Competition increases the transaction costs of intellectual property agreements

How does competition among companies affect the transaction costs of patent portfolios? The answer helps us understand the economics behind different IP governance structures, such as licenses (in-licensing, out-licensing, cross-licensing), joint ventures, and patent pools.

Prevously, I described how the transaction costs of allocating intellectual property rights influence merger and acquisition strategy. For this discussion, I focus on competition as a key factor that increases the transaction costs of portfolio portfolios. With respect to intellectual property, two dimensions of competition drive up transaction costs of contracting between companies that could work together through a joint venture or strategic partnership.

1. To the extent the companies' intellectual property positions overlap.

Intellectual property positions can be mapped in a technological space. Positions within an IP space, as defined by similarity or dissimilarity of patent portfolios, are one way to measure the market position of companies.

Greater overlap and proximity of position in this IP space means greater competitive intensity. Companies that exert more competitive pressure on each other will have a greater incentive to protect their position relative to each other. Intense haggling over how to allocate intellectual property rights may ensue because contracting becomes complex. That means higher transaction costs to complete IP agreements.

2. To the extent the companies compete in large markets that are patent intensive.

When the companies pursue a large market, a strong intellectual property portfolio can be valuable because it favorably positions the companies. The more the companies are competing to be the market leader in that technology space, the more two companies will seek to have strong patent positions.

Take for example competition in mobile. Apple, Google, Microsoft, Samsung and others are battling for market share in smartphones and mobile computing devices. Not surprisingly, Apple and Samsung are locked in several patent infringement lawsuits in the United States, Korea, and the European Union. If the tablet market wasn't large and growing, it wouldn't make economic sense to engage in protracted and expensive patent litigation.

Google's $12.5 billion acquisition of Motorola Mobility, and its 17,000 patents, was motivated by Google's desire to have a strong patent portfolio in mobile computing. Larry Page, Google's CEO, stated that the acquisition of Motorola's patents “enable[s] us to better protect Android from anti-competitive threats from Microsoft, Apple and other companies.” Similarly, the company's press release reasoned:

The acquisition of Motorola Mobility, a dedicated Android partner, will enable Google to supercharge the Android ecosystem and will enhance competition in mobile computing.

On the one hand, Google justified the Motorola deal as fighting anti-competitive behavior from Apple, Microsoft, and Oracle. At the same time, the company trumpeted the acquisition as fostering competition.

Transaction costs of IP agreements are higher in large, patent intensive markets as players are less willing to enter into IP contracts. Platform competition characterizes the industry. When platform competition dominates, there may or may not be strong overlap in IP positions. Companies seek to grab a substantial market share because of the tremendous opportunity.

Conclusion

Because competition drives up the transaction costs of contracting, IP contracts will be more expensive to complete. That means patent portfolios will be costlier to assemble and govern. Competitors may be less willing to enter into contract IP governance structures. Instead, merger or acquisition will look like an attractive option.

Against this backdrop, transaction costs are one factor that determine the appropriate structure to govern patent rights. What are the relative transaction costs of licenses versus joint ventures versus strategic partnerships?

Douglas Y. Park
Twitter: @DougYPark

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Source: AP Photos

Do more lawyers mean lower wages for lawyers? The legal blogosphere has been abuzz since Mark Greenbaum argued in the Los Angeles Times that too many new lawyers drives down lawyers' wages. However, Mr. Greenbaum's argument is based on misunderstandings of competition in the legal industry.

To summarize, Mr. Greenbaum contends that there are too many new lawyers and that the job market cannot support them. Instead of allowing new law schools to flood the market with more lawyers, thereby driving down wages, the American Bar Association should be stripped of its accreditation power because of irreconcilable conflicts of interest.

"No More Room At The Bench"

In arguing for a slowdown in number of new lawyers, Mr. Greenbaum asserts:

"There is a finite number of jobs for lawyers, and this continual flood of graduates only suppresses wages."

