Technology Licensing Contracts Features and Diversity - CiteSeerX

Technology Licensing Contracts Features and Diversity CHRISTIAN BESSY Centre d’Etude de l’Emploi, Aton, Paris, France E-mail: [email protected] and ERIC BROUSSEAU Universite´ de Nancy, Aton, Nancy, France E-mail: [email protected]

Given the nature of knowledge and characteristics of the intellectual property rights system, technological transactions tend to be governed by contracts that are costly and not highly profitable. This explains why there are so few technology licensing agreements. However, in some situations, private and specific institutions tend to enable property rights to be more precise, knowledge transfers to be easier, and technology licensing agreements to be less complex to design and to run. This explains why there is a concentration of technology licensing agreements in some industries and in some relational situations. These shed light on the design of firms’ strategies to valorize intellectual assets and of public policies to stimulate innovation and diffusion. © 1999 by Elsevier Science Inc. I. Technology Licenses, Firm Strategy and Public Policy The literature on intellectual property rights (IPRs) [e.g., Ordover (1991); Scotchmer (1991); Besen and Raskind (1991)] frequently insists on the idea that technology licensing agreements (TLAs) strongly influence the properties of IPR systems. Obtaining a better understanding of license contracts is essential to shed light on at least three debates. The first debate is related to the economics of science, innovation, and technology. The central question here is the optimal level of protection that should be given to

This paper draws from research funded by the French Commissariat Geńe´ral du Plan. We thank the many professionals, especially Francis Hagel [Schlumberger & Licensing Executive Society (LES)] and Thierry Sueur (L’Air Liquide & LES), who helped us in our investigations. Preliminary versions of this paper were discussed at the Universities of Paris-Dauphine, Aix-Marseille, Compie´gne, and at the EALE and the LES Conferences. We thank the participants in these workshops for their comments. We are also grateful to the two referees of this journal for their suggestions. The usual caveats apply.

International Review of Law and Economics 18:451– 489, 1998 © 1999 by Elsevier Science Inc. 655 Avenue of the Americas, New York, NY 10010

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innovators given the “protection/diffusion” dilemma.1 The licensing of technology seems to be an efficient complement to strong IPRs. [e.g., Ordover (1991); Arora (1995)]. Indeed, when an innovator is allowed to license his technology, he spreads it in the economic system, while at the same time he increases his return on innovation investments and efforts. That said, the possible misalignment of incentives for licensors and licensees has to be carefully examined to better understand how licensing could be stimulated. The second debate is related to the economics of intellectual property systems. Several recent contributions point out that the various intellectual property laws (IPLs) and institutions in charge of managing IPRs operationalize intellectual property principles very differently among countries and industries [e.g., Besen and Raskind (1991); Lerner (1995); Lanjouw (1994); Deffains (1997); Bessy and Brousseau (1997a, 1997b)]. In these papers, the subtle strategies followed by firms to protect and valorize their stock of knowledge is pointed out. It is therefore essential to analyze how licensing behaviors affect the ability of the legal system to generate and diffuse inventions. The third debate is related to competition law (and to the economics of competition). IPL generally departs from competition law (CL) (antitrust law), but the interactions between the two are complex. License contracts profoundly affect the strength of the monopoly position granted to the patentee, and IPL cannot be considered to be so radically opposed to CL. License contracts, however, must be carefully studied to understand whether licensors misuse the dominant position that they have through IPL protection [see Ordover (1984); Gilbert and Shapiro (1990); Ordover (1991)]. In turn, as pointed out by Jorde and Teece (1990), when applied to interfirm agreements about knowledge creation and sharing, CL can strongly affect the ability to innovate. Thus, the licensing of technology is at the heart of numerous complementary questions of firm strategy and public policy. Moreover, from a theoretical point of view, license contracts are particularly interesting because they govern informational and immaterial transactions. As pointed out by Arrow (1962), transactions concerning information cause particularly complex problems. In the case of technology, these problems are complicated because there is a high level of uncertainty (about the economic value of invention and the successfulness of the transfer, among other concerns). As a result, incentive schemes and governance mechanisms that are implemented in license contracts can teach scholars a lot concerning coordination and contract economics. The fact that many scholars insist on the importance of licensing practices to grasp the actual attributes of IPR systems and to understand firms’ technological strategies contrasts with the small amount of research devoted to these practices. Quantitatively, little precise is known about the willingness of firms to license, given their nationality, size, industry, etc. Qualitatively, the actual features of license contracts are not widely unveiled. In fact, there are several theoretical contributions—mainly based on incentive theory [e.g., Shapiro (1985)]—that try to explain the basic features of license contracts. Most of these studies are dedicated to the consequences of those theoretical contracts on competition and on the technological dynamic [e.g., Gallini and Winter (1985); Shepard (1987); Gallini and Wright (1991)]. However, there is very little research based on substantial applied studies trying to identify actual firms’ practices [although see 1 The literature tries to determine the extent and the duration of intellectual property protection given its effects on collective efficiency: e.g., Nordhaus (1969), Gilbert and Shapiro (1990), Klemperer (1990), Scotchmer and Green (1990), Gallini (1992), Merges and Nelson (1994), and Chang (1995).

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Taylor and Silbertson (1973); Contractor (1981); Caves et al. (1983); Anand and Khanna (1996)]. In fact, the literature is mainly dedicated either to justifying the existence of license contracts, or to describing their role in the dynamics of technology. It does not, however, analyze in detail the actual features of license agreements. There are several justifications for this: Y Y

Y

First, license contracts, like much information related to firms’ intangible and intellectual assets, are often considered highly confidential; Second, the licensing of technology seems to be a relatively marginal practice for many firms. There are obviously some well-known companies that earn very large royalty revenues (e.g., RCA, Texas Instrument, Dolby, Innovatron, etc.), but several statistical indicators show that most firms prefer to directly exploit their innovation.2 As will be pointed out hereafter, this is mainly due to the difficulty and cost of licensing, and to the relatively low profitability of such activity. The third reason is a theoretical one. There are few detailed studies of technological license agreements because many scholars do not consider them substantially specific compared to trademark licenses or franchise contracts [e.g., Shapiro (1985)]. We think, however, that the characteristics of IPRs (cf. the second part of Section III) and knowledge (cf. the first part of Section III) endow technological transactions with very specific features that should be taken into account to really understand licensing practices. This type of assumption is also made by Caves et al. (1983), Anton and Yao (1994), Arora (1995), and Anand and Khanna (1996).

It could be argued that the apparent marginality of licensing does not justify major efforts to overcome the information access problems and to pursue specific investigations. This is not the case for at least two reasons. First, technology licenses play a very important role in many industries because they can represent a substantial share of firms’ revenue and profits, but also because they are essential in technological competition. Second, it seems essential to wonder why there are such strong differences among industries and countries. Are there any resource misallocations and underexploitations in the sector where patent licensing is not used to valorize firms’ intangible

2

Although IPR practices vary from one country to another, French data show several interesting phenomena:

Y

Y

First the registration of a patent is not such a common practice. In France only 21.4% of industrial corporations own patents. Large firms are familiar with IPR instruments, whereas small firms are not. Moreover, patenting is highly concentrated in certain specific industries. U.S. data confirm this [cf. Grilliches (1990)]. Second, many firms do not register patents for licensing purposes, but exploit them directly. For instance, when French firms register their patents abroad, they do it in countries where they are directly operating industrial or commercial activities (in 80% of the cases in the United States and in Japan, and in 90% of the cases within the European Community). If most firms will have anticipated licensing agreements, they would have registered in many countries where they are not present. Third, licensors generally contract with a small number of licensees [cf. also Caves et al. (1983)]. Our own survey of the 450 main French industrial corporations shows that even in that population a large number of firms do not own any patents (around one third), and half of the patentees (one third of the sample) do not license. As a result, licensing practices are highly concentrated in a small number of firms. In fact, only the largest firms are really able to operate an intellectual property department capable of efficiently managing this type of relationship. The industry in which the firm operates is also a major determinant of its willingness to license. License contracts are concentrated in the chemical, pharmaceutical, electronic, electrical equipments, and professional machinery industries [cf. Anand and Khanna (1996)].

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resources? Moreover, one can wonder whether such resource misuse is not due to institutional failures. In this paper, we present the first results of an investigation performed on a sample of French firms. After a rapid presentation of our sample, methodology, and analytical framework (Section II), we will point out the essential characteristics of licensing contracts, essentially by focusing on the major sources of differences between technology transfers and other types of interfirm intangible transactions (Section III). Then, we will propose a framework to understand and analyze the diversity of licensing agreements (Section IV). II. Factual Data and Methodology The Sample This paper is based on two types of factual data: detailed case studies and a database on TLAs built up through mailed questionnaires. Ten case studies were carried out in 1997 though detailed interviews with managers responsible for Intellectual assets management, alliances, research and development (R&D), strategy, business development, etc., in 10 large French industrial firms or French subsidiaries of transnational corporations. These case studies describe in detail the way those firms manage their innovation efforts and their intellectual assets. The case studies also survey several cases of technology transmission or technology codevelopment. In most firms we obtained the details of several licensing agreements. This enabled us to collect a wide range of empirical evidences and stylized facts on TLA practices. These case studies were completed by a wider data collection through questionnaires mailed to the 450 leading French firms. We thus obtained two types of data. First, we collected basic information by phone on 140 firms concerning their propensity to license their technology. Second, we obtained detailed information on about 30 firms. Each questionnaire is composed of two parts. The first part is devoted to the management of intellectual assets by the firm: resources allowed, patent policy, licensing policy, etc. The second part is dedicated to the collection of data on licensing agreements. We asked firms to choose the TLAs that they consider to be the most representative of their activity and to describe them in detail: type of resources exchanged, contractual safeguards, payment formulas, renegotiations provision, supervision and arbitration mechanisms, duration, special clauses, etc. Data on 46 of the most representative licensing agreements drawn up by these firms have thus been collected. There are absolutely no intragroup licensing agreements in our sample. Compared to previous studies, our sample, although small, seems to be representative of the diversity of TLA practices. Indeed, the general characteristics of our sample of contracts (in terms of frequency of the various types of clauses) are very close to those described in previous studies by Caves et al. (1983), Arora (1995), and Anand and Khanna (1996). The major interest of our data set is that it describes quite precisely the contractual practices. Statistical Methodology Our paper relies both on qualitative descriptions pulled out of our case studies, and on a statistical processing of our database. We will also make extensive references to statistics displayed in previous studies.

