Journal of Legal Studies, Vol.

PROPERTYRIGHTS IN EMERGING PLATFORMTECHNOLOGIES

"platform" technologies.' The story is by now well known.2 Apple

THE JOURNALOF LEGALSTUDIES

PLATFORM TECHNOLOGIES EMERGING

THE JOURNALOF LEGALSTUDIES

PLATFORM TECHNOLOGIES EMERGING

THE JOURNALOF LEGALSTUDIES

TECHNOLOGIES PLATFORM EMERGING GROUP1 2 GROUP GROUP3

PLATFORM TECHNOLOGIES EMERGING

THE JOURNALOF LEGALSTUDIES

PLATFORM TECHNOLOGIES EMERGING

EMERGING PLATFORM TECHNOLOGIES 0.5 Peripheral Price 0.3 V V

THE JOURNALOF LEGALSTUDIES

V Platform FIGURE 3.-Price of platform price. Price

distortion as a percentage of uncoordinated price, graphed as a function

EMERGING PLATFORM TECHNOLOGIES

18% Possible Increase Profit

distortion as a percentage of uncoordinated profit, graphed as a function

THE JOURNALOF LEGALSTUDIES

PLATFORM TECHNOLOGIES EMERGING

THE JOURNALOF LEGALSTUDIES

TECHNOLOGIES PLATFORM EMERGING

THE JOURNALOF LEGALSTUDIES

PLATFORM EMERGING TECHNOLOGIES

243 U.S. 502 (1917).

THE JOURNALOF LEGALSTUDIES

EMERGING PLATFORM TECHNOLOGIES

EMERGING PLATFORM TECHNOLOGIES

THE JOURNALOF LEGALSTUDIES

EMERGING PLATFORM TECHNOLOGIES

THE JOURNALOF LEGALSTUDIES

67Adaptedfrom Carlton& Perloff,supranote 17, at 528.

PLATFORM EMERGING TECHNOLOGIES

THE JOURNALOF LEGALSTUDIES

and V k E (Ni - Ji), bk <--Pk;

+ p), p, Z(bj pj) < j Ji

if 3 Ji g Ni such thatj Ji satisfiespj < bj and (b- pj) p; jE Ji

TECHNOLOGIES PLATFORM EMERGING

THE JOURNALOF LEGALSTUDIES

For a given pi, the first-order condition to this maximization problem is

Di(p, pi, p-i)

piD'(p, pi, p-i)

EMERGING TECHNOLOGIES PLATFORM

THEJOURNAL LEGAL OF STUDIES

which at the uncoordinated prices simplifiesto

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