The Journal of Legal Studies 2000 Lichtman

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Property Rights in Emerging Platform TechnologiesAuthor(s): Douglas LichtmanSource: The Journal of Legal Studies, Vol. 29, No. 2 (Jun., 2000), pp. 615-648Published by: The University of Chicago PressStable URL: http://www.jstor.org/stable/724698

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PROPERTYRIGHTS IN EMERGINGPLATFORMTECHNOLOGIESDOUGLAS LICHTMAN*

ABSTRACTThis article considers anexternalitythataffects abroadrangeof markets,specificallymarkets where one set of firms sells some platform technology such as a computer,video game console, or operating system, while another possibly overlapping set offirms sells peripherals compatible with that platform, for example, computer soft-

ware or video game cartridges. The externality causes certain peripheral sellers tocharge prices that are unprofitably high. That is, these firms could earn greaterprofits if only they could coordinate to charge lower prices. In many markets, suchcoordination is possible; firms can contract, for example, or integrate. In marketsbased on relatively new platform technologies, however, coordination will typicallybe difficult. The article explains why and argues that intellectual property law canand should facilitate price coordination in these "emerging technology" settings.I. INTRODUCTION

EVER since Apple lost to IBM, technology firms have recognized the im-portant role third-party innovation plays in the development of emerging"platform" technologies.' The story is by now well known.2 Apple

* Assistantprofessor,Universityof Chicago Law School. E-mail:[email protected] o Marshallvan Alstynefor numerous onversationsn whichthe natureofthe externalitydescribedhere was firstdiscoveredand to JohnPfaff for excellentresearchassistance.Thanksalso to readersDouglasBaird,ScottBaker,DanFischel,WendyGordon,Deb Healy, MarkJanis,Bill Landes,Gene Lee, Saul Levmore,Anup Malani,KimberlyMoore,CaseyMulligan,RandyPicker,EricPosner,RichardPosner,andIngoVogelsang; oworkshopparticipants t Duke University,the Universityof Chicago, the UniversityofSouthernCalifornia,he 1999 Social Science ResearchCouncilWorkshopn AppliedEco-nomics, and the 1999 Telecommunications olicy ResearchConference;and, finally,to ahelpful anonymousreferee. I regretthat I could not accommodate ll of the suggestionsIreceived,althoughmanyarereflectedhere and others have foundtheirway into a relatedpapercurrently nderway.1 For thepurposesof thispaper, he term"platform" efers o any objecta consumer anpurchase t a nonzeropriceto enhance hevalueof some number f independentlyurchasedgoods,andthe term"peripheral"efers o anypurchased oodwhose value is in thatmannerincreased.Desktopcomputers,VCRs, and operating ystemsare thus "platforms,"whilemodems,videotapedmovies,andapplications oftwareare all "peripherals."2 Thisaccountwas drawn rom PeterNorton,InPraiseof an OpenLotus 1-2-3Aftermar-ket, PC Wk., March3, 1987, at 32; Steve Gibson,The Macintosh'sNubus Delivers on[Journal of Legal Studies, vol. XXIX (June 2000)]@2000byTheUniversity f Chicago.All rightsreserved. 047-2530/2000/2902-0002$01.50

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616 THEJOURNALOFLEGALSTUDIESdesignedits firstdesktop computerswith easy-accesshardwareportsandan accessibleoperatingsystem,the purposebeing to facilitatethird-partydevelopmentof compatiblehardware nd softwareaccessories.But whenIBM entered he home computermarket,Appledecided thatits best strat-egy was to offer a moreintegratedproduct.Thus,the sameyearIBMun-veiled the IBM PC, a machinewith built-inexpansionslots for hardwareandwell-publicizedhardware ndsoftware pecifications,Appleintroducedthe Macintosh,a unit thathad someadvantages ver the IBMPC out of thebox but was markedlyess accessibleto third-partyevelopment.Withinafew years,hundreds f availablehardware ndsoftwareadd-ons includingdozensof applications ndaccessories hatIBMitself had not anticipated)madethe IBMPC the dominanthomecomputingplatform.The IBMapproach-what is todayreferred o as "openarchitecture"-has been a popularone in recentyears.In the market orhandheld omput-ers, for example,both Palm3andHandspring4ave adoptedvariantsof thestrategy,makingavailableat no chargeand to all comersthe interface pec-ifications or theirrespectivecomputingplatforms.5 he motivation n eachof these instances s the same:open-architecturetrategiesallow platformdevelopersto decentralize he innovativeprocess.Firmslike IBM, Palm,and Handspringdo not need to themselves bearthe full responsibilityofboth identifyingthe most compellingapplicationsor theirplatformsandthen eitherdevelopingor contractingwith othersto developthe necessaryperipherals;nstead,underan open-architecturepproach,hey can sharethatresponsibilitywiththird-partynnovators.Theplatformdevelopers arntheirprofitson sales of the platforms; he third-partyntrepreneursarntheirs on sales of associatedhardware,oftware,andserviceperipherals.The open-architecturetrategyhas a problem,however, n thatit createsa market tructureraughtwith externalities.Think,for example,aboutpe-ripheral rices.Early n thedevelopment f anyplatform/peripheralcosys-tem,peripheral evelopersenjoy significantdiscretion o set theirpricesin-Apple's OpenArchitecture romise, InfoWorld,June22, 1987, at 10; OpenArchitecture:Roomfor Doubt,PC Wk., December10, 1985 at 20; andDavidSanger,Will I.B.M. ShiftStrategy?N.Y. Times,March22, 1984,at D-2.

3 Interface pecificationsor Palm's ine of handheld omputers reavailableat no chargefrom the companywebsite,http://www.palm.comlastvisited October1, 1999).4 Interface pecificationsor Handspring's ecentlyunveiledhandheldunit are also avail-able at no chargeandto all comers;see http://www.handspring.comlastvisited October1,1999).5 In this paper, he phrase"interface pecifications" efers o anyinformationirmsneedin order o developperipherals ompatiblewitha givenplatform.That nformationmightbeinformation boutphysicalattributes f the platform-for example, heprecise ayoutof thepins in the platform's erialport-or it mightbe informationmorealongthe lines of a soft-wareprotocol or the exchangeof encoded nstructions.


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618 THEJOURNALOF LEGALSTUDIEStheirpricesfor fear thatany priceconcessionsthey achieve will be offsetby priceincreases romfuture irms.This is in fact the externalitytself atwork: owerpricesfor currentperipheralsead to increaseddemand or theplatform,which,in turn, eads to increaseddemand or futureperipherals;thatincreaseddemand emptsfuturefirms to raise theirprices,and thosehigherpricesunderminehe benefitsof the originalpricereductions.Notethat this same problemalso makes verticalintegrationunworkable.Theplatformownercouldin theorybuyout currentperipheralellers and lowerthepricesof theirperipherals;ut when new peripheralellers would enterthemarket,hose sellers wouldchargecorrespondingly igherprices,elimi-natingor reducing he benefitsof the original ntegration.

Wheredoes this leave us? The aboveargumentsombineto suggestthatin markets based on relatively new platformtechnologies,pure open-architecturetrategiesaredecidedlysecond best. The best way for a plat-formowner o introduce newplatformechnologymight ndeedbe tomakeit profitableor a largenumberof unidentifiedirms o develop compatiblehardware nd softwareaccessories,'butaccomplishinghatgoal by makingpublicly available the platform'stechnical specifications nvites ineffi-ciency. Everytime,consumerswill face pricesthatareunnecessarily igh.Everytime,peripheralellerswill earnprofits hatareunnecessarilyow.Platformowners choose the open-architecture pproach,however,be-cause undercurrent egal rulesthey have no betteralternative. nsteadofgivingawayinterfacenformation,hesefirmsshouldbe usingthat nforma-tion as leverage,sharing t with all interested hird-party evelopers,butonly on the conditionthat the firmsparticipaten some sort of a price-reductionor profit-sharing rogram.But intellectualpropertyaw gets inthe way. Completely nsensitiveto the peculiardynamicsof the platform/peripheralmarket tructure,he modemintellectualproperty egimeunder-minesplatform wners' nfluenceby allowingunauthorizedirms o reverse

engineerthe platformand, in that way, develop compatibleperipheralswithout heplatformowner'spermission.Worse,everytimeplatformown-ers attempt o compensate-say, requiring hatplatformpurchasers greeto use theplatform nly in conjunctionwith authorized eripherals-courtsinterpret ne or another ntellectualpropertydoctrine o as to blockthe ad-

7 Accord, http://www.palm.com/devzone/business.htmllast visited October 1, 1999)("Recognizing third-partyevelopers'] rucialrolein oursuccess,we are committedo sup-porting[their]efforts with information, deas, developmentandmarketing upport. Their]businesssuccesswill also be ours.";"Ourrole is to get devicesintocustomer'shands,builddemand or [our]platform, ndhelpcreatenew uses for theproducthroughechnologyandinnovation.";"[Third-partyevelopers'] oleis to provide hird-partyardware ndsoftwaresolutions,peripherals,ccessoriesorotherproductshatenhance heplatform nd the usabil-ity of the devices.").


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EMERGINGPLATFORMTECHNOLOGIES 619justment,againwithouteven considering he possibilitythatbroaderntel-lectualproperty ightsmightfacilitatea beneficialform of pricecoordina-tion.The argumentn this article, then, is not that intellectualproperty awshouldrecognize n all platformownersabsolutecontroloverwhichfirms,if any, develop peripherals ompatiblewith theirrespectiveplatforms.Noris it thatplatformownersshouldalways enjoyabsolutecontrolwithrespectto emergingplatform echnologies-that is, absolutecontrol over the firstgenerationof some handheldcomputeror the firstrelease of a new op-eratingsystem.Thepoint,instead, s that when courts nterprethe intellec-tualproperty ightsrecognized n platform echnologies, hey shouldcon-sider the possibility that broader readings would facilitate pricecoordination hat, in turn,might lead to lower prices for consumersandhigherprofits orproducers.Forthereasonssketchedabove,thatpossibilityis especially strong n marketsbasedon emergingplatform echnologies-although here are surely exceptionsto that rule and,conversely, settingsinvolvingmoreestablished echnologieswhere this samelogic mighthold.Thisargument asimplicationsora numberof specificpatentandcopy-rightdoctrines;hose are considered ater n the article.As readers amiliarwith the intellectualpropertyiteraturewill recognize,however, t also hasimplications or an importantdebate n intellectualpropertyaw, a debatethatbeganwith a famous articleby EdmundKitch8andconcerns he wis-domof allowing original nventors o coordinate heprocessthroughwhichlaterfirms mproveanddeveloptheir nventions.9Thatdebatehas,up untilnow, focused on only one type of coordination: oordinationdesignedtoreducetheresourceswasted whenrival firmseither nadvertently uplicateone another's esearchor race to be first o completesomeincrementaltep.Thispaper ntroduces o thedebatea secondtypeof coordination:oordina-tion designedto capturedemand-sidenterdependencies. he shift in em-phasis is important ince, as others have pointedout,'"given transactioncosts and uncertainty,downstream oordinationas it is traditionally on-ceived is virtually mpossiblefor an original nventor o bringabout.Afterall, originalinventorshoping to lessen the risk of duplicativefollow-on

8 EdmundKitch,The NatureandFunctionof the PatentSystem,20 J. Law & Econ. 265(1977).9 Fora senseof the debate,see RobertMerges& RichardNelson,On the ComplexEco-nomicsof PatentScope, 90 Colum. L. Rev. 839 (1990); MarkLemley,The EconomicsofImprovementn IntellectualPropertyLaw, 75 Tex. L. Rev. 989 (1997); Donald McFe-tridge & Douglas Smith, Patents,Prospects,and Economic Surplus:A Comment,23 J.Law & Econ. 197 (1980);SuzanneScotchmer,ProtectingEarlyInnovators: houldSecond-GenerationProductsBe Patentable? 7 RandJ. Econ. 322 (1996).10 Thepointwas firstmadeexplicitin Merges& Nelson,supranote9, at 874-75.