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TABLE 1. Frequency distribution of the likert based variables

Inclusion in wider agreements Technology transfer agreement Commercial agreement Joint venture Reciprocity requirement Cross-licensing Sales of goods to the licensor Providing of services to the licensor Additional Transfer of Resources Test and development data Consultant services Plans, red books, manuals Prototypes, equipment Commercial data Training Personnel delegation

No never

2

3

4

Highly intensive

Total

41.3 47.8 52.2

10.9 17.4 15.2

17.4 15.2 4.4

21.7 13.0 17.4

8.7 6.5 10.7

100 100 100

65.2 54.3 56.5

13.0 13.0 19.6

13.0 13.0 10.9

2.2 2.2 8.7

2.2 6.5 4.3

100 100 100

21.7 23.9 32.6 32.6 39.1 30.4 43.5

4.4 13.0 21.7 10.9 23.9 6.5 10.9

13.0 26.1 8.7 19.6 13.0 32.6 23.9

30.4 28.3 21.7 21.7 15.2 19.6 8.7

30.4 8.7 15.2 15.2 8.7 10.9 13.0

100 100 100 100 100 100 100

Given the nature of this paper and the space constraint, we will not be able to present in detail all the statistical and econometric tests that have been performed on our database. The detailed results are available in Bessy and Brousseau (1997c) and in forthcoming, more econometric, oriented papers. According to the aim of this paper, we will display descriptive statistics as well as some results of a data analysis throughout the paper. We will analyze, first, the frequency of certain types of contractual clauses (Tables 1 and 2). Second, we will highlight the results of a detailed analysis of the correlation among the variables (Table 3). Third, we will point out the existence of several categories of contracts clearly differentiated by their features thanks to the results of a multiple correspondence analysis and a hierarchical clustering [Lebart et al. (1984); Table 4]. Only the most relevant results will be given here. The data were processed with the ADDAD-SAS software (©ADDAD, Paris, France). Correlations between the variables were calculated using the Pearson correlation coefficient. The results are comparable to those obtained by computing the phi coefficient (w) derived from the chi-square (x2) statistic (Table 3). Correlations do not obviously prove a causality relationship but are good indicators of the existence of relationships between phenomena. Correspondence analysis is a weighted principal component analysis of a contingency table. We processed several analyses to ensure a robust synthesis of the structural relationships among the variables. The taxonomy is obtained by a clustering method that is based on the reciprocal neighbor method from the measures tables obtained in the correspondence analysis. The aggregation criterion is the centered moment of order two of a partition. At each step, one minimizes the intraclass variance of the partition built. This supported the division of the sample into five main classes. The resulting taxonomy is analyzed by examining the correlation between each class and the categorical values (Table 4).

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Technology licensing contracts TABLE 2. Frequency distribution of the discrete variables % Payment Mechanism Contracts implementing payments Lump-sum Payment Two-part tariff Royalties Customized Royalty Rate Governance. Renegotiation. Duration Governance Mechanism Implementation Arbitration Supervision committee Coexistence of two mechanisms Renegotiation Provision On royalties On the object of the TLA “Hardship” clause On the exclusivity conditions Contract Duration ,7 years [7.12] years .12 years Patent life Safeguards Exclusivity clauses On the technology On a geographical area Technology 3 geographical area Usage restriction clauses Not reselling the technology On a specific geographical area On a specific field of application On a specific mode of commercialization Most Favored Licensee Clause On Royalty Rates On Geographical Restrictions Grant-back clause Property rights on development Uses rights Simple information right

%

91.4 8.7 45.7 37.0 58.7 43.4 23.9 30.4 10.9 63.0 34.8 15.5 21.7 26.1 34.8 28.3 17.4 19.6 71.7 54.3 54.3 37.0 87.0 37.0 58.7 50.0 13.0 17.4 15.2 2.2 65.2 13.0 47.8 4.4

Conceptual Framework In technology and innovation, decisions are made in a radically uncertain environment [Knight (1921); O’Driscoll and Rizzo (1985)]. Consequently, substantive rationality [Savage (1954)] cannot apply, and the modeling of economic behavior should preferably be based on the bounded rationality paradigm [Simon (1987)]. Moreover, in technology and know-how transfers, transaction costs are of particular importance. Indeed, it is difficult to define (“measure”) what is transferred and to make commitments enforceable. Last but not least, in intangible exchanges institutions matter

TABLE 3. The most significant correlations I3T1

I3T3

1.0 0.55*

1.0

I3A1

I3A3

1.0 20.47*

1.0

I3V1

I3V3

I6C1

I6C3

Technology transfer agreement

1.0 20.65*

1.0

0.34*

0.53*

1.0 20.43* 20.43* 0.45*

1.0

0.34*

AND

0.35* 0.45* 20.27 20.26

0.30*

20.35*

20.30*

0.33* 0.33*

20.37* 20.28 0.27 0.25

20.35* 20.31*

0.31*

20.35* 20.26

0.25

0.38* 0.32* 20.37* 20.34*

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*Correlation coefficient (Level of significance: 10%. *:5%).

0.25 20.31*

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0.29* 20.25

20.41* 0.36*

C. BESSY

Weak (I3T1) Strong (I3T3) Commercial agreement Weak (I3A1) Strong (I3A3) Joint-venture Weak (I3V1) Strong (I3V3) Cross licensing Weak (I6C1) Strong (I6C3) Goods purchases by the licensor Weak (I6P1) Strong (I6P3) Transfer of codified knowledge Weak (I5I1) Strong (I5I3) Transfer of noncodified knowledge Weak (I5J1) Strong (I5J3) No payments (I7I1) Lump-sum payments (I7I2) Two-part Tariff (I7I3) Annual royalties (I7I4) Customized royalty rates (UF81) Supervision arbitration neg. mech. (I102) Renegotiation provision (I172) Duration ,7 years (I161) Duration .12 years (I163) Patent life (I164) Exclusivity clause on technology (TEC2) Exclusivity clause on geog. area (GEO2) Usage rest not reselling technol. (RTE2) Usage restriction on geog. area (RGE2) Usage restrict on technol. sub-field (RDO2) Grant-back (I142)

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TABLE 3. The most significant correlations I6P1 1.0 20.54* 0.41*

I5I1

I5I3

I5J1

I5J3

I7I1

I7I3

I7I4

UF81

I102

1.0 0.29*

1.0

I172

I161

I163 I164 TEC2 GE02 RTE2 RGE2 RD02 I142

1.0 1.0 20.41* 1.0 0.55* 20.33* 1.0 20.51* 0.42* 0.28*

1.0 1.0

0.28* 20.28*

20.33* 20.52* 20.25

I7I2

1.0 0.28*

1.0 20.70* 1.0 20.37* 20.37* 0.50* 20.29* 0.28*

20.25 0.27 20.31* 20.25 0.38* 20.31* 20.25 20.29* 20.31* 20.50* 0.43*20.26 20.31* 20.30* 20.27


0.36*

I6P3

1.0 1.0 20.34* 20.36*

0.36* 20.38* 0.38 0.36 0.45 20.31* 20.42*

*Correlation coefficient (Level of significance: 10%. *:5%).

0.31*

0.35 0.36

1.0 1.0 1.0 0.30*1.0 0.43* 1.0 20.25 0.38*0.29* 0.37*

1.0 1.0

0.39

0.34*

1.0

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particularly: Their properties play an essential role because they influence the strength of IPRs and provide agents with collective resources that can bring down the costs of negotiation, contract design, supervision, conflict settlement, etc. For at least these three reasons, our analysis is based on new institutional economics (NIE) categories [Williamson (1985, 1996); North (1990)]. Moreover, the NIE framework is particularly powerful in this case because it provides us with a framework that is able to deal with both property rights settlement [North (1990)] and transaction governance [Williamson (1985, 1996)]. According to North (1990), one of the essential roles of the institutional framework is to set up property rights (PRs) to enable economic agents to use and transfer resources. But he also emphasizes that agents must always dedicate resources and efforts to establish the boundaries of the resources they exploit or to transfer them to a third party (measurement costs), and to exclude unauthorized parties from access to these resources (enforcement costs) because the institutional setting of PRs is never complete. This explains why agents have to build governance structures—largely studied by Williamson (1985, 1996)—when rights to use resources are transferred or shared. Indeed, governance structures enable agents to specify what is transferred, under what conditions, and to make these agreements enforceable. This was especially pointed out by Macneil (1974) who explained that when the rights and duties are quite ambiguous and complex, it is impossible (or too costly) to write a complete contract (a “transactional” contract) to precisely state the rights and duties of both parties in a transaction and, therefore, to make them enforceable by the institutional framework (i.e., the judicial system). He therefore explained how agents create a private order through the settlement of a “relational” contract that enable them to negotiate throughout their relationship to state their actual rights and duties and to make them enforceable. This view of contracting strongly influenced the concept of hybrid forms settled by Williamson (1985, 1996). The analyses of Macneil (1974) and North (1990) are congruent in the sense that both authors, using a different language, develop the idea that the delimitation of the rights and duties of economic agents depends on both collective coordination devices— e.g., the institutional framework—and interindividual coordination devices: the governance structures set up by contracts. They also recognize that in various cases the establishment and enforcement of these rights are performed in various proportions at the collective and at the general level. Macneil links the ability to govern a transaction at a more or less collective level with the features of the transaction (basically as Williamson does). North insists on the idea that governance depends upon the ability of the institutional framework. In our view, both factors play a role, but to get a better understanding of what is going on, a third category of coordination device has to be recognized between the general institutions of the society—i.e., the institutional framework—and the interindividual governance structures: the private or specific institutions. Industry unions, standardization and certification bodies, scientific societies, trade associations, etc. indeed play a role in the economics of coordination because they create (sometimes informal) rules and provide agents with supervision and enforcement means (both for these collective rules and for their private agreements). These rules and enforcement mechanisms complete the institutional framework in that they state individual rights and duties

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more precisely. They therefore facilitate interindividual governance and bring coordination costs down.3 We will argue that, given the nature of knowledge and characteristics of the IPR system, technological transactions tend to be governed by “relational” contracts. This explains why TLAs are costly for patentees and therefore why there are so few TLAs (Section III). However, we will point out that in some situations, private and specific institutions tend to enable property rights to be more precise, knowledge transfers to be easier, and technology licensing contracts to be less complex to design and to run (i.e., more “transactional”). Technology transfers will be less expensive and, therefore, more frequent. This will enable us to explain why there is a concentration of TLAs in some industries and in some relational situations (Section IV). III. The Specificities of Technology Licensing Agreements TLAs are designed to govern the exchange of a particular resource: knowledge. In our view, among the various intangible resources, knowledge has specificities that will influence the nature of the contractual arrangements that govern transactions concerning it. As a result, TLAs cannot be assimilated, as is often done in the economic literature, to simple franchise or trademark license contracts, even if some aspects of the technology license relationship resemble other contractual relationships (e.g., the moral hazard problem). Two major characteristics differentiate the licensor-licensee relationship: Knowledge is a specific intangible resource that must not be reduced to information (the first part of Section III); and involved IPRs are relatively weak and incomplete (the second part of Section III). TLAs tend, therefore, to be relatively incomplete and complex contracts because technological transactions are complex to perform, highly uncertain and hard to secure. Moreover, because these contractual features lead to relatively high transaction costs, economic agents are incited to implement cost-saving solutions that, in turn, reduce the profitability of licensing for the licensor. The Specificity of Knowledge Technology licensing contracts support technology and knowledge transfer among firms. Two characteristics of knowledge seem to deeply influence their specificity: Y

Y

First, knowledge is embodied in many and diverse supports. Technological transactions cannot therefore be assimilated to pure informational transactions. In particular we will point out that technological transactions enable licensors to link the transfer of knowledge to the transfer of other resources that are more easily controllable than information flows (see the first subsection of the first part of Section III); Second, knowledge is characterized by a very high level of uncertainty regarding its economic value and its uses. At the same time, the uncertainty that characterizes these transactions explains why contracts are incomplete and why they implement many safeguards. It also explains the type of payment mechanisms that often introduce a risk-sharing principle between the licensor and the licensee (see the second subsection of the first part of Section III).

3 On the one hand, the collectivization of governance enables agents to dedicate fewer private resources to coordination. On the other hand, it enables the generation of economies of scale and scope.

