Patent Pools, Litigation and Innovation Jay Pil Choi (UNSW, Michigan State) Heiko Gerlach (U of Queensland) 2nd ATE Symposium at UNSW Sydney December 15, 2014 Patent Pools, Litigation and Innovation 1
Patent Pools and Antitrust patent pools=agreements of two or more IP owners to jointly license to third parties single license contract for a bundle of patents with multiple owners many patent pools in different industries until end of WWII Supreme Court decision in 1945 impeded further pool formation 1995 DOJ/FTC Guidelines for the Licensing and Acquisition of Intellectual Property Patent Pools, Litigation and Innovation 1. Introduction 2
competitive effects of patent pools depend on relationship among constituent patents (e.g. Lerner & Tirole 2004) complementary patents: pro-competitive substitute patents: anti-competitive 2004/2007/2014: European Commission also reviews patent pools favourably, introduces safeguards Wireless ¡Lan ¡ ¡ Golden ¡Rice ¡ Gene0c ¡Tes0ng ¡ One ¡Blue ¡ HIV ¡drugs ¡(2010) ¡ ¡Pool ¡(2000) ¡ (2008) ¡ (2009) ¡ ¡(2010) ¡ Patent Pools, Litigation and Innovation 1. Introduction 3
Patent Pools and Probabilistic Patents “probabilistic patents” (Lemley & Shapiro, 2004): half of litigated patents found to be invalid patents right to “try to” exclude licensing in the shadow of litigation: royalty rates reflect the strength of patents pools with probabilistic, complementary patents have two effects 1 litigating individual patents not profitable : patent pools are stronger litigation entity than individual firms 2 prevent individual patent holders from engaging in Bertrand type competition to avoid litigation against their own patent Patent Pools, Litigation and Innovation 1. Introduction 4
patent pools can be used as a mechanism to discourage patent litigation and charge higher licensing fees this in turn reduces future downstream innovation incentives if patents sufficiently weak, complementary patent pools can be anti-competitive formalize the court’s idea in Duplan vs Deering Milliken: “the ... patents in suit were known ... to be weak and, ..., they [the parties] were confident that these patents could be invalidated. The main purpose of the patent pool in the case was to protect the parties from challenges to the validity of their patents in order to gain the power to fix and maintain prices in the form of royalties which they... exercised thereafter.” Patent Pools, Litigation and Innovation 1. Introduction 5
Theoretical Literature on Patent Pools Patent Pools and Static Welfare ◮ Shapiro (2003) ◮ Lerner and Tirole (2004) ◮ Lerner, Strojwas and Tirole (2007) Patent Pools and Innovation Incentives with Ironclad Patents ◮ Llanes and Trento (2013) ◮ Dequiedt and Veraevel (2006) ◮ Kwon et al . (2008) Patent Pools and Probabilistic Patents ◮ Choi (2010) ◮ Gilbert and Katz (2006) Patent Pools, Litigation and Innovation 1. Introduction 6
Empirical Literature Lampe and Moser (2010, 2013) ◮ Sewing Machine Combination (1856-1877), the first patent pool in U.S. history ◮ pool discouraged patenting and innovation, more likely to sue outsiders ◮ attributed to fact that patent pools create more formidable entities in court and thus increase the threat of litigation for outside firms Joshi and Nerkar (2011) ◮ global optical disc industry: MPEG-2, DVD3C, DVD6C patent pools ◮ patent pool inhibits, rather than enhances, innovation by firms Patent Pools, Litigation and Innovation 1. Introduction 7
Lampe and Moser (2010, 2013): “19th century data suggest that the sewing machine patent pool discouraged invention by outside firms..” Patent Pools, Litigation and Innovation 1. Introduction 6
Lampe and Moser (2010, 2013): “19th century data suggest that the sewing machine patent pool discouraged invention by outside firms..” Patent Pools, Litigation and Innovation 1. Introduction 6
2. Complementary Patent Pools and Future Development Incentives two complementary patents, A and B , which are owned by two separate firms patents essential for development new technology by third firm C potential innovation can create a total value of v implementation cost of c ≥ 0 distributed according to cdf G(c) reversed hazard rate of G ( . ), r ( . ) = g () / G (), monotonically decreasing in its argument how does patent pool affect future incentives to develop new innovations? consider ex ante licensing: commitment mechanism not to hold up firm C ’s investment incentives Patent Pools, Litigation and Innovation 2. Complementary Patent Pools and Future Development Incentives 7
