Broken Symmetry

Every Patent Affects Two Different Markets

There are two different markets relevant to every valuable patent. First, there is the market for the R&D work that results in the patent.  Prices in this market are set by the opportunity costs for the time of scientists and engineers who are capable of theorizing about and experimenting with the technology.  Second, there is the market for the claimed products or services that the R&D work opened up.  The second market is the one that everyone naturally thinks about.  In fact, our whole nation has had a blind spot for the first market for a long time because corporate R&D divisions were serving that market very well until the Bayh-Dole Act was passed in 1980.  Most universities have not been able to consistently match pre-product funding with the flow of R&D produced by their faculty.  One former R&D employee from Apple and Microsoft blames Silicon Valley, saying "Silicon Valley forgot how to do R&D."

Within the law of antitrust, one can observe how this blind spot is affecting the outcome of litigation.  The essential facilities doctrine of antitrust law has been applied in an inconsistent way because most judges don't see that there are two different markets.  R&D work almost always has natural monopoly characteristics.  But patents covering valuable R&D should not therefore trigger the essential facilities doctrine.  Lots of R&D work needs the barrier to entry that only legal exclusivity can provide in order to recover even a reasonable profit.  Yet if the same patented R&D is valuable because the claims cover a product, the production and distribution of which have natural monopoly characteristics, then applying the essential facilities doctrine to require the patent owner to make licenses available on a non-exclusive basis might make sense.

Consider two concrete examples.  Example 1:  I patent R&D claiming a new type of telephone.  The essential facilities doctrine should not be invoked to require me to license others to sell the patented telephone.  Producing telephones is not a natural monopoly because the total average costs are not always declining.  Note that this is true even though the telephone demonstrates network effects.  Example 2:  I patent R&D claiming a new type of telephone network.  The essential facilities doctrine probably should be invoked to require me to license others on a non-exclusive basis who need to use the telephone network for their own products or services to be valuable.  Building telephone networks is a natural monopoly because the total average costs are always declining.  In both cases, the crucial question is whether the second market has natural monopoly characteristics.  The first market almost always will.

In some cases in the past, when the essential facilities doctrine has been invoked against patent owners, judges have decided either to let the patent owner maintain full exclusivity or to deny any compensation.  Better would be for judges to let most patent owners do whatever they want, but require compulsory licenses in the subset of cases in which the actual product or service sold has natural monopoly characteristics.

Those with an extraordinary interest in reading more can wade through this paper.  But know that I am no longer enthralled with the idea of applying the reverse doctrine of equivalents in patent law or the Feist originality doctrine from copyright law to the same effect.  Too much potential for mischief.

How did the United States get stuck on the peak of a Sombrero?

Consider a ball resting at the center of the sombrero pictured at right.  Poised at the very center of the sombrero and at rest, the ball will not move.  It is in an (unstable) equilibrium.  Nonetheless, if nudged, the ball will roll down into the ring of the sombrero.  The lowest ring around the peak of the sombrero is a stable equilibrium.  Any further nudges will push the ball around the ring a bit; but the ball will end up rolling around the ring from then on.

In this example, physicists would call the direction in which the ball gets nudged an "order parameter."  And here's what makes the order parameter interesting: Starting from the peak of the sombrero, the ball will roll in any direction easily.  But starting from the ring of the sombrero, the ball will tend to roll only along tangents to the ring.  The symmetry of the order parameter is broken as it moves into a new equilibrium.  Thus, broken symmetry signals a new equilibrium.

People, firms, and even whole markets can persist in unstable equilibriums, like the peak of the sombrero.  If it's a big enough sombrero, even relatively big nudges won't move us off the peak.  In addition, from the peak of the sombrero, every direction looks about the same.  So for a long time we might get nudged one way and then nudged back again without ever leaving the peak.