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620 THEJOURNALOF LEGALSTUDIESinvestment ace the Herculean ask of negotiatingdetailed contractswitheveryincrementalnnovator,avoidingoverlapby specifyingexactlywhichresearchpath each is authorizedto pursue.The type of coordinationconsideredhere, by contrast,can be significantlyachievedthroughmoremanageablemeans. For example,the original nnovatorcan impose pricecaps keyedto roughperipheral ategoriesor developa profit-sharing lanwhere the percentageeach firm contributes s constantacross all firms.Thus, the argumentpresentedhere supportswhat was Kitch's originalclaim: intellectualpropertyaw should,in certaincases, empoweroriginalinventors o coordinate he behaviorof follow-on inventors.The paperproceedsas follows. SectionII characterizeshe basic exter-nalitythat can cause pricesto be unprofitably igh in platform/peripheralmarkets.This partshows that while the effect can obtain in a varietyofcircumstances,t is particularlyikely in marketsbased on emergingplat-formtechnologies.Thesection also confirms hattheexternality anbe sig-nificant, thus justifying the possible recognitionof additionalpropertyrights.SectionIII plays out the implications or intellectualpropertyaw,consideringn some detail how patent,copyright, rademark,nd tradese-cret law mediatethe relationshipbetweenplatformowners andperipheraldevelopersandhow minoradjustmentso severalspecific patentandcopy-rightdoctrinesmightfacilitatedownstream oordination ndtherebybenefitnot only platformownersbutalso third-partyevelopersand consumersaswell.

II. THE NEED FOR COORDINATIONThis sectionbeginswith a somewhat tylized exampledesigned o intro-duce the basicplatform/peripheralnteraction.The section thenpresentsadiscussionof relatedwork and sets up the more formalmodel thatappearsin the Appendix.The section concludeswith some estimatesas to the sizeof the priceandprofitdistortions ausedby the demandexternality.

A. How Peripheral Prices RelateConsidera single peripheral/platformair-say, a wordprocessorandthe associateddesktopcomputer.To keep thingssimple, et us suppose hatthe computerhas no intrinsicvalue, so consumerspurchaset only if theyalso planto purchase he wordprocessor.Assumethe computers sold ata price,P, and the wordprocessors sold at a price,Pwp.Figure1 is a number ine thatdivides consumersnto threegroupsbasedon how muchthey value the wordprocessor.Group1 is madeup of con-sumerswho value the wordprocessorbelowits retailprice.These consum-ers would not purchase he wordprocessoreven if they alreadyownedthe


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EMERGINGPLATFORMTECHNOLOGIES 621GROUP1 GROUP GROUP3

0PwP PwP+ P

FIGURE.-Consumer valuations or a hypotheticalword processor,represented n anumberine that increases romleft to rightandstartsat zero.

computer ince, to them,the software'spriceexceeds its value.Group2 iscomposedof consumerswho value the wordprocessorabove its cost, butnot enoughto warrantpurchasinghe computer.Unlike the consumers ngroup 1, these consumerswould purchase he word processor f they al-readyowned the computer.Group3 consistsof consumerswho value thewordprocessor o muchthat,for thisreasonalone,theyarewillingto pur-chase both the computerand the wordprocessor.Now introduce secondperipheralo themarket,his time a spreadsheet.To the seller of the word processor, his is an important vent. True,theintroduction f a secondperipheral oes nothing o changethe behaviorofconsumersn the firstand thirdgroups;'"heformerwill refuse to purchasethe word processorregardless,and the latter were readyto buy both thecomputer ndthe wordprocessor ven beforethespreadsheet ecameavail-able. For some consumers n the second group,however,the spreadsheetaloneor in combinationwith the wordprocessorwill be enoughof a reasonto purchasea computer. n otherwords,for some consumersn this group,the spreadsheetwill tip the balance,leadingthem to purchase he spread-sheet,the computer,and the wordprocessor.This is the externality hat motivates he paper.Thinkof a randomcon-sumerdrawn romgroup2. Holdingconstant hepricesof the wordproces-sor and the computer, his consumer'sdecision as to whether o purchasethe word processorturnsentirelyon the price of the spreadsheet. f thespreadsheets cheaprelative o theconsumer'svaluationof thespreadsheet,the consumermightdecide to purchase he computer,he spreadsheet, ndthe wordprocessor.If, by contrast, he spreadsheets sold at a price tooclose to or above the consumer'svaluation,the consumerwill forgo allthreecomponents.This is an externalityn that it is a consequenceof thespreadsheeteller'spricingdecision thathas no directeffect on the spread-

" This is a bit of a simplification.The existence of the spreadsheet ould increasecon-sumerdemand orthe wordprocessorf wordprocessorsandspreadsheetsrecomplements,andcoulddecreasedemand or wordprocessorsf wordprocessors ndspreadsheetsre sub-stitutes.These effects are considered n the next two subsections.


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622 THEJOURNALOF LEGALSTUDIESsheetseller'sprofit; n the absenceof coordination,t is thereforea conse-quencehe will ignorewhenchoosinghis price.

B. WhyProfitsMightRiseThatthere s anexternalityn this markets of courseonlyhalf the story;the externalityhas interestingpropertiesonly if it also turnsout that thefirmscan earngreaterprofitsby accounting or it. Thus,what we reallywant to know is whether,were the spreadsheet eller to lower its price,profits romwordprocessor aleswouldincreaseby more thanprofits romspreadsheetales woulddiminish.To answer his question,we need to de-

velop a moreformalmodel;that is the task of the next subsection.Here,we can use a simpleranalysisto previewthe results.Theperipheral/peripheralxternality risesbecauseconsumersare in es-senceamortizinghecost of a platformacrossseveralpurchasing ecisions.This is why lowerperipheral ricesare so helpful:a lowerperipheral riceallows consumers o retainextrasurplus rom a particularransaction, ndthatsurplusmakes theplatform eemcheaperwhenconsumersareconsid-eringeveryotherpossible purchase.The cheaperplatformmakes consum-ers more willing to buy, and the effect propagatesacrossall peripherals.The fact thatseveralperipherals recompatiblewith the sameplatform sthereforeenoughto set up the possibilityof a profitablepricereduction:lowering price by a small amountwouldhave a negligibleeffect on eachfirm's profitsbut, overall, those small price reductionswould add up towhat consumerswould perceiveto be a substantial eduction n the plat-form'stotal cost.Whether hatpossibilitycan be realized n any given case, however,de-pendson the strengthof two additionalactors.First,whena given periph-eral firm owers its price,some of the otherfirmsare made worse off. Sup-pose, for example,thatMicrosoft were to lower the price of its popularwordprocessor.Makersof competingwordprocessorswouldsurelyexperi-ence a dropin sales;even thoughMicrosoft's owerpricewould increasedemand or most peripherals y making desktopcomputers eem less ex-pensive, it would decrease demand for these substitutegoods. True,theotherfirmscould lower theirpricesas well, butthat still wouldnotchangethe key result: hese firmswould be worse,not better,off by virtueof Mi-crosoft'shypotheticalpricereduction.Second,andworking n the oppositedirection,when a given peripheralfirmlowers its price, some of the other firmsare made betteroff in waysthathavenothing o do with the increase n platform ales. To staywith theaboveexample,for some consumersowninga wordprocessormakes own-ing an electronicspreadsheetmoredesirablesince, together, he programs


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EMERGING LATFORMTECHNOLOGIES 623createbetterdocuments han eitherprogram an alone.Thus,a lowerpricefor wordprocessorswould increase he demand or spreadsheetsboveandbeyond any increase causedby the increasein platformsales. Firms thatsell electronicspreadsheetswould thereforebe even betteroff than ourini-tial analysis suggested.Whether irms overall can lower prices and increaseaggregateprofits,then,dependson the numberof firmsin each of the abovecategories,onthe strengthof eacheffect, andon the numberof firms n neithercategoryandthussubject o just the basicanalysis.Thismakesgeneralobservationssomewhatcomplex.Nevertheless,a few generalstatements an be made.Forexample, n marketswhere consumers endto have strongpreferencesforparticular eripherals, lowerpriceforanyoneperipheralwill typicallynot significantly educedemand or any otherperipheral, ndso there willalmostalwaysbe some opportunityor profitablepricereductions.Exam-ples here mightincludethe market or trendyvideo games or the marketforpopularmusic.By contrast,n marketswhereperipherals re all almostperfectsubstitutes,mutuallybeneficialpricereductionsareunlikely.Low-ering the price of a given brandof ink cartridgeor blankvideotape,forinstance,would probablydecrease overallprofits,since a lower price forone brandwould forcecompetingbrands o either ose sales or lower theirpricesas well.Of particularnteresthere:therewill typicallybe anopportunityor mu-tuallybeneficialpricereductionsn anymarketbasedon an emergingplat-formtechnology.There are two reasons.First,earlyin the developmentofa peripheralmarketonly a small numberof peripherals reavailable.Theseperipherals rein most cases unique,and so loweringthe priceof one willrarelymuch diminishsales of any other.Second,peripheralsn thesemar-kets tend to be uniquefor anotherreason:at these early stagesperipheralfirms areidentifyingentirelynew typesof hardware ndsoftwareadd-ons.The whole purposeof open-architectureevelopment s to set third-partydevelopersfree to identifynew applicationsor a given platform echnol-ogy.12Everytime a third-party eveloperdoes so, that firm will create aperipheral ailored to the new use, and thatperipheralwill be uniqueascomparedo all availableperipherals t least untilthe firm'sfirst-mover d-vantagesdissipate.13

