NBD404 – R&D AND

INTELLECTUAL PROPERTY
LECTURE 9 - INTELLECTUAL PROPERTY AND INNOVATION
Intellectual Property from a society’s view

Benefits Costs

• Incentives for Innovation • Temporary monopoly

o Directly
o Innovation becomes tradable

• Duplication costs
• Knowledge disclosed

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 Intellectual Property
US constitution - Article 1, Section 8:
1.The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to
pay the Debts and provide for the common Defence and general Welfare of the United
States; but all Duties, Imposts and Excises shall be uniform throughout the United
States;
2.To borrow Money on the credit of the United States;
3.To regulate Commerce with foreign Nations, and among the several States, and with the
Indian Tribes;
4.To establish an uniform Rule of Naturalization, and uniform Laws on the subject of
Bankruptcies throughout the United States;
5.To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of
Weights and Measures;
6.To provide for the Punishment of counterfeiting the Securities and current Coin of the
United States;
7.To establish Post Offices and post Roads;
8.To promote the Progress of Science and useful Arts, by securing for limited Times
to Authors and Inventors the exclusive Right to their respective Writings and
Discoveries;
9.-18: ....
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Intellectual Property in reality

• Do the benefits outweigh the costs?

 Difficult to answer

• But do patents give innovation incentives?

 If no, we are close to answering the first question

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Patenting motives

• What are innovator’s motives to patent?

• Protection and strategic motives

• What are strategic motives?

- Block competitors
• Offensive: Keep others from using the technology, even though there might be
no direct interest in using the content of the patent – Blocking “patenting around”
• Defensive: Prevent the own technological to manoeuvre being reduced by
patents of others
- Generating licensing revenues
- Currency: Exchange potential / negotiation mass
- Internal performance indicator / motivation
- Reputation: improvement of the technological image

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Patenting motives

Source: Blind et al (RP 2006)

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Patenting motives

• Blind et al (RP 2006):

- Empirical analysis of all German patent applicants with more than three patent
applications at the EPO in 1999
- Response rate of 33%  522 responses

Source: Blind et al (RP 2006)

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Patenting motives

Source: Blind et al (RP 2006)

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Other means to protect an innovation

Source: Blind et al (RP 2006)

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Intellectual Property in reality

• Protection motive is important

• BUT strategic motives are also very strong

 they imply additional downsides
- Less competition  higher deadweight loss
- Fewer business opportunities
- Risk and costs of litigation

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Intellectual Property in reality

• Do patents create net innovation incentives?

• The question is less related to the requirement of a patent

system in general but rather than the specific parameters of a
given patent system

A book written by two

economists/legal scholars
that takes a very critical view on
the current IP system
 See the first chapter on canvas

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The idea of intellectual property

• Property and property rights are seen as the cornerstone of

market economies

• Property gives incentives to create, grow and produce

• Property rights ensure that right-holders are protected

- Property rights allow transfer of property (selling, renting etc) to higher-value users
- Tons of research shows that the effectiveness of property rights matters for
economic growth

• If that works for tangible assets, why should it not work for
intangible assets?
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IP – The critique

• Intellectual Property is not 100% equal to property

- More than one person can use an invention at the same time. More than one person
can invent the same technology independently
 in contrast, tangible property is a rival good
- IP has a less precise “notice function”  you may not know that you are using IP
that you are not allowed to use
- IP has less clear boundaries
 in many cases a judge is required, and judges may contradict each other
(in natural resources the latter two are also not so clear cut)
- IP provides only a right to exclude others from imitation
 enforcement is costly
- Some patents are just dubious

• Also property rights can fail, if rights are highly fragmented such that
negotiation to combine them become too expensive
 remember the steep increase of patents in the recent past

• Patents may block later innovation (cumulative innovation)

