Broken Symmetry

Elves or Trolls? According to Robert Frost, it's Neither

I had the privilege of hearing Prof. Geradin speak at a recent conference.  On my view, he is one of the best academic experts on patent law.  But I have to question the premise of his recent paper, Elves or Trolls? The Role of Non-practicing Patent Owners in the Innovation Economy.

I question it not because I disagree with the basic argument, which is that some patent trolls perform an important role in clearing markets by speculating on the prospective value of patent claims in litigation.  Rather, I question it because I believe it falls short of a full theory of how inventions foster growth within an economy.

But today I'm feeling a little lazy.  So instead of making the argument explicitly, I'm going to quote Robert Frost's excellent poem, "Mending Wall," which takes as its subject the question of why people spend time and money on defining and maintaining property rights.  Note that Frost explicitly addresses the role of Elves in the allocation of property.

Something there is that doesn't love a wall,
That sends the frozen-ground-swell under it,
And spills the upper boulders in the sun,
And makes gaps even two can pass abreast.
The work of hunters is another thing:
I have come after them and made repair
Where they have left not one stone on a stone,
But they would have the rabbit out of hiding,
To please the yelping dogs. The gaps I mean,
No one has seen them made or heard them made,
But at spring mending-time we find them there.
I let my neighbor know beyond the hill;
And on a day we meet to walk the line
And set the wall between us once again.
We keep the wall between us as we go.
To each the boulders that have fallen to each.
And some are loaves and some so nearly balls
We have to use a spell to make them balance:
'Stay where you are until our backs are turned!'
We wear our fingers rough with handling them.
Oh, just another kind of out-door game,
One on a side. It comes to little more:
There where it is we do not need the wall:
He is all pine and I am apple orchard.
My apple trees will never get across
And eat the cones under his pines, I tell him.
He only says, 'Good fences make good neighbors'.
Spring is the mischief in me, and I wonder
If I could put a notion in his head:
'Why do they make good neighbors? Isn't it
Where there are cows?
But here there are no cows.
Before I built a wall I'd ask to know
What I was walling in or walling out,
And to whom I was like to give offence.
Something there is that doesn't love a wall,
That wants it down.' I could say 'Elves' to him,
But it's not elves exactly, and I'd rather
He said it for himself. I see him there
Bringing a stone grasped firmly by the top
In each hand, like an old-stone savage armed.
He moves in darkness as it seems to me~
Not of woods only and the shade of trees.
He will not go behind his father's saying,
And he likes having thought of it so well
He says again, "Good fences make good neighbors."

The Third Rail in IP Law: Ownership

Via IP Dragon I found this article by Patti Waldmeir about how a new law in China might prevent foreign inventors from obtaining protection in China unless the invention is made on Chinese soil first filed in China:

If the revisions are adopted, foreign companies would have to draft patents in Chinese for inventions made in the country. But because China’s patent regime is so new – dating only from the early years of this century – there are relatively few Chinese-literate lawyers who are experienced in this area.

Substantive IP law can harmonize all it wants.  Unless ownership law harmonizes also, there won't be free-trade in IP.

Reigniting the Engine of Growth with the Sparkplug of Invention

Why do patents end up in litigation?  Typically, people answer that it is the amount of money at stake.  This answer is not wrong.  Since the cost of litigation is relatively constant, people should be (and in fact are) more willing to pay lawyers to litigate claims that are very large compared to the cost of litigation.  But this is not a full answer to the question.  For this answer does not explain why patents specifically should end up in litigation more often.  In fact, trillions of dollars in legal rights are exchanged everyday around the globe without litigation.  By comparison, the amount of money at stake in patent lawsuits is relatively small.

The Theory of Focal Points

Economist Thomas Schelling is famous for advancing a theory of conflict and cooperation. According to Schelling, even when communication (and hence negotiated agreement) are difficult or impossible, two people can cooperate through a shared focal point. For example, if I told you to meet me in New York City tomorrow but for some reason I couldn't tell you where and when, we might still meet by going to a famous spot at noon, such as Grand Central Station or the top of the Empire State Building.  Our shared vision of these famous spots is a focal point that permits us to coordinate.

The theory of focal points explains why some groups of people fight and some cooperate.  When the focal point for a first group is mutually exclusive to the focal point for a second group, conflict emerges.  When the focal point is shared or non-mutually exclusive, cooperation emerges.  To some extent, all conflict between people can be viewed as a costly renegotiation of focal points.

With Schelling's theory in mind, let's revisit the question of patents.  What are the focal points for the various parties involved in patent litigation?  To simplify the question, suppose there are only two groups involved in patent litigation: "inventors" (or their employers) and "producers" (i.e., the people who sell products or services that practice a claimed invention).  Ignore for now the detail that some inventors are also producers, and that some producers are also inventors.

When patents are litigated, the focal point for inventors is on obtaining a large royalty or payment for the right to practice the invention.  By contrast, the focal point for producers is on paying a small (or no) royalty or payment to practice the invention.  Although both inventors and producers seek profit, at the point in time when patents are litigated, these focal points are mutually exclusive because (at worst) both have incurred costs of R&D for developing the invention.  Patent litigation thus becomes a zero sum game.

The Focal Point of Profit

At first glance, therefore, one might think that inventors and producers are doomed to conflict.  Before rushing to that conclusion, however, it's worth noting that in some broader sense, at least, inventors and producers share a focal point -- namely, profit.

Profit is an unusually broad focal point.  As Adam Smith is famous for pointing out, the voluntary exchange of goods and services creates profit.  With profit the focal point, the problem of avoiding conflict between inventors transforms into a problem of identifying and promoting the circumstances in which the voluntary exchange of inventions for cash can take place between inventors and producers.

