Appendix: an illustrative example.

• Author: Risch, Michael
• Position: Why Do We Have Trade Secrets?

An example of the analysis in Parts III and IV will help illustrate the points made. Assume that a secret is worth $1000 to a company (O), but the same information is worth only $500 if the information were also in the hands of a competitor (C). Presumably, the competitor would then have $500 of value in an efficient market, (305) assuming the secret is the entire value of the business--simplifying assumptions made for the sake of example.

Without more, there is no social gain by protecting the trade secrets. The owner may be unhappy, but such is life. In the optimal world, we would want neither party to spend money to protect or to take the information, which are inherently wasteful activities. (306) Also, we would not want the competitor to reverse engineer or perform any research to develop the same information unless we knew that the effort would advance knowledge beyond the owner's level of information because that expenditure would just shift revenues between the parties without the creation of new social benefit. (307) Finally, we would expect the competitor to independently develop or bargain for use of the secret if the competitor valued the information more than the owner.

Unfortunately, we do not live in the optimal world, and the above assumptions do not hold true. The competitor wants some profits and the owner is unwilling to transfer rights to the secret. Thus, the competitor will either appropriate the owner's information or independently develop or reverse engineer it. Hopefully, these acts would create additional social benefit by building on the original information. The competitor thus has choices to make about how much to spend to obtain the information, leaving the owner choices about how much to spend to protect the information.

1. No Trade Secrets

   In the absence of trade secret law, one would expect the competitor to spend as much as possible to obtain the secrets, up to a point where it is marginally cheaper to independently develop. In theory, the competitor would spend an amount that would maximize his chances of success in light of whatever the owner is spending. (308) Similarly, the owner would spend as much as possible to protect the secrets, up until the point where it is marginally less costly (309) to lose the secret than to protect it. How much each spends will depend on how much the other spends and the likelihood of success depending on cost levels. This leads to three variables:

   * o is the amount the owner spends for protection and detection;

   * c is the amount the competitor spends for appropriation and avoiding detection; and

   * p(o,c) is the probability of appropriation based on the amounts spent. (310)

   Complex math could be used if we knew what the function p looked like, but in general we do not; here a simple table will suffice for illustrative purposes. The table that follows shows nine states of the world, where o is low ($50), medium ($100), and high ($150), and where c is low ($50), medium ($100), and high ($150).

   One final introductory point: in this illustration, I combine the costs for detection and protection/appropriation; one would expect that more costly means of appropriation include resources allocated to not getting caught and that more costly means of protection include better ways of detecting misappropriation. Furthermore, one would expect that expenditures on protection include expenditures to avoid accidental disclosure. In each box, I put the following values:

   * P is my assigned probability p(o,c) for a specified value of o and c; (311)

   * [O.sub.L,M,H] is the expected value O gets in low, medium, and high states of the world; and

   * [C.sub.L,M,H] is the expected value C gets in low, medium, and high states of the world.

   The following formulas define O and C:

   * [O.sub.x] = V - ([P.sup.*]L) - o, where V is the value (here...