Evaluating Appropriability Defenses for the Exclusionary Conduct of Dominant Firms in Innovative Industries

In response to antitrust cases challenging the exclusionary conduct of dominant firms, some dominant firms offer an “appropriability defense”: a claim that prohibiting the challenged conduct would harm innovation by lessening the dominant firm’s return to investment in research and development (R&D) and, in consequence, undermining that firm’s incentive to innovate. This paper explains that an “appropriability defense” should be questioned, and often rejected, if the dominant firm would be expected to increase its own R&D effort in response to increased R&D by its rivals. The paper provides an analytical framework for determining whether a dominant firm would behave this way, based on evaluating the firm’s likely incremental gain from new product development if its rivals also introduce new products relative to its gain if its rivals do not upgrade their products. The paper also identifies potentially observable factors relevant to making this assessment. The application of the framework in individual cases is illustrated using the facts of three classic antitrust monopolization cases involving new product development: the Microsoft case involving Netscape and Java, the IBM plug compatibility cases (treated as a single case), and the FTC’s patent portfolio case against Xerox. J. Baker on Appropriability Searle Antitrust Economics Conference Draft 2 Evaluating Appropriability Defenses for the Exclusionary Conduct of Dominant Firms in Innovative Industries