Discussion Paper No. 807

THE EFFECTS OF NON-ASSERTION
OF PATENTS PROVISIONS:
R&D INCENTIVESIN VERTICAL RELATIONSHIPS
Noriaki Matsushima
Koki Arai
Ikuo Ishibashi
Fumio Sensui

April 2011

The Institute of Social and Economic Research
Osaka University
6-1 Mihogaoka, Ibaraki, Osaka 567-0047, Japan

The eﬀects of non-assertion of patents provisions: R&D
incentives in vertical relationships∗
Noriaki Matsushima†
Institute of Social and Economic Research, Osaka University
Koki Arai‡
Competition Policy Research Center, Japan Fair Trade Commission
Ikuo Ishibashi§
Osaka School of International Public Policy, Osaka University
Fumio Sensui¶
Graduate School of Law, Kobe University
April 15, 2011

Abstract
Using a simple downstream duopoly model with vertical relations and downstream
R&D, we investigate the eﬀect of non-assertion of patents (NAP) provisions. A monopoly
upstream ﬁrm decides whether to employ NAP provisions. If it does so, it freely incorporates the R&D outcomes into its inputs. Incorporation improves the eﬃciency of thedownstream ﬁrms’ production. We have interpreted the introduction of NAP provisions
as a source of technology spillover. Using the technologies of two downstream ﬁrms is
optimal for the upstream ﬁrm if and only if the degree of technology spillover is small. In
addition, if the ex ante cost diﬀerence between the downstream ﬁrms is signiﬁcant, suchtechnology spillovers erode both the proﬁt of the eﬃcient downstream ﬁrm and social
welfare. We interpret our result in the context of an actual antitrust case related to thismodel.

Keywords: vertical relations, investment, technology spillover, NAP provisions
JEL Classiﬁcation codes: K43, L11∗

The views expressed herein are those of the authors and should not be interpreted as those of the Japan
Fair Trade Commission.
†
Corresponding author: Noriaki Matsushima, Institute of Social and Economic Research, Osaka University,
6-1 Mihogaoka, Ibaraki, Osaka 567-0047, Japan. Phone: (81)-6-6879-8571. Fax: (81)-6-6879-8583. E-mail:nmatsush@iser.osaka-u.ac.jp‡
Koki Arai, Competition Policy Research Center, Japan Fair Trade Commission, 1-1-1 Kasumigaseki,
Chiyoda, Tokyo 100-8987, Japan. E-mail: koki arai@jftc.go.jp§
Ikuo Ishibashi, Osaka School of International Public Policy, Osaka University, 1-31 Machikaneyama,
Toyonaka, Osaka 560-0043, Japan. E-mail: ishibashi@osipp.osaka-u.ac.jp¶
Fumio Sensui, Graduate School of Law, Kobe University, 2-1 Rokkodai, Nada, Kobe, Hyogo, 657-8501,
Japan. E-mail: sensui@kobe-u.ac.jp1

1

Introduction

The Japan Fair Trade Commission (hereinafter, “JFTC”) decided to conduct a hearing into
Microsoft Japan (hereinafter, “MS”) on September 1, 2004, and delivered its decision in accordance with the Antimonopoly Act on September 16, 2008. The JFTC found the following
violation of the Act. When MS directly negotiated with personal computer production/sales
ﬁrms in Japan from January 1, 2001, to July 31, 2004, to enter into contracts licensing
OEMs (Original Equipment Manufacturers) sales of MS Windows (“OS”), it forced the licensed OEM suppliers (hereinafter, “OEM suppliers”) to pledge not to ﬁle lawsuits against
MS or other licensees on the grounds that Windows infringes a patent right (non-assertionof patents provisions; hereinafter, these provisions are referred to as “NAP provisions”). In
addition, MS set contract terms with OEM suppliers that would unduly restrain their business activities. MS abandoned the NAP provisions in direct contracts from August 1, 2004,
but the NAP provisions in contracts that were to expire by July 31, 2004, remained in eﬀect
even after August 2004. The JFTC ruled that these actions had a negative impact on faircompetition in the PC/AV (Personal Computer/Audio Visual) technology exchange market,
prevented fair competition under Paragraph 13 (Trading on Restrictive Terms) of the Unfair
Trade Practices (JFTC notice #15 in 1982) and violated Article 19 of the AntimonopolyAct.
In the MS case, the main issues were as follows.
1. Whether OEM suppliers were forced to enter into direct contracts containing NAP
provisions.
2. Whether OEM suppliers were very likely to become less motivated in their R&D activities concerning PC/AV technologies before July 31, 2004.
3. Whether OEM suppliers were very likely to become less motivated in their R&D activities concerning PC/AV technologies even after August 1, 2004.
4. Whether the NAP provisions would have a negative impact on competition in PC/AV
technology trading or PC markets.
2