Look at what happens, however, when a group of people start seeing the sombrero rather than its peak alone. That group will start rolling the ball in the same direction.  And note that it doesn't much matter what direction that is.  Any direction will do in getting us off the peak of the sombrero (so long as there isn't another group just as big trying to roll it back the other way).  Once off the peak, things will look very different to everyone, not just the people who can see the whole sombrero.  We might even be able to reach a new consensus: "We'll either go left or right around the ring.  But any other direction doesn't make sense."

When it comes to patent law in the United States, we're at the peak of a sombrero right now.  Here's what I see: We're spending tens of billions of dollars every year on new R&D.  But some of that money is spent redundantly (in ignorance of the prior art), and some of it is completely lost (to patent infringement) because ideas, once disclosed, are impossible to take back.  Trade secret torts and contracts just aren't as good a way to solve these problems.  Turning a blind-eye to patent infringement is bad long-term policy for the United States.  There are already a few other countries that are watching and hoping that we'll drop the ball on this one.  (Or I guess not push the ball far enough in the right direction.)

With the big sombrero in mind, it shouldn't be so hard for everyone to see how strong patent rights are a smart way "to promote the progress of science and the useful arts" through market-based incentives.  Both the Venetians in the 15th Century and our Founding Fathers in 1787 saw the value of patents.  Where did we go astray?

I also gave a brief explanation for the name "Broken Symmetry" in my first post to this blog, but I wanted to revisit the metaphor because it has been so fruitful for me in understanding the organic evolution of markets and firms.

The more things change...

Thousands of years ago Plato (top left) wrote that "Until philosophers are kings, or the kings and princes of this world have the spirit and power of philosophy, and political greatness and wisdom meet in one, and those commoner natures who pursue either to the exclusion of the other are compelled to stand aside, cities will never have rest from their evils, -- nor the human race, as I believe, -- and then only will this our
State have a possibility of life and behold the light of day."

Plato's student Aristotle (bottom left) understood government differently: "When several villages are united in a single complete community, large enough to be nearly or quite self-sufficing, the state comes into existence, originating in the bare needs of life, and continuing in existence for the sake of a good life. And therefore, if the earlier forms of society are natural, so is the state, for it is the end of them, and the nature of a thing is its end. ... Hence it is evident that the state is a creation of nature, and that man is by nature a political animal. And he who by nature and not by mere accident is without a state, is either a bad man or above humanity; he is like the 'Tribeless, lawless, hearthless one, ' whom Homer denounces- the natural outcast is forthwith a lover of war; he may be compared to an isolated piece at draughts."

This week, Judge Posner (top right) made the following remarks on problems in the current credit-market: "This would be fine if zero regulation were the social desideratum, but it is not. The correct approach is to carve down regulation to the optimal level but then finance and staff and enforce the remaining regulatory duties competently and in good faith. Judging by the number of scandals in recent years involving the regulation of health, safety, and the environment, this is not being done. And to these examples should probably be added the weak regulation of questionable mortgage practices and of rating agencies' conflicts of interest and, more basically, a failure to appreciate the gravity of the moral hazard problem in the financial industry."

As Aristotle saw things differently from Plato, so Becker (bottom right) sees the purpose for regulation differently from Posner: "It would run counter to human nature for regulators to take a skeptical attitude toward the riskiness of various assets when the market is indicating that these assets are not so risky, and when originating and holding these assets has been quite profitable. One can expect regulators to mainly follow rather than lead the market in assessing riskiness and other asset characteristics."

Updated RSS Feed

I just switched my RSS feed to Feed Burner, and added the ability for readers to subscribe by email.  I don't post very often, so hopefully readers will find this a more convenient way to keep track of what's new on Broken Symmetry.

How Abraham Lincoln was wrong about one thing, but right about almost everything else

On February 11, 1859, Abraham Lincoln gave a lecture to the inhabitants of Jacksonville, Illinois on the topic of discoveries and inventions.  His most famous words from this lecture are the last few that were recorded:

"Next came the Patent laws.  These began in England in 1624;* and, in this country, with the adoption of our constitution.  Before then, any man might instantly use what another had invented; so that the inventor had no special advantage from his own invention.  The patent system changed this; secured to the inventor, for a limited time, the exclusive use of his invention; and thereby added the fuel of interest to the fire of genius, in the discovery and production of new and useful things."

