Abstract:
This chapter explores how weakened intellectual property (IP) protections distort innovation markets by limiting monetization strategies and undermining smaller innovators. Relaxed IP laws favor large firms that leverage economies of scale, disadvantaging startups and research institutions reliant on licensing-based models. Diverse monetization strategies (direct, indirect, and giveaway) are crucial for fostering innovation, but weak IP regimes narrow these options. Historical evidence shows strong IP protections promote investment in high-cost sectors like biotech and semiconductors, driving disruptive advancements. In contrast, weak IP rights push firms toward vertical integration, reducing competition and diversity. Notable case studies, such as Qualcomm and Arm, illustrate the risks of weakening IP protection. Ultimately, robust IP rights ensure markets can freely allocate innovation capital, creating a more dynamic and competitive innovation ecosystem.
Chapters in the Book:
- Part4- The Hidden Costs of Free Stuff
- Chapter 12- How free Stuff Distorts Innovation and Competition (p.249-278)
Summary
12. How free Stuff Distorts Innovation and Competition
In the early years of the internet, many users supported weak copyright enforcement, believing it aligned with the public interest. The federal judiciary has broadly supported the fair use exemption and the Digital Millenium Copyright Act (DMCA) safe harbour.[1] Central to this development was the idea that expanded access to informational goods benefits the public. This intellectual climate has promoted a relaxation of IP protections, with advocacy for weak patent and copyright laws. However, as will be shown, this climate ignores the divergence between private interests and public benefits. In short, the weak IP trajectory in patent, copyright, and antitrust law in recent years risks the incentives and funding that support innovation. In particular, the erosion of IP protections has favoured intermediaries and implementers, while disadvantaging research institutions and startups in upstream markets. In other words, weak IP environments limit the range of strategies for monetizing knowledge assets and therefore excludes many firms from the market. A “free stuff” approach to IP rights is ultimately harmful in the long run and undermines innovation.
While this might seem counterintuitive at first, weakened IP protections offer only immediate benefits like free access. Strong protections, on the other hand, provide long-term benefits like diverse and higher-quality innovations.
A point often mentioned is that reducing IP protections in the last years has not harmed innovation. It is often cited that national R&D intensity in the U.S. has increased from 2.54% in 2006 to 3.4% in 2021. Following this logic, digital platforms show innovation can thrive without formal IP systems. However, this consensus is mistaken. Between the late 1990s and the mid- 2000s, weakened IP protections forced firms to adapt, with some failing. Firms that embed an innovation within a larger suite of products (like search engines) can capture innovation returns indirectly, even without strong IP protections. On the other hand, stand-alone innovators (like chip developers) face higher risks in weak IP environments, especially where high development costs exist in tandem with low imitation costs. In these cases, the innovator is exposed to expropriation by any firm that can replicate the exposed asset and distribute it at a reduced price. These larger incumbents often outcompete smaller innovators by leveraging economies of scale. In other words, weak IP protection creates barriers for smaller innovators who lack the infrastructure to commercialize at scale. This leads to innovators being pressured to vertically integrate, bundle products, or merge with larger firms. The result of that is reduced competition and innovation diversity.
12.1. Diverse Strategies for Monetizing Innovation
Weak IP protections can undermine transactional diversity and innovation in content and technology markets. In contrast, robust IP enforcement enables diverse monetization strategies for generating returns from innovation. Without strong protection, the range of viable strategies shrinks, negatively impacting innovation and competition. Broadly speaking, there are three types of mechanisms through which individuals or firms can earn positive returns from informational assets. They will be discussed in the following.
12.1.1. Direct Monetization
In direct monetization, a firm directly extracts revenues by selling the right to use the asset, whether by outright sale or a license. In content markets, Disney exemplifies this by selling movie tickets, DVDs, or streaming access via Disney+. In wireless technology, Arm licenses its chip architecture to semiconductor firms. A more familiar example is Microsoft Windows, which is delivered on a stand-alone basis, in exchange for a subscription fee. This strategy is common in software and content industries, seen in services like Netflix for video and Spotify for music.
12.1.2. Indirect Monetization
A firm can indirectly extract revenue by embedding technology in complex products that are hard to replicate. For example, automotive manufacturers integrate innovations into multi-component systems requiring significant funding and expertise. Consequently, the automotive industry has relied less on patents and more on cross-licensing among major competitors. Similarly, mobile operating systems create integrated ecosystems, making replication difficult for all but the most advanced firms. For example, Apple embeds Siri in iPhones without separate user fees. Likewise, Google integrates Maps and Waze into Android, offering them free to users despite high development costs.