5. Whether the NAP provisions were justiﬁed.
6. Whether a cease and desist order was appropriate.
For the purpose of this paper, we set up a simple theoretical model to examine issues
2 to 4 above and investigate whether the JFTC decision was appropriate. This paper isorganized as follows. Section 2 brieﬂy describes the NAP provisions that provide incentives
for our study and related articles. Section 3 explains the model. Section 4 sets out the main
results. Section 5 compares the analytical results with the information described in Section
2. Section 6 concludes the paper.

2

Motivating case and related articles

2.1

The MS case

The outline of the NAP provisions in Windows OEM sales contracts is as follows (the text
is taken from the JFTC decision)
Content of the NAP provisions The NAP provisions in the direct contract
entered into in 2001 are set forth in (d) of Article 8 of BTD (Microsoft Business
Terms Document for OEM customers) for Large Accounts with Third-Party Installer Rights and have the following content, generally speaking.
If an invention used in the “product” licensed to OEM suppliers based on
the license agreement or in the “product” version licensed to OEM suppliers inaccordance with the license agreement is also employed in a future product, areplacement-use product or successor product of such a “product,” the OEM supplier shall agree that (A) it will not ﬁle a lawsuit and (B) it will not initiate action
against, prosecute, support, or participate in any kind of judicial, administrative,or other proceedings against Microsoft and its aﬃliate ﬁrms or their licensees interms of infringement of the “OEM supplier’s patent” that might arise in the“immunity period” resulting from production, use, sales, or distribution of the
future product, replacement-use product, or successor products.
On the surface, this provision appears to be advantageous only for MS, but it may leadto technology leakage. If MS improves its OS technologies using an OEM supplier’s R&D
outcomes, it may yield positive impacts both for MS and for OEM suppliers, but the possible3

eﬀects of such technology leakage are not simple. This is because such positive impacts would
vary, depending on how they spill out and who would beneﬁt from them. In fact, MS raised
the following objection.
It is unreasonable to recognize the NAP provisions as a violation of the Antimonopoly Act for the following reasons.
The NAP provisions are reasonable provisions commonly used by technologyrelated ﬁrms, including those in the AV consumer electronics industry, to mitigate
risks of patent infringement lawsuits and reduce the costs necessary to mitigate
such risks while disseminating new technologies. Because the NAP provisions
would, by deﬁnition, prevent patent infringement lawsuits, they could potentially reduce corporate willingness to engage in R&D eﬀorts. In principle, if such
an abstract possibility is illegal, this is tantamount to recognizing that the NAP
provisions are in themselves illegal. However, as mentioned above, they havereasonable objectives. If the JFTC recognizes as illegal the NAP provisions thatare widely used in the industry, speciﬁc reasons are necessary under competition
law to justify this decision. If the JFTC regards the NAP provisions as illegal
without speciﬁc criteria to justify the illegality of the NAP provisions, our industry, which has been using the NAP provisions, will inevitably become confused.
This will have signiﬁcantly detrimental eﬀects and seriously confuse legitimate
intellectual property licensing practices. In addition, OEM suppliers have also
beneﬁted from the NAP provisions over many years because they have engaged
in business operations without concern for patent lawsuits. OEM suppliers expect the NAP provisions to apply to themselves and other OEM suppliers. The
JFTC’s decision to overturn the NAP provisions will destroy such expectations.
Furthermore, the NAP provisions are an important element of the compensation that OEM suppliers provide in return for licenses of the Windows series.
The NAP provisions also serve to maintain OEM suppliers’ royalty payments
at a low level. For this reason, if the JFTC decision is applied retroactively, it
would void the NAP provisions. All OEM suppliers that wish to void the NAP
provisions while beneﬁting from low royalty payments should return such proﬁts
to MS. Without such a provision, the JFTC decision would be unjust.
It is obviously necessary to pay due attention to international harmonization
when enforcing competition law. MS employs NAP provisions worldwide. Corporations all over the world, including Japanese ﬁrms, also use NAP provisions on a
global scale. In such situations, the competition authority should avoid problems
in applying a legal principle to the same kind of trading practices. Without these
NAP provisions, global corporations, including the so-called AV consumer elec4

tronics industry, face uncertainty when they plan licensing or trading practices
in accordance with applicable legal standards.
As mentioned earlier, this trial was to examine whether the NAP provisions violated
the Antimonopoly Act, not to judge their legality. For this reason, the arguments of MS
were ruled to be inappropriate. Considering these facts, we analyze the eﬀects of MS’ NAP
provisions by establishing a simple model to describe the situation detailed above.