If such voluntary exchanges never occurred, we might have reason to doubt whether conflict between inventors and producers could ever be avoided.  Fortunately, such exchanges do, in fact, occur.  Thus, it can be inferred that the conflict arises over how what is exchanged (services and patent rights) should be valued.

Again, this might seem puzzling at first because, at least in principle, there should be no difference in how value is measured.  At least within the United States, the same rules for accounting and reporting financial statements apply to both inventors and producers.  In principle, the inventors and producers should be able to compare their financial statements, and reach some agreement over the value of an invention.

But since this never seems to occur, the most reasonable inference seems to be that the conflict arises from a difference in how we interpret accounting and financial statements.  In fact, it is precisely here that the focal points of inventors and producers diverge.  Having had the rare opportunity of working both in patent law and accounting, it has been my privilege to be one of the first to have noticed this.  In short, a better theory of accounting would help resolve conflicts over patented inventions and restore a cultural norm of cooperation within patent law.  Astute readers should note that, in addition to patent law, Venice was the birthplace of double-entry accounting in the 15th century.

Problems with the Static Picture of Cost Accounting

As described by William H. Waddell and Norman Bodek in Rebirth of American Industry, the theory behind the most dominant method of accounting (which is called "cost accounting") was developed at General Motors in the early 20th century by Alfred Sloan, Pierre DuPont, and Donaldson Brown.  The relevant detail about this theory is that it was designed to measure (and hence manage) return on investment (ROI).  To that end, the paradigm that Sloan, DuPont, and Brown had in mind in developing their rules for accounting was a static picture.  Specifically, their picture was of what the corporation would be worth in liquidation.

With the picture of the corporation in liquidation in mind, it is easier to understand why so many things that we might intuitively imagine to be costs are instead treated as assets under cost accounting.  For example, under the cost accounting system, unsold inventory is reported as an asset.  Cost accounting assumes that the inventory could be sold at cost in liquidation.  The reporting ignores, of course, the fact that unsold inventory will incur expenses.  More importantly, it ignores that what's unsold before liquidation is less likely to sell at cost in liquidation.

Under the cost accounting system, IP is called an asset on balance sheets.  Again, the assumption is that patents can be sold at cost during liquidation.  Again, this assumption begs several important questions.  Perhaps most importantly is the question of why, if the IP is so valuable, it could not be used to attract financing or revenue, thereby avoiding liquidation.  There were (and are) reasonable answers to that question when debt or equity are unavailable for reasons that have nothing to do with the demand for the patented invention.  But its salience suggests that there might be better ways to measure the value of IP.

Whereas all patents cost something to procure, market demand only emerges for a handful of all patented inventions.  Thus, the system of cost accounting has given managers and investors the perverse incentive to aggregate thousands of patents, inflating their balance sheets, much like we saw prior to the subprime mortgage debacle.  Firms invest billions of dollars in new technology, spend millions on patent portfolios, inflating their asset accounts -- all before attracting a single customer!  Not to be outdone, when the corporation fails, the cost accounting system encourages us to sell the patents at auction, and let third-parties extract whatever they can from the legal rights.  On my view, the system of cost accounting, coupled with the shortage of patent lawyers who really understand technology, are responsible for the emergence of the worst kind of patent trolls.

Dynamic Accounting and the Promise of Cooperation

Fortunately, there is now a light at the end of the tunnel.  In fact, many corporations have shifted away from the static picture of corporations inherent in cost accounting to a more dynamic picture.  Lean accounting, in fact, was practiced at Ford Motor Company almost 100 years ago, before Ford was eclipsed by the success of General Motors.  It turns out that cost accounting is a perfectly fine system of accounting when demand is basically infinite relative to the cost of supply.  If the market is never cleared, then the corporations that use cost accounting will end up reporting higher return on investment (ROI) than the corporations that use lean accounting.  Lean accounting is an inherently more stable mechanism for promoting growth within a corporation in part because it does not tradeoff short-term gains in income against long-term sustainable growth.  But once GM started doing it, everybody else in the automobile industry, and eventually the entire economy, had to follow.

Under a dynamic theory of accounting, IP is more like equity than it is like an asset.  That's because the primary value of patent rights is in promoting invention and collaboration, both of which are dynamic because people are dynamic.  Elsewhere I have explained how inventors are customers.  Within the cycle of growth of corporations, inventors and customers are the source of information about demand.  It is no accident that unmet need was considered by Judge Learned Hand to be the most important of the secondary considerations on obviousness.

By contrast, assets are static.  By adopting rules for reporting and managing the IP that are more consistent with the actual mechanism whereby it increases profit, we will in turn discourage wasteful conflicts.  A very important corollary to this is that stronger patent rights would be beneficial in promoting collaboration and avoiding conflict.  Strong property rights discourage people from litigating what could be solved through negotiation at an earlier point in time. As Robert Frost noted, "Good fences make good neighbors."  With a change to the accounting rules, these early negotiations will happen more often.

Finally, let me emphasize that changes to financial statements need not be dramatic.  For example, the simple addition of average daily debit and credit flows for each balance sheet account would permit the shift in managing and investing that I'm advocating here. Since most accounting is now done by computers, this kind of change is actually very cheap.  The value of inventions could then be measured easily by comparison between the average daily debit and credit flows before and after an invention had been implemented.  Suddenly, inventors and producers have a numerical way to measure the value of an invention.

Inventors are Customers

Have you ever wondered why startups are better at innovating than larger corporations?

Some people say that it's because of the culture, which promotes teamwork.  Others say it's the focus on a constrained set of resources.  Both are true to some extent.  But I don't see either as the root cause.

Startups are often founded by people who are frustrated because their own needs have not been met by existing products or services.  In other words, unmet needs are the source of inspiration to inventors.

Inventors are simply frustrated customers.

And if you think about it, this might explain why so many venture capital funds, investment banks, and large corporations have failed at promoting innovation.  Innovation needs to be driven by customer needs.

