What Hap­pens When a Com­pa­ny Los­es a Patent?

One option is for the affect­ed country’s gov­ern­ment to license for­eign-owned patents to local firms with­out the con­sent of the patent’s own­er. Called com­pul­so­ry licens­ing (CL), it can be a boon — even a life­saver — for patients. But drug com­pa­nies argue that over­rid­ing patents harms them finan­cial­ly, which makes them less like­ly to devel­op new drugs or to improve old ones.

Does their argu­ment hold water? Does com­pul­so­ry licens­ing harm innovation?

The Kel­logg School’s Nico­la Bianchi and coau­thors tack­led this ques­tion by ana­lyz­ing an episode of CL trig­gered by World War I. In 1918, the U.S. con­fis­cat­ed thou­sands of Ger­man-owned patents under the Trad­ing With the Ene­my Act (TWEA). While the boom in Amer­i­can inno­va­tion fol­low­ing this peri­od is well stud­ied, no one has pre­vi­ous­ly exam­ined how CL affect­ed the Ger­man inven­tors who lost their patents.

The researchers found that, in this sce­nario, hav­ing a patent licensed by the U.S. actu­al­ly increased innovation.

Fall­out from the Trad­ing With the Ene­my Act

The bulk of licens­ing of con­fis­cat­ed Ger­man patents took place between 1919 and 1922, when the U.S. licensed 1,246 patents to Amer­i­can firms.

Bianchi teamed up with Joerg Bat­en of Germany’s Eber­hard-Karls Uni­ver­si­ty and Petra Moser at New York Uni­ver­si­ty to con­duct the research based on new­ly avail­able Ger­man patent data from 1900 – 1930.

The team decid­ed to focus its study on chem­i­cal patents. They start­ed by exam­in­ing all 79,591 patents issued to Ger­mans for chem­i­cals. Chem­i­cal patents were issued into more than 200 sub­class­es, 79 per­cent of which con­tained at least one patent con­fis­cat­ed by the U.S.

They then used these patent sub­class­es to com­pare how com­pul­so­ry licens­ing affect­ed dif­fer­ent chem­i­cal research areas or ​“fields.” The researchers found that in those fields that had been affect­ed by CL, Ger­mans applied for about 3 addi­tion­al patents per year after 1918 — a jump of about 28%. In fields that had not had any patents over­rid­den, patent­ing out­put stayed flat.

And, though they are an imper­fect mea­sure, patents are a good way to study inno­va­tion, Bianchi explains.

“The idea here is that we’re mea­sur­ing tech­no­log­i­cal out­put by count­ing the num­ber of patents,” Bianchi says.

Focus­ing on High-Val­ue Patents

Of course, not all patents rep­re­sent a valu­able innovation.

Some­times patents are applied for mere­ly as a strat­e­gy to block a competitor’s research. Bianchi and his team want­ed to know if the increase in patent­ing activ­i­ty rep­re­sent­ed an uptick in mean­ing­ful inno­va­tion or whether it was sim­ply part of a chess move.

To find out, the researchers looked at the num­ber of times that the patents had been renewed by their Ger­man inven­tors, both before and after 1918. Pre­vi­ous research estab­lished that patent-renew­al activ­i­ty is a good proxy for patent val­ue. The longer the renew­al peri­od, the more valu­able the patent, and the more like­ly that it rep­re­sents true inno­va­tion. They deemed patents that were not renewed for at least five years to be low value.

After weed­ing out the low-val­ue patents, the researchers found a 17 per­cent increase in high-val­ue patent activ­i­ty in fields with CL dur­ing the post-war years com­pared with pre-war years.

CL and Competition

While com­pul­so­ry licens­ing in a giv­en field did appear to spur inno­va­tion in that field, this does not nec­es­sar­i­ly mean that the indi­vid­ual Ger­man com­pa­nies whose patents were poached came out ahead. What did their patent activ­i­ty look like?

Bianchi’s team was able to iden­ti­fy 50 Ger­man firms that had at least one of their chem­i­cal patents licensed under the TWEA. They found that firms whose patents had been poached applied for an addi­tion­al 0.42 patents in fields with CL after 1918. Giv­en that firms applied for an aver­age of 0.46 patents per firm per year before 1918, this equals a whop­ping 91 per­cent increase.

This increase was strongest in fields where com­pe­ti­tion had been low pri­or to 1918. Put sim­ply, CL was high­ly effec­tive in fos­ter­ing inven­tion because com­pe­ti­tion bal­looned in fields where it had pre­vi­ous­ly been weak.

“Firms that lost their patents in the U.S. patent­ed a lot more in the tech­no­log­i­cal area where they lost the patent,” Bianchi says. ​“That is an impor­tant result, because it says that the firms which were direct­ly harmed by com­pul­so­ry licens­ing patent­ed more in the same tech­no­log­i­cal areas.”

In oth­er words, patent losers did not throw up their hands and quit inventing.

“One-Shot Events” Are Key

Giv­en the unique­ness of the peri­od stud­ied, it would be sim­plis­tic to gen­er­al­ize these find­ings to sug­gest that CL always leads to increased inno­va­tion and com­pe­ti­tion. Still, lessons can still be gleaned.

While the patent con­fis­ca­tions under the TWEA were per­ma­nent — an unlike­ly action nowa­days — firms could expect that such patent seizures would not hap­pen again. After all, the TWEA was first and fore­most a wartime mea­sure. This cre­at­ed a per­cep­tion that the CL episode was a ​“one-shot event,” as Bianchi terms it.

Bianchi says that know­ing CL will not be repeat­ed the next time a valu­able patent is issued is key to using it to boost innovation.

One-shot events sig­nal that though inven­tors may lose their com­pet­i­tive edge tem­porar­i­ly, all is not lost, because they can regain it with their next innovation.

“What real­ly mat­ters here is the expec­ta­tion that firms have about com­pul­so­ry licens­ing in the future,” Bianchi says.

“Com­pul­so­ry licens­ing shouldn’t be invoked just to give an advan­tage to local domes­tic indus­tries,” Bianchi cau­tions. ​“Gov­ern­ments need to agree to only do this to help in crises or events where com­pul­so­ry licens­ing will gen­er­ate a greater good, and we know there are cas­es where the greater good should def­i­nite­ly pre­vail against pri­vate interests.”