Patently Unfair

Conley explains that, traditionally, U.S. patent laws have provided an incentive for innovation by creating an enforceable property right for the inventor. That system of laws has remained fairly static throughout our nation’s history. Recently, however, decisions of the U.S. Supreme Court have been gradually adjusting patent law. About once a year for the past 10 years, the Court has agreed to review a significant issue of patent doctrine, and in most of those cases, the Court ruled in favor of defendants that sought to weaken the patent laws. In addition, the Court’s decisions are shifting patent law from being based on property rights to being based on liability, so that an infringing firm simply makes a payment instead of being barred from appropriating another company’s intellectual property.

Conley and Orozco wondered how these broad changes in the patent regulatory environment would affect various types of companies. The commonly held view is that patents are important legal tools used by companies across the board. However, some research suggests that branding or trade secrets are more effective methods of capturing the rewards of innovation, except in a narrow slice of industries. Other research suggests that patents are most important for start-ups and highly specialized firms. Conley and Orozco’s results suggest that patent benefits vary depending on a firm’s size and strategic position within its industry.

“In the marketplace for ideas, specifically for intellectual property, management has traditionally assumed that the rules of the game are the domain of the lawyers,” Conley says. “That’s not true anymore. What we’ve seen happen in the Supreme Court is that the rules are no longer exogenous variables, to use an econometric term. They are endogenous. They have become something that the players themselves can shape.”

This is important because of a fundamental shift in how corporate value is measured, Conley says. “Thirty years ago, if you looked at the valuation of firms in, say, the S&P 500, you would find that the hard assets on the balance sheet more or less reflected the corporate value. Since that time, the basis of corporate valuation has shifted from tangible to intangible assets.”

A Market for Advocacy

The researchers decided to examine which firms are vying to shape the patent jurisprudence developed by the U.S. Supreme Court. Even if not directly involved in a case, companies and other stakeholders—such as individuals, government representatives, advocacy groups, trade groups, and professional associations—can try to influence the Court by filing amicus briefs. By analyzing the amicus brief “advocacy market,” Conley and Orozco were able to investigate whether companies cluster in ways that support a particular patent position.

They identified 23 patent-related cases that were reviewed by the Court of Appeals for the Federal Circuit (CAFC) and then by the Supreme Court. The CAFC, created in 1982, represented a watershed for patent law, Conley explains, because it handles all patent appeals, and only intellectual property cases, from all federal trial courts. The goal behind its formation was to create bright-line rules that would make patent rights clearly understandable, taking the uncertainty out of the system.

In 7 of the 23 cases, no firms had filed amicusbriefs. For the remaining 16 cases, the researchers identified a total of 191 corporate amicus briefs that urged the Supreme Court either to affirm or reverse the CAFC’s decisions in the various cases. The researchers coded the briefs according to type of industry: complex technology or discrete technology. “Complex technologies” were defined as those that incorporate a large number of separately patentable elements, such as machinery, computers, and telecommunications equipment. “Discrete” technologies were defined as those that rely on only one or a few patentable elements, such as food, textiles, chemicals, and drugs.

The researchers also coded for small versus large company size (500 employees or more versus less than 500 employees) and for offensive versus defensive “patent capability.” Offensive firms are predisposed to benefit from monetizing patent rights compared with its competitors in the same or similar industry. Conversely, defensive firms tend to be more adept at manufacturing, modifying, and improving technologies, and commercializing them rapidly. These firms use unlicensed third-party technology either because they do not have the means to monitor the patent system or because strategic advantages such as early establishment of a user base make the risk of patent litigation worthwhile. When coding patent capability, the researchers examined a database to see whether the companies submitting amicus briefs had been directly involved in patent litigation themselves since 1982. The companies that had more often been a plaintiff (alleging patent infringement) were considered to have offensive patent capability; those that had more often been a defendant (accused of infringement) were considered to have defensive patent capability.

By applying a statistical model, the researchers found that, as expected, offensive patent capability was positively and significantly associated with advocacy for strong patent rights, and defensive patent capability was negatively and significantly associated with strong advocacy. Industry played an insignificant role, but company size was negatively associated with stronger patent advocacy, indicating that large firms generally favor weak patent rights.

Sizing Up Your Position

In response to the shift in valuation from tangible assets to intangible ones, Conley says, larger firms are now trying to change the “rules of the game” through amicus briefs. Many of the rules changes that large firms advocate would make the utility of a patent right uncertain, according to Conley. In contrast, small firms want patent law to be crystal-clear. “Raising uncertainty means you have to spend a lot of money to clarify what your position is,” Conley explains. “If you don’t have the resources, you’re going to be regressively discriminated against.”

Furthermore, many venture capitalists view patents as a precondition for investment in small entrepreneurial firms. Understandable laws make it easier for independent inventors to raise money and compete with large firms, Conley says, because venture capitalists will know the risks and can better quantify them.

Reed Hastings is one example of an independent inventor who successfully attacked an incumbent, Conley says. Hastings was a California software engineer who grew tired of paying late fees to Blockbuster. The final straw came when he amassed a $40 fee for a movie he had misplaced and felt embarrassed to tell his wife. Determined to create a better system for renting movies, Hastings came up with Netflix, which he launched as a subscription system in 1999. Walmart and others tried to copy this simple business model, but because Hastings had obtained a patent on it, the retail giant had to back down.

Conley and Orozco conclude from their findings that weakening patent rights and shifting to a liability regime will favor firms that are large and possess defensive patent capabilities. If the Supreme Court continues to shift the law from a property basis to a liability basis, they say, it may weaken the position of small entrepreneurial firms across industries and may increase the cost of capital for start-ups.

The recent changes in patent law may have unintended consequences for economic productivity. “The companies that are going to grow the economy are not the Microsofts and the Apples,” Conley says. “They’re going to sustain the economy, but the companies that will make a difference are a whole bunch of smaller entities that don’t have any resources but need some power. Typically they need the power of the patent. So let’s not change the patent system in a manner that just shifts all the advantage to those that own the power today. They’re not going to create the jobs of tomorrow.”

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