Do venture capitalists know customer needs?  Some do.  But their incentives are driven by large corporations (on the M&A side) and investment banks (on the IPO side).

Do investment banks know customer needs?  Some do.  But their incentives are driven by whatever will sell at a given moment.

Do large corporations know customer needs? Some do.  But their incentives to do M&A may also be driven by (misguided) attempts to increase ROI regardless of whether that will help them sell more at lower cost.

From whence in the cycle of innovation does the knowledge of customer needs arise?  It's at the point in the cycle where the beginning and the end meet.  Customers are the end, inventors the beginning. 

Inventors are customers.

Why the Venetians didn't invent a Prize system for Inventions

Over at PatentlyO, Dennis Crouch covers the news that McCain has proposed a publicly funded prize for developing a better battery for cars.  Dennis also points out how this strategy worked historically for England in solving an important navigational problem: John Harrison solved the timing problem by miniaturization.

One can only hope that this is a symbolic gesture by McCain toward the need for patent reform.  $300 million is only a drop in the bucket that has already been spent on solving this problem.  Ballard Power Systems, for example, has by itself spent at least that amount developing fuel cell technology, which many scientists believe to be a more viable alternative to the battery as a non-oil alternative power plant for cars.

I point this out not because I want the government to spend more money than McCain has earmarked for this R&D, but because I want the government to spend less money.  That money has to come from somewhere folks.  And that somewhere is taxes.  Don't bet on it coming from a higher capital gains tax if McCain were elected either.  The possibility of having another "conservative" president in office, increasing spending, decreasing taxes, and increasing money supply is terrifying to me.  Already it appears that the United States has indentured itself to the rest of the world for the foreseeable future thanks to our profligate spending and inflationary monetary policy over the past few decades.

There is a proper role for government "prizes," a role that the NSF and NIH have been performing quite well for decades.  That role is in funding the curious exploration stage of scientific discovery.  Observations of nature are often the source of inspiration for later innovations by authors and inventors.  Few businesses in the history of the world have been willing to pay for curious exploration of the natural world.  We still need government funding for that.

But we should limit government funding to that stage, and let the needs of industry drive funding for development of those natural observations into new products and services.  The distortions in the food market that resulted from government subsidies of ethanol production are Exhibit A as to why government funding of R&D is a bad idea.  Government starts with a noble plan: to reduce global warming.  But it ends with people starving in the developing world.  To avoid catastrophe, investing must be disciplined by market needs -- a discipline that government, by definition, lacks.  Private markets and firms are a cheaper way to make things than government because they don't make money unless they match (i.e., synchronize) their outflow of things to an inflow of demand for those things.  Government doesn't have to (at least not over the short-term).

The United States should follow the example of the 15th Century Venetians, who harnessed the power of market-based incentives to encourage innovation in solving the most important problems their society faced.  Read this description of how inventors worked together at the Arsenal, the 16th Century equivalent of Ford's Highland Park manufacturing plant (but for boats, not cars):

Everything concerning ship-building and armament, direction of the works, purchase of wood and iron, organisation of the workshops, discipline of the workmen, commanding of the troops, training of the seamen, storekeeping, provisioning and contracts was under the provveditori. They formed themselves into a committee for testing and examining all the new inventions submitted by their fellow-countrymen or by foreigners.

Rather than $300 million for the particular purpose of batteries, why not  $300 million for marketing and public education about the patent system?  The provveditori are like a combination of modern day venture capitalists and patent examiners.   I don't think most Americans have any idea how important the patent system is to our future.  Maybe patent law is too important to be left to the patent lawyers.

Update: I can't find a good modern analogy to the provveditori.  Their work is performed by a combination of people and computers today.  In some ways, they are like a heijunka box.  In others, they are like patent examiners, lawyers, consultants, or investors.  Their role in many companies today seems largely to be filled by goods and services obtained from various markets external to the company.  Have we made a step forward or a step back?

Trade Secret Lawsuits are Ownership Disputes... How Filing More Patent Applications Might Avoid Some Litigation

WSJ reports that startup LimitNone is suing Google for breach of contract and trade secret misappropriation:

LimitNone, which no longer offers the product, says it worked on gMove as a member of an authorized Google developer program and with the assurance that Google wouldn't seek to build a similar tool itself.

Looks like contracts and trade secret protection weren't the right way to go for LimitNone.  I've been involved with a few trade secret lawsuits, and they are very messy.  People complain all the time about how difficult it is to interpret patent claims, and how poor the patent office is at examining them.  But filing a patent application does do one thing extraordinarily well: it plants a stake in the ground that says: "On this date, our startup knew this much about the technology and thought this part was what was valuable."

With that stake in the ground, the discussion about who did what when gets much simpler.  That's because describing the scope of the trade secret is only the smaller part of what makes trade secret lawsuits messy.  The larger part of the messiness is due to the competing claims between joint developers for ownership of the IP in question.

When a patent application is filed, some questions about validity and all questions about infringement are left to be determined later.  But the process of drafting the application and getting assignments tends to resolve ownership questions earlier, and at the moment in time when they are easiest to resolve.  A good patent lawyer will sit down with the various parties involved with a development effort, make a determination as to who contributed to conception, when, and what each person's obligations were and to whom at that point in time.  A couple hours worth of work can avoid millions of dollars of litigation.

A New Kind of Firm for the R&D Market

Having articulated an improved theory for the firm, one which makes explicit the value of matching supply and demand cycles, I can now say why, in accordance with that theory, a new kind of firm would be beneficial to the market for R&D.

For at least three reasons, market price signals have failed as a means for coordinating the supply cycles with the demand cycles for R&D.

