Commercializing Innovation Conference (4-5 November 2005)

~Kieff  – McManis – Partnoy – Lichtman – Smith ~
~Lerner – Abramowicz – Wagner – Gold – Merges – Haber – Cohen ~

Scott Kieff

The problems of the intellectual property (“IP”) anticommons have become infamous. The potential for vast numbers of IP rights to cover a single good or service is feared to so unduly tax and retard the creation, use, or sale of the good or services that no enterprise may even try. The transaction costs of the deal alone may be overwhelming. Those wanting to enter such a line of business fear they will be held up, leaving un-met the demand for the goods or services it would have provided. Simply put, too many property rights in IP may block deals from getting done. The impact may be life threatening. To cite just one prominent example, we may never see various diagnoses and treatments targeted to specific genetic profiles that are otherwise promised by DNA-on-a-chip technology but putatively blocked by the existence of patents on so many of the underlying pieces of DNA. To date, the suggested responses to the anticommons concern in IP have included a host of reforms in patent law and policy. This paper offers an alternative solution based on private ordering. The core of this private ordering solution is a limited liability entity structured so that all of its stakeholders are themselves limited in their actual and potential stakes, such as by being financed by debt rather than equity and set up so that it avoids significant capital accumulation while providing certain royalties to owners of all patents that would be infringed by its business mode. The structure of such an entity is designed to serve a crucial coordination function on behalf of all relevant property owners and other members of the team production story, with participation by many members enhancing the coordination effect on the rest. Two implications of this private-ordering solution also are explored: the ways it may avoid some practical costs and risks of legal reform in this anticommons context; and some basic lessons about how to conceptualize certain aspects of the IP system.

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Charles McManis

The past two decades have witnessed a growing debate in the United States over patenting genetic products and processes.  At the heart of the debate are two interrelated questions-1) whether granting patents on the results of upstream genetic research  undermines the norms of the biological research community; and 2) whether such patenting promotes or retards biomedical innovation, technology transfer, and/or the development of downstream commercial products and processes.  Much of this debate has focused on the impact of a 1980 piece of legislation commonly known as the Bayh-Dole Act. 

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Frank Partnoy

 Patents are options.  Specifically, patents are call options, consisting of the right, at various stages, to purchase a stream of expected cash flows associated with excluding others from developing patented subject matter.  Patent holders can monetize this right by developing and commercializing the patent (exercising a "development option") and/or litigating, or threatening to litigate, the patent (exercising a "litigation option").
 The insight that patents are options is important to patent valuation and policy.  First, because patents are options, patent holders receive the full value associated with the right to exploit the underlying subject matter immediately upon issuance.  Moreover, this value is transferred to the patent holder from society, which collectively would otherwise retain the option.  Just as a company transfers value from shareholders to executives when it issues stock options, so too does the Patent and Trademark Office transfer value from the collective to patent holders when it issues patents.  Further, the value of patents, like the value of stock options, is positive when they are granted, even if they turn out to be worthless at a future date.
 Second, because patents are options, they should be valued using option pricing theory.  Patent scholars and market participants traditionally have valued patents (incorrectly, in our view) just as firms value projects, by comparing the cost of developing the patent to the present value of expected future cash flows from the exclusion of competitors.  This approach is commonly known as discounted cash flow (DCF) analysis.  However, since 1973, financial economists have developed more sophisticated mathematical models for valuing projects with optionality, including, most recently, binomial and "real" option pricing models, which are superior to standard closed-form models because they incorporate the value of the right to abandon or delay, at each of several stages, either development or litigation.  We argue that these models are not only are more accurate, but also illuminate the importance of certain variables (e.g., volatility) that are relevant to assessing patent policy. 
 Third, because patents are options, the appropriate scope of patent protection and patent policy should depend, at least in part, on the factors that determine option value.  The option value that the patent holder receives at issuance must provide sufficient incentive for a patent holder to create and commercialize the patent, but should not overcompensate the patent holder or create a suboptimal preference for litigation over development.  Option theory suggests that the existing patent regime improperly favors the exercise of litigation options over development options, and that it would be beneficial to reduce the value of litigation options (e.g., by increasing their exercise price).

