WHY START-UPS OFTEN CHOOSE TRADE SECRECY OVER PATENTING: New study of patents as negotiating assets

Both patents and trade secrets can be used in transferring a technology from a start-up firm to an established competitor. New research by Andreas Panagopoulos and In-Uck Park finds that start-ups have stronger incentives to innovate when potential buyers don’t have giant portfolios for which acquiring the new patent would not much make difference.

Otherwise, start-ups are more likely to choose to hide their technology and opt for trade secrecy over patenting. This is potentially damaging to the whole economy, hindering both the growth of start-ups and the diffusion of new ideas, which happens more easily through patents than when there is extensive trade secrecy.

The study, published in the November 2018 issue of the Economic Journal, provides new insights into current controversies surrounding patents. The authors note that while managers do not value them much, they employ them a great deal in building gargantuan patent portfolios. Take IBM, for example: it was granted a record 8,088 patents in 2016, more than 22 a day. These patents were added to its 50,000 strong patent portfolio.

IBM is not an outlier. Samsung has more than 65,000 patents; Canon has more than 40,000; while Google, Microsoft and all the known high street firms follow suit with equally sizable patent portfolios.

Such accumulation of patents has been attributed to their use as bargaining chips in licensing negotiations when ownership is contested. Each patent is viewed as an additional ‘foot soldier’ that aids the firm in its legal jousting with competitors in a war where victory often depends on the size of each firm’s ‘patent army’.

Herein lies the problem. Small firms, like start-ups, that lack such portfolios are at a disadvantage. In fact, for start-ups, patents may even be a ‘liability’ as they can invite infringement (ownership) allegations from competitors with a portfolio of patents, in which case the chances of firm survival are bleak.

Such fears could explain why these innovative fledglings frequently just choose to hide their technology and opt for trade secrecy over patenting. Yet the economy is in need of both start-ups and patents. Start-ups create new ideas that propel the economy, while patents help to diffuse such ideas instead of hiding them like trade secrets.

The new study considers a start-up that sells its patent or trade secret to an established competitor. It is understood that both patents and trade secrets can be used in transferring a technology. But unlike patents, trade secrets do not transfer bargaining power because they do not openly describe a technology and cannot be employed by courts in deciding who owns what.

If by selling a patent the start-up sells more than a trade secret would, shouldn’t the patent be traded at a premium compared with the secret? Though the answer is a straightforward yes, there is caveat to this argument.

Consider a start-up that sells its patented technology to a buyer that lacks a patent portfolio. Even though the patent will translate into additional technical competencies, on its own it does not offer the buyer much in terms of bargaining leverage. It’s just a ‘knight’ looking for an army. Therefore, the sale of a patent is nothing more than a transfer of technology, something that trade secrets can do equally well.

If, on the other hand, the buyer has a patent portfolio that is too strong and not in need of an extra ‘sword’, then (again) the sale of a patent simply transfers a technology and nothing more.

Consider now a buyer that has a patent portfolio that is neither minimal nor overreaching, and is still in need of extra leverage. In this setting, when the start-up sells its patent, the additional ‘foot soldier’ enhances the buyer’s portfolio’s ability to settle future conflicts over ownership. Therefore, the start-up is selling more than a technology: it is also selling bargaining power.

In conclusion, patent portfolios that are not overreaching can allow for the concomitant trading of a patented technology and of its accompanying bargaining power, offering start-up firms greater incentives to innovate than trade secrets.

Patents as Negotiating Assets: Patenting vs. Secrecy for Startups’ by Andreas Panagopoulos and In-Uck Park is published in the November 2018 issue of the Economic Journal.