Why Openness Leads To Greater Innovation: The Friction Of The Hold Up Problem

from the the-hold-up-problem dept

Tue, Aug 10th 2010 1:12pm — Mike Masnick

There's an article over at GigaOm that's discussing some of the economics of open source software, specifically in relation to the development of Flash, and as a way to explain why Apple is so anti-Flash. But the key point of the article, a reminder of the so-called "hold-up problem" in economics, which basically shows the additional transaction costs associated with having to rely on another party:

The reason is based on what economists call "the hold up problem." When a business relies on assets owned by another party, it may become dependent on that party's cooperation in the future. In this situation, the party with ownership of a key resource may gain the ability to "hold up" its partner, demanding an unreasonably high price. Hold up becomes a problem especially when a business needs to make large capital investments that assume future cooperation from the owner of a complementary asset.

While the article goes on to explain why the problem is particularly an issue in IT, and why that explains why so many companies rely on open source software (to avoid the hold up problem), it actually is a good explanation for the friction and higher transaction costs involved in all sorts of innovation that relies on solutions that are locked up either via copyright or patents.

The biggest conceptual mistake that people have in thinking that copyright and patents lead to greater output or innovation is that they have trouble understanding the nature of dynamic creativity or innovation. It's tough to realize that innovation and creativity are both ongoing processes. There is no beginning, middle and end. They just keep going, and a single "flash of genius" is meaningless if it does not become a part of that dynamic flow. But the "hold up problem" described above gets in the way nearly every time if you have to rely on some other party -- such as a copyright holder or a patent holder -- to give their approval. It's why we so fear a permission-based culture that doesn't let such things move forward. Each time that it happens, it not only slows down both creativity and innovation, but adds additional wasteful transaction costs that are a dead weight loss to society.

These cases are the norm. Research has shown time and time again that it's the ongoing process that matters, not any particular element of it. And to make that ongoing process keep moving forward, you need less friction, not more. The hold-up problem shows how friction decreases a market from functioning properly, and in many, many cases, both patents and copyright serve to do one main thing: to add a hold-up problem where none need exist. In other words, they serve to add friction to the processes of creativity and innovation, rather than to take away friction. That should be seen as a serious problem.

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Filed Under: copyright, economics, friction, hold up problem, innovation, open source, openness, patents

20 Comments

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DMNTD, 10 Aug 2010 @ 1:24pm

Spot on...
In the vision of advancement you are spot on Mike. The situation you have here is a failure to see past their own nose. It inflates with the ego and gathering of money, so then it becomes a prospect to hold-up advancement.
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Dark Helmet (profile), 10 Aug 2010 @ 1:31pm

From bad to worse...
The hold up problem in the case of commercial software vs. open source is bad, but what about where there is not open source alternative? THAT'S where IP really gets in the way of progress.

For a single entity to be able to hold hostage the betterment of the masses for the sake of profit is a crime, particularly in the realm of pharma....
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Ryan, 10 Aug 2010 @ 2:23pm

Similar Issue
While it's perhaps a slightly bigger stretch to call them the "hold-up problem", the same sort of fallacious paradigm that requires unnecessary friction occurs in so many other places as well.

Restrictions on free trade(preventing consumers from acquiring resources at their cheapest), "creating" and saving jobs via subsidization, credits, etc.(preventing progress and market adaptation to changing scarcity by propping up unnecessary wasters of resources and labor), the gigantic dead weight that is the overhead of the government and its inefficient misallocation of resources, compulsory licensing/testing/approval of various endeavors and potential advancements, etc.

I think it just all comes down to the fact that most people have apparently lost sight of why jobs and economic transactions exist - to reduce scarcity and produce as much value for each consumer as possible with the given labor and resources. Instead, people see jobs and other artifacts of society as an end in themselves and we needlessly impede the progress of our own quality of life.
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Anonymous Coward, 10 Aug 2010 @ 3:35pm

Re: From bad to worse...
http://tropicaldisease.org/
http://www.iowh.org/
http://www.dndi.org/

Not for long, if they are not careful.