2.2

Main results and related work

We now describe the model setting and the results in this paper. This article assumes
that MS is an upstream ﬁrm while OEM suppliers are downstream ﬁrms. A monopoly
upstream ﬁrm supplies an input to two downstream ﬁrms. The two downstream ﬁrms supply
their ﬁnal products to consumers and engage in cost-reducing R&D. We assume that if
the upstream ﬁrm employs NAP provisions, it freely incorporates R&D outcomes into its
inputs. Incorporation of R&D improves the eﬃciency of the downstream ﬁrms’ production.
We interpret the introduction of NAP provisions as a source of technology spillover. The
theoretical model yields the following result. Using the technologies of the two downstreamﬁrms is optimal for the upstream ﬁrm as long as the degree of technology spillover is small.
If the spillover is large, the upstream ﬁrm should not introduce NAP provisions from theviewpoint of proﬁt. In addition, if the ex ante cost diﬀerence between the downstream ﬁrms
is signiﬁcant, such technology spillover erodes both the proﬁt of the eﬃcient downstreamﬁrm and social welfare.
We review several articles related to our paper. A seminal article in the ﬁeld of researchjoint venture including spillover eﬀects is that of d’Aspremont and Jacquemin (1988). Theyshow that cooperative behavior can play a positive role in oligopoly industries. The positive
and normative eﬀects of cooperative R&D are examined by Suzumura (1992), who ﬁnds that,in the presence of suﬃciently large R&D spillovers, neither noncooperative nor cooperativeequilibria achieve even second-best R&D levels. In the absence of spillover eﬀects, however,while the cooperative R&D level remains socially insuﬃcient, the noncooperative level may
overshoot the ﬁrst- and second-best levels of R&D.
5

Some articles discuss technology investments in oligopoly models with vertical relations.
Ishii (2004) extends the model of Suzumura (1992). He examines the eﬀects of cooperative
R&D in two vertically related duopolies, which are two ﬁnal-good manufacturers and two
input suppliers, with horizontal and vertical spillovers. Vertical R&D cartels yield a larger
social surplus than noncooperative R&D. If the horizontal spillover rate between the input
suppliers is insuﬃciently high, vertical R&D cartels yield a larger social surplus than horizontal ones. Regarding information ﬁrewalls, Milliou (2004) considers the case in which
information ﬂows from a downstream nonintegrated ﬁrm to the downstream division of avertically integrated ﬁrm via its upstream subsidiary. In a setting where both the integrated
and the nonintegrated ﬁrms engage in cost-reducing R&D and compete in the product market, she shows that the impact of the R&D information ﬂow on innovation, output, andproﬁts is positive for the integrated ﬁrm and negative for the nonintegrated ﬁrm. Thesepapers do not consider the structures of technology spillover to be exogenously given.1
The following papers consider market structures in which downstream ﬁrms determine
the degree of technology spillover, but not vertical market structures.2 The role of a researchjoint venture is analyzed by Poyago-Theotoky (1999), who shows that when spillovers of information are treated as endogenous, ﬁrms never disclose any information when determining
the degree of R&D spillover noncooperatively. Gil-Moltó et al. (2005) investigate the eﬀectof technology distance between two ﬁrms engaging in cost-reducing R&D investments withtechnology spillover.3 In their model, the technology distance is endogenously determined
They show that the two ﬁrms are noncooperatively interested in using very similar (or thesame) R&D technologies in order to obtain a very high degree of spillovers. Milliou (2009)
also extends the discussion in Poyago-Theotoky (1999) by changing the timing of the decisions concerning the degree of technology spillover. She shows that even if each ﬁrm protects
its technology without cost, it sometimes chooses not to protect the outcomes of its R&D
1

Versaevel and Vencatachellum (2009) incorporate strategic delegation into a model with technology

leakage.
2

Moreover, in our paper, the upstream monopolist determines the degree of technology spillover.

3

Piga and Poyago-Theotoky (2005) investigate this matter in the context of spatial competition.

