The Knockoff Economy

by Kal Raustiala

  Google feels the same way. The Google Android operating system, despite being on the market only since 2007, is now installed in nearly half of US mobile phones and is the biggest mobile platform in the United States (Apple’s iPhone is second at about a quarter of the market, and RIM’s BlackBerry third at under 20%). Like IBM and Linux, Google pumps enormous resources into development of Android, and yet it licenses the software for free, and licensees can copy and modify the software at will. As people shift more of their Web access to mobile phones, Google wants to make sure that people continue to use its search engine and see the search-related ads that Google sells. By denying Apple dominance in the smartphone market, Google is helping to ensure that Apple does not fundamentally threaten Google’s core business.

  The open-source approach is most famously associated with software, but is not limited to it. The basic method—free and open copying, and a collective process of incremental improvements—is at play in several of the industries we have explored in this book. Most obviously, we saw the open-source dynamic at work in the MathWorks computer programming experiments described in Chapter 4. A pioneer will establish a basic approach to solving a programming problem. Then the tweakers improve the pioneer’s work and expose the flaws that limit its ultimate value. And in doing so, they prepare the ground for the next pioneer. Both flavors of innovation play an important role in the development of a winning program.

  We also saw the interplay between pioneers and tweakers in the open-source-like development of new football strategies. Of course, in football there are no open-source licenses (because football formations and plays, unlike software, have not been copyrighted, such licenses are neither necessary nor possible). But the general open-source method is important to many teams’ success. Mouse Davis (probably) invented the spread offense in the 1970s. A decade later, Mike Leach tweaked it by spreading not just the receivers but the entire offensive alignment. At about the same time, Rich Rodriguez tweaked the spread in another way, mashing it up with more traditional offenses to create the spread-option. And then Chris Ault tweaked the spread-option, moving the quarterback up from the shotgun to the pistol position.

  Coaches and offensive coordinators tweak each other’s ideas in an effort to create a new twist on an existing formation or play that will allow them an edge next game day. But coaches also share ideas—and not only because, inevitably, their innovations are broadcast for all to see on millions of television sets around the nation. As the New York Times vividly described in its profile of New York Jets coach Rex Ryan, coaches from around the nation have come to “take the Ryan cure” by watching his offseason practices.29

  The culinary world also features some open-source elements. Chefs often say that culinary change is the product not of large inventive leaps, but of collective, incremental processes of innovation. If so, spreading and sharing innovative ideas is essential to creating them. Freedom to copy enables chefs to learn from one another and thereby to keep incrementally improving their offerings.

  Adding to this process is the tradition of staging, or apprenticing, in fine restaurants. As we described in Chapter 2, stagiers have access to the inner workings of a great restaurant. Some certainly misuse that access—as did Robin Wickens, if he did indeed try to pass off the creations of Chicagobased chef Grant Achatz and others as his own in his distant Australian restaurant. But for most chefs, staging is a way to gain invaluable experience, to learn from the greats, and to participate in the process of running a top kitchen. For the leading chefs who control these kitchens, stagiers are part of a long tradition of openness and teaching. But stagiers also bring new energy and ideas, and can help improve and revitalize a restaurant’s offerings.

  That cuisine is an art form characterized by incremental and collective innovation is a widely view held among top chefs. Earlier we noted that three of the world’s most famed and innovative chefs—Ferran Adria of El Bulli, Heston Blumenthal of the Fat Duck, and Thomas Keller of the French Laundry (along with acclaimed food writer Harold McGee)—offered a manifesto on cuisine in 2006 in the pages of the British newspaper The Guardian.30 In it, they declared that “three basic principles guide our cooking: excellence, openness, and integrity.” The chefs, famously inventive, wrote that they embrace innovation, but built on the bedrock of tradition—and that the best culinary traditions are “collective, cumulative inventions.”

  Many of the chefs and restaurateurs we interviewed for this book expressed similar sentiments. They endorsed the idea that even truly groundbreaking cooking is necessarily derivative of what came before. And they believed that sharing ideas and techniques is part of the ethos of cuisine. Not all concurred, of course. But for many, openness was essential to innovation, and in any event valuable beyond its creative potential.

  In all these settings, then, innovators innovate by tweaking the creativity that another has pioneered. And neither the pioneer nor the tweakers are motivated by the prospect of monopoly rights over their creations. Indeed, it is the absence of monopoly rights that makes all this tweaking possible. Without a system of open copying, both the ability and the incentive to tweak are far weaker. In short, the open-source method presents a very different approach to innovation than that embedded in our IP laws. Rather than monopoly control, open source rests on no control.

  And in a sense, nearly every story told in this book exhibits a bit of the open-source method: because these are creative industries that lack effective protection against copying, their underlying innovations are open to rivals and partners alike. But as fields as disparate as software and football illustrate, that does not mean that innovation grinds to a halt. Instead, innovation can blossom in an open setting. This innovation may be different: collaborative, incremental, and multipronged. But once we escape the romantic notion that the only innovation that counts is that of the lone inventor with the big breakthrough, we can see that the freedom to copy and improve can be a terrific foundation for innovation.