GlaxoSmithKline, Pfizer and Novartis are all jumping up and down, looking at how the competition is working to try and find something they can use.
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Andrew, 10 Aug 2010 @ 3:53pm

I don't get it.
Please someone explain this to me. I can see that openness leads to innovation. But say we get rid of copyright and patents. What is the incentive for content creators and inventors? Not everyone is so altruistic (or are in a good enough financial position) that they create and innovate purely for the greater good. These things require a huge commitment of time and resources, and the prospect of limited financial reward ensures that a lot of great ideas never get off the ground.

I am an inventor with a great idea which I am working on in my spare time, not in my job. I am in the process of building a prototype, which is costing a significant amount of spare time and not so spare money. Why should I keep going? I expect a payoff at the end. Otherwise I'm just throwing money down the drain. Someone tell me why I should innovate for free so that everyone can use a better product. Or tell me how I can do this and make it rewarding for me without selling or licencing a patent. And I don't mean rewarding in a warm and fuzzy kind of way, I've got a family to look after.

What is the mechanism for rewarding content creation and innovation in a system without copyright or patents? Fame is not enough.
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Anonymous Coward, 10 Aug 2010 @ 4:14pm

Re: I don't get it.
Correct me if I'm wrong, but I believe if you are inventing a physical object that isn't software code or a method (say business) of doing something, you have techdirt's praise. Patenting objects as the original founders of the patent system desired is good, patenting ideas that are code is silly and harmful. The patent review process needs a massive overhaul as well, as many, many patents are being granted that are obvious in nature and with prior art. Patent without use or license (hoarding patents) should not be permitted, as it actually discourages invention.

As for copyright, a system of limiting copyright to say 10-20 years is desired. Copyrights should expire upon death of the owner, as well. Renewal is harmful, it adds a layer of management that is cumbersome and harmful to innovation.

Current copyright law is life + 70-120 years depending on who/what corp owns it, and it almost certainly will be pushed to be extended again after 70 years pass the last rules change. This means a lot of overhead on every future creation to verify copyrights, and a lot of blocked free creativity...
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Chris Mikaitis (profile), 10 Aug 2010 @ 4:38pm

Re: I don't get it.
I think it matters what you are producing, and how you intend to make money off of your production. If you are producing a physical product, and it is unique and without equal, you are in a tight spot. It's hard for everyday people to see a new product and not try to improve upon it.

I had a thought several years ago about an auto-swing door for waitresses. The problem is that waitresses always back out of doors with a tray full of goods. Many times they have a window at head height to determine obstacles before they push the door. These 'head height' windows ignore stupid children with irresponsible parents. My girlfriend is in this field and has had many waitresses spill food (or burn themselves) to prevent hurting a kid.

My idea is for a door that would use pressure plates on both sides to determine who is in the path. With weight on only one side, it would transmit power to a balanced door to allow a small amount of power to 'swing' the door outwards. Pressure on the other plate would stop the door.

This seemed like a good idea, but the idea of 'patenting' this idea is absurd. I would prefer to give this to the world, with time stamps to back up the fact that I gave it, then be able to use this as a reference on a resume.

You may have a marketable product... but it will likely not be recognized as your own once the process is through...
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Mike Masnick (profile), 10 Aug 2010 @ 5:44pm

Re: I don't get it.
Please someone explain this to me. I can see that openness leads to innovation. But say we get rid of copyright and patents. What is the incentive for content creators and inventors?

Selling a product in the market? Solving a need that you have? Lots of incentives that have nothing to do with patents.

Not everyone is so altruistic (or are in a good enough financial position) that they create and innovate purely for the greater good.

I'd never suggest doing it for altruistic reasons at all, or did I here. Altruism is a personal choice, not one that you put on others. I am saying that rather than using a gov't granted monopoly, focus on other business models.

These things require a huge commitment of time and resources, and the prospect of limited financial reward ensures that a lot of great ideas never get off the ground.

Your mistake is assuming no patent means limited financial rewards.

I am an inventor with a great idea which I am working on in my spare time, not in my job. I am in the process of building a prototype, which is costing a significant amount of spare time and not so spare money. Why should I keep going? I expect a payoff at the end.

You should keep going if you think there's a significant payoff at the end. No one said otherwise.

Someone tell me why I should innovate for free so that everyone can use a better product.