1. Most basic science is now funded by the government.  R&D therefore tends to be supplied much earlier than the demand for it by large firms.  Thus, there is a funding gap between research and venture-capital backed startups.  This funding gap is part of the cause for the observation by many R&D buyers that "ideas are cheap."
2. Even when supply and demand can be matched in time, sensitive ownership and trade secret issues raise the transactions costs for transferring technology from one large entity to another
3. There is a shortage of service professionals (especially patent lawyers) who understand R&D and can assist in negotiating technology transfers.  This shortage has hit the inventors the hardest.

Some inventors have given up on finding proof-of-concept financing for their work, only later to watch a venture-capital backed startup make millions or billions, with very little (if any) flowing back to the pioneering inventors.  Some large firms have gotten tired of paying millions or billions for startup companies, only later to layoff the employees who do similar work to what is already done by top-quality teams within the large firm.

Since the Bayh-Dole Act was passed in 1980, our best scientists and engineers have been less concerned with industrial R&D needs, instead being content to turn their published papers in to the technology transfer office so that a patent application can be churned out.  Every once in a while, a graduate student drops out to start a new company with a new idea.  In technology corridors like Silicon Valley and Boston, that every once in a while has been often enough to make a few professors rich.  But the rest of the time and at most universities, if an idea turns out to be valuable enough for industry to commercialize, the university ends up negotiating a license for patent rights alone.  Often and at an increasing rate, that negotiation comes at the end of a long litigation.

Venetian Capital Management provides a new way to meet the R&D needs of large firms with the best R&D teams available for those needs.  Inventors or large firms interested in learning more about Venetian Capital Management services should contact me by email.

How the Quanta decision is good for patent owners

The Supreme Court handed down its decision in Quanta v. LG Electronics today.  Already some commentators have concluded that the decision was harmful to patent owners.  Not so fast.

There were two issues before the Court in Quanta:

• Whether exhaustion doctrine should apply to method claims
• Whether on the facts of this case, the patent owner (LGE) had exhausted its enforceable patent rights against Quanta by Intel's sale to Quanta of goods covered by LGE's patents

On my view, on both counts the Supreme Court has helped patent owners by clarifying both the scope of the rights of patent owners and of the obligations of patent licensees.

First, by unifying the exhaustion rules for product and process claims, the Supreme Court is saving everybody time and money.  The procedural posture of the case only highlights the problem with having different rules.  Recall that the holding by the district court that gave rise to the appellate jurisdiction over the first issue arose only after the district court issued a second order clarifying that its summary judgment of exhaustion was based on the product claims of the patents-in-suit.  The reason that a second order was necessary is because the parties were still bickering over whether the distinction between product and process claims might provide some loophole in the summary judgment.  It's not so hard to imagine patent owners and prospective licensees bickering over the same thing in the future had the Supreme Court not unified the exhaustion rules so that they applied, unambiguously, to both product and process claims.  Not to mention the prosecution games that would result.  As the Court was acutely aware in writing this opinion, such distinctions exalt form over substance.

Second, even though Quanta effectively got a free pass in this case, patent licensees like Intel are NOT off the hook because of this opinion.  One thing that's unusual about this opinion is that the activities of Intel, a third-party, feature more prominently in the recitation of facts than do the activities of Quanta, a named party.  The reason there are so many facts about Intel is that the Court knows that this lawsuit (and others like it) could have been avoided had the patent owner (LGE) and licensee (Intel) sorted things out without dragging downstream firms (like Quanta) into their fight.  The lawsuit against Quanta resulted only after Intel refused to play ball with LGE.  At the end of its opinion, the Supreme Court practically begs LGE is to sue Intel for breach of contract.  And they should!  If the understanding between LGE and Intel was that Intel's customers were going to pay part of the royalties due LGE, and those customers didn't come through, then Intel absolutely should be required to make good for the shortfall.

Under Quanta, the Supreme Court did nothing to hurt (and probably helped) patent owners' ability to contract for a fair royalty.  But Quanta does give patent owners a strong argument for demanding higher royalties from their licensees.  Specifically, patent licensees can no longer tell patent owners, "Go and get  the rest of the royalties you want from each of our customers."  Patent owners have a definite answer to that one now: "I can't."

Thus, on my view, this is a modest victory for norms of cooperation.

Surowiecki on M&A

In an earlier post, I blogged about how Microsoft's antitrust liability should arguably have been limited to fair value for the inventing, R&D, and early-stage proof-of-concept commercialization done by smaller competitors (such as Netscape).

The other side of the same coin is that far less M&A would be necessary if more large corporations simply transferred new technology in rather than buying smaller firms in order to get it.  Here's James Surowiecki making the point in the most recent New Yorker:

"Merger mania also rests on what you might call the fallacy of ownership—the assumption that you have to own a company to make money from its properties. In fact, much of what mergers are supposed to accomplish can be achieved through partnerships and alliances. Google has made deals to handle searches and advertising for companies like A.O.L. and I.A.C., giving it access to their customers without the hassle of an acquisition. And I.B.M. has, in recent years, marketed the products of its competitors Sun Microsystems and Novell, enabling it to expand its offerings and its potential customer base. If CBS and CNET had simply agreed to cross-promote each other’s brands and distribute each other’s content, CBS would have had many of the benefits of merging without the costs."

There's no need for ownership if all you're looking to do is get from point A to point B.  Leases and rentals often will get you the same benefits -- without the costs of maintenance.

The difference between Venture Capital and Venetian Capital

To a thoughtful student of European history, Silicon Valley of the 21st century might cause deja vu.  For there was another culture and place in which entrepreneurs and financiers lived within a small radius of one-another, and were constantly bumping into one-another at social and business gatherings: 15th century Venice.

