PATENT PRAGMATISM: A THREAT TO R&D AND INNOVATION

The Economist of 12th September carried an important article on the new trend of patents as financial assets. Reporting this at a time when the World Intellectual Property Organization (WIPO)  has just published its new report World Intellectual Property Indicators 2009 which shows that the number of patents being registered is now falling for the first time in years, this trend represents a sea-change in how patents have come to be regarded. The financialisation of intellectual property (IP) is actually the evolution of a longer-term trend of business short-termism and patent pragmatism divorced from innovation.

The Economist notes that the view of patents has been changing for some time: ‘What was once viewed as a stodgy legal asset is fast becoming a sought-after financial one’. But this is not particularly surprising. The emergence of patents as financial assets is an expression of how today’s risk-averse business culture with its focus upon short-term and predictable market returns, has reduced innovation to extremely narrow and instrumental terms. Once regarded as an indicator of innovation, patents have increasingly become an end in themselves – a means to recoup costs of R&D and to minimise the risks of investment in R&D.

The financialisation of patents is just the latest expression of the trend towards short-term financialisation rather than longer-term investment in R&D and innovation.

EXPRESSION OF A LONGER-TERM TREND

The Economist notes that this trend is still at an early stage but is growing relatively quickly – by perhaps 20-30 per cent a year. They cite this figure from Coller Capital, an investment firm that has snapped up IBM’s portfolio of medical-device and health-care patents. Intellectual Ventures, based near Seattle, has spent a large proportion of its $5 billion fund on buying patents: 27,000 to be precise. Other players exist and the field is growing.

On one level, the selling of IP is understandable and inevitable. For individual inventors and universities, many of whom lack the resources to chase infringers or to develop their IP effectively, the recession is forcing them to sell in order to survive. But at another level, particularly for many large technology providers, this behaviour represents a new phase of short-term pragmatism. As Peter Holden of Coller’s remarks, ‘Well-timed patent sales are also a way for public technology firms to meet quarterly profit targets’. Managing their IP more pragmatically means selling off patents that are peripheral to their core businesses. Patents effectively become an end in themselves, divorced from any innovation that the company may have pursued in the future.

PATENTS DIVORCED FROM INNOVATION

The current recession has certainly speeded up the longer-term squeeze on R&D budgets. As the demand for a rate of return on investment in R&D has grown, businesses have become increasingly risk-averse and wary of experimentation or unproven new ideas. Instead they have placed an emphasis upon profiting from the ones they already own. The result has been, as I have argued elsewhere on this blog, the reduction of innovation to extremely narrow and instrumental terms. Increasingly, patent production has become more closely related to the development of patent portfolios as a source of revenue in itself.

Ironically, one of the best expressions of this dynamic is the proliferation of patents themselves.

Although WIPO now suggest we are seeing a decline in globally of registered patent fillings for the first time, this is the opposite trend of the early part of this decade. According to the OECD, the early part of this decade saw an explosion of patent registrations: more than 442,000 patents applications were filed in Europe and the US in 2002, compared to around 224,000 a decade earlier. In their revealing study of the patent system in the US, Innovation and Its Discontents: How Our Broken Patent System is Endangering Innovation and Progress, and What to Do About It authors Adam B Jaffe and Josh Lerner made the key point back in 2004, that this increase in patenting does not reflect an explosion of inventiveness or innovation. They argued that this increase was accompanied by a proliferation of patent awards of dubious merit. This was supported by another 2004 study by James Bessen, a researcher at Boston University’s School of Law, and Robert Hunt, an economist at the Federal Reserve Bank of Philadelphia, that showed that by the end of the 1990s, firms were able to obtain more than twice as many software patents for every R&D dollar spent than at the start of the decade. They concluded that the growth in the number of patents was now exceeding the increase in R&D expenditure which indicated that ‘cheap’ patents were being used as a substitute for more R&D. The Economist concluded in their  survey on patents and technology in 2005 that industry  was doing too much patenting merely for the sake of it.

The proliferation of ‘cheap’ patents in the earlier part of this decade  was really an expression of how patents had rapidly become an end in themselves and, ironically, had become a substitute for more R&D spending. Developing a patent portfolio to exploit financially, became a key means of both minimising the risks of R&D investment and competition. For example, in this period, a company like IBM earned over $1 billion annually from its patent portfolio while a company like HP saw its revenue from licensing quadruple in less than three years to over $200m in 2005. Microsoft, a company that held a mere five patents in 1990 (when it was at its monopolistic height) rapidly began to file thousands of patents. Like many other large companies, Microsoft created a new Corporate Division to exchange its technology for cash or equity in start-up firms and to pursue patent infringements. The result? A massive rise of patent-related litigation.

LITIGATION AND FINANCIALISATION

The increase in patent-related litigation has increasingly made lawyers the key players in the competitive struggle between firms rather than entrepreneurs and researchers. (Even Dilbert has observed this trend). Litigation licensing units in large firms have successfully extracted license agreements and/or past royalties from smaller rivals. Texas Instrument, for example, has in recent years netted close to $1 billion annually from patent licenses and settlements resulting from an aggressive enforcement policy. In some years, revenues from these sources have exceeded net income from product sales!

It is not only large companies with patent portfolios that have increased their litigation practices. A new practice of ‘patent trolling’ has emerged – a practice where large companies are sued for dubious patent infringements by non practicing entities. Google published a statement on their Public Policy Blog, for example, stating that 90% of companies suing them for patent infringement were non practicing entities, and that in lots of cases, the patents had been “invented” by the patent lawyers themselves. See stopsoftwarepatents.org.

Patent trolling is to be expected and will grow as IP is increasingly financialised. Opportunism in business is nothing new. But the pursuit of patents as financial assets reveals how far (and fast) the trend towards short-term instrumentalism in innovation has gone. By concentrating on existing portfolios, patents as financial assets are a substitute for more R&D spending.

SHORT-TERMISM

This is not an abstract point to make about what might happen in the future. Its impact is already here and can be seen in the practices of companies like Novartis who now invest huge amounts of time and money in pursuing legal loopholes to extend the lifespan of their patents, rather than develop new ones. While this may squeeze the last drop of profit out of existing blockbuster drugs, it comes at the expense of their own development of new and genuinely innovative medicines.

This may very well ensure more profits in the immediate future through exploiting the patent system in this way rather than investing in long-term R&D, but the approach smacks of staggering short-termism. Last year, only two research-based pharmaceutical companies generated more than 10 per cent of their revenue from “major” products less than three years old, and there are no signs of an upturn.

The greatest danger of patents as financial assets, however, is the threat of the institutionalised separation of R&D from innovation itself. The emphasis is upon the knowable and the exploitation of what exists, to gain the short-term return. But longer-term experimentation, discovery and unexpected outcomes are now in danger of being expunged from corporate culture and practice altogether. This is not a trend to celebrate but to resist.

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