12 That is how Palm Computingexplains its open architectureprogram.See http://www.palm.com/devzone/business.htmllastvisited October1, 1999) ("As we focus on theplatform,we'rerelyingon [our hird-partyevelopers]o reachnew markets, xtendexistingapplicationso the handheld,and work withreal-life users to findentirelynew ways to usethis platform.").13 Sometimes ntellectualproperty ightsfurther nsurethat a givenperipherals unique,as where a firm s granted opyrightor patentprotectionor its peripheral. or a discussion


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624 THEJOURNALOF LEGALSTUDIESC. A Formal Model

The formalmodel thatfollows builds on a foundation irstset outby Au-gustinCournotn 1838.14Cournotnotedthat ndependentmonopolistic ell-ers of complementary oods earnmaximalprofits f each chargesa pricebelow its individually ationalprice.Sellersof complementary oodsface aproblem imilar o the one facedby peripheralellers:by definition,a lowerprice or oneproductncreases ales of allcomplementary roducts; utthosebenefitsareignoredwhencomplementary oods arepriced ndependently.Cournot roved his result or thenarrow ase whereproducts redirect om-plementsandareusefulonlyas directcomplements,15ndhe framedbut wasunable o solve themorecomplicated ase where theproductshave uses inaddition o theiruse aspartof thecomplementaryombination.16Many papershave extended and recastCournot'swork;"of particularrelevance here is a series of recentpapers applyingit to the platform/peripheral etting.18 hesepapersassume hatone orseveralfirmssell someplatformat a supracompetitivericewhile another,nonoverlappinget offirmssell peripherals lso at supracompetitive rices.Theyshow that f theplatform ellers were to integratewith the peripheralellers,priceswoulddecrease andprofitswould rise. The currentpapertakes the next step byshowingthat a similardynamic akes holdeven in marketswhere the rele-vant platform s sold at a competitiveprice.The prior papersfocus on apricedistortion ausedby verticallystackedmonopolies: heplatformmo-nopolistsare upstream,peripheralmonopolistsare downstream,and eachmonopolistchooses its pricewithoutconsidering mplications or firms inof the implications f layered ntellectualproperty ightsof thissort,see Lemley,supranote9; andScotchmer, upranote 9.

14 AugustinCournot,Researches nto the Mathematical rinciples f theTheoryof Wealth1838 (NathanielBacontrans.,OxfordPress 1897).15 Id. at 99-107.16 Id. at 107-108.17 Thesepapersshow how Cournot'soriginal nsightexplainscore featuresof, for exam-ple, the automobileandnewspaperndustries.Foran overviewof the literature,ee DennisCarlton& JeffreyPerloff,Modem IndustrialOrganization23-33 (2d ed. 1999).18 See Steven J. Davis,JackMacCrisken,& Kevin M. Murphy, ntegratingNew Featuresinto the PC OperatingSystem:Benefits,Timing,andEffects on Innovation 7-31 (unpub-lishedmanuscript,n file withauthor,1998);NicholasEconomides,The Incentive or Non-price Discrimination y an InputMonopolist,16 Int'l J. Indus.Org.271 (1998); NicholasEconomides,The Incentive or Vertical ntegrationDiscussionPaperNo. EC-94-05,N.Y.U.,SternSchoolof Business1997);NicholasEconomides,NetworkExternalities,Complemen-tarities,and Invitations o Enter,12 Eur. J. Pol. Econ. 211 (1996); NicholasEconomides,QualityChoiceand VerticalIntegration, 7 Int'l J. Indus.Org.903 (1999); Nicholas Eco-nomides & StevenSalop, Competition ndIntegrationAmongComplements, nd NetworkMarketStructure,0 J. Indus.Econ. 105 (1992);RandallHeeb,Innovation nd Vertical nte-gration n ComplementaryoftwareMarketsunpublished h.D.dissertation,Univ. Chicago1999).


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EMERGING LATFORMTECHNOLOGIES 625the othergroup.This paper,by contrast, ocuses on the Cournotdistortioncausedby independent orizontallyarrayedmonopolists.Whether he plat-form developerhas marketpoweris irrelevant;he externalityhere is anexternalityamongperipherals.Forthepurposesof themodel,let us now formallydefinethe term"plat-form" to meanany objecta consumercan purchaseat a nonzeroprice,oranystateof the worlda consumer anbringabout hroughnontrivial nvest-ment, to enhance the value of some numberof independentlypurchasedgoods; and the term "peripheral" o refer to any purchasedgood whosevalueis in thatmanner ncreased.This is a broaderdefinition hanthatpre-viously adopted,'9 ndthe model thus has relevance o a broaderclass ofproductsand activities.Forexample,since consumersmusttravel o a shop-ping mall before they can make purchasesat the individualstores in themall, traveling o the mall is in some sense a "platform"whose pricecanbe measuredn termsof both time and nconvenience, ndthevarious temssold in the mall are in some sense "peripherals" o that initialplatformexpense.20Inthis paper,however, he primary ocus will remainon physicaltechnologyplatformspurchased hrough inancial nvestmentsandthe pe-ripheralsassociatedwith thoseplatforms.Because of theirrelationshipwith the platform, he priceof anyone pe-ripheralaffects sales of every otherperipheral.As was pointedout in theintuitivediscussion,however,peripherals re often linked in otherways aswell. To be precise:peripherals re "substitutes"f, werethe relevantplat-formavailableat zero cost, a decrease n the priceof one wouldlead to adecrease n demand or the others;andperipherals re "complements" f,were the relevantplatformavailableat zerocost, a decrease n the priceofone would leadto an increase n demand or the others.The model assumesthat each peripherals sold by only one firm,thateach firmsells only one peripheral, nd that firmsthat sell peripheralsdonot also sell the platform.Morecomplicated ases follow the samegeneralpatterns.The model also assumes that peripheral irms are independent,meaning hat each makesits own decision withrespectto price.One couldeasily extend this workto addressdecisionswith respectto otherproductfeatures,for example, productquality or service support.21Using thesedefinitionsandunder these conditions,the following propositionand tworelatedcorollariesareproven n the Appendix.PROPOSITION.n settingswheretwo or morefirms sell peripherals nd

19 Theterms wereoriginallydefined n note 1 supra.20 Similarly,beforea consumer an shopon-line,the consumermustinstallandconfigurean Internet onnectivitypackage.This installationprocessis also a "platform" nvestment,at that an expensiveone for consumerswho are not yet computeriterate.21 Thepaperscited in note 18 supramake this pointwithrespect o theirmodels as well.


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626 THEJOURNALOF LEGALSTUDIESthoseperipherals re neithercomplementsnorsubstitutes, ach firm wouldearngreaterprofit f eachchargeda pricelowerthanits individually atio-nal price.COROLLARY. In settingswhere some fractionof the peripherals recomplements,he proposition ontinues o hold for all firms.COROLLARY. In settingswhere some fractionof the peripherals resubstitutes,he proposition ontinues o hold for firmsthat do not sell sub-stitutes,and thepropositionmay or maynot holdfor firmsthat sell substi-tutes.The comments n thepriorsubsection houldhelpto makeclear the rele-vance and implicationsof these more formal statements.Note that whilethe proposition eferencesonly the benefitsthatpricecoordination onferson peripheral evelopers,coordinationn fact also benefitsconsumersandthe platformowner. Forconsumers, he reward s lowerprices,greateref-ficiencyfromcloser-to-marginal-costricing,and an increase n the rate ofperipheralnnovation.Fortheplatform wner,theprimary ayoffis greaterconsumerdemand,an increase hatcomes about thanks o both the lowerperipheral ricesand the increasedrate of peripheralnnovation.

D. TheSize of theEffectThe work of the previoussubsectionwas to developthe article's coreeconomicclaim:that,undercertainconditions,peripheralirmswill chargepricesthat are unprofitably igh. The Appendixpresentssome additionalinformation bout hiseffect,showing n greaterdetailhowperipheralnter-dependence hifts and distortsdemand or any given peripheral.This sec-tion uses the model presentedn the Appendix o estimatethe size of thepriceandprofitdistortionsor somerepresentativeases.Thepurpose s toconfirm hat these distortionsare sizeableand,hence,thatit is worthwhile

to considerat least some minormodifications o the current ntellectualproperty egime.To keepthe mathematicsmanageable,we considerhereonly cases withtwo peripheralsnd a platformhathasno intrinsicvalue. Demand or eachperipherals assumed o be uniformon [0, V] (that s, lineardemand),andconsumervaluationsor the two peripheralsre assumed o be uncorrelated.These restrictions ause the two firmsto behaveidentically,allowingus tofocus onjust one of themin the graphs hatfollow.Figure2 shows coordinatedand uncoordinated eripheralprices as afunction of platformprice. The top line represents he prices each firmwouldcharge n the absenceof coordination,while thelower linerepresentsthe lower pricesthe firms wouldcharge f the two could coordinate.Plat-formprice is markedon the horizontalaxis, and it increasesfrom left to


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EMERGING PLATFORM TECHNOLOGIES 6270.5 V

PeripheralPrice

0.3 V

V 2VPlatform Price

FIGURE .-Uncoordinated (top line) and coordinated (bottom line) prices for the two-firmsetting with consumer demand uniformly and independently distributed on [0, V]. Platformprice increases left to right.

right.The axis is labeled as a functionof V in orderto give it meaningfulcontext.Forexample,a price greater hanVmeansthatconsumerspurchasethe platformonly if they arewillingto purchasebothperipherals. latformpriceis cappedat2Vsince,athigherprices,no consumervalues theperiph-eralsenoughto purchase he platform.Severalfeaturesof the graphwarrant rief comment.First,at a platformpriceof zero,the uncoordinatedriceand the coordinatedpriceare identi-cal. This makes sense since, in cases wherethe platform s free, the priceof one peripheraldoes not affect demandfor the other,so each firm willset its priceappropriately.econd,as platformpricerises,peripheral ricesfall. Again, this follows intuition.Since consumersconsider the platformprice when determininghow muchthey are willing to pay for any givenperipheral,a higherplatformprice eats away at consumerwillingnesstopay as seen by the peripheralirms,leadingthe firmsto compensatewithlowerprices.Third,both lines are kinkedbecause,above a certainplatformprice,noconsumersare in "group3" with respectto eitherperipheral.Thatis, atsome point,no consumersarewilling to purchase he platform implybe-causetheyvalue one of the peripherals ighly.In this example,a platformprice of V is the absolutehighest platformpricefor which any consumercould conceivablyvalue one peripheral noughto purchaseboth thatpe-ripheral ndtheplatform.The kinksfall slightlybelow Vsince theperipher-als themselvesare sold atnonzeroprices,andthusgroup3 is emptiedevenbefore the platform eachesa priceof V. This also explains why the kinksare not aligned.The lower line representsowerprices,so at a given plat-


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628 THEJOURNALOF LEGALSTUDIES

33%PercentageDrop 20%

V 2VPlatform Price

FIGURE .-Price distortion as a percentage of uncoordinated price, graphed as a functionof platform price.

formprice,there are alwaysmoreconsumers n group3 when pricesarecoordinated hanthere arewhenpricesare not coordinated.This naturallyimpliesthatgroup3 is emptied n the uncoordinatedase beforeit is emp-tied in the coordinated ne.Figure3 compares he coordinatedand uncoordinated rices showninFigure2. The vertical axis depictsthe pricedistortionas a percentageofthe uncoordinatedrice.Thus,at a platformpriceof V in this example, fthe firmscouldcoordinate,heywould chooseprices33 percent ower thantheir uncoordinated rices.The kinks in the line are causedby the kinksshownin the previousfigure.The percentages constantonce theplatformis so expensivethat heonlyconsumerswhopurchaset are consumerswhopurchasebothperipherals.

