Management of Intellectual Property in Supply Chain Outsourcing

Abstract

Firms outsource productive tasks to different locations in order to exploit factor price differentials and gain efficiencies from specialization. However, the benefits of outsourcing come with two risks. The first problem occurs when firms share their pre-existing intellectual property (IP) such as database and trade secrets with contractors. While IP is shared to facilitate the outsourcing project, the contractor may behave opportunistically and misappropriate the IP for its own benefit. Since firms derive significant value from their IP, this can lead to severe economic damages in terms of reduced market share and brand value. The second agency problem arises due to non-contractible effort exerted by the contractor. Depending on the outsourced task, shirking can lead to higher costs and poor quality product. In this dissertation, contractual solutions are developed to mitigate these agency problems associated with outsourcing.

First, several IP misappropriation cases are enumerated in the context of outsourcing. The existing literature is reviewed and the limitations are addressed in the light of these actual cases. Second, theoretical models are developed by considering two forms of IP misappropriation, depending on whether a R&D contractor emerges as a direct competitor of the principal firm, or the contractor sells the principal?s IP to a competitor. Contracts are developed to implement a ?carrot and stick? strategy, whereby firms share limited IP with their contractor and also provide incentive payments to deter shirking problem. It is shown that complementary strategies like product differentiation, task modularization, and investment in technological solutions can be useful when legal enforcement is weak. It is also demonstrated that even under the possibility of IP misappropriation; firms may gain from outsourcing if in-house inefficiency is high. However, if legal enforcement is weak, outsourcing would entail higher transaction costs. Finally, an event study is conducted to examine the effect of trade secret misappropriation on the value of Lexar. While Lexar is still outsourcing, it is explored how Lexar survived the IP misappropriation problem through product differentiation and marketing strategies.