THE NATURE OF SEQUENTIAL INNOVATION.

Author:Buccafusco, Christopher
 
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TABLE OF CONTENTS INTRODUCTION 4 I. CUMULATIVE INNOVATION AND CREATOR DECISION-MAKING 10 A. Innovation, Contracts, and Firms 10 B. Assuming Innovation Versus Producing It 14 C. The Nature of Decisions to Build On or Build Around 16 II. LEGAL FACTORS AFFECTING DECISIONS TO BUILD ON OR BUILD AROUND 18 A. Patent and Copyright Law 19 1. IP Scope 22 2. Owning and Licensing IP Rights 29 B. Other Legal Doctrines that Influence Decisions to Build 31 On or Build Around III. TECHNOLOGICAL AND ARTISTIC FACTORS AFFECTING DECISIONS TO 33 BUILD ON OR BUILD AROUND A. Innovation Spaces and the Maturity of the Field 34 B. Dependency on Input Factors 30 C. Tacit Knowledge 38 IV. MARKET FACTORS AFFECTING DECISIONS TO BUILD ON OR BUILD AROUND 41 A. Consumer Tastes for Similarity Versus Novelty 41 B. Market Intermediaries 40 V. CREATOR FACTORS AFFECTING DECISIONS TO BUILD ON OR BUILD AROUND 47 A. Risk and Uncertainty Aversion 49 B. Valuing Past and Future Creativity 53 C. Tastes for Pioneering and Tweaking 57 VI. REGULATING SEQUENTIAL INNOVATION 60 A. Optimizing Creativity Through Building On and 61 Building Around B. Bargaining over Sequential Innovation 63 C. Generalizing About Building On and Building Around 68 D. Sequential Innovation: IP Doctrine and Beyond 70 CONCLUSION 79 INTRODUCTION

In 2014, Taylor Swift, an admired and popular singer-songwriter, released her fifth album, 1989. The following year, Ryan Adams, also an admired and popular singer-songwriter, released his fifteenth album, 1989. Adams's 1989 was a song-by-song imitation of Swift's 1989. It may seem odd that Adams would release an album of another singer-songwriter's material. But in popular music, this is not unusual. Popular musicians often cover other musicians' songs. Indeed, as we shall see, copyright law is set up to allow them wide freedom to do so. (1) It is unusual that Adams decided to cover an entire Taylor Swift album, rather than a single song. (2) But Adams's decision to engage in wider imitation than is customary leads to the question this Article explores: Under what conditions would a person or a firm decide to build on already-existing creativity rather than attempt to create something new?

This question arises across the entire range of creative and innovative work. Imagine that a smartphone company is considering updating its touchscreens for an upcoming product release. To do so, it has two options: license another firm's patented technology or develop its own technology that does not infringe the other firm's patents. Or consider a movie studio that wants to produce a summer blockbuster. It can purchase the rights for an existing copyrighted story, or it can have its own writers create a new story. How should the smartphone company and the movie studio decide what to do?

Whether we are talking about Ryan Adams, a smartphone company, or a movie studio, the answer is (conceptually) the same and pretty simple. The actors should choose whichever strategy maximizes the ratio of benefits to costs. (3) The hard part is doing that calculus. As this Article demonstrates, focusing on how intellectual property (IP) law affects cumulative innovation is not sufficient. (4) Doing the calculus right requires a broader model. This Article provides such a model and demonstrates how policymakers can use it.

Understanding the costs and benefits of building on existing works and technologies, versus undertaking new creative or inventive efforts, is deeply complicated. We refer to a creator's decision whether to license preexisting IP or strike out on its own as the build on/build around (O/A) decision, and it is a decision antecedent to almost all sequential innovation. A downstream (5) creator faced with a world of existing IP rights must choose whether to design around those rights or whether to pay a license fee and borrow from them. (6) The O/A decision involves weighing a wide range of factors, including the scope of existing IP rights, the costs of designing around those existing rights, (7) and a host of nonlegal, contextual factors that may point toward building on or building around in particular instances.

