Market Crowding and Appropriability in the Semiconductor Industry

David Tan

Goizueta Business School

Emory University

david_tan@bus.emory.edu

Patent litigation is a particularly costly way of appropriating gains from R&D. When firms can derive transitory market power from other sources, they avoid litigation. Because of this, instances of patent litigation provide a window on some otherwise unobservable competitive conditions in an industry. In my dissertation, I argue that occupying a differentiated market position gives a firm lead time against competitors when it introduces new products or enters new market segments. Essentially, occupying a differentiated position provides a form of structural protection that offsets the need to use patent enforcement to deter entry or earn revenue. As a consequence, increased crowding around a firm's market position should erode appropriability and increase its propensity to litigate patents.

When there is uncertainty about the structure of consumer preferences or feasibility of manufacturing techniques, introducing new products to the market may be the only way to reveal information about underlying demand conditions. This is privately costly for firms introducing new products, and the benefits might be only partly appropriable. The successes and failures of a firm's products reveal information that other firms can learn from to develop their own products. I argue that this sort of vicarious learning is most likely to occur between firms occupying similar market positions. A firm's experience in serving various segments of consumers provides it with an important source of knowledge about the overall structure of demand in an industry. This informs a firm's own product development efforts but also provides it with the capacity to learn from the experiences of others. As a consequence, firms serving similar segments of consumers learn more from one another's actions while firms serving different segments of consumers learn less. In a highly segmented industry, similarity in the sources of firms' market knowledge can be conveniently represented as distances in a multidimensional market space. Differential rates of learning can then be viewed as spillovers of market knowledge localized to firm positions in market space.

When too effective, vicarious learning by competitors shortens the lead time that a firm has before imitative or improved products appear on the market. If the effectiveness of vicarious learning increases with market proximity then increased crowding around a firm's market position should reduce appropriability. To test my main prediction, I rely on the argument that firms choose among alternative appropriability strategies given their varying costs and effectiveness. Structural protection from competitors due to lead time provides an attractive alternative to costly patent enforcement. When this structural protection is weak, firms shift their mix of appropriation strategies towards more aggressive patent enforcement. I propose to test this prediction using data on patent infringement suits filed by semiconductor firms from 1977 through 2001. I combine this with data on firms' product offerings across segments of integrated circuit devices in order to compute measures of market crowding.