Patents and Cumulative Innovation: what is the impact of Federal Circuit patent invalidations?

"Patents and Cumulative Innovation: Causal Evidence from the Courts" is  paper by Alberto Galasso (University of Toronto) and Mark Schankerman (London School of Economics and the Center for Economic Policy Research, CEPR).  This paper will shortly be distributed as CEPR Discussion Paper 9458, looks really interesting  The authors' concluding comments are as follows, with citations omitted:

"In this paper we estimate the causal effect of patent rights on cumulative innovation, using patent invalidation decisions of the [United States] Federal Circuit. The identification strategy exploits variation in the propensity of judges to invalidate and the fact that the three-judge panels are generated by a random computer algorithm. There are three key empirical findings. First, invalidation leads to a 50 percent increase in subsequent citations to the focal patent, on average. Second, the impact of patent invalidation is highly heterogeneous, with large variation across patents and technology fields. Third, we find that this effect only occurs between patents owned by large firms that appear to block small innovators. Thus, invalidation of large firm patents ‘democratizes’ innovation by small firms.

These findings suggest that some licensing deals are not taking place in the presence of patent protection. There are two main reasons why this might occur. First, it might be optimal for a patent owner to restrict access if licensing reduces joint profits (e.g., because it intensifies downstream competition). Second, information asymmetry and uncoordinated, multilateral bargaining can lead to licensing failures even when it would increase joint profits. It is important to distinguish between these explanations because they differ in terms of their implications for welfare and policy (even putting aside the effect on consumer surplus). Our empirical findings help to do this.

The impact of patent invalidation is concentrated on a small subset of patents which have unobservable characteristics that suggest the presence of asymmetric information that induces bargaining failure in licensing. Our results also help to pin down where the bargaining failure occurs. The effect is concentrated in fields characterized by two features: complex technology and high fragmentation of patent ownership. This reinforces the market failure interpretation, since earlier studies identify these features as key determinants of licensing breakdown ... . We find no evidence of blocking in non-complex fields such as chemicals, mechanical, and pharmaceuticals. [...]

Overall, our findings show that patent rights block cumulative innovation only in very specific environments, and this suggests that government policies to address this problem should be targeted. However, scaling back patent rights may not be the most appropriate policy. Theoretical models of cumulative innovation show that such policies have ambiguous effects on overall innovation incentives.[...] It may be preferable to design policies and institutions that facilitate more efficient licensing and thereby promote cumulative innovation ...".

This blogger simply does not have the economics background to enable him to comment on the paper. He will only confine himself to making the usual caveat that data is always a problem.  Litigated patent disputes are always going to be easier to identify and analyse because of their public nature, and patents that are the subject of disputes which are appealed to the Federal Circuit cannot even be assumed to be typical of litigated patents as a whole. It would be interesting to match research on US data with any available data from the more litigation-averse Europe, to see whether the findings here are reinforced or weakened and, if so, how and to what extent. It would also be good to know whether the authors' conclusions chime in with the expectations of the economics-friendly European Commission as to what the effect of patent invalidation decisions of the new Unified Patent Court will be.

CIPA defends UK patent box

From Treasury to Treasure? Tax-
efficiency from the Patent Box*

The United Kingdom's Chartered Institute of Patent Attorneys has been quick to defend the increasingly-repeated assertion that the British "patent box" tax scheme [frequently discussed on IP Finance since it was originally proposed: see pieces listed here] is simply a tax avoidance device, rather than a mechanism for encouraging investment.  In to a media release last week, CIPA's President Chris Mercer nails the myth firmly.  The media release reads as follows:

‘Patent box’ designed  to encourage innovation, not avoid tax, says patent attorneys’ president 

“Headlines in today’s media linking the ‘patent box’ to tax avoidance measures are missing the point,” says Chris Mercer, President of the Chartered Institute of Patent Attorneys. 

“Fiscal measures are one of the few tools government can use to influence corporate behaviour,” he says. “The Patent Box has only just come into effect, but there are already signs that it is having a positive effect. Companies – especially mid-size, technology-based enterprises – are starting to incorporate IP into their strategic plans. Patent attorneys are being invited to talk to main boards, not just to the R&D department [Both of these are 'attitude-changers' rather than anything else, but attitude-changing is vital if we expect there to be a change in investment behaviour too]. This is good example of how a government initiative is actually achieving the desired effect – encouraging businesses to innovate and add value by protecting their IP. 