But you're not innovating for free. You say you're working on a great idea. I assume there's a market for that idea, so you should be able to help that market and make money by selling products, no?

Or tell me how I can do this and make it rewarding for me without selling or licencing a patent.

The specifics probably depend on the product itself, but if there's no valuable product, then the patent is worthless anyway. If there's a valuable product, then you can sell the product.

If you're concerned that others will automatically copy your product, well, that's part of competition. Since you've been working so hard on the product, I would imagine you know the product and the market better than your would-be competitors, meaning I'm sure you'll be able to stay ahead in the marketplace -- not to mention that you'll have the first mover advantage (which is a huge driver of profit margin for many products).

What is the mechanism for rewarding content creation and innovation in a system without copyright or patents? Fame is not enough.

Selling products certainly seems to be the answer. Seems odd that you ignore that.
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Lawrence D'Oliveiro, 10 Aug 2010 @ 6:12pm

Re: I don't get it.
Andrew spouted:

But say we get rid of copyright and patents. What is the incentive for content creators and inventors?

You can answer the question yourself. Content creation and invention go back right into the mists of human prehistory, while copyrights and patents are only a few centuries old. In other words, for over 99% of our existence, we didn’t need these intellectual-monopoly mechanisms to create or invent. Why should we need them now?
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Anonymous Coward, 10 Aug 2010 @ 8:24pm

Re: I don't get it.
"What is the incentive for content creators and inventors?"

Humanity's demand for content and innovation is incentive to create content and innovate. Necessity is incentive.
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Andrew, 10 Aug 2010 @ 10:34pm

Re: Re: I don't get it.
Thank you for your reply Mr Masnick. Like Agent Mulder, I want to believe.

Ok, so I make a better/new product and sell it to make money without a patent to protect it from being copied. The product sells in the millions, is copied and improved and I in turn improve my own version of the product. This is great, everyone gets a better product and I make more money than the rest with my first-to-market advantage and niche knowledge. But to get to this stage I have most likely mortgaged my house and spent 5-10 years learning how to run and then develop the business. Not everyone has the skill or desire to run a business.

For a lot of small inventors, the patent is the product. They don’t want to run a business, it is not what they are good at. What other business model should people like this use? A patent seems necessary in this case as a company won’t pay for intellectual property that is already in the public domain, or does not have the perceived protection of a patent. Companies also won’t sign non-disclosure agreements when the inventor makes a pitch so the inventor needs the patent as well. How can small inventors who don’t want to run a company commercialise their invention other than with a patent?

What about this: I invent something physical that has quality and is non-obvious. I file a patent and licence it out for the life of the patent for a modest annual fee, non-exclusively and with no royalties. This seems fair as most inventions would not exist without, and are built on top of the work of a previous inventor. Companies can buy in cheaply and develop the product. Competition means a better product. The inventor gets a cheque for their efforts that can support them in inventing more great products. Win-win-win.
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Mike Masnick (profile), 10 Aug 2010 @ 11:13pm

Re: Re: Re: I don't get it.
But to get to this stage I have most likely mortgaged my house and spent 5-10 years learning how to run and then develop the business. Not everyone has the skill or desire to run a business.

This is why many, many, many businesses in this world involve multiple founders with different skills. Quite frequently, startups have a "business" founder and a "tech" founder. You don't have to run a business. You have to partner with someone who does.

And, no, that's not easy, but life isn't always easy.

I've had some "great ideas" in my life, but my programming skills are not very good. So, I partnered up with folks who can program. Find people who complement your skillset and work with them.

For a lot of small inventors, the patent is the product. They don’t want to run a business, it is not what they are good at. What other business model should people like this use?

Again, no reason they can't partner up with someone who runs the business side, while they focus on building/inventing. This can work out nicely in that the inventor doesn't even have to worry about patents/licensing and can really just focus on inventing.

A patent seems necessary in this case as a company won’t pay for intellectual property that is already in the public domain, or does not have the perceived protection of a patent.

Well, you'd be surprised. Again, there is often value in having a deal with the inventor to better understand the product/market and to work on improvements. It may not be a licensing deal, but there could still be a contractual/consulting arrangement.

