Managing Cartels Through Patent Pools

• Author: Weimin Wu
• DOI: 10.1177/0003603X19863592
• Published date: 01 September 2019
• Date: 01 September 2019
• Subject Matter: Articles

Article

Managing Cartels Through

Patent Pools

Weimin Wu*

Abstract

This article addresses one aspect of patent pools that has not received much attention—a patent

pool’s role in stabilizing a cartel of downstream producers. This article first reviews the problem

of cartel cheating. Any potential mechanisms that a cartel can use to increase its stability face

three main challenges: (1) the cost of management, (2) agency costs, and (3) the requirement of

secrecy. This article argues that the vertical licensor–licensee relationship inherent to a patent

pool would contribute to more effective monitoring of compliance with cartel agreements by

licensees. It also argues that the aggregation of patents in a patent pool would better effectuate

the punishment of cartel cheating. The article’s main finding that a patent pool is uniquely suited

to manage a cartel is a reminder that an overly permissive view of patent pools can invite

anticompetitive hazards.

Keywords

patent pool, cartel, cartel management, agency cost, vertical relationship

I. Introduction

Over the years, U.S. courts have condemned several patent pools for violating Section 1 of the Sher-

man Act because they facilitated price-fixing.

1

For example, the U.S. Supreme Court in Standard

Sanitary held that a patent pool, which was composed of patents on the enameling process of sanitary

ironware, facilitated a cartel of sanitary ironware manufacturers.

2

In analyzing patent pools, courts and

*Associate, King Wood & Mallesons, Beijing, China; SJD, University of Iowa College of Law, IA, USA, 2019; J.D., University of

Iowa College of Law, 2015

Corresponding Author:

Weimin Wu, University of Iowa College of Law, 130 Byington Rd, Iowa City, IA 52242, USA.

Email: weimin-wu@uiowa.edu

1. See generally United States v. Line Material Co., 333 U.S. 287 (1948) (holding that a patent pool of two electrical device

manufacturers violated Section 1 of the Sherman Act by fixing the prices of the devices made under the patent licenses.);

Hartford-Empire Co. v. United States, 323 U.S. 386 (1945) (holding that a patent pool of glass container manufacturers

illegally restricted the competition in the glass container market); United States v. New Wrinkle, Inc., 342 U.S. 371 (1952)

(holding that a patent pool concerning wrinkle finish violated antitrust laws by fixing minimum prices for wrinkle finish

products).

2. See Standard Sanitary Mfg. Co. v. United States, 226 U.S. 20 (1912).

The Antitrust Bulletin

2019, Vol. 64(3) 457-473

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DOI: 10.1177/0003603X19863592

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antitrust enforcement agencies have focused predominantly on the ex-post effects of patent pools on

the output and price in the product markets.

3

However, they have given little attention to the question:

What, from an institutional perspective, makes a patent pool a superior entity to abet collusion in the

downstream product markets.

The answer to this inquiry starts from an understanding that a cartel is unstable because cartel

members have strong incentives to cheat on their agreements.

4

Thus, a cartel needs some mechanisms

to strengthen its stability.

5

This article will argue that a patent pool is an ideal candidate to manage a

cartel because of two reasons: (1) the vertical licensor–licensee relationship with downstream produc-

ers

6

and (2) its potential market power through the aggregation of patents.

7

This article is composed of

four sections. Section II focuses on basic economic principles underlying cartels’ instability. Section

III examines the functions of a cartel manager. Section IV argues why a patent pool can be an ideal

cartel manager. Section V further illuminates arguments in Section IV by analyzing how Hartford

Empire, one of the largest patent pools in the U.S. history, managed a cartel of glass container

producers in the 1930s.

II. Cartels as Unstable Institutions

A cartel is an association of independent firms established to reduce competition through price-fixing,

output reduction, or other restrictive practices.

8

However, economic models have shown that cartel

members have strong incentives to cheat on their agreements. This section explains the following: (A)

why firms form a cartel and (B) after the cartel formation, why firms cheat on the cartel agreements.

A. Why Firms Form a Cartel

Firms collude with each other to obtain market power so that they can raise prices profitably.

9

Collusion is by no means the only way to achieve market power. History is abundant with examples

of a single firm attempting to gain market power through exclusionary conducts. For example, the

American Can company in the early 1900s attempted to obtain a monopoly in the can market by

denying competitors can-making machineries and raw materials.

10

However, excluding competing

firms from the market is a time-consuming and expensive undertaking.

11

A faster approach to obtain

3. See Richard J. Gilbert, Antitrust for Patent Pools: A Century of Policy Evolution, 2004 STAN.TECH.L.REV.3 (2004) (arguing

that courts have focused on various price or output restrictions in analyzing patent pooling agreements).

4. See Margaret C. Levenstein & Valerie Y. Suslow, What Determines Cartel Success?, 44 J.ECON.LIT 43, 47 (2006) (“[C]artels

are fundamentally unstable: firms agree to restrict output, but then engage in secret cheating that erupts in price wars”).

5. See, e.g. Daniel Orr & Paul W. MacAvoy, Price Strategies to Promote Cartel Stability,32E

CONOMICA 186 (1965) (exploring

a pricing strategy to maintain cartel stability that maximizes the profits of loyal member firms in the presence of cheating

members); D. K. Osborne, Cartel Problems,66AM.ECON.REV. 835 (1976) (discussing various rules that can stabilize

cartels).

6. See discussion infra, text accompanying notes 68–80.

7. See discussion infra, text accompanying notes 81–104.

8. See generally JOE S.BAIN,INDUSTRIAL ORGANIZATION 271–72 (1959) (defining cartel as a group of rival sellers who arrive at an

understanding as to what price to charge or what outputs to produce).

9. See William M. Landes & Richard A. Posner, Market Power In Antitrust Cases,94HARVARD L.REV. 937, 937 (1981)

(referring market power as “the ability of a firm (or a group of firms, acting jointly) to raise price above the competitive level

without losing so many sales so rapidly that the price increase is unprofitable and must be rescinded”).

10. See United States v. American Can Co, 230 F. 859 (D. Md. 1916), appeal dismissed, 256 U.S. 706 (1921).

11. One of the American Can company’s strategies to obtain monopoly in the United States was to buy out plants owned by

competitors, which turned out to be extremely costly. In order to induce competitors into voluntarily selling theirplants and

staying out of the can making business after the selloff, the American Can company paid competitors 1 ½ to 25 times the real

value of the purchased plants. See American Can Co, 230 F. 859, at 877 (“[O]ne factory which had not made a can, and

which had cost $16,000, was bought for $80,000.”).

458 The Antitrust Bulletin 64(3)