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ALIGNING PATENT NOTICE AND REMEDIES

WITH COMPETITION

A REPORT OF THE

FEDERAL TRADE COMMISSION

JON LEIBOWITZ

WILLIAM E. KOVACIC

J. THOMAS ROSCH

EDITH RAMIREZ

JULIE BRILL

Chairman

Commissioner

Joni Lupovitz

Eileen Harrington

Richard Feinstein

David Vladeck

Joseph Farrell

Willard K. Tom

Randolph W. Tritell

Jeanne Bumpus

Susan S. DeSanti

Cecelia Prewett

Donald S. Clark

Chief of Staff

Executive Director

Director, Bureau of Competition

Director, Bureau of Consumer Protection

Director, Bureau of Economics

General Counsel

Director, Office of International Affairs

Director, Office of Congressional Relations

Director, Office of Policy Planning

Director, Office of Public Affairs

Secretary of the Commission

Report Drafters and Contributors

Suzanne Michel, Deputy Director, Office of Policy Planning

William Cohen, Deputy General Counsel for Policy Studies

William Adkinson, Office of the General Counsel

Erika Meyers, Bureau of Competition

Suzanne Drennon Munck, Office of Policy Planning

Joel Schrag, Bureau of Economics

Karen Goldman, Office of General Counsel

Christopher Bryan, Office of the General Counsel

Christopher Falcone, Office of the General Counsel

Inquiries concerning this report should be directed to:

Suzanne Michel (202) 326-3094 or smichel@ftc.gov

Acknowledgments:

The Commission thanks the Hearings participants for the contribution of their expertise and time

to this project.

The Commission thanks the Berkeley Center for Law and Technology and the Competition

Policy Center at the University of California at Berkeley for hosting Hearings in Berkeley,

California.

THE EVOLVING IP MARKETPLACE:

ALIGNING PATENT NOTICE AND REMEDIES

WITH COMPETITION

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Technology Markets and Patent Markets

Chapter 1: Evolving Pathways of Innovation: Open Innovation, Technology Transfer

and Ex Ante Patent Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

Chapter 2: The Evolving Patent Marketplace: Ex Post Patent Transactions . . . . . . . . . . . 49

Patent Notice

Chapter 3: Patent Notice: A Competition Perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73

Patent Remedies

Chapter 4: The Economic and Legal Foundations of Patent Remedies . . . . . . . . . . . . . . . 137

Chapter 5: Lost Profits Damages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149

Chapter 6: The Hypothetical Negotiation in Reasonable Royalty Damages . . . . . . . . . . . 159

Chapter 7: Calculating Reasonable Royalty Damages .. . . . . . . . . . . . . . . . . . . . . . . . . . . . 177

Chapter 8: Permanent Injunctions in Patent Cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 213

Appendices

Appendix A: Statistics Describing Patent Damage Awards. . . . . . . . . . . . . . . . . . . . . . . . . 245

Appendix B: Overview of Post-eBay Permanent Injunction Case Law. . . . . . . . . . . . . . . . 253

Appendix C: Hearing Participants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 280

Appendix D: Public Comments and Hearing Submissions . . . . . . . . . . . . . . . . . . . . . . . . . 293

Appendix E: Hearing Agendas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 298

THE EVOLVING IP MARKETPLACE:

ALIGNING PATENT NOTICE AND REMEDIES

WITH COMPETITION

INTRODUCTION

Innovation benefits consumers through the development of new products, processes and

services that improve lives and address unmet needs. It is key to meeting society’s greatest

challenges in areas as diverse as energy production, communications and health care, and it is

essential to sustained economic growth and global competitiveness. But innovation is a complex

process. It involves a series of steps from idea to invention through development to

commercialization, each of which can be expensive, risky and unpredictable.

The goal of the patent system is to promote innovation in the face of that expense and

risk. It does so by giving patent owners the right to exclude others from making, using or selling

a patented invention for 20 years. By preventing copying that might otherwise drive down

prices, the patent system allows innovators to recoup their investment in research and

development (R&D). The patent system plays a critical role in promoting innovation across

industries from biotechnology to nanotechnology, and by entities from large corporations to

independent inventors.

The patent system’s exclusive right promotes innovation, but so too does competition,

which drives firms to produce new products and services in the hope of obtaining an advantage

in the market. The patent system and the antitrust laws share the fundamental goals of enhancing

consumer welfare and promoting innovation. The legal doctrines that most successfully

accomplish those goals align the patent system and competition policy so that one does not

undermine the effectiveness of the other. One important aspect of that alignment is antitrust

enforcement that recognizes the incentives to innovate created by the patent system.

Condemning efficient, legitimate uses of patent rights can undermine those incentives and harm

consumers. For that reason, the guidance of the 2007 FTC/DOJ Report on IP and Antitrust

focused on incorporating careful consideration of the benefits of patent rights into antitrust

analysis.1 Another aspect of that alignment is a proper balance between exclusivity and

competition. Invalid or overbroad patents disrupt that balance by discouraging follow-on

innovation, preventing competition, and raising prices through unnecessary licensing and

litigation. For that reason, many of the recommendations in the 2003 FTC IP Report focused on

improving patent quality as a means of balancing exclusivity and competition.2

FED . TRADE COM M ’N & DEPT . OF JUSTICE ANTITRUST DIV ., ANTITRUST ENFORCEM ENT AND

INTELLECTUAL PROPERTY RIGHTS : PROMOTING INNOVATION AND COM PETITION (April 2007), available

at http://www.ftc.gov/reports/innovation/P040101PromotingInnovationandCompetitionrpt0704.pdf

FED . TRADE COM M ’N , TO PROM OTE INNOVATION : THE PROPER BALANCE OF COM PETITION AND PATENT

LAW AND POLICY , Exec. Summ., at 1 (Oct. 2003), (“2003 FTC IP Report”), available at

http://ftc.gov/os/2003/10/innovationrpt.pdf.

Two areas of patent law beyond patent quality impact how well the patent system and

competition policy work together to further their common goal of enhancing consumer welfare.

The first is notice – how well a patent informs the public of what technology is protected. The

second is remedies – judicially awarded damages and injunctions following a court finding of

patent infringement. The impact of notice and remedies on the alignment of the patent system

with competition policy results from the operation of relevant legal rules and practices on

competition among patented technologies.

A patent does not necessarily confer market power because patented inventions often

compete with alternative technologies. Patentees can earn rewards in the market by selling a

patented product themselves or by licensing the patent for others to practice. In either case, the

market reward earned by the patentee, and the economic value of the invention, will depend upon

the extent to which consumers prefer the patented technology over alternatives. A patent

covering a highly valued, disruptive technology can confer market power and generate significant

market rewards. More often, competition from acceptable alternatives will limit the market

reward that a patent owner receives.

Competition among patented technologies at every stage of the innovation process helps

generate lower prices, more choices and higher quality products for consumers. Products

compete to be purchased by consumers. Developed technologies compete in technology markets

to be chosen for incorporation into products. Early-stage technologies compete for development

funding. By aligning the patentee’s market reward with consumer preferences, competition in

product and technology markets encourages investment in those inventions that are more likely

to be valued by consumers. When patent law facilitates and does not distort this competition, it

aligns with competition policy to the benefit of consumers.

FTC Hearings on the Evolving IP Marketplace

To explore the interplay of notice, remedies, innovation and competition, the FTC held

eight days of hearings beginning December 2008. In addition, the FTC cosponsored a workshop

with the Patent and Trademark Office (PTO) and the Department of Justice in May 2010, on the

intersection of patent policy and competition policy. The hearings and workshop involved more

than 140 participants, including business representatives from large and small firms, start-ups

and the independent inventor community, leading patent practitioners, economists, and patent

law scholars. The FTC also received over 50 written submissions.3 This report is based on

testimony, written submissions and independent research.

The report begins by examining the role of technology markets and patent markets in

innovation today. Those roles have evolved in recent years in ways that heighten the importance

of patent notice and remedies to competition among technologies. As Chapter 1 discusses,

collaboration and technology transfer have become increasingly important pathways to

Appendices C-E list participants, comments received and topics examined at the hearings and workshop.

Transcripts and written submissions are available at http://www.ftc.gov/bc/workshops/ipmarketplace/.

innovation with significant benefits for consumers. Patents play an important role in supporting

these technology markets, and undermining that role would harm innovation. At the same time,

as described in Chapter 2, we see increasing activity and complexity of business models in

markets for patents that do not involve technology transfer. In these markets, patents are bought,

sold and licensed as assets whose value is based on their ability to extract rents from

manufacturers already using the patented technology. This activity risks distorting competition

among technologies and deterring innovation, especially when driven by poor patent notice and

remedies that do not align with the economic value of the patented invention. Chapters 3

through 8 make recommendations for adjustments to the legal rules and practices governing

notice and remedies to better align them with competition policy without undermining patent

law’s support for innovation.

How Patent Notice Affects Innovation and Competition

Clear notice of what a patent covers can increase innovation by encouraging

collaboration, technology transfer and design-around. Clearly defined patent rights can help

companies identify and license technology they wish to develop or adopt. Poor patent notice can

undermine the patent system’s ability to fulfill this role, however. Potential collaborators or

licensees may not find relevant patents, or they may hesitate to invest in technology when the

scope of patent protection is unclear.

Notice affects competition among technologies at every stage of the R&D process. The

ability to identify and assess the scope of relevant patents at an early stage can be critical for

firms considering making investments in developing and commercializing an innovative product.