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The Diversity of Knowledge Embodiments. Knowledge is incorporated into diverse supports. In concrete terms, it is embodied in very diverse resources: written material, drawings, statistical data, organizational rules, operating processes, equipment, other physical resources, human capital, etc. The very nature of knowledge implies that it is never totally codifiable.4 Consequently, the wording of a patent is generally not sufficient to reproduce the technical work that is patented.5 That is why technology licensing implies many transfers in addition to the patent description6: private information that is not capable of being patented [industrial secrets and test data, among other things; cf. Hilgartner (1995)], training, technical support, consultant services [cf. Taylor and Silbertson (1973); Contractor (1981); Arora (1995)], equipment, and other physical resources that are essential to implement and use the technique. In our sample, 78.6% of TLAs cover the provision of technical test data and development data in addition to the transfer of the right to use them. The proportion reaches 76% for technical support, 67.4% for prototypes and physical resources, the same percentage for plans and manuals (“red books”), 65% for employee training, 60.8% for commercial data, and 56.5% for employee delegation in the licensees facilities.7 Arora (1995) suggests that this plurality of knowledge embodiment enables patent users to protect themselves against the failure of the patent system. Indeed, Arora points out that there are at least two transfers in a licensing agreement: the right to use public but protected knowledge; and the necessary know-how to make that knowledge operational. According to Arora, the patent system enables the innovator to solve the moral hazard problem caused by the irreversible transfer of know-how. If the licensee is an opportunist, then the licensor can rely on the law and public institutions to prevent him from being so. Moreover, the fact that the transmission of know-how is indispensable to implement the technology protects the patentee against patent infringement without strong search and defense efforts (and costs). On the licensee side, the duality of knowledge helps him to solve the adverse selection problem. Indeed, because knowledge is partially protected by IPRs, the potential licensee can evaluate the technology before using it. We agree with Arora’s contribution. However, in our view, it is not sufficient to establish a difference between codified and noncodifiable knowledge to understand the economics of licensing contracts. Indeed, knowledge is also incorporated in tangible resources.8 This view is very close to that of the cognitive sciences. 4 The codification of knowledge implies, moreover, that the various users of the codified material share common knowledge about the codification principles. 5 We argue [in Bessy and Brousseau (1997a)] that the incompleteness of patent codification is due not only to the boundaries of human language, but also to description costs and failures of the IPR institutions (which incite economics agents to hide some essential aspects of the information); cf. the second part of Section III. 6 Callon (1993) notes that these exchanges must be accomplished through diverse types of relational networks relying on different strategies for coordination (market exchanges and scientific cooperation, for example). 7 These figures are very comparable to those highlighted by previous surveys [e.g., Caves et al. (1983)]. Moreover, these percentages reflect the intensity of these exchanges. In our survey firms’ willingness to exchange additional resources in addition to the rights of use is weighed on a scale of 1 to 5. Technical and test data ranked first (3.3), followed by consultant services (2.9), personnel training (2.7), plans (2.7), material and prototypes (2.7), commercial data (2.4), and employees delegation (2.4). 8 In the biotechnology industry, where many scientific laws remain undiscovered, much of the knowledge is based on statistical inferences made from the properties of biological material. The transmission of this material is one of the major means of knowledge circulation. [cf. Hilgartner (1995); Cassier (1995); Cassier and Foray (1997); Zylbersztajn and Lazzarini (1997)]. Even in fields where the codification is more intensive— e.g., chemicals and mechanical equipment—the circulation of prototypes is a major vector of knowledge diffusion.

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One of the major consequences of this specificity of knowledge is that its circulation can be controlled through the control of the movements of physical resources. Hence, the rights to access physical resources are a way to compensate for the failures of the IPRs. For instance, some industrial firms (e.g., oil companies) license to engineering companies the development of (process) technologies. The access to industrial installations (e.g., oil wells) is in that case a licensor’s means of avoiding a licensee’s opportunistic behavior. In our sample, the majority of TLAs (67.4%) cover the provision of physical resources. Moreover, firms declare that their licensing agreements are linked to additional selling contracts. These contracts cover the provision of physical resources with a greater intensity (mean of 3.3 on a scale of 1–5) than the provision of intellectual services (3.0) or of other services (2.7). Thus, due to the heterogeneity of exchanged resources, economic agents can resort to several legal tools to construct license agreements. Beyond the IPL that organizes the granting of exploitation rights, the licensor can protect confidential information and know-how through trade secret law, can secure payments by relying on general contract law (etc.) because he provides its licensee with diverse services or even physical resources. From a public policy point of view, this means that IPL is far from being the sole tool on which action can be taken when one wants to modify the license features.9 The second contractual consequence of the variety of knowledge embodiment is that it enables economic agents to govern knowledge-based transactions more easily by playing on the fact that several resources with complementary features have to be exchanged: Y

Y

The tacit dimension of knowledge obliges the firms to organize personnel circulation between the two entities. This is done through the provision of technical support (76% of the licenses in our sample), training (65%), and employee delegation (56.5%), among other ways. This substantially decreases information asymmetries between the licensor and his licensee. The former is able through employee visits to supervise his partner to some extent. Obviously, potential opportunistic behaviors are not definitely eliminated. Should opportunistic behavior occur, the licensor can suspend the provision of the resources that are necessary to exploit the patent. Indeed, in many cases the licensor controls resources that have to be regularly provided to the licensee (e.g., some specific technical support or a very idiosyncratic input, among other things). He can, therefore, avoid building a very specific governance structure to monitor his licensee’s behavior.10

In conclusion, the patentee can play on the fact that it is possible to bundle the provision of several resources to govern knowledge transaction at a lower price. Such practices are, however, often in conflict with antitrust laws. Indeed, antitrust commissions can estimate that these bundled sales result from monopoly power. Consequently,

9 It is important to emphasize that a firm’s ability to secure their IPRs can be affected by other laws than the IPL; especially through the standard contract law that usually does not allow interfirm agreements to depart from basic antitrust principles [e.g., Ordover (1991)]. 10 He can even oversimplify the TLA. Some licensors prefer to give up for free the right to exploit a patent and base their remuneration on the provision of an unavoidable resource. This withdraws the supervision costs that are often associated with the management of royalties. We observed such a case in the chemical industry where a company develops technologies that can be used only with some of the chemical products it produces. As a result, it controls the use of its technology and is remunerated for it by the provision of a physical input.

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this potential to transform intangible exchanges into tangible ones cannot be fully exploited by patentees as a mean of withdrawing intangible transfer costs and risks. The Uncertainty about the Value and Uses of Knowledge. Regarding its value, knowledge is a highly uncertain resource when it is transferred between two economic units. This is partly due to the well-known information asymmetry about quality inherent in every market transfer of information [cf. Arrow (1962)]. But it is also due to the radical uncertainty over the potential use of knowledge. Two different phenomena are in question: Y

Y

First, the receiving party can use knowledge in ways that are not easily observable by the prior holder. This is typically a moral hazard problem (hidden action), but in a specific informational context where it is quite impossible to build ex-ante incentive schemes or (infallible) supervision mechanisms because all the potential uses of knowledge cannot be anticipated and made observable (because of the cognitive limits of the licensor over the licensee’s activities). Second, knowledge is itself an input in the process of knowledge creation. The unit that benefits from a transfer can be conducive to the creation of new knowledge that will increase the value of the initial knowledge. The question is then how to remunerate each party for its contribution to the knowledge-creation process. Again, due to the uncertainty of such a process, it is very difficult to solve it ex-ante by an optimal incentive scheme. Ex-post there are great problems of observability (and therefore of verifiability) and of indetermination of the right quasi-rent sharing because of the joint production problem [Alchian and Demsetz (1972)]. Moreover, the new knowledge can encapsulate the old, and its usage by a third party can spoil the property rights of the initial innovator. In fact, the new innovator’s rights overlap with those of the initial innovator.

In sum, although it is to a large extent irreversible, the transfer of knowledge can generate future uses that are very difficult to forecast but that spoil the value of both parties’ cognitive assets as well as the revenues they receive. That is why, as pointed out by Caves et al. (1983), firms hesitate to license technologies linked to their core competencies. This also explains why they restrict their number of licensees. Uncertainty also has an impact on technology licensing contracts, especially on their completeness, on the payment mechanisms, and on the implementation of restriction clauses. Uncertainty as it has been defined above induces a high level of contract incompleteness. It is quite impossible to design ex-ante a contingent contract that will precisely settle the rights and duties of the two parties, especially as regards rights to use the techniques in specific ways, resources that have to be provided to the licensee, and payments to the licensor. A fortiori, an optimal contract is out of reach. First, such contracts would not necessarily be enforceable ex-post both because supervising licensee’s behavior would be very difficult (especially for a court), and because the contract would be very complicated. Second, the ex-ante design of such a contract is radically impossible because agents do not know all the possible future situations. These favor the implementation of “relational” contracts [Macneil (1974)] or “hybrid” contracts [Williamson (1985, 1996)] and related governance structures dedicated to the management of a cooperative process between two independent units that have some degree of interdependence. Moreover, this notion of cooperation is present in French license law [Foyer and Vivant

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(1991)]. In our sample, 63% of the contracts implement a renegotiation provision and 45.6% design a specific governance device to settle conflicts (either a committee or a third-party arbitrator). It must be clear, however, that even if the general features of technology transfer tend to favor the implementation of incomplete contracts (implementing negotiation structures), the level of incompleteness can greatly vary from one industry to another and from one transaction to another. Indeed, the incompleteness is influenced by the potential preexistence of collective coordination mechanisms such as common behavior conventions, information circulation networks, and common knowledge, among others. The more collective mechanisms there are, the more complete contracts there will be (cf. first part of Section IV). Beyond the incompleteness of technology licensing contracts, uncertainty leads to the laying out of contractual safeguards that are implemented through the payment mechanism (1) and through diverse usage restrictions (2) [cf. also Caves et al. (1983)]. The CONTRACTUAL SAFEGUARDS IMPLEMENTED THROUGH THE PAYMENT MECHANISM. uncertainty about the effective economic value of technology leads the licensee to prefer the payment of annual royalties to that of a set price [this is the case in 90.5% of the contracts implementing a payment mechanism in our sample; cf. also Degnan and Horton (1997)].11 Indeed, the annual fee enables the licensee to avoid making a sunk investment, and allows him to assess each year the net profitability of the license. He thus avoids committing himself to a transaction in which he is uncertain about what he will actually receive in exchange. This calls for the implementation of renegotiation clauses in the contract (63% of our contracts implement a renegotiation provision). Uncertainty has a second consequence: Royalty rates are to some extent conventionally set. The studies of Contractor (1981) and Caves et al. (1983) confirm this. Because of the uncertainty about the actual value transferred though a technology transfer, economic agents would probably reach any agreement about a royalty rate customized to each transaction only with difficulty. By referring to an average royalty fee, parties can reach an agreement more easily. This is due to the logic both of focal points [Kreps (1991)] and behavioral norms [of fairness norms in that case, cf. Granovetter (1985) and Orlean (1994)] that are embodied in conventions [Lewis (1969)]. One can, moreover, suppose that these conventional rates are set at about the average level of profitability of technology transfer in that industry. The norm is thus “fair” because on average each licensee pays the actual value for the transfer (less a risk premium granted by the licensor). Additionally, one can point out that the licensor agrees to practice such a conventional rate because it decreases the intensity of intertechnology competition [Contractor (1981)].12 The fact that payments are generally based on royalties rather than on fixed fees means that licensors bear a part of the licensee’s industrial and commercial risks. This

11 In some cases, uncertainty is so great that parties prefer to substitute payment in kind for monetary payments. Indeed this avoids the complex task of estimating the value of a technology. This opens the door to barter. See second part of Section III. 12 In their survey of 428 licensing executives’ practices, Degnan & Horton [1997] pointed out that conventions were considered as a relatively important factor (3.7 on a 1 to 5 Likert scale) in the determining of royalty rates. They also pointed out that it is not the only means since those rates are also quite sensitive to the implemented safeguards and the expected value of technology when it is possible to assess it through past experience. This is thus coherent with our interpretation.

