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The Impact of Patent Wars on Firm Strategy: Evidence from the Global Smartphone Industry

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The Impact of Patent Wars on Firm Strategy: Evidence from the Global Smartphone Industry Organization Science Articles in Advance, pp. 1–20 ISSN 1047-7039 (print) ISSN 1526-5455 (online) https://doi.org/10.1287/orsc.2016.1092 © 2016 INFORMS The Impact of Patent Wars on Firm Strategy: Evidence from the Global Smartphone Industry Yongwook Paik Olin Business School, Washington University in St. Louis, St. Louis, Missouri 63130, [email protected] Feng Zhu Harvard Business School, Harvard University, Boston, Massachusetts 02163, [email protected] trategy scholars have documented in various empirical settings that firms seek and leverage stronger institutions to Smitigate hazards and gain competitive advantage. In this paper, we argue that such “institution-seeking” behavior may not be confined to the pursuit of strong institutions: firms may also seek weak institutions to mitigate hazards. Using panel data from the global smartphone industry and recent patent wars among key industry rivals, we examine how smartphone vendors that are not directly involved in patent litigation strategically respond to increased litigation risks in this industry. We find that as patent wars intensify, smartphone vendors not involved in any litigation focus more of their business in markets with weaker intellectual property (IP) protection because of institutional arbitrage opportunities. This strategic response is more pronounced for vendors whose stocks of patents are small and whose home markets have weak-IP systems. Our study is the first to examine the relationship between heterogeneity in national patent systems and firms’ global strategies. It provides a more balanced view of firms’ institution-seeking behavior by documenting how they make strategic use of weaker institutions. Keywords: patent wars; patent litigation; intellectual property (IP) enforcement; patent thicket; smartphone; platform-based markets; platform competition History: Published online in Articles in Advance November 21, 2016. Introduction that are not themselves directly involved in patent liti- Strategy scholars have documented in various empirical gation. In that regard, our conceptual approach is simi- settings that firms seek stronger institutions1 to mitigate lar to that of McGahan and Silverman (2006) and Oxley hazards and gain competitive advantage. Among these et al. (2009), using industry rivals’ patent litigation activ- settings are the location choices of foreign production ities as events that are exogenous to a focal nonlitigated facilities by semiconductor firms (Henisz and Macher firm. We argue that, because of uncertainty, when com- 2004), cross-border investment patterns of U.S. venture mercializing products that involve a thicket of patents 2 capital firms (Guler and Guillén 2010), and equity listings (Shapiro 2001), firms that are not directly involved in 3 on the U.S. stock exchange by Mexican firms, which sub- litigation could be affected by escalating patent wars sequently confer reputational advantages (Siegel 2005). among various patent holders and infringers. Firms may Studies have also shown that multinational corporations perceive that an increase in patent litigation risk could deter them from expanding their businesses in countries try to mitigate the hazards of weak institutions by sourc- with a strong institutional environment (i.e., countries ing innovations that are of greater value internally than with strong intellectual property (IP) protection) in which to potential competitors from R&D units located in coun- patent enforcement strategies are more effective. As a tries with weak institutions (Zhao 2006) or by employing result, in a global competition with heterogeneous insti- foreign supervision for subsidiaries located in countries tutional environments, multinational corporations take with weak institutions (Zhou 2015). In this paper, how- advantage of institutional arbitrage opportunities (Zhao ever, we argue that weak institutions may also help firms 2006) to mitigate the overall hazards they face when mitigate hazards and that firms’ “institution-seeking” patent wars intensify, rebalancing their efforts across dif- behavior may therefore not be confined to the pursuit of ferent countries to carry on more of their business in coun- strong institutions. tries with weak institutions (i.e., countries with weak-IP We demonstrate how firms seek weak institutions to protection). mitigate hazards in the context of the global smartphone Understanding how heterogeneous institutional envi- industry. To that end, we investigate how industry rivals’ ronments in different countries influence firms’ global aggressive patent enforcement activities affect firm strat- strategies is important for our understanding of firm egy across