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Inadvertent infringement

NTP vs RIM

• NTP, Inc. is a patent holding company

• RIM (Research in Motion) is the producer of Blackberry phones

• Both were parties in an important patent lawsuit

- NTP claimed that a number of mobile phone manufacturers infringe their wireless
email patens, and offered licenses
- None of the manufacturers, including RIM payed
- NTP claimed to have been unaware of the NTP patents before notification (and tried to
invalidate them by claiming that the knowledge was already in the public domain)
- The jury found the patents to be valid, and willful infringement of RIM
 Damages of $57.5 million (33 damages, 20 for willfulness and 4.5 for legal fees)
AND an injunction basically shutting down the Blackberry service
- RIM appealed, injunction was stayed
- Case settled for $612.5 million

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Fuzzy boundaries

• Unique Concepts vs. Kevin Brown

• US patent 4018260
• The outcome of the case turned on the interpretation of claim 1:
- “right angle corner border pieces,” labeled 15 in the figure.
- The claim also describes linear border pieces (labeled 14) and distinguishes them
from the right angle corner border pieces.
• Did Brown infringe the
patent?
- 2 judges decided against
Unique,
- 1 judge for Unique
(proposing a broader claim
interpretation)

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Enforcement

Source: 2017 PWC patent litigation study

costs

Source: American Intellectual Property Law Association

(AIPLA), Report of the Economic Survey 2015

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Dubious patents? – 2 examples
US 6004596: Sealed crustless sandwich
A sealed crustless sandwich for providing a convenient sandwich without
an outer crust which can be stored for long periods of time without a
central filling from leaking outwardly. The sandwich includes a lower
bread portion, an upper bread portion, an upper filling and a lower filling
between the lower and upper bread portions, a center filling sealed
between the upper and lower fillings, and a crimped edge along an outer
perimeter of the bread portions for sealing the fillings therebetween. The
upper and lower fillings are preferably comprised of peanut butter and
the center filling is comprised of at least jelly. (…)

US 4022227: Method of concealing partial

baldness
A method of styling hair to cover partial baldness
using only the hair on a person's head. The hair
styling requires dividing a person's hair into three
sections and carefully folding one section over
another.

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Fragmentation

U.S. Government Accountability Office (GAO):

A typical smartphone uses from 50,000 to 250,000 patented

technologies because such devices incorporate technologies
from digital cameras, global positioning systems, and wireless
communication. In contrast, pharmaceutical company
representatives we spoke with said they are able to conduct
thorough patent searches, in part, because there are fewer
patents per drug.
(GAO-13-465)

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Does IP stimulate innovation?

• Lerner (AER P&P 2009)

• Analysis of the effect of major patent policy changes on

domestic patent applications

• Sample of 60 countries listed in the International Monetary

Fund's International Financial Statistics with the highest GDP in
1997

• 177 events (64 percent strengthening the patent system)

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Lerner (AER P&P 2009)

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Lerner (AER P&P 2009)

Non-linear relationship:
- In countries with low protection, a positive change has a positive effect on innovation
- In countries with high protection, a positive change has a lower impact (maybe even
negative)
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Patents and future innovations

• So far, we basically assumed that an innovation is isolated.

However, innovators typically build on prior innovations
 Very often innovation is cumulative

• A problem that arises: Does the patent system ensure that

early innovators are compensated according to their
contribution, while late innovators have an incentive to invest?

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Example: The laser

• The laser builds on the maser

- Both use similar principles to create electromagnetic waves
- The Maser creates microvaves
- The Laser creates light waves

• The maser patent invented by Townes and assigned to the Research

Corporation was so broad that it covered all kind of electromagnetic
waves

• Later Townes did additional work and obtained a patent on the laser
assigned to Bell Labs

• Bell was sued by the Research Corporation for patent infringement

 the case settled granting royalties (licensing fees) to the Research
Corporation – the maser patent was “blocking” the laser patent
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Basic innovation
Surgical
instrument

Application 1
Example:
Laser
Weapon

Basic innovation Application 2

Construction
tool

Application 3

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 Problems of cumulative innovation
t=0 t=1 t=2 t=3

𝜋𝑇𝑣1 + 𝐿 − 𝑐1 , 𝜋𝑇𝑣2 − 𝐿 − 𝑐2 𝜋𝑇𝑣1 + 𝐿 − 𝑐1 , 𝜋𝑇𝑣2 − 𝐿 − 𝑐2

yes yes

Ex ante Ex post
yes License? yes License?