In support of his position, Mr. Greenbaum reasons:

"From 2004 through 2008, the field grew less than 1% per year on average, going from 735,000 people making a living as attorneys to just 760,000, with the Bureau of Labor Statistics postulating that the field will grow at the same rate through 2016. Taking into account retirements, deaths and that the bureau's data is pre-recession, the number of new positions is likely to be fewer than 30,000 per year. That is far fewer than what's needed to accommodate the 45,000 juris doctors graduating from U.S. law schools each year."

Analysis: Why More Lawyers Do Not Mean Lower Wages

Both prongs of Mr. Greenbaum's analysis rest on misconceptions and misplaced assumptions.

Mr. Greenbaum's statement about the connection between new lawyers and wages is overly simplistic. First, he apparently assumes that lawyers are employed by law firms, companies, or the government. This ignores solos. Solos create their own opportunities. Second, Big Law is not cutting back salaries because there are more new lawyers. The correction in salaries is due to client pressure on law firms to reduce fees, the economic downturn, and misplaced hiring and management policies. Third, Mr. Greenbaum assumes that income levels could not be maintained with more lawyers. Yet, Mr. Greenbaum presents no evidence that lawyers' wages have declined as the number of lawyers has increased. The claim that lawyers' salaries have decreased conflicts with the perception that lawyers cost too much and make high salaries.

More importantly, whether more lawyers pushes down income turns on three factors:

1. Demand for legal services
2. The intensity and character of competition
3. External forces affecting competition in the legal industry

Mr. Greenbaum should have said that when the number of lawyers increases faster than the demand for legal services, fees will face downward pressure because of increased competition. As the supply of lawyers increases relative to demand, competition increases.  And Mr. Greenbaum says nothing about the demand for legal services. The economic downturn -- not an influx of new lawyers -- reduced the legal budgets of companies.

Price competition has increased over the past two years, but not because of a flood of new lawyers. Separately, the commoditization and automation of certain practice areas is intensifying price based competition.

Moreover, Mr. Greenbaum's analysis of the demographic data is incomplete. If there is demand for only 30,000 (or any other number of) new lawyers every year, then supply does not outstrip demand. When supply and demand are in relative balance, an increase in the number of lawyers will not drive down wages because competitive intensity does not increase.

The crucial point is that even if lawyers' wages have decreased, it is not because there are more lawyers. Other factors have had a much bigger effect on incomes than the supply of lawyers.

Conclusion

Many lawyers are uncertain about how to react to the changing competitive landscape of the legal profession. Crafting good solutions to the legal profession's problem requires a solid understanding of that landscape. If lawyers have difficulty understanding what is happening in their own profession, how can they understand their clients' businesses?

Douglas Y. Park
Twitter: @DougYPark

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NOTE: This blog post is based on a discussion that blog co-author Soyeun Choi and I had about Mr. Greenbaum's essay.

Pfizer's general counsel, Amy Schulman, leads the company's efforts to reduce legal costs while preserving quality. Schulman's goal is to have 75 percent of Pfizer's legal work done by law firms in the Alliance.

Sure, companies like Cisco and du Pont have used alternative fees and flat fees for many years. But Pfizer is taking it a step further. Pfizer's program covers a broader range of legal services than other companies' arrangements.

Competition For Alternative Fees?

Pfizer can impose alternative fees to this extent because the company has so much legal work. Law firms are vigorously competing for a piece of Pfizer's work because they can secure guaranteed revenues. Competition puts downward pressure on prices. Because of competition, some law firms will accept alternative fees for their work, with the understanding that they are effectively billing below their prevailing hourly rate.

These firms may be able to make up for it by charging hourly to companies who do not have the bargaining power to compel alternative fees.

Perhaps these firms are strategically smarter than their competitors as to pricing. Maybe they understand that they cannot keep raising rates without providing added value.

Alternatively, firms who accept alternative fees may be more financially desperate or may provide lower value services.

Looking at it from the other direction, an intellectual property boutique in San Francisco attracts clients by offering a monthly subscription fee. The firm's clients are mostly venture-backed companies, not corporate giants like Pfizer.

Conclusion

On the one hand, one of the world's largest pharmaceutical companies moves toward alternative fees and brings along large law firms. At the same time, a small law firm gains small clients by offering a flat fee for services. That alternative fees are both imposed by companies, and offered by law firms, suggests that we will be seeing more of this business strategy in the legal industry. Look for changes in industry structure and competition to follow.