12.1.3. Giveaway Monetization
In a giveaway strategy, firms offer technology at zero or below-market prices to boost sales of complementary goods that are harder to imitate. The two-sided giveaway model comprising a “free” IP asset and a complementary “pay” asset can be illustrated by the Bluetooth wireless communications technology. Here, the patent owners pooled patents to offer Bluetooth technology royalty-free, driving device adoption.
An example in the content industry is academic research. Research is shared freely on platforms like SSRN or in journals, which are supported by university revenues. In this case, these giveaway practices are viable because content producers (like academics) benefit indirectly through complementary goods or services sold at a positive price. In this case, the complement would be teaching services, that are sold at a positive price to students.
Firms can engineer a potentially infinite variety of business models using these building-block strategies of direct, indirect, and giveaway monetization strategies. It would be expected that competitive markets naturally push firms to find the most efficient monetization mix through trial-and-error. The radio market illustrates this mix of diverse models. Some firms operate on a traditional ad-based terrestrial model; other firms operate on a satellite-based subscription model. A third group of firms offer streaming and other internet radio services, which in turn comprise ad-supported and subscription-based models.
12.2. The Adverse Effects of Weak IP Rights
Policy changes that weaken IP protections interfere with monetization strategies, making it harder for innovators to deliver creative or technological assets directly to users. This has two adverse consequences for both innovation and competition policy. First, the weakening of IP rights compels firms to adopt indirect or giveaway strategies, disadvantaging smaller R&D-focused entities that lack complementary assets for such models. Second, IP weakening favours content aggregators and distributors over originators. This impoverishes the innovation ecosystem over time by shifting value toward vertical integration and away from innovation. The long-term effects of this dynamic may end in lower overall welfare by two channels. First, weak IP protections reduce innovation incentives by deterring market entry. This may “dry up” the innovation pipeline on which implementers rely. Second, a weak IP regime can shrink overall innovation by undermining licensing-based models, which could otherwise promote broader knowledge distribution.
To illustrate the consequences that can result from reducing the strength of IP protections, consider Viacom International, Inc. V. YouTube, Inc. The decision broadened the DMCA safe harbour protection of online intermediaries for infringements on their platforms. This weakened IP environment forces content owners to abandon direct monetization strategies. As a consequence, content owners often accept revenue-sharing from infringing uploads via programs like YouTube’s “Content ID.” The reason for that is that enforcing rights through takedown requests is quite ineffective. Ultimately, the platforms’ low liability leaves content owners with weak negotiating power. In the end, this dynamic transfers wealth from content originators to aggregators, because originators struggle to adapt while aggregators thrive in weak-IP environments.
The critical question is whether limiting direct monetization strategies for content production serves the public interest in fostering a strong innovation ecosystem. Looking at technology markets, we find that limiting IP protections reduces access costs for users but may undermine innovators’ incentives to invest in R&D. In these markets, the policy consensus favouring weaker IP protections assumes that lowering access costs aligns with maintaining robust innovation. However, the real concern is whether this preference for weaker IP protections, which limits monetization strategies, is sustainable and beneficial in the long-term. In the following, this question will be assessed by examining “simple” and “complex” cases in both content and technology markets.
12.2.1. The Simple Case
The “simple case” against substantially weakening IP rights arises whenever direct monetization is the only viable strategy for capturing returns on innovation. Therefore, limiting IP protection prevents innovators from attracting investment capital to fund the innovation process. In biopharmaceuticals, high development costs and low success rates make it economically infeasible to rely on giveaway models without robust IP protections. Since the cost of developing new drugs is high, and generic competitors benefit from low appropriation costs, strong IP protection is essential. Similarly, in content markets, large-budget projects like animated movies rely on IP protections to recover investment, as copying and distribution costs are low in the digital age. This does not mean that weak IP protection will reduce overall content production. However, it could lower the quality of major projects and reduce investment in high-cost endeavours. In short, YouTube would still be full of thousands of entertaining home videos, but major motion pictures would rarely be undertaken. These two examples support the hypothesis that weak-IP environments are economically unviable when development costs are high, and replication costs are low. This is especially true when firms cannot shift to non-IP monetization strategies.This combination drives away investment capital unless a secure property-rights infrastructure is in place. That is precisely what happened in the U.S. biotech industry. Here, a combination of three legal decisions and policy actions in 1980 (Diamond v. Chakrabarty, USPTO patents, Bayh-Dole Act[2]) restored secure IP rights. In the following years, an emerging market in biotech innovations grew due to the secure exclusivity for investors in funding costly development and commercialization processes. This led to significant advancements in the field. For example, these policy actions triggered investment in biotech, resulting in the release of synthetic human insulin in 1983. That development would be followed by the blossoming of the U.S. biotech industry and the release of hundreds of new biotechnological products over the next decades.