  First-Mover Advantage

  First-mover advantage usually refers to the period of de facto exclusivity that an innovator enjoys due to the practical difficulties of copying a particular innovation. In other words, if it takes time for copyists to successfully copy a creation, the creator may have a first-mover advantage—particularly if being first can provide enough of a head start to lock in markets or at least make it hard for latecomers to compete. In some cases, first-mover advantage can offer a sufficient incentive to engage in meaningful innovation, even without the prospect of IP rights to protect that innovation.

  It’s important to note that first-mover advantage has been employed in different ways by people thinking about different questions. There is a lively debate in the business literature, for example, regarding just how often first-mover advantage gives firms durable market dominance, versus instances where a first entrant loses out to a better organized “fast follower.” We’re not entering this particular debate. Instead, we use the concept of first-mover advantage simply to capture the idea that even without legal protection against copying, creators can sometimes gain significant benefits from their creations before others imitate them.

  In a sense, first-mover advantage is the essence of IP rights: the central premise of these rights is to extend this period of de facto exclusivity by making it illegal to copy an innovation for a set period of time. Patent and copyright are not perpetual; anyone can copy the work of another innovator eventually. But the law is meant to be calibrated so that the gain to the first mover is large enough that it will incentivize continued innovation.

  The interesting question here is how much a creator can benefit from “natural” (that is, nonlegal) barriers to copying as opposed to those barriers created by legal restraints. In other words, how much first-mover advantage is there absent IP rights? And is this advantage sufficient to motivate meaningful levels of innovation?

  As we saw in Chapter 4, first-mover advantage seems to be enough to maintain substantial innovatio
n in football. New formations and plays can offer meaningful advantages to creative coaches and teams, even though nothing stops other teams from copying those innovations.* In fact, many football coaches teach others their plays and approach. In part, coaches keep innovating despite the prospect of copying because they are incredibly short-term thinkers who have to win a game every week; winning now trumps the possibility of losing over the longer term as (hypothetically) their idea spreads.

  But there is another reason that copying does not deter innovation in football. Football formations and plays often depend on a certain kind of team and player, and teams cannot be reconstituted quickly. Given this, an innovative coach can achieve substantial success with a new formation even if opponents ultimately adopt it too. The window in which the innovating team is the only one using the new system—or at least, using it well—is large enough to make innovations worthwhile.

  Fashion also exhibits some first-mover advantage, though how much is a hotly contested point among those who study apparel markets. It is easy to copy a new design, and it is not hard to find examples of a hot dress appearing quickly in inexpensive stores such as Forever 21. Some even claim that knockoffs have appeared in stores before the original.31 While the instances in which copyists beat or match originators to market are unlikely to be frequent enough to really matter, it is still the case that many copyists are remarkably fast. Hence the lead time enjoyed by originators is often brief.

  But—and this is important—it is hard to see how that lead time can shrink entirely. There is no point in knocking off a garment that does not sell well. And most designs do not sell well. The only way to be sure a garment will sell is to see how it fares in the stores. In short, copyists can only be so fast before they are simply making bets on what trends will be hot. And if they are that good at guessing what will be hot, why not just make it themselves and be first—or open a store and sell only those designs guaranteed to sell?

  So while copying in fashion can be fast, in reality there is almost always some degree of lead time for innovators. And this lead time, as we explained in Chapter 1, is essential for the operation of fashion’s piracy paradox to operate. The freedom to copy a design that is becoming hot helps to create trends and, ultimately, expands the market for that design. For this to work, however, the design must become hot in the first place. Over time this dynamic leads to the diffusion and eventual death of the design and, as early adopters seek something fresh, the debut of a new design. The creative cycle starts anew.

  What is special about the piracy paradox in fashion, in other words, is not just that an innovative designer can sell enough units before copies emerge to make innovation worthwhile. If the only advantage to fashion designers was that short window of exclusivity, we would be making a simple first-mover advantage argument. Instead, the heart of the piracy paradox is that copying drives early adopters to seek new designs. That in turn gives the innovator a new market to chase. What really matters in fashion is not the first-mover advantage per se. Rather, the lead time a first mover has makes it worthwhile for the fashion conscious to chase new designs. The fashion-following consumer is the key player. Since the fashion conscious are differentiators, not flockers, they will only adopt designs that differentiate.32 And in a system of free and legal copying, that requires some lag between the debut and the diffusion of a design. As a practical matter, that lag continues to exist, no matter how fast copying technologies become.

  Databases also exhibit some degree of first-mover advantage. Like an innovative football team deploying a new formation, a successful database can remain competitive due to the need to train users in the new interface. What do we mean? As law professors, we rely heavily on legal databases such as Westlaw. These databases charge paying customers a substantial fee, and they require extensive training to learn to use well.* That training begins in law school, and the big database companies allow students to use their products for free as a way to get them to learn—and to become hooked. Once a law student becomes comfortable with Westlaw (or its primary competitor, Lexis-Nexis) he or she is unlikely to shift to another database. The result is that even if we create a new database tomorrow with all the legal materials contained in Westlaw—and lower prices—we will have a hard time competing with the incumbent firms, who know that lawyers who have spent years, if not decades, using one system are unlikely to start over just to save a few bucks.