different institutional environments for firms behavior. However, because institutional environments, 1 Paik and Zhu: The Impact of Patent Wars on Firm Strategy 2 Organization Science, Articles in Advance, pp. 1–20, © 2016 INFORMS such as national-IP protection regimes, are often quite et al. 2013). Recent studies have shown that litigants’ stable over time, it is an empirical challenge to study strategic responses may include countersuing, settling, how they affect firm behavior. Our empirical setting offers exiting the market, inventing their way around patented a rare opportunity to overcome this challenge. Using technologies, and strengthening their own patent portfo- panel data from the global smartphone industry and recent lios (e.g., Bessen and Meurer 2006, Hall and Ziedonis patent litigation battles among key industry rivals, we 2001, Lanjouw and Lerner 2000, Lanjouw and Schan- provide empirical evidence on how smartphone vendors kerman 2003, Somaya 2003). These studies have begun not involved in litigation strategically respond to chang- to enhance our understanding of the effects of patent ing hazards that are caused by firms’ aggressive patent enforcement strategies on the strategic behaviors of direct enforcement strategies in strong-IP countries. As patent rivals. wars intensify, we find that smartphone vendors that are Less attention, however, has been paid to how patent not directly involved in patent litigation gradually focus litigation activities affect market participants that are not more of their business in markets with weak-IP protec- themselves directly involved in patent litigation. As these tion and that this strategic response is more pronounced often represent the majority of the firms in an indus- for vendors whose stocks of patents are small and whose try, understanding their strategic responses is important home markets have weak-IP systems. We also find that for understanding the broader competitive dynamics and this strategic response is consistent with shifts in vendors’ market evolution. Moreover, because of the increasing product launch strategies and is mostly driven by market level of global competition for many products today and expansion within markets in which the vendor is already the significant heterogeneity of institutional environments present rather than by market entry or exit. Together, these across different countries, it has become increasingly changes play a role in shaping the competitive landscape important to gain a better understanding of how firms of the global smartphone market. Thus, our findings pro- react to patent enforcement strategies and of their conse- vide a more balanced view of firms’ institution-seeking quences on a global scale (Somaya 2012). behavior and offer a stepping stone for developing a better theory of how firms make strategic use of various institu- The Outbreak of Patent Wars tional settings. Because of the confluence of (a) technological conver- This paper also contributes to the patent enforcement gence across industries and (b) strategic patenting, many strategy literature (e.g., Agarwal et al. 2009; Somaya industries are increasingly experiencing patent thickets— 2003, 2012; Somaya and McDaniel 2012), which focuses dense webs of overlapping patent rights (Shapiro 2001, on how firms leverage their patents for competitive advan- Ziedonis 2004)—which cause hold-up problems (Hall tage. Specifically, we focus on the strategic behaviors 2004; von Graevenitz et al. 2011, 2013). In such indus- of firms that are not involved in any patent litigation, tries, it is nearly impossible to identify all relevant thereby contributing to the recent literature on how poten- patent holders or even to confidently conclude whether tial patent enforcement might affect industry participants’ or not there is any potential infringement. Thus, firms behavior (Agarwal et al. 2009, Clarkson and Toh 2010). in these industries rely on cooperative mechanisms, such Somaya (2012) notes that a firm’s patent enforcement as patent pooling (Bittlingmayer 1988, Joshi and Nerkar strategy is not implemented in a vacuum, but it must take 2011, Merges 1996), cross-licensing (Grindley and Teece local institutional environments into account, especially 1997), standard-setting organizations (SSOs),4 and even the effectiveness of IP systems, which is an important tacit patent litigation “truces” between firms (Von Hippel topic that has yet to be considered in the literature. Our 1988), to obtain access to one another’s patents. study is the first to address this important gap and examine Cooperative mechanisms are not always sustainable, the relationship between the effectiveness of local IP sys- though. For example, some portion of the patent thicket tems and firms’ product market strategies in an interna- may be crucial in establishing an industry-wide technol- tional context. ogy standard or in establishing
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