“The idea that anyone would start inventing things and patenting them as a way of avoiding tax is nonsensical,” he added. 

There has also been an increase in patent applications at the Intellectual Property Office. ”This increase is a welcome and much-needed,” said the CIPA President. “UK companies have been falling behind their foreign competitors in terms of patent filings. The Patent Box and other government  measures to encourage innovation may have helped reverse the trend.

This blogger doubts that there is any correlation between the availability of patent box tax breaks and the number of patents filed.  In his view, given the cost and the sheer effort that attends the filing of most patents, and the negative return that most of them can realistically expected to deliver, anything that encourages investors to commit to new products and processes rather than concentrate on old, tried-and-tested ones, should be warmly welcomed.

* The illustration is of a Merck family Treasure Chest Christmas Ornament, available here for US$ 18.99.

Three Stories About China: Yum Brands, the Venture Capital Market in China and More, and Hollywood

Several years ago, Yum Brands, the company that owns KFC (Kentucky Fried Chicken), Taco Bell and Pizza Hut, was lauded as the company that had figured out how to succeed in China.  Indeed, a substantial portion of its profits were based on its sales in China—specifically KFC (4,200 restaurants in China) and to a lesser extent Pizza Hut (almost 800 restaurants in China).  When asked about the cause of its success, a representative from Yum Brands said “a first mover advantage.”  And, a big part of that first mover advantage was a very strong brand.  Unfortunately for Yum Brands and its investors, times have been very tough for Yum—a strain of bird flu plus regulatory challenges based on claims of “excessive antibiotics and hormones” have led to empty restaurants.  Consumer confidence is dropping and the value of the brand with it.  How should Yum Brands rehabilitate its brand in China?  Any suggestions?

Stanford business school professor Steve Blank recently visited China on a book tour concerning startups and has many, many interesting observations concerning venture capital and startups in China in his five blog posts titled “China -- The Sleeper Awakens.”  Blog posts three and four are very interesting; although I believe they are all worth reading.  Here are his lessons learned from his fourth post titled “Zhongguancun in Beijing – China’sSilicon Valley”:

• China has the biggest Venture Capital industry outside the U.S
• For software, the action is in Beijing
• China has closed its search, media and social network software market to foreign companies
• Beijing’s VC’s primarily invest in the Technology, Media and Telecommunications segment
• Liquidity is via IPO’s not buy outs

Finally, the New York Timesrecently reported on how Hollywood’s latest releases are not doing as well as expected in China.  The reason given is something between Hollywood’s blockbusters have no depth and are just bunch of explosions, and China’s moviegoers are more interested in domestic films.  Interestingly, several of the Hollywood movies discussed in the article concern films arguably with a “built in” fan base that loved an earlier work the movie is based upon.  I wonder if they will move to capturing the power of nostalgia by reworking more Chinese tales.  What do you think? 

Is the Apple brand getting a bit of a free-pass?

The hottest topic in the high tech world must certainly be the recent developments surrounding Apple. In particular, we refer to the drop in the share price from over US$ 700 per share to just under (for a moment) US $400 per share, the slowing profitably in the iPhone and other products, leading to the first quarterly decline in year-over-year net revenue in years here, and suggestion of the impending payment of a dividend (suggesting that the company may not have any better use for these sums). Truth be told, the hagiography surrounding the late Steve Jobs and the unprecedented success of the company over the last decade was probably unsustainable, such that this spate of less than unequivocally flattering news for Apple cannot be said to be a complete surprise. To expect the company to continue to come up with world-beating new product categories, blending design and functionality, together with a unique supporting ecosystem of contents and users, requires a certain faith more appropriate for more spiritual lines of business. Perhaps all the company's recent challenges mean is that Apple may no longer be a completely unique success story, but it is still among the world's most successful and admired companies.

