ECONOMIC ANALYSIS OF NETWORK EFFECTS AND INTELLECTUAL PROPERTY Peter S. Menell† ABSTRACT The information revolution has brought demand-side effects to the fore of economic activity, business strategy, and intellectual property jurisprudence and policy. Intellectual property doctrines play a central role in harnessing network effects, promoting innovation to overcome excess inertia, and balancing consumer welfare, competition, and innovation. This Article surveys and integrates the economic, business strategy, and legal literatures relating to network effects and intellectual property. Part I introduces the topic of network effects and provides an overview of the Article. Part II describes the functioning of network markets. Part III examines the interplay of business strategy, contract, standard setting organizations, intellectual property, and competition policy. Part IV presents three principles for tailoring intellectual property regimes and competition policy to network technologies. Part V traces the evolution of intellectual property protection for network features of systems and platforms. Part VI discusses the interplay of intellectual property protection and competition policy. Part VII assesses the extent to which intellectual property protection and competition policy align with the normative design principles. Part VIII identifies promising areas for future research. DOI: https://doi.org/10.15779/Z381V5BD7T © 2019 Peter S. Menell. † Koret Professor of Law and Director, Berkeley Center for Law & Technology, University of California at Berkeley School of Law. Thanks to participants at the 2015 Economics of Intellectual Property Research Handbook Conference, the 2017 Intellectual Property Scholars Conference, and especially Michael Carrier for their comments on this project. I am grateful to Alex Barata, Concord Cheung, Louise Decoppet, Amit Elazari, Andrea Hall, Megan McKnelly, Reid Whitaker, and Samantha Vega for research assistance. 220 BERKELEY TECHNOLOGY LAW JOURNAL [Vol. 34:219 TABLE OF CONTENTS I. INTRODUCTION ............................................................................... 222 II. FUNCTIONING OF NETWORK MARKETS ................................... 225 III. INTERPLAY OF BUSINESS STRATEGY, CONTRACT, STANDARD SETTING, INTELLECTUAL PROPERTY, AND COMPETITION POLICY ......................................................... 230 IV. RAMIFICATIONS FOR INTELLECTUAL PROPERTY AND COMPETITION POLICY ................................................................... 236 A. PARSIMONY PRINCIPLE: NO INTELLECTUAL PROPERTY PROTECTION FOR FUNCTIONAL ATTRIBUTES ABSENT SIGNIFICANT TECHNOLOGICAL ADVANCE ................................................. 238 B. PROPORTIONALITY PRINCIPLE: OVERCOMING EXCESS INERTIA WITHOUT UNDUE PROTECTION ................................................................... 239 C. DETERRENCE PRINCIPLE: DISCOURAGING OVERREACH WITH BALANCED REMEDIES ..................................................................................... 241 V. INTELLECTUAL PROPERTY PROTECTION FOR NETWORK FEATURES ..................................................................... 243 A. TRADE SECRET PROTECTION ......................................................................... 244 B. COPYRIGHT PROTECTION ............................................................................... 245 1. Software Copyright Legislation: The Copyright Act of 1976, the CONTU Report, and the 1980 Amendments ............................................. 246 2. Software Copyright Jurisprudence: The First Wave ........................................ 248 a) Unprotectability of Functional and Network Features ............. 249 b) Permissibility of Reverse Engineering ......................................... 259 3. Software Licensing ........................................................................................ 260 a) The Free Software Movement (General Public License) ......... 261 b) The Open Software Movement (Permissive Licenses) ............. 263 c) Dedication to the Public Domain ................................................ 264 d) Federal Preemption of Contractual Restrictions ....................... 264 4. Interoperability Exception to the DMCA’s Anti-Circumvention Prohibition .................................................................................................... 265 a) GPL 3.0 - DRM Provision ............................................................ 268 5. Software Copyright Jurisprudence: The Oracle v. Google Litigation ................ 268 6. Standards and Codes .................................................................................... 273 C. TRADEMARK PROTECTION, UNFAIR COMPETITION LAW, AND FALSE ADVERTISING PROTECTION .............................................................. 275 D. PATENT PROTECTION ...................................................................................... 279 1. Patentability Requirements ............................................................................281 a) Subject Matter Eligibility ............................................................... 281 b) Nonobviousness ............................................................................. 284 2. Scope ............................................................................................................ 285 2019] ECONOMIC ANALYSIS OF NETWORK EFFECTS 221 3. Licensing ...................................................................................................... 286 a) Standard-Setting and FRAND Commitments ........................... 286 b) Insurance Pools and License on Transfer (LOT) Commitments .................................................................................. 287 c) GPL 3.0 ............................................................................................ 287 4. Remedies ....................................................................................................... 289 a) Injunctive Relief .............................................................................. 289 b) Monetary Relief ............................................................................... 291 5. Design Patents .............................................................................................. 293 VI. INTERPLAY OF INTELLECTUAL PROPERTY PROTECTION AND COMPETITION POLICY IN NETWORK INDUSTRIES .................................................................. 295 A. PRIVATE ENFORCEMENT ................................................................................ 297 1. Misuse Doctrines .......................................................................................... 297 2. The Principle of Exhaustion ......................................................................... 299 3. Ambush of Standard-Setting Processes .......................................................... 300 4. Breach of Contract for Failure to License SEPs on FRAND Terms ............ 302 5. Private Antitrust Liability ............................................................................ 304 a) Refusals to License Patented Technologies and Copyright-Protected Works .......................................................... 304 b) Patent Thickets ................................................................................ 306 c) Improper Leveraging of Market Power ...................................... 307 B. PUBLIC ENFORCEMENT ................................................................................... 308 1. Intellectual Property Licensing Guidelines ...................................................... 309 2. Significant Network Market Enforcement Actions ....................................... 312 VII. ASSESSMENT OF INTELLECTUAL PROPERTY PROTECTION AND COMPETITION POLICY FOR NETWORK TECHNOLOGIES .......................................................... 314 A. INSTITUTIONAL CONSIDERATIONS ............................................................... 314 B. MEASURING PROGRESS BASED ON THE NORMATIVE PRINCIPLES ........ 315 1. Parsimony Principle ...................................................................................... 316 2. Proportionality Principle ................................................................................ 319 3. Deterrence Principle ...................................................................................... 321 VIII. FUTURE RESEARCH DIRECTIONS ............................................. 322 222 BERKELEY TECHNOLOGY LAW JOURNAL [Vol. 34:219 I. INTRODUCTION The economics of intellectual property begins with the classic appropriability problem: In a competitive economy, imitators can enter markets for information goods after inventors and authors have incurred research and development (R&D) costs and sell the innovative or creative product at the cost of reproduction. Without means for appropriating an adequate return on investment in R&D, the market will under-produce technological advances and creative expression.1 The provision of intellectual property protection for technological advances and creative expression affords inventors and authors a mechanism to recoup their investments, although not without imposing the deadweight loss of monopoly exploitation and potentially interfering with cumulative creativity.2 Conventional analysis of intellectual property seeks to optimize the duration and scope of intellectual property rights in order to balance these tradeoffs.3 This framework applies to goods and services for which consumer demand is independent—i.e., where one consumer’s