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has two consequences. First, licensors are incited to implement safeguard clauses and supervision mechanisms to avoid hold-up (see the next subsection and the second part of Section III, below). This increases the licensor’s cost of licensing. Second, the licensor is not able to extract the whole innovator’s rent. This incomplete extraction is all the stronger when conventional royalties rates are applied. CONTRACTUAL SAFEGUARDS THROUGH DIVERSE USAGE RESTRICTIONS. Uncertainty about the potential uses of the transferred technology and knowledge leads licensors to implement safeguard clauses to avoid licensees’ opportunistic behavior and hold-up: Y

Y

First, uses rights are transferred only with restrictions (in 87% of the cases in our own sample) either by limiting the geographical scope of the licenses [in 58.7% of the cases in our sample and in 68% of the contracts reviewed by Caves et al. (1983)], or by defining market segments or niches (in 50% of our contracts). In fact, these restriction clauses are due to two factors: the uncertainty about the exact transferred rights of usage (which gives a large margin of maneuver to potential opportunists); and the incompleteness of IPRs (which makes defense against patent and license infringements difficult, time consuming, and costly; cf. the second part of Section III). For these two reasons, licensors have to diversify their risks by licensing to several licensees and by restraining each licensee’s scope of activity to reduce damages should opportunism occur. To benefit from efficient protection, these restrictions have to be easily verifiable by a court. This explains the frequent recourse to geographical restrictions. Geographical restrictions also enable the patentee to avoid direct competition with its licensee on the markets where he exploits his technology. The patentee, therefore, does not lose his monopoly position, despite his licensing policy. Due to this situation, such restrictions could be considered as pro-monopoly policies by antitrust authorities. It should be remembered, however, that when the patentee licenses his technology the licensor is not able to efficiently capture his innovator’s rent and face risks. Geographical restrictions are thus essential to incite him to license. Such geographical restrictions frequently lead to bilateral dependencies. Indeed, to accept such restrictions, licensees frequently ask for territorial exclusiveness.13 Such exclusivity gives them a monopoly position that can compensate for the usage restrictions to which they are subject. Licensors are incited to concede such advantages because, on the one hand it increases the commercial value of their license, and on the other hand it facilitates the supervision of licensees (because there are few horizontal externalities among licensees). The rationale of territorial exclusiveness is, in this case, very close to the rationale that explains such principles in franchise contracts [cf. Williamson (1985)]. However, it creates a bilateral interdependence that can be harmful for the licensor (cf. the second part of Section III). Last but not least, “technology flowback” clauses can be implemented. These give the licensor a right over any development by the licensee. We observed this clause in 65.2% of the contracts in our sample [43% in the study by Caves et al. (1983)]. It has two advantages. First, it enables the licensor to benefit from the unanticipated development of his initial innovation. Second, it substantially decreases the licensee’s incentives to invest in R&D efforts. As a result, the probability that the licensee will

13 A large portion of the contracts in our sample (71.7%) contain an exclusivity clause that can be a geographical exclusivity (75.7%) or a market exclusivity (75.7%). Moreover, these exclusivity clauses are positively correlated with the implementation of geographical restrictions: see Table 3 (RGEO2 3 GEO2). See also Caves et al. (1983).

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develop the required competencies to compete technologically with the licensor decreases. Caves et al. (1983) point out that all these restrictive clauses are likely to be implemented when the licensed technology is a core activity of the licensor’s. The Incompleteness of the Patent System In a recent article [Bessy and Brousseau (1997a)], we pointed out that the specific features of knowledge and technology, and the cognitive and economic constraints that bind patent and judicial institutions, limit the completeness of industrial property rights. This incompleteness has two aspects. First, the usage rights to an idea are never completely and totally clearly set. Second, knowledge codification is often incomplete. This is due to both the boundaries of human language and to patentees’ strategic behaviors. Because the patentees anticipate the incompleteness of the patent system, and therefore incomplete protection, they try to make the patent unusable without the transmission of complementary resources. This incompleteness of intellectual title deeds has some convergent influence on technology licensing contracts with uncertainty: Y

Y

The rights and duties of the two parties are never unambiguously and completely stated. This calls for the implementation of an ad hoc governance structure organizing negotiation between the two parties or, at least, an arbitrage mechanism. Economic units have to exchange resources other than the patent itself. This provides them with additional governance means.

But there are also specific consequences of this incompleteness. One of them is the implementation of the “most favored nation” clause in some contracts (17.4% in our sample, but that is systematic in some industries like consumer electronic equipment, where it concerns the royalty rate). Because IPRs are incomplete, licensing agreement negotiations are one of the occasions (along with the patent office’s examination and infringement trials) during which the actual scope of patents is discussed. If a potential user estimates that, given the patent’s actual contribution to an innovation, the patentee claimed too wide a protection, he can threaten him with legal proceedings to contest his property rights. He can also negotiate favorable licensing conditions with him (low restrictions and low fees, among other conditions). In that case, the patentee’s property rights are de facto reduced, but he can prefer this second solution because of trial costs and delays, and because his title deed is publicly and unambiguously restrained or destroyed in case of unfavorable judgment. The negotiations of license contracts can therefore be close to the contradictory debates performed at the patent office or in courts. If all licensing negotiations were of that type, it would be very costly and time consuming. That is why the two parties can agree to implement a clause in which the licensor agrees to grant all licensees the most favorable license conditions that he gives to any. Licensees ask for this clause because it enables them to potentially benefit from fair contractual arrangements, but to avoid costly negotiation. Indeed, each licensee, unless he is the most capable of contesting the patent claim because he intimately knows this technology, knows that he is not the best potential negotiator to reach the most favorable licensing conditions. On the other hand, the licensor is incited to accept this type of clause because it greatly decreases both his bargaining costs—most licensees sign contracts without negotiating—and the probability of contesting his title deed. Indeed, if there is no coordination between the licensees,

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even the most capable will not try to negotiate more favorable licensing conditions because, first, the licensee is not necessarily aware that he is the best negotiator and, second, his individual costs can be superior to his expected individual gains. As pointed out by North (1990), when property rights are incompletely set by public institutions, transaction costs—i.e., “measurement” (specification) and “enforcement” costs—are higher. This is because the collective system involved in the management of property rights and transactions benefits from economies of scale and of scope in defining and enforcing the uses right of economic agents. Moreover, when these collective systems fail, agents have to bear these costs directly by building specific governance structures. They can, however, develop strategies to reduce these costs. This is particularly the case as regards supervision. Because property rights are weak, and because there are uncertainties about the possible uses of knowledge, licensors potentially have to dedicate important resources to supervise licensees’ behaviors. That is why they will tend to implement contractual solutions that bind supervision requirements. Three types of solutions are used: Y

Y

Technological Barter Through Free Cross-Licensing: An important part of the supervision effort is often dedicated to appraising whether there is any cheating about the evaluation of the basis of royalty assessment. Technological barter avoids such an effort. The two companies exchange the right to use two technologies that are estimated as “equivalent,” without referring to any monetary value. Specialists in the profession consider technical, industrial, and commercial arguments to estimate that the two technologies can be roughly considered as equivalent. To a large extent this simplifies ex-ante negotiations.14 Also, the ex-post governance problems are simplified because the barter creates a situation in which each party is in a position to threaten the other through unfair use of the licensed technology. The control of opportunistic behaviors thus relies on a balance of credible threat. In our sample, cross-licensing is required from the licensee in 34.7% of the contracts. Moreover, it is positively correlated to the absence of payment to the licensor (I7I1 3 I6C3) and to the nonimplementation of supervision mechanisms, renegotiation provision, and contractual safeguards (I6C1 3 I102, I172, RDO2). A possible degradation of the principle of technological barter (because it is not always possible) is to simply implement barter between a patent and another type of resource. Indeed in our sample, the licensor can demand reciprocity in terms of goods or service deliveries by the licensee (respectively, in 45.6% and in 43.4% of the cases). In such cases, there are no credible threats. However, the implementation enables simplification of the payment mechanism. In our sample, reciprocity in terms of goods is also positively correlated to the nonimplementation of complex contractual and governance structures (I6P1 3 I102, I172, GEO2, RTE2). Set Priced License. Again, to limit the required effort of supervision dedicated to estimating the actual intensity with which the licensee uses the technology, some licensors give usage rights in exchange for a lump sum payment. However, this goes against the logic of royalties linked to uncertainty about the actual value of the transferred technology (cf. the second subsection of the first part of Section III). As suggested by Arora (1995), lump-sum payments could correspond to the remuneration of services (technical support and training, among other services). The license

14 Our interviewees pointed out that these direct agreements between operational R&D or manufacturing specialists are often easier to establish than arrangements involving lawyers and finance specialists.

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Y


is then given free of charge. In Arora’s model, the payments are spread over two periods to solve the adverse selection problem. The licensee makes the second payment only when the licensor provides him with the required know-how to use the technology. In our sample, there are lump-sum payments in 59.4% of the cases in which payments are performed. However, in 83.4% of these cases, these lump-sum payments are associated to royalties based on sales. This is also documented by Degnan and Horton (1997). As a result, there are only 10% of cases in which there are, strictly speaking, lump-sump payments. The other cases are, in fact, two-part tariffs that enable firms to benefit from the advantages of both royalty payments (which solves the adverse selection problem) and lump-sum payments (that decreases the ability of licensees to cheat). Moreover, two-part tariffs are a good way to share exploitation risks between the licensor and the licensee. This is probably why they are implemented so often. This seems to reconcile Arora’s vision with ours.15 The Indexing of Royalties on Easily Observable Variables. If economic agents were in the process of remunerating the actual contribution of a technology to a licensee’s results, they would have to implement very complex basis of assessment and remuneration formulas. Most of the significant variables would not be easily observable and verifiable, and the remuneration scheme would require intensive supervision efforts. To avoid such efforts and to save costs, agents implement very rough, but easily observable, basis of royalties assessments like total sales of the products incorporating the licensed technology or even total sales of the company. In our sample, 35.7% of the contracts implementing the payment of royalties base them on the generated sales, and royalties are based on total sales in 64.3% of the cases. This is also documented by Caves et al. (1983, p. 258). This is another source of licensors’ incomplete capture of innovation rents.

Incomplete IPRs also have an impact on the implementation of safeguards in contracts. Due to the incompleteness of the patent system, the transferred rights of use are always imprecise and not easily enforceable. Ex-ante, a complete contract able to settle each party’s rights and duties in every feasible situation cannot be designed. Ex-post it is complex to assess, for instance, whether a licensee’s behavior generates patent infringements. In the previous section, we reviewed clauses—such as geographical restrictions or a “technology flowback” principle—that are partly designed to solve this problem. We mention here other contractual solutions that are more directly linked to overcoming the incompleteness of IPRs: Y

The licensor’s technology can be misused by the licensee, thus reducing the payment of royalties. This can be unintentional (management mistakes or inability to learn), but can also be the result of deliberate strategic behaviors (e.g., to neutralize a technology in a competitive process among technologies). The point is that it is very difficult for a third party to determine unambiguously whether a misuse is deliberate or not. However, such deliberate behaviors can be very harmful for the licensor, especially if he granted exclusive licenses. He then can implement a performance clause that stipulates a minimum level of either sales or royalties for fear of contract breach [cf. Caves et al. (1983)].