6

investments because ﬁrms enjoy higher total cost reduction without such protection.4

3

The model

Two downstream ﬁrms supply their ﬁnal products to consumers. A monopoly upstreamﬁrm supplies an input to the two downstream ﬁrms. The downstream and upstream ﬁrms
represent OEM suppliers and MS, respectively, as described in the previous sections. Eachdownstream ﬁrm needs one unit of input to produce one unit of ﬁnal product. The upstreamﬁrm oﬀers a common wholesale price, w, to the downstream ﬁrms. The marginal cost of the
upstream ﬁrm is cu , which is a positive constant.
To simplify the analysis, we assume that the products of the downstream ﬁrms arehomogeneous and that the ﬁrms compete in quantity. The inverse demand function for theﬁnal products is given as:
p = a − x1 − x2 ,(1)

where p is market price, a is a positive constant, and xk represents the output of downstreamﬁrm k (k = 1, 2). Note that we assume a to be large enough to secure an interior solution in
equilibrium. The constant marginal cost of downstream ﬁrm k is given as:
ck = c̄k − ek − γk ej ,where c̄k is the ex ante marginal cost, ek and ej represent the eﬀort levels of downstreamﬁrms k and j, respectively, and γk represents the degree of R&D spillover from downstreamﬁrm j to k (k, j = 1, 2, j ̸= k). The ex ante marginal costs of the ﬁrms are c̄1 = c andc̄2 = c + d, where c and d are positive constants. That is, downstream ﬁrm 1 is more eﬃcientthan downstream ﬁrm 2. These eﬀort levels are endogenously determined by the downstreamﬁrms. When downstream ﬁrm k makes an eﬀort ek , it incurs an investment cost of ϕe2k where
ϕ is a positive constant. We impose the following assumptions.
Assumption 1 We assume that ϕ ≥ 1 to satisfy the second-order conditions of optimal ek
4

In Milliou (2009), an asymmetry between a ﬁrm’s outgoing spillovers and its incoming spillovers canoccur. This property is diﬀerent from the previous papers.

7(k = 1, 2). We also assume that d ≤ (a − c)(12ϕ − 7)/(42ϕ − 7) to ensure that the quantities
supplied by the downstream ﬁrms are positive.
The upstream ﬁrm is able to choose the degree of R&D spillover, γk (k = 1, 2). If the
upstream ﬁrm absorbs technology from downstream ﬁrm k, the degree of R&D spilloverfrom downstream ﬁrm k to j becomes γ where γ is a positive constant (0 ≤ γ ≤ 1). This
assumption captures the following technology leakage. Technology from a downstream ﬁrm(an OEM supplier) is incorporated into the input of the upstream ﬁrm (OS produced by
MS). The incorporation positively inﬂuences the marginal cost of another downstream ﬁrm(an OEM supplier). This means that this technological improvement in the input (OS)solves production problems that downstream ﬁrms (OEM suppliers) face. In this case, theupstream ﬁrm has four options regarding absorption of technology from downstream ﬁrms:(i) not absorbing the technology, (ii) absorbing the technology from downstream ﬁrm 1, (iii)
absorbing the technology from downstream ﬁrm 2, and (iv) absorbing the technologies fromboth downstream ﬁrms. Note that depending on the upstream ﬁrm’s decision concerningtechnology absorption, asymmetric R&D spillover can occur. We also suppose that the
upstream ﬁrm can commit to this choice. That is, given the choice by the upstream ﬁrm,
each downstream ﬁrm engages in R&D investment. Figure 1 shows the market structure inthis model.
[Figure 1]
The decision-making process in this setting is as follows. First, the upstream ﬁrm decides
the technological source from which it obtains the technology. Second, each downstreamﬁrm decides its investment level ek . Third, the upstream ﬁrm decides the wholesale price w.
Finally, each downstream ﬁrm decides its output xk .

4

Analysis

We solve the game by backward induction.
In the ﬁnal stage, given γk , ek (k = 1, 2), and w, the proﬁt of each downstream ﬁrm is

8

as follows:
π1 =(a − x1 − x2 − (c − e1 − γ2 e2 ) − w)x1 − ϕe21 ,(2)

π2 =(a − x1 − x2 − (c + d − e2 − γ1 e1 ) − w)x2 − ϕe22 .