They may unnecessarily elect not to pursue a R&D effort when the scope of coverage is unclear

if they fear that another firm has blocking patents. Such decisions deter and lessen innovation

and competition among technologies that might otherwise have been created. Poor patent notice

also hinders competition by forcing firms to design products with incomplete knowledge of the

cost and availability of different technologies. Technologies compete to be incorporated into

products. But that competition is distorted if designers cannot discern in advance which

technologies carry the cost of patent royalties and negotiate those royalties before they incur sunk

costs based on the patented technology.

When firms choose technologies and market products despite an uncertain patent

landscape, they risk post-launch patent assertions and litigation. As described in Chapters 2 and

3, resolving these claims often involves expensive litigation, which diverts resources and disrupts

business operations. If the firm pays royalties, costs may increase and consumers may be

deprived of the full benefit of competition among technologies.

Firms can invest in patent clearance activities – attempts to identify patents that might

read on their planned activities – to reduce uncertainty and avoid later infringement allegations.

Such efforts are often expensive. In the information technology (IT) industries, where products

consist of many components covered by numerous patents, firms may not reliably identify all

relevant patents. When they do identify patent risks, firms may unnecessarily design around

those risks or take a license due to unclear patent scope. To the extent that patent clearance and

product design are made more expensive by poor notice, they impose unnecessary costs.

As discussed in Chapter 3, a firm attempting patent clearance must undertake three

activities. One is claim interpretation. To fulfill their notice function, patent claims must clearly

delineate the scope of patent rights. A second is predicting what claims might emerge from

pending patent applications. A third is identifying potentially relevant patents or applications.

Effective patent notice supporting each one of these activities implicates multiple legal rules and

practices, including claim interpretation, specification requirements and application examination.

Chapter 3 examines those rules and practices and makes recommendations for improving patent

notice. Doing so would better align patent law and competition policy by allowing competition

among technologies to function more effectively.

How Patent Remedies Affect Innovation and Competition

Effective patent remedies are critical to the patent system’s incentives to innovate. Patent

infringement interferes with a patentee’s ability to realize its patent’s value in the marketplace.

Remedies protect the ability of patentees to earn returns in the market by stopping and deterring

infringement in the case of injunctions, and by making patentees whole through damage awards

when infringement has occurred. As explained in Chapter 4, to perform that role, patent

remedies should seek to replicate the market reward that the patent holder would have earned

absent infringement.

Compensatory damage awards that either under or overcompensate patentees for

infringement compared to the market can have detrimental effects on innovation and

competition. Undercompensation can undermine the patent system’s incentives to innovate.

This could impair investment in R&D and result in fewer new, innovative products and services.

Damage awards that exceed what the invention could have earned absent infringement when

competing with alternatives can lead to higher prices. Consumers are effectively deprived of the

benefit of competition among technologies. Overcompensation can also encourage speculation

in patent rights and litigation. As discussed in Chapter 2, this can deter innovation by raising the

costs and increasing the risks of investment. Moreover, damages law that systematically

overcompensates certain types of inventions can over-incentivize invention and patenting in that

field. This outcome can disrupt the market’s ability to allocate R&D resources to those areas

most likely to generate the products most valued by consumers.

Calculating patent damages that replicate the market reward for the invention by

constructing the world but for infringement can be a very difficult task for litigants and

factfinders. Over the years, courts have developed an extensive jurisprudence surrounding the

calculation of patent damages. While the fundamental principles of damages law are sound,

some legal rules and practices are not well-grounded in economic analysis. For instance, some

rules do not reflect a full appreciation of the appropriate role of competition from non-infringing

alternatives in determining patent damages. Trial practice has allowed ill-supported damages

testimony into evidence. Chapters 4 through 7 develop an economically grounded approach to

calculating patent damages and recommend changes to better align patent law and competition

policy by producing damage awards that more closely replicate the market value of the invention.

Permanent injunctions prohibiting future infringement play a critical role in protecting the

exclusivity that allows a patentee to reap the market reward for its invention. Following a

finding of infringement, an injunction preserves the patentee’s exclusivity going forward. Just as

importantly, the threat of an injunction creates a significant deterrent to infringement, which

allows patentees to obtain the full market reward for the invention, supported by an exclusive

market position, without costly litigation.

Under some circumstances, however, the threat of an injunction can lead an infringer to

pay higher royalties than the patentee could have obtained in a competitive technology market.

At the time a manufacturer faces an infringement allegation, switching to an alternative

technology may be very expensive if it has sunk costs in production using the patented

technology. That may be true even if choosing the alternative earlier would have entailed little

additional cost. If so, the patentee can use the threat of an injunction to obtain royalties covering

not only the market value of the patented invention, but also a portion of the costs that the

infringer would incur if it were enjoined and had to switch. This higher royalty based on

switching costs is called the “hold-up” value of the patent. Patent hold-up can overcompensate

patentees, raise prices to consumers who lose the benefits of competition among technologies,

and deter innovation by manufacturers facing the risk of hold-up.

One challenge for injunction analysis is to protect the critical importance of patent

exclusivity for innovation while recognizing that, in some instances, patent hold-up can

undermine innovation and harm consumers. Chapter 8 proposes an approach that balances these

concerns within the equitable analysis required by eBay v. MercExchange.4 The proposed

approach aligns patent law and competition policy by preventing hold-up based on sunk costs

when innovation would not be harmed.

eBay, Inc. v. MercExchange, LLC, 547 U.S. 388 (2006).

EXECUTIVE SUMMARY

CHAPTER 1

EVOLVING PATHWAYS OF INNOVATION: OPEN INNOVATION,

TECHNOLOGY TRANSFER AND EX ANTE PATENT TRANSACTIONS

Understanding what changes to the law of patent notice and remedies would increase

innovation and better align the patent system and competition policy requires that we first

examine how the pathways to innovation and the role of patents in promoting innovation have

evolved. In one significant change, many firms have increasingly embraced “open innovation.”

In a traditional or closed model of innovation, a firm relies on its own research and development

(R&D) to create the products it markets. But a firm that pursues an open innovation strategy

recognizes that valuable ideas can originate with others and seeks to acquire those inventions that

fit its business model. Many of the inventions acquired and commercialized by large firms

originated with start-ups and small companies, which have accounted for a steadily increasing

percentage of R&D spending over the past 30 years.

Consumers benefit from open innovation strategies. The growth of technology transfer

has permitted a division of labor to emerge between those who invent and those who

manufacture most efficiently. This division of labor speeds up the rate of innovation and results

in broader, faster distribution of new products to consumers. By providing a pathway for

invention without commercialization, technology transfer also lowers barriers to entry for

inventors who do not have access to the capital required to build manufacturing facilities and

establish distribution channels. Easier entry supports additional sources of invention, which

increases competition among technologies to be further developed and incorporated into

products. That competition benefits consumers by generating better, cheaper products.

Moreover, competition among early-stage technologies for development funding is an important

mechanism for allocating scarce resources to those inventions having the greatest chance of

generating the products most valued by consumers.

The patent system facilitates open innovation and technology transfer in ways that

implicate patent quality, patent remedies and the notice function. The exclusive patent right

creates incentives for sellers of technology to invent, and for buyers of technology to purchase

and invest in further development. But the nature and effectiveness of the exclusive patent right

depend in part on the remedies available for its infringement. Damages must make a patent

owner whole or infringement will undermine the patent system’s incentives to innovate.

Permanent injunctions must deter infringement and protect the exclusivity. Good notice of

patent rights encourages investment in new technologies. But poor quality patents can

discourage innovation by creating uncertainty and raising costs.

Patents also facilitate open innovation and technology transfer by creating rights based on

intangible concepts, which makes contracting easier and helps create a market for ideas. In a

technology transfer agreement, patents often define the rights to be transferred. Thus, patent

transactions (licensing or sales) form the basis of many technology transfer agreements. Patent

transactions that occur as part of a technology transfer agreement can be considered ex ante

because they occur before the purchaser has obtained the technology through other means. Such

ex ante patent transactions accompanied by technology transfer are an important means for

advancing innovation, creating wealth, and increasing competition among technologies.

CHAPTER 2

THE EVOLVING PATENT MARKETPLACE: EX POST PATENT TRANSACTIONS

While the open innovation model and technology transfer are important pathways to

innovation, not all patent licensing and sales occur ex ante as part of a technology transfer

agreement. In many cases, the licensee or purchaser already uses the patented technology when

approached by the patent owner, but it lacks a license to use the technology. These patent

transactions occur ex post, after the firm accused of infringement has invested in creating,

developing or commercializing the technology. The firm needs the ex post license to avoid

liability, even if it invented or obtained the technology independent of the patentee, because

patent infringement is a strict liability offense.

The ability of patentees to assert their patents against infringers is important to the patent

system’s role in promoting innovation and facilitating technology transfer. The threat of a patent

infringement suit deters infringement and safeguards the exclusivity that is the heart of the patent

system. A business model based on invention followed by technology transfer will only succeed

if a firm can prevent copying and recoup its investment in R&D.

But ex post licensing to manufacturers that sell products developed or obtained

independently of the patentee can distort competition in technology markets and deter

innovation. The failure of the patentee and manufacturer to license ex ante with technology

transfer results in duplicated R&D effort. When a manufacturer chooses technology for a

product design without knowledge of a later-asserted patent, it makes that choice without

important cost information, which deprives consumers of the benefits of competition in the

technology market. If the manufacturer has sunk costs into using the technology, the patentee

can use that investment as negotiating leverage for a higher royalty than the patented technology

could have commanded ex ante, when competing with alternatives. The increased uncertainty

and higher costs associated with ex post licensing can deter innovation by manufacturers.

Increasing activity by patent assertion entities (PAEs)5 in the information technology (IT)

industry has amplified concerns about the effects of ex post patent transactions on innovation and

competition. The business model of PAEs focuses on purchasing and asserting patents against

manufacturers already using the technology, rather than developing and transferring technology.