Figure4 comparablydepictsthe profitdistortion,againas a functionofplatformprice.This time, the vertical axis represents he profitloss as afunctionof uncoordinated rofits.Again, andfor the same reasons as ex-plainedabove,theline is kinkedandthe distortions constantoncetheplat-form exceeds a certainprice.As with any presentation f this sort, the graphsshownhere are onlyrepresentative. hepricedistortions a functionof manyfactors,and it canbe madeto look worseor betterby varyinganyof severalassumptions.Theassumptionsused to generate hesegraphs,however,werechosenbecausethey seemreasonable:he two peripheralswere assumed o be of compara-ble popularity, he distortion s shown under the full range of platformprices,andso on. If the assumptions re indeedfair,thenthe graphscon-firmthatthe effect can be sizeable.


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EMERGING PLATFORM TECHNOLOGIES 629

18%PossibleProfit Increase

10%

v 2VPlatform Price

FIGURE4.-Profit distortion as a percentage of uncoordinatedprofit, graphed as a functionof platform price.

III. IMPLICATIONSThe externality dentified n the precedingsectionlikely affects a widevarietyof platform/peripheral arkets.It probablyaffects marketswhere

consumerspurchasevideo game consoles separately romcompatiblecar-tridgesand marketswhere consumerspurchasecomputerhardware epa-ratelyfrom niche or locked-in software.In cases like these, however,af-fected firms can mitigate the externality's mplicationsby coordinatingpricesthrough ontract,ntegration, r some other ormalor informalmech-anism.This, for example, might be one reasonwhy Microsoft bundlesaword processor, spreadsheet,and database ogetherin its Office productand, further,why Microsoftthen tries to sell the Office product ogetherwith the Windowsoperating ystem.Marketsof this generalform arenotof particularnteresthere,then,because,even if it is significant,anyexter-nalityin these marketscan be addressedhroughconventionalmeans.Inmarketsbasedon emergingplatform echnologies,however,voluntarycoordinations likely unworkable.As was explained n the Introduction,this is because of the dynamicnatureof still-maturingmarkets.Withfirmsconstantlyenteringandexitingthe market, t is almostimpossible o bringall affectedfirms ogether or a single negotiation.Andnegotiationsamonganysubsetof the firmsareunlikelyto result n a significantpricereductionsince involvedfirmswill be hesitant o lowertheirpricesfor fearthatanyprice concessionsthey achieve will be offset by corresponding rice in-creasesfromuninvolved irms. Of course,the platformowner itself mightbe able to partially olve the problemby, for example,payingsubsidies ofirmsthat lower theirprices;but any suchsolution s significantlyimited.


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630 THEJOURNALOF LEGALSTUDIESWhennew peripheralellers enterthe market,afterall, those sellers eitherwill chargecorrespondingly igherpricesor will themselvesdemanda sig-nificantsubsidy, n bothcases significantlyunderminingither heplatformowner'sobjectivesor its profitability.In emerging echnologycases, then,the mostpromisingway to internal-ize theperipheral/peripheralxternalitys toempoweroneparty-the obvi-ous choicebeingtheplatformowner-to coordinatehebehaviorof all theotherfirms.The issue is thus an issue for intellectualpropertyaw. Patent,copyright, rademark,ndtradesecretprotection ombineto give platformowners a certaindegreeof influenceovereverywould-beperipheral evel-oper.But thatinfluencehas traditionally een constrained;ourts have ingeneralbeen unwillingto recognizetoo muchinfluencefor fear thatplat-form ownerswould use it to exclude firms from the peripheralmarket.22That,of course,misses the insight of open-architecturetrategies:manyplatformowners n factrely on third-partynnovationboth to developtheirplatformsquicklyand to identifynew applications.23heseplatform wnerswould use additional nfluence not to exclude peripheral irms from themarketbut instead to make the peripheralmarketmoreprofitable.Thus,there s another actor or courts o considerwhenapplyinganyof thevari-ous doctrines hatdetermine he scope of a platformowner's intellectualproperty ights:the possibilitythat broader ightswill be used to facilitatedownstream oordination o the benefitof consumers, hird-party evelop-ers, and also the platformowner.The firstsubsectionbelow sketchesthe basicrightsintellectualpropertylaw recognizesin platformowners as a matterof course. This providesabaseline for the analysisthat follows. Thesecond subsectionconsidersdis-cretionary ightscourts at theiroptionrecognizeon a case-by-casebasis.The subsections organizedaround our maininquiries-in patent aw, thedistinctionbetweenrepairand reconstruction, nd the doctrineof patentmisuse;and, n copyrightaw,the definitionof the term "derivativework"and the doctrineof fairuse-and argues hateach of theseinquiries hould

22See, for example, Sega EnterprisesLtd.v. Accolade, Inc., 977 F.2d 1510, 1526 (9thCir. 1993) ("If disassemblyof copyrighted bjectcode is perse an unfairuse, the ownerofthe copyrightgainsa de factomonopolyover [thesale of add-ongoods]"); Sage Products,Inc. v. DevonIndustries,nc.,45 F.3d 1575, 1579 (Fed.Cir. 1995) ("[The platformowner]thus seeks to keep for itself a market n partswhich are intendedto be periodicallyre-placed-this is no more than an attempt o expandpatentrightsto an unpatentedadd-on]product.").23 An openmarketn peripheralsmightalso be a crediblecommitmentmechanism.Con-sumerswouldhesitate o purchasea platformf theythought hattheplatformownerwouldlaterhavemonopolisticpowerin themarket or peripherals.Ona related heme,see JoesphFarrell& NancyGallini,Second-Sourcings a Commitment:Monopoly ncentives o AttractCompetition,103 Q. J. Econ. 673 (1988).


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EMERGING LATFORMTECHNOLOGIES 631be guided n partby the arguments resented arlier n thepaper.The thirdand final subsectionconsiders wo possible objections o thisproposal:hatcourtsmightnot have the expertiserequired o engagein the analysisen-dorsed here andthat,even with broaderrights,as a practicalmatterplat-formownerswill not be able to coordinate ollow-on innovation.

A. The IntellectualPropertyBaselineIf platformowners were able to patent nterfaceinformation--say,as-sertingrightsin the preciselayoutof the pins thatmakeup the platform'sserialportor the specificdimensionsof the diskettesacceptedby the plat-form's disk drive-platform owners wouldfully controlthe associatedpe-ripheralmarkets.Any peripheraldeveloperusingthe patenteddetail with-out the patentholder'spermissionwouldbe an infringer,vulnerable o anaction fordamagesas well as injunctive elief.This is rarely hecase,how-ever, becauseinterfacedetails are for the most part"obvious" given thepriorart.24 ell, for example,did not andprobably ould not claim the par-ticularportconfigurationshat allowhardware dd-ons o interfacewith theDimensionXPS desktopcomputer ince, no matterhow originalother as-pects of the machinemight have been, the serial connections hemselveswerecommonplaceat the time Dell filed its patentclaims.25For similarreasons,copyright, oo, rarelygives platformownerssignifi-cant influenceoverperipheraldevelopers.The main limitationhere is thatinterfacespecificationsconceivablyeligible for copyright-for example,the specific patternof Os and Is necessary o cause an operating ystemtoread data from a diskette-typically do not satisfySection 102(a)'sorigi-nality requirement.26ccordingto the SupremeCourt'sinterpretationfthatprovision n Feist, to be eligible for copyrightprotectiona work not24 35 U.S.C. ? 103(a)("A patentmaynotbe obtained ., .if the differencesbetweenthesubjectmattersoughtto be patentedand the priorart are such that the subjectmatteras awholewouldhave beenobviousat the time the inventionwas madeto a personhavingordi-naryskill in the artto whichsaidsubjectmatterpertains.").Someinterconnection etailsdoqualifyfor patentprotection.Forexample,Nintendoearneda patentfor the designof thecartridge/consolenterfaceon one of its early video game consoles. See U.S. Patent No.4,799,635(1989).Similarly, heeight-trackassette s a patentedmeansof bringingnforma-tion to the compatible assetteplayer.See U.S. PatentNo. 3,403,868(1968). Even in caseswhere a patent ssues, however,protections not airtight. n Hewlett-Packard ompanyv.Repeat-O-Type tencilManuf.,123 F.3d 1445 (Fed.Cir. 1997),Hewlett-Packard'satentson a particularnk-jetprinter artridgewereheld not to be infringedby a competitor'sprac-tice of purchasing artridges n the openmarket,modifying hemso as to makethem refill-able, and,withoutHewlett-Packard'sonsent,selling the modifiedcartridgesor use with

Hewlett-Packardrinters.25Amongthe relevantpatentsare U.S. PatentNos. 5,291,585(1994) (software or access-ing I/O devices)and5,668,696(1997) (systemforheatdissipation).26 17 U.S.C. ? 102(a).