(3)

On the basis of the maximization condition for each downstream ﬁrm, the output of eachdownstream ﬁrm is calculated as follows:a − c + d + (2 − γ1 )e1 − (1 − 2γ2 )e2 − w,
3a − c − 2d + (2 − γ2 )e2 − (1 − 2γ1 )e1 − w
x2 (γ1 , γ2 , e1 , e2 , w) =.
3
x1 (γ1 , γ2 , e1 , e2 , w) =

(4)
(5)

The proﬁt function of the upstream ﬁrm is given as:
πu = (w − cu )(x1 (γ1 , γ2 , e1 , e2 , w) + x2 (γ1 , γ2 , e1 , e2 , w))=(w − cu )(2a − 2c − d + (1 + γ1 )e1 + (1 + γ2 )e2 − 2w).
3

In the third stage, the upstream ﬁrm sets the optimal w:
w(γ1 , γ2 , e1 , e2 ) =2(a − c + cu ) − d + (1 + γ1 )e1 + (1 + γ2 )e2
.
4

(6)

By using the aforementioned calculation result on xk (γ1 , γ2 , e1 , e2 , w) and w(γ1 , γ2 , e1 , e2 ),we calculate the investment levels and obtain the following result:(7 − 5γ1 )(6(2(a − c − cu ) + 5d)ϕ − (7 − 5γ2 )((1 − γ2 )(a − c − cu ) + γ2 d)), (7)864ϕ2 − 6((7 − 5γ1 )2 + (7 − 5γ2 )2 )ϕ + (7 − 5γ1 )(7 − 5γ2 )(1 − γ1 γ2 )(7 − 5γ2 )(6(2(a − c − cu ) − 7d)ϕ − (7 − 5γ1 )((1 − γ1 )(a − c − cu ) − d))e2 (γ1 , γ2 ) =.
(8)
864ϕ2 − 6((7 − 5γ1 )2 + (7 − 5γ2 )2 )ϕ + (7 − 5γ1 )(7 − 5γ2 )(1 − γ1 γ2 )e1 (γ1 , γ2 ) =Substituting ek (γ1 , γ2 ) (k = 1, 2) into the proﬁt functions of the downstream ﬁrms, we have:ϕ(144ϕ − (7 − 5γ1 )2 )(e1 (γ1 , γ2 ))2,(7 − 5γ1 )2ϕ(144ϕ − (7 − 5γ2 )2 )(e2 (γ1 , γ2 ))2π2 (γ1 , γ2 ) ≡.
(7 − 5γ2 )2π1 (γ1 , γ2 ) ≡The proﬁt of the upstream ﬁrm is
πu (γ1 , γ2 ) ≡216ϕ2 K 2,
[864ϕ2 − 6((7 − 5γ1 )2 + (7 − 5γ2 )2 )ϕ + (7 − 5γ1 )(7 − 5γ2 )(1 − γ1 γ2 )]29(9)where K ≡ 12(2(a−c−cu )−d)ϕ−(a−c−cu )∑2i=1 (1−γi )(7−5γi )+((7−5γ1 )−γ2 (7−5γ2 ))d).

The consumer surplus and the social surplus are:(x1 (γ1 , γ2 ) + x2 (γ1 , γ2 ))2πu (γ1 , γ2 )
=
,
2
3
2
∑
πi (γ1 , γ2 ).
SW (γ1 , γ2 ) ≡ CS(γ1 , γ2 ) + πu (γ1 , γ2 ) +CS(γ1 , γ2 ) =

(10)
(11)

i=1

We must compare the proﬁts of the upstream ﬁrm in the four cases: (i) γ1 = γ2 = 0, (ii)γ1 = 0 and γ2 = γ, (iii) γ1 = γ and γ2 = 0, (iv) γ1 = γ2 = γ. From the comparison, we
ﬁnd that πu (γ, γ) is the largest value among the four cases if and only if γ ≤ 2/5 and thatπu (0, 0) is the largest value among the four cases if and only if γ ≥ 2/5 (the calculation isavailable upon request). This is summarized in Proposition 1.
Proposition 1 It is optimal for the upstream ﬁrm to use the technologies of both downstreamﬁrms if and only if γ ≤ 2/5. It is optimal for the upstream ﬁrm to do nothing if and only ifγ ≥ 2/5. If γ = 2/5, it is indiﬀerent for the upstream ﬁrm to choose one of the four cases.
From the above comparison, we only have to compare cases (i) and (iv). Comparing
these two cases, we have the following proposition:
Proposition 2 CS(γ, γ) > CS(0, 0) if and only if γ < 2/5. π2 (γ, γ) > π2 (0, 0) for any γ
and ϕ. π1 (γ, γ) > π1 (0, 0) if and only if d < d˜p (γ, ϕ) such that d˜p (γ, ϕ) satisﬁes π1 (γ, γ) =π1 (0, 0). SW (γ, γ) > SW (0, 0) if and only if d < d˜w (γ, ϕ) such that d˜w (γ, ϕ) satisﬁes
SW (γ, γ) = SW (0, 0).
The diﬀerence between π1 (γ, γ) and π1 (0, 0) is shown in the following ﬁgure (this is the caseof ϕ = 3/2).
[Figure 2]
The diﬀerence between SW (γ, γ) and SW (0, 0) is shown in the following ﬁgure (this is thecase of ϕ = 3/2).
[Figure 3]

