Why did Tesla Give Away Patents for Free? An Analysis of the Open-Technology Strategy from an Operational Perspective

The U.S. electric car manufacturer Tesla, and its rockstar CEO Elon Musk, are never short of surprises. In June 2014, Elon, in broken English (a reference to an Internet meme), announced that “all our patents are belong to you,” opening up all of Tesla’s patents to anyone who wants to use them “in good faith.” This announcement ignited the Internet. Some praised Elon’s altruism and open-source spirit. Others viewed it as a publicity stunt, believing that the real secret recipe was never patented (just like Coca-Cola). Elon’s own words, “the world would all benefit from a common, rapidly evolving technology platform,” hinted that he was not entirely altruistic, and wanted to promote the electric vehicle technology.

Tesla Wall

A more careful inspection of the circumstance of the announcement sheds more light on Elon’s motivation. Tesla had collaborated for years with Toyota, an auto giant known for hybrid cars, on developing electric cars before their relationship ended. The rumor went, and Elon was surely aware, that Toyota moved its focus from electric cars to hydrogen fuel-cell cars, the former’s main competing technology. In fact, Toyota’s announcement of phasing out its collaboration with Tesla came only a few weeks before Elon’s announcement to open up its patents, and just one week after Elon’s announcement Toyota unveiled its first hydrogen fuel-cell car. Was Elon’s announcement a response to Toyota’s pursuit of a competing technology? We believe the answer is yes, and here is proof Toyota felt the same: a few months later, Toyota countered Tesla’s move by opening up 5,600 of its fuel-cell patents as well. Toyota stated that such a move would open “the door to the hydrogen future” and “spur development and introduction of innovative fuel-cell technologies” around the world. But what exactly do they aim to achieve by opening up patents?

Battery-based electric cars and hydrogen fuel-cell cars are the two most promising alternative energy vehicle technologies. In their current states, each has pros and cons. Battery-based cars are generally simpler in construction, thus potentially cheaper and more reliable, but the slow charging speed (at best 30 minutes) is a significant bottleneck. By contrast, hydrogen fuel-cell cars can be refueled as quickly as gasoline cars, but the ultra-high-pressure liquid hydrogen storage requires sophisticated engineering and construction, which lead to cost disadvantages and potential safety concerns. Tesla and Toyota cannot simply depend on their own to overcome such obstacles, and would greatly benefit from the efforts of potential suppliers to advance their technologies. However, given that both technologies have crucial shortcomings, which one will dominate the industry is highly unpredictable. Such a state of uncertainty means that a component supplier making an investment into a technology would bear significant risks, which strongly inhibits supplier investments and, by and large, the industries’ developments. For example, Panasonic is a major player in both the battery and hydrogen fuel-cell markets, and may potentially advance these technologies by making large investments. But betting on the wrong technology may lead to huge losses in the future. As a result, Panasonic is more cautious in investments and tries to “wait out” the technological uncertainty.

Panasonic heading
Panasonic batteries and tower

In fact, the same reasoning applies to other players in the ecosystems. Consider a consumer buying a car. What she or he aims to get out of the purchase is not just the car itself, but a means of transportation. To realize the car’s utility, other implicit inputs are needed, such as roads and charging/fueling stations. These inputs are so widely available for gasoline cars that they are mostly left out of purchase decisions. However, the same is not true for alternative energy vehicles. For example, charging and hydrogen fueling stations are far less widespread than gas stations. In this sense, a charging/fueling network can be considered as a “component” of the true “product” (means of transportation) that a consumer buys, and an energy company can be considered as a “supplier” of this component. One can see that the above reasoning about component suppliers also applies here: because an energy company faces the uncertainty of whether electric cars or hydrogen fuel-cell cars will become mainstream in the future, it hesitates to invest large amounts in building charging or hydrogen fueling stations, hence inhibiting the industries’ growths.

We believe that Tesla opened up its patents to tip the scale between the two competing technologies in its favor. This is the logic: if Tesla’s patents are more likely to be adopted by other auto makers because they are free, the electric vehicle technology is more likely to become mainstream, and holding on to this belief, component suppliers (including energy companies by extension) are more likely to make investments into the electric vehicle technology rather than the competing hydrogen fuel-cell vehicle technology. One thing Tesla might not have anticipated, however, was that its competitor might use this strategy as well, which would more or less cancel out any advantage it had created. This is what happened with Toyota’s countermove.