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632 THEJOURNALOF LEGALSTUDIESonly mustbe original o the author literally,"not copied")but also mustdemonstrate ome modicumof creativeachievement.27rotocolsfor themost partfail to demonstratehat modicumof creativeachievement incemanyarein factarbitraryatterns.28Even whereprotocolsdo evidence sufficientoriginality,copyrightpro-tectionis still typicallydenied. The courtsare inconsistentas to how thispointis framed,withsome courts nvoking hemergerdoctrinewhileothersinvoke the doctrineof scenes a faire, Section 102(b), or the somewhatblurredabstraction-filtration-comparisonest fromAltai;29 ut the variousapproaches ll emphasize he samefundamentalopyrightprinciple: opy-rightprotection xtendsonlyto theexpressiveelementsof a work,andevencreativeprotocolsaremore functional hanthey areexpressive.Trademarkaw gives platformdevelopers omeinfluenceoverperipheralsellers,althoughn most casesthis is likelybut a modest actor.Evenunau-thorized irms can advertise hat theirperipherals recompatiblewith theplatform ince that s a truthful laim,and, f appropriatelyrafted, t wouldnot lead to anyconfusionas to the sourceof theperipheral.30Whatunautho-rized firms cannot do is claim that their peripheralsare "officially li-censed" or, as the above implies,use platformbrandnamesor logos inways thatwould mislead consumersas to theperipheral'source.31

A platformowner's most significant nfluence,however,likely comesfromthe fact that the platformowner can deny uncooperativeirmsaccess27 FeistPublications . RuralTel. Serv.Co., 499 U.S. 340, 345 (1991) ("Original,as theterm s usedin copyright,meansonlythatthework was independentlyreatedby the author... and that t possessesat least some minimaldegreeof creativity").28 See, for example,Mitel,Inc. v. Iqtel,Inc., 124 F.3d 1366, 1373 (10thCir. 1997).29 The cases applyand intermix hese four basic inquiries.Somecasespursue hemsepa-ratelyandexplicitly;otherspursue hemin the contextof the Altai (ComputerAssocs.Int'l,Inc. v. Altai, Inc., 982 F.2d 693, 709-10 (2d Cir. 1992)) abstraction-filtration-comparisonframework.See, for example,Mitel, Inc. v. Iqtel, Inc., 124 F.3d (withinAltai frameworkrelyingon ?? 102(a)and 102(b)andscenes a faire);GatesRubberv. BandoChem.Indus.,Ltd.,9 F.3d 823 (10thCir. 1993)(withinAltaiframeworkelyingon ?? 102(a)and 102(b),merger,and scenes a faire);Batemanv. Mnemonics, nc., 79 F.3d 1532 (11th Cir. 1996)(questioning pplication f Altaiframeworkn this context).Menell discussesthehistoryofAltaiand ts applicationo the abovecasesin PeterMenell,AnEpitaphor TraditionalCopy-rightProtection f NetworkFeatures f Computer oftware,43 AntitrustBull. 651 (1998).30 As a generalrule,one firmcan use another irm'strademarko marketproducts r ser-vices provided hat the use is truthfuland thereis no likelihoodof confusionas to source.See, for example,Smithv. Chanel,Inc.,402 F.2d 562 (9thCir. 1968) (competitor'srade-markused in comparative dvertising).This is especiallytruein cases wherethe mark sessentially he only meansof informing onsumersas to the true natureof the product.31Some anecdotalevidenceas to the marketvalueof this type of trademark rotection:for a fee of $500, Palm allowsperipheral evelopers o use the official Palmlogo, the onlyconditionbeingthat the peripheral asscertaincompatibilityests. The details areavailableat http://www.qpqa.com/palm/base-pr.htmllastvisited on October1, 1999).


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EMERGINGPLATFORMTECHNOLOGIES 633to privateinformationaboutthe platform nterface.As a formalmatter,tradesecret aw helpsplatformownerskeepthis information rivateby, forexample, forbiddingformeremployees from divulgingtechnicaldetails;but,truthbe told,this is morea practical emedy han t is a legal one. Thefirm thatdesignsa platformquiteobviouslyhas special expertiseabouttheplatform'snnerworkingsandcanchoose when and whethero divulgethatinformation.The value of this private nformation f course varies with the costs ofreverseengineering.In instanceswhereit is difficult for an unauthorizedfirmto extractprotocol nformationrom both the platformand authorizedperipherals,heplatform wnerwill findthat ts private nformations quitevaluable, and, hence, the platformowner will enjoy significant nfluenceover every would-beperipheraldeveloper.By contrast,wheretechnologymakesit easy to extractspecificationnformation,he platformowner'sin-fluencewill be significantly onstrained, ndtheownermightthereforenotbe able to bringaboutmeaningfulpricereductions.These lattercasesmightbe more common that intuitionwouldat firstsuggest.Afterall, peripheralfirmsare not simply beingaskedto lowertheirprices n a staticsetting,butare insteadbeingaskedto lowertheirpriceseven as demand ortheirprod-ucts is increasinghanks o otherfirms'pricereductions; hus,when we saythattheplatformowner will findit difficult o coordinate hemarket n set-tingswhere the costs of reverseengineeringarelow, we mean low relativeto therequestedpricedrop,whichin manycases can turnout to be a ratherlargenumber.

B. DiscretionaryDoctrinesThebaselinerightsoutlinedabove-mainly tradesecretprotectionof in-terface information-will in manyinstancesnot give the platformowner

sufficient everageto coordinatedownstream nnovators.The cases intro-duced below bear evidenceto thatfact;if the simpleact of keepinginter-face information ecretwas enoughto give platformownerssignificantn-fluenceoverwould-beperipheral evelopers,platformowners would neverhaveresorted o the licensingandrelatedschemes summarized elow.Thattradesecretprotectionmightbe too weak, however, s only one of two ar-guments n favorof the recognitionof broader ights.The otherargumentapplieseven in cases where tradesecretprotections sufficient.In cases wherereverseengineerings expensive,a platformownergainssignificant nfluenceby threatening o withhold interface nformation. nthesecases, theplatformowneralreadyenjoyssignificantnfluence,so it ishardto see anyharm n recognizing hat nfluenceexplicitly.Yet suchrec-ognitionwould likely increasesocietalefficiencysince it would eliminate


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634 THEJOURNALOF LEGALSTUDIESseveral bad incentives that trade secret law today creates.For example,firmsattemptingo keep the costs of reverseengineeringhigh will, at themargin,be tempted o designawkward, umbersome rotocols.Simple pro-tocols are somethingof a liabilityto a firmrelyingon the expenseof re-verseengineering; omplicatedhandshakes remoredifficult o reverseen-gineer. In other words, by not recognizingbroaderrights, the currentintellectualproperty egimecreatesa perverse ncentivefor platformown-ers to design unwieldyinterfacespecifications.And, moretroubling, n acompetitionbetweentwo otherwiseequivalentplatforms,he morecumber-some technologywill prevail-first attractingmoredevelopers hrough hepromise of coordination, hen attractingmore consumers thanks to thehigheravailabilityof peripherals.Similarly,a firmrelyingexclusively on trade secretprotectionwill betemptedto increase its influence over would-beperipheraldevelopersbydelayingthe introduction f its platform o market.Reverseengineeringsimpossibleso long as the platformneverleaves its owner'sphysicalcon-trol; thus,to a firmrelyingon the expenseof reverseengineeringas a sub-stitutefor explicit intellectualpropertyprotection,delay is at the marginattractive.Consideringhatone of the goals of intellectualpropertyprotec-tion is to promotethe promptdisclosure of innovative deas, this sort ofbehaviorseems undesirable.32The text below surveysfourdiscretionarynquiries n intellectualprop-ertylaw that, n differentsettings,determine he relativerightsof platformownersandperipheral evelopers. t is in the contextof theseinquiries hatthe analysispresentedn this articlecould most easily be brought o bear.The purposehere is not to offer detailedexplanationsof the variousdoc-trines andinterpretations,ut insteadsimplyto pointout thattheseare thekey inquiriesaffectedby the article.1. Repair/ReconstructionPatentLaw). Plaintiffin Sage Productsv.DevonIndustries33evelopedand sold a disposal system designedfor usewith hazardousmedicalmaterials.Onecomponentof the systemwas a re-movable nnercontainerhatwouldactuallymake contactwith the hazard-ous waste. This componentwas designedto be used once and then dis-carded.Plaintiffheld a patenton the completedisposal system-the innercontainer s usedin combinationwiththe restof theapparatus-butits pat-ent did not, and on obviousnessgroundsprobablycould not, explicitly

32CompareWilliamLandes& RichardPosner,An EconomicAnalysisof CopyrightLaw,18 J. LegalStud.325, 331 (1989) (arguing hatcopyrightaw shouldrecognizebroadrightsin derivativeworksbecause, n the absenceof suchprotection, uthorswouldat the margindelay publicationn order o firstpreparederivativeworksthemselves).33 45 F.3d 1575 (Fed.Cir.1995).


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EMERGING LATFORMTECHNOLOGIES 635claim the inner container tself. When a competitorbegan selling replace-mentcontainers,plaintiff-patenteeued,arguing hatevery time one of itscustomersused a containermadeby its competitor,he consumerwas im-permissibly"reconstructing"he patentedcombinationand therefore hecompetitorwas liable for eithercontributoryr induced nfringement.The distinctionraisedin a case like Sage is the distinctionbetweentherepairandreconstructionf a patentedcombination.34he issue arises ininstanceswherea peripherals listedas an elementof a patentclaim. Thepatentholderargues hat,by replacing he listedelement,usersinfringe hecombinationpatent-and note that this is a plausibleargumentgiven thatpatentlaw frequentlyrecognizesexclusive rights in particular ombina-tions, for example,the combination f unpatentable lue andunpatentablepaper o form thefully patentablePost-Itnote.35Alleged infringers espondthatthis typeof hyperliteralnfringementhouldbe excused,in essence onan impliedlicensetheory.The distinctionbetweenrepairandreconstructions thus a questionofpatentscope-a question hat n this contextdetermineswhetherperipheraldevelopersneed theplatformowner'spermissiono sell compatibleperiph-erals. To the extentthatreplacing he peripherals deemedreconstruction,it is underthe patentholder's exclusive purview;to the extent thatthosereplacements re deemedrepair, he patentholder has no exclusiveright.This s ajudiciallydevelopeddistinction, ndcourts odayconsiderhe "total-ity of the circumstances"whendeterminingwhethera given actinfringes.36Oneimplication f the current aper s thus to suggestthatone factorcourtsshould consideras partof this inquiry s how eachresultwouldaffectthestructurendexistenceof the marketorreplaceable omponents.2. PatentMisuse. Platformownershave fromtimeto timeattemptedocontrolperipheral evelopersby imposingrestrictiveicenseson purchasersof the platform.Forexample, n Motion PicturePatentsCompanyv. Uni-versalFilmManufacturingCompany,37laintiff-patenteeonditioned achsale of its patented ilmprojectoron the stipulationhat the purchaser entfilmsonly fromdistributorspprovedby thepatentee.Whenthreeunautho-rized film distributors tarted o offer films for sale, the patenteesued,ar-guingthat(1) becauseno purchaser f theprojector oulduse unauthorized

34 See AroManufacturing o. v. ConvertibleTop ReplacementCo., 365 U.S. 336 (1961)(Aro I); and Aro ManufacturingCo. v. ConvertibleTop ReplacementCo., 377 U.S. 476(1964) (Aro II). Additionalcases are collected and analyzed n MarkJanis,A Tale of theApocryphalAxe: Repair,Reconstruction,nd the ImpliedLicensein IntellectualPropertyLaw,58 Md. L. Rev. 423 (1999).35U.S. PatentNo. 5,153,041 (1992).