• Venice was isolated from Florence, Rome, and Constantinople in much the same way that Silicon Valley is isolated from New York, Los Angeles, and Washington, D.C. today.
• Venice was geographically limited in its extent by the lagoon in much the same way that Silicon Valley is limited in its extent by the mountains and San Francisco Bay.
• Venice was home to an aspiring group of artisans who had something to prove to the elder statesmen in Florence and Rome in much the same way that Silicon Valley is home to entrepreneurs with something to prove to the CEOs, investment bankers, and politicians in New York and D.C.
• Venice was home to a network of merchant bankers, many of whom knew one-another personally and shared in the burden of diligencing investment in much the same way that Silicon Valley is home to a network of venture capitalists who know one-another and share in the burden of diligencing investments in new ventures
• By the mid-15th century in Venice, most of the prominent merchant bankers knew who the best artisans were, and were happy to work exclusively with those artisans on deal after deal much as Silicon Valley venture capitalists are happy to work exclusively with the same serial entrepreneurs on startup after startup.

But there is one way in which Silicon Valley differs from 15th century Venice, which went on to spread its technology and art throughout Europe in the centuries thereafter:

• Venice, unlike Silicon Valley, was home to the birth of patent law in the late 15th century.

The Venetians were smart enough to realize even in the 15th century that they would have to feather the nest for new artisans and inventors in order to ensure that a pipeline of new art and technology kept flowing freely. Not coincidentally, when Venetian glassworkers carried their new technology with them to the rest of Europe, they carried also, like the fire of Prometheus, the idea of a patent system.

From Clan to Keiretsu: the Evolution from Conflict to Cooperation and What it means for Innovation

World history has thus far given rise to two different paradigms for institutional design: the clan and the keiretsu.

For most of human history, the clan has been the dominant form for institutional design.  The clan is the most politically and economically efficient form of government when communication between people is difficult and credible commitment uncertain.  In a world in which two groups can achieve a better outcome for both over the long-term by cooperation, but in which each can achieve a better outcome  for itself over the short-term, difficulties in communicating and making commitments will result in repeated conflict between the two groups.  And it is not at all certain whether the repeated conflicts will eventually lead to cooperation over the long-haul.  In some places, such as Papua New Guinea, Northern Ireland, or Palestine, the barriers to communication and commitment may never be overcome.

About three centuries ago, a different paradigm began to emerge: the keiretsu.  Although the paradigm could not be recognized as such for many hundreds of years, the early forms of corporations, such as the sovereign charters for the groups that set out to explore and colonize the "New World", were nonetheless distinct from the clan in their strategy for organizing people.  Instead of motiving people to organize for the purpose of defeating another clan, the corporation motivated people to organize for the reward of long-term profits that could be realized by cooperation toward a common goal.  So long as there was no other corporation in competition for the same goal (in which case, the two competing corporations would begin to take on more clan-like characteristics), the strength of the corporation was defined entirely in terms of how-well the vision of  its members was shared.  The keiretsu may have reached its highest peak thus far in Japan in the 1950s and 1960s, as the entire nation organized together with the common goal of rebuilding the Japanese economy.

Having recognized these two paradigms for institutional design, the world now has a choice in deciding what kind of institution it will build: will it be the warlike clan or the peaceful keiretsu?

But the question is not as simple as it might seem.  Because as the experience of Japan has demonstrated over the past few decades, the keiretsu has a weakness that has been serious enough to prevent it from taking over as the dominant form of human institution.  Although the keiretsu has been more effective than the clan in organizing people into achieving long-term goals, its success has depended crucially on improved communication and the ability to extract personal commitments from its members.  It is no wonder then that Japan should have been home to the culture in which the keiretsu model has closest approached perfection.  The corollary is that where communication and commitment remain difficult, the dominant form of institution will remain the clan.  And communication and commitment have become much more difficult in a globalized world in which change happens everywhere and all at once.

Communicating and committing to cooperate in the decades-long cycle of innovation is perhaps the most complex challenge the business world has ever faced.  In fact, as the norms of conflict demonstrated by the plague of antitrust and IP litigation demonstrate, we have not yet been able to evolve from a clan-like model for competition.

But the Internet has permitted for unprecedented ease in communication.  And the evolution of the law of organizations in the United States and around the globe promises new flexibility and accountability in achieving lasting commitment between diverse groups.  As Lincoln anticipated long ago, the law of patents may give birth to a new age of cooperation among diverse groups of people within industry.

I'm looking forward to seeing how we rise to the challenge.

Update: Perhaps the earliest proto-keiretsus were not corporations, but coinsurance agreements in Genoa in the 15th century.

A Simple Proof that Innovation Requires Inventors

Over at the blog for Techdirt (an unfortunate misnomer), my evil-initial-twin Mike Masnick has in a series of posts been arguing, in summary, that ideas are cheap and that execution is what matters for innovation.

To Mr. Masnick (and whomever agrees with him) I present the following proof that his argument is incorrect:

If it is true that execution is what matters to innovation, then it should be possible, in principle, to build a Turing machine capable of innovation.  No such Turing machine exists.  Therefore, an inventor is required for innovation.

Incidentally, this proof also explains why Malcolm Gladwell is mistaken to distinguish between inventing and artistry on the grounds that inventions may be reproduced independently whereas artistry is unique.  He observes, inter alia, that the claims of multiple patent applications have often overlapped. This is true.  But the specification and drawings of a patent merely describe in words and with pictures the work of each inventor, which remains unique.

Certain readers may recognize in this proof the general strategy followed by Goedel in proving his incompleteness theorem.

Germany Leads the Way

Today on the IAM blog, Broken Symmetry's favorite IP investment management journalist Joff Wild blogs about new IP-focussed investment funds in Germany.

IP Bewertungs AG (a/k/a IPB) stands out from the pack.  According to an executive at IPB, IPB doesn't merely aggregate patent rights.  IPB is actually spending time and money after acquiring IP rights on pre-commercialization development.