This report uses the term “patent assertion entity” rather than the more common “non-practicing entity”

(NPE) to refer to firms whose business model primarily focuses on purchasing and asserting patents.

Taken literally, the term NPE encompasses patent owners that primarily seek to develop and transfer

technology, such as universities and semiconductor design houses. Patent assertion entities do not

include this latter group.

Some argue that PAEs encourage innovation by compensating inventors, but this argument

ignores the fact that invention is only the first step in a long process of innovation. Even if PAEs

arguably encourage invention, they can deter innovation by raising costs and risks without

making a technological contribution.

The clear benefits for innovation and competition stemming from ex ante patent

transactions contrast with the detrimental and ambiguous effects of ex post transactions. An

important goal in aligning the patent system and competition policy is to facilitate ex ante

transactions while making ex post transactions less necessary or frequent.

Improving the notice function of patents would help with both. Manufacturers often

license ex post because they were not aware of the patent ex ante. Multiple factors can contribute

to notice failure, including overbroad, vague claims, the large number of patents potentially

relevant to IT products, and the pendency of patent applications in the Patent and Trademark

Office (PTO). More clearly defined patent rights could help companies better find and license

technology they wish to develop ex ante, which would support technology transfer. Better notice

could also help companies obtain licenses or design around patents in advance of marketing a

product, thereby decreasing the amount of ex post licensing.

Remedies law requires a careful balance to accomplish the goal of facilitating ex ante

transactions while reducing the frequency of ex post transactions. On the one hand, any

adjustments to remedies law must be careful not to undermine the patent system’s incentives to

innovate. On the other hand, if remedies overcompensate patent owners compared to the market

reward absent infringement, they can distort competition and encourage patent speculation.

Improvements in both notice and remedies law, as discussed in the following sections, can better

align the patent system with competition policy and balance these concerns.

CHAPTER 3

PATENT NOTICE: A COMPETITION PERSPECTIVE

The Nature and Sources of Notice Problems

The hearings examined three principal notice challenges, listed below. Numerous IT

panelists indicated that notice problems were substantial, often leading firms to abandon patent

“clearance” efforts. In contrast, panelists from the pharmaceutical and biotech sectors generally

found patent notice sufficient for effective, albeit sometimes costly, clearance searches.

Difficulty interpreting the boundaries of issued claims. To fulfill their notice function,

patent claims must delineate the scope of patent rights with sufficient clarity that a person skilled

in the relevant art can reliably determine whether planned activities would infringe. The hearings

explored several interrelated sources of ambiguity or uncertainty:

•

Language is inherently imprecise.

Some art areas, such as software, lack clear nomenclature and common

vocabularies for claiming.

Claiming using functional language, which describes what the invention does

rather than what it is, can produce abstract, ambiguous claims.

Some applicants may have incentives to draft ambiguous claims that might be

viewed narrowly by the PTO and then construed broadly in litigation.

PTO examination often focuses on issues of novelty and nonobviousness and may

result in deferring clarification of claim boundaries until litigation.

Claims that may issue from pending applications. Because products can infringe

subsequently issued patents, an effective clearance search should include pending applications.

A requirement that most applications be published 18 months after filing provides a partial

solution. However, applications can be amended during examination, provided that there is

sufficient support in the specification. Adequacy of notice depends on whether the application is

published and the extent to which the specification enables third parties to foresee the claims that

may emerge.

Difficulty of identifying and reviewing published patents. IT panelists described the

difficulty in performing patent clearance that results from the sheer number of relevant patents,

potentially numbering in the thousands. They explained that IT products typically contain many

different components, each of which may be covered by numerous patents. They also reported

that reliably identifying all patents that might be asserted was undermined by the lack of

predictable vocabulary and frustrated by short product cycles. Panelists from other industries

generally found clearance searches manageable.

Guideposts and Trade-offs

We examine possible notice enhancements with several guideposts in mind. Cost is

obviously important. Often, patent applicants are best positioned to supply low-cost, but very

valuable, information. Timing is another key consideration. Notice is more beneficial to third

parties when they are still planning their R&D strategies and before they make sunk investments

that may expose them to hold-up. Accordingly, many of the suggested improvements look to the

examination process, rather than to litigation.

Trade-offs between notice and scope pose particularly thorny issues, and it is vital that

they be approached with a full understanding of the notice implications. Divergence in the extent

and nature of notice problems among industries also poses challenges. We look for ways to

improve notice in problem areas without impairing the patent system elsewhere and without

sacrificing the benefits of a unitary patent system, with doctrines applicable across technologies.

Improving the Ability to Understand Existing Claims: Indefiniteness

Under Section 112, second paragraph of the Patent Act, 35 U.S.C. § 112, claims must

“particularly point[] out and distinctly claim[] the subject matter which the applicant regards as

his invention.” Otherwise, the claims are invalid on grounds of “indefiniteness.” An

indefiniteness standard that weeds out claims reasonably susceptible to multiple interpretations

could reduce ambiguity and improve notice in a broad range of settings.

PTO review. The Federal Circuit requires that claims be “insolubly ambiguous” to be

invalid as indefinite.6 The PTO Board of Patent Appeals and Interferences has adopted a lower

threshold of ambiguity, however, by ruling that a claim may be indefinite if it is “amenable to

two or more plausible claim constructions.”7 Miyazaki approaches indefiniteness with a focus on

notice. In contrast, the “insolubly ambiguous” standard accepts substantial ambiguity. It

preserves claims that require a court to make hard choices among varying interpretations, thereby

overstating what marketplace participants are likely to understand. The Miyazaki approach is

preferable when implemented during PTO review. In the PTO, indefiniteness rulings promptly

add clarity and require only a claim amendment from the applicant.

Recommendation. In assessing indefiniteness, the PTO should adhere to the

principle articulated in Miyazaki.

Functional claims. The Federal Circuit has also recognized notice concerns in recent

rulings finding computer-implemented means-plus-function claims indefinite.8 In each case, the

invalidated claims covered a function implemented by means of a computer or microprocessor,

but the specification provided no details regarding the relevant program. The court ruled that

without disclosing in the specification some form of algorithm for performing the claimed

function – not necessarily anything highly detailed – the applicant had not satisfied definiteness

requirements. This presents a helpful opportunity to enhance notice regarding software patents,

but the reach of the “algorithm” requirement is still uncertain. The rulings also point the way

toward steps that would add clarity to functional claims that fall outside the means-plus-function

format.

Recommendation. The Commission recommends that courts give weight to

notice objectives as they further explicate the circumstances in which a patent’s

specification sufficiently supports a means-plus-function claim. Those objectives

require sufficiently detailed structure to inform the public of the means that fall

within and outside of the claim’s scope. Similar concerns apply more broadly,

and the Commission urges that courts extend their recent focus on indefiniteness

to address functional claiming in general.

Exxon Research & Eng’g Co. v. United States, 265 F.3d 1371, 1375 (Fed. Cir. 2001).

Ex Parte Miyazaki, 89 U.S.P.Q. 2d 1207, 2008 WL 5105055, at *5-6 (Bd. Pat. App. & Interf. Nov. 19,

2008).

Finisar Corp. v. DirecTV Group, Inc., 523 F.3d 1323, 1340 (Fed. Cir. 2008); Aristocrat Techs. Australia

Pty, Ltd., v. Int’l Game Tech., 521 F.3d 1328, 1338 (Fed. Cir. 2008).

Improving the Ability to Understand Existing Claims: Enhancing the Value of the

Specification for Claim Construction

Claim construction raises a set of issues with profound notice implications. Claims are

interpreted “in light of the patent specification,” but this principle often leaves significant

ambiguity regarding claim coverage. Hearing testimony focused on enhancing the value of the

specification for claim construction through more stringent enforcement of Section 112, at least

in the IT industry, and by defining claim terms.

Enforcement of 35 U.S.C. § 112, ¶ 1. Panelists stressed the importance of calibrating

claim scope to the specification for predictable claim construction and effective public notice.

As claims extend farther beyond the invention expressly described in the specification, their

boundaries become more ambiguous. Patent law achieves that calibration through two

requirements recited in 35 U.S.C. § 112, the written description requirement and the enablement

requirement.9 There was considerable testimony, however, that the written description and

enablement requirements have been much less stringently enforced in IT industries than

elsewhere, leading to concerns over ambiguous scope. The hearings suggested several ways to

address this issue.

Whether a specification sufficiently supports a patent’s claims under Section 112 is

assessed through the eyes of the hypothetical “person having ordinary skill in the art,” or

PHOSITA. What the PHOSITA is likely to understand or find demonstrated is a reasonable

proxy for what third parties are likely to perceive. Some analysts have argued that, at least for

Section 112 purposes, the level of skill attributable to the PHOSITA has been set too high in IT

contexts and too low in biotech settings. Attributing too high a skill level to the IT PHOSITA

could unduly reduce disclosure requirements for the specification, allow broad, ambiguous

claims, and raise serious notice concerns. To ensure adequate notice, the level of skill ascribed to

the PHOSITA must reflect facts and avoid inappropriate rules of thumb.

Recommendation. The Commission urges courts to direct heightened attention

and provide additional guidance regarding assessment of PHOSITA skill levels

relative to the problems posed by the art. To serve notice goals, application of the

PHOSITA standard should be fact-based, up-to-date, and appropriately tailored to

the specific technology at hand.

A second problem derives from the requirement that the specification enable third parties

to make or use the invention without “undue” experimentation. From the perspective of

competitive impact, time-consuming experimentation is more likely to be undue in settings

where product life-cycles are measured in months than where they are measured by decades.

The specification must (1) describe the invention sufficiently to convey to a person having skill in the art

that the patentee/applicant was in possession of the claimed invention at the time the application was

filed, and (2) enable third parties to make or use the invention without undue experimentation.

