Chapter 7: IP rights, business profitability and market competition
CHAPTER 7 - IP RIGHTS, BUSINESS PROFITABILITY AND MARKET COMPETITION: EVIDENCE FROM AUSTRALIAN MICRODATA
One of the key purposes of the IP system is to promote economic development by creating an innovation-friendly and fair competition environment. However, granting exclusive rights, although usually for a limited time, may also reduce competition by increasing the market power of intellectual property owners. An effective IP system seeks to balance the interests of innovators and the broader public interest by providing an environment in which creativity and invention can flourish for the benefit of all.
In IP economics literature, studies focused on comprehensively examining the empirical relationship between IP, business profitability and market competition are relatively few. This is particularly true in the Australian context, where the number of evidence-based studies of economic impacts of IP at both micro (firm) and macro (market) levels in Australia has been limited, as data has been limited.(40)End note 40. Examples include: Griffiths, W.E, Jensen, P.H. and Webster, E. 2005. The Effects on Firm Profits of the Stock of Intellectual Property Rights, Melbourne Institute Working Paper Series Working Paper No.4, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne; Webster, E.M. and Jensen, P.H., 2011. Investment in Intangible Capital: An Enterprise Perspective. Available at SSRN: https://ssrn.com/abstract=870071
Understanding the economic impact of intellectual property rights (IPRs) on Australian firms and industries has been constrained by a lack of basic information on IPR usage. Specifically, what firms and industries in Australia use or rely most on patents(41)End note 41. Patents in this chapter refer to standard patents in Australia., trade marks and designs? What are the economic impacts of IPRs on Australian firms? Do firms using IPRs have a higher profitability on average than firms that do not? What are the impacts of IPRs on market competition in Australia? Do the IPRs owned by those IP-intensive firms reduce competition in their respective industries?
With these questions in mind, the Office of the Chief Economist (OCE) at IP Australia integrated its Intellectual Property Longitudinal Research Data (IPLORD) into the Business Longitudinal Analysis Data Environment (BLADE) created by the Australian Bureau of Statistics to create a purpose built dataset that enables in-depth analysis of these questions.(42)End note 42. BLADE is a comprehensive database sourced from the Australian Taxation Office (ATO), the Australian Bureau of Statistics (ABS), and other government agencies, integrating administrative, tax, and IP records at the individual firm level from 2001–02 onwards. This study sought to produce detailed evidence showing the relationship between business markups and IP activity and shedding light on how IPRs affect business profitability and market competition in the Australian economy.
The number of Australian firms filing for IP rights has been growing
The number of Australian businesses that filed at least one patent, trade mark or design doubled in the 15 years from 2001-02 to 2015–16. While this is indicative of increased IP activity in the Australian economy, the overall proportion of Australian firms that used IP rights is still relatively stable, approximately six to seven per cent across all the years in the 15-year period.
Larger and older firms are more likely to use IP rights
On average, firms that own IPRs are larger (in terms of number of employees), older and more profitable than those without IPRs, as shown in Table 4. IPRs can be a costly venture, with attorney fees, application and renewal fees and, in some instances, litigation costs. Older or larger businesses tend to have greater resources, including financial, knowledge and organisational capital, to equip them to apply for and use IP rights. This in turn may also increase the average profit of such businesses.
Businesses can use IP rights in different ways, depending on their specific needs, the sophistication of their knowledge capital and the characteristics of their markets. This can range from holding a single patent, trade mark or design, to a combination of any two or three IP rights.
Businesses owning more than one type of IP right tend to be larger and older than businesses with a single IPR (Table 4). Among businesses with a single IPR, those owning patents only are relatively larger and older than those owning only trade marks or designs.
Table 4: Average values of selected variables by IPR ownership(43)End note 43. IPR owners refer to any businesses owning at least one valid patent, trade mark, or design right at the end of a financial year during the period from 2001-02 to 2015-16, while non-owners of IPRs are the counterparts of IPR owners.
Source: Australian Bureau of Statistics, BLADE dataset 2019 version.
Firms that are profitable are more likely to use IP rights
Our study used two measures of a business’s profitability: (1) profit per invested capital and (2) profit per employee.(44)End note 44. Profit per employee equals to total profit divided by full-time equivalent employees at each business level for each financial year in the BLADE. Full-time equivalent employees are obtained based on the calculation done by Hansell D., Nguyen, T. and Soriano, F. 2015. Can we improve on a headcount? Estimating unobserved labour input with individual wage data. Paper presented at the 25th ALMR Conference, Fremantle WA (10-11 November 2014). ABS Canberra. Profit per invested capital equals to total profit divided by total invested capital at each business level for each financial year. Invested capital approximately equals to the subtraction of current liabilities from a business’ total assets. For details, refer to: Damodaran, A. 2007, ‘Return on Capital (ROC), Return on Invested Capital (ROIC), and Return on Equity (ROE): Measurement and Implications’ (PDF). New York University Stern School of Business. See also: https://www.investopedia.com/terms/r/ returnoninvestmentcapital. asp or https://en.wikipedia.org/wiki/Return_on_capital. By definition, profitability is a business’s ability to produce a return on an investment based on its resources. Therefore, we use these two measures as they may show different aspects of a business’s capability to make profit based on the two major inputs, capital and labour.
As reported above, larger and older firms are more likely to own IP rights. Similar patterns are observed in the average values of profit per employee between those that own and do not own IP rights. However, for average profit per invested capital, there are some slight differences. On average, those that do not own IP rights have a profit ratio over invested capital of 4.8 per cent, which is slightly higher than those that own IP rights. This is because the majority of those that own IP rights―87 per cent―only own trade marks and these firms have a lower profit ratio over invested capital of 3.2 per cent compared with those that do not own IP rights.