15 In our sample there is no significant correlation between the implementation of dry lump sump payments (i.e., those without royalties) and the provision of services or tangible resources. This seems to invalidate Arora’s assumption. per se. However, Arora’s arguments about lump-sump payments can be combined with ours on royalty payments to explain why there is so often a combination of the two.

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The licensor is also potentially the victim of an exorbitant appropriation of knowledge by the licensee. Indeed, because IPRs are fallible and incomplete, and because the licensee has access through know-how and material transfers to the cognitive resources of the licensor, he can learn things that are not licensed. This explains why licensors protect themselves against this type of knowledge extortion by providing training and support services rather than by opening the doors of their own facilities to the licensee’s employees. Small firms, however, are often unable to provide such services and are potentially victims of knowledge pillage [cf. Caves et al. (1983)].

To offset the incompleteness and the failures of the patent system, economic agents do not rely only on interindividual (contractual) devices. They also benefit from collective mechanisms that do not belong to the intellectual property or public institutions category [cf. Brousseau (1999)], but that back up these institutions: The Private Institutions. To coordinate, agents rely on informal rules (customs and conventions; (cf. Section II) see the second subsection of the first part of Section III) as well as on private collective organizations that offset the failures of public institutions. These informal or private institutions impact on measurement and enforcement costs and, thus, participate in the characterization of an IPR system. Regarding the licensing of technology, two types of institutions play an important role. Y

Y

Structured scientific and professional communities generate rules of behavior that enable their members to benefit from the common interpretation of rules that enable them to codify (or decodify) knowledge but also to state whether such a use of the transferred knowledge is fair or unfair. Moreover, these communities ensure information circulation (cf. the first part of Section IV). This reduces information asymmetries and favors self-discipline [cf. Granovetter (1985)]. Private institutions dedicated to information asymmetries reduction. In some industries, like consumer electronics or pharmaceutical products, commercial databases on the sales of every type of product are permanently maintained and updated. These enable licensors to benefit from precise information on which royalties can be settled easily. Such specialized information media severely bound the abilities of agents to cheat and manipulate information.

In either case, the existence of collective coordination resources enables agents to simplify the governance structure they have to implement at a bilateral level. Obviously, these collective resources greatly differ from one industry to another and do not exist in every industry. As a result, despite common features, license contracts can be very different across industries. Moreover, this induces very different levels of transaction costs. The more collective resources there are and the simpler the contracts and governance structures are, the lower the transaction costs. This will be developed in Section IV. To sum up, given the specificity of knowledge transfers and the incompleteness of the related institutional environment, TLAs tend be incomplete and relational contracts. This obliges agents to dedicate a quite extensive amount of resources to the ex-post governance of the transaction, because they have to negotiate and mutually adjust, and because supervision has to be exercised by the licensor. Moreover, because resources have to be dedicated to the actual transfer of knowledge, technology licensing operation tend to be, all things equal, relatively costly. To decrease these costs, patentees tend to implement contractual clauses that are

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robust to uncertainty and avoid complex supervision and interpretation. This concerns especially payment mechanisms that tend to implement simple formulas that do not enable the innovator to be remunerated according to the actual use of its technology. In addition, because strong adverse selection problems occur with technology, licensees frequently ask for remuneration systems that share risks with the licensor (i.e., annual royalties). All things being equal, licensing provides the licensor with a relatively low remuneration in the sense that its remuneration is noticeably inferior to the value generated by its innovation. These high costs and low remuneration generate a low profitability of licensing operations. Moreover, the combination of risk-sharing remuneration formulas and contractual safeguards induces mutual interdependencies. The innovator must, therefore, bear its client’s risks along with its innovator and producer risks. This is why firms are so reluctant to license. In addition to increasing risks of being imitated and competed with, licensing does not generally generate such high net revenues. Moreover, medium and small firms often do not have the (human) capacities and capabilities to efficiently perform and secure their knowledge transfers. Our investigation, therefore, points out why TLAs differ from standard selling contracts and why, all things equal, their low profitability does not incite innovators to optimize the diffusion of a technology. At the same time, we pointed out several means that simplify licensing operations, and therefore favor a better remuneration of licensors, and, thus, a greater willingness to license, which generates a wider diffusion of innovation: Y Y

First, the licensor can bundle the provision of knowledge with the provision of other resources. Second, the licensor can benefit from the existence of a specific institutional framework that provides him with collective resources that overcome the incompleteness of both the IPL and the available contractual solutions.

In Section IV, we will point out that although TLAs tend to be relational, the existence of a specific environmental and relational situation enables patentees to implement more transactional and therefore less costly governance structure to exchange technology. This basically explains the concentration of TLAs in a specific industry sub-segment and in specific relational situations. That also explains the diversity of TLAs. IV. Explaining the Diversity of License Agreements In the previous section we tried to point out the common features of TLAs. However, our discussion led to the mention of specific cases in which royalty payments are not implemented and in which governance relies on sociotechnical networks rather than on bilateral governance structures, among other cases. Although they rely on common solution classes because they govern transactions that have identical features, TLAs are diverse. Everyone involved insists on this point [e.g., Contractor (1981); Anand and Khanna (1996)]. This is largely due to the variations of transaction features, but it is also due to variations in the institutional environment. In our view, these two factors will influence licensing contracts that will resemble one of the two contractual categories identified by MacNeil (1974): Y

“Transactional” or “classical” contracts as qualified by MacNeil are also qualified as “market” contracts by Williamson (1985). These are almost complete contracts that,

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in this case, essentially describe the conditions to which the rights to use a patent are transferred between two economic units; “Relational” contracts [MacNeil (1974)] or “hybrid forms” according to Williamson (1985, 1996) are relatively incomplete contracts that, first and foremost, design a negotiation structure both to perform an actual process of knowledge sharing and creation and to complete industrial and commercial cooperation.

Obviously, there is a continuum of solutions between these two polar cases. The existence of diverse categories of TLAs is documented in Table 4, in which the results of a hierarchical clustering of our sample are given. Five classes of contracts emerged. The five categories can be ranked on a relational-transactional axis, on which contracts tend to be increasingly complete and simple. The relational class groups TLAs that resemble those described in Section II. They are designed to cover the exchange of many types of resources in addition to the patent by itself, are incomplete, implement many safeguards and a specific governance structure. On the other hand, although they are not as simple as a selling contract for a commodity, transactional TLAs tend to be complete and to not implement complex governance structures. Intermediary classes share features of both categories.16 Basically, our idea is that, given the characteristics of the institutional environment, the ability to rely on collective mechanisms to govern technology and knowledge transfers vary. This leads agents to implement more or less complete contracts, the costs of which vary considerably. The institutional framework, therefore, plays a major role in the explanation of interindustry differences in licensing practice. A certain amount of research has already documented this influence of the institutional framework. However, our own study differs on two points. First, most of these studies insist on the quantitative impact of the institutional environment, which leads to a very heterogeneous propensity to license [e.g., Caves et al. (1983) on intercountry comparisons; Anand and Khanna (1996) on interindustry comparisons]. We choose to point out qualitative impacts (to explain the quantitative ones). Below, we will demonstrate the types of possible contractual arrangements given the various institutional environment features. Second, most of these studies rely on a very narrow vision of the institutional environment. Most of the time it is reduced to the legal (formal) framework. As pointed out in the first section, such a characterization is insufficient. More16

The five classes are:

Y

“Relational TLAs”: These long-term agreements govern the exchanges of many resources along with the right to use a patent. These contracts implement many safeguards, specific negotiation supervision and arbitration structures, and two-part tariffs, “Development TLAs”: This groups agreements through which a licensor gives a licensee a right to develop his technology. They do not implement payments but are a renegotiation structure aimed at discussing the conditions of the exploitation of the result of the R&D process when completed, “Relational Commercial TLAs”: These short-term agreements are linked to commercial agreements. The licensor transfers to the licensee a right to use a patent and the necessary resources to exploit it. Geographical restrictions and other safeguards are implemented to avoid competition between the licensor and his licensees. In turn, the licensor bears the risks (payments based on royalties), “One-Shot Complete Transfer”: These contracts are designed to transfer the right to use a patent for its whole life in exchange for a lump-sum payment. The absence of restrictions and royalties avoids any ex-post supervision and renegotiation needs. As a result, these contracts do not implement governance structures. They typically govern the exchange of a technology that is not a key one for the patentee, “Transactional TLAs”: These correspond to a simple transfer of the right to use a patent and, therefore, do not cover the exchange of additional resources. They generally do not implement strong safeguards and do not anticipate ex-post renegotiation. They are relatively short term and tend to implement uniform royalties payments.

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TABLE 4. The five classes of contracts

Frequency Inclusion in a wider agreement Technology transfer Weak (I3T1) Strong (I3T3) Commercial agreement Weak (I3A1) Strong (I3A3) Joint venture Weak (I3V1) Strong (I3V3) Transferred Resources Codified Knowledge Weak (I5I1) Strong (I5I3) Uncodified Knowledge Weak (I5J1) Strong (I5J3) Reciprocity Cross licensing Weak (I6C1) Strong (I6C3) Goods purchases Weak (I6P1) Strong (I6P3) Payment mechanism No Payment (I7I1) Lump Sum Payment (I7I2) Two Part Tariff (I7I3) Royalties (I7I4) Customized royalty rate (UF81) Governance Supervision. Arbitration. Negotiation Mechanism (I102) Renegotiation provision (I172) RP on royalties (R172) Duration ,7 years (I161) [7.8] years (I162) .12 years (I163) Patent life (I164) Safeguards Exclusivity Clauses (I112) EC on Technology (TEC2) EC on Geog. area (GEO2) Usage restriction (I122) Not Reselling Techno (RTE2) Geographic Area (RGE2) Fields of application (RDO2) Most Favored Licensee (I132) Grant-back (I142)

Transactional TLAs

One-Shot Complete Transfer

Relational Commercial TLAs

Development TLAs

Relational TLAs

Sample

36.4 36.4

50 50

50 16.7

50.0 25.0

38.0 28.5

41.3 30.4

81.8 0

75.0 0

17.7 50

75.0 0

23.8 38.1

45.6 23.9

54.5 27.2

50.0 25.0

66.0 0

75.0 25.0

42.8 38.1

52.1 28.2

63.6 0

50.0 0

50.0 25.0

14.0 29.0

30.4 28.3

54.5 27.2

50.0 0

0 83.3

75.0 25.0

19.0 38.1

32.6 37.0

0 100

90.9 0

100 0

66.7 0

50.0 50.0

47.6 9.5

65.2 8.7

72.7 27.3

100 0

50.0 16.7

75.0 0

33.3 23.8

54.3 19.6

0 0 54.5 45.5 54.5

0 100 0 0 NS

0 0 16.7 83.3 0

0 0 66.7 33.3 100

8.7 8.7 45.7 39.9 58.7

100 0 0 0 NS

18.1

25.0

0

75.0

66.7

43.4

27.2 9.1

25.0 0

66.7 16.7

100.0 25.0

81.0 61.9

63.0 34.8

9.0 18.1 45.5 27.2

50.0 0 0 50.0

100 0 0 0

25.0 50.0 25.0 0

28.6 42.9 9.5 19.0

34.8 28.3 17.4 19.6

54.5 27.3 45.4 72.7 27.2 27.2 36.4 18.1 27.3

50.0 25.0 50.0 50.0 0 25.0 0 0 0

83.3 83.3 50.0 100 16.7 83.3 16.7 0 66.7

75.0 75.0 75.0 75.0 50.0 50.0 50.0 0 100

81.0 61.9 51.1 100 52.4 76.2 76.2 28.5 90.5

71.7 54.3 54.3 87.0 37.0 58.7 50.0 17.4 65.2

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over, it cannot explain interindustry differences within a country. Anand and Khanna (1996) try to overcome this limitation by linking the strength of property rights to the characteristics of technology and knowledge (through its degree of codification). We believe, however, that this characterization needs refining. On the one hand, the very nature of the diverse types of organization and rule that characterize an institutional environment has to be pointed out. On the other hand, even if the strength of IPRs is an essential characteristic, it cannot summarize all the determining characteristics that influence TLAs and cannot explain the differences. In our view, there is a great difference between horizontal and vertical TLAs: Y