However, the factors traditionally considered in evaluating “undue experimentation” omit this

commercial perspective.

Recommendation. Determinations regarding whether a disclosure requires undue

experimentation should give recognition to the competitive significance of the

time required for experimentation; when product life-cycles are short, greater

disclosures may be needed in order to be competitively meaningful.

Defining claim terms. One concern raised repeatedly during the hearings was that claims

frequently use terms with no apparent definition in the specification. Litigants disputing claim

interpretation may turn to different dictionaries to find a favorable definition. The problem is

exacerbated for fast-moving technologies lacking widely-accepted terminology. Notice would be

improved through undisputed claim term definitions.

Recommendation. The Commission recommends that patent applicants be

required either (i) to designate a dictionary for use in assigning meaning to terms

not defined in the application or (ii) to acknowledge acceptance of a PTOdesignated default dictionary for that purpose. The PTO-designated default

dictionary could vary by art unit.

Recommendation. The Commission urges the PTO to continue to look for ways

to press patent applicants to include definitions or contextual explanations of key

terms. Mechanisms that could accomplish this include (i) requiring applicants to

provide a glossary defining any key terms that are not covered by a designated or

default dictionary or that the applicant chooses to define differently than in such a

dictionary or (ii) requiring that applicants include key claim terms in the

specification and provide a ready means for identifying where they appear.

Recommendation. The Commission urges that the PTO convene a

government/industry task force or hold a workshop to explore ways of fostering

greater uniformity in the methodology or language used for describing and

claiming software inventions.

Improving the Ability to Understand Existing Claims: Enhancing the Value of the

Prosecution History for Claim Construction

In addition to the language of the patent itself, important evidence relevant to a claim’s

meaning may appear in the prosecution history. Panelists registered considerable support for

increasing and recording exchanges between examiners and applicants pertinent to patent scope.

They explained that engaging the applicant in ways that build a prosecution history record

enables all participants in the patent system to better understand claim boundaries. The PTO

very recently has exhorted its examiners to take steps in these directions.10

Recommendation. The Commission urges that examiners be further encouraged

to build a record that improves claim scope clarity. In part, this may be achieved

through greater focus on Section 112 standards. Additional notice may be derived

via indefiniteness rejections or interviews tailored to elicit information from

applicants regarding the meaning of their claims. Beyond this, the Commission

reiterates the recommendation in its 2003 IP Report11 for “a concentrated effort to

use examiner inquiries [under PTO Rule 105] more often and more extensively,”

as a means, for present purposes, of increasing and recording examiner/applicant

exchanges pertinent to patent scope.

Recommendation. The Commission recommends that the PTO continue to

encourage examiners to make greater and more informative use of statements of

reasons for allowance and for withdrawing indefiniteness rejections and that

courts accord such statements due weight as prosecution history relevant to claim

interpretation.

Improving the Ability to Foresee Evolving Claims

Adequate notice requires both knowledge of those patent applications pending in the PTO

that might issue with relevant claims and an ability to foresee the evolving claims that could issue

as a result of prosecution. Knowledge of the applications comes through their publication. The

ability to foresee claims depends on enforcement of the Section 112 requirements. The amount of

time an application remains pending in the PTO also affects notice.

Publication of applications. Until a patent application is available to public view, third

parties have no opportunity to determine whether they have freedom to operate. Under current

law, most U.S. patent applications are published 18 months after filing. For applications filed

only domestically, however, the applicant may keep the application secret until the patent issues.

Hearing testimony described unpublished applications as a threat to expensive R&D, although

independent inventors feared publication would allow large companies to appropriate their

inventions.

Recommendation. The Commission recommends legislation requiring

publication of patent applications 18 months after filing, whether or not the

applicant also has sought patent protection abroad (subject to possible adjustments

to provide any necessary protection to independent inventors). This

See USPTO, Supplementary Examination Guidelines for Determining Compliance with 35 U.S.C. 112,

76 Fed. Reg. 7,162 (Feb. 9, 2011).

2003 FTC IP Report, ch. 5, at 13-14.

recommendation is consistent with that made in the 2003 FTC IP Report, which

noted the “benefits of publication to business certainty and the potential

competitive harms and hold-up opportunities that flow from unanticipated

‘submarine’ patents.”12

Section 112 requirements. Once an application is published, third parties have notice of

the specification and pending claims. However, a patent applicant can amend and add new

claims during prosecution. The ability of third parties to foresee evolving claims depends on the

extent to which the specification provides effective notice of the range of claims that ultimately

might issue. The disclosure requirements of Section 112 (written description and enablement)

provide protection against undue broadening of claims through additions and amendments.

Panelists from the IT industry expressed concern about how well these protections allow

them to foresee claims that might issue. One reason is the perceived lax enforcement of the

Section 112 requirements for IT patents. Another reason is the nature of the written description

requirement, which, traditionally, has not focused on precisely the right question for notice

purposes. Thus, it uses an already written claim to evaluate the sufficiency of the specification.

But it does not ask whether the specification allows the PHOSITA to predict what might be

claimed as within the scope of the invention. Enablement analysis presents a similar problem.

Unless a manufacturer can predict when making R&D investments that patent claims covering its

product could emerge, the broadened claims reach beyond the application’s effective notice.

A breakdown of notice regarding evolving claims can have important competitive

consequences. In its 1988 Kingsdown decision, the Federal Circuit declared that it is not “in any

manner improper to amend or insert claims intended to cover a competitor’s product the

applicant’s attorney has learned about during the prosecution of a patent application,” provided

the claims are adequately supported by the original disclosure.13 If the competitor could not have

predicted those claims, application of the Kingsdown doctrine subjects its innovation to

unexpected infringement liability. That result impairs the competitive efforts of rivals and

undermines the patent system’s goal of fostering innovation.

Recommendation. The Commission recommends that consideration of the

PHOSITA’s ability to foresee future evolution of the claims be more fully

incorporated into application of the written description requirement; the applicant

should not be understood to have been in possession of the subject matter of a

new or amended claim of scope broader than what the PHOSITA, on the filing

date, could reasonably be expected to foresee from the specification.

Continuation practices. Another way of addressing some of these issues would be to

limit infringement exposure when claims have been broadened using continuations.

Id. at 15.

Kingsdown Med. Consultants, Ltd. v. Hollister, Inc., 863 F.2d 867, 874 (Fed. Cir. 1988).

Continuation applications enable an applicant to extend the prosecution period, potentially for

many years, while maintaining the benefit of the initial filing date. So long as the original

application’s specification contains adequate support for any claim additions or amendments,

continuation practice provides a means to broaden coverage of the application’s claims.

Continuations are not the source of the notice problem regarding evolving claims, and

they often serve important, entirely legitimate needs. They do, however, extend the period of

new-claim gestation and thereby raise third-party exposure to opportunistic conduct that takes

advantage of intervening market commitments, such as the conduct sanctioned in Kingsdown. A

targeted limitation on enforcement of broadened continuation claims could limit the potential

competitive harm.

Recommendation. The Commission recommends enactment of legislation to

protect from infringement actions third parties who (i) infringe properly described

claims only because of claim amendments (or new claims) following a

continuation and (ii) developed, used, or made substantial preparation for using,

the relevant product or process before the amended (or newly added) claims were

published.14

PTO funding. Finally, a crucial predicate for this discussion is an ongoing examination

process. Unfortunately, the PTO currently suffers under a huge application backlog. Delay in

commencing the examination procedures that begin to add clarity and in issuing patents only

adds to the period of uncertainty.

Recommendation. The Commission recommends that the PTO receive the

funding and information systems needed to promptly and properly examine the

many applications that it faces.

Improving the Ability to Sift Through a Multitude of Patents

Identifying and reviewing the patents and applications that might conceivably apply to a

new product often present daunting challenges in IT industries. In addition to the sheer number

of patents, testimony emphasized that unclear claim language and the diverse ways in which

claims might be expressed make search less effective. The hearings considered three ways to

address these issues.

Improving clearance search. The PTO provides public access to paper and electronic

files of patents, but organizes them under a system that differs from industry-based

classifications. Moreover, particularly in software contexts, researchers and applicants may

describe the same invention using different words, undermining reliable search.

The Commission first made this recommendation at 2003 FTC IP Report, ch. 4, at 31.

Recommendation. The Commission recommends that the PTO instruct

examiners to classify patents using an industry-based classification system, as

well as the PTO classification system, in art units where the additional

classifications would significantly improve public notice. The Commission

further recommends that the PTO explore mechanisms for encouraging examiners

to compile search-friendly lists of descriptive terms for applications under review

and patents ready for issuance.

Recommendation. The Commission urges that the PTO explore with the

software industry whether ways might be devised to foster greater uniformity in

the methodology or language used for describing and claiming inventions, as a

means of enhancing search capabilities.

Identifying patent assignees. Potential users of a technology need a ready means of

identifying the current owner of a patent. One strategy for navigating an environment with many

potentially relevant patents is to concentrate clearance efforts on patents held by competitors or

others who are likely to sue. This strategy falters if the public cannot identify current owners.

Panelists reported that under current law parties often fail to record assignments or list “shell

companies” as assignees. A patent confers a right to exclude, and it is important to clearance

efforts that the public faced with that right have a ready means of identifying the owner.

Recommendation. The Commission recommends the enactment of legislation

requiring the public recordation of assignments of patents and published patent

applications. To ensure that such listings provide maximum benefit to public

notice, they should identify both the formal assignee and the real party in interest.

