Hiding in the Patent’s Shadow: Firms’ Use of Secrecy to Capture Value from New Discoveries

How do firms use secrecy to capture value from inventions? Can a strategic mix of secrecy and patent protections secure for the firm a competitive advantage when commercializing its new technologies? And what role does patent “disclosure” play as a strategic choice in winning for the firm super-normal profits from innovation? Answering these questions is fundamental if we are to understand the central focus of strategic management in the new knowledge-based economy: How firms create and sustain value in their intangible assets. Since Teece (1986), we have understood that effective management of intangible assets is frequently the decisive element in firm success. Firms often identify secrecy as the most exploited—and effective—means of earning super-normal profits from technology discoveries (Levin, et al., 1987; Cohen, et al., 2002). Yet with the exception of several qualitative studies (Liebeskind, 1996; 1997), the field has lacked the ability to empirically investigate the use by firms of secrecy and its strategic implications. By employing a novel data source, the continuation patent, my paper offers the field a view into this otherwise hidden strategic behavior by firms. Contrary to the widely-held impression that patent and secrecy are substitutes, my theory and evidence demonstrate complementarity between patenting and secrecy. Furthermore, secrecy is shown to be a choice that firms exploit when developing innovation strategies. This choice is widely available to firms, and not narrowly constrained by technological characteristics as has been previously suggested (Arora, 1996). My research also sheds light upon the drivers of the firm’s choice of secrecy when crafting a technology-tomarket strategy, suggesting that different types of secrecy—technology and application—are functioning, and that the firm’s ability to exploit these types create opportunities for distinct strategic moves. To empirically investigate these issues, I employ a previously unexploited patent-based data source, the continuation, and use these data to explore firms’ strategic uses of secrecy. 1 Doctoral Candidate, Walter A. Haas School of Business, University of California, Berkeley. Firms’ use of the continuation, in effect a delaying mechanism, is widespread: continuation use in some sectors exceeds 70% of all U.S. patents issued. The continuation phenomenon in patenting has nevertheless been largely ignored in the literature. I argue that the continuation application affords the patentee a strategic opportunity, to secure a more valuable secrecy than simple trade-secret provides. And while the literature has traditionally viewed secrecy as a substitute to patenting (Friedman et al., 1985), I demonstrate that secrecy functions routinely as a complement to the act of patenting itself. By using U.S. continuation patent data I am able to analyze firms’ patent-secrecy strategies, contending that firms take advantage of the complementarity between secrecy and patenting, that this complementarity offers incumbents in the technology path significant benefits, but that its use is subject to constraints associated with the speed at which profits arrive from the commercialization of the invention. I use the U.S. continuation patent data to empirically test for the existence of these firms’ uses of secrecy as an element of patenting strategy, specifying a binomial logit to test secrecy-based hypotheses along with several other explanations derived from the literature on firms’ continuation use (Merges, 1999; Quillen and Webster, 2002). In developing refutable implications, I model the competitive interaction of innovating firms, and find that incentives to acquire strategic secrecy are particularly strong in incumbent firms to prevent disruptive or displacing innovation by entrants. I also create a strategic framework for understanding complementary uses of patenting and secrecy that supports my core arguments: The value firms attach to secrecy in appropriating rents from inventions is an important determinant of the use of continuation application strategies in firm patenting. I test my hypotheses by creating a new database, collecting the continuation application data on over 2 million patents issued to firms between 1975 and 2000. Because the value that firms attach to secrecy is not readily observable, I construct a measure of this value derived from the Cohen et al. (2001) surveys. Using this measure required that I develop another analytic innovation, and I construct to my knowledge the first concordance matching U.S. patents to International Standard Industrial Classifications (ISIC), using the framework pioneered by Silverman (1996) as a model. I find support for my hypotheses that as firms attach increasing importance to secrecy as a mechanism for capturing value, they are more likely to choose continuation patenting as a strategic option, in particular when the firm is an incumbent in control of the technology trajectory, yet constrained by the rate at which profits arrive from the innovative activity. This paper makes four main contributions to the existing literature. First, I create and test a framework for understanding firms’ choices in developing patenting and secrecy strategies, demonstrating that these mechanisms are routinely used as complements. Second, I provide an econometric specification for the use by firms of secrecy, a strategic choice by firms that has heretofore been hidden from us. Third, I exploit a rich new data source, the continuation application in U.S. patenting, that promises to spawn a wide array of studies. Finally, I contribute to the existing literature on firm patenting strategy, substantially informing our understanding of an economically important and complex phenomenon. Discovering how firms capture and sustain competitive advantage from their intangible assets is fundamental to our understanding of the strategic management of technology. With the growing importance of “knowledge” as a driver of economic value, unresolved questions concerning the role and effectiveness of different firm appropriability mechanisms loom large. This paper contributes to the literature a means, a framework, and empirically-supported hypotheses that enlighten firm secrecy strategies. Secrecy, long known to be the most effective method of capturing value from discoveries, has heretofore been hidden from us. By furthering our understanding of the relationship between secrecy and patenting in corporate appropriation strategies, this paper will be a welcome addition to researchers, managers, and policy-makers alike.