Y

In horizontal agreements between competing firms, a logic of market sharing dominates. Therefore, the competitive features of the industry largely influence the nature of license contracts (the first part of Section IV). However, horizontal TLAs share a common feature. They tend to be “transactional contracts” because their aim is essentially to organize the transfer of rights of use among similar firms. Moreover, there are often many collective resources that can be used to support these agreements. Their degree of completeness is then strongly influenced by the basic features of the industry. Vertical agreements are usually intended to organize actual transfers between complementary companies that have a common interest in an industrial or commercial project. These agreements are most often based on “relational contracts” because actual knowledge transfers have to be performed, and because very few collective resources can back up private governance efforts. The degree of privacy of coordination and the degree of incompleteness of the contract is, however, strongly dependent on relational specificities. Indeed, certain situations enable agents to simplify the design of these hybrid governance structures and, thus, to bring transaction costs down (the second part of Section IV). Horizontal Relations: Knowledge Commonality and Technological Interdependencies

The logic of market sharing dominates in horizontal agreements between effective or potential competitors. Indeed, there are no other reasons to explain why a firm chooses to give up a monopoly right. If a firm licenses its own competitors, it is either because it would be impossible (lack of resources) or too costly to directly exploit its technology on a specific market (or market segment), or because it wants to capture rents generated by diffusion (imitation) that it cannot prevent (or it has no interest in preventing). The propensity to license and the available contractual solutions will principally depend on two factors: Y

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The degree of knowledge commonality that influences both the ease (and the governability) of technology transfers and the completeness of IPRs (the first subsection of the first part of Section IV); The technological interdependencies among firms that incite technology transfers and the construction of collective governance resources to manage them (the second subsection of the first part of Section IV).

Common Knowledge and Completeness of IPRs. The features of licensing contracts greatly depend on each industry’s institutional environment, which can be characterized by the fact that knowledge is common (as opposed to specific) and that IPRs are relatively complete (as opposed to incomplete), these two elements being strongly correlated:

474 Y

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A high degree of commonality of knowledge17means that an industry’s members share the same type of knowledge. Put another way, they do not own specific competencies (in the sense of evolutionary theory) because they are on the same “technological frontier” and serve the same types of markets thanks to similar production processes.18 In that context, all the industry members are able to interpret the wording of a patent in the same way, and a patentee does not really need to transfer knowledge and other resources when he wants to transfer his technologies to another economic unit. When knowledge is common, IPRs are, everything remaining equal, stronger (or less weak), because all the protagonists involved in their management share common rules of interpretation. As a result, patent claims and patentees’ rights are less ambiguous, and patent infringements are more easily verifiable [cf. Bessy and Brousseau (1987a)].

Thus, the more that knowledge is common, the more “transactional” [MacNeil (1974)] contracts will be. If knowledge is common, the license contract does not have to organize a knowledge or even a technology transfer. It just has to define what rights of use are given to the licensee. Moreover, the more that knowledge is common, the more precise the contractual specification of transferred property rights and the greater the ability to involve (public and private, formal and informal) collective systems. Licensing contracts are, therefore, relatively simple and complete. They give (generally restrictive) exploitation authorization in exchange for royalty payments.19 On the other hand, in industries where firms have very specific competencies, agents have to transfer knowledge and cannot rely on collective resources to make the governance of their transaction easier. More “relational” contracts are necessary to organize a successful transfer and to secure the interests of both parties (cf. Section III). In the cases we studied we observed such a difference between TLAs, given the characteristic of the industry in terms of commonality of knowledge. For instance, in the 17 Anand and Khanna (1996) have a very similar argument to ours. However, according to them, the essential factor in contract differentiation is the degree of knowledge codification. The less ambiguous the link between a text and the economic and technical properties of a technical realization, and the stronger the industrial property rights, then the more complete the license contracts will be. We think, however, that their focus on codification is too restrictive. Y

First, technology licensing does not only cause problems in property rights protection; it also causes problems of knowledge circulation. Now, the problem of knowledge transmission cannot be reduced to the question of codifiability. As pointed out in Section III, knowledge is embodied in different support and is, therefore, transferred through the circulation of various resources. Moreover, sociotechnical networks [Callon (1993)] and professional communities [Nelson (1993)] convey knowledge, even if tacit, second, the strength of IPRs surely depends on the codifiability of knowledge, but this is far from being the sole factor. We have pointed out [in Bessy and Brousseau (1997)] that it also depends on the conventions that are specific to each industry and that precisely determine fair and unfair uses of licensees’ rights.

Moreover, our data seem to invalidate the interpretation of Anand and Khanna (1996) in terms of knowledge codification. Indeed, if they were right, one should observe a greater propensity to exchange codified knowledge in transactional contracts, and noncodified knowledge in relational contracts. As can be seen in Table 4 (Lines I5I1 to I5J3), this is not the case. Indeed, the propensities to exchange codified and uncodified knowledge follow the same trend between transactional and relational contracts. Much codified and uncodified knowledge is exchanged in relational contracts and much less in transactional ones. 18 That is why imitation occurs. Mansfield et al. (1981) and Mansfield (1985) document that imitation is very rapid in many industries because knowledge is common, but also that there are strong interindustry differences. 19 The literature on license contracts based on the incentive framework [e.g., Gallini and Wright (1991); Shepard (1987)] typically corresponds to this type and this context of licensing agreements. It is, however, not well designed to deal with the other types of contract.

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organic chemical industry, in which scientific rules, industrial principles, and technomarketing properties of molecules are well known by the whole industrial and scientific community, TLAs tend to simply (and completely) define the types of rights of use that are transferred to the licensee. Indeed, it is not useful to organize a transfer of knowledge, and a judge, with the assistance of experts, can easily arbitrate conflicts because patentee’s rights are quite unambiguous. This is quite different in the biotechnology industry, for instance, in which research has been largely performed by small units (university laboratories and start-up companies) on very specific subfields. The scientific community is not already well organized, and all the researchers in the field do not share the same basic knowledge. The industrial community is highly scattered and does not share common views about the principles governing the manufacturing of products and the market. As a result, knowledge is not only largely tacit, but also is incomplete and spread among many small entities that do not maintain strong relationships with each other. The consequence is that when two units want to exchange technology, they have to exchange many resources besides the wording of the patent. They also have to implement specific means of supervision and arbitration to make their complex and specific agreement self-enforceable. Beyond our case studies, our correlation table also documents this. In Table 3, columns I5I1, I5I3, I5J1, and I5J3, which refer to the intensity of exchanges of knowledge in addition to the wording of the patent, show that the more additional resources are exchanged, the more safeguards and renegotiation provisions are implemented. This confirms that when both parties do not have to actually transfer knowledge, they are able to implement more transactional agreements. All the applied studies confirm the polarization of license contracts according to such a framework (even if theoretical categorization varies). Caves et al. (1983), for instance, point out that 25% of their contracts are of the “transactional” type. Moreover, both Anand and Khanna (1996) and our own studies point out that these “transactional contracts” are concentrated in specific industries. According to our investigation, they are concentrated in the chemical, pharmaceutical, and electronics industries. Anand and Khanna (1996) state that they are more frequent than other types of agreement in the chemical (one third of the contracts in their database), electronic (24%), and computer (18%) industries. This confirms that the characteristics of an industry strongly impact on the ability to design and run certain types of contracts. To a large extent, the degree of commonality of knowledge itself depends on the age of the industry. Indeed, all the collective resources [knowledge codification, conventions, associations and societies, social networks, etc.; cf. Nelson (1993)] that favor knowledge circulation and IPR security have to be built over time. Although there are other necessary conditions, older industries are, therefore, more likely to be characterized by a high level of commonality. Technological Interdependencies Between Industry Members. The second factor that strongly influences license agreements does not impact on the transfer and governance costs, but rather on the incentives to transfer knowledge and technologies to competitors. Indeed, the very nature of technology creates more or less strong technological interdependencies among industry members that influence the density of technology license agreements, and, in the end, their capacity to govern such transfers. There are three different causes of technological interdependencies:

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1.

There are technological spillovers due to the boundedness of the cognitive resources of each industry protagonist. Consequently, each protagonist cannot realize all the potential developments of a technique, especially when a core technology can engender many applications or when highly complex technological systems are designed. This is a frequent situation in the chemical and biotechnology industries. Cumulative developments increase the value of the initial invention, and the diverse innovations are linked because the use of a marginal innovation implies the use of all its mother inventions. 2. There are increasing returns of adoption that are due to network externalities among technologies or among users of a technology. They favor the setting up of a unique technological standard [cf. David (1985); Cowan (1990); Antonelli (1994)]. The electronics industry provides the best example of this phenomenon, because one can observe the combination of physical network externalities (to ensure interoperability) and technical externalities (among the diverse technical components of these network-provided services). 3. Regulation or standardization constraints can also lead to the adoption of common technologies. Most of the time these standards or regulations are created to overcome negative externalities. This is, for instance, the case either in network services where interoperability requirements are high (e.g., telecommunications) or in industries that can generate strong negative externalities in terms of environment or health. When technological interdependencies are high, it is either a quasi-obligation [(1) and (2)], or an obligation (3) for a patentee to license his technology to any potential licensee, even if it is a direct competitor. In the first two cases, it is the competition among technologies that forces a patentee to try to develop his “market share” either to initiate additional development or to increase the relative number of users of his technology. In either case, licensing is essential because the technology market share directly impacts on the short-term generated revenues and on the long-term viability of the technology. In such competitive games, license agreements play an essential role.20In the latter case, one is often in a compulsory license regime, either through the antitrust law (like in the telecommunications industry, where a patentee cannot use its intellectual property monopoly power to create entry barriers), or through the specific law linked to the various domains of public policy (like in the healthcare industry, in which it is obligatory to license a basic technology to those who want to develop therapeutic applications). Whatever the situation, when there are strong technological interdependencies, there will be many licensing agreements that, everything being equal, impact on the ability to manage those agreements. Three phenomena are in question. First, these interdependencies imply intense exchanges of information through industrial and commercial relationships, the circulation of employees’, etc. [e.g., Hyde (1997)]. These exchanges reduce information asymmetries. This has consequences on technology transfers and governance:

20 This refers, for instance, to the famous VHS versus Betamax and V 2000 competition where JVC (VHS) won against Phillips (V 2000) and Sony (Betamax) because it agreed to license its technology at a low cost.

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A reduction of adverse selection problems: everything remaining equal, uncertainties about the actual value of an innovation decrease for the potential licensee because he has access to many information sources; A lowering of moral hazard because, for the same reasons, licensor and licensee supervision is easy; Easier enforcement, because, as pointed out by Granovetter (1985) or Milgrom et al. (1990), reputation effects, which are the foundation of collective retaliations against opportunists, greatly depend on dense links among the members of a community. When there is a tight relationship and a fluid information circulation, cooperative behaviors and, therefore, the enforcement of agreements are guaranteed.