It's hard to overstate the importance these words have had for patent law.  They have been a motto for patent lawyers for generations.  But not many people, even patent lawyers, have read the whole speech.  Everyone in America should be required to read this speech in high school or college.  I will come back to it again and again in the future.  There are many, many posts I could write about this speech.  Practically every sentence in it sparkles with insight into human nature and invention.  The speech is as beautiful a piece of American prose as we are ever likely to get from a patent lawyer.

In this speech, Lincoln anthropomorphizes the United States into "Young America," the "most current youth of the age," which some people "think conceited, and arrogant; but has he not reason to entertain a rather extensive opinion of himself?"  Lincoln is funny, but also honest.  For example, he observes how Young America "is always very anxious to fight for the liberation of enslaved nations and colonies, provided, always, they have land, and have not any liking for his interference."  Have we changed much?  Read the whole thing to get all of his insights into questions about the relationship between "Old Fogy" and "Young America" (i.e., international trade and politics), natural resource use,  the process of invention, joint invention, and more.

But my point in this post is that he miscalculated one important thing.  It's a miscalculation that he can hardly be faulted for.  Nobody can see into the future.  But it's important to revisit the past, and reconsider Lincoln's words now as we consider and reconsider how we as a nation are going to grow in the future.

In this speech, Lincoln delineates four stages of human progress in making inventions and discoveries. 

First, Lincoln points to human speech.  "If I be in pain I wish to let you know it, and to ask your sympathy and assistance; and my pleasurable emotions also, I wish to communicate to, and share with you.  But to carry on such communication, some instrumentality is indispensable."  Second, is writing -- "the art of communicating thoughts to the mind, through the eye."  Third, printing, "a great gain; and history shows a great change corresponding to it, in point of time."

And finally came the fourth, and the passage from this speech that everyone is familiar with.  Lincoln picked patent law as the fourth stage of human progress in promoting inventions and discoveries.

Even Lincoln couldn't have predicted the Internet.  None of us did.  It just happened, much like the printing press did in the 15th century.  We're still experiencing the aftershocks, and will be for some time. There are some Catholic churches in the world that are not ready for the democratisation of knowledge made possible by the Internet.

So Lincoln was wrong about one thing: patent laws are not the fourth stage in human progress.  They're the fifth.

* As an aside, regular readers will note that Lincoln was also mistaken in attributing the origination of patent laws to the English Statute of Monopolies.  The Venetians had a patent system in place in the late 15th century.  And English and other European monarchs were granting exclusive rights to inventions by letters patent well before the Statute of Monopolies anyway.

Natural Monopolies in Antitrust & IP

Here's another "big think" paper I wrote but never published on the subject of how natural monopolies are handled by judges in antitrust, patent, and copyright law.

In a nutshell, judges are generally aware of the phenomenon of natural monopolies.  The essential facility doctrine is more or less explicitly designed to handle the situation.  But to avoid the potential vitiation of their economic benefits, patent and copyright law should offer the release valve of compulsory licensing remedies in this situation as well.  You don't need the Feist originality doctrine or the reverse doctrine of equivalents to do this work; you could just write it into the remedies law explicitly.  Nevertheless we have these doctrines, so we might as well given them definite work to do.  My readers know that I generally favor rules that are explicitly economic.

A Concise History of the First-to-invent Rule of Priority in United States Patent Law

For years I've been meaning to polish up this paper and try to get it published.  But diminishing marginal returns have this way of slowing you down.

Anyway, here's a link to the post on SSRN.  Maybe it will be interesting to some of my blog readers.

