Conglomerate Blog: Business, Law, Economics & Society

Thanks again to The Glom for hosting me as a guest blogger. It’s been a lot of fun. Before I go, I wanted to post about a project that I am working on over the summer. (I’ll be presenting this work at the National Business Law Scholars Conference in LA in a couple of weeks – stop by and chat if you’re there!)

Patent trolls have been getting a lot of attention in the popular press and in the academy lately, and this focus on trolls has been useful in highlighting some of the inefficiencies of the patent system as it currently exists. But the focus on trolling has obscured a deeper shift in the role that patents play in our innovation environment, of which trolling is just a part. That shift is toward the “financialization” of the patent system. A patent can be modeled as a probabilistic stream of revenues based on licensing and enforcement of the underlying exclusive rights. As such, it can be valued and bought and sold like any other asset. Recent years have seen the development of a nascent secondary market for patents. Transactions in this nascent market have taken a variety of forms, ranging from “over the counter” sales of patent portfolios in stand alone transactions or as drivers of M&A activity, to the collateralization of patents as securities in debt offerings, to exchange mediated through entities that purport to serve as “market makers.”

Most of the commentary on these developments has focused on they extent to which they have been efficient in matching buyers and sellers of patents, and on how these new markets could perform better through increased transparency, improved notice about the content of patent claims, and better pricing methodologies. But discussions about improving patent markets elide the normative question whether such markets are desirable at all. Indeed, perhaps the most common defense of patent trolls is that they increase the liquidity and efficiency of the secondary market by serving as willing buyers and sellers.

Achieving efficiency in the exchange of an asset isn’t the goal of the patent system. Instead, the patent system exists to promote innovation. Now, a robust market for patents can in theory accomplish that in much the same way that capital markets promote investment. First, a patent market can allocate “working capital” – here, patentable inventions – to its most efficient users. In this regard, patent markets might facilitate commercialization by allowing inventors, developers, and commercializers to find each other and strike welfare enhancing arrangements for technological development. The problem, though, is that there is a difference between markets for technology and markets for patents. Where the fit between the underlying product and the patent is imperfect, strategic behavior may result. And it turns out that trolling behavior is most prevalent in software, the industry where the fit between patents and product is weakest.

Alternatively, patent markets might allocate risk. They could reduce the risk of infringement liability and provide a way to “clear” the market of low-value patents that inevitably issue from the Patent Office. But the welfare benefits of this dynamic could be undermined if liquidity draws into the system patents that would otherwise rationally go unenforced or by skewing innovative activity toward patentability. This dynamic is somewhat similar to the originate-to-distribute theory of the subprime mortgage meltdown. A liquid market for an inefficient asset produces more of the inefficient asset. It means that markets may not be the solution to strategic patent behavior, they may exacerbate it.

Of course, these effects are likely to be dynamic and context-specific, so the normative case against patent markets ultimately will depend on empirical research to uncover the actual functioning of these nascent markets. But for the moment, at least, I am skeptical of their effectiveness.

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Thanks again to The Glom for hosting me as a guest blogger. It’s been a lot of fun. Before I go, I wanted to post about a project that I am working on over the summer. (I’ll be presenting this work at the National Business Law Scholars Conference in LA in a couple of weeks – stop by and chat if you’re there!)

Patent trolls have been getting a lot of attention in the popular press and in the academy lately, and this focus on trolls has been useful in highlighting some of the inefficiencies of the patent system as it currently exists. But the focus on trolling has obscured a deeper shift in the role that patents play in our innovation environment, of which trolling is just a part. That shift is toward the “financialization” of the patent system. A patent can be modeled as a probabilistic stream of revenues based on licensing and enforcement of the underlying exclusive rights. As such, it can be valued and bought and sold like any other asset. Recent years have seen the development of a nascent secondary market for patents. Transactions in this nascent market have taken a variety of forms, ranging from “over the counter” sales of patent portfolios in stand alone transactions or as drivers of M&A activity, to the collateralization of patents as securities in debt offerings, to exchange mediated through entities that purport to serve as “market makers.”

Most of the commentary on these developments has focused on they extent to which they have been efficient in matching buyers and sellers of patents, and on how these new markets could perform better through increased transparency, improved notice about the content of patent claims, and better pricing methodologies. But discussions about improving patent markets elide the normative question whether such markets are desirable at all. Indeed, perhaps the most common defense of patent trolls is that they increase the liquidity and efficiency of the secondary market by serving as willing buyers and sellers.

Achieving efficiency in the exchange of an asset isn’t the goal of the patent system. Instead, the patent system exists to promote innovation. Now, a robust market for patents can in theory accomplish that in much the same way that capital markets promote investment. First, a patent market can allocate “working capital” – here, patentable inventions – to its most efficient users. In this regard, patent markets might facilitate commercialization by allowing inventors, developers, and commercializers to find each other and strike welfare enhancing arrangements for technological development. The problem, though, is that there is a difference between markets for technology and markets for patents. Where the fit between the underlying product and the patent is imperfect, strategic behavior may result. And it turns out that trolling behavior is most prevalent in software, the industry where the fit between patents and product is weakest.

Alternatively, patent markets might allocate risk. They could reduce the risk of infringement liability and provide a way to “clear” the market of low-value patents that inevitably issue from the Patent Office. But the welfare benefits of this dynamic could be undermined if liquidity draws into the system patents that would otherwise rationally go unenforced or by skewing innovative activity toward patentability. This dynamic is somewhat similar to the originate-to-distribute theory of the subprime mortgage meltdown. A liquid market for an inefficient asset produces more of the inefficient asset. It means that markets may not be the solution to strategic patent behavior, they may exacerbate it.

Of course, these effects are likely to be dynamic and context-specific, so the normative case against patent markets ultimately will depend on empirical research to uncover the actual functioning of these nascent markets. But for the moment, at least, I am skeptical of their effectiveness.

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