Nevertheless, in listening over the last few weeds to the punditry and podcast chatter about the company, one wonders whether the company is getting a bit of a free-pass on the strength of its goodwill and reputation. We have previously suggested here that Apple's ultimate asset may well be its goodwill and reputation, which at the business level enables it to enjoy higher profit margins, even as its technological/design uniqueness may be diminishing in certain areas. But the halo effect of the company's goodwill and reputation may also color the way that commentators relate to the company. I thought of this in particular in listening to a recent Bloomberg podcast interview with Ken Segall, the Apple advertising executive who created the name “iMac” and who had a lead role in the company's famous iconic "Think Different" campaign ad campaign here. Segall is also the author of Insanely Simple here, a widely discussed book about the mind-set of Steve Jobs that fueled the company's unimaginable growth.

Two points in Segall's interview particularly stick out. The first relates to the claim that Apple, and especially the various models of the iPhone, are merely incremental rather than revolutionary, and it is "revolutionary" that has characterized the Apple story since the launch of the iPad. Segall seemed to find the very claim odd—of course the various models of the iPhone are incremental, you can only have one revolution per product (what he called the "dark side" of innovation). Nevertheless, he went to speak in rapture about his own experience with the iPhone 5, expressing the kind of personal attachment to the device and ecosystem that lies at the heart of the product's continuing success. At that moment, one of the presenters jumped in and observed that she was actually a bit disappointed with the iPhone 5, since in her view the model did not really add a whole of functionality and features to the previous model. Segall simply ignored her comment, perhaps to suggest that the presenter did not really "get it" with respect to what makes the iPhone special.

In that context, the interview went on to mention that the Galaxy s4, Samsung's about-to-be launched competitor to the iPhone 5, has received tepid reviews from pundits ranging from the Wall Street Journal here to the New York Times here. The sense one gets of this tepidness is that the Galaxy s4 is "merely" an incremental improvement of the Galaxy s3 and it lacks the "class" of the iPhone 5. To a listener such as me, I had a tough time trying to figure out why the commentary about iPhone 5 and the Galaxy s4, respectively, seem to be coloured with different rhetorical brushes, despite what seems to be a common theme. (Full disclosure, I own a Galaxy s2 device, for the simple reason that the price was right and it does what I want it to do. However, common wisdom holds that the majority of people of my generation own an iPhone. Common wisdom also holds that, at least until now, the iPhone is clearly the preferred device as a matter of status. If you want to make a social statement, you do so with the iPhone.)

It seems to me that part of the answer is that Apple may be enjoying a bit of a free-pass based on the continuing strength of its goodwill, even at the price of a bit of some cognitive dissonance between the strength of its reputation and questions about its continued superiority in product development. Don't get me wrong, there is nothing wrong with this free pass, it being one of the reasons that a company so covets creating a strong brand. More power to Apple on that account. Nevertheless, even the world's most powerful brand may not be able to enjoy such a free pass forever. At some point, the aphorism—"what have you done for me lately?"—will kick on and the answer to the question may have decisive impact on the continuing strength and staying power of the Apple brand as a major component in its phenomenal success story.

If it's creative and it's culture, there may be tax relief ahead

According to "Tax reliefs for the creative sector", a Department for Culture, Media & Sport Policy Paper (here), the UK government has published revised draft Regulations -- the Cultural Test (Programmes and Video Games) Draft Regulations 2013 (here; explanatory memorandum here)-- setting out the cultural test which a company must pass if it wishes to qualify for relief under the Corporation Tax Act 2009 in respect of high-end television production, animation production and video game development.

An earlier draft of these Regulations was published four months ago with the draft Finance Bill 2013; the current, revised draft Regulations have been amended so as to reflect the results of the government's consultation exercise -- and also to address the concerns of the European Commission, which has approved the relief for TV programmes but is to investigate the relief for video games. As well as amendments to terminology (including the personnel involved in video games development), the changes include an amended method of awarding points and more restrictive rules on the way points must be distributed. Publication of the draft Regulations gives those who are potentially eligible for relief a chance to size up their chances of getting it.

IP valuation and the emergence of a tradable asset class

Here's a piece from IP Finance's friend and supporter Jackie Maguire (Coller IP), giving a bit more context to the sudden emergence of officially-sponsored and commissioned studies into IP valuation and the role of IP assets in funding business activity and in stimulating growth. Explains Jackie:  

"Many Governments have now adopted an innovation-led growth strategy and are promoting the importance of IP in underpinning their aspirations for economic growth.  The race to prove the perfect model for growth persists and there appears to be a growing desire to remove all the obstacles for failure in technology transfer.  

