Intellectual Property Strategy for Network Effects
Disclaimer: I am not an IP lawyer. Please consult a lawyer for legal advice. Below is a general strategy based on my understanding of IP strategy and network effects.
Amazon, Google, Facebook, Apple. These are some of the most powerful and impactful companies in the world. While each of them has a different company vision and mission, all of their products benefit from network effects. According to a study by NFX, network effects are responsible for 70% of the value created by tech companies since the Internet became widely used. Network effects refers to the increase in value to the user when the number of users using the same product or service increases. Two main types of network effects exist: same-side network effects and cross-side network effects. A same-side network effect is relevant for a social media platform (such as Facebook, Instagram etc.) where users want to be on the platform with the most number of users. An example of cross side network effects in play is a marketplace (such as Amazon) where more buyers increase the value for sellers on the platform and vice versa.
What is Intellectual Property?
Intellectual property refers to products created from human intellect that are protected by law. The most common forms of IP are copyrights, patents, trade secrets and trademarks. Each of them offer a specific type of protection, and their usage depends on multiple factors (see below matrix for additional information).
In this article, I will focus on copyrights and patents given that they are more relevant in the context of a software platform. The main difference between the two being, patents protect the idea, while copyright protects the written code or expression; software patents are a lot harder to get compared to obtaining copyrights.
How does intellectual property help with network effects?
One can either implement a defensive strategy or an offensive strategy while using IP to create or defend network effects.
Defensive Strategy
In a defensive IP strategy, we focus on two main goals: (1) Deter copying of network effects generating assets; (2) Gain freedom to operate network effects generating assets.
We start by identifying assets that generate or defend network effects on our platform. According to Prof. Andrei Hagiu & Julian Wright in “How defensible are Zoom’s network effects?” , to create strong defensibility, network effects must be accompanied by high switching costs or high cost of coordination among its users or both.
High switching costs occur when users spend time, money or effort in features to get the most value out of the product. These features must be identified, listed, and protected. For example, Amazon’s 1-Click patent that was filed in 1997 allowed users to checkout by clicking just one button by using the customers’ payment and shipping information stored on Amazon’s servers. Customers who already took the effort to store their credentials would prefer to use Amazon’s checkout function for products over that of competing platforms. Hence, Amazon’s goal with its 1-Click patent was to deter copying of its feature that created high switching costs for customers. This is exactly what Barnes and Noble, the largest book retailer at the time discovered, when Amazon filed a patent infringement suit against them for their 1-click checkout system.
High cost of coordination. Features that enable coordination among various participants of a platform such as ease of adoption, coordination of supply and demand, product search etc. are critical for generating and maintaining network effects. Thus, these features must be part of any platform’s IP strategy. For example, Uber’s surge pricing patent allows them to temporarily raise prices, which encourages drivers to work more, helping supply meet demand. Airbnb’s location-based ranking patent helps customers list and discover properties more efficiently. Uber and Airbnb’s goals with their IP seems to be based on freedom to operate because they have not sued rival platforms for similar implementations.
Offensive Strategy:
In an offensive strategy, we use our IP portfolio to not only create network effects but also deter a competitor’s network effects through open sourcing and public disclosure measures.
Open-sourcing. Why would any firm open source its proprietary products? Allow me to paint a picture. There are two primary groups competing in a given industry: firms using old and dominant technology (higher proportion) and others using variations of a newer technology. Thus, the prices and profits of the innovator will be determined by the market share of the incumbent, not by the rivals with whom it is sharing a much smaller market. So by opening up specific patents and sharing just enough knowledge, the innovator can reduce barriers to entry to create a rapidly-evolving technology platform that spurs adoption and innovation. Widespread use of its patents could make the innovator a de facto standard setting organization with considerable industry power. The innovator benefits from the strong network effects it initiated by growing the overall market for new entrants and with it, its own market share.
For instance, in 2007, Google realized that if a firm gained control over the mobile market, it could lock out Google search; and if Google Search was not available on mobile phones, people would eventually stop using Google Search on desktops. Thus, by open sourcing Android, Google not only protected its search engine but also created powerful network effects for its App market (Playstore). Android became the industry standard for OEMs, leading to more usage of the platform and generated demand for developers to create apps for the Playstore. Android currently owns 72% of the smartphone OS market.
More recently, Google is using a similar strategy with TensorFlow. TensorFlow, Google’s machine learning framework, was open sourced at the end of 2015 as a standardized way to build deep learning models and became the industry standard, adopted widely by developers and ML engineers. While developers can run their own TensorFlow models, Google has a cloud service for the same purpose, reducing setup and maintenance hassles. Furthermore, it has proprietary hardware called TPUs that are optimized to deliver better per watt performance. Thus, open sourcing Tensorflow allows Google to position Google Cloud as the best place to run machine learning workloads.
Public Disclosure or Defensive publishing is an IP strategy that preemptively deters competitors from obtaining a patent. It involves providing comprehensive descriptions of a product, device or method so that it enters the public domain and becomes prior art (non-patentable material). Therefore, public disclosure of otherwise patentable information can prevent competitors from staking a claim in cutting-edge technology by destroying the novelty of the invention, making it the most offensive strategy in the spectrum.
Defensive publishing is especially useful for players in extremely competitive areas such as Deep tech, where even the slightest advances can lead to significant losses in competitive advantages. IBM and Google, for example, frequently use their blogs (IBM Technical Disclosure Bulletin & Google AI Blog) to publish their state of the art research, thereby raising the bar for their competitors’ patent applications. Furthermore, the cost of using defensive publications is lower compared to costs associated with other IP strategies, such as securing patent rights. Therefore, if the cost of obtaining a patent and enforcing it is higher than the potential economic benefit of your network effects generating assets, public disclosure may be the best option.
Conclusion
In conclusion, intellectual property can provide platforms with a unique opportunity to create or defend their network effects. Firms can create a combination of offensive and defensive strategies for managing their IP in order to optimize their network effects.