timing of licensing game in the absence of litigation : firms decide whether or not to form a patent pool 1 set licensing fees 2 ⋆ If they do not form a patent pool, they set the licensing fees ( f A , f B ) independently ⋆ If they form a patent pool, they offer package licensing at F firm C decides whether to buy licenses and develop innovation or not 3 firm C develops the new innovation if development cost satisfies c < v − f A − f B probability new innovation to be developed is given by G ( v − f A − f B ) Patent Pools, Litigation and Innovation 2. Complementary Patent Pools and Future Development Incentives 8
Licensing with Independent Firms firm A solves the following problem given firm B ’s royalty rate f B max f A G ( v − f A − f B ) f A first order condition for firm A’s optimal royalty rate f A is given by G ( v − f A − f B ) − f A g ( v − f A − f B ) = 0 (1) which implicitly defines reaction function f i = Θ( f j ) f A = G ( v − f A − f B ) g ( v − f A − f B ) . MRHR condition ensures unique Nash equilibrium at intersection of B = f ∗ and reaction functions such that f ∗ A = f ∗ F ∗ = f ∗ A + f ∗ B Patent Pools, Litigation and Innovation 2. Complementary Patent Pools and Future Development Incentives 9
Licensing with Patent Pool the optimal package license is derived by solving max FG ( v − F ) F optimal ex ante licensing fee F ∗∗ satisfies the following first order condition: G ( v − F ∗∗ ) − F ∗∗ g ( v − F ∗∗ ) = 0 , (2) which can be rewritten as F ∗∗ = G ( v − F ∗∗ ) g ( v − F ∗∗ ) . patentees do not internalize increase in other patentee’s profits when demand for package is increased by price reduction patent pool decreases overall royalty rates and simultaneously increases both patentees’ profits and induces more future innovations Patent Pools, Litigation and Innovation 2. Complementary Patent Pools and Future Development Incentives 10
Proposition When firms form a patent pool, total licensing fees are lower and there are more subsequent innovations, F ∗ = f ∗ A + f ∗ B > F ∗∗ Social and private incentives to form a patent pool are perfectly aligned. variation of well-known result that dates back to Cournot’s (1927) analysis of the complementary monopoly problem patent pool increases social welfare and is pro-competitive in the presence of multiple blocking patents dynamic efficiency interpretation for allowing patent pools of complementary innovations Patent Pools, Litigation and Innovation 2. Complementary Patent Pools and Future Development Incentives 11
3. Probabilistic Patent Rights and Litigation with Patent Pools probabilistic patents: p A = α ≥ 0 and p B = β ≤ 1 where α ≤ β probabilities that court will uphold validity of patents if challenged symmetric information structure: α and β common knowledge two additional stages after firm C ’s decision whether to buy licenses ◮ if firm C does not buy, upstream firm can decide whether to sue for infringement; in this case, firm C will contest the validity of the patent ◮ court decides on validity of patent and litigation outcome revealed fee setting has two potential margins: demand or litigation margin we first consider game where only litigation margin is binding, then we consider game where both margins may be binding Patent Pools, Litigation and Innovation 3. Probabilistic Patent Rights and Litigation with Patent Pools 12
timing of the game with litigation and demand margin 1 firms A and B decide whether or not to form a patent pool 2 firms A , B or pool set licensing fees 3 firm C draws development cost c from G ( . ) and decides whether to engage in development ⋆ if firm C does not develop, the game ends 4 firm C decides for each technology whether to buy license or not 5 upstream firms (or pool) decide(s) whether to sue firm C for infringement; if sued, firm C contests the validity of the patent in court 6 litigation outcomes revealed; if patent has been challenged and upheld, its holder proposes new license fee for firm C 7 if firm C has license for all non-invalidated patents, it receives v . Patent Pools, Litigation and Innovation 3. Probabilistic Patent Rights and Litigation with Patent Pools 13
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