Modifying liability for inadvertent infringement. The consequences of notice failures

are particularly harsh because infringers are held liable even if they have no knowledge of the

patent. Recent studies show that patent infringement litigation often seeks recovery from such

“inadvertent infringers.” If efforts to improve notice do not succeed, consideration of

modifications to strict liability – such as prior user rights or an “independent invention” defense –

may be appropriate. But a substantial change along these lines could result in a dramatically

different patent system, and knowledge in this area is limited. Under these circumstances,

research designed to better understand how modifications to strict liability for patent

infringement would affect incentives to invent and innovate would be desirable.

CHAPTER 4

THE ECONOMIC AND LEGAL FOUNDATIONS OF PATENT REMEDIES

The Patent Act incorporates the fundamental goal of fully compensating patentees for

infringement by requiring that a court award a successful patentee damages “adequate to

compensate for the infringement.” Courts have defined damages “adequate to compensate” as

those that make the patent owner whole by placing it in the position it would have been but for

the infringement. This standard aligns patent law and competition policy by replicating the

market reward for the invention, meaning the amount the patentee would have earned in the

absence of infringement by either selling a patented product or by licensing the patented

technology.

Courts have developed an extensive jurisprudence on how to calculate compensatory

damages. Current law identifies two categories of patent damages – lost profits and reasonable

royalties – and provides legal rules for determining which category applies and how damages

should be calculated. Calculating accurate damages is a difficult task, however. The calculation

is based on a hypothetical world of no infringement but continued competition from noninfringing alternatives. Undercompensation can harm consumers by decreasing incentives to

innovate. Overcompensation can also hinder innovation and deprive consumers of the benefits

of competition in multiple ways. To address these concerns, this report seeks to derive an

economically grounded approach to calculating patent damages and to test the current legal rules

for calculating damages against that approach.

CHAPTER 5

LOST PROFITS DAMAGES

When a patentee commercializes the invention itself, its market reward is measured by

the profits it earns. In this context, infringement generally entails making and selling a

competing product containing the patented technology. Infringing competition can reduce a

patentee’s profits in a number of ways, including by diverting sales from the patentee’s product,

eroding the patentee’s sales price, and causing the patentee to lose collateral sales of nonpatented

products.

Recommendation. In assessing how the market would have rewarded the

invention absent infringement, courts should allow a patentee flexibility in

creating the “but for” world to address different losses and avoid

undercompensation. Patentees should not be denied an opportunity to establish

lost profits through application of rigid rules that do not reflect sound economic

principles or imposition of evidentiary requirements beyond what is required for

the court to make a reasonable approximation of the patentee’s loss.

Non-infringing Alternatives in a Lost Profits Calculation

It is also important that the legal rules recognize how alternatives to the patented

invention would have affected the patentee’s profits. In the world absent infringement, the

infringer might have sold an alternative to the patented technology. Accurately calculating

damages in the face of that competition requires an examination of consumer preferences for the

patented invention over alternatives. The more consumers prefer the patented invention, the

greater the number of sales that infringement causes the patentee to lose. When consumers freely

substitute alternatives for the patented product, infringement causes fewer lost sales. Economic

tools, including those frequently used in antitrust analysis, can help determine the number of lost

sales.

Two current legal rules fail to give proper consideration to the role of alternatives in

determining lost profits damages: the entire market value rule and the practice of making dual

awards of lost profits and reasonable royalty damages.

The entire market value rule. When a patented invention is only one component of a

larger product, the “entire market value rule” awards lost profits damages based on the entire

value of the patented product if (1) the patented feature is “the basis for customer demand” of the

infringing product and (2) the patented and unpatented components together “constitute a

functional unit.”15 The entire market value rule distracts litigants and factfinders from a careful

reconstruction of a market lacking infringement. Proper consideration of the “degrees of

substitutability” among products is eliminated under the all or nothing “basis for customer

demand” test. The “functional unit” prong introduces an irrelevant consideration into the

analysis. A more nuanced economic analysis would seek to determine the number of consumers

that would choose an alternative if the infringing product were not available. Under this

economic analysis, the infringer’s sales are effectively “apportioned” according to the value that

the invention imparts to the entire product.

Recommendation. Courts should reject the entire market value rule as a basis for

awarding a patentee lost profits damages based on all infringing sales and instead

require proof of the degree of consumer preference for the patented invention over

alternatives.

Dual awards. Courts have awarded lost profits damages on a portion of the infringing

sales while also awarding reasonable royalty damages on the remaining infringing sales. Such

dual awards can give more than required to put the patentee in the position it would have been

but for the infringement. When an analysis of consumer preferences shows that, absent

infringement, some consumers would have purchased an alternative to the patented product,

giving the patentee reasonable royalty damages on those sales overcompensates it.

Recommendation. Courts should reject dual awards of lost profits and reasonable

royalty damages when competition from alternatives would have prevented the

patentee from making all the infringer’s sales in a world of no infringement.

CHAPTER 6

THE HYPOTHETICAL NEGOTIATION IN REASONABLE ROYALTY DAMAGES

When a patentee does not market its invention, it can instead earn the market reward for

the patent through licensing. For this reason, when a patentee cannot or chooses not to prove lost

profits from infringement, the measure of damages is the amount that the patentee would have

received in the market for licensing the patented technology. Patent law appropriately

implements this concept by awarding reasonable royalty damages based on what a willing

Rite-Hite Corp. v. Kelly Co., 56 F.3d 1538, 1550 (Fed. Cir. 1995) (en banc).

licensor and willing licensee would have agreed to in a hypothetical negotiation, assuming the

patent is valid and infringed. In an actual negotiation and, therefore, a hypothetical negotiation,

the maximum amount a licensee would pay depends upon the economic value of the patented

invention, meaning the incremental value of the invention compared to alternatives.

Concerns with the Hypothetical Negotiation Framework

Its counterfactual nature. Courts have, in some instances, allowed reasonable royalty

damage awards that appear to be more than a hypothetical negotiation would have produced. In

doing so, they have implicitly or explicitly rejected the central premise that the award must be

consistent with what a willing licensee would pay for the patented technology. Many cases

suggest unease with the hypothetical negotiation due to its counterfactual assumption that the

infringer never infringed and the parties reached agreement. Underlying this unease is often a

concern that the maximum royalty the infringer would have been willing to pay could not

adequately compensate the patentee and would have been unacceptable to it. Some cases also

contain overtones of punishing infringers.

Both concerns are inappropriate. First, compensatory damages for the strict liability

offense of infringement are not meant to be punitive. Second, arguments that the patentee would

have rejected the maximum amount the infringer would have paid are based on assumptions that

the patentee could have made more by not licensing. The patentee may have been better off

selling the invention or a competing product exclusively. In that case, however, the patentee

should be entitled to damages based on lost profits. The law must be flexible in allowing the

patentee to prove its lost profits in order to provide adequate compensation. But a patentee who

has failed or chosen not to do so should not be allowed to use unproven arguments of direct

losses to inflate a reasonable royalty award beyond what a willing licensee would pay.

Deterring infringement. Some cases that seem to reject the willing licensor/willing

licensee model have expressed concern that the prospect of paying reasonable royalty damages

supplies an insufficient deterrent to infringement and leads firms to choose to infringe by

charging only the “normal” royalty. This concern ignores several other deterrents to

infringement incorporated within the patent system. First, the argument incorrectly assumes that

damages following trial will be the “normal” royalty. The law, however, requires that the

hypothetical negotiation amount incorporate the assumption that the patent is valid and infringed,

which will raise the royalty rate. In addition, enchanced damages penalize those who willfully

infringe and deter copying. Finally, and perhaps most importantly, the threat of injunctive relief

provides critical deterrence to infringement, as discussed more fully below.

Recommendation. The Commission recommends that courts award reasonable

royalty damages consistent with the hypothetical negotiation analysis and willing

licensor/willing licensee model. Concerns about punishing infringement,

deterring infringement, the counterfactual nature of the analysis, or unproven lost

profits that the patentee may have suffered, should not inflate the reasonable

royalty damage award beyond what a willing licensee would have paid for a

patent known to be valid and infringed. Doing so risks awarding patentees more

than the economic value of their inventions compared to alternatives and creating

problems of overcompensation and market distortion.

CHAPTER 7

CALCULATING REASONABLE ROYALTY DAMAGES

Accurately calculating reasonable royalty damages based on a hypothetical negotiation

and the willing licensor/willing licensee model presents numerous challenges for litigants and

courts. An economically grounded approach to damages calculation that appreciates the role of

competition in establishing the economic value of an invention would increase the accuracy of

that determination. Chapter 7 suggests several steps courts can take to increase the accuracy of

reasonable royalty damage awards.

The Georgia-Pacific Factors and Their Implementation

Courts and juries often make reasonable royalty damage awards by considering some or

all of the Georgia-Pacific factors, a list identified by a district court in 1970 as relevant to the

issue.16 This list has served as a touchstone for expert testimony, jury instructions, and judicial

review of damage awards. Clarifying the appropriate role of the Georgia-Pacific factors would

help increase the accuracy of reasonable royalty damage awards. The factors do not provide a

conceptual framework for calculating damages. Rather, they are properly understood as a nonexhaustive list of evidence categories that may be, but are not necessarily, relevant to a specific

calculation.

Recommendation. Courts should consistently adopt and apply the hypothetical

negotiation and willing licensor/willing licensee model as the conceptual

framework against which conduct of the damages trial is tested. In particular,

courts should recognize that the Georgia-Pacific factors provide only a list of

evidence categories. Implementing this recommendation will have practical

consequences regarding jury instructions, admissibility of evidence and decisionmaking, discussed below.