Second, technological interdependencies favor the emergence of collective governance mechanisms. Some of these are deliberately built, whereas others spontaneously emerge. In both cases, the large number of intraindustry relationships and the similarities among them explain the emergence of these collective mechanisms that mutualize and bring transaction costs down [cf. Brousseau (forthcoming); Bessy and Brousseau (1997b)]. Two types of mechanism have to be identified: Y

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On the one hand, economic agents favor the development of efficient supervision systems that enable a clear statement of the basis of the royalties settlement. Because most industry members are both licensors and licensees, they have a common interest in building such mechanisms; On the other hand, the dense network of transfers among industry members, the huge amount of cross-licensing increases retaliation capabilities. This enables transactors to simplify governance structures because it is not necessary to implement complex safeguards.

Third, learning effects also bring governance costs down. Because firms design and manage many TLAs, they can conceive cost-saving solutions: Y

Y

First, agents standardize license contracts to economize on negotiations and the management of contracts [cf. Brousseau (forthcoming)]. Learning is the key to this standardization because it enables agents to fix the efficient contractual solutions given the industry and the legal environment. Second, at a collective level, the large number and the multilateral nature of technology transfers tend to favor the commonality of knowledge and, therefore, the simplification of technology transfers (cf. the first subsection of the first part of Section IV).21

21 One might, therefore, think that the commonality of knowledge and technological interdependencies are linked. This is not the case, as illustrated by the computer and professional electronic equipment industries where the commonality of knowledge is considerably less than in the chemical industry [cf. Taylor and Silbertson (1973); Levin et al. (1987); Mansfield (1986); Cohen et al. (1996); Anand and Khanna (1996)]. One notices, however, numerous licensing agreements [e.g., Anand and Khanna (1996)]. One could add that in these two industries knowledge is not yet easily codified. Thus some industries are characterized by strong technological interdependencies and others by common knowledge, in the long run, technological interdependencies favor commonality of knowledge and knowledge codification. However, in the short term, there are industries, especially emerging industries, in which there are strong interdependencies without common knowledge (e.g., biotechnology). Moreover, commonality of knowledge does not generate technological interdependencies (e.g., mechanical construction). It is, therefore, important to discriminate between the two characteristics.

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Thus, the stronger the technological interdependencies, the more “transactional” that licensing agreements will be. Indeed, these complete and simple contracts can be supported by collective devices. Moreover, technological transfers are simplified. Our case studies confirm this strong influence of technological interdependencies on the emergence of collective governance devices that enable agents to implement simpler contracts and, therefore, to decrease transaction costs. It can be pointed out by contrasting the cases of the electronic consumer industry and engineering services. In the electronic consumer industry worldwide standards tend to be implemented in most product sectors [cf. (2)]. Indeed, a television system, for instance, requires compatibility between the broadcasting network and the television set, and the development of digitized high-definition television increases these requirements because interoperability has to be implemented at the service level (e.g., encryption, payment management, programming, interactivity management, etc.). As a result, all the manufacturers are implementing the same technology in their television sets and television peripherals. This means that the owner of a patented technology that became the de facto standard (like VHS for the video recorder) sells licenses to all the manufacturers in the world. Because most big firms own patents that cover a part of the de facto worldwide technological standard, there is a tremendous amount of multilateral licensing. This stimulated the development of a community of licensing executives, of frequent intercompany exchanges of information about licensing behaviors, of service companies specialized in the gathering and publication of data about the intensity of use of the various technologies, etc. These induced the development of conventions about what is fair and unfair regarding the use of a licensed technology, about the adequate level of royalty rates, and provided the industry members with the means to enforce agreements. In that industry, a TLA is quite standardized and simple. It does not implement detailed restrictions and does not design a specific governance device. It often refers to the “practices that are considered to be fair by the profession” and implements payment mechanisms based on information that is made public by industry unions or by private marketing companies. In the engineering service industry, on the other hand, most companies do not want to either license or patent their technical knowledge because they consider it to be their major source of competitive advantage, and because they sell not technology but services produced with highly idiosyncratic technologies. As a result, intercompany exchanges of technology and knowledge are quite scarce, and there are no occasions for and no incentives to develop collective means to govern them. In this industry, TLAs are quite complex, in the sense that they describe in detail what the licensee is authorized to do with the technology. The licensor requires many audit rights to check whether the licensee enforces the agreement. These types of agreements are highly specific and create a situation of mutual dependency. There are, therefore, no references at all, for example, to common practices or royalty rate conventions. Although TLAs tend to be frequent and multilateral in the consumer electronics industry, they are exceptional and monolateral in the engineering services industry. Merges (1996) shares common views with us and gives many historical examples of this correlations among the existence of technological interdependencies, the emergence of collective devices that make the governance of technological transactions easier, and the willingness to license. Callon (1997) also documents this in the specific case of technology transfer between universities and firms. In sum, when one speaks of horizontal TLAs, contracts tend to be transactional. Moreover, they are strongly dependent on the nature of the industry. Managerial

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discretion is weak because the institutional framework and the technology characteristics impose both the licensing policy and the main features of TLAs. The more often that knowledge is common and that technology is interdependent, the more often “transactional” contracts are used to manage simple rights of use transfers (rather than technology and knowledge transfers).22 Because “transactional” contracts are less costly than “relational” ones, there is a strong propensity to license in those industries where knowledge is common and technological interdependencies are strong. Vertical Relations and Relational Specificities When it is a question of vertical licensing, the industry characteristics impact less on contractual agreements than on specific relational situations. Compared to horizontal TLAs, vertical TLAs are more intensively dedicated to the actual transfer of knowledge. Moreover, they are often set in the framework of cooperative R&D processes. As a result, licensing agreements are not set up to share a market but rather to cooperate, in the sense of Richardson (1972). In this context, the two parties have little likelihood of belonging to the same industries and sharing common knowledge. Nor do they benefit from collective coordination resources. As a result, they have to rely on “relational contracts” to perform their technology and knowledge transfers. Because relational contract governance costs are quite high, economic agents necessarily limit the number of such transfers. These types of arrangements are, therefore, less frequent than transactional horizontal licenses. Moreover, these high governance costs lead economic agents to balance out the “hybrid” governance mode with the hierarchical one (i.e., vertical integration). In some cases, this tradeoff can enable contract designers to simplify the “relational” contract because the threat of takeover can be used as a safeguard. In sum, vertical relations favor the implementation of relational contracts, but specific situations can lead to less relational and more transactional agreements. This is linked both to the type of technological transaction that is performed (the first subsection of the second part of Section IV) and to the existence of alternative modes of governance (the second subsection of the second part of Section IV). Uses Right Transfers Versus Technology and Knowledge Co-development. As pointed out above, vertical agreements generally are oriented more toward technology transfer than horizontal agreements. One can, however, establish means of discrimination among various situations in which the transfer of technology does not play the same role as in the interfirm cooperation process. On the one hand, a codevelopment process is managed through the implementation of TLAs, whereas, on the other hand, technology is just used as a counter-bargaining tool. Former agreements are more relational than later ones. LICENSE AGREEMENTS AND TECHNOLOGICAL COOPERATION. As documented by Jorde and Teece (1990), the management of cooperative processes of (incremental) innova-

22 Because economic entities are almost obliged to license (and to license according to the industry’s conventions), managerial discretion essentially lies in the choice of the partners, especially to manage technological spillover and standardization processes. This explains the importance of the literature on core competencies and complementary alliances in the analysis of technological and standards competition [e.g., Hagedoorn (1990); Teece et al. (1994)].

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tions requires the implementation of complex governance structures that are open to bargaining. If innovation processes were linear, the management of those cooperative situations would be relatively simple because technology and knowledge transfer would be unilateral at each stage of the innovation process. As regards property rights, it would be sufficient at least to organize a cascade transfer among the diverse protagonists in the process. Because many innovation processes are incremental [concerning an increasing number of technologies, according to Jorde and Teece (1990)], the management of IPRs and of cooperation as a whole is much more complex because transfers are made back and forth between the entities involved in the process. Moreover, because IPRs are incomplete, and because knowledge and technology are embodied in many supports, the management and the security of such types of cooperative processes cannot be reduced to simple transactional license contracts. Jorde and Teece (1990) insist on the idea that these processes require the implementation of long-term exclusive agreements. They quote the example of partnerships between automobile makers and providers of automobile components. These are not, however, sufficient because of the incompleteness of IPRs, which will not be able to secure the side or ex-post uses of the shared knowledge and technology. Jorde and Teece insist on the idea that to secure these types of cooperative processes, and, therefore, to incite agents to make risky investments in cooperative development processes, collective tangible resources are built. Moreover, these tangible resources enable partners to consolidate their competitive position vis-a´-vis their competitors by reducing the ability of competitors to imitate the innovation and to bring a similar innovation to the market. As a result, the licensing process by itself tends to be a part of a broader, cooperative long-term agreement in which many types of transfers are performed and many types of links are created between the two entities. In our data there is a positive correlation between the fact that the TLAs tend to be relational and their inclusion in a joint venture process (Table 3, Column I3V3). Moreover, relational contracts tend to be more corelated than the other types of contracts to joint-venture settlement (Table 4, Line I3V3). It should, however, be pointed out that license contracts, strictly speaking, play an important role in reducing the complexity of such cooperative agreements. In fact, what we called in this paper “relational” license agreements enables the implementation of a simpler governance structure than, for instance, JVs or consortia. In some papers such a tradeoff is presented through a moral hazard approach in which the question is to incite parties to the optimal level of R&D effort. Given specific conditions, Katz and Shapiro (1986) or Morasch (1995), for instance, show how cross-licensing is more efficient than JVs. There are, however, other arguments in favor of cross-licensing. For instance, the JV settlement obliges a costly reorganization of R&D and even of industrial and commercial capacities. Cross-licensing avoids this. We even observed cases where a one-way TLA can substitute for quasi-integration.23 Our data confirm this possible partial substitution between quasi-integration and relational contracts. In our data, even if relational TLAs can be associated with the settlement of formal JVs, this is not the case in the majority of the contracts belonging 23 For instance, to accelerate the development of a specific category of therapeutic applications, S, a pharmaceutical company, licensed to B, a leader in the field, the development of specialties. The two companies are the copatentees of B’s innovations and exploit them on their own side. A coordination committee, however, is intended to manage the continuance of the R&D process and to set possible financial compensation (if needed).

