Measuring Patent Thickets

Measuring the effect of patenting on industry R&D is an age old pursuit in innovation economics. It's hard. The latest interesting attempt comes from Greg Day (Georgia Business) and Michael Schuster (OK State, but soon to be Georgia Business). They look at more than one million patents to determine that large portfolios tend to crowd out startups. I'm totally with them on that. As I wrote extensively during troll hysteria, patent portfolios and assertion by active companies can be harmful to innovation.

The question is how much, and what to do about it. Day and Schuster argue in their paper that the issue is patent thickets, as their abstract shows. The draft article Patent Inequality, is on SSRN:

Using an original dataset of over 1,000,000 patents and empirical methods, we find that the patent system perpetuates inequalities between powerful and upstart firms. When faced with growing numbers of patents in a field, upstart inventors reduce research and development expenditures, while those already holding many patents increase their innovation efforts. This phenomenon affords entrenched firms disproportionate opportunities to innovate as well as utilize the resulting patents to create barriers to entry (e.g., licensing costs or potential litigation).

A hallmark of this type of behavior is securing large patent holdings to create competitive advantages associated with the size of the portfolio, regardless of the value of the underlying patents. Indeed, this strategy relies on quantity, not quality. Using a variety of models, we first find evidence that this strategy is commonplace in innovative markets. Our analysis then determines that innovation suffers when firms amass many low-value patents to exclude upstart inventors. From these results, we not only provide answers to a contentious debate about the effects of strategic patenting, but also suggest remedial policies to foster competition and innovation.

The article uses portfolio sizes and maintenance renewals to find correlations with investment. They find, unsurprisingly, that the more patents there are in portfolios in an industry, the lower the R&D investment. However, the causal takeaways from this seem to me to be ambiguous. It could be the patent thickets that cause that limitation, or it could simply be that industries dominated by large players are less competitive and drive out startups. There are plenty of (non-patent) theorists that would predict such outcomes.

They also find that firms with large portfolios are more likely to renew their patents, holding other indicia of patent quality (and firm assets) equal. Even if we assume that their indicia of patent quality are complete (they use forward cites, number of inventors, and number of claims), the effect they find is really, really small. For the one reported industry - biology, the effect is something like a -0.00000982 percent likelihood of lapse for each additional patent. This is statistically significant, I assume, because of the very large sample size and a relatively small variation. But it seems barely economically significant. If you multiply it out, it means that each patent is 1% more likely to lapse for every 1,000 patents in the portfolio (that is, from 50% chance of lapse, to 49% chance of lapse. For IBM - the largest patentee of the time with about 25,000 patents during the relative time period, it's still only a 25% change. Most patentees, even with portfolios, would be nowhere near that. I'm just not sure what we can read into those numbers - certainly not the broad policy prescriptions suggested in the paper, in my view.

That said, this paper provides a lot of useful information about what drives portfolio patenting, as well as a comprehensive look at what drives maintenance rates. I would have liked to see litigation data mixed in, as that will certainly affect renewals one way or the other, but even as is, this paper is an interesting read.

The Role of IP in Industry Structure

I've long been a fan of Peter Lee's (UC Davis) work at the intersection of IP and organizational theory. His latest article is another in a long line of interesting takes on how IP affects and is affected by the structure and culture of its creators. The latest draft, forthcoming in Vanderbilt Law Review, is titled Retheorizing the Impact of Intellectual Property Rights on Industry Structure. The draft is on SSRN, and the abstract is here:

Technological and creative industries are critical to economic and social welfare, and the forces that shape such industries are important subjects of legal and policy examination. These industries depend on patents and copyrights, and scholars have long debated whether exclusive rights promote industry consolidation (through shoring up barriers to entry) or fragmentation (by promoting entry of new firms). Much hangs in the balance, for the structure of these IP-intensive industries can determine the amount, variety, and quality of drugs, food, software, movies, music, and books available to society. This Article retheorizes the role of patents and copyrights in shaping industry structure by examining empirical profiles of six IP-intensive industries: biopharmaceuticals; agricultural biotechnology, seeds, and agrochemicals; software; film production and distribution; music recording; and book publishing. It makes two novel arguments that illuminate the impacts of patents and copyrights on industry structure. First, it distinguishes along time, arguing that patents and copyrights promote the initial entry of new firms and early-stage viability, but that over time industry incumbents wielding substantial IP portfolios often absorb such entrants, thus reconsolidating those industries. It also distinguishes along the value chain, arguing that exclusive rights most prominently promote entry in “upstream” creative functions—from creating biologic compounds to coordinating movie production—while tending to promote concentration in downstream functions related to commercialization, such as marketing and distribution of drugs and movies. This Article provides legal and policy decision makers with a more robust understanding of how patents and copyrights promote both fragmentation and concentration, depending on context. Drawing on these insights, it proposes calibrating the acquisition of exclusive rights based on the size and market position of a rights holder.

Professor Lee surveys six industries, looking for commonalities in how they are structured, and how IP fits in with entry and consolidation. This is not an empirical paper in the sense of, say Cockburn & MacGarvie, who found that patents reduced entry into the software industry unless the entrant had patent applications. Instead, it looks at the history of entry and consolidation in the different industries as a whole, using studies like Cockburn & MacGarvie (which is discussed in some detail) as the foundational base for the theoretical view that puts all the empirical findings together.

The result is a sort of two dimensional axis (though Prof. Lee provides no chart, which wouldn't have added much). He finds that, in general, IP leads to entry early in time, but as the industry (or product area) matures, then IP leads instead to consolidation, as companies find it easier to acquire IP than create it on its own in crowded areas. He also finds, however (and I think this is a key insight in the paper), that IP leads to more entry upstream (early creation stage) and more consolidation downstream (commercialization and marketing).

This second axis is the more interesting one (there are lots of articles about development of thickets over time), but it is also the harder one to prove, and it depends a lot on your definition. For example, Professor Lee discusses video streaming services such as Netflix and Hulu but doesn't discuss whether he views them as horizontally consolidated because there are so few of them. I've always thought of IP as fragmenting video streaming, because rights holders want to monetize their IP by holding on to it. Hence, we have to pay separately to get Star Trek: Discovery on CBS streaming, Hulu has many TV shows that Netflix doesn't, and soon Disney will pull out of its exclusive deal with Netflix to create its own service. That's 5 or more services I have to sign up with if I want to get all the shows (contrast this with the story he tells about music streaming, in which the music distributors all distribute all the music, and the distributor record labels consolidate to enhance market power against the distributor streamers). Indeed, this issue is so important that the services have (as Prof. Lee points out) vertically integrated by consolidating production with distribution (Netflix and Amazon making its own shows, Comcast and NBC/Universal, and AT&T buying Warner). Professor Lee discusses this as a penchant for consolidation, but it is not clear why IP drives it. I think it is consolidation caused by upstream entry (as he would predict) by the likes of Netflix and Amazon in the creation space, because they also happen to be distributors. But then why don't the record labels become streamers? Why does this fragmentation work for video and not music? I'd be interested in hearing how Professor Lee breaks this down.

As you can probably tell, this is a thoughtful and thought-provoking paper, and I recommend it, especially to those unfamiliar with the literature on the role of IP in industry organization and entry.