10

From the viewpoint of the downstream ﬁrms, the investment reduction through the technology spillover does not necessarily have a negative impact on their proﬁtability. We now
brieﬂy explain the reason for this property. Basically, the downstream ﬁrms have incentives
to make excessive investments to prevail over their competitors because the competition
structure between the downstream ﬁrms is strategic substitution. This incentive will be reduced because of the technology leakage determined by the upstream ﬁrm. The mitigationof this intensive investment competition has a positive impact on the downstream ﬁrms. In
particular, it has a more advantageous impact on the ineﬃcient downstream ﬁrm with lessincentive for R&D. This is because the beneﬁt of cost reduction for a downstream ﬁrm is
proportional to its quantity supplied, whereas the investment cost does not depend on thisquantity as it does in the standard setting of R&D. Anticipating this asymmetry of technological spillover, the eﬃcient ﬁrm reduces its R&D investment more than the ineﬃcientﬁrm does. When the ex ante cost diﬀerence between the downstream ﬁrms is large, thediminished incentive of the eﬃcient ﬁrm for R&D investment decreases its proﬁt.
The upstream ﬁrm’s decision concerning this technology absorption has two eﬀects: thestrategic eﬀect mentioned above, and the direct eﬀect of technology leakage. The former
decreases the total quantity supplied but the latter increases it. The latter positive eﬀect issmall when the spillover eﬀect is large (γ is large). We brieﬂy explain the reason. The larger
the degree of spillover eﬀect, the smaller are the equilibrium eﬀort levels of the downstreamﬁrms. The total amount of technology leakage is proportional to the equilibrium eﬀort
levels. The two properties imply that the positive eﬀect of a marginal increase in the degree of
spillover eﬀect becomes weak as the degree of spillover eﬀect becomes large. Therefore, when
the degree of spillover eﬀect is large, the technology spillover caused by the decision of the
upstream ﬁrm decreases the total quantity supplied by the downstream ﬁrms. Anticipating
this negative eﬀect, the upstream ﬁrm does not absorb technologies from the downstreamﬁrms when the degree of spillover eﬀect is large. Note that the decrease in this total quantity
supplied also harms consumers.
The eﬀect of technology absorption on the social surplus can be explained by the combina-

11

tion of the abovementioned eﬀects. When the ex ante cost heterogeneity is large, technology
absorption by the upstream ﬁrm has a negative impact on the eﬃcient ﬁrm. When the degreeof spillover eﬀect is large, the technology absorption has negative impacts on the upstreamﬁrm and consumers. The right-hand side of Figure 3 shows the combination of those two
properties.

5

Interpretation of analytical results

We derive the following results. It is only optimal for the upstream ﬁrm (MS) to use technology from both eﬃcient and ineﬃcient downstream ﬁrms (OEM suppliers) if the degreeof technology spillover is small. If MS may not commit “not to take over technology afterinvestment,” it will exploit OEM suppliers’ investment eﬀorts. For this reason, if the leakage
is large, MS should not introduce NAP provisions in some cases. If the preexisting cost gap
is signiﬁcant, technology leakage will erode the proﬁts of the eﬃcient OEM supplier. We
now interpret the result.

5.1

The JFTC decision

Arguments by the respondent (MS) (from Section 1)

The NAP provisions arereasonable provisions commonly used among technology-related ﬁrms, including those in the
AV consumer electronics industry, to mitigate risks of patent infringement lawsuits and reduce the cost necessary to mitigate such risks while disseminating new technologies. Because
the NAP provisions would, by deﬁnition, prevent patent infringement lawsuits, they could
potentially reduce corporate willingness to engage in R&D eﬀorts. In principle, if such an
abstract possibility is illegal, this is tantamount to recognizing that the NAP provisions arein themselves illegal.

Decision by hearing examiners

This hearing is to examine whether the NAP provisions

would violate the Antimonopoly Act and does not make decisions concerning the legality of
the NAP provisions. For this reason, the arguments made by MS are inappropriate.