Within the Europe Commission, the Innovation Union strategy seeks to create a true innovation system in Europe where scientific excellence, a broad and strong knowledge base and the ability to bring results to the market and innovate are all included.   The Innovation Union includes over 30 action points to ensure that innovative ideas can be turned into products and services that create growth and jobs.

 This drive for success in taking new ideas to market is leading to much Government debate about the role that IP plays, exactly how valuable a company’s IP is -- and also the different approaches used to place a figure on this value.  The mechanisms for unlocking this value, via asset-based lending, litigation or otherwise, are seen to be challenging for those smaller businesses that make up a significant proportion of the growth economy, those very companies that have to convince others that their IP is worthy of finance.

There are now three parallel studies ongoing that are seeking to inform policy surrounding these issues  (did all the officials attend the same summit?...).  One, funded by Scottish Enterprise (noted here), one commissioned by the UKIPO (noted here) and another funded by the European Commission.  Each seeks to understand how IP is valued and could be used to secure the investment often required in the early stages of growth.

Jackie Maguire of Coller IP in the UK together with Danny Ryan and representatives of 10 other countries (including Germany, Sweden, Poland, Italy, Denmark, Belgium, Spain and Portugal ) are involved in the third study and have been appointed as IP valuation experts.

The experts were appointed by the European Commission at the beginning of 2013 to undertake a project during the course of 2013.  The work of this Expert Group will help implement the Innovation Union by looking at the very specific issue of the valuation of IP, the various purposes for which it is required and how new tools and mechanisms might open up the trading of IP assets.

Some policy officials consider that the accurate valuation of IP remains a major obstacle to the emergence as a tradable asset class and that the introduction of more transparency and standardization in IP valuation procedures may render the trading of IP rights significantly more efficient and profitable.  Many of us realise that it is a lot more complicated than that, but we have to start somewhere!

IP valuation mechanisms in the context of litigation, accounting and financial transactions are being currently researched and best practice examples are being compiled to show what can be achieved at a national and European level.  This includes how IP is valued with respect to awarding damages and how financial institutions are lending against IP assets.  The group will report at the end of the year and aims to recommend measures which will be implemented at a European level to unlock IP value.

Jackie hopes that with all of the results of all of these studies and calls for information that useful, coherence and consistent policy will be implemented and that the vision that she and Coller IP have always held, for IP to recognised as a tradable asset, will be achieved".

IP assets and the facilitation of business funding: a new project

A media release from Valuation Consulting's Kelvin King spreads the word that, together with Inngot, his company will be seeking to generate some of the evidence upon which the UK's fabled commitment to evidence-based intellectual property policy will be based.  According to Kelvin:

"Work for the UK Intellectual Property Office (IPO) and the Department for Business, Innovation & Skills (BIS) has established that the majority of UK business investment, and business value, now lies in intangible rather than fixed, tangible assets.  Now, the IPO has commissioned Valuation Consulting Co and Inngot to investigate the role of intellectual property (IP) in facilitating business finance and economic growth.

IP-backed finance is gathering pace on the international stage, and the EU is working to encourage IP ‘valorisation’. However, the area is not without its challenges, including asset identification, due diligence procedures [these being practical issues that crop up regularly even outside the context of valorisation], valuation and value realisation [these lying, in this blogger's opinion, at the heart of this project since they seem to be characterised by so much uncertainty and lack of consistency, at least when viewed from a lay standpoint]. This new IPO project has been initiated to examine the current role of IP in facilitating business finance and economic growth within the UK, and investigate the barriers to the broader use of IPRs and related business intangible assets for debt and equity fundraising.

The qualitative study complements wider Government initiatives to encourage business investment in innovation. It is particularly directed at understanding how value-producing intangibles can be harnessed more effectively to meet the funding requirements of knowledge-based small and medium enterprises seeking to innovate and grow. The results, drawing on markets where IPRs are used for funding, will be used to develop methods to enable wider application where lenders and IP-rich enterprises could both benefit".

IP Finance wishes Kelvin and his colleagues the best of luck. We all look forward to seeing not only the conclusions that are reached but the data and the assumptions on which they are based.