Innovation and the Firm: A New Synthesis

• Published in: Stanford law review Vol. 70; no. 5; pp. 1431 - 1501
• Main Author: Lee, Peter
• Format: Journal Article
• Language: English
• Published: Stanford Students of the Stanford Law School 01.05.2018; Stanford Law School; Stanford University, Stanford Law School
• Subjects: Acquisitions & mergers; Agricultural biotechnology; Antitrust laws; Capital costs; Causes of; Company acquisition/merger; Competition; COSTS; Drugs; Economic aspects; Foreclosure; High technology industry; INDUSTRY; Influence; Information technology; Innovations; Intellectual property; Law and legislation; Licenses; LICENSING; Mergers, acquisitions and divestments; Patent licencing; Patent licenses; Patent licensing; Pharmaceutical biotechnology industry; Pharmaceutical industry; PHARMACEUTICALS; Scholarships; Social aspects; Tacit knowledge; TECHNOLOGY; Technology and law; Technology transfer; Value chain; Vertical integration; UNITED STATES; United States > US; Chicago Illinois
• ISSN: 0038-9765; 1939-8581

Recent scholarship highlights the prevalence in high-technology industries of vertical disintegration, in which separate entities along a value chain transfer knowledge-intensive assets between them. Patents play a critical role in this process by lowering the cost of transactions between "upstream" technology generators and "downstream" parties that further develop technologies, thus promoting vertical disintegration. This Article challenges that prevailing narrative by arguing that vertical integration pervades patent-intensive fields. In biopharmaceuticals, agricultural biotechnology, information technology, and even university-industry technology transfer, firms are increasingly integrating under a common organizational framework rather than remaining separate and licensing patents between distinct entities. This Article explains the surprising persistence of vertical integration by retheorizing the relationship between innovation and the firm. It therefore sheds new light on a longstanding debate over whether innovation should be organized within a hierarchical organization—the firm—or coordinated through market exchanges among separate entities. Synthesizing previously disconnected lines of theory, this Article first argues that the challenge of aggregating tacit technical knowledge—which patents do not disclose—leads high-tech companies to vertically integrate rather than simply rely on licenses to transfer technology. Relatedly, the desire to obtain not just discrete technological assets but also innovative capacity, in the form of talented engineers and scientists, motivates vertical integration. Finally, strategic imperatives to achieve rapid scale and scope also lead firms to integrate with other entities rather than simply license their patents. Tacit knowledge, innovative capacity, and strategic considerations explain not only why firms vertically integrate but also why they do so by acquiring preexisting organizations and granting them significant autonomy, an underappreciated phenomenon this Article describes as "semi-integration." The result, contrary to theory, is a resurgence of vertical integration in patent-intensive fields. This Article concludes by evaluating the costs and benefits of vertically integrated innovative industries, suggesting private and public mechanisms for improving integration and tempering its excesses.