Opening up one’s technology is not without costs—a lesson taught vividly by the case of IBM PC. In the late 1970s, the major personal computer manufacturers such as Apple and Atari used proprietary (closed) architectures, meaning that components produced for different systems were not compatible. When IBM entered the market with the PC, it utilized an open architecture, such that anyone could make “IBM-compatible” computers—effectively opening its architecture technology. This strategy greatly stimulated component suppliers to develop products for the PC (and PC-compatible computers), and IBM quickly became the market leader. However, once the PC proved successful, competitors soon flooded the market with PC-compatible computers, and IBM’s market share dwindled to 5% before it sold the whole PC business to Lenovo in 2005. In fact, IBM made unsuccessful attempts to regain control of the architecture, but could not turn the tide. Note that the risks of opening up a technology go hand-in-hand with its virtue of driving supplier investments. In fact, we would argue they are the two sides of the same coin. It is precisely because opening up a technology lowers barriers to entry for competitors, that suppliers have more confidence in the technology’s eventual domination. Nevertheless, it seems that when Tesla and Toyota both opened up their technologies and exposed themselves to such risks, their effects on suppliers canceled out and both firms may be left worse off. Are there any additional benefits for these firms in doing so then?

In our paper, we model and analyze two competing firms deciding on whether to open up their respective technologies to each other, whereas a supplier decides on whether to invest in improving each technology. Our analysis confirms the above intuitions that opening up a technology may incentivize supplier investments into this technology but also exposes the firm to potentially intensified future competition. In addition, the analysis reveals deeper insights into the effects of opening up a technology. First, imagine both firms opening up their technologies. Then regardless of how the market’s preference pans out, both firms will be able to adopt the more popular technology. In other words, by both opening up their technologies, the firms can mitigate their technological risks. We refer to this effect as the “risk-pooling benefit” of open technologies. Second, we find that in some cases, firms will not unilaterally open their technologies, even if both firms doing so actually benefits them. This is a phenomenon known as the “prisoner’s dilemma,” which suggests that without a collaborative relationship the firms may be stuck at a suboptimal state of closing down technologies. In such cases, an agreement to open up their respective patents to each other, similar to the phenomenon of cross licensing, can benefit both parties in ways otherwise not possible. Cross licensing is widely used for firms to trade patents as well as to avoid or settle patent-infringement disputes, and our work has suggested a different purpose for this practice. Last but not least, we find that in certain cases, if a firm opens up its technology, it will receive the sole investment from a supplier, but when both firms close down their technologies, the supplier is forced to invest in both technologies, which end up benefiting the firms. As a result, firms may intentionally close down their technologies to “coerce” the supplier into making more investments. This is an interesting discovery that goes against the intuition that closing down a technology discourages supplier investments. We summarize our findings below.

Open technology chart

In conclusion, the open-technology phenomenon is very complex and rich. We verified some intuitions about why Tesla gave away its patents for free, but also discovered deeper effects that Tesla may have not been aware when making the move. This suggests that firms considering opening up their technologies should carefully consider the big picture and all possible scenarios, particularly the potential reactions from competitors and suppliers; otherwise, unexpected outcomes may ensue. Since the announcement of opening up its patents, Tesla had made efforts toward vertical integration by building its own Supercharger charging network and leading a coalition with Panasonic in building the Gigafactory battery plant. For the Gigafactory venture, Tesla convinced Panasonic to make a nontrivial $1.6 billion investment, which may have been partially driven by Tesla’s open-technology strategy. We will watch with interest whether in the future other auto makers will take advantage of Tesla and Toyota’s open patents to compete with them, and if this happens, whether Tesla and Toyota will take it kindly or attempt to back-paddle like IBM once did.

Gigafactory battery plant

Reference

Hu B, Hu M, Yang Y (2016) Open or closed? Technology sharing, supplier investment, and competition. Manufacturing Service Operations Management. Permalink: http://dx.doi.org/10.1287/msom.2016.0598.

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