Josh Lerner

English

Research Papers in Economics

The Patent System and Competition 
 
A Statement to the Federal Trade Commission/ Department of Justice Hearings on 
Competition and Intellectual Property Law and Policy in the Knowledge-Based Economy 
 
Josh Lerner
* 
 
 
 
The U.S. patent system has undergone a profound shift over the past two decades.  
The strength of patent protection has been dramatically bolstered, and both large and small 
firms are devoting considerably more effort to seeking patent protection and defending their 
patents in the courts.  Many in the patent community—U.S. Patent and Trademark Office 
officials, the patent bar, and corporate patent staff—have welcomed these changes.  But 
viewed more broadly, the reforms of the patent system and the consequent growth of patent 
litigation have created a substantial "innovation tax" that affects some of America's most 
important and creative firms.
1 
 
  Almost all formal disputes involving issued patents are tried in the Federal judicial 
system.  The initial litigation must be undertaken in a district court.  Prior to 1982, appeals 
of patent cases were heard in the appellate courts of the various circuits.  These differed 
                                                                 
*Jacob H. Schiff Professor of Investment Banking, Graduate School of Business 
Administration, Harvard University and Research Associate, National Bureau of Economic 
Research.  Harvard Business School’s Division of Research proved financial support.  All 
opinions are my own. 
 
1One question raised by this argument is as follows: if these obstacles are important, why 
has the share of R&D expenditures being undertaken by American firms substantially 
increased in recent years?  The rapid pace of change in many facets of information 
technology may have created more opportunities.  In addition, improvements in the 
management of innovation with established firms may have increased the efficiency of 
such spending (see Kortum and Lerner [1998] for a discussion).     2
considerably in their interpretation of patent law.  Because few appeals of patent cases were 
heard by the Supreme Court, substantial differences persisted, leading to widespread "forum 
shopping" by litigants.  
 
  In 1982, the U.S. Congress established a centralized appellate court for patent cases, 
the Court of Appeals for the Federal Circuit (CAFC).  As Robert Merges [1992] observes, 
  While the CAFC was ostensibly formed strictly to unify patent doctrine, it 
was no doubt hoped by some (and expected by others) that the new court 
would make subtle alterations in the doctrinal fabric, with an eye to 
enhancing the patent system.  To judge by r esults, that is exactly what 
happened. 
 
The CAFC's rulings have been more "pro-patent" than the previous courts. For instance, the 
circuit courts had affirmed 62% of district court findings of patent infringement in the three 
decades prior to the creation of the CAFC, while the CAFC in its first eight years affirmed 
90% of such decisions [Koenig, 1980; Harmon, 1991]. 
 
  The strengthening of patent law has not gone unnoticed by corporations.  Between 
1988 and 2000, patent applications by U.S. corporations have more than doubled [U.S. 
Department of Commerce, 2001].  Furthermore, the willingness of firms to litigate patents 
has increased considerably: the number of patent suits instituted in the Federal courts has 
increased from 795 in 1981 to 2573 in 2001 [Administrative Office, various years].  These 
suits lead to significant expenditures by firms.  For instance, I have estimated [1995] that 
patent litigation begun in 1991 led to total legal expenditures by U.S. firms that were at least 
25% of the amount on basic research by these firms in that year.  Litigation also leads to 
substantial indirect costs.  The discovery process is likely to require the alleged infringer to   3
produce extensive documentation, time-consuming depositions from employees, and may 
generate unfavorable publicity.  Its officers and directors may also be held individually 
liable. 
 
  As firms have realized the value of their patent positions, they have begun reviewing 
their stockpiles of issued patents.  Several companies, including Texas Instruments, Intel, 
and Wang Laboratories, have established groups that approach rivals to demand royalties on 
old patent awards.  In many cases, they have been successful in extracting license 
agreements and/or past royalties.  For instance, Texas Instruments i s estimated to have 
netted close to one billion dollars annually from patent licenses and settlements resulting 
from their general counsel's aggressive enforcement policy. 
 
  This has had two particularly striking consequences.  The first has been the growth 
of litigation—and threats of litigation—between large and small firms.
2  This trend is 
disturbing.  While litigation is clearly a necessary mechanism to defend property rights, the 
proliferation of such suits may be leading to transfers of financial resources from some of 
the youngest and most innovative firms to more established, better capitalized concerns.  
Even if the target firm feels that it does not infringe, it may choose to settle rather than fight.  
It either may be unable to raise the capital to finance a protracted court battle, or else may 
believe that the publicity associated with the litigation will depress the valuation of its 
equity. 
                                                                 
2Several examples are discussed in Chu [1992].  Examples may include the dispute 
between Cetus Corporation and New England Biolabs regarding the taq DNA polymerase 
and that between Texas Instruments and LSI Logic regarding semiconductor technology.   4
 
  In addition, these small firms may reduce or alter their investment in R&D.  For 
instance, a 1990 survey of 376 firms found that the time and expense of intellectual property 
litigation was a major factor in the decision to pursue an innovation for almost twice as 
many firms with under 500 employees than for larger businesses [Koen, 1990].  These 
claims are a lso supported by my study [1995] of the patenting behavior of new 
biotechnology firms that have different litigation costs.  I showed that firms with high 
litigation costs are less likely to patent in subclasses with many other awards, particularly 
those of firms with low litigation costs. 
 
