How bad is it?

Patent Failure: How Judges, Bureaucrats, and Lawyers Put Innovators at Risk (buy)

James Bessen and Michael Meurer

Princeton University Press

352 pages

Anyone who has paid the slightest bit of attention to the technology press in recent years knows that the patent system is out of control. Barely a week goes by here at Ars that we don't report on an absurd patent application or a frivolous patent lawsuit. And we're no longer surprised when an innovative technology company is forced to write an 8- or 9-figure check as a result of a frivolous patent lawsuit.

But although there's now plenty of anecdotal evidence that patents are harming innovation, especially in software, there has been little hard data on the subject. Most people in the software industry suspect something is wrong, but we haven't been able to prove it, much less quantify the extent of the problem.

A new book by James Bessen and Michael J. Meurer, both of Boston University, aims to fill this gap with one of the most comprehensive empirical analyses of the patent system that has been performed in decades. Rather than piling up anecdotes of beleaguered innovators and rapacious patent trolls, Bessen and Meurer have done the hard work of collecting detailed data about the patent system. And the findings documented in Patent Failure: How Judges, Bureaucrats, and Lawyers Put Innovators at Risk are sobering.

Measuring patent performance

Patents are supposed to create a positive incentive for innovation by enhancing the profits of companies that develop new technologies. If the patent system is working properly, the average firm's patent portfolio should generate more profits than the total cost of defending against patent infringement lawsuits from other firms. If, in contrast, litigation costs exceed patent profits, that suggests the patent system is actually creating a net dis-incentive to innovation. In that case, innovative companies would be better off with no patent system at all.

Focusing on public companies, Bessen and Meurer use several sources—including the results of patent auctions, the rate of patent renewals, and the effect of patent portfolios on market capitalizations—to determine the value of public firms' patent portfolios. They estimate the costs of patent litigation (which can include factors such as business uncertainty, executive distraction, and bad publicity in addition to attorneys' fees) by observing how defendant firms' stock prices changed on the day the patent lawsuits were announced. They also divide their study into two categories of patents: chemical and pharmaceutical patents in one category, and all other patents in the other.

Their data suggests three broad conclusions. First, patent litigation began rising sharply in the early 1990s. The costs of defending against patent litigation for non-chemical firms held steady at about $2 billion per year during the 1980s, but by 1999 (the last year for which they have reliable data), patent litigation was costing defendants more than $10 billion annually. Second, while the chemical and pharmaceutical industries also experienced increased litigation during the 1990s, the problem was much less dire; the patent system still appeared to offer positive innovation incentives for drug and chemical firms.



Patent profits and litigation costs for publicly-traded US companies

Most shockingly, Bessen and Meurer's data suggest that outside of the chemical and pharmaceutical industries, litigation costs for the average public firm actually exceed profits from their patent portfolio by a wide margin. By 1999, the last year in their sample, defendending against patent lawsuits cost non-chemical public firms about $12 billion, while their patent portfolios generated only about $3 billion in profits. This data suggests that outside the chemical and pharmaceutical industries, the patent system actually reduces the net returns to innovation; firms don't earn enough from their patents to offset the costs of defending themselves against patent infringement lawsuits brought by other firms.



Patent profits and litigation costs for publicly-traded US companies

These results come with an important caveat: Bessen and Meurer focus was on publicly traded companies, not privately-held firms or individual inventors. The data does show that the patent system works relatively better for smaller firms, so including private firms in the calculation might mitigate the patent system's negative effect somewhat. But even if the patent system works relatively better for such firms, the net effect is still likely to be negative because public companies perform the lion's share of research and development. Moreover, the evidence suggests that the patents held by small firms are actually less valuable than patents held by large firms. The patent system may be a net positive for smaller firms, but the overall impact outside the chemical and pharmaceutical industries is still likely to be negative.