Preview: James Bessen - History Backs Up Teslas Patent Sharing

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TECHNOLOGY

History Backs Up Tesla’s Patent Sharing

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When We're Hungriest for Leadership

by James Bessen

The Boardroom's Quiet Revolution

JUNE 13, 2014

CMOs: Build Digital Relationships or Die

Yesterday, Elon Musk, CEO of Tesla, the electric car company, announced that Tesla would make its patents freely available to
competitors. To many people this announcement seemed surprising if not shocking. After all, the conventional wisdom holds
that patents are essential to keep competitors from imitating innovations, especially for small startup companies. If rivals
imitate, they will drive down prices, wiping out the potential profits on innovation, thus making it difficult or impossible to earn
a return on R&D investments.

But while this conventional wisdom applies to mature technologies, it is often wrong during the early stages of major new
technologies. Indeed, since the Industrial Revolution, innovators have made their inventions and knowledge freely available to
rivals during the early stages of critical new technologies including textile technology, Bessemer steel production, the personal
computer, wireless communications, and the Open Source software that powers the Internet. Often innovators did not patent
their inventions or when they did, they allowed other innovators to use them freely. Nearly two hundred years ago, the Boston
Manufacturing Company, the leading producer of cotton cloth using the most important technologies of the Industrial
Revolution, stopped enforcing its patents, allowing competitors to use its innovations, much like Tesla.

Moreover, these innovators shared knowledge for sound economic reasons. Some commentators have noted that Tesla’s move
will help it hire talented engineers. Others see it as a brilliant PR move. They are right, but Tesla’s action is also central to their
business strategy. There are real benefits to sharing knowledge that substantially outweigh the costs and this economic logic is
very similar to the economics that motivated past innovators to share.

Consider first the benefits. Musk tells us “We believe that Tesla, other companies making electric cars, and the world would all
benefit from a common, rapidly-evolving technology platform.” In order for Tesla to succeed, a lot of complementary
knowledge and infrastructure needs to be developed. Auto mechanics need to learn how to repair electric vehicles; drivers need
to learn to drive and to maintain them; new marketing and distribution channels need to emerge; and the roads need to be
populated with charging stations for long distance travelers. All of these developments will happen faster if multiple electric
vehicle makers coordinate around common, open standards, each contributing knowledge as new techniques are tried. The
success of electric vehicles will benefit most from powerful “network effects” when they share enough knowledge to create a
“common, rapidly-evolving technology platform.”

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These benefits were much the same for early stage technologies in the past. A large body of complementary knowledge was
needed to implement these technologies. The engineers of the early US Bessemer steel mills met regularly with their rivals as a
self-described “band of loving brothers” until they had developed common standards for producing steel, slashing production
costs by 78% in the process.

But what about the argument that competition will destroy profits? The critical thing about many major new technologies begin
as a competition between two groups: those using the old, dominant technology and the other startups using the new
technology. Musk realizes that, “Our true competition is not the small trickle of non-Tesla electric cars being produced, but
rather the enormous flood of gasoline cars pouring out of the world’s factories every day.” This is likely to remain true for a
decade or two. And as long as it remains true, the
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prices and profits of Tesla will be determined by the market share of gasoline
cars, not by the trickle of rivals with whom Tesla is sharing its inventions. Sharing knowledge with them will not undercut
profits in the near term.

This pattern, too, is seen in past examples of knowledge sharing. The early Bessemer steel mills competed mainly against
makers of iron rails for the railroads, not against the trickle of other Bessemer mills. The early textile makers competed against
home weavers and British imports.

This history explains why the conventional wisdom is sometimes wrong, but it also contains a warning for the future: the
conditions that make knowledge sharing advantageous today won’t last forever. Eventually electric vehicles will replace much
of the market for gasoline-powered cars. Then competition from other electric vehicle makers will affect Tesla’s profits and such
extensive sharing might no longer be beneficial. But that is tomorrow’s problem. Elon Musk is shrewd to grasp today’s
opportunity firmly, despite the conventional wisdom.

James Bessen, an economist at Boston University School of Law, is currently writing a book about technology and jobs. You can follow him on Twitter.

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