The second deleterious effect has been the emergence of individual inventors who 
seek to “hold up” established firms in their industries.  In many cases, these individuals have 
received patent of dubious validity.  For instance, in the financial services arena, individual 
inventors have received patents on the basic techniques of option pricing and exchange-
traded stock indexes (both have which have been widely employed for decades), and are 
now seeking royalties for their “discoveries.”  (The discussion in Lerner [2002] has more 
details.)  In many instances, established players have chosen to settle such disputes, not 
wishing to risk the uncertainty associated with trying a complex piece of intellectual 
property.  Of particular worry has been the possibility that the individual will succeed in 
getting a preliminary injunction to shut down activity at the established firm [Lanjouw and 
Lerner, 2001]. 
   5
  These effects have been particularly pernicious in emerging industries.  Chronically 
strained for resources, USPTO officials are unlikely to assign many patent examiners to 
emerging technologies in advance of a wave of applications.  As patent applications begin 
flowing in, the USPTO frequently finds the retention of the few examiners skilled in the 
new technologies difficult.  Companies are likely to hire away all but the least able 
examiners.  These examiners are valuable not only for their knowledge of the USPTO 
examination procedure in the new technology, but also for their understanding of what other 
patent applications are in process but not awarded.  (A large fraction of U.S. patent 
applications are held confidential until time of award.)  Many of the examinations in 
emerging technologies are as a result performed under severe time pressures by 
inexperienced examiners.  Consequently, awards of patents in several critical new 
technologies have been delayed and highly inconsistent.  These ambiguities have created 
ample opportunities for firms that seek to aggressively litigate their patent awards.  The 
clearest examples of this problem are the biotechnology and software industries.  In the 
latter industry, examples abound where inexperienced examiners have granted patents on 
technologies that were widely diffused but not previously patented [see, for instance, the 
many examples chronicled in Aharonian, 2002]. 
 
  It might be asked why policy-makers have not addressed the deleterious effects of 
patent policy changes.  The difficulties that Federal officials have faced in reforming the 
patent system are perhaps best illustrated by the efforts to simplify one of the most arcane 
aspects of our patent system, the "first-to-invent" policy.  With the exception of the 
Philippines, all other nations award patents to firms that are the first to file for patent   6
protection.  The U.S., however, has clung to the first-to-invent system.  In the U.S., a patent 
will be awarded to the party who can demonstrate (through laboratory notebooks and other 
evidence) that he was the initial discoverer of a new invention, even if he did not file for 
patent protection until after others did (within certain limits).  A frequently invoked 
argument for the first-to-invent system is that this provides protection for small inventors, 
who may take longer to translate a discovery into a completed patent application. 
 
  While this argument is initially compelling, the reality is quite different.  Disputes 
over priority of invention are resolved through a proceeding before the USPTO's Board of 
Patent Appeals and Interferences known as an interference.  The Board will hold a hearing 
to determine which inventor first made the discovery. 
 
  The interference process has been characterized as "an archaic procedure, replete 
with traps for the unwary" [Calvert, 1980].  These interferences consume a considerable 
amount of resources: the adjudication of the average interference is estimated to cost over 
one hundred thousand dollars [Kingston, 1992].  Yet in recent years, in only about 55 cases 
annually has the party that was second-to-file been determined to have been the first-to-
invent [Calvert and Sofocleous, 1992].  Thus, the U.S. persists in this complex, costly, and 
idiosyncratic system in order to reverse the priority of 0.03% of the patent applications 
filed each year. 
 
  But this system has proved very resistant to change.  At least since 1967, proposals 
have been unsuccessfully offered to shift the U.S. to a first-to-file system.  In January 1994,   7
for instance, former USPTO Commissioner Bruce Lehman was forced to withdraw such a 
proposal.  While the voices raised in protest over his initiative—as those opposing earlier 
reform attempts—were led by advocates for small inventors, it is difficult not to conclude 
that the greatest beneficiary from the first-to-invent system is the small subset of the patent 
bar that specializes in interference law. 
 
  It may be thought puzzling that independent inventors, who are generally unable 
to afford costly litigation, have been so active in supporting the retention of first-to-
invent.  A frequently voiced complaint is that small inventors take longer to prepare 
patent applications, and hence would lose out to better-financed rivals, in a first-to-file 
world.  This argument appears to be specious for several reasons.  First, economically 
important discoveries are typically the subject of patent filings in a number of countries.  
Thus, there is already an enormous pressure to file quickly.  Second, the recent reforms of 
the U.S. system have created a new provisional patent application, which is much simpler 
to file than a full-fledged application.  Finally, as former Commissioner Lehman notes, 
many most vocal independent inventors opposing patent reform are "weekend hobbyists 
. . . [rather than representatives of] knowledge-based industries" [Chartrand, 1995]. 
 