  Probably the most common example of first-mover advantage is software. Being first—and creating a network of users that all rely on the same program and, as a result, can easily share files and documents—can give decisive and durable advantages to the first mover’s product. And that can lead to substantial market control and lasting profits. We wrote this book using Microsoft Word, not because it is the best word processing product in existence, but because we both already had it (and it is plenty good for our purposes). There is not much competition in the word processing world, and that is partly because we all know that if we have a Word document we can send it to virtually anyone and that person too will use Word to open it. We are all part of the Word network, and that makes sharing and communicating easy—and Bill Gates rich.

  Only a few industries exhibit such “positive network externalities,” as economists call them: benefits that accrue from the fact that others are using the same network. The simplest example of network externalities is a telephone: a single phone is useless, two phones on a network are nice, but hundreds of millions of connected phones are much, much better. Each additional phone on the network makes the other phones more valuable. As we have just discussed, first-mover advantages can certainly accrue in the absence of positive network externalities. But when these externalities exist, the power of first-mover advantage is much greater. The ability to lock consumers in a network that they do not want to leave makes it easier to defeat new entrants into a market, even those that mimic or improve on an existing product.

  Think of (the short) history of social networks. Perhaps Facebook, so dominant today, will give way to Google +. But many people do not want to shift over to Google + because their friends are all on Facebook. It is not impossible to dislodge a leading product even when network externalities exist—Friendster and Myspace, after all, were ultimately buried by Face-book. But it is more difficult. When products exhibit positive network externalities, first-mover advantages are very powerful.

  In sum, first-mover advantage is a key concept not just in the industries we have explored but in all IP-protected industries. The fundamental purpose of copyright and patent is to create first-mover advantage: IP laws regulate second movers so the first mover has ample time to make money. Our point is simply that first-mover advantage still exists when IP law is absent or ineffective, and in some cases first-mover advantage is powerful enough to sustain a meaningful level of innovation. In others, such as fashion, it is a necessary input into a more powerful dynamic of innovation.

  Branding and Advertising

  Brands play an important and often unappreciated creativity-inducing role in several of the industries we have explored in this book. By brands we mean familiar names and symbols such as Nike and its swoosh or Apple with its famous apple-with-a-bite-taken image.

  Brands are protected by trademark law. The traditional justification for trademark protection has little to do with innovation. Instead, trademark functions to ensure that consumers can identify the source of products and thereby buy the item they want, and not an imitation. Put in economic terms, trademarks reduce the search costs associated with consumption. If you’ve had a positive experience with basketball shoes from Adidas, then marking them with the trademark-protected three-stripes helps ensure that you can quickly find their shoes the next time you are shopping. And of course it also lets everyone else know which shoes you prefer.

  So brands are fundamentally a shortcut—rather than try on lots of shoes, we save time by heading straight for the Adidas rack. Brands can be extremely valuable as a result, an
d firms take expensive measures to develop and protect them. Legally, trademark law prevents the unauthorized use of a brand in a way that would confuse consumers about the source of products or services. But trademark law goes further. It also aims to prevent anything that would “dilute” consumers’ ability to associate a famous brand with the brand’s owner, as well as any uses of the brand that might tarnish its image.

  Unlike patent and copyright, trademark law is not generally thought of as a spur to creativity. In fact, over a century ago the Supreme Court struck down the Trademark Act of 1870 on precisely this ground. The act was created under the part of the Constitution that authorizes Congress to make patent and copyright law, which are powers given to Congress “To promote the Progress of Science and useful Arts.” Trademarks, the Court said, have “no necessary relation to invention or discovery.”33 For that reason, Congress’s power to enact a trademark law could not be grounded in the power to “promote … Progress.”*

  While that view has a superficial appeal, it misses some important effects of trademarks. Trademarks can, in fact, function as an incentive mechanism, only in a different manner from that of other IP rights. And as we will describe, trademarks can interact with other creative incentives in important ways.

  The power of brands is very apparent in any big drugstore. Walk into a CVS drugstore, as we did recently in Charlottesville, Virginia, and you can buy, for $20.99, 300 tablets of Advil brand ibuprofen. That is just under $0.70 per tablet. The CVS private label ibuprofen—which contains exactly the same dosage of the same medicine—costs $17.79 for 750 tablets, or about $0.24 per tablet. The Advil brand ibuprofen, in other words, is almost three times as expensive as the CVS ibuprofen, despite the fact that they are functionally indistinguishable—they will both get rid of your headache equally well. And this situation is not limited to medicines. On a recent visit to a local grocery in Charlottesville, for example, we found that a 14-ounce box of Cheerios cost $4.59. A 14-ounce box of the store-brand version—the same basic product, except for the packaging—cost $2.75. Despite this significant price differential, Cheerios are the best-selling brand of cereal in the United States.*