Costs of intellectual property

This page attempts to list the costs of Intellectual property.

Legal costs

Companies pay patent attorney salaries, patent filing and maintenance fees, and significant litigation costs (it can easily cost over a million dollars to defend from a patent infringement lawsuit, even if you win), as well as higher insurance premiums due to the risk of being involved in patent infringement litigation. Some patents that should not have been granted, and others whose coverage is ambiguous, plus the unknown existence of some hidden patent lurking in the thousands granted to date, pose significant uncertainty to companies, especially high-tech start-up companies who cannot afford to risk a patent infringement lawsuit from a more established company. They might not even be able to afford to pay the patent attorneys to examine and issue an opinion regarding every potential patent issue that arises. So the company either forges ahead, risking a lawsuit, or decides to avoid making the product out of fear of litigation.

Patents as a Hindrance to Technical Progress

In practice, the patent system often hinders technical progress. In the automobile industry, for instance, Henry Ford did not own the patent over the automobile, and had to fight against the patent’s owners, who constituted a closed cartel and were not interested in mass production of inexpensive models.

Henry Ford was denied a license on the ground that he had not demonstrated his competence, and when Ford persisted in producing cars, the cartel immediately brought a lawsuit against him for infringement of the patent. The suit was ultimately decided in Ford’s favor in 1911 and the cartel disintegrated.

Another interesting case is the early history of aviation. Orville and Wilbur Wright mimicked the wing twisting of gliding birds by constructing a mechanism that warped the horizontal plane of an airplane’s wings at either side in opposite directions. They patented this mechanism and claimed in their patent that their rights extended to any system that varied the "lateral margins" in opposite directions.

The Wright-Martin Company was threatening to sue those considered to be infringers— effectively any airplane manufacturer, and engaged in protracted litigation. With the formal entry of the United States into World War I imminent, however, the US government sought a solution to the patent litigation, since some firms were reluctant to take contracts because of the threat of patent infringement suits.

Inordinately broad patents are especially problematic. For nearly a quarter of a century, for example, James Watt was able to prevent other engineers from constructing new types of steam engine, even under license from himself. At least one historian argues that the Industrial Revolution did not really take off until 1785, the year Watt’s patent expired.

During the period of Watt's patents the United Kingdom added about 750 horsepower of steam engines per year. In the thirty years following Watt's patents, additional horsepower was added at a rate of more than 4,000 per year. Moreover, the fuel efficiency of steam engines changed little during the period of Watt's patent; while between 1810 and 1835 it is estimated to have increased by a factor of five.

Many new improvements to the steam engine, such as those of William Bull, Richard Trevithick, and Arthur Woolf, became available by 1804: although developed earlier these innovations were kept idle until the Boulton and Watt patent expired.

Ironically, Watt's own efforts at developing a superior steam engine were hindered by the very same patent system he used to keep competitors at bay. When the patents expired, far from being driven out of business "Boulton and Watt for many years afterwards kept up their price and had increased orders."

Product Differentiation

The existence of patents also induces wasteful expenditure of resources by competitors trying to "invent around the patent," i.e., to develop competing products that are sufficiently differentiated so as not to infringe on an existing patent. There are incentives for a firm to duplicate the prevailing best technology patented by another firm in a way that does not infringe on patents. More generally, there are incentives for a firm to develop a technology even if it is worse than the current best one, if it is better than the one it has and the best is blocked by patents.

Thus, although these activities increase the level of research-and-development spending, from the social point of view they are not necessarily an efficient use of available resources.

Worse still, patent owners also have incentives to invent around their own patents to preclude potential competition. To the extent that the patent system itself induces these activities, resources devoted to them (as well as the associated legal expenses) are essentially wasted from the social point of view, and should be regarded as another cost of the system. For example, to protect its monopoly position in the market for plain-paper copiers, Xerox patented every conceivable aspect of its technology. IBM had spent millions to ‘invent around’ Xerox’s major patents—with 25 percent of the budget going for patent counsel, not R&D.

Defensive patents

Venture capitalists insist on a strong patent portfolio when evaluating whether to invest in a company. But this is because, in part, patent portfolios are necessary to defend against other companies' portfolios. If there were no patent system, one would not need to defensively spend money building up a mountain of patents to use in counterclaims or cross-licensing negotiations.

Studies

It seems reasonable to assume that patents must have some effect on technological innovation, but the interesting question is the practical magnitude of this effect. The results of the few studies that have attempted to detect it empirically do not favor the pro-patents position.

• Edwin Mansfield directed two important studies on this topic in the 1980s. The first studied thirty-one patented innovations in four industries: chemicals, pharmaceuticals, electronics, and machinery. One purpose of the study was to answer a simple question: what proportion of innovations would be delayed, or not introduced at all, if they could not be patented? According to the firms, about one-half of the patented innovations in the sample would not have been introduced without patent protection. The bulk of these innovations occurred in the drug industry. Excluding drug innovations, the lack of patent protection would have affected less than one-fourth of the patented innovations in our sample.

• The results of the second study were even more negative: According to detailed data obtained from a random sample of 100 firms from 12 manufacturing industries, patent protection was judged to be essential for the development or introduction of one-third or more of the inventions during 1981–83 in only 2 industries — pharmaceuticals and chemicals. On the other hand, in 7 industries (electrical equipment, office equipment, motor vehicles, instruments, primary metals, rubber, and textiles), patent protection was estimated to be essential for the development and introduction of less than 10 percent of their inventions. Indeed, in office equipment, motor vehicles, rubber, and textiles, the firms were unanimous in reporting that patent protection was not essential for the development or introduction of any of their inventions during this period.

• A more recent paper approached this problem from a slightly different angle, but also failed to support the pro-patents position. If patents do indeed stimulate innovation, then presumably stronger patent protection should induce a higher rate of innovation. The authors addressed the question "Do Stronger Patents Induce More Innovation?" by studying the impact of a significant Japanese patent law reform implemented in 1988. Their main finding was that "the average response in terms of additional R&D effort and innovative output was quite modest." An econometric analysis using Japanese and U.S. patent data on 307 Japanese firms confirmed that the magnitude of the response was quite small.

• A study published in The Columbia Science and Technology Law Review suggests that patents may harm new technology, economic activity, and societal wealth. The study was a multi-user interactive simulation of patent and non-patent systems.