  As this case study suggests, the failure of Federal reform efforts is due to several 
factors.  First, the issues are complex, and sometimes difficult to understand.  Simplistic 
claims frequently cloud these discussions.  For instance, because firms use patents to 
protect innovations, it is frequently argued that a stronger patent system will lead to more 
innovation.  Second, the people with the greatest economic stake in retaining a litigious and   8
complex patent system—the patent bar—have proven to be a very powerful lobby.  The 
efforts of the highly specialized interference bar to retain first-to-invent is a prime example.  
Finally, the top executives of technology-intensive firms have not mounted an effective 
campaign around these issues.  The reason may be that the companies who are most 
adversely affected are small, capital-constrained firms who do not have time for major 
lobbying efforts. 
 
  Thus, an important policy concern is that we avoid taking steps in the name of 
increasing competitiveness that actually interfere with the workings of innovative 
businesses.  The 1982 reform of the patent litigation process may well have had exactly this 
sort of unintended consequence.  At the very least, steps to enhance the quality of patents 
being issued are certainly needed.   9
References 
 
Administrative Office of the United States Courts,  Annual Report of the Director, 
Washington: U.S. Government Printing Office, various years. 
 
Gregory Aharonian, “Internet Patent News Service,” http://www.bustpatents.com, 2002. 
 
Ian A. Calvert, "An Overview of Interference Practice,"  Journal of the Patent Office 
Society, 62 (1980), pp. 290-308. 
 
Ian A. Calvert and Michael Sofocleous, "Interference Statistics for Fiscal Years 1989 to 
1991," Journal of the Patent and Trademark Office Society, 74 (1992), pp. 822-826. 
 
Sabra Chartrand, "Facing High-Tech Issues, New Patents Chief in Reinventing a Staid 
Agency," New York Times, July 14, 1995, p. 17. 
Michael P. Chu, "An Antitrust Solution to the New Wave of Predatory Patent Infringement 
Litigation," William and Mary Law Review, 33 (1992), pp. 1341-68. 
 
Robert L. Harmon, Patents and the Federal Circuit, Washington: Bureau of National Affairs, 
1991. 
 
William Kingston, "Is the United States Right about 'First-to-Invent'?,"  European 
Intellectual Property Review, 7 (1992), pp. 223-226. 
 
Mary S. Koen, Survey of Small Business Use of Intellectual Property Protection: Report of 
a Survey Conducted by MO-SCI Corporation for the Small Business Administration, Rolla, 
Missouri: MO-SCI Corp., 1990. 
 
Gloria K. Koenig, Patent Invalidity: A Statistical and Substantive Analysis, New York: 
Clark Boardman, 1980. 
 
Samuel Kortum and Josh Lerner, “Stronger Protection or Technological Revolution: What 
is Behind the Recent Surge in Patenting?,”  Carnegie-Rochester Conference Series on 
Public Policy, 48 (1998), pp. 247-304.   
 
Jean O. Lanjouw and Josh Lerner, “Tilting the Table? The Use of Preliminary 
Injunctions,” Journal of Law and Economics, 44 (2001), pp. 573-603. 
 
Josh Lerner, "Patenting in the Shadow of Competitors," Journal of Law and Economics, 38 
(1995), pp. 563-595. 
 
Josh Lerner, “Where Does State Street Lead?  A First Look at Finance Patents, 1971-
2000,” Journal of Finance, 57 (2002), pp. 901-930.   
 
Robert P. Merges, Patent Law and Policy, Charlottesville: Michie Company, 1992.   10 
 
U.S. Department of Commerce, Patent and Trademark Office, 2001 TAF Special Report--
All Patents, All Types, January 1977 -- December 2000, Washington: U.S. Government 
Printing Office, 2001. 
 

An Antitrust Solution to the New Wave of Predatory Patent Infringement Litigation,&quot;

An Overview of Interference Practice,&quot;

Facing High-Tech Issues, New Patents Chief in Reinventing a Staid Agency,&quot;

Interference Statistics for Fiscal Years

Internet Patent News Service,” http://www.bustpatents.com,

Is the United States Right about 'First-to-Invent'?,&quot;

Patent Invalidity: A Statistical and Substantive Analysis,

Patent Law and Policy, Charlottesville: Michie Company,

Patenting in the Shadow of Competitors,&quot;

Patents and the Federal Circuit, Washington: Bureau of National Affairs,

Stronger Protection or Technological Revolution: What is Behind the Recent Surge

Survey of Small Business Use of Intellectual Property Protection: Report of a Survey Conducted by MO-SCI Corporation for the Small Business Administration,

Tilting the Table? The Use of Preliminary Injunctions,”

Where Does State Street Lead? A First Look at Finance Patents,

The Patent System and Competition

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The Patent System and Competition

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Research Papers in Economics