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Protecting Innivation
The Digital Music Distribution Revolution
Fraunhofer and MP3
In 1991, Fraunhofer IIS of Germany developed an algorithm that would
set in motion a revolution in how music was distributed, stored, and
consumed. This format for compressed audio files was later dubbed
MPEG-1 layer 3—a.k.a. MP3. By 1995, software programs were
available that enabled consumers to convert tracks from compact discs
to MP3 files. This technology transformed how music could be
manipulated—a song was now a file that could be kept on a hard drive,
and the file was small enough to be shared over the Internet.
AGUNG KURNIAWAN– SISTEM INFORMASI

Napster Takes the Lead
In 1999, while a student at Northeastern University in Boston, Shawn
Fanning released Napster—a software program that allowed users with
Internet access to easily share MP3 files. Napster provided a user-
friendly solution to music fans wishing to share and find music online.
Napster provided a user interface with a search box that pointed
individuals to other users with the files they wished to download. The
Napster servers did not host any MP3 files; rather they hosted a
database with information on which users had which files to share and
whether they were online, and connected one computer to another for
downloading.

iTunes Just in Time
On April 28, 2003, Apple opened its iTunes Music Store. After striking
agreements with the five major record labels (Sony, Universal, BMG,
Warner Music Group, and EMI), iTunes launched with an initial
catalogs of 200,000 songs for purchase at 99 cents per song.i iTunes
showed immediate signs of success, boasting 50 million downloads
within the first year, and quickly became the leading distributor of
music online

Appropriability
appropriability The degree to which a firm is able to capture the rents
from its innovation.
tacit knowledge Knowledge that cannot be readily codified or trans-
ferred in written form.
socially complex knowledge Knowledge that arises from the interaction
of multiple individuals.

PATENTS,
TRADEMARKS, AND
COPYRIGHTS
Patent A property right protecting a pro- cess, machine, manufactured
item (or design for manufactured item), or variety of plant.
Trademark An indicator used to distin- guish the source of a good.
Copyright A property right protecting works of authorship.

Theory in Action
IBM and the Attack of the Clones
In 1980, IBM was in a hurry to introduce a personal computer. When
personal computers first began to emerge at the end of the 1970s,the
idea that individuals would want personal computers on their desks
seemed ludicrous. However, as total U.S. personal computer sales
reached $1 billion, IBM began to worry that the personal computer
market could actually turn out to be a significant computer market in
which IBM had no share.

Continued
IBM decided to use many off-the-shelf components from other
vendors, including Intel’s 8088 microprocessor and Microsoft’s soft-
ware. IBM was not worried about imitators because IBM’s proprietary
basic input/output system (BIOS), the computer code that linked the
computer’s hardware to its software, was protected by copyright. IBM’s
copyright turned out not to be difficult. Copyright protected the writ-
ten lines of code, but not the functions those codes produced. Compaq
was able to reverse-engineer the BIOS in a matter of months without
violating IBM’s copyright.

Advantages of
protection
Because proprietary systems offer greater rent appropriability, their
developers often have more money and incentive to invest in
technological development, promotion, and distribution. Protecting the
technology also gives the developing firm architectural control over the
technology.

Advantages of
Diffusion
First, external development efforts typically lack the coordination of
internal development. External developers may have very diverse
objectives for the technology; rather than work together toward some
unified vision of what the technology could achieve in the future, they
might work in different, possibly even conflicting, directions.26 Much
of their effort may be redundant, as different external developers work
on solving the same problems without communicating with each other.

Continued
UNIX provides a stark example of this. UNIX was an operating system
first developed by AT&T’s Bell Laboratories in 1969. Though a
Department of Justice injunction forbade AT&T from selling software
commercially, it made the source code for the product available
through licensing arrangements. Though the software community
made several attempts to standardize the UNIX operating language,
their efforts failed. AT&T also challenged the commercialization of
several UNIX variants, but to no avail. Ulti- mately, AT&T sold the
division responsible for UNIX to Novell, and Novell handed over the
rights to the UNIX trademark to the X/Open standards-setting body.

Production Capabilities,
Marketing Capabilities, and
Capital
If the firm is unable to produce the technology at sufficient volume or
quality levels (or market the technology with sufficient intensity), then
protecting the technology so that the firm is its sole provider may
significantly hinder its adoption. Example JVC was promoting its VHS
standard for video recorders, its management knew JVC was at a
disadvantage in both manufacturing and marketing capabilities
compared to Sony (which was promoting the Beta technology). JVC
chose to vigorously pursue both licensing and OEM agreements, lining
up Hitachi, Matsushita, Mitsubishi, and Sharp to boost the technology’s
production rate.

Industry Opposition against
Sole-Source Technology
Sometimes other industry members are able to exert strong pressure against the adoption
of a technology that would give one (or a few) producer(s) undue control and power, caus-
ing a technology that is restricted to such production to be rejected or more hotly contested
than a more open technology. Sony and Philips’ Super Audio CD (SACD) audio format. Sony
and Philips had jointly created the original compact disc (CD) format and split the royalties
on every CD player sold, totaling hundreds of millions of dollars. The rest of the world’s
leading consumer electronics producers (including Hit- achi, JVC, Matsushita, Mitsubishi,
and Toshiba) and record producers (including Time Warner and Seagram’s Universal Music
group) banded together to form the Digital Video Disk (DVD) Audio consortium. This
consortium’s purpose is to promote the DVD Audio standard that is intended to displace the
CD and enable royalties to be split among the 10 companies that control the patents.

Resources for
Internal
Development
If a firm does not have significant resources (capital, technological
expertise) to invest in the technology’s functionality, it may have
difficulty producing a technology that has an initial performance level,
and rate of improvement, that the market finds attractive.

Control over
Fragmentation
For technologies in which standardization and compatibility are
important, maintain- ing the integrity of the core product is absolutely
essential, and external development can put it at risk. As the UNIX
example illustrates, if the developing firm relinquishes all control over
the development of the technology, the technology will have no shep-
herd with the ability and authority to direct its trajectory and ensure
that a single standard remains intact.

Incentives for
Architectural Control
Architectural control over the evolution of a technology is always
valuable; however, it becomes particularly valuable if a firm is a
significant producer of complements to the technology in question. A
firm with architectural control can typically design the technology to be
compatible with its own complements and incompatible with those of
competitors. If the technology is chosen as the dominant design, this
architectural control allows the firm to ensure that it reaps the lion’s
share of the rewards in complements production.

Summary of Chapter
1. The degree to which a firm can capture the rents from its innovation efforts
is largely determined by the degree to which competitors can quickly and
easily imi- tate the innovation. Some innovations are inherently difficult to
copy; others are difficult to copy because of the mechanisms the firm uses
to protect its innovation.
2. The three primary legal mechanisms used to protect innovation in most
countries are patents, trademarks, and copyrights. Each mechanism is
designed to protect a different type of work or good.
3. International treaties have helped to harmonize patent, trademark, and
copyright laws around the world. Most countries now have patent,
trademark, and copyright laws of some form, and in some instances
protection can be applied for in multiple countries simultaneously.

Summary of Chapter
4. Protecting an innovation also preserves the firm’s architectural control,
enabling it to direct the technology’s development, determine its
compatibility with other goods, and prevent multiple incompatible versions
of the technology from being produced by other firms.
5. Diffusing a technological innovation can encourage multiple firms to produce,
distribute, and promote the technology, possibly accelerating its
development and diffusion. Diffusion can be particularly useful in industries
that accrue increasing returns to adoption. It is also useful when the firm has
inadequate resources to be the sole developer, producer, distributor, and
marketer of a good.

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