Without hearing more, it's difficult to know exactly what kind of development they're doing.  But it's easy enough to imagine that they've got a team of scientists or engineers assigned to each portfolio of IP that they've acquired, working to further refine the inventions patented into product or service concepts that are more susceptible to early-stage commercial development.  Without the know-how of these scientists and engineers mixed in, naked IP is far less valuable to prospective transferees.

Coupled with the earlier article on IPB published by IAM magazine, which laid out some facts about the comprehensive diligence process that IPB goes through prior to acquiring a patent portfolio, IPB is beginning to emerge as a thought leader in this market.

Antitrust and IP: Revisiting Microsoft Antitrust Liability

I just found a link to this editorial from Charlie Munger on the Reflections on Value Investing blog.

Charlie argues that corporations with market share should not be held liable under antitrust law for adding improvements to products or services that were pioneered by smaller competitors.

He's partly right, but he leaves something out.  Microsoft had already spent billions and billions of dollars setting up manufacturing, marketing, and distribution channels.  How could it benefit consumers to demand that a new firm rebuild the same infrastructure whenever an improvement to the existing product or service was demonstrated to be valuable to consumers?

Except for the IP.  The small competitor that comes along has done something important and valuable for consumers by inventing and demonstrating the commercial viability of the improvement.  Without these Schumpeterian upstarts snapping at its heels, Microsoft would have little incentive to make such improvements.

So he's right that antitrust liability doesn't make sense.  But he's silent on the corollary, which is that IP infringement liability probably does make sense.  There's no way to ensure that these Schumpeterian upstarts have incentive to keep snapping at Microsoft's heels without strong IP.

Whom does the Constitution say IP is For?

"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;"

I'll be in attendance at the Law & Econ of Innovation Conference tomorrow.  Come say hello if you're there too.

What the PTO will look like in a few years?

The NYT on Sunday carried this article on the USA National Innovation Marketplace, founded by inventor Doug Hall.

First, this is more evidence of how the shortage of patent lawyers is forcing inventors in many technical fields to find new ways to attract private funding.  I discussed other consequences of the shortage in an earlier post on Stranded R&D.

Second, I wonder: How much more effective would the National Innovation Marketplace be if we had patent lawyers draft a set of claims, and put that up with the other materials offered on the website?

Isn't that what the PTO should look like in an era in which the costs of offering multimedia and social networking services through a website have dropped so low that even teenagers can launch new companies?

UPDATE: On a conference call today (5/13/8) I hear from Patent Commissioner John Doll (a fellow former p-chem grad student!) that the PTO is working on a social network for Examiners.  Why not offer a social network for both inventors and Examiners?  Why not work with Planet Eureka, which has already built one?  The idea of software engineers hired by the PTO reinventing this particular wheel is particularly troubling to me.

Summing Up: Feathering the Nest for Inventors

Sensible patent reform should focus on feathering the nest for inventors in the United States.  There is nothing more important to our long-term prospects within the global economy.  To summarize the posts made this week:

IP is a limited exclusive right to an inventor's time, not a limited exclusive right to a thing.  I.e., IP is Not an Asset.  Lawyers, business people, and politicians should consider how the patent law will affect the activities of inventors.  A plugged R&D pipeline can lead to Stranded R&D and an exodus of inventors from the United States.  We would promote the progress of arts and sciences better by building legal and financial institutions that recognized the benefit of a division of labor between inventing ideas and building things.  This is What Adam Smith taught the Founding Fathers.

IP is not an Asset: Patents and Inventors Need to Stick Close

Earlier this week, Peter J. Wallison argued that conventions in fair value accounting may in part be the cause for the recent bubble markets.  Specifically, Wallison pointed to the convention (implemented under FASB 157) that requires assets to be carried at "market" values, even when those assets are not being held for trading purposes.

Almost any scientist or engineer would immediately have recognized the truth of this argument.  Our understanding of any system -- chemical, electrical, mechanical, or financial -- will be limited in part by the accuracy of our tools of measurement.  When one considers how FASB 157 required banks to report the values of MBSs, CDOs, and CDO^2s on their balance sheets far above what the banks would themselves have been willing to give away for the same assets, one understands how the financial markets quickly lost track of the intrinsic value backing the securities traded.

This wisdom has direct relevance to the secondary markets for IP.  Most of the firms now in the secondary markets for IP have taken the view -- and are conducting their businesses -- as if IP were an asset.  This is because IP does bear some characteristics of an asset.  Namely, like real and personal property, IP can be protected through exclusive rights.  The analogy to property has thus come to dominate our understanding of the nature of IP.

Although accountants often treat IP as an asset, IP is not a commodity.  IP is more like equity, although it is not like other equity.  IP is a limited exclusive right to human capital (namely, to inventors' time solving a technological problem).

Maybe part of the reason that Abraham Lincoln understood the importance of patent law is because he understood that human capital cannot be owned.  The photograph shows the Emancipation Proclamation, whereby Lincoln did more for the cause of freeing human capital than many other men together have done in the course of human history.  Lincoln loved the patent system because he understood that it too could lead to more freedom.  Scientists and engineers work best free from the immediate demands of business people and customers.  The idea of a patent system carries within itself the promise of more innovation and more freedom.

POSTSCRIPT: Please note that I do not believe that inventors are literally enslaved right now.  There are obviously huge differences between the enslavement of millions of black Americans and the metaphorical enslavement of inventors who are now forced to do work other than inventing because of the broken patent system.  I do, however, believe that making people more free leads always to a multiplicity of unanticipated social benefits.