Firms that own designs only, have the highest profit ratio over invested capital on average, at 10.2 per cent. The most plausible explanation for this is that businesses with designs only have a relatively smaller need for costly physical capital, but depend more heavily on human capital, in particular the skills of designers. Firms that own all three types of IP rights and those that own combinations of different IP rights and patents only, all have a higher average profit per invested capital than firms that do not own IP rights.
Users of IP rights are concentrated in Manufacturing and Wholesale trade
Manufacturing, Wholesale Trade and Professional, Scientific and Technical Services are the top three Australian industries in terms of the total number of businesses owning IP rights. The industries with the highest percentage of businesses owning IP rights are Wholesale Trade, Manufacturing, and Information Media and Telecommunications.
Table 5 lists the industry subdivisions under the Australian and New Zealand Standard Industrial Classification (ANZSIC) that are simultaneously intensive in all three types of IP rights, patents, trade marks and designs.(45)End note 45. This research adopts a similar method to that adopted by the USPTO, the EPO/EUIPO and UKIPO to identify IPR-intensive industries. We chose the top 25 per cent as the cut-off point for IPR-intensive industries in Australia, based on the ranking of the total number of each IPR divided by the total number of employees in that industry. For details, see: https://www.uspto.gov/sites/default/files/news/ .../IP_Report_March_2012.pdf, to https://euipo.europa.eu/tunnel-web/secure/ webdav/guest/document_library/ observatory/documents/IPContributionStudy/ IPR-intensive%20industries_en.pdf and https://euipo.europa.eu/tunnel-web/secure/ webdav/guest/document_library/ observatory/documents/IPContributionStudy/ performance_in_the_European_Union/ performance_in_the_ European_Union_full.pdf. They are almost all concentrated in the Manufacturing and Wholesale Trade industries.
Table 5: Industries that are intensive in all three types of IP rights
Source: Australian Bureau of Statistics, BLADE dataset 2019 version.
IP rights increase profits for profitable firms
This study applied econometric techniques to the BLADE dataset to measure the independent contributions of IP rights to business profitability on average by controlling for other factors.
The econometric analysis confirms the link between ownership of IP rights and Australian firm profitability for profitable businesses.(46)End note 46. Due to our model specification using the natural logarithm of profitability, non-profitable businesses dropped out from the estimation. This means that our econometric results do not hold for businesses that do not make a profit. Ownership of IP rights, specifically patents, trade marks and designs, is strongly and positively associated with firm profitability. Businesses that hold all three types of IP rights, patents and trade marks, or trade marks and designs, contribute to business profitability more significantly compared to businesses that hold other combinations of IP rights on both measures of business profitability. This may indicate that technological inventions (as proxied by patents) are more likely to be financially rewarding when they are also commercialised (as proxied by trade marks) and combined with aesthetic designs (proxied by design rights). However, we do not find any significant positive impact on business profitability associated with the number of any one type of IP rights, which suggests that the quantity of IP rights owned alone is not a decisive factor in contributing to profitability.
No conclusive evidence that IP rights affect market concentration
While intellectual property rights may give certain market power for businesses to make a profit, they may also reduce competition in the market due to their granting of exclusive rights. Not all IP rights can create a monopoly or even reduce market competition however. In fact, it is quite rare for an IPR to bestow monopoly power for a complete market to a business, as current technologies develop rapidly, and many technologies may have viable substitutes in the market.
This study uses the Herfindahl-Hirschman Index (HHI), a widely used measure of market concentration, as a proxy to determine market competitiveness.(47)End note 47. The Herfindahl-Hirschman Index (HHI) is calculated by squaring the market share of each firm competing in a market and then summing the resulting numbers. It can range in value from close to zero to one. The econometric analysis in this study does not find any overall significant impact of IP rights on market concentration or competition at an industry subdivision level. This suggests that Australia’s IP system does not currently give rise to strong concerns about its impact in terms of inhibiting market competition significantly at an overall industry subdivision level.
Our study finds that Australian businesses that own any of the three types of IP rights, especially those with multiple types of IP rights, are more likely to perform better in terms of profitability (average profit per invested capital or per employee) than businesses that do not own any IP rights. However, the number of IP rights that a firm owns does not appear to be significantly associated with business profitability. A potential implication is that IP policy should aim not at increasing the number of IP rights alone but should rather focus more on the quality of IP rights, the underlying innovations they are protecting and how businesses exploit IP rights in the marketplace.
Disclaimer: The results of these studies are based, in part, on Australian Business Registrar (ABR) data supplied by the Registrar to the ABS under A New Tax System (Australian Business Number) Act 1999 and tax data supplied by the Australian Taxation Office (ATO) to the ABS under the Taxation Administration Act 1953. These require that such data is only used for the purpose of carrying out functions of the ABS. No individual information collected under the Census and Statistics Act 1905 is provided back to the Registrar or ATO for administrative or regulatory purposes. Any discussion of data limitations or weaknesses is in the context of using the data for statistical purposes and is not related to the ability of the data to support the ABR or ATO’s core operational requirements. Legislative requirements to ensure privacy and secrecy of this data have been followed. Only people authorised under the Australian Bureau of Statistics Act 1975 have been allowed to view data about any particular firm in conducting these analyses. In accordance with the Census and Statistics Act 1905, results have been confidentialised to ensure that they are not likely to enable identification of a particular person or organisation.