The conversation around intellectual property (IP) is typically dominated by patents and copyright, but there is one often overlooked pillar: trade secrets. 

Trade secrets represent over US$5 trillion in value and roughly two-thirds of all intangible assets in the United States alone. They are also, by definition, invisible. A study Colleen Cunningham and I recently published in Management Science provides rare, granular evidence on how firms manage confidential information in high-stakes environments. 

Our findings suggest that stronger trade secret protection can induce firms to innovate even when no registered IP, like patents, is claimed. What’s more, it can spur firms to share innovations with other companies.

A quasi-natural experiment in the oil patch

Managers face a persistent dilemma that can be called a “knowledge leakage trap”: The more valuable an innovation is, the riskier it may be to use, because deploying a new process or recipe requires sharing it with employees, contractors or partners who may eventually take that knowledge to a competitor. One CEO we interviewed put it bluntly: “Our trade secrets are constantly getting passed around.”

This fear results in firms holding back their most advanced inventions. The problem is particularly acute in sectors where employee mobility and uneven bargaining power between partners are common. Besides oil and gas, such sectors include chemical, cosmetic and food products, semiconductors, and advanced manufacturing.

Our study looks at over 47,000 hydraulic fracturing wells in the US between 2014 and 2018. In certain US states, stringent regulations require firms to disclose the chemical ingredients in their fracturing fluids unless those ingredients are substantiated trade secrets. This creates rare documentation of actual trade secret use at the level of individual wells.

The Defend Trade Secrets Act of 2016 (DTSA) served as the external shock to trade secret protection for our study. This was the first US federal legislation to create a unified jurisdiction for trade secret cases in the country. Legal experts at the time described it as the most significant expansion of federal intellectual property law in at least 30 years. By comparing how firms in states with weaker pre-existing trade secret protections responded to the DTSA against those in states where protection was already stronger, we could isolate the effect of strong protection.

We found that in states where the legal change represented the biggest shift – Arkansas, Louisiana and Pennsylvania – the proportion of wells using at least one trade secret ingredient rose by 22 percentage points after the DTSA came into force. The share of ingredients kept secret per well increased by 3.7 percentage points (from a baseline of 2.2%). Not only did firms introduce new secret ingredients at higher rates, but they also didn’t use fewer disclosed novel ingredients or reduce their patenting activity. Wells with trade secret ingredients produced, on average, 26% more oil and 6% more gas than those without.

Perhaps the most counterintuitive finding was that firms ostensibly shared more secret information with other firms after the law changed, as measured by sourcing trade secrets from third parties. In other words, firms trusted that the legal environment would help protect them from leaks. The conventional assumption is that stronger trade secret protection means more hoarding. Our data suggest the opposite may be true.

What this means for executives

Secrecy tends to work best where reverse engineering is difficult, when the pace of technological change is fast, and where patenting is not the automatic default. Chemical formulations, algorithms, manufacturing processes and production techniques all fit that profile.

Our research also suggests that secrecy and patenting aren’t mutually exclusive. Increased trade secret use among the firms in our sample did not come at the cost of disclosed innovation. Instead, firms used more secrets and introduced more novel disclosed ingredients, and didn’t patent less. 

Treating secrecy as an afterthought to a patents-first strategy means leaving significant value unprotected and, in many cases, unused. In fact, rather than viewing trade secrets as a passive alternative to patents, executives can use them as a catalyst for experimentation and competitive advantage. 

Our study suggests several ways to do so:

• Leverage trade secrecy in high-leakage environments: Stronger legal frameworks like the DTSA allow firms to increase trade secret use, particularly in regions where non-compete enforcement is low or competition is stiff. The European Union’s Trade Secrets Directive serves a similar purpose.
• Prioritise secrecy for "complex recipes": Inventions that involve a combination of ingredients or processes – which are harder to reverse engineer but valuable and hence tempting for a partner to misappropriate – benefit most from trade secret protection.
• Secrecy as a catalyst: Managers should exploit legal protections to move innovations out of the lab and into real-world applications where they can reap immediate ROI. Contrast this with patenting, where approval could take years. To a large extent, this is why firms in the business of fast-moving technologies such as software have relied heavily on secrecy and trade secret protection. An example is the recent pivot by Alphabet’s DeepMind to more secretive measures.
• Complement patenting with secrecy: Secrecy doesn't have to replace patenting or other types of disclosures. In fact, we found that firms often increased their use of both disclosed and secret novel inputs post-DTSA. This suggests that a robust secrecy strategy can enhance a firm’s broader innovation portfolio.

A book chapter I recently co-wrote provides further detailed advice to managers on how to create and capture value from their business secrets.

Secrecy and openness can complement each other

Prior research has suggested that stronger reliance on secrecy could dampen the flow of knowledge that feeds invention, leading to fewer patents filed and less disclosures for rivals to build on. Our findings suggest that the picture is more nuanced. 

What we observed was more experimentation, not less. Bolstered by stronger legal protection, firms deployed novel recipes, sourced more broadly, disclosed new inputs more, and didn’t retreat from patenting. Secrecy and openness, it turns out, are not as opposed as one might think.