The Role of Alternative Technologies

Manufacturers often choose among competing alternative technologies to incorporate into

new products. A manufacturer will not pay more to use patented technology than the increased

profits it anticipates from using the patented invention compared to the next best alternative. If

royalties exceed this economic value of the invention, manufacturers can bargain for a lower rate

or choose an alternative. Because alternative technologies play a crucial role in actual licensing

negotiations, they must play a commensurate role in the hypothetical negotiation that determines

Georgia-Pacific Corp. v. United States Plywood Corp., 318 F. Supp. 1116, 1120 (S.D.N.Y. 1970),

modified and aff’d, 446 F.2d 295 (2d Cir. 1971).

reasonable royalty damages. Recent case law has suggested, however, that the availability of

non-infringing alternatives does not necessarily cap reasonable royalty damage awards.

Recommendation. Courts should recognize that when it can be determined, the

incremental value of the patented invention over the next-best alternative

establishes the maximum amount that a willing licensee would pay in a

hypothetical negotiation. Courts should not award reasonable royalty damages

higher than this amount.

Timing of the hypothetical negotiation. A manufacturer’s costs in choosing an

alternative to the patented technology and the ability of alternatives to cap a reasonable royalty

can depend on the timing of the hypothetical negotiation. As it chooses technologies to

incorporate into a new product, a manufacturer will often make investments (e.g., building

manufacturing facilities) based on that choice that make it more costly to switch to an alternative.

If the hypothetical negotiation is deemed to take place after investments have increased switching

costs, the reasonable royalty may be higher than it would have been at the time of the design

choice. This result overcompensates patentees compared to the economic value of the invention

because of investments by the infringer. The ability of patentees to demand and obtain royalty

payments based on the infringer’s switching costs is commonly called “hold-up.” The case law

places the hypothetical negotiation at the time infringement began, but it does not precisely

define that point in time.

Recommendation. To prevent damage awards based on switching costs, courts

should set the hypothetical negotiation at an early stage of product development,

when the infringer is making design decisions and before it has sunk costs into

using the patented technology.

Reasonable royalties applied to standards. Hold-up may have especially severe

consequences for innovation and competition in the context of standardized technology. IT firms

often achieve interoperability among products by working together in standard setting

organizations (SSOs) to jointly adopt industry-wide technical standards. Alternative

technologies compete for inclusion in the standard. Once a technology is incorporated into a

standard, a firm with a patent reading on the technology can demand a royalty that reflects not

only the value of the technology compared to alternatives, but also the value associated with

investments made to implement the standard. Switching costs may be prohibitively high when

an industry becomes locked into using standardized technology. Were patentees able to obtain

the hold-up value, this overcompensation could raise prices for consumers while undermining

efficient choices made among technologies competing for inclusion in a standard.

One way that many SSOs attempt to address this problem is through licensing rules that

require participants to agree to license patents on RAND (Reasonable and Non-Discriminatory)

terms. But panelists complained that RAND was not defined and provided little guidance in

licensing negotiations. More clarity in the damages case law on the role of alternatives and

timing in the hypothetical negotiation would support a definition of RAND that limits hold-up.

A definition of RAND based on the ex ante value of the patented technology at the time the

standard is chosen is necessary for consumers to benefit from competition among technologies to

be incorporated into the standard.

Recommendation. Courts should apply the hypothetical negotiation framework

to determine reasonable royalty damages for a patent subject to a RAND

commitment. Courts should cap the royalty at the incremental value of the

patented technology over alternatives available at the time the standard was

chosen.

Courts’ Gatekeeping Role in Reasonable Royalty Damages Cases

Litigants frequently present damages evidence in patent cases to the jury through an

expert witness who offers opinion on the appropriate damage award. The judge acts as a

gatekeeper in determining whether that opinion testimony is sufficiently reliable to be admissible

under Federal Rule of Evidence (FRE) 702. To be reliable, expert testimony must be: (1) based

on sufficient facts or data; (2) the product of reliable principles and methods; and (3) result from

reliable application of those principles and methods to the facts of the case.

Calls for more vigorous judicial gatekeeping excluding unreliable testimony on damages

have received heightened attention in the patent community and generated broad agreement at the

hearings. Such gatekeeping is especially important for achieving accurate awards in the context

of the hypothetical negotiation, which can be difficult for jurors to apply. Panelists maintained,

however, that courts rarely exercise their gatekeeping authority in patent damages matters.

Decisions under Daubert17 that examine only the reliability of an expert’s methodology, without

fully considering whether he reliably applied that methodology to the facts of the case, can result

in admission of improper testimony. The recent Federal Circuit opinion, Uniloc v. Microsoft,18

emphasizes the need for damages experts to tie accepted methodologies to the facts of the

particular case.

Recommendation. In their gatekeeper role of enforcing FRE 702, courts should

test the admissibility of expert testimony on damages by assessing whether it will

reliably assist the trier of fact in determining the amount a willing licensor and

willing licensee would have agreed to as compensation for use of the patented

invention in the infringing product. Courts should not deem evidence as relevant,

reliable and admissible solely because it falls within one of the Georgia-Pacific

factors.

Daubert v. Merrell Dow Pharms., Inc., 509 U.S. 579 (1993).

Uniloc USA, Inc. v. Microsoft Corp., Nos. 2010-1035, 2010-1055, 2011 WL 9738 (Fed. Cir. Jan. 4,

2011).

Recommendation. Consistent with FRE 702, courts should require a showing

that a damages expert’s methodology is reliable, that he reliably applies the

methodology to the facts of the case, and that the testimony is based on sufficient

data. Demonstration of a reliable methodology without satisfaction of the other

two prongs should not establish admissibility.

Comparable licenses and averages. The issues surrounding the admissibility of royalty

rates on licenses claimed to be comparable to the hypothetically negotiated license illustrate the

importance of active gatekeeping. Basing reasonable royalty awards on royalty rates in patent

licenses that are “comparable” to the license that would result from the hypothetical negotiation

(or averages of such royalty rates) is a common methodology for setting reasonable royalty

damages. Such evidence can reliably assist the trier of fact in setting the hypothetical negotiation

license only if the patented invention and its infringing use are sufficiently similar to those of the

comparable license. Key attributes in assessing comparability include the technology that is

licensed, the rights licensed (e.g., whether a license covers one patent or several), and the type

and terms of the license (e.g., running royalty or lump sum). In Lucent v. Gateway19 and other

cases, the Federal Circuit has recently applied a more rigorous review of damage awards that

considers whether licenses offered as “comparable” are sufficiently similar to support a jury

verdict.

Recommendation. Courts should admit expert testimony based on comparable

licenses as reliable only upon a satisfactory showing of similarity between the

licensed patent and the infringed patent, and between the non-price terms of the

comparable license and hypothetical license. That showing should be sufficient to

support an inference that the royalty rate for the comparable license provides a

reliable indicator of the royalty that would be reached in the hypothetical

negotiation.

Choosing the Royalty Base: The Entire Market Value Rule

The entire market value rule arose in the context of calculating lost profits damages for a

patent covering a component of a product. The law allows the patentee to recover lost profits

damages based on the entire market value of the product when the patented component is the

“basis for customer demand.” Otherwise lost profits damages will be based only on the value of

the patented component or “apportioned.”

The entire market value rule as developed for lost profits has no corollary in the context

of calculating a royalty by multiplying a royalty base times a royalty rate. There is no amount of

potential damage funds, such as the profits lost on a product, to be entirely awarded or

apportioned. Moreover, the base and rate are closely interrelated. Altering the base in response

to a legal test should result in recalibrating the rate. Nonetheless, courts have imported this rule

into reasonable royalty determinations as a technique for identifying the royalty base.

Lucent Techs., Inc. v. Gateway, Inc., 580 F.3d 1301 (Fed. Cir. 2009).

Recommendation. Courts should eliminate the entire market value rule and the

question of whether the patented feature was the “basis for customer demand”

from the determination of the appropriate base in a reasonable royalty damages

calculation. It is irrelevant and it risks injecting significant confusion that

threatens to produce inaccurate awards.

Identifying the base. Multiple considerations apart from the entire market value rule

influence parties’ choice of a royalty base in actual licensing negotiations, including convenience

of the parties and the practice in the industry. Where the patented invention is only one

component of a larger product, the product may be the only item that is priced and can be

monitored. However, the practical difficulty of identifying a royalty rate that accurately reflects

the invention’s contribution to a much larger, complex product counsels toward choosing the

smallest priceable component that incorporates the invention. Because the choice of a base in an

actual licensing negotiation is not driven by whether the patented feature is the “basis for

customer demand,” that question should not drive the choice of base in a hypothetical

negotiation. (The rule’s concern with the extent to which a patented invention drives customer

demand is relevant for identifying an appropriate royalty rate.)

Recommendation. Courts should identify as the appropriate base that which the

parties would have chosen in the hypothetical negotiation as best suited for

accurately valuing the invention. This may often be the smallest priceable

component containing the invention.

CHAPTER 8

PERMANENT INJUNCTIONS IN PATENT CASES

In addition to awarding damages for past patent infringement, courts may also grant

permanent injunctions prohibiting future infringement. In 2006, in eBay v. MercExchange, a

unanimous Supreme Court held that the grant of permanent injunctive relief in a patent case is

governed by “traditional equitable principles.” The Court listed four factors that a patentee must

satisfy to obtain an injunction:

(1) that it has suffered an irreparable injury; (2) that remedies available at

law, such as monetary damages, are inadequate to compensate for that

injury; (3) that, considering the balance of hardships between the plaintiff

and defendant, a remedy in equity is warranted; and (4) that the public

interest would not be disserved by a permanent injunction.20

eBay, Inc. v. MercExchange, LLC, 547 U.S. 388, 391 (2006).