Firm 1 no Firm 2 no
invest? invest? 𝜋𝑇𝑣1 − 𝑐1 , −𝑐2
no no
0,0 𝜋𝑇𝑣1 − 𝑐1 , 0

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Observations

• L depends on the bargaining position of the two firms (for example, competition for a license
may speak in favor of firm 1)
• If the first innovation is very basic, its value can be very low, and firm 1 requires licensing
revenues to break even (for example, consider 𝑣1 = 0)
• If the innovation takes place within one firm, the firm will invest in both if
𝜋𝑇 𝑣1 + 𝑣2 − 𝑐1 − 𝑐2 ≥ 0 and 𝜋𝑇𝑣2 − 𝑐2 ≥ 0
- However, with separate firms, both firms will share the surplus of the second innovation. For example, firm
1
1 gets 𝜋𝑇𝑣2 − 𝑐2 . But, if 𝜋𝑇𝑣1 − 𝑐1 < 0, the license fee may not be enough for the first firm to break
2
even.
 Innovation 1 will not take place
- Stronger patent payoff (e.g., larger T) may solve the problem
• Firm 1 may be able to hold up firm 2 in an ex post license
(it is possible that 𝐿 > 𝜋𝑇𝑣2 − 𝑐2 )
- Firm 2 will anticipate it and not invest in the first place
- Problem can be avoided with ex ante licensing
• In this setting, ex ante licensing always takes place because there is a cake to share
if 𝜋𝑇𝑣2 − 𝑐2 > 0.
 That may not be true anymore if 𝑣1 decreases because of 𝑣2 (competition)

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Many inputs
Example:
Durable glass

Research tool 1

Touchscreen
Semiconductors

Research tool 2 Application

Magnets

Research tool 3

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Example: Pneumatic Tyres

• 1845 patent on air-filled leather tire

 Didn’t work very well

• Solid vulcanized rubber was invented separately

• In 1888, John Dunlop put the two ideas together:

rubber with an inner tube

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 Problem of many inputs - Royalty stacking
• Assume a demand curve of w(z)=1-p
- p is the total price: p1+p2
- w(z) is the willingness to pay of the customer z
p p1 Assume p2=1/4
1 1 Is the price ¼ individually
optimal?

1-1/4 No, optimal price for firm 1 is 3/8

Optimal total price=1/2
=3/4 if p2=1/4
 incentive to deviate

1/2

3/8

1/2 1 z 3/8 1 z
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 Problem of many inputs - Royalty stacking
• Equilibrium prices are p1=1/3 and p2=1/3  p=2/3
• To see this
p1 p2
1 Assume p2=1/3 1 Assume p1=1/3

If p2=1/3, it is optimal for

1-1/3 1-1/3 If p1=1/3, it is optimal for
firm 1 to choose p1=1/3
=2/3 =2/3 firm 1 to choose p2=1/3

1/3 1/3

1/3 1 z 1/3 1 z
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Observations

• Price for the research tools is higher if ownership is dispersed

• Why?
- Both licensors try to increase their share of the cake, by doing so the cake
decreases
- One licensor does not take the effect of the own price on the profit of the other
licensor into account
 Increasing p1 implies a negative externality on licensor 2
- A double marginalization problem

• Potential solution:
- Joint ownership of inputs
• M&A
• Patent Pools

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Does IP block future innovation?