12.2.2. The Complex Case
In markets beyond life sciences, the economic case against weakening IP rights is more complex due to viable non-IP-dependent monetization strategies. Google, for example, has earned returns through giveaway and indirect monetization strategies, such as providing free search services funded by targeted ads. Contrary to the standard incentive thesis, substantially reducing IP protections in this market may not result in appreciable reductions in innovation. The reason is that some firms already rely on non-IP-dependent indirect or giveaway monetization strategies. In addition, those that do not and are not able to shift to non-IP-dependent strategies will simply exit the market. However, the argument that robust IP protections are unnecessary in tech industries assumes non-IP monetization strategies are always more efficient. This is wrong. Weak-IP environments may favour integrated firms with complementary assets, creating an entry barrier for smaller, innovation-focused entities. Ultimately, this shift can lead to a less competitive market structure compared to a system with stronger IP protections.
An illustration for these relationships can be found by looking at the U.S. software industry prior to, and after, the extension of IP protection to software. Prior to the 1980s, software lacked IP protection. Software development was mainly bundled with hardware and developed in-house or on a customer-specific basis. In the 1960s, the Copyright Office began accepting software registrations, and IP protection for software was secured by the 1980 copyright amendment. This reduced entry barriers, allowing independent software developers to sell software directly to businesses and home users. Contrary to popular belief, secure IP rights allowed the de-bundling of hardware and software, fostering innovation and competition in the software industry. Counterintuitively, the extension of IP rights helped developers secure returns on R&D by directly selling software, rather than relying on hardware-plus-software bundles or client-specific projects. Therefore, the hardware market benefited, as hardware producers no longer needed to replicate bundled software and could enter the market more easily.
Moreover, IP protection also increased consumer choice, because users could now mix and match hardware and software for diverse purposes. This example illustrates a broader point. A weak-IP environment limits business models, forcing innovators to adopt indirect or giveaway strategies that may restrict access to technology inputs. On the other hand, strong-IP protection allows innovators to select the most efficient monetization strategies, promoting flexibility in the commercialization of innovation. Surprisingly, weaker IP regimes may therefore result in markets dominated by integrated firms that manage innovation and commercialization internally. The licensing-based business model, common in sectors like wireless communications, benefits from secure IP rights and promotes competition through royalty payments to device producers. In a similar fashion, without secure IP rights, licensing arrangements become unviable, and markets may be dominated by a few firms with integrated R&D and production. Hence, a reduction in IP protections can harm both innovation and competition by distorting business models and undermining the effectiveness of licensing and R&D investment.
12.2.2.1. Broadcom/Qualcomm (2017-2018)
Qualcomm is an innovation specialist that focuses on the design and production of chipsets for wireless communications devices. To monetize this investment, Qualcomm relies on a patent-dependent licensing business model. However, this licensing model that became a target of global antitrust regulators. In 2017, the FTC sued Qualcomm, arguing it had a duty to license patents to direct competitors. As Qualcomm’s antitrust litigation did not appear to be headed toward a rapid resolution, Broadcom attempted to acquire Qualcomm for $103 billion. A reason for that suggested merger might have been Qualcomm’s legal vulnerabilities and Apple withholding royalties during the litigation. Analysts speculated Broadcom aimed to shift Qualcomm’s revenue model from licensing patents to focusing on physical chipset sales. If the acquisition had succeeded, Qualcomm’s technology could have been internalized, limiting market access and reducing competition. Ultimately, the Broadcom acquisition was blocked by the U.S. Government on national security grounds. Yet, this case shows that secure patent enforcement supports broader access to technology, unlike a model where technology is locked within integrated firms.
12.2.2.2. Nvidia/Qualcomm (2020)
In 2020, Nvidia, an integrated chip manufacturer, sought to acquire Arm, a UK-based company that licenses chip architecture widely used in the wireless communications market. Regulators were concerned that Nvidia, as an integrated chip manufacturer, might abandon Arm’s licensing model, which could harm competition. Resistance from the EU and the U.S. authorities led to the withdrawal of the Nvidia/Arm transaction in 2022.
Similar to the Broadcom/Qualcomm deal, the Nvidia/Arm transaction highlighted vulnerabilities in the licensing-based model of chip companies. Here too, a weak intellectual property regime may lead firms to abandon disaggregated business structures in favour of integrated models. Shifting away from licensing-based innovation may, once again, reduce market competition because firms monetize internally rather than through licensing. In the end, the lack of reliable IP enforcement pushes companies like Qualcomm and Arm to adopt internal innovation monetization models. Collectively, this results in less innovation and competition compared to markets with stronger property-rights protections.