How Permanent Injunctions Affect Innovation and Competition

Although the injunction analysis is equitable, to most benefit consumers, it should be

conducted in a manner that furthers the patent system’s goal of promoting innovation and

recognizes consumer interest in aligning the patent system and competition policy. Three

characteristics of injunctions that affect innovation support generally granting an injunction. The

first and most fundamental is an injunction’s ability to preserve the exclusivity that provides the

foundation of the patent system’s incentives to innovate. Second, the credible threat of an

injunction deters infringement in the first place. This results from the serious consequences of an

injunction for an infringer, including the loss of sunk investment. Third, a predictable injunction

threat will promote licensing by the parties. Private contracting is generally preferable to a

compulsory licensing regime because the parties will have better information about the

appropriate terms of a license than would a court, and more flexibility in fashioning efficient

agreements.

A fourth characteristic of injunctions affects the alignment of the patent system and

competition policy. An injunction’s ability to cause patent hold-up can support withholding

injunctive relief in some situations. A manufacturer’s high switching costs combined with the

threat of an injunction can allow a patent owner to obtain payments unrelated to the economic

value of its invention. Hold-up and the threat of hold-up can deter innovation by increasing costs

and uncertainty for manufacturers. It can also raise prices to consumers by depriving them of the

benefit of competition among technologies. In such circumstances, injunction law threatens to

disrupt the alignment of the patent system and competition policy.

A challenge for injunction analysis is to integrate and balance awareness of these issues.

Hold-up can harm innovation and competition. But denying an injunction every time an

infringer’s switching costs exceed the economic value of the invention would dramatically

undermine the ability of a patent to deter infringement and encourage innovation. For this

reason, courts should grant injunctions in the majority of cases, but criteria are needed to help

identify those instances in which the harm to the patentee from ongoing infringement is small

compared to the costs from hold-up. These criteria include: (1) whether the patented technology

is a minor component of a complex product that would have been easy to design around ex ante;

(2) whether the infringement affects the patentee’s ability to compete in a product or technology

market; and (3) whether the infringer copied the patented technology.

Analyzing eBay’s Four Factors

To be implemented by courts, these concerns about innovation and aligning the patent

system and competition policy must be translated into the eBay framework. In fact, these

concerns fit well within the equitable nature of the injunction remedy and eBay’s four factor

analysis.

Irreparable harm/inadequacy of money damages.21 Much discussion concerning

injunction law post-eBay has focused on whether the patentee and infringer compete in a product

market. Conventional wisdom assumes that patentees that do not compete in a product market

cannot obtain injunctions because money damages will adequately compensate any harm they

may suffer from infringement. Conventional wisdom also assumes that a patent owner practicing

the patent can and should be granted an injunction.

The class of non-practicing patent owners is too diverse to be subject to a simple rule.

Patentees that license as part of a technology transfer program can suffer harm from infringement

akin to that suffered by manufacturing patentees. These patentees compete in a technology

market to have their technology purchased for incorporation into new products. The availability

of an injunction is important to such patentees, who rely on the threat to deter infringement and

encourage ex ante licensing. The harm suffered by these patentees as a result of infringement can

be analogous to that suffered by manufacturing patentees, including loss of a customer base and

harm to reputation as an innovator. However, denial of an injunction may not prevent a patent

assertion entity (PAE) from receiving the full value of the invention. That patentee will not have

the same concerns about deterring future infringement and protecting its reputation as an

innovator that other patentees may have.

This is not to say, however, that courts should assume all manufacturing patentees will

suffer irreparable harm from infringement. While that might often be the case, the analysis must

consider other facts. The patent may cover a minor component of the infringing product.

Competing products may include non-infringing alternatives that are acceptable to customers,

making it less likely that the infringement (as opposed to competition generally) is harming the

patentee. The variety and complexity of different factual scenarios caution against creating any

assumptions of irreparable harm based on a finding of infringement, a patentee’s use of the

patent, or its willingness to license.

Recommendation. Courts should not presume irreparable harm based on a

finding of infringement or the patentee’s use of the patent. Conversely, courts

should recognize that infringement can irreparably harm the ability of patentees

that primarily engage in technology transfer through licensing to compete in a

technology market.

Balance of the equities and hardships between the parties. Under this factor, courts

must consider the effect of an injunction on an infringer and balance it against the harm that

infringement imposes on the patentee. This factor allows courts to weigh the expense and harm

to an infringer facing hold-up against the harm to the patentee by considering whether the

invention is a minor component for which acceptable alternatives are available, and how

infringement affects the patentee’s ability to compete in a goods or technology market. Courts

can also consider whether the infringer copied the technology.

Courts and commentators often analyze these two factors as one. Appendix B, Section III.A.

Recommendation. Courts should consider the hardship of an infringer facing

hold-up under this prong. Courts should reject the statement that an infringer

“cannot be heard to complain if an injunction against continuing infringement

destroys the business”22 except in those instances where an infringer “elects” to

infringe by copying a patented invention with knowledge of the patent.

Public interest. Under the public interest factor, courts must examine the effect an

injunction would have on third parties, including the public at large. Courts often cite the

public’s interest in the patent system’s ability to promote innovation as supporting an injunction.

While this is important, in some circumstances, such as those involving hold-up based on a

patent for a minor component, an injunction could unduly raise prices to consumers and deter

rather than promote innovation.

Recommendation. When warranted by the facts, courts should consider the

public’s interest in avoiding patent hold-up, which can increase costs and deter

innovation.

Injunction Analysis in the Standard Setting Context

Hold-up in the standard setting context can be particularly acute. Standards are often

adopted to make products compatible and interoperable with other products in the industry.

“Lock-in” can make an entire industry susceptible to hold-up. In addition to higher prices and

other economic harms, hold-up in standards-based industries may discourage standard setting

activities and collaboration, which can harm innovation.

eBay provides a framework for evaluating whether to issue an injunction in the standard

setting context. A prior RAND commitment by the patentee or its successor-in-interest can

provide evidence that denial of an injunction in favor of ongoing royalties will not irreparably

harm the patentee. The infringer’s inability to participate effectively in the market without

complying with the standard is relevant to the balance of hardships. The public interest factor

may consider whether grant of an injunction would deprive consumers of interoperable products;

raise costs above the incremental value of the invention compared to alternatives at the time the

standard was set; or threaten to undermine the collaborative innovation that can result from the

standard setting process.

Recommendation. Courts should give careful consideration under each of eBay’s

four factors to the consequences of issuing an injunction prohibiting use of a

patented invention incorporated into an industry standard. Whether the patent

owner made a RAND commitment will also be relevant to the injunction analysis.

E.g., 3M Innovative Properties Co. v. Avery Dennison Corp., No. 01-1781, 2006 WL 2735499, at *2

(D. Minn. Sept. 25, 2006).

Remedies Following Denial of an Injunction

When the analysis leads a court to deny an injunction, the question naturally arises of

what remedy to apply. The court opinions that address the question most commonly require

ongoing royalties that allow the manufacturer to continue making the infringing product. The

Federal Circuit has held that this remedy can be appropriate in lieu of an injunction. No

consensus on how to set the royalty rate has emerged from the case law, however. The Federal

Circuit has stated only that district courts must articulate a reasonable basis for determining the

amount, and that the award should account for the changed relationship of the parties resulting

from an adjudicated finding of infringement of a valid patent.

Ongoing royalties. To form a coherent remedies system, the legal rules for ongoing

royalties following denial of an injunction must be consistent with the rationale for denying the

injunction in the first place. When a court denies an injunction to prevent hold-up, the

alternative remedy should not perpetuate the hold-up. The ongoing royalty should be based on a

willing licensor/willing licensee model with the assumption that the patent is valid and infringed

in order to account for the changed relationship of the parties following litigation. Concerns

about preserving the deterrent value of injunctions and patentees’ incentives to innovate are best

addressed by carefully defining and limiting the circumstances under which injunctions are

denied.

Recommendation. The Commission recommends that to fully compensate

patentees but avoid creating hold-up, courts base awards of ongoing royalties

following denial of an injunction on the willing licensor/willing licensee model,

assuming the patent is valid and infringed.

Delaying the injunction. In several instances, courts have granted a permanent

injunction but delayed the time for it to commence in order to give the infringer time to design

around the patent or the parties time to reach a licensing agreement. Where a design around

option is feasible and the infringer is afforded sufficient time to implement it, a delayed

injunction can be a useful tool to prevent hold-up while avoiding the concerns associated with

denying an injunction for the life of the patent. In addition, allowing the parties time to negotiate

a license can conserve judicial resources.

Remedies in the International Trade Commission

Patent holders who believe that imported products infringe their patents may file a

complaint with the International Trade Commission (ITC) under Section 337 of the Tariff Act of

1930. Panelists expressed concern that patentees that are unlikely to obtain an injunction in

district court under eBay may instead pursue a case in the ITC. Such patentees might include

patent assertion entities (PAEs) and those whose patent is subject to a RAND commitment for

use in a standard. The Federal Circuit has held that eBay’s equitable test does not apply to ITC

decisions to grant an exclusion order barring importation of infringing products. Thus, unlike the

situation in district court, a finding of infringement in the ITC has led to a nearly automatic

exclusion order, which is sometimes tantamount to an injunction. In some circumstances, this

outcome could generate hold-up and harm innovation and competition.

Section 337 provides two mechanisms through which the ITC can limit the potential

harm from hold-up. The first is through the domestic industry requirement. To file suit in the

ITC, a patent owner must meet the domestic industry requirement, which can be satisfied by

showing “substantial investment in [the patent’s] exploitation, including engineering, research

and development or licensing.”23 The ITC should interpret the domestic industry requirement as

not satisfied by ex post licensing activity solely focused on extracting rents from manufacturers

based on marketed products. Consistent with the legislative history’s concern with innovation

and the language of the statute, relevant licensing activity can be that which “exploits” the patent

through technology transfer that can result in the commercialization of new products and

services. This interpretation would limit access to the ITC for PAEs, who are least likely to

obtain an injunction under eBay, but not other non-practicing patent owners who compete in

technology markets.