Douglas Y. Park
Twitter: @DougYPark

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The smart grid faces many challenges

The recent Berkeley Stanford CleanTech Conference on the Smart Grid made clear that the smart grid is in its infancy. Energy providers must solve the challenges of new energy sources, regulatory organization, and the energy needs of electric vehicles.

The Key Challenge For The Smart Grid

Keynote speaker Andrew Tang of PG&E framed the primary challenge of the emerging smart grid as integrating new power sources. Renewable energy sources in California will increase from 15% in 2009 to a mandatory 30% in 2020. While solar power will jump from 4% to 40% of renewable energy, the total TW of solar power will increase 20 times.

Since 40% of all US solar interconnections lie within the PG&E territory, although only 5% of the US population does. Solar energy is concentrated in San Francisco, San Jose, and Fresno. The top 20 cities account for 38% of the solar interconnections.

The Impact Of Electric Vehicles On The Smart Grid

Electric vehicles will test the smart grid's ability to deliver the energy required to charge them. The number of electric vehicles in the PG&E service area is projected to reach between 219,000 and 845,000 by 2020. Local management of electricity is the key to dealing with the distribution impacts that the increase in electric vehicles will produce.

To put this in perspective, an electric vehicle requiring a 240V charge takes four hours to fully charge. That is the equivalent of the average peak summer load of a single home. A 240V electric vehicle is three times the load of an air conditioner, whose adoption during the 1970s tested the grid's ability. While the grid met the test of the air conditioner, the electric vehicle, when combined with the need to accommodate renewable energy sources, poses a more daunting test.

Four Big Challenges Going Forward

Within the overriding challenge of integrating new sources of energy, four discrete issues must be addressed:

1. Dealing with the spike in the peak load versus the off-peak load.

As the number of electric vehicles increase, the peak load during a given day will be at leas two times the off-peak load.

2. Dealing with intermittent renewable energy.

Because the sun does not always shine, and the wind does not blow consistently, the amount of renewable energy produced will vary. Variances in the available energy will affect the ability to power electric vehicles.

3. Dealing with local concentration of distributed generation.

Energy is not produced everywhere. Rather, energy production is concentrated in certain locations. Local management of distributed generation is critical.

4. Dealing with the local concentration of electric vehicles.

The sale of electric vehicles is concentrated in certain zip codes.  This means that certain locations will experience the brunt of the increased load on the grid from electric vehicles. The grid must be able to deliver enough power to those areas.

Regulating And Organizing The Smart Grid

Reliability of the smart grid should be a guiding policy objective. Currently, however, regulation of the smart grid is highly fragmented, in part because utilities and state energy commissions have their own standards for operation, transmission, and quality. Such fragmentation and lack of organization undermines reliability.

The question becomes: Will national standards prevail? Or will states and utilities continue to regulate in isolation? Jurisdictional issues must be resolved, probably at the federal level. While states and utilities do not yet have the incentive to organize themselves yet, coordination should start before the smart grid becomes develops too far.

A related question is how much will the utilities exert control at the home and business level. Part of the smart grid's promise is that energy consumers can interact with energy providers and control how they consumer energy. For that to happen, utilities have to change the way they interact with customers. That may require drastic changes to time of use, demand side management, and pricing models.

I disagree with the panelist who, in discussing how the smart grid will be coordinated and organized, drew an analogy to the internet. The panelist argued that a global, non-governmental body can regulate the smart grid.

The analogy does not work. In contrast to the internet, energy businesses such as utilities are local in scope. Localities have different energy requirements. A rural area uses energy differently from an urban area. The local nature of utilities complicates efforts to regulate the smart grid on a national level. The regulatory structure of utilities will need to be aggregated at a regional or national level.

Conclusion

The conference presented many issues surrounding the future of the smart grid. Despite the presence of many smart people, which blog contributor Soyeun Choi duly noted, the conference raised more questions than it answered. Given the early stage that the smart grid, that is inevitable.

What do you think are the key issues for the smart grid going forward? What solutions do you see for these problems?