12.3. The Case for Business-Model Agnosticism
Firms can adopt various monetization strategies, whether relying on IP rights or not, without affecting innovation and competition policy. As long as markets remain free from collusion or anticompetitive tactics, efficient strategies will be rewarded while less effective ones will fail. Comparing different strategies in IT markets helps illustrate this point. Notably, operating systems in PCs, mobile devices, and servers showcase diverse approaches. These strategies are discussed separately below.
12.3.1. PC Operating System Market
In the 1980s, Microsoft and Apple took different approaches to monetizing their operating systems. Microsoft licensed Windows to any computer producer, while Apple kept its Mac operating System (OS) exclusive to its hardware. Apple used an indirect strategy, embedding its OS in its devices. Microsoft adopted a partial giveaway strategy in which APIs were free to developers but charged original equipment manufacturers (OEMs) for Windows. Microsoft’s more open approach helped Windows become the PC market standard. In contrast, Apple’s closed strategy limited its reach and hurt its market position.
12.3.2. Mobile Operating System Market
A similar dynamic occurred in the mobile OS market in the late 2000s. Google’s open-source Android OS, was released for free with conditions. It quickly displaced closed-source OSs from the likes of Nokia and Blackberry. However, this does not mean only giveaway strategies succeed in mobile OS markets. Apple’s indirect strategy, embedding iOS in its hardware without licensing, secured significant market share. As a result, both Google’s partial giveaway and Apple’s indirect strategies now support competing business models.
12.3.3. Server Operating System Market
In other circumstances, markets have rewarded entities that have modified what the market judged to be an excessively generous giveaway strategy. Initially, Linux struggled with adoption but gained traction after for-profit entities invested in its ecosystem. For example, Red Hat distributed free Linux copies, charging for manuals and support, creating a hybrid monetization strategy. This strategy promoted Linux adoption while boosting sales of its complementary services. In a similar fashion, IBM invested over $1 billion in Linux, embedding it into its hardware as an indirect monetization strategy. Yet, Microsoft Windows remained dominant, illustrating the coexistence of giveaway, indirect, and direct monetization strategies in the server market. This shows that competitive forces refine business models similarly to how markets refine pricing strategies. Consequently, policymakers should avoid interfering with the market-driven process of discovering optimal innovation monetization strategies.
A legal regime that does not provide secure IP protections violates this principle. Both tangible and intangible goods markets rely on secure property rights enforcement to support diverse monetization strategies. Since weak-IP regimes discourage direct monetization of IP assets it pushes firms toward indirect strategies like bundling or cross-subsidization. This in turn increases entry costs for outside companies and disadvantages innovation specialists who create valuable knowledge assets. Specifically, in content markets, only intermediaries benefit from weak-IP regimes by reducing input costs through IP asset commoditization. This commoditization shifts value extraction towards non-IP-dependent segments where intermediaries have competitive advantages.
For example, YouTube thrives under weak copyright by eliminating content costs and competing in online advertising, its area of expertise. In the smartphone market, Apple benefits from weak patent protection by lowering royalty payments and focusing value extraction on distribution and marketing. In both cases, the ones who suffer are the innovators because economic surplus shifts to downstream firms that do not invest in innovation. This shows that weak-IP policies undermine sustainable innovation by preventing innovators from earning fair returns in a secure property-rights environment.
12.4. How weak IP Distorts Innovation Markets
Popular belief assumes weaker IP rights favour public access by reducing monopoly rents. This is a short-sighted policy that is unlikely to result in a net public gain. The private interests of aggregators mainly focus on weakening IP rights as cost lowering mechanisms. However, this position misaligns with public interest in sustaining innovation. In life sciences and high-cost content industries, weak IP rights deter innovation by limiting firms’ abilities to recover development costs. In information technologies, weak IP regimes divert capital from innovation-focused entities lacking complementary assets for indirect monetization. This distortionary effect is likely to especially impact start-ups. Typically, these entities rely on IP rights to monetize innovation through partnerships along the commercialization pathway. As mentioned, weak IP policies favour larger integrated firms, leading to incremental improvements rather than disruptive breakthroughs. This shift skews the knowledge ecosystem, leading to suboptimal innovation and competition outcomes.