What about this: I invent something physical that has quality and is non-obvious. I file a patent and licence it out for the life of the patent for a modest annual fee, non-exclusively and with no royalties. This seems fair as most inventions would not exist without, and are built on top of the work of a previous inventor. Companies can buy in cheaply and develop the product. Competition means a better product. The inventor gets a cheque for their efforts that can support them in inventing more great products. Win-win-win.

Seems a hell of a lot better than the way patents are often used. But, why not structure the same thing as an expertise-sharing situation. You can call it a yearly license, or you can set it up as a membership setup, where everyone who pays not only gets access to you (can ask questions) but to each other as well -- and then you have a community of folks interested in making your invention really marketable, and you make money off of the membership fees of those individuals sharing the knowledge to take a market from zero to much bigger.

Studies have shown that, especially in emerging markets, there's actually value in a variety of companies competing in that market to not just define the market and improve the product, but to help spread the word of the product and the benefits of it.
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Hephaestus (profile), 11 Aug 2010 @ 7:09am

Re: Re: I don't get it.
"Copyrights should expire upon death of the owner, as well."

Actually it should last as long as it would have if he was alive. You dont want to incentify killing the author to profit from his works.
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Dale B. Halling, 11 Aug 2010 @ 9:02am

The Investment Problem
The so called friction problem ignores the investment problem. The biggest limitation, after talent, to invention is investment. Without property rights it is impossible to finance a house or finance software development or other inventions. The open source community has been around for over a decade and its record of innovation is weak at best. Most of the open source software is an extension of existing software. Most notably Linux is just UNIX that has been updated and ported to other platforms. Open source’s record of innovation is mainly the sort of incremental innovation that you would expect from a large company. Open source has not transformed the software industry, it has not created significant wealth or jobs, it has not lead to any revolutionary applications. However, it has shifted wealth from software inventors to finance and management.
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Anonymous Coward, 11 Aug 2010 @ 10:24am

Re: From bad to worse...
It can be even worse when there CANNOT be an open source alternative, due to patents or other things.
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Anonymous Coward, 11 Aug 2010 @ 10:28am

Re: The Investment Problem
> and its record of innovation is weak at best.

http://www.dwheeler.com/innovation/innovation.html
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Mike Masnick (profile), 11 Aug 2010 @ 11:25am

Re: The Investment Problem
Open source’s record of innovation is mainly the sort of incremental innovation that you would expect from a large company. Open source has not transformed the software industry, it has not created significant wealth or jobs, it has not lead to any revolutionary applications.

You lost all credibility with the statement above.

One word to prove you wrong: Google.
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Mike Masnick (profile), 11 Aug 2010 @ 11:28am

Re: The Investment Problem
And just after I replied to this, I saw the latest study showing how open source is fueling innovation throughout the enterprise:

http://www.linux-foundation.org/weblogs/amanda/2010/08/11/forrester-congratulations-o pen-sourcers-you%E2%80%99re-on-the-winning-team/

Once again, Halling shows he has no credibility on this subject.
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TtfnJohn (profile), 11 Aug 2010 @ 10:04pm

Re: Re: Re: I don't get it.
"You dont want to incentify killing the author to profit from his works."

You don't!!!!!!! :-)
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TtfnJohn (profile), 11 Aug 2010 @ 10:27pm

Re: The Investment Problem
"Open source’s record of innovation is mainly the sort of incremental innovation that you would expect from a large company."

Oh, like Microsoft?

You probably wouldn't notice it if you saw it on your MS desktop so you have no idea if there's been a revolutionary application or not.

"it has not lead to any revolutionary applications."

Still, let me introduce you to one that you use every day whether you realize it or not. The Apache Web Server.

"Open source has not transformed the software industry"

Really? I wonder what MS has been so worried about all these years then?

Don't work much in networking or backbones do you? Don't work much on large scale commercial applications such as dynamic layout and typesetting like newspapers do you? Let me introduce LaTeX.

"it has shifted wealth from software inventors to finance and management."

I'd suggest that after IBM, Microsoft and Apple have been more responsible for that than Open Source has ever been. Not because they're particularly evil rather that after a certain point that's the way the market works. Programmers move out of the basement to become cubicle drones in large corporations unless they're highly skilled and can sell their skills to the highest bidder. Apparently you're not one of them.

I think it's called the free market.
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