• Question difficult to answer because cumulativeness is difficult

to measure

• Galasso and Schankerman (QJE, 2015) analyze this setting

relying on patent citations and patent invalidations

• The idea:
- Patent have to cite prior art
- That includes invalidated patents
- If a patent gets invalidated, we can analyze whether more subsequent patents cite
the invalidated patent

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Galasso and Schankerman (QJE, 2015)

• Additional problem: Endogeneity of the Court’s decision

- A higher valued patent lets the patent holder invest more in non-invalidation
- Follow on innovators can identify invalid patents, and invest accordingly

• Solution: Instrumental variable approach

- Focus on Federal Circuit decision (2nd instance after the District Courts)
- 3 judges are assigned randomly
- All judges have a track record in invalidating patents which allows to calculate the
probability of an invalidate vote of a given judge  can be interpreted as bias
(varies from 24.4 to 76.2 percent)
- This allows to calculate the probability that at least 2 judges vote for invalidation
which serves as an instrument (denoted by Judges Invalidity Propensity (JIP))
- Then 2SLS with

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Galasso and Schankerman (QJE, 2015)

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Galasso and Schankerman (QJE, 2015)

Results:
• Patent invalidation leads to about a 50 percent increase in
subsequent citations on average

• For most patents, the marginal treatment effect of invalidation is not

statistically different from zero.
- Effect focuses on a few patents
- Effect is present only in the fields of computers and communications, electronics, and
medical instruments (including biotechnology).
- The impact is entirely driven by the invalidation of patents owned by large firms, which
increases the number of small innovators subsequently citing the focal patent.

• Patent rights block cumulative innovation only in very specific

environments

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Does IP stimulate innovation?

Moser (AER, 2005)

• Dataset of close to fifteen thousand innovations at the Crystal Palace
World's Fair in 1851 and at the Centennial Exhibition in 1976

• The paper tests the following argument: if innovative activity is motivated by

expected profits, and if the effectiveness of patent protection varies across
industries, then innovation in countries without patent laws should focus on
industries where alternative mechanisms to protect intellectual property are
effective.

• Analyses of exhibition data for 12 countries in 1851 and 10 countries in

1876 indicate that inventors in countries without patent laws focused on a
small set of industries where patents were less important, while innovation
in countries with patent laws appears to be much more diversified
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Moser (AER, 2005)

• Why historic trade fair data?

- Large differences in patent systems across countries
- Domestic patent law very important, foreign patens were expensive

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Moser (AER, 2005)

• Instruments: an optical lens, an improved watch movement or a watch escapement, a

barometer, or a theodolite etc
• Cluster in this technology area in countries with low patent protection
• Bavaria patents were “ill-enforced”
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Moser (AER, 2005)

• Moser runs regression analysis. The following graph shows the

predicted shares across industries

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Moser (AER, 2005)

• The Netherlands abolished patent laws in 1869, presumably

because they were considered to be related to protectionism
which was at odds with the Netherland’s commitment to free
trade

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Moser (AER, 2005)

• Patent laws do affect incentives but are also important for the
direction of innovation

• But also countries with no patent law reveal a perhaps

surprising amount of high-quality innovations
- In 1851, Switzerland and Denmark contributed 110 exhibits per million people,
compared with a mean of 55 and a median of 36 per million people for all
countries

• On average only a small share of innovations were patented

- In 1851, 11 percent of British exhibits were patented.

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Summary

• Moser (JEP, 2013):

- Historical evidence suggests that in countries with patent laws, the majority of
innovations occur outside of the patent system.
- Countries without patent laws have produced as many innovations as countries with
patent laws during some time periods, and their innovations have been of comparable
quality.
If a substantial share of innovation occurs outside of the patent system, policies that
implement even the most drastic shifts towards stronger patents may fail to encourage
innovation.
If property rights in ideas encourage inventors to publicize technical information, a shift
towards patenting may encourage the diffusion of knowledge.
Overall, the weight of the existing historical evidence suggests that patent policies,
which grant strong intellectual property rights to early generations of inventors, may
discourage innovation. On the contrary, policies that encourage the diffusion of
ideas and modify patent laws to facilitate entry and encourage competition may be an
effective mechanism to encourage innovation.

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