In a nutshell, I believe that the first-to-invent rule was an unintended consequence of (a) the federalist form of government we adopted and (b) natural rights theories that were prevalent among the founding generation.

It's time to get rid of the rule.  Interferences are usually a waste of time and money.  I like the proposed first-inventor-to-file amendments.

Lawyers as Choice Architects: Holmes, Posner, Hayek, and Sunstein

111 years ago, Oliver Wendell Holmes, Jr. wrote in The Path of the Law:

For the rational study of the law the blackletter man may be the man of the present, but the man of the future is the man of statistics and the master of economics.

Holmes's prophecy came true with the advent of law and economics, which is now the dominant theory of law for academics and practicing lawyers alike.  There isn't an area of law left untouched by the theory.  Judge Posner, perhaps its most prominent proponent, has himself put every major area of law on display through the lens of economics.  Economic analysis turns out to be ridiculously useful in achieving what Holmes identified as the object of the study of law: "the prediction of the incidence of the public force through the instrumentality of the courts."  Without economics, how else could lawyers predict the prospective behavior of large groups of people?

The answer is psychology.  And psychology, after taking a back seat for the past few decades, is making a comeback in law through the work of professors like Cass Sunstein, Richard Thaler, and Ian Ayres.  (I would add Charlie Munger, but he doesn't publish widely or often enough.)  What these professors share is an interest in the cases in which the behavior of people predictably deviates from the fundamental rational hypothesis of economics.  See the series of guest posts that Sunstein has done on "choice architecture" and "libertarian paternalism" on the Volokh Conspiracy for a sampler.

The power of "choice architecture" lies in its promise for weaker government interference with private choice.  In a world in which public and private rulemaking is uninformed by the quirks of human psychology (think of our herd instincts), government is more likely to ban entirely some activities that might be efficient at low intensity, or mandate some activities that might be done voluntarily, but not as consistently as necessary.

As "choice architects," lawyers seek to build legal systems with privately adaptable rules, which permit a decentralized, spontaneous order.  In this sense, libertarian paternalists build on the work of Hayek and Rothbard (although both would have disliked being associated with any form of "paternalism").

Would it be too bold to say: "For the rational study of law the master of economics may be the lawyer of the present, but the lawyer of the future is the student of irrational human nature and the master of psychology."

Rebundling Ownership and Control of Patents

On Friday I attended a panel on the "State of the Legal Profession" held at Stanford Law School.  The panel was well-designed, with a variety of perspectives from lawyers in-house, at law firms, in academia, or in public interest.  It's hard to get six lawyers to agree on anything, but it seems that everyone more or less agreed that the traditional law firm business model is not holding up well in the 21st century.

There are many reasons for this, one of which -- the inaccuracy of the billable hour as a metric for the value of legal services -- I've discussed in a previous entry.  Another reason that was obvious after hearing the panelists is the relatively inelastic supply of talent graduating from law schools every year.  That pool of talent hasn't grown much in decades, even as the demand for legal services has exploded.  Public interest advocates are seeing more and more people opt for pro se representation in court or no representation in transactions (see, e.g., subprime mortgage lending).  Law firms are raising salaries higher and higher to attract talented associates, but also increasing leverage (i.e., the ratio of associates to partners) in order to continue attracting talented partners (profits-per-partner being a key metric for partners in deciding where to work).  Meanwhile in-house counsel is facing increasing pressures from company management to keep down the costs of legal bills as global competition narrows the margins on products and services.  Another time I may elaborate on how some big law firms are beginning to resemble a Ponzi scheme in this regard.  And anyone keeping tabs on the credit market knows how ugly deleveraging can get.

So what can be done?  There's no choice for now but to get more efficient with the supply of talent that we've got.  My earlier post gave a suggestion for how more efficient incentives could reduce costs for certain kinds of transactional work.  But it didn't elaborate on how rebundling of ownership and control is capable of solving a whole class of principal-agent problems in legal services.  A similar solution could be used by many companies to reduce the costs of procuring and enforcing patents.