What the Founding Fathers knew about R&D that we have forgotten

As evidenced by his lecture on discoveries and inventions, Abraham Lincoln had a deep understanding of the patent system.  It is amazing how his lecture, which is now well over 150 years old, can seem so fresh today.  He and Charlie Munger have inspired me to undertake a historical review of other important lessons of the imminent dead.  Today the lesson is from Scottish enlightenment thinker Adam Smith, famous for his authorship of The Wealth of Nations. I must shamefully admit that I have thus far been unable to make it through the entirety of his treatise.  I have nonetheless been the beneficiary of the wisdom of Adam Smith through the help of editors, from whom we have the following excerpt:

To take an example, therefore, from a very trifling manufacture; but one in which the division of labour has been very often taken notice of, the trade of the pin-maker; a workman not educated to this business . . . nor acquainted with the use of the machinery employed in it (to the invention of which the same division of labour has probably given occasion), could scarce, perhaps, with his utmost industry, make one pin in a day, and certainly could not make twenty. But in the way in which this business is now carried on, not only the whole work is a peculiar trade, but it is divided into a number of branches, of which the greater part are likewise peculiar trades. One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on, is a peculiar business, to whiten the pins is another; it is even a trade by itself to put them into the paper; and the important business of making a pin is, in this manner, divided into about eighteen distinct operations, which, in some manufactories, are all performed by distinct hands, though in others the same man will sometimes perform two or three of them.

Adam Smith goes on and on from here about the many benefits of the "division of labour."  Although controversial in his day, the benefits of "the division of labour" are in our day a fact so well-accepted by the majority that many people seem unaware of the history of this idea.  We seem to assume it a logical consequence of any business. That it is not.  In each case in which a division of labor is successfully implemented in business, there was first an entrepreneur who saw the benefit of separating one task into two.  Henry Ford brought the magic of divisions of labor to the production of cars through the assembly line.   Most people can't imagine this, but before him others probably scoffed at the idea that something as complex as a car could ever be assembled without a single person overseeing the entire process.

Are we not still scoffers?  In the United States, we now live in an age in which most lawyers, business people, and researchers believe that R&D and early-stage product development are incapable of being done by two teams.  The fact remains, however, that the best inventors and the best startup CEOs are not often the same person.  And the best R&D and the best product development tend to occur in different environments.  We have strained for the past twenty-years in the United States to force inventors into the role of entrepreneurs, and entrepreneurs into the role of inventors.  Being a hardworking nation, we have not been entirely unsuccessful.  But how much more successful might we be were we to accept once and for all that there is an efficient division of labor between R&D and commercialization (yes, even the "commercialization" done by startups)?

The patent system is the most sophisticated and efficient means for implementing a division of labor between R&D and commercialization ever conceived by humans.  It is by cutting back at patent rights in the United States that we have inadvertently forced inventors to become entrepreneurs and entrepreneurs to become inventors.  Let us not further disintegrate the division of labor between R&D and commercialization by weakening our patent laws in 2008.  Let us recognize that good inventors and good startup CEOs are not always (or often!) the same person.  Let us "promote the progress of science and the useful arts" in the ways our Founding Fathers intended, by a division of labour between R&D and industry.

Stranded R&D

In 1980, Congress passed the Bayh-Dole Act.  Overnight with its passage, universities and government-funded R&D labs gained a comparative advantage in funding R&D.  Universities and government labs have a cost advantage in that many had already spent tens of billions of dollars setting up research labs for non-commercial purposes, including teaching and curious exploration.  Many scientists and engineers found the prestige of academia, and the increase in professional freedom it promises, a compelling offer.  The result has been a gradual shutting down of corporate R&D labs, and an expansion of industry collaboration with scientists and engineers now employed by universities and government labs.

Many people think of the Bayh-Dole Act as an unmitigated success story.  Several multi-billion dollar technology companies that are now household names (such as Genentech and Google) started in graduate school research labs.  Many inventors are happier in the more collaborative environment that academia offers.  Collaboration is an under-appreciated driver of innovation.

Unfortunately, so far universities have underperformed private benchmarks for the successful transfer of technology.  Despite spending almost an order of magnitude more on R&D (about $50 billion), the AUTM reports only about a factor of two more revenue from R&D (about $2 billion) than does IBM (about $1 billion on about $5 billion in R&D) over an overlapping period from the mid-nineties to the mid-zeroes of the present decade.  Although it is tempting to attribute the difference in returns entirely to the diversion of R&D funding into pure science (an attribution that ought to silence the Bayh-Dole critics who favor pure science), it is important to remember that there was a net inflow of the most productive researchers from industry into academia over the same period of time.  This concentration of the brightest minds of science and engineering within academia would probably have led to a faster increase in returns from R&D if there weren't something else going on.

And there is something else going on.  The costs of licensing and litigation of patents has skyrocketed over the same period of time.  The biggest reason for increasing costs has been the inelastic supply of patent lawyers relative to the exploding demand for their services.  Unlike patent prosecution, which can be done by non-lawyer patent agents and examiners, patent licensing and litigation are services that require a state bar license (and the three years of ABA-accredited law school that this usually requires).  Law firms are struggling to meet demand by increasing starting associate salaries (patent boutiques started the chain reaction in both instances over the past ten years), but the corresponding increase in associate to partner ratios at most law firms (necessary to keep profits-per-partner high and retain top partners) has led to a decline in the quality of services overall.

It is worth noting that many technology transfer offices are staffed by non-lawyer scientists and engineers with formal or informal business training.  Many of these employees are probably undervalued by the legal services market because of their lack of state bar credentials.  Seeing the value, university tech-transfer offices and other government and private firms not constrained by state bar requirements are scooping these types of employees up.  Non-lawyers will probably play a growing role in R&D funding and technology-transfer going forward, even in providing "legal" services.  The investment banks (such as Altitude Capital) and venture capital funds (such as Intellectual Ventures) that have recently entered the secondary market for patents are early signs of this trend.

The result of these macroeconomic trends in R&D is a market in which many startups and smaller companies are realizing only a fraction of the intrinsic value of their R&D.  Technology is stranded in later-stage startups and other small private companies that are not eligible for further venture capital financing, acquisition, or IPO.  Problems in the credit markets and the passage of the Sarbanes-Oxley Act have further exacerbated the problem for these companies in the acquisition and IPO arena.  In effect, the United States is piling up a vast, invisible junkyard of stranded R&D that could be socially valuable if placed into the hands of the right owners.