12

5.2

Applicability

The NAP provisions generally suggest that if MS may use OEM technologies, it is assumed
to employ a large quantity of OEM technologies. On the other hand, from the viewpointof OEM suppliers, a quality gap may erode the proﬁts of a high-quality OEM supplier;
incentives for investment may also be compromised with a cost gap between the eﬃcientand ineﬃcient ﬁrms. In other words, if we discuss the contracts containing these provisions
in relation to the Antimonopoly Act, and OEM suppliers have a technology gap, then it isnecessary to pay due attention to the possibility that the NAP provisions erode the proﬁts
of eﬃcient OEM suppliers or interfere with OEM suppliers’ incentives to invest. This is also
related to OEM suppliers’ viewpoints expressed in the JFTC decision.
The JFTC decision (taken from the hearing examiners’ judgment, page
114, JFTC Decisions) As recognized in 3(1)A above, because the NAP provisions will be applicable in the future, they will apply to licensed products aswell as future products and will be in eﬀect for a very long time. In addition,
because a wide variety of patent rights may fall under free licenses as a result of
the expansion of the Windows series capabilities, the JFTC determines as follows.
[. . .] MS has expanded/enhanced the AV capabilities of Windows series, and several OEM suppliers have expressed their concern that the NAP provisions would
have an impact on their patent rights in relation to their own PC AV technologies (Panasonic has expressed concerns about AV technology patents in general;
Sony has concerns about the standard speciﬁcations of “MPEG-1,” “MPEG2,” “IEEE1394,” “MPEG-4” AV, digital video broadcasting and its multimedia platform; Toshiba has expressed concerns about the standard speciﬁcationsof “IEEE1394,” “MPEG-2” AV and “MPEF-4” AV—Attachment (1), Written
Statement (2), Respondent’s Brief (3)) and they requested that MS remove the
NAP provisions. From these viewpoints, while recognizing that their PC AV
technologies would be incorporated into the Windows series, OEM suppliers had
no choice but to develop their own PC AV technologies.
We have shown that the diminishment in the eﬃcient ﬁrm’s incentive for R&D decreases
its proﬁt if the ex ante cost diﬀerence between the downstream ﬁrms is large. Because the
JFTC decision recognizes that large corporations such as Panasonic, Sony, and Toshiba andperhaps other highly eﬃcient ﬁrms had concerns about NAP provisions, the above analysis
13

is on point in its theoretical implications. In response to NAP provisions, Sharp and Sotec
did not request MS to remove or amend the NAP provisions; Sharp had few patent rights in
PC-use OS and Sotec specialized in selling PCs without customizing the Windows series.
As for the negative impacts of NAP provisions on competition policies, it is suggested
that a dominant ﬁrm in the PC OS market such as MS would occupy a more advantageous
position than new entrants that do not use NAP provisions. However, if NAP provisions
are “reasonable provisions commonly used among technological ﬁrms, including the AV consumer electronics industry,” it is diﬃcult to imagine new entrants not using NAP provisions
in reality. Furthermore, concerning the negative impacts of NAP provisions on competition policies, MS may have had problems in introducing the NAP provisions or negotiating
possible amendments with OEM suppliers; however, this paper does not analyze this topic.

6

Conclusion

This paper analyzes a theoretical background to the JFTC decision on the MS case inwhich JFTC decided to commence hearing proceedings on September 1, 2004, delivering
its decision on September 16, 2008, in accordance with the Antimonopoly Act. This JFTC
decision ruled that the Act had been violated in the following way. When MS directly
negotiated with personal computer production/sales ﬁrms in Japan from January 1, 2001, to
July 31, 2004, to enter into contracts licensing OEM sales of MS Windows (“OS”), it forced
the licensed OEM suppliers to accept NAP provisions. MS set contract terms with OEM
suppliers that would unduly restrain OEM suppliers’ business activities. Some issues in the
MS case remain in dispute. We analyze the case by setting up simple theoretical models,
focusing on the following three points:
1. Whether OEM suppliers were very likely to become less motivated in their R&D activities concerning PC/AV technologies before July 31, 2004.
2. Whether OEM suppliers were very likely to become less motivated in their R&D activities concerning PC/AV technologies even after August 1, 2004.