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to the relational class (Table 4, Line I3V3). Indeed, as argued here, relational TLAs enable the performance and security of the exchange of many resources without systematically leading parties to implement a more specific governance structure than a relational TLA. That is why there is a positive correlation between the fact that many resources are transferred and the basic features of a relational contract (length of term, mutual safeguards, and renegotiation provisions) but not with the fact that a JV is implemented (Table 3, Columns I5I3 and I5J3). TECHNOLOGY AS A BARGAINING COUNTER. On the other hand, patents are sometimes considered by licensors only as bargaining counters that enable them to access other resources. The desired resources can be other technologies or any other type of resource. Whatever it is, the patent is a simple counterpart in a barter exchange. There are even situations where the patent is only used as a hostage that guarantees another transaction. In these cases, licensing agreements increasingly resemble a simple transactional contract. In the first two cases, the license agreement is essentially aimed at ensuring the transfer of a resource— e.g., technology—against another resource. In the case of bilateral technology transfer, one observes cross-licensing agreements that have to organize the transfer of knowledge, and, therefore, tend to be “relational,” but that can avoid implementing strong safeguards because there is mutual dependence and often there are no royalty payments (because of the barter situation); they, therefore, tend to be “transactional.” Cross-licensing agreements, therefore, are hybrid between these two extremes. This is also the case of the barter of technology against, for example, financial, human, tangible, and commercial resources. In these cases, there is often a free license in exchange for a tangible transfer or access to a market or to industrial capacities. In our sample there is a positive correlation between the fact that the contract tends to be transactional and the implementation of reciprocity through cross-licensing or goods purchasing by the licensor. Table 3 points out that crosslicensing is positively correlated to the absence of payment to the licensor (I6C3 3 I7I1) and is negatively correlated to the implementation of safeguards, renegotiation provision and specific governance structure (Column I6C1). This is the same when bartering relies on goods and not on technology (Columns I6P1 and I6P3). This therefore confirms the ability of bartering to avoid the implementation of complex and costly governance structures. But the patent can even be used in a more generic way. In that case, patents are used as simple title deeds that are exchanged by the parties to make their commitment credible. A patentee then gives a free license to a partner to signal his cooperative behavior. For instance, in the framework of an alliance, one can give one’s partner a free license to a technology, although he will not directly use the technology. It potentially enables him to use the technology for free or to perform competing developments. The license is therefore a credible licensor’s commitment [Williamson (1985)] because it gives the licensee a means of retaliation. Through this type of licensing agreement, the licensor expresses his trust in his partner. As pointed out in Brousseau (1996), this type of signal is often necessary to implement trust and mutual confidence in bilateral relationships. Indeed, to overcome some aspects of contractual incompleteness, rational trust based on the idea that the two parties share common goals and have common interests is essential [Meńard (1994)]. In practice, one can observe this type of strategy both in bilateral alliances (in which case only one or a small

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number of patents are generally licensed) and in multilateral alliances (in which case licenses cover packages of patents related to a wide technical domain). Whatever the case, such types of licenses do not really organize technology transfer, moreover they are free. As a result, they tend to be transactional TLAs. Integration as a Credible Threat. Because licensing agreements are complex and costly and do not have a high level of profitability, licensing strategies essentially result from the fact that in some cases an inventor is not able to exploit an invention alone or to bring it to the market due to a shortage of, for instance, financial, R&D, industrial, or marketing capabilities. This situation will lead the inventor to license his technology to a partner who will exploit it generally in a specific niche or geographical market. In this case, the logic of “relational” contracts prevails. However, in some specific situations, the implemented contracts can be less relational because the governance structure can be simplified. This is essentially due to the ability of one party to take over the other, which gives it considerable means of retaliation, or, to the contrary, make contractual safeguards ineffective. Two main cases arise: small versus large company relationships; and international license agreements. LARGE AND SMALL FIRMS. A large firm can generally take over a small firm (even if it is depending on the small firm’s equity distribution). Large firms can, therefore, acquire a technology either by license agreements or by taking over the small firm. In that context, the former have several advantages. First, TLAs are a good way to test the technology before a possible integration of the small and medium business (SMB). Second, TLAs enable the licensee to maintain the autonomy of the innovator and thus its potential inventiveness. Third, the threat of possible integration weakens the patentee’s bargaining position. The agreement then becomes “transactional” because the small business is unable to implement safeguards. Moreover, it is often poorly remunerated, because standardized rates of royalties can be imposed by the large firm.24 Licensing agreements are, therefore, likely to be favored by the large firm because they are potentially less costly and at least as efficient as integration. The contract features essentially depend on the strength of the bargaining power asymmetry between the two parties. This asymmetry first increases with the equity dissipation of the SMB. Second, it also depends on the IPR system. In French law, for instance, the damages for patent infringements are based solely on the exploitation losses supported by the patentee. This makes the cost of counterfeiting a small firm by a large one very low. This is not the case in the United States. Third, bargaining asymmetries depend strongly on the inventiveness of small firms. Indeed, if the small firm has a strong ability to innovate, the integration threat becomes less credible because large firms can consider that this ability to invent is linked to the independence of the small firm [e.g., Wolff (1996)]. Moreover, if it is very inventive, it can organize competition among several large firms. TLAs among small and large firms are thus generally less “relational” than the average agreements governing actual transfer of knowledge. If the small firm has a strong ability to innovate, cooperative governance mechanisms and profit-sharing schemes are, nevertheless, implemented.

24 In addition, Caves et al. (1983) document that small firms are unable to protect their stock of knowledge against pillaging, because they cannot prevent access to their R&D facilities by engineers of large firms.

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Although our data set does not enable us to document this point, our case studies do. We observed a major player in the consumer electronic industry that tries to evaluate the defense potential of innovative SMBs before proposing them agreements. When those firms have a weak financial structure, when they do not have strong industrial partners, or when their patent portfolio can be contested, this firm chooses to negotiate licensing contracts that do not implement many safeguards for the licensor even if the large firm claims exclusiveness. To the opposite, when the SMB benefits from a strong bargaining position, the same large firm establishes a partnership with the innovative firm to benefit from priority access to its technological developments. We documented such behavior in several other cases. PENETRATING FOREIGN MARKETS. Considerable literature [e.g., Caves (1982); Hennart (1988)] is devoted to the trade-off among diverse alternatives to penetrating foreign markets and performing international technology transfers. Imitation risks can lead the firm to make direct investments. On the other hand, the difficulty and the cost of creating and managing an efficient local subsidiary can lead the firm to license its technology. Ex-ante it has to patent it in the target country, and the nature of IPL is a strong determinant of the possibility to adopt this policy. Caves et al. (1983) list the factors that favor licensing versus direct investment: the small market size as compared to the minimum efficient size of the activity; the absence of required additional assets; the quickness of technological obsolescence; and expropriation risks. Because there are often effective technology and knowledge transfers, these TLAs tend to be relational. However, the contract is in fine strongly dependent on the relational situation. The licensee brings to the partnership its own resources: local industrial facilities; commercial networks; specific brand name reputation; and knowledge of local consumers. The more specific its resources [in the sense of evolutionary theory, see Teece et al. (1994)], the less substitutable it is for the licensor, and the more relational the contract will be (because the relationship tend to be a partnership). There are, however, cases in which the local licensee does not own really specific resources. In these cases the threat of contract breach or integration is credible and the governance structure can be lightened and oriented more to serve the interests of the licensor. Such possibilities also depend obviously on the local law on foreign investments. Generally speaking, North-South technology transfers correspond to this latter situation. Local firms are generally not gifted with many decisive advantages compared to a local subsidiary of a foreign firm (which can hire local employees and buy specific capacities), and the IPL is often weaker than local corporate law. As a result, takeovers and direct investments are very credible threats that enable licensing agreements to be simplified. These factors that favor less “relational” contracts have to be balanced against the fact that the weaknesses of IPRs and the effectiveness of knowledge transfers call for “relational” agreements [cf. Arora (1985) and the first subsection of the first part of Section III). In sum, TLAs can sometimes be substituted by other governance modes, especially a hierarchy. This enables the potential integrator to implement less relational TLAs than they should. The threat of integration is, however, greatly dependent on the core competencies of the potentially integrated firm and of the institutional environment. To sum up, license agreements tend to be “transactional” or “relational” according to whether they manage, respectively, a horizontal or vertical transfer. However:

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FIG. 1. Causes of TLA differentiation.

Y

Y

To really observe “transactional” contracts in the case of a “horizontal” license, the industry has to be characterized by a great deal of common knowledge and by strong technological interdependencies. If one of these two conditions does not hold, and a fortiori if the two do not hold, contracts tend to be less “transactional” and more “relational”; that is, less complete and less supported by collective governance. The actual “relationality” of vertical agreements is linked to the fact that they really concern a process of technology codevelopment, and to the fact that there are no alternative means of governance. In simple technology transfers, or when one party can integrate the other, the governance structure can be simplified and contracts are less relational.

Figure 1 tries to summarize these elements. It shows the causes of TLA distribution along the continuum between purely transactional and purely relational contracts. This figure has to be understood, however, as a heuristic representation of our previous reasoning. It is not a schematization of a predictive structural model. V. Conclusion In this article we have tried to point out how the new-institutional framework can be used to clarify the complexity and diversity of TLAs. In our view, there are two polar types of such contracts that can be related to MacNeil’s categorization of “transactional” and “relational” contracts [MacNeil [1974)]. Relational contracts are often linked to strategies that consist of maintaining the exclusiveness of knowledge and technology within a small circle of partners controlling complementary assets. Ex-post they tend to create strong interdependencies between the

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parties because the licensees have to invest in specific assets or development processes, and the licensor irremediably transfers a part of his cognitive patrimony. These interdependencies require the implementation of ex-post negotiation mechanisms and contractual safeguards. On the other hand, “transactional” contracts are primarily devoted to spreading the technology over the maximum number of users. In such situations, there are no real knowledge transfers and specific investments. Moreover, there are multilateral horizontal exchanges that by themselves secure each transfer. As a result, contractual safeguards are useless and specific governance structures are not required. The continuum from relational contracts to transactional ones is linked to two correlated phenomena: Y

Y

An increasing collectivization of governance. This collective governance obviously relies on public institutions (especially on the IPR system and antitrust regulation), but also on private institutions and informal conventions. A decrease in technology transfer costs. According to North (1990), the institutional governance of transaction governance enables firms to benefit from economies of scale and scope as well as from learning effects. As a result, transactional licenses are more frequent than relational ones.

These enable us to go back over the public policy problems mentioned in our introduction (cf. Section I). Compared to other research work, we insisted on the essential role of private and informal institutions and on the contrast between very different types of TLAs. Y

Y

Y

As concerns scientific and technological policies, it must also be pointed out that the intermediary governance structures play a fundamental role in the generation of incentives to innovate and diffuse knowledge and technology. As a result, public institutions and the law are not the only tools to manage and stimulate technological and economic dynamics. Concerning IPRs, our contribution prolongs those of Contractor (1981) and Caves et al. (1983), which insist on bad capture through licensing of innovation rents. This is mainly due to the weakness of IPRs. However, as pointed out here and in Bessy and Brousseau (1997a, 1997b), public policies cannot be reduced to changing the wording of the law. The strengthening of IPRs is also a question of the organization of the judicial system. Indeed, when complex knowledge and technology cases are managed, more specialized courts and judges can better protect property rights. But, as pointed out in this paper, strong IPRs also depend on the existence of private institutions and informal rules. Public authorities can support these institutions and favor their emergence. Concerning antitrust and (pro)-competition policies, our contribution points out that the efficient transfer of knowledge requires contractual arrangements that have anticompetitive properties (exclusivity clauses, long-term commitments, bundling, etc.). This does not mean that these arrangements should automatically be authorized. When there are private institutions to support the governance of technology transfer, contracts that are too “relational” should not be permitted. When these private institutions do not exist, they should be temporarily permitted according to the gestation period of the technology [Krafft (1996)]. Moreover, antitrust authorities should authorize the development of those private arrangements and institutions that enable a technology market to emerge.

486


From a theoretical point of view, the cases we studied pointed out two interesting phenomena used by economic agents to decrease transaction costs when transactions would be expected to be costly because they are uncertain and complex, and because property rights are incompletely defined. Y

Y

First, agents have recourse to informal and private collective means of governance like conventions (informal rules) and private institutions (private supervisor, arbitrators, or standardization committees, among others). The important point, here, is that these institutions do not only partially take charge of the enforcement of contracts [cf. Meńard (1997)], but they also simplify their design by setting up common rules that avoid negotiations and provide agents with predesigned solutions to their coordination problems [cf. Brousseau (forthcoming)]. Second, the securing of such transactions is preferentially performed through solutions that create mutual interdependencies (bundling, barter, and mutual safeguards, for example) that, ultimately, strongly decrease the incentives to cheat because both parties share some common interest.

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