Or to put the question differently, how should patents be valued if not by the cost of litigation?
It seems to me that there ought to be a way to measure the introduction of new products, and rank them by novelty and by widespread acceptance, in some way that reflects a more substantial measure of innovation and its impact on the economy.
There is no single right answer to this question. For earlier ruminations, see Reigniting the Engine of Growth, which was cross-posted to PatentlyO (where some of the comments were very good). But the best answers will share at least this in common: Simplicity
Complex rules are too easy to game. To discourage fraud and bad behavior, rules have to be simple (not just valuation rules, by the way, this is true for any rules).
But innovation is complex. Doesn't that preclude any simple measure? Yes and no. Yes in that any measure will be an approximation. This is true for any complex phenomenon, however. That doesn't stop us from measuring temperature, humidity, barometric pressure, and then forecasting the weather. Weather forecasts are not perfect, but at certain times and in certain places they are useful. Why else would we bother? The small talk alone is not sufficient.
The ultimate answer must be that there are ways to measure innovation. Indeed, everything that for-profit organizations do is complex, even putting aside innovation. Yet we have a highly developed set of rules we follow and measurements we take in tracking the performance of these for-profit organizations. They're called accounting rules and financial statements.
Some people think that you can go even one more step removed and look at the public market price of for-profit organizations, compare that against the number of patents pending or issued, and make predictions about how a company's stock price will move in response to the number of patents. That may work in a few isolated cases, but in general public stock prices are driven up and down by too many other influences. If you stick with the financial statements, you're only increasing your signal to noise ratio
To recap what is obvious for anybody exposed to accounting but unfamiliar to the rest, financial statements include (1) a snapshot in time of the assets, liabilities, and equity of a company (this is called the balance because it has to balance assets with liabilities and equity) and (2) a time-averaged summary of revenues and expenses (this is the income statement, or just P&L for "Profits and Losses"). Actually most also include a cash-flow statement, but we can ignore that for purposes of explaining how innovation might be measured. The cash-flow statement is there so that people can figure out how much of the revenue and expenses were "accounting adjustments," which smear revenue and expenses out over time, rather than actual cash changing hands.
So how can a financial statement give you insight into how innovative a company is? The answer is that whenever a company makes an actual improvement (whether or not that improvement is patented!) in a product or process for making a product, that actual improvement will be reflected in its stream of revenues and expenses.
For example, say PayPal introduces a new feature on April 1. Before April 1, PayPal was spending $0.30 per customer to generate $0.50 in revenue per customer. After April 1, PayPal spends $0.25 per customer and generates the same $0.50 in revenue. The value of the feature is $0.05 per customer. In this example, the PayPal increased its profit margin. That's the most obvious way that innovations add value to companies, and it's the one that most people think of, but it's not the only one!
In some cases, the company may not actually have lower costs or be able to charge higher prices as the result of an innovation. Yet the company may still be more profitable as the result of the innovation. This seems to be the more common case for most incremental innovations, which in fact are the majority of those patented in my experience.
Some of you are scratching your heads, wondering: "How can a company be more profitable if it doesn't charge higher prices or pay less in costs?" The answer is turnover. Consider Company X, which sells 10 widgets a day for $100 after paying $60 to make each them. Total profit per day = 10 x ($100 - $60) = $400.
Now consider Company Y, which sells 100 widgets a day for $100 after paying $60 to make each of them. Total profit per day = 100 ($100 - $60) = $4000.
What's the difference between these companies? Turnover rate. Company Y is selling widgets for the same price at the same cost much faster than Company X. You might think this is easy to do, but in fact it is very difficult.
Now of course if Company X and Company Y have otherwise identical accounting entries, the difference in turnover rates will show up as a difference in earnings on the next financial statement. And if the differential in turnover is sustainable over many accounting periods, it will almost certainly show up as increased earnings.
The problem that readers of public financial statements have in backing out these inventory turnover rates is that many products (both old and new) are combined into a single earnings figure. Moreover, adjusting entries often washout the signal reflected in increased (or decreased!) inventory turnover rates. In practice, at least retail investors have to do a little extra research to figure out whether inventory turnover ratios are increasing or decreasing for particular products, and by how much.
So there you have it, Tim. That's my suggestion for a simple way to measure the value of innovation: Read it off the time-series of revenue and expenses. If you can convince the SEC to get public companies to report this info, we will all be indebted to you.
Thanks to Paul Kedrosky for the link.