36 Aktiebolagv. E. J. Company,121 F.3d 669 (Fed.Cir. 1997).37 243 U.S. 502 (1917).


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636 THEJOURNALOFLEGALSTUDIESfilms withoutviolatingthe license and (2) becauseafterviolatingthe li-cense purchaserswould be usingthe patentednventionwithoutthe patentholder'spermission, hat(3) by sellingunauthorizedilms the distributorswere illegally inducingpatent nfringement.Undermodemlaw, patentholdersandpurchasers f patentedgoods arefree to "contract as they choose, provided that no law is violatedthereby.'"38That s, theinquiryn a case likethisis phrasedn thenegative:restrictiveicenses are to be upheldso long as other bodies of law do notprohibit hat result. Contract aw, for example, precludesenforcementof"unconscionable" onditions,39andspecific patentdoctrinescondemncer-tainconditions, orexample,conditions hatserveto extendthepatent ermbeyondits statutory uration.40Whatis troublingabout this analyticalap-proachas appliedhere is thatone of the legal barriers mphasizedn thenegative nquiry s the doctrineof patentmisuse.Patentmisuseis traditionallyn affirmative efense to a chargeof patentinfringement.t is anequitabledoctrine,henotionbeingthata courtshouldnot use its powerto assista patentholderwhere, n this oranyother nterac-tion, the patentholderis exercisingits rightsin a manneragainst publicpolicy.41The defense can be invoked n anycase. An alleged infringer, orexample,can arguethata given patentshould not be enforcedbecause, nsome entirelyunrelatednstance,the patenteehas impermissiblyused itspatentpower.A patentholderwhose actionsarefoundto constitutemisuseloses all rightsvis-a-visall partiesuntil the practice s discontinued nd itseffects on the marketare "fully dissipated."42Why is this troubling?As a practicalmatter,bringing his interpretationof patentmisuse into thenegative nquirymeans thatpatentholderscannoteven attempt o use restrictive icensesfor this purpose.Thestakesare toohigh;one misstepand thepatentholder n essenceforfeitspatentprotectionon the platformentirely.43 ecause the argumentspresented n this paper

38Mallinckrodt . Medipart, nc., 976 F.2d 700, 703 (Fed. Cir. 1992). AccordB. BraunMedical,Inc. v. AbbottLaboratories,24 F.3d 1419 (Fed.Cir. 1997).39See E. AllanFarnsworth, ontracts .28, at 307-17 (3d ed. 1999).40 Brulottev. Thys Co., 379 U.S. 29, 32 (1964) ("patentee'suse of a royaltyagreementthatprojectsbeyond heexpiration ate of thepatent s unlawfulper se"); Boggildv. KennerProds.,776 F.2d 1315, 1320-21 (6thCir. 1985),cert.denied,477 U.S. 908 (1986) (wherepreexpirationndpostexpirationoyaltiesareidentical,agreements unlawfulperse).41 See MortonSaltCo. v. G. S. SuppigerCo., 314 U.S. 488 (1942).42 B. B. Chem.Co. v. Ellis, 314 U.S. 495, 498 (1942) (aftera findingof patentmisuse,apatentholder'srightsshouldnot be enforceduntilthe patentholder"is able to show that thas fully abandonedts presentmethodof restrainingompetitionn the sale of unpatentedarticlesandthat the consequencesof thatpracticehave beenfully dissipated").43Forsomeanecdotal vidence hatpatentholdersarereluctant o riskvulnerabilityo thedefense,see RichardH. Stem, Post-salePatentRestrictionsafter Mallinckrodt: n Ideain


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EMERGING LATFORMTECHNOLOGIES 637would favor, in certaincircumstances,he enforcementof restrictive i-censes of this sort,the draconianpenaltiesof patentmisuse seem unneces-sarilychilling.Courtswould betterserveequityby in these instancesnar-rowing the maximumpatentmisuse penalty and thus enablingfirms toattemptwhatmightturnout to be permissibleandsociallybeneficial icens-ing regimes.3. Fair Use (Copyright). Platformownershave also tried to controlperipheraldevelopersby using copyright o limit the reverseengineeringprocess.Forexample, n SegaEnterprisesLtd.v.Accolade,Inc.,"AccoladepurchasedromSega video gamecartridges ompatiblewith Sega's videogame console andproceeded o reverseengineerthe cartridgesn order oidentifythe relevant nterfacespecifications. ntermediatetepsin thatpro-cess requiredAccolade to duplicateand manipulateSega's copyrightedvideo gamecode. (Amongother hings,Accolade hadto translate he codefrom machine anguageto a formmore accessible to humanreaders.)SoSega sued,not arguing hatAccolade hadillegallyused the interface peci-fications-an argumentnot available o Sega because,as notedpreviously,interface nformation tself is generallynot eligible for copyrightprotec-tion-but arguing nstead hat, n theprocessof reverseengineering,Acco-lade hadinfringedSega's rights n the validly copyrighted ideo games.

Two prominent ases evaluatearguments f this sort: he NinthCircuit'sSega case summarizedabove and a contemporaryFederal Circuitcase,Atari Games v. Nintendo.45Both courtsagreedthatany such infringementcould in theorybe excused underthe doctrineof fair use.46Fair use is anaffirmative efense to copyrightnfringementhatmustbe raisedon a case-by-casebasis.47It is meantto excuse literal nfringementwherepublicpol-icy favorsthat result.A book reviewer,for example,can invokethe doc-trine to defend an infringement harge arisingout of his unauthorized seof a bookexcerpt,and a comediancan similarlyuse it to defendan unau-Searchof Definition,5 Alb.L. J. Sci. &Tech. 1 (1994).For a related riticismof thedoctrineof patentmisuse,see MarkLemley,The EconomicIrrationalityf the PatentMisuseDoc-trine,78 Cal. L. Rev. 1599 (1990).

44977 F.2d 1510(9thCir.1992),as amendedby 1993 U.S.App.LEXIS78 (9thCir.1993).45 975 F.2d 832 (Fed.Cir. 1992).Thetwo cases have been the subjectof extensivelegalcommentary. ee, forexample,JulieCohen,ReverseEngineering nd the Rise of ElectronicVigilantism: ntellectualPropertymplications f "Lock-Out"Programs, 8 S. Cal.L. Rev.1091 (1995);DennisKarjala,CopyrightProtectionof ComputerDocuments,ReverseEngi-neering,andProfessorMiller,19 U. DaytonL. Rev. 975 (1994).46 This sentence s somewhatcarefullyphrasedbecause,while both courtsagreedon theroughcontoursof thefair use analysis, he FederalCircuit nAtariultimately efused o rec-ognize the defenseon the particularacts of that case.47 17U.S.C.? 107. For a general ntroduction,ee MarshallLeaffer,Understanding opy-rightLaw427-76 (3rded. 1999).


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638 THE JOURNALOF LEGALSTUDIESthorizedparody.The defense is codifiedat Section 107 of the CopyrightAct, butcodificationhas not significantly onstrainedhe doctrine'sscope.This is still, as it originallywas, an all-inclusive,equitablenquiry.48The courts n Sega andNintendoconsidereda numberof factors n de-termininghatcopyrightnfringement ecessary o the creationof compati-ble peripheralsould be excused on thispublic policy exception;but,as itwas in patentlaw with the distinctionbetweenrepairandreconstruction,the fair use inquirypursuedn these cases did not weigh in the possibilitythat a findingof infringementwould have forced would-beperipheralde-velopers to negotiatewith the relevantplatformowners and thus wouldhave empoweredthose platformowners to coordinateperipheralprices.This is not to say that this factorwill alwaysbe determinativer even thatit shouldhave beendeterminativen theseparticularases;but it should nthe futurebe consideredsince, as this articleargues,publicpolicy will insome cases be better servedby rejecting he fair use defense and therebyexpandingplatformowners' influence over downstreamperipheraldevel-opers.4. DerivativeWork Copyright). A lastapplicationor the analysispre-sented n this article s in the interpretationf Section106(2)of theCopy-rightAct, whichgrants o copyrightholders he exclusiveright"to preparederivativeworks"based on a copyrightedwork.49 In MicroStarv. Form-gen, Inc.,5" ormgenheld copyright n a popularvideo gamethat,in addi-tion to 29 playable evels of monstersandscenery,camewitha utilitythatallowed usersto create additional amelevels. MicroStar,an independentfirm,collected 300 user-createdevels and sold them on a single compactdisc as anaccessory o Formgen'sgame.Thedisc didnotreplace heorigi-nalgame; t onlycontaineddatathatwould allowuserswho alreadyownedthe game to play the additional evels createdby otherusers.Micro Starthensued for a declaratoryudgment hat ts productdidnotinfringeForm-gen's copyright,andFormgencounterclaimedor a preliminarynjunctionbarring urtherdistribution f Micro Star'sproduct.In a case like this, the analysisturnson the questionof whether he ac-cessory at issue is a derivativework,which Section 101 defines to mean"a workbaseduponone or morepreexistingworks."" Readliterally,ofcourse,thatdefinitionwould includeeveryworkof authorshipver created

48 TheHouseReporton the CopyrightAct of 1976makesthispoint explicitly,H.R.Rep.No. 1476,94thCong.,2d Sess. 65 (1975),and heSupremeCourthas nterpreted 107accord-ingly;seeHarper& RowPublishers,nc. v. NationEnterprises,71 U.S.539,560 (1985).49 17 U.S.C. ? 106(2).

50 154 F.3d 1107 (9thCir. 1998).51 17 U.S.C. ? 101.


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EMERGING LATFORMTECHNOLOGIES 639since, to some extent, "every book in literature, cience and art,borrowsand mustnecessarilyborrow"fromthatwhich camebefore.52 ourts here-foremustapplythe statutoryanguagenarrowly,although xactlyhow nar-rowlycontinues o be anopenquestion n boththeplatform/peripheralon-text53 ndmoregenerally.54Thisdefinitional ssue is yet anotherndirectnquirynto the scopeof theunderlyingntellectualproperty ights n a given platform. f add-onvideogamelevels are deemed to be derivativework,the platformowner'scopy-rightin essence expandsto include controlover the market or this addi-tionalproduct. f not, that marketremainsopento any firmcapableof re-verseengineeringhe relevantprotocols.Again,the arguments resentednthispapersuggestthatpartof this definitionalnquiry houldbe consequen-tialist: n addition o consideringhetrade-offbetween ncreased ncentivesto createcopyrightableworks on the one hand and increasedpublicaccessto already xistingcopyrightableworks on theother,courtsshouldconsiderwhetherbroader ights mightmakepossiblebeneficialcoordination f thesortintroduced arlier he article.