This Article's account of the O/A decision, and the ways in which it drives sequential innovation, draws from and extends two related but distinct literatures. First, a number of scholars have focused on the influence of IP law on sequential innovation. They have highlighted the ways in which changes to the breadth or scope of IP rights affect the pace and direction of creativity and innovation. (8)

This research has not, however, typically looked beyond the influence of IP laws to consider the host of other factors, described in this Article, that influence sequential innovation.

A second cohort of scholars has applied concepts derived from Ronald Coase's seminal "theory of the firm" to innovation relationships. (9) The theory of the firm literature analyzes the factors that determine whether parties to a transaction vertically integrate, with one buying the other, or operate as separate entities. (10) This is known as the "make-or-buy" decision. In the innovation context, this approach inquires into the factors that influence whether a would-be innovator will integrate its innovation activities into the firm or contract externally to obtain them. (11)

Although this line of inquiry motivates our own questions, the existing theory of the firm literature has not previously focused on sequential innovation. Indeed, the existing literature typically frames innovation as a one-step process, starting from the premise that a firm desires to innovate and must decide whether to do so in-house or to pay another firm to innovate for it. (12) For example, a car company needing new braking technology can either develop that technology using its own engineers, or it can contract with another firm to develop that technology for them.

This is an incomplete way to model innovation. The world is full of existing innovations, many covered by one form of IP or another. A model of innovation should account for existing IP rights by integrating (1) the sequential nature of innovation, (13) (2) the fact that innovators often confront existing IP rights, (14) and (3) the fact that would-be innovators face a decision whether to borrow from these existing rights (usually by licensing them), or innovate in ways that fall outside the scope of those existing rights. (15) With this Article, we present such a model.

Accordingly, in this Article we push the inquiry back in time, to when the firm or other creator is deciding whether to innovate at all, or simply to license existing IP rights. (16) We are interested in how the car company in our earlier example decides if developing a new braking system is worthwhile in the first place (regardless of whether the development is done internally or externally). In other words, before we can answer the question of whether a firm should contract with another to produce an innovation or whether it should innovate in-house, we first need to know whether the innovation will take place at all, or whether the firm will borrow from an existing idea instead. In a world of existing innovations and associated IP rights, virtually all make-or-buy decisions are preceded by O/A decisions.

This Article highlights the major factors that influence whether a creator or inventor is likely to build on existing works and ideas or build around them to a new solution. We have organized these factors into four categories: (1) Legal, (2) Technological and Artistic, (3) Market, and (4) Creator. Each of the four categories contains a number of factors that can affect the O/A decision. For example, with respect to the Technological and Artistic category, would-be creators may have to consider, among other things, the maturity of the industry or medium, the degree to which downstream creations depend on upstream inputs, and the importance of tacit knowledge. (17) While we have assigned all legal factors that influence O/A decisions to one category, we have split the nonlegal factors into three categories. The main difference between these three categories is that factors that influence the O/A decision directly through a price signal are assigned to the Market category, while factors that influence the O/A decision through the behaviors and preferences of the innovators are assigned to the Creator category. When constraints arise from the characteristics of a particular technological or artistic environment and influence O/A decisions, we assign them to the Technological and Artistic category. We have used this categorization because the channels through which factors from the four categories influence O/A decision differ substantially and the policy responses to these influences may also differ between categories. (18)

Whether firms and individuals make O/A decisions well or poorly is not simply a matter of their own success or failure--society as a whole is affected. If, for example, a pharmaceutical firm underestimates how difficult developing a new drug that does not infringe existing IP rights will be, it will waste resources on innovation and, in so doing, increase the price of the resulting drug and perhaps delay its arrival. Had its calculations been correct, the firm should have built its new drug upon existing IP rights and acquired the necessary licenses to do so. Similar problems arise if creators are inappropriately risk averse and pay to license rights that they could have easily built around. The mistaken O/A decision will result in a higher cost to produce new work. If the mistake is big enough, the new work may not be produced at all.

These examples only scratch the surface; O/A decisions pervade all areas of creativity and innovation. Just as musicians have to decide whether to borrow or create melodies and progressions, computer programmers must decide whether to borrow or innovate code. Yet despite the centrality of O/A...

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