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Douglas Lichtman

Prior to adopting a technical standard, standard-setting organizations (SSOs) typically endeavor either to make sure that the standard does not infringe patent rights or to acquire the necessary permissions. The task is a difficult one. Some members have such significant patent portfolios that they do not themselves know whether they hold relevant patents. Other members are aware of their own patent holdings but refuse to speak up, fearful that highlighting specific patents in their portfolio might inadvertently reveal some aspect of their long-term strategic plans. Members with pending or planned patent applications are often similarly quiet, in this case not wanting to reveal information that is not yet, and might never be, public. And all this does not even yet mention the problems associated with patent holders who might be accidentally left out of the selection process or who might strategically lay low in the hope that an infringing standard will be adopted and lead to lucrative patent royalties.

Standard-setting organizations are thus in a bind. In response, many today experiment with a licensing provision known as defensive suspension.Under defensive suspension, the standard-setting process begins as per normal, with the SSO selecting a technical standard and negotiating patent permissions with any patent holders willing to step forward. Then, instead of publishing a license that authorizes any taker to use the standard subject to whatever royalties the patent holders require, a new clause comes into play: the known patent holders reserve for themselves the right to terminate the license of any licensee who asserts that the licensed standard infringes the licensee's patent rights. Put simply, the patent holders retain a right to retaliate. If a licensee comes forward and asserts patent rights over the standard, participating patent holders can retract that license and assert their own patents against the now-former licensee. The idea, quite obviously, is to discourage licensees from using patents to tax or derail adopted standards. But the mechanism turns out to have more complicated implications-for the turncoats who are its target, and for every other stakeholder as well.

In this Article, I endeavor to clarify the strategic value, public policy analysis, and likely legality of defensive suspension clauses as they might be used in the standard-setting context. I begin with the strategic issues, considering how patents threaten technical standards and the degree to which defensive suspension might mitigate those concerns. In Part II, I turn to the law, examining how analogous mechanisms have fared in the courts and using those cases to highlight the possibilities for abuse. In Part III, I briefly conclude, emphasizing three core considerations that should guide SSOs as they draft these clauses and courts as they endeavor to situate defensive suspension within the antitrust and patent law jurisprudence.

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Henry Smith

Intellectual property is most like property when not viewed in isolation. Although it is true that the nature of the “resource” is very different – because it is nonrival – than the typical resource in the law of property, this is not the end of the story. Intellectual property, like property in general, can be seen as the solution of a complex coordination problem of accession writ large. Different actors combine inputs with something that can
be said to belong to the public. As long as the innovator’s or commercializer’s rival input is valuable enough and the overall coordination problem of investment, appropriation, and consumption is complex enough, experience and theory of systems and human artifacts should lead us to expect a major role for modular solutions. Property, with its boundaries and rights of exclusion indirectly protecting an indefinite range of internally
interacting uses, makes the system of commercializing innovation modular. Ultimately, the desirability of intellectual property rights is an empirical question, but the answer must take into account the crucial role of modularity in organizing production of modular artifacts, which commercialized inventions themselves have increasingly become.

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Josh Lerner

Over the course of the nineteenth and twentieth centuries, the United States evolved from a colonial backwater to become the pre-eminent economic and technological power of the world.  The foundation of this evolution was the systematic exploitation and application of technology to economic problems: initially agriculture, transportation, communication and the manufacture of goods, and then later health care, information technology, and virtually every aspect of modern life.

From the beginning of the republic, the patent system has played a key role in this evolution.  It provided economic rewards as an incentive to invention, creating a somewhat protected economic environment in which innovators can nurture and develop their creations into commercially viable products.  Based in the Constitution itself, and codified in roughly its modern form in 1836, the patent system was an essential aspect of the legal framework in which inventions from Edison's light bulb and the Wright brothers' airplane to the cell phone and Prozac were developed.

In the last two decades, however, the role of patents in the U.S. innovation system has changed from fuel for the engine to sand in the gears.  Two apparently mundane changes in patent law and policy have subtly but inexorably transformed the patent system from a shield that innovators could use to protect themselves, to a grenade that firms lob indiscriminately at their competitors, thereby increasing the cost and risk of innovation rather than decreasing it.

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Michael Abramowicz

Intellectual property ordinarily passes from private ownership to the public domain, but it is possible to imagine regimes that would selectively convert some public domain property back to private ownership. Privatization might be useful in some cases to promote further scientific development of intellectual property, to provide incentives for unpatentable improvements, to encourage commercial experiments, to generate increased advertising or marketing, and to prevent overuse. Privatization has drawbacks too, including both the familiar drawbacks of private ownership and the rent-seeking that a system of privatization might entail. If selective privatization is appropriate, auctions may be the best mechanism for privatizing rights in a way that limits rent-seeking, and information markets might provide a useful means for determining when privatization is appropriate.