C. JudicialCompetence ndImplementationroblemsTherearetwoprimary bjections hatmightbe raisedagainst hepropos-als sketchedabove:first,that courts do not have the expertiserequired oengagein thesuggestedmarketanalysisand, second,thatevenwithbroaderrights,as a practicalmatterplatformownerswill not be ableto coordinatefollow-on innovationbecause of various informational ndlogisticalcon-straints.These are admittedly mportantobjections;each is considered nturnbelow.To evaluatejudicial competence n the currentsetting,it is helpful todrawananalogy o antitrustaw. Practices ubject o review under he Sher-man andClaytonActs are either evaluatedcase by case underthe rule ofreason or deemedillegal withoutregard o the specificfacts at hand undera perse rule.Sometimes he choice betweenrule-of-reason eview andperse prohibitions straightforward;hese are cases whereexperience uggests

52 MicroStar,154 F.3dat 1110 (quotingEmersonv. Davies, 8 F. Cas. 615, 619 (C.C.D.Mass. 1845) (No. 4436)).53 Compare,orexample,LewisGaloobToys,Inc.v. Nintendoof Am., Inc.,964 F.2d 965(9thCir. 1992) (hardware dd-on hat alteredvideo gameperformanceot derivativework)withMicroStar,154 F.3d 1107(softwareadd-on hatalteredvideogame performanceoundto be derivativework).54 Compare,orexample,MirageEditions, nc.v. Albuquerque .R.T.Co., 856 F.2d 1341(9thCir. 1988)(purchaserf copyrighted rt book createdderivativeworkby removingandframingparticular ages) with Lee v. A.R.T. Co., 125 F.3d 580 (7th Cir. 1997) (oppositeresult for note cardsmountedon ceramic iles).


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640 THEJOURNALOFLEGALSTUDIESthatthepracticeat issue has virtuallyno pro-competitivepplication nd sotheperse rule is obviouslyappropriate."5n the remaining ases, however,the choice turns n largeparton the questionof judicialcompetence.Thatis, practicesthat have some pro-competitiveapplicationmight still bedeemed llegal perse, the logic beingthat,as applied o thesepractices, heexpectedbenefitsof case-by-casereview are outweighedby the expectedcosts-costs that include the direct costs of litigation, he costs associatedwith uncertainty,and, most important,he costs associated with judicialerror.56Thus, n formulating ntitrust olicywithrespect o perse rules,courts nessence ask a questionsimilar o the one being posedhere: s thejudiciarysufficientlyskilled at analyzingmarketstructure o as to justify case-by-case consideration f the specific practiceat issue, or are courts so likelyto err n theiranalysisof thispractice hata discretionarynquirys unwise?Thisquestionwas recentlyaddressed y the SupremeCourtwithrespect oa practice hat bearsstrongsimilarities o the coordination nderconsider-ationin thispaper:pricecoordinationhroughhe use of verticalmaximumpriceagreements.For nearly 50 years, vertical maximumprice agreements-contractsthroughwhich an upstreammanufacturer r supplier mposesa price capon relateddownstream etailersor resellers-were prohibitedundera perse rule.57 ut,in 1997,the SupremeCourtoverruled hose earliercases andheld that verticalmaximumprice agreementsarerightly udgedundertherule of reason.58 ruthbe told, this most recentcase does not offer signifi-cant insightinto the Court'slogic. The opinionmakesonly a few vaguereferences o the possibleharms thatmightobtainif verticalprice agree-ments areapprovedn error,59 ndin the end the opinionseems to simply

55NationalSoc'y of ProfessionalEngineers . UnitedStates,435 U.S. 679, 688-92 (1978)(perse rules areappropriate henapplied o "agreementswhose natureandnecessary ffectare so plainlyanticompetitivehatno elaborate tudyof the industrys neededto establishtheir llegality").56 CompareFrankH. Easterbrook, erticalArrangementsnd the Rule of Reason,53 An-titrustL. J. 135, 157 (1984) (theperse ruleis appropriaten instanceswhere"case-by-caseadjudication . . would permittoo manydeleteriouspractices o escape condemnation");FrankEasterbrook,MaximumPriceFixing,48 U. Chi. L. Rev. 886, 909-10 (1981) ("Thecostsof trying o separate eneficialagreements mongcompetitors .. arelarge;onepartic-ular cost is the chance of error";"[a]t some point,though,the [possiblebenefits]becomeso largein relation o the costs of inquiry including he costs of error) .. that there s nolonger . . . justification for using per se rules.").57Kiefer-Stewart o. v. JosephE. Seagram& Sons, Inc., 340 U.S. 211 (1951);Albrechtv. HeraldCo., 390 U.S. 145 (1968).58State Oil v. Khan,522 U.S. 3 (1997), overrulingAlbrecht,390 U.S. at 145.59 522 U.S. at 8.


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EMERGING LATFORMTECHNOLOGIES 641assert thatanticompetitive ehavior"canbe appropriatelyecognizedandpunished"case by case.60

Despite these shortcomings,however,this recent decisionis consistentwith a broad rend n antitrustaw awayfromperse prohibitions.61 ndeed,with this most recentruling,almostall restraintsmposedby upstreamirmson their downstream ounterpartsre now evaluatedunder he ruleof rea-son.62The courts considerthe facts when rulingon the legality of restric-tionson, say, sales territories rcustomer ists.63A manufactureran refuseto dealwithan affiliateof long standing-perhapsevenreplace hatretailerwith anotheror a wholly owned subsidiary-and at worst still be subjectonly to the case-by-case,rule-of-reasonnquiry.64This is not because thereis no chance that courtswill err in their evaluationof these complicatedmarketrelationships.This is not because these practicespose no risk ofanticompetitive pplication,nor because the costs of litigationand uncer-taintyhave been shown to be trivial n these instances.Theprominence fthe rule of reason insteadreflects a gradualconsensuswithinthejudiciaryand also the academythat,when it comes to analyzingmarketstructure,courtscan be trustedwith at least some degreeof discretion.Wouldanalysisunder he fourintellectualpropertydoctrines ntroducedin the previoussubsectiondiffer from the analysis required n traditionalantitrust ases?Absolutely.The antitrust pproachs passive,the law sim-ply allowingfirms n appropriateases to coordinatepriceswithout ear ofantitrustiability.The proposedapproach,by contrast,contemplatesaffir-mative ntervention, amely,therecognitionof broaderproperty ights.Butin the choice between bright-linerules and case-by-caseanalysis, thatseems to be a distinctionwithouta difference.Thecurrentntellectualprop-erty regimefunctionsas a per se denial of affirmative ntervention.Thatstandsin obvious contrastwith both the recent decision with respectto

60 Id. at 7-9.61 Thistrendhas been well documented lsewhere.See, forexample,Alan J.Meese,TyingMeets the New InstitutionalEconomics:Farewell o the Chimeraof Forcing,146 U. Penn.L. Rev. 1 (1997);ThomasA. Piraino,Jr.,MakingSenseof the Rule of Reason,47 Vand.L.Rev. 1753, 1753-60 (1994);EarnestGellhorn& TeresaTatham,MakingSense Outof theRule of Reason,35 Case W. Res. L. Rev. 155 (1985).62 The lone holdout is the per se prohibition n minimumprice agreements,a doctrinewithroots all the way backto Dr. Miles MedicalCo. v. JohnD. Park& SonsCo., 220 U.S.373 (1911).Eventhatperse ruleknows imitations;orexample,under heColgatedoctrine,minimumprice agreements nforcedby purelyunilateralactionnever fall underantitrustlaw's purview.See United Statesv. Colgate& Co., 250 U.S. 300 (1919).63 These and otherexamplesare discussed n HerbertHovenkamp,FederalAntitrustPol-icy: The Law of Competition nd Its Practice392-440 (1994).64 Id.


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642 THE JOURNALOFLEGALSTUDIESmaximum esaleprice agreements nd the broader rendof whichthatdeci-sion s a part.65

As for the second concern raised above-the worry that, even withbroader ights,as a practicalmatterplatformownerswill not be able to co-ordinatethird-partydevelopers-it is certainlytrue that propertyrightssolve only partof theproblem acing platformowners.Broader ightsobli-gate would-bedevelopersto identify themselves to the platformownersinceonlytheplatform wner s ableto authorize firm o marketperipher-als.Theyfurther bligateperipheralirms o complywith theplatform wn-er's requests,at least so long as the coordinatednetworksubjectto thoserequests s stillmore attractive hansomecompeting,uncoordinatedption.What these rightsdo not do, however,is help the platformownerknowhow to wield this influence n the face of unknownproductsand uncertaindemand.This is a significantproblem;however,experiencein otherindustriessuggeststhatupstreamirmscan oftendevelopmechanismshateffectivelyconstrain he priceschargedby relateddownstreamirms andcan do thisdespiteinformationalimitations.Forexample, newspaperpublishers ypi-cally grantnewspapercarriersexclusive sales territoriesn orderto makepossiblecertaineconomiesof scale in the deliveryprocess.Havingdoneso, however,publishersarethen interestedn limitingdeliverypricesin or-der to ensurethat carriersdo not abuse theirexclusivepositions.So news-paper publishershave devised a mechanism-the aforementionedmaxi-mum price agreements-to constraincarrierdiscretion,keeping deliverypricesdown andhencenewspaper alesup.66Publishers hoose these maxi-mumpricesdespitethe fact thatcarriershave private nformationwith re-spectto local demandconditions, he qualityof theirdeliveryservice,andso on.A similardifficultyarises n the auto ndustry.Automobilemanufacturersalso typicallyassigntheirdealersexclusive sales territories,his time as away of eliminatinga free-rider roblemwithrespect o dealerservices.(AsDennisCarltonandJeffreyPerloffexplain, f car dealerswere notassignedexclusive sales territories, cunningdealerwouldopen shopnext door toanotherdealer,keep priceslow by skimpingon d6corandservice,andputa sign in the window advisingconsumersto "test drive thereand buyhere.")67 Exclusivesales territoriesn this contextagaincreate a situation

65See also United Statesv. JerroldElectronicsCorp.,187 F. Supp.545 (E.D.Pa. 1960),aff'd percuriam,365 U.S. 567 (1961) (refusing o apply per se rule wheretechnology irmlinkedsales of new technologyto service and maintenance f thattechnologyon groundsthat new technologyshouldbe treateddifferently rom establishedones).

66Albrecht, 390 U.S. 145.67Adapted rom Carlton& Perloff,supranote 17, at 528.