The basic contractual framework for accomplishing this is simple, although the practical execution is difficult, requiring human capital with a high-level of expertise in three different, (now) weakly-overlapping professional disciplines.  Instead of paying a law firm by the hour (or paying a high fixed-rate) to prosecute patents, clients could pay a much lower (or zero, or negative) fixed-rate for their work, and then give them a slice of any future royalties earned on the portfolio.  Lawyers who (a) believe in the value of their services, (b) understand the technology patented, and (c) believe in the prospective value of the market that the patents are meant to cover should be willing to accept lower rates in exchange for a slice of future profits.  The trouble is that there just aren't that many lawyers who understand law, technology, and venture capital investing.  And the ones that do (think of senior partners at big law firms) generally are too comfortable with the status quo.

Not every company is going to feel comfortable with doing things differently, especially if the current system is meeting their needs.  Nonetheless the potential is there for forward-looking clients and entrepreneurial patent lawyers to innovate on the traditional business model, and maybe even lead the way into a better model for legal services in every market.

UPDATE: Thanks to IPKat I have learned that the French bar is in the middle of a protracted struggle to keep scientists and engineers out.  Not surprising, but comforting to know that we're not the only ones with this problem given the implications that our excessive domestic regulations have for the United States in competing in a global economy.

Avoiding Consistency Traps

"A foolish consistency is the hobgoblin of little minds."

-Ralph Waldo Emerson

The new pilot program designed to promote Examiner interviews before first Office Actions is an excellent idea, which PTO Director Dudas and his team deserve praise for trying out.

The reason that this program makes so much sense is because all of us who have prosecuted have seen how Examiners can fall into a "consistency trap" by taking a position on how an invention relates to the prior art before fully understanding the invention claimed.  Psychologists (professional negotiators and sales people) have documented the consistency trap in many studies over the years.  It is a very real psychological phenomenon.  One that even our Founding Fathers knew about and avoided when they closed the Constitutional Convention to the public, thereby giving the delegates more freedom to explore ideas and change their opinions without feeling held to them by published accounts of their speeches.

If Examiners have a chance to ask questions and listen to inventors and their representatives prior to committing opinions to writing, valid claims are going to issue quicker, and with less risk of prosecution history estoppel.  Correspondingly, invalid claims are going to be trimmed back or dropped sooner.

Kudos to Director Dudas and his team for coming up with this program.  We look forward to hearing more about this pilot program, and seeing how much it improves efficiency by compensating for this quirk of human psychology.

Broken symmetries at Ford

In the automotive industry, Ford has one of the strongest brand names in the world.  But for the past ten years, it has been dogged by persistent problems, driving its market value close to $10 billion at one point earlier this year.  What are we to make of Ford's long-term prospects in the automotive market?  Here are a few factors relevant to Ford's durable competitive advantage I have been considering:

• Product Quality: the newest quality ratings from J.D. Powers and Consumer Reports put Ford quality in striking distance of its Japanese competition
• Brand Identity: Ford has a brand name that is very differentiated from that of its Japanese competition, and probably in a favorable way from the perspective of customers in the emerging markets of Europe, South America, Asia, and India
• Economies of Scale: Mullaly is implementing at Ford the same scale advantages that have been practiced at Toyota for some time: centralizing worldwide design and production, narrowing the number of models and brands to the core few that offer the highest margins.

It's possible that GM and Chrysler will catch-up eventually, but Ford appears to have a good head start on its American competition in these regards.  And it's selling at under $20 billion despite doing almost $200 million in sales annually, and a well-capitalized balance sheet.

Is this what Charlie Munger would call a Lollapalooza?  Probably not, but it's definitely got me interested.  My grandfather used to own a factory that sold parts to the automakers in Detroit.  I also have some sentimental interest in seeing the American automakers recover their mojo.

UPDATE: here's the WSJ mulling it over.

UPDATE 2: for some of us, this wasn't too surprising.