As the returns to investment in R&D decline, so too do the number of jobs available for researchers outside academia.  This is a problem that is vital to the health of the U.S. economy within its global environment.  If current trends continue, there will be more Ph.D. engineers living in China than in the U.S. by 2010.  The number of U.S. patents issuing to foreign entities is already nearly equal to the number of patents issuing to the U.S.  If the U.S. were to strengthen its patent system, we would be far better positioned than any other nation in the world to bring the power of market-based incentives to bear on the problem of attracting the most talented human capital -- the single most important problem we face in our long-term prospects for economic growth.

People are starting to recognize these problems.  Recently, the Brookings Institute has called for the government to setup a National Innovation Foundation.  But aren't the market-based incentives of a strong patent system a better way for the government to encourage R&D funding?  Although a handful of firms, including Intellectual Ventures, Ocean Tomo, and other new entrants are struggling to meet immediate needs, the inventors and startups most in need cannot afford to hire anyone to answer the lobbyists hired by the large corporations that are net payers of patent licenses (when forced to pay at the end of protracted litigation).

Although the big picture of innovation is so large and complex that it is difficult for most people to understand, the solutions are actually simpler and easier than most would imagine.  First, the patent laws should be reformed in ways that would promote private settlements of disputes over patent infringement rather than litigation.  Some recent changes to the patent law have been beneficial in this regard, and some detrimental.  Unfortunately, the Supreme Court's recent holding in Medimmune makes it harder than ever for inventors to get to the table with large corporations without ending up in litigation.  And after Mercexchange, startups and independent inventors do not have the threat of an injunction to keep licensees at the bargaining table when those startups and inventors have failed to find funding to themselves commercialize the technology.  Neither of these by themselves is fatal.  The threat of injunction was no doubt abused by opportunistic speculators from time to time over the past few decades.  But not in decades has it been more difficult for investors in R&D to see a return through patent licensing.

Second, if the government is going to provide funding to solve these problems, that funding might best be used to lower the barriers to entry for the practice of patent law.  For scientists and engineers, especially those who understand business, the opportunity costs of wages are probably much higher than the costs of a law school education.  Public funding of scholarships for scientists and engineers who intend to study law would over time decrease the transactions costs associated with patent licensing, and gradually decrease the amount spent on litigation as it becomes easier and easier for opposite parties to reach agreement on differing valuations of a technology.

Third, institutional investors should consider allocating a larger share of their funding to hiring more employees for their technology transfer offices now, and later for investing in private equity funds that specialize in R&D investment.  The technology transfer offices are now overwhelmed by the demands on their time in many cases.  As a result, they tend to focus on the biotech and pharmaceutical inventions that are likely to provide the largest payouts, ignoring the many other areas of R&D that could nevertheless have a transformative impact on our society.  In terms of private equity investments, over the short-term the lack of licensing revenue is going to impede the returns for these funds.  But restarting the R&D engine of economic growth is going to require the public and private sectors to work together.

These are complex problems that it will take teamwork to solve.

Update: Silicon Valley never fails to disappoint in its farsightedness.  Jaisen Mathai, Michael Arrington, and Stu Phillips are all groping around the edges of the problem.

Update 2: I was recently asked whether the figures for IBM and AUTM include capital gains from equity.  The answer is no, neither do.  I have seen no evidence and have no reason to believe, however, that the AUTM should be seeing larger returns from equity on its R&D than IBM.  So the larger point about relative efficiency in technology transfer seems still to be sound.

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 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.

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.

When failure = success? Patents stimulate new ventures.

"If I had a world of my own, everything would be nonsense. Nothing would be what it is because everything would be what it isn't. And contrary-wise; what it is it wouldn't be, and what it wouldn't be, it would. You see?"

- Alice in Wonderland

The PatentlyO posts from Bessen and Meurer are taking a trip to crazy town.  Today, their post on "patent failure" focuses on the impact that the patent system has had on publicly traded companies.  The authors conclude the post with the following remark:

"Third, we find that small publicly traded firms get small positive R&D incentives from patents. This is also very likely to be true for small, non-publicly traded firms and non-profit inventors."

Yet the point of their post is that the patent system has failed to promote R&D.  Since when are large publicly-traded companies the source of innovation in our economy?  I fail to see reasoning to support their conclusion that the patent system fails because (net) it imposes a "tax" on large publicly traded companies.  If I understand them correctly, it seems that their facts and the inferences they themselves draw from those facts and inferences suggest that the patent system is a success.

If a patent "tax" that requires manufacturers to pay inventors for R&D work ends up creating more social value than the tax plus the transactions and administrative costs of maintaining it, then it's what most economists would call a success.  Bessen and Meurer observe that publicly-traded companies are net payers of this tax, while smaller, private companies are net receivers.  Without knowing the magnitude of the payments and receipts on both ends, we can't definitively say that the system is creating social benefits.  But it seems that even Bessen and Meurer are conceding that the system works in the pharmaceutical arena.  What evidence do we have that the same might not be true in the other industries they have studied -- and at a growing rate as transactions and administrative costs decline?

As a society, we should not be concerned that big companies are paying small companies for new technology so long as they're paying a fair price.   And without patents, how would smaller companies convince larger companies to pay for valuable technology that cannot be protected with trade secrets?  Would it be better for the economy if more publicly traded companies simply bought-out smaller R&D-focused companies and then fired the employees who don't have valuable know-how?  Because of the benefits of divisions of labor (and very possibly antitrust issues), I think not.   

Specifically, R&D often requires a very different environment from the one that most publicly-traded companies can provide, both socially and financially.  First, almost by definition most publicly-