Douglas Y. Park
Twitter: @DougYPark

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Newsweek's Green Rankings

Newsweek just released its first Green Rankings of the Standard & Poor's 500. The following factors were used to rank the companies:

• an "environmental impact score" based on more than 700 metrics. The metrics were collected by Trucost, a company that analyzes emissions and natural resource use;
• a "green policies score" based on an analysis of corporate policies conducted by KLD Research & Analytics, a leader in socially responsible investing research; and
• a "reputation survey score" based on a survey of CEOs, corporate environmental officers, and academics conducted by CorporateRegister.com, an online directory of company-provides corporate social responsibility and environmental reports.

Based on this data, the top five green companies are: Hewlett-Packard, Dell, Johnson & Johnson, Intel, and IBM.

Here are the strategies of a few major corporations to become green, sustainable, and low carbon footprint.

Samsung: Energy Efficient Products, Greener Manufacturing

In July, Samsung announced a $4 billion plan to become greener called Eco-Management 2013. Under the plan, Samsung will spend $2.5 billion to improve the energy efficiency of its consumer electronics products, such as TVs and refrigerators. The company will spend $1.5 billion to reduce carbon emissions from its manufacturing plants. The goal is to produce the most energy efficient consumer electronics products.

Samsung's plans dovetail with South Korea's efforts to become a leader in cleantech.

Apple: Looking To Changing The Terms Of The Debate

Apple is ranked number 133 in the Newsweek Green Rankings. In response to criticism over its environmental practices, Apple is establishing a major initiative. Instead of just becoming more sustainable or green, Apple wants to broaden measure of greenness to include a company's carbon emissions from all sources and the impact of its products.

CEO Steve Jobs explains the reasoning behind Apple's new effort:

"A lot of companies publish how green their building is, but it doesn't matter if you're shipping millions of power-hungry products with toxic chemicals in them. It's like asking a cigarette company how green their office is."

Consistent with this position, Apple released detailed data on its carbon emissions for the first time. The company is also providing information about the materials used in its products.

Apple supports its position by pointing out that its products are responsible for more than half of its carbon footprint. Therefore, the company argues, it does not make sense to focus on the energy efficiency of its manufacturing operations. The company claims that its environmental impact can be attributed to the following sources:

• Product Use - 53%
• Manufacturing - 38%
• Transportation - 5%
• Facilities - 3%
• Recycling - 1%

UPS v. FedEx: Delivery Services Go Head To Head

UPS is ranked number 85 in the Newsweek Green Rankings, while FedEx is ranked number 93. Last year, both companies discussed their carbon emissions disclosures. While both bragged that they disclosed their direct emissions (Scope 1 emissions), FedEx one upped UPS by stating that it would disclose indirect emissions linked to power generation (Scope 2 emissions) in its 2009 disclosure.

This year, FedEx and UPS publicly continued their quest to be the most carbon friendly transport company. UPS released its Scope 3 emissions, which includes all other indirect emissions, for example, trucking services and planes. See here for UPS's Corporate Sustainability page and FedEx's Environment page.

Just last week, the companies provided data to ClimateBiz.com to show that they are doing more about their carbon footprint than their competitor. Clearly, these rivals care about their greenness relative to one another.

What Does It All Mean?

Like all rankings, Newsweek's rankings can be second guessed and picked apart. What do the metrics that were used in the analysis mean? At this point, it's difficult to say because the business of measuring sustainability and greenneess is still emerging. There is little consensus about what it means for a company to be green.

One problem is that using the same metrics to compare companies across industries does not make sense. Companies' inputs, outputs, and value chains vary in their energy usage intensity. What a technology company can do to be green might greatly differ from what an oil company or a mining company can do. Therefore, different metrics should apply for different industries.

Despite these differences, efforts by Samsung, Apple and the other companies to lay out green and sustainability measures are a step in the right direction. It will take a while for company observers to decide on most important indicators of greenness.

As that process evolves, companies should continue wrestling with how they are going to improve their bottom line through green efforts. The key is for companies to engage in meaningful activities, and not merely greenwash their products for marketing or public relations purposes.

Douglas Y. Park
Twitter: @DougYPark