12.4.1. Evidence: Distortions Based on Entity Type
U.S. technology history shows a relationship between IP strength, organizational form, and market structure over six decades. Broadly speaking, there have been three patent regimes: weak enforcement (1950s–1970s), strong enforcement (1980s–mid-2000s), and renewed obstacles to enforcement (mid-2000s–present). Data shows that private-sector R&D spending has always been concentrated in large firms, but small firms’ market shares varied depending patent enforcement strength. During weak-patent periods (1950s–1970s), small firms accounted for only 5%-7% of private R&D expenditures. However, in the strong-patent period (1980s–mid-2000s) small-firm R&D reached about 25% of private expenditures by 2011. Since the early 2010s, small firms’ R&D share has started to decline again to 18%-19%.
Throughout this period, small firms’ R&D spending seems to fluctuate with changes in patent protection strength. Interestingly, the judicial decisions and legislative changes like the 2006 eBay v. MercExchange ruling and the 2011 America Invents Act[3] have created an impact. This is consistent with a recent empirical study finding that following the eBay decision, U.S. firms were less likely to engage in technology licensing. This suggests that weakening patent protections led smaller firms to cut R&D due to lower expected returns, while large firms maintained innovation using non-IP strategies. It would also explain that when patent protection is restored to stronger levels (1980s–mid-2000s) the market can freely allocate innovation capital. This happens without the transactional distortions induced by a weak-IP regime. Contrary to standard expectations, these trends suggest that strengthening patent protection, lowered entry barriers and reduced market concentration.
12.4.2. Evidence: Distortions Based on Innovation Types
Whenever patent protections are weakened, innovation capital is shifted toward large firms that can monetize innovation without relying on patents. The same effect should be expected concerning the allocation of innovation capital across different types of innovation projects. In other words, reduced patent protections divert investment from patent-dependent fields to sectors better suited for non-patent monetization strategies.
A study by Schultz shows funding in patent-intensive sectors dropped from 50.5% in 2004 to 25.1% in 2015.
Specifically, biopharmaceutical and medical-device industries lost funding share, falling from 19% and 10% in 2004 to 15% and 6% in 2017, respectively. Semiconductor investment also declined, raising concerns over economic efficiency and national security due to the sector’s strategic importance. These investment shifts align with weaker patent protections following key legal changes like the eBay decision (2006) and the America Invents Act (2011). This suggests a shift of innovation from IP industries to non-IP industries.
12.4.3. Implications: Why Distorting Innovation Markets Matters
It may be contested that, even if weak-patent protection drives innovation away from firms, the resulting gap can be filled by large firms or publicly funded research entities. However, this does not work in reality. Large firms and public funding alone would likely underperform compared to a system with robust IP protections that supports diverse innovators. Furthermore, public funding excels at basic research but struggles to convert it into market-ready products. Without legal exclusivity, private investors simply have no incentive to invest into risky, costly development (e.g., pharmaceuticals). Historical experience testifies to this point. After WWII, despite lavish U.S. federal R&D funding, commercialization lagged due to policies barring patents or exclusive licensing on federally funded research. And while post-WWII U.S. public funding drove major advances in fields like aerospace and computing, when federal R&D funding dropped in the late 1960s, R&D performance declined.
Additionally, large firms often avoid disruptive innovations that could lead to their profitable products becoming obsolete, prioritizing stable cash flows over risky breakthroughs. Typically, it is start-ups that are motivated to create disruptive technologies that challenge incumbents. Small firms have historically driven major technological breakthroughs, like the telephone, airplane, FM radio, and synthetic human insulin. Large tech companies, in turn, frequently acquire start-ups to access groundbreaking innovations, once they are discovered. Effectively large companies are outsourcing high-risk R&D. Consequently, small innovators rely on patents to compete with incumbents in production, distribution, and partnerships, ensuring a fair playing field. Thus, weakening patent protections may sustain innovation but could reduce disruptive advancements that propel significant technological progress.
12.5. Closing Thoughts
This chapter has shown that weakened IP protections distort innovation markets by limiting firms’ abilities to create effective business models. These models vary across markets and are adjusted based on economic and technological changes. Therefore, limiting IP protections restricts the freedom to choose from diverse transactional structures. This harms market efficiency in selecting the best mechanisms for monetizing innovation. Consequently, it threatens the viability of certain firms, particularly smaller ones, and innovation projects relying on IP rights. Secure IP rights prevent such distortions by allowing markets to develop optimal structures for innovation and commercialization. Policy actions reducing IP protections restrict these strategies, especially for innovation specialists in knowledge ecosystems.
[1] See Chapter 4 and 5 for further information.
[2] See Chapter 7,8,10 and 12 for further information.
[3] See Chapter 2,8,9,10 and 12 for further information.
