August 2012

A PUBLICATION OF CHILTON CAPITAL MANAGEMENT

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Let Them Steal It

Samuel Rines

to an existing technology at a high level of quality and design. Imitation is the creation of a lower quality product with many of the same qualitative aspects as the innovation. Stealing is Good How could imitation be a good thing for the developed world? How could the blatant copying of innovative products be a positive? The notion that lower protections of IP in less-developed countries is important, or at least not devastating, to the developed world is at best counter-intuitive. Nonetheless, there is a case for the long-term benefits of lower IP protections and allowingor ignoringimitations. As less-developed countries strive to keep up with the developed world, the temptation to short cut the necessity to innovate is overwhelming. The short cutting leads to imitation of products, software, services, and everything in between. Economically, this engenders the necessity to innovate continuously on one side of the equation, and the lack of incentive to innovate on the other. Countries that have a tendency to imitate and copy do not need to have a culture of innovation. They can simply create a lower quality reproduction and bring it to market. There are some problems with the imitateto-profit transition, however. The most glaring is that it is unlikely the imitation products will be allowed into the markets of the innovating country, and many of the other countries with significant IP protections in place. The imitator is restricted to its own domestic market, whereas the innovator can still sell its product or service in the less developed country. The quality of imitations is typically lower. And, as imitation leads to

he US and other developed nations tend to have a tremendous advantage inventing and innovating. Less-developed nations struggle to keep up technologically and occasionally resort to unscrupulous methods to maintain pace with their industrial counterparts. One of the preferred tactics is imitation, and the imitation is not always f lattering. Such imitations are usually of a lower quality than the original, and usually remain so for an extended period. Imitation of intellectual property is, simply, stealing, and the industrialized world does not take this well. The condemnation of imitation, and the defense of intellectual property, has become a crusade of corporations and politicians. It is a simple and seemingly non-debatable argument: developed economies suffer from the imitation and de facto theft of intellectual property. It is not quite so simple. Intellectual property rightsIPin the less developed world can be more relaxed than in the developed world, and this may benefit the developed nations in the long run. Granted, theft is theft, and the typical corporation may not feel so conf licted, or be interested in the long term effects of imitation and weak IP rights. But maybe they should be.

What is Innovation? Innovation can be thought of as the process of applying creative and differentiating properties

the lower rates of innovation in the imitating countries, a larger gap in innovation emerges between the two. The loss to the innovator is the sale of a few marginal units to the imitator. The benefit is the necessity to innovate continuously. Why? Because at some point the imitations begin to reach a quality level similar to the original, and evolve enough from the original innovation that they are likely to be allowed into the developed markets. Essentially, there is a cycle of innovation to imitation and back again. The lack of protections accelerates this cycle, and forces the innovators to chase, ceaselessly, the next innovation.

More than aligning incentives to benefit the innovators, there is an awakening to the necessity of innovation in the long run. Since most countries with low IP protections cannot typically sell their imitations in the developed world, the incumbent innovators are unlikely to have faced competition from these imitators. This creates competition in innovation in the long run, and drives a higher rate of innovation in the short run as incumbent innovators attempt to maintain their lead. Does It Really Matter? Whether or not IP is enforced, innovators from the IP protected economies have an advantage. In the case of the persistently low IP regimes, the innovators are forced to innovate continuously to avoid the quality of the initial product being imitated. It also reduces the incentives of the imitator to innovate and create new industries and products. This is a competitive advantage, and it keeps competition from entering the innovative, higher IP markets. However, there are also benefits to the innovator if an imitating country begins to switch from low to high IP protection. It creates a larger market for their innovations, increases the expected profits for innovations, and therefore incentivizes innovation. The downside is the eventual competition from the previous imitators after they have adjusted to the higher IP protection climate. Developed countries may find that enforcing higher IP is simply not worth the headache, and that imitators are not true competitors in the broad market. Imitators do not easily become innovators. In many ways, it makes sense to let them steal it.
Sources: Marchetti, Society as a Learning System: Discovery, Invention, and Innovation Cycles Revisited; Edwin Lai, International Intellectual Property Rights Protection and the Rate of Product Innovation; Amy Jocelyn Glass, Product Cycles and Market Penetration.

The notion that lower protections of IP in less-developed countries is important, or at least not devastating, to the developed world is at best counter-intuitive.
Lower IP protections and high levels of imitation create disincentives for the imitators to innovate, and create incentives for innovators to continue innovating. In the long-run, economies with an emphasis on innovation have the advantage in quality and in industry creation. Stealing is Bad While weak IP and the existence of unpunished imitators do have the effect of creating a larger innovation gap between the countries, stronger IP also creates a better climate for innovators. Since developing nations do not start from a tabula rasa, countries are likely to begin with weak IP and later move slowly and only incrementally towards a stronger regime. This movement is never seamless, because it requires an entirely different set of economic drivers. Weaker IP countries tend to have a high level of imitation driving their economies, and find it difficult to adapt as stronger IP begins to take hold. Moving from a lower to a higher IP stance is a boon for innovators. The incentives for the innovators to accelerate innovation are high: they have a monopoly in selling in the previously imitating countries, and therefore higher expected profits. This energizes the innovators to turn out innovations more quickly in an attempt to capture profits from larger, more protected markets. Imitators will find themselves unable to continue their previous imitation cycle. They are forced, instead, to attempt to innovate on their own. But it is not a fast shift to this different mindset. It takes time to create a culture of innovation.

SAMUEL RINES is an a nalyst and Economist at chilton capital m anagEmEnt in houston, tExas. dirEct quEstions or commEnts to: srinEs @chiltoncapital .com ZACH BECk is thE E ditor of chilton currEnts and an opErations spEcialist at chilton capital m anagEmEnt in houston, tExas. for furthEr information on chilton capital m anagEmEnt stratEgiEs and sErvicEs, plEasE contact christophEr l. K napp, cKnapp@chiltoncapital .com for rEprints contact srinEs@chiltoncapital .com www.chiltoncapital .com/currEnts