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Polk Wagner

One of the bedrock principles of the divided nature of our Federal government is that courts are not policymakers. As with many such
principles, however, this division between the judiciary and the policymakers turns out to be more hortatory than foundational. And as
any student of the patent law understands, this principle is especially difficult to discern with respect to the United States Court of Appeals for
the Federal Circuit: the structure and operation of the regulatory system for patents, the court’s unique role as an exclusive appellate body, and
the patent doctrine itself have combined to place the Federal Circuit as the central actor in modern innovation policy in the United States.
Although there are plainly a range of concerns with this allocation of power, this Essay takes the Federal Circuit’s policymaking role as given,
and proceeds to map the contours of the Federal Circuit’s work from an innovation policy perspective. The paper moves in three parts. In the
first, I explore the question of how and why the Federal Circuit is widelyregarded to be the key player in innovation policy in the United States—
a role in stark contrast to the general presumption against judicial policymaking. In Part II, I attempt to explain the patent law doctrine
created by the Federal Circuit in innovation policy terms. And finally, in Part III, I offer some observations, analysis, and suggestions
regarding how an carefully-considered “innovation policy” centric Federal Circuit might operate.

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Richard Gold

The difficulty of ensuring the commercialization of university research is not one that can be answered simply by setting up the right set of economic incentives. University research and its transfer to the private sector respond not only to economics, but to shifting cultural norms and other values that often override or reduce economic incentives.

Culture obviously plays an important role in the economic growth of a society. This belief can be traced back to the work of Max Weber (1930) who argued that cultural changes play a critical role in the development of capitalism and its institutions.  Lal (1999) demonstrated the importance of Western individualism for the growth of markets in the West.
Culture can be defined as "the enduring behaviours, ideas, attitudes, and traditions shared by a large group of people and transmitted from one generation to the next."   As such, culture will shape the behaviours and actions of individuals, and consequently the institutions set up by a given society.

This paper will show that economic incentives and institutional structures cannot alone explain the difference observed in the effectiveness of technology transfer at American universities.  The cultural atmosphere at these institutions plays a critical role in achieving successful commercialization.  Specifically, what is required is a culture of entrepreneurship. In Part I, we will discuss the necessity for New Institutional Economics to include culture as a fundamental element of economic theory. In Part II, we will provide examples of how culture impacts economic systems, particularly those related to patent law.  In Part III, we will investigate the role of culture in the commercialization process at American universities. Particularly, we will show that successful technology transfer requires a specific cultural atmosphere at the university.

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Robert Merges

Property rights and contract law are two of our most basic legal categories. Many legal scholars describe what makes them different; this Essay describes how they work together to promote economic exchange. Incorporating the insights of both “transaction cost” and “new property rights” economics, it identifies two crucial contributions that property rights make to real-world contracting: (1) precontractual liability, or protection for disclosure of sensitive information in the period leading up to contract formation; and (2) enforcement flexibility after a contract is executed, in the form of many subtle but important advantages that accrue to a contracting party who also holds a property right. This Essay argues that property’s “transactional” role is growing in importance, as the “new economy” ushers in a more transaction-intensive industrial structure featuring greater numbers of smaller, more specialized firms.

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Stephen Haber

What role does access to finance play in the adoption or commercialization of new technologies? There are two answers to this question: no role at all; or, a large role, but its extent cannot easily be determined. The first answer assumes that capital markets are efficient: any innovation that is not adopted must have promised a risk-adjusted rate of return below the prevailing interest rate. The second answer assumes that there are imperfections in capital markets, but that determining their precise impact on innovation is difficult as a practical matter because technologies that are not adopted or commercialized are difficult to observe.  Moreover, even when we identify innovations that have been by-passed, we cannot know for sure whether they were by-passed because of an imperfection in the capital market or because that innovation was unattractive to investors for any number of reasons.  This paper offers an answer to the question of the role of finance in the process of  innovation by employing history as a laboratory. I look at the adoption of a particular set of technologies— those associated with the mechanized production of cotton cloth in the late nineteenth and early twentieth centuries— in two countries where those technologies had been slow to disseminate until that time, Brazil and Mexico.

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