14

3. Whether NAP provisions have a negative impact on competition in PC/AV technology
trading or PC markets.
The theoretical model yielded the following result. If the technology of an OEM supplieris introduced into MS’ OS, and the marginal cost of the other OEM supplier decreases, thenusing the technologies of these two OEM suppliers is optimal for MS as long as technology
leakage is small. If technology leakage is large, MS should not introduce NAP provisions. In
addition, if the preexisting cost gap is signiﬁcant, technology leakage will erode the proﬁt of
the eﬃcient OEM supplier.
This analysis implies that OEM suppliers face diﬀerent impacts depending on their position in the downstream market and that OEM suppliers should oﬀer factual evidence thatconsiders such perspectives. For example, if OEM suppliers have a technology gap, theyshould clarify possible problems in competition policies, because these problems might damage the proﬁts of eﬃcient OEM suppliers or remove their incentive to invest. On the other
hand, our analysis also reveals that quantiﬁcation of these impacts requires careful review.
It may be necessary to examine how to respond to the dominant position of MS in themarket, although this paper does not cover such a topic. The JFTC decision argues that MS
has a problem because it “keeps using” NAP provisions despite having achieved dominancein the market. The decision also indicates that it is a problem that a dominant supplier uses
NAP provisions and that the network eﬀect would serve to further enhance MS’ dominantstatus. Antimonopoly Act experts often state that it is no problem, from the viewpoint of
the Antimonopoly Act, for new entrants to adopt such an approach because it encourages
competition, but it becomes a problem if it is used by a supplier with dominant status.

15

References[1] d’Aspremont, Claude and Jacquemin, Alexis, 1988. Cooperative and noncooperative
R&D in duopoly with spillovers, American Economic Review 78, 1133–37.
[2] Marı́a José Gil-Moltó, Nikolaos Georgantzı́s, Vicente Orts, 2005. Cooperative R&D withendogenous technology diﬀerentiation Journal of Economics and Management Strategy
14, 461–476.
[3] Ishii, Akira, 2004. Cooperative R&D between vertically related ﬁrms with spillovers.
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[4] Milliou, Chrysovalantou, 2004. Vertical integration and R&D information ﬂow: is therea need for ‘ﬁrewalls’ ? International Journal of Industrial Organization 22, 25–43.
[5] Milliou, Chrysovalantou, 2009. Endogenous protection of R&D investments. Canadian
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[6] Piga, Claudio and Poyago-Theotoky, Joanna, 2005. Endogenous R&D spillovers andlocational choice. Regional Science and Urban Economics 35, 127–139.
[7] Poyago-Theotoky, Joanna, 1999. A note on endogenous spillovers in a non-tournament
R&D duopoly. Review of Industrial Organization 15, 253–262.
[8] Suzumura, Kotaro, 1992. Cooperative and noncooperative R&D in oligopoly withspillovers. American Economic Review 82, 1307–1320.
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55.

16

MS

MS

w

w

w

w
γ

OEM 1
x1

e1

e2

OEM 2
x2

OEM 1
x1

e1

e2

OEM 2
x2

Consumers

Consumers

No absorption

Absorbing the technology of ﬁrm 1

MS

MS

w

w

w

γ
OEM 1
x1

e1

e2

OEM 2
x2

OEM 1
x1

w
γ

γ

e1

e2

OEM 2
x2

Consumers

Consumers

Absorbing the technology of ﬁrm 2

Absorbing both technologies

Figure 1: The market structure

17

d
0.2

0.15

0.1

0
DΠ
1
-0.005
-0.01

0.15
0.1
d

0
0.2
0.4
Γ

0.05

0.05

0.6
0.8

10
0.2

π1 (γ, γ) − π1 (0, 0)

0.4

0.6

0.8

1

Γ

π1 (γ, γ) > π1 (0, 0)

Figure 2: The eﬀect of technology spillover on the eﬃcient OEM supplier(Left-hand)(Right-hand)

x-axis: γ, y-axis: d, z-axis: π1 (γ, γ) − π1 (0, 0),x-axis: γ, y-axis: d, Shaded region: π1 (γ, γ) > π1 (0, 0).

18

d
0.2

0.15

0.1

0
-0.005DSW-0.01-0.015
-0.02
0

0.15
0.1
d

0.2
0.4
Γ

0.05

0.05

0.6
0.8

10

0.2

π1 (γ, γ) − π1 (0, 0)

0.4

0.6

0.8

1

π1 (γ, γ) > π1 (0, 0)

Figure 3: The eﬀect of technology spillover on the social surplus(Left-hand)(Right-hand)

x-axis: γ, y-axis: d, z-axis: SW (γ, γ) − SW (0, 0),x-axis: γ, y-axis: d, Shaded region: SW (γ, γ) > SW (0, 0).

19Γ