Using Patents in Promotional Activities

A traditional view of patents and patenting shows a trade-off between the benefit of appropriation and the cost of information revelation. However, firms may benefit from information revelation to consumers because patents can provide credible information about the firm ’ s ability to develop new technologies and produce good quality products. In fact, we frequently observe that many firms use their patents for promotion in a variety of industries, including foods, cosmetics, and electronic devices. We construct a simple model to study a usage of patents in promotion activities, a promotional patent, and investigate an advantage for a firm to employ a promotional patent. We make two findings. First, we find a positive information value of a promotional patent to a high-type firm. The benefit stems from an increase in the consumers’ willingness to pay in two ways. The expected valuation to the consumers increases because i) the patented innovation directly improves the product quality and ii) the promotional patent increases a likelihood of the firm to be a high type. The firm then absorbs the increase of the expected valuation. Second, the information value to the high-type firm is non-monotonic. The information value increases (decreases) with a prior probability that a firm is a high type when the prior probability is low (high).

• Patent
• Information Revelation
• Promotional Activity

1. Introduction

A traditional view of patents and patenting shows a trade-off between the benefit of appropriation and the cost of information revelation¹. In fact, inventors often hesitate to apply for patents because inventors’ knowledge may spill over to their competitors. Horstmann et al. [5] suggest a mechanism how a firm’s technical knowledge leaks to its competitor via a patenting behavior, and study the trade-off of patenting between its benefit and cost. They show that a leading firm keeps its invention confidential when patenting behavior reveals to the following firm that the following firm could profitably imitate the leading firm. Choi [6] argues that the patent system cannot provide perfect protection to innovators as empirical studies suggest, and shows that information revelation through infringement suits can be harmful for patentees. In his two-period model with costly imitation, there are two potential imitators, and the process of liti- gation reveals information about which competitors can profitably imitate the paten- tee².

However, inventors may often benefit from information revelation, because patents can provide credible information about inventors’ attributes, which are hardly obser- vable to outsiders, thereby relieving information asymmetry (Long [10] ). Mann and Sager [11] show a positive correlation between patents obtained by start-up firms in the software industry and total investment, and find that a single patent brings USD 2.7 million in investment into a start-up firm from venture capitalists, suggesting that patents serve as an indicator of a firm’s higher performance. They also point out that patent signals do not work well in the initial funding round and that patent values increase in the consequent rounds. Similarly, Hsu and Ziedonis [12] study a relation between firm values and patents in the semiconductor industry. Contrary to Mann and Sager [11] , Hsu and Ziedonis [12] show that in earlier funding stages, when investors face uncertainty about the firm’s performance, patents serve well as an indicator of the firm’s performance, leading to more investments into the firm.

This paper suggests a new aspect of the benefit from information revelation of patents³. That is, a firm can reveal its ability to develop new technologies and produce new products of good quality by using a patent for promotion. For example, Kirin Brewery Company obtained a patent, Process of Browning (Japan Patent No. 3836117), and mentioned the patented manufacturing process of its new low-malt beer in a TV commercial without explaining the technology in detail. Even if consumers do not understand how the new process contributes to the quality or taste of low-malt beer, they may believe that the taste of low-malt beer must be great just because of the fact that the new patented process is used for the product. In fact, we frequently observe that many companies use their patents for promotion in a variety of industries, including foods, cosmetics, and electronic devices. Using a questionnaire survey, the Institute of Intellectual Property in Japan shows that firms often use patents for demonstrating their advantage in performance to their competitors and their product’s prominent functions to their customers (Institute of Intellectual Property [14] ).

We construct a simple model to study a usage of patents in promotion activities. A firm with two types provides new products whose quality is either good or bad. The product quality is stochastically determined by not only the firm’s type but also its production technology. The technology is either normal or innovative. The innovative technology is assumed to be protected by a patent. Consumers can observe neither the firm’s type, the product quality, nor the production technology. However, if a firm employs a promotional patent, consumers become certain about the production technology because a patent provides a credible information about a firm’s type to the consumers. The firm posts a take-it-or-leave-it offer as a price which is equal to the expected valuation to the consumers.

We make two findings. First, we find a positive information value of a promotional patent to the high-type firm. The benefit stems from an increase in the consumers’ willingness to pay in two ways. The expected valuation to the consumers increases because i) the patented innovation directly improves the product quality and ii) the promotional patent increases a likelihood of the firm to be a high type. The firm then absorbs the increase of the expected valuation. Second, the information value to the high type firm is non-monotonic. The information value increases (decreases) with a prior probability that a firm is a high type when the prior probability is low (high).

The organization of the rest of this paper is as follows. Section 2 introduces the model and describes a situation where a firm does not use a promotional patent. Sec- tion 3 describes a situation in which a firm uses a patent in promotional activities if the firm has a patented innovation, and examines an advantage of a firm to employ a promotional patent. Section 4 provides concluding remarks and briefly discusses assump- tions put in this paper. A direction of future researches is suggested as well in this section. The Appendix includes the proof of proposition.

2. The Model

We construct a simple model to study a usage of patents in promotion activities. A single firm introduces new products into a monopoly market with a continuum of identical consumers whose mass is normalized to one. The new products are of either good quality (henceforth, G) or bad quality (henceforth, B). Each consumer demands at most one unit, and worth of G and B products to consumers is one and zero, respectively. Two factors jointly and stochastically contribute to the product quality. One is the firm’s type and other is a production technology the firm owns to produce the new products. However, the product quality is assumed to be unobservable to the consumers.

The firm’s type is either high (henceforth, H) or low (henceforth, L). The H type firm is more likely to produce the G products than the L type. The firm’s type is the firm’s private information, and that the consumers know only prior probability of the firm to be an H type, which is a common knowledge.

The production technology is either innovative or normal. If the firm has invented an innovative technology through R & D activities, it uses the process innovation to produce the new products; otherwise, it uses an existing technology (i.e., a normal technology). We assume a higher likelihood of innovation for the H type firm. Speci- fically, the L type firm develops the process innovation with probability whereas the H type succeeds in obtaining the innovative technology with certainty⁴. The process innovation enhances a probability of the firm to produce the G products, but a likelihood differs between the firm’s types. Table 1 shows probabilities that the firm produces the G products given the firm type and the production technology. We assume naturally. Thus, the firm type affects the product quality not only directly but also indirectly through a production technology the firm develops through R&D activities.

The firm announces a price which is a take-it-or-leave-it offer. Then, the consumers buy the products if the price is at or below the expected valuation. We employ perfect Bayesian equilibrium as a solution concept in which the consumers hold a belief about the firm’s type. In any equilibrium, however, a price offered by the firm does not reveal any private information because switching a price to imitate the other type is costless for the firm and thus both types should announce the same price. Moreover, the consumers cannot observe the production technology. In other words, the consumers meet no opportunity to update their belief about the firm’s type. Consequently, the firm offers a price which is equal to the expected valuation to the consumers, which is given by

The price is then accepted by the consumers.

3. Promotional Patent

This section considers the firm to use a patent in promotional activities. We refer to such a usage of a patent as a promotional patent. Suppose that the firm patents the process innovation (i.e., the innovative production technology) and then reveals the fact to the consumers by employing a promotional patent. As we discussed in the introduction part, employing such a promotional patent is prevalent in business situations. We assume that a promotional patent is costless because printing messages such as “patented” and patent number on product packages is inexpensive. A promi- nent feature of a promotional patent is to provide credible information about aproduc-

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