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EMERGING LATFORMTECHNOLOGIES 643where retailershave marketpower;but,perhapsbecause the informationalandmonitoringdifficultiesare more severein the automobilendustry hanthey are in the newspaper ndustry,automobilemanufacturers ave beenreluctant o set price caps directly.Instead,car manufacturers ffer salesrewards o dealers and salesmen.The lower the price dealerscharge,themore carstheysell, andhence thegreaterheircorrespondingales rewards.Sales rewards hus give dealers an incentive to choose lower prices thanthey otherwisewould,reducing he pricedistortion.There are otherexamplesof mechanisms hathelp to constrainpricesinsituationscharacterized y at least some degreeof imperfect nformation.For instance,certainmalls use profit-sharing rograms o tie storeprofitstogetherand n thatway encouragendividual tore ownersto chargepricesthat accountboth for the directeffects on theirown profitsandforthe indi-recteffects on overallmall traffic.68Thepointhere is only that,armedwiththe appropriatentellectualproperty ights,platformowners,too, mightbeable to use these or relatedmechanisms o mitigate hepriceandprofitdis-tortions discussedin this article.69This seems especially likely in caseswhere prices are considerablyhigherthan optimalsince, in those cases,even animperfect oordinationmechanism ould stillyield significantlyn-creasedprofits.

IV. CONCLUSIONThe externalitydentified n this papercan arise wheneverthree condi-tions aremet: (1) consumersmake an initial investment hat increases hevalueof some numberof products, 2) thoseproductsare sold by indepen-dent firms,and (3) a subsetof those firms have at least limited marketpower.As was pointedoutin theIntroduction,heseconditionscanbe sati-sfiedin a varietyof settings,although hispaperhas focusedalmostexclu-sively on varioustechnologyapplications.In theory,the resultingprice distortioncan be eliminatedby contract,verticalintegration,or merger;but, in the context of emerging platformtechnologies,coordination roblemsmake thesesolutions mplausible.Thedynamicnatureof marketsbased on emerging echnologiesmakes it diffi-

68 This same resultcouldin theorybe achievedby adjustmentso eachstore'srent;how-ever,rent seems to be keyedto otherexternalities,or example,externalitieswithrespect othe decision to open a particular hop in a given mall. On these externalities, ee B. PeterPashigian& EricGould,Internalizing xternalities: hePricingof Space n ShoppingMalls,41 J. L. Econ. 115 (1998).69 TOplayout oneexample:platform wnerscouldrequirewould-beperipheralevelopersto paya licensingfee upfront; heplatform wnercould thenuse those fees to funda systemof sales incentivessimilar o those used in the automotivendustry.


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644 THE JOURNALOFLEGALSTUDIEScult to gather all affected firms for a single negotiation, and the externalityitself undermines the benefits of any negotiation conducted among a subsetof the affected firms. These problems can be solved by property rights.Thus, the paper has argued that intellectual property law should take stockof these issues, offering the possibility of stronger rights in cases where co-ordination would otherwise be implausible.Recent enthusiasm for legal rules that constrain the behavior of platformowners has to some degreecrowdedout conversations egarding egal re-form of the sort discussed here. That is unfortunate.Just as traditional net-work economics related to lock-in and network effects suggest that legalintervention limiting platform owner control might in some cases improvesocietal welfare, the network economics introduced in this paper suggestconversely that legal intervention supportive of owner control can at timesincrease societal welfare as well.

APPENDIXSuppose hatN firmseachproduceone peripheralompatiblewith a given plat-form.Eachfirm E [1, N] sells its peripheral t pricepi, and theplatforms avail-able atpricep, whichfor thepurposesof this modelis exogenous.Assumethattheplatformhas no intrinsicvalue, which is to say thatconsumerspurchase t onlybecause it enablesthemto use peripherals.If theplatformwerefree,a given consumerwould be willingto pay up to bifortheperipheral. Becausetheplatforms notfree, however, he consumer s willingto pay only up to bei, wherebe, is the consumer's"effective" valuationof the ithperipheral iven all prices,p-i, and the platformprice,p.Define N = {1, 2, 3, . . . , N and N, = N - {i}. The term be,i s therefore

p- 0 ifbj


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EMERGING LATFORMTECHNOLOGIES 645

Price 100

0Quantity

FIGUREA1.-Demand as reshapedby the pricesof, anddemand or, two additionalpe-ripherals.The three ines areinterpretedn the text.Figure Al interprets equation (Al) in the context of a specific example. Therightmost line represents demand for one peripheralunder the assumption that con-sumer valuations are uniformly distributed on [0, 100] and the relevant platform isavailable at no charge. The leftmost line shows how demand shifts when the plat-

form price is nonzero; in this example, price was set to 80. The middle line showshow demand is then reshapedby the introduction of two additionalperipherals.Thisparticular line shows demand under the assumptions that consumer valuations forthe other two peripheralsare independent and uniformly distributedon [0, 100] andthat the two additional peripherals are each sold at a price of 30.The introduction of the two additional peripheralsnot only shifts demand up andto the right, it also bends it. The upward shift is easy to understand: the effectiveprice of the platform has diminished, so demand partially recovers the loss repre-sented by the leftmost line. The bending at the top is more complicated. The intu-ition is that consumers who value at the highest extreme are especially rare sincesuch consumers not only must value the peripheral highly to begin with, but alsomust happen to value the other peripherals so much that the platform's effectiveprice is nearly zero. The confluence of these events is rare, and so, at the top of thecurve, a given price reduction lures fewer new purchasersthan would a correspond-ing change elsewhere in the curve.Denote the demand faced by firm i E N by Di(p, Pi, P-i), which means that thedemand for firm i's peripheral is a function of the price of the platform (p), theprice of the peripheral (pi), and the prices of all other peripherals (p-i). Note thatp-i does not affect Di directly, but instead influences Di through its effect on theeffective price of the platform. Firm i thus chooses pi to maximize its profit, ti,where r7i = piDi(p, pi, p_-) with both p and p-i taken as given. Firm i's first-ordercondition to this maximization problem isX/iapi -= Di(p, Pi, P-i) + piD'(p, Pi, P-i). (A2)Denote aDi/lap as DI. Let pUbe firm i's uncoordinated price in equilibrium. Weassume that the firms settle on a Nash equilibrium for ease of discussion; in cases


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646 THEJOURNALOF LEGALSTUDIESwhere there is no equilibrium, prices would churn and our claim would instead bethat they churn at levels that are unprofitably high. At pUthe first-order conditionin equation (A2) equals zero, so we get that

pU = Di(p, pU,pUi)/D(p, pU,pUg). (A3)Define pU = (p, . p..., p). The various claims made in the paper all assert thatp" is unprofitably high, in other words, that lowering prices would raise aggregateprofits. To see this, define total network profit, ItN, to beN = piDi(p, P, P-i). (A4)

For a given pi, the first-order condition to this maximization problem isa7N/aPi = Di(p, pi, p-i) + piD'(p, pi, p-i) + pj(aDj/ap). (A5)j#i

The critical point is this: any price for which this derivative is negative is, bydefinition, a price that is unprofitably high. A lower price increases aggregateprofits.It is helpful to rewrite equation (A5) asequation (A5) = equation (A2) + pj(aD/api). (A5')j#i

We know that equation (A2) = 0 for all i whenever prices are at the levels givenby p". We also know that pj > 0 for all j (since these are prices). Thus, at pU,theclaim (weakly) holds whenever

BRuapi = pj(Dj1/api)< O. (A6)j#iPROPOSITION.n settings where two or more firms sell peripherals and thoseperipherals are neither complements nor substitutes, each firm would earn greaterprofit if each charged a price lower than its individually rational price.We prove the proposition in two steps. First, we show that absent coordinationevery firm will charge too high a price relative to the prices that would maximizeaggregate profit. Then we show that whenever every firm is charging too high a

price relative to the prices that would maximize aggregate profit, there exists a setof coordinated prices such that each firm individually earns greater profit than itwould under uncoordinated conditions.Consider equation (A1). We know from equation (Al) that changes in the otherfirms' prices shift demand for any given peripheral, and in predictable ways. Lowerprices for the other peripherals mean increased demand for the original one. Con-versely, higher prices for the other peripherals mean lesser demand for the originalone. We defined the bracketedterm to be the "effective" platform price and furtherdefined Pe, to be the expected effective platform price. We thus know that JDiap,ei- 0 (that is, demand for the ith peripheraldecreases as the effective platform priceincreases) and Japiapj > 0 (an increase in firm j's price increases the effective

price of the platform as perceived by consumers thinking of purchasing any otherperipheral).The sign of equation (A6) is determined by the sign of JD/lkpifor all pairs (i,j) e N where i ?j. Since the peripherals are neither complements nor substitutes,


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EMERGINGPLATFORMTECHNOLOGIES 647the only relationship between their demand and other firms' prices is the relation-ship through the platform. Thus, for any pair, we know

~Dj/lpi = ~Djl/pej X aPejlapi, (A7)which is less than or equal to zero. Thus the inequality in equation (A6) holds, andwe know that every firm can lower its price and (weakly) increase its profits.Now we want to show that individual profits also rise-that is, if at the uncoordi-nated prices equation (A6) is negative, then there exists some set of prices (p* =[p* ... .5 p*]) such that p* -- p1 and for which individual firm profits rise evenwithout side payments between the firms. This proof proceeds as a proof by induc-tion. First we show that the result holds for the two-firm case, then we show thatif it holds for N firms, it also holds for (N + 1) firms.Define ntr to be cnr/iapjevaluated at price vector p". From the previous proof, weknow that at the uncoordinated prices, a marginal price reduction by either firmincreases overall profits. A price reduction lowers a firm's own profits, so it mustbe true that a price reduction by the first firm lowers its profits by less than it in-creases the second firm's profits, and vice versa. Thus,

I1II< I , 1, (A8)17tn2117t121. (A9)

Accounting for the signs, this implies (which will be useful below)7t'1172 < 7t127t21. (A10)

Let us now assume that we have a small downward deviation in prices from p".Differentiating each firm's profit function, we get

dItl = t11idp1 tl12dp2, (All)dit2 = It21dP1+-r22dp2. (A12)If both equations (All) and (A12) are greater than zero, then the price reductionwill have increased profit for both firms and the corollary would immediately betrue. If both are less than zero, then the reduction will have decreased aggregateprofits, which we know to be impossible. Thus, the case of interest is the case whereone is positive and the other is negative. Without loss of generality, let us assume,then, that equation (All) > 0 and equation (A12) < 0.Let us define firm 2's "break-even" price change, dpb, to be the change in P2such that, for a given change in pl, din2equals zero. In other words,

dpb(dpl) = -(1(n21/i22) X dp. (A13)If firm 2 selects this price change, then firm l's change in profit due to a givenchange in pi isdIrt= [111 - (i121r21)/122]X dp. (A14)Since dp1 < 0, firm l's profit rises on

The Journal of Legal Studies 2000 Lichtman

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