Second, Section 337 requires the ITC to consider “the public health and welfare,

competitive conditions in the United States economy, the production of like or directly

competitive articles in the United States, and United States consumers” in deciding whether to

grant an exclusion order.24 The ITC has rarely used this public interest provision to deny a

remedy. But its language should allow consideration of whether an exclusion order based on a

minor patented component of a complex product can unduly harm consumers by causing holdup, distorting competition, raising prices and deterring innovation. These concerns can be

especially powerful when a patentee asserts a patent in the ITC that is subject to a RAND

commitment against standardized technology.

Recommendation The FTC recommends that the ITC consider whether only

those licensing activities that promote technology transfer “exploit” patented

technology within the meaning of Section 337, and therefore satisfy the domestic

industry requirement. The FTC also recommends that the ITC incorporate

concerns about patent hold-up, especially of standards, into the decision of

whether to grant an exclusion order in accordance with the public interest

elements of Section 337.

19 U.S.C. § 1337(a)(3).

19 U.S.C. § 1337(d)(1).

CHAPTER 1

EVOLVING PATHWAYS OF INNOVATION: OPEN INNOVATION, TECHNOLOGY

TRANSFER AND EX ANTE PATENT TRANSACTIONS

INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32

II.

THE INCREASING IMPORTANCE OF OPEN INNOVATION . . . . . . . . . . . . . 34

III.

Open Innovation Embraces Technology Transfer . . . . . . . . . . . . . . . . . . . . 34

The Role of Small Companies and Start-ups in Open Innovation . . . . . . . 36

PATENTS FACILITATE OPEN INNOVATION AND TECHNOLOGY

TRANSFER . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39

Patent Exclusivity Encourages Invention, Development and Disclosure . . 40

Patenting by Small Companies and Start-ups . . . . . . . . . . . . . . . . . . . . . . . . . 43

IV.

AREAS OF PATENT POLICY THAT AFFECT OPEN INNOVATION AND

TECHNOLOGY TRANSFER . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46

CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48

CHAPTER 1

EVOLVING PATHWAYS OF INNOVATION: OPEN INNOVATION, TECHNOLOGY

TRANSFER AND EX ANTE PATENT TRANSACTIONS

INTRODUCTION

Innovation benefits consumers through the development of new products, processes and

services that can improve lives and address unmet needs. It is key to meeting society’s greatest

challenges in areas as diverse as energy production, communications and health care, and it is

essential to sustained economic growth and global competitiveness.1 But innovation is a

complex process. It involves a series of steps from idea to invention through development to

commercialization. Both the invention process and the development process can be expensive,

risky and unpredictable.2

The goal of the patent system is to promote innovation in the face of that expense and

risk. By preventing copying that might otherwise drive down prices, the patent system allows

innovators to recoup their investment in research and development (R&D). The patent system’s

exclusive right promotes innovation, but so too does competition, which drives firms to produce

new products and services in the hope of obtaining an advantage in the market. As discussed in

the FTC’s 2003 Report on the patent system, To Promote Innovation: The Proper Balance of

Competition and Patent Law and Policy, the policies that most successfully promote innovation

and enhance consumer welfare are those that align the patent system and competition policy by

balancing exclusivity and competition.3 Many of the recommendations in the 2003 FTC IP

Report focus on improving patent quality a means of achieving that balance.4

Areas of patent law beyond those affecting patent quality can have a significant impact on

how the patent system aligns with competition policy. Hearings held by the FTC during 2008

OFFICE OF SCI. AND TECH . POLICY , NAT ’L ECON . COUNCIL , EXECUTIVE OFFICE OF THE PRESIDENT , A

STRATEGY FOR AM ERICAN INNOVATION : DRIVING TOW ARDS SUSTAINABLE GROWTH AND QUALITY JOBS

4 (2009).

LEWIS M. BRANSCOMB & PHILLIP E. AUERSWALD , DEPT . OF COM M ERCE , BETWEEN INVENTION AND

INNOVATION : AN ANALYSIS OF FUNDING FOR EARLY -STAGE TECHNOLOGY DEVELOPMENT 32-41 (2002).

FED . TRADE COM M ’N , TO PROM OTE INNOVATION : THE PROPER BALANCE OF COM PETITION AND PATENT

LAW AND POLICY , Exec. Summ., at 1 (Oct. 2003) (“2003 FTC IP Report”), available at

http://ftc.gov/os/2003/10/innovationrpt.pdf.

A second report, issued jointly by the Federal Trade Commission and the Department of Justice

Antitrust Division in 2007, considers how antitrust law and competition policy can maintain an alignment

with the patent system that best promotes innovation. FED . TRADE COM M ’N & DEPT . OF JUSTICE

ANTITRUST DIV ., ANTITRUST ENFORCEM ENT AND INTELLECTUAL PROPERTY RIGHTS : PROMOTING

INNOVATION AND COM PETITION (April 2007).

and 20095 explored two: (1) notice, meaning how well a patent informs the public of what

technology is protected; and (2) remedies, meaning damages and injunctions following a finding

of patent infringement. Understanding how patent notice and remedies affect innovation and

competition requires that we first examine how the pathways of innovation and the role of

patents have evolved. That is the goal of this chapter.

In one important aspect of that evolution, many firms are increasingly embracing “open

innovation.” In a traditional or closed model of innovation, a firm relies on its own R&D to

create the products it markets. But a firm that pursues an open innovation strategy recognizes

that valuable ideas can originate with others and seeks to acquire those inventions that fit its

business model. Many of the inventions acquired and commercialized by large firms originate

with start-ups and small companies, which account for a steadily increasing percentage of R&D

spending.

Consumers benefit from open innovation strategies. Technology transfer permits a

division of labor between those who invent and those who manufacture most efficiently. This

can speed up the rate of innovation and result in broader, faster distribution of new products to

consumers. By providing a pathway for invention without commercialization, technology

transfer also lowers barriers to entry for inventors who do not have access to the capital required

to build manufacturing facilities and establish distribution channels.6 Easier entry supports

additional sources of invention, which increases competition among technologies to be further

developed or incorporated into products. That competition benefits consumers by resulting in

better, cheaper products. Moreover, competition among technologies for development funding is

an important mechanism for allocating scarce resources to those inventions having the greatest

chance of generating the products most valued by consumers.

The patent system facilitates open innovation and technology transfer in ways that

implicate patent remedies and the notice function. The exclusive patent right creates incentives

for sellers of technology to invent and buyers of technology to make the purchase and invest in

further development. But the nature of the exclusive right depends in part on the remedies

available for its infringement. Patents also define rights based on intangible ideas, which helps

create a market for technology and makes contracting easier. But a patent’s success in doing so

depends upon how well it provides notice of what technology it protects. Chapters 3-8 of this

report draw on the insights and information of this chapter in analyzing the law of patent notice

and remedies and making recommendations to improve them.

Transcripts and agendas for the hearings and written submissions are available at

http://www.ftc.gov/bc/workshops/ipmarketplace/. Appendices C, D and E provide lists of hearings

participants, agendas and written submissions.

ASHISH ARORA , ANDREA FOSFURI & ALFONSO GAMBARDELLA , MARKETS FOR TECHNOLOGY :

THE ECONOMICS OF INNOVATION AND CORPORATE STRATEGY 12-13 (2001).

II.

THE INCREASING IMPORTANCE OF OPEN INNOVATION

In a traditional or “closed” model of innovation, a company’s R&D activities lead to

internally developed products that the company then markets. The company transfers little

technology either into or out of the firm as part of the R&D process, and it forms few

collaborations. This was the predominant model of innovation for many companies in the past,

especially those having large research arms, like AT&T’s Bell Labs.7 Certainly, large companies

continue to invent and develop new technologies that they then market,8 but many are

increasingly receptive to a model of “open innovation.”9

Open Innovation Embraces Technology Transfer

An open innovation strategy allows invention to flow both into and out of the firm. It

recognizes that valuable inventions can come from outside the firm and seeks those that fit well

with a firm’s business model. Open innovation can involve collaboration or technology transfer

from a company that has invented an idea to another that further develops, uses or markets it.

Such technology transfer allows the acquiring firm to leverage external sources of knowledge to

support its own innovation.10

For example, a panelist from Procter & Gamble (P&G) described how that company is

pursuing an open innovation approach. Traditionally, P&G’s new products came from internal

R&D efforts. But in 2000, the company adopted a goal of acquiring 50% of its innovation from

R&D conducted outside of the company. It exceeded that goal in 2008. As a result, the company

reports that its R&D productivity has increased by 60%, the rate of its innovation has doubled,

Chesbrough at 214-15 (5/4/09); OPEN INNOVATION : RESEARCHING A NEW PARADIGM 2-3 (Henry

Chesbrough, Wim Vanhaverbeke & Joel West eds., 2006) (contrasting closed innovation models like

AT&T’s Bell Laboratories with open innovation models). Even in a closed innovation model,

knowledge transfer from one firm to another that stimulates further innovation can occur through reverse

engineering and review of patent documents.

See, e.g., Yen at 47 (12/5/08) (“Cisco invests more than $5 billion annually in R&D.”); Krall at 73

(3/18/09) (“Sun reinvests between 15 and 20 percent of its annual revenues back into R&D annually.”);

Miller at 148 (3/18/09) (“[Procter and Gamble] invests over $2.2 billion per year in research and

development and we employ over 8,900 scientist[s] in 29 research centers in 13 countries.”); Watt at 12

(5/4/09) (Amgen spent $3 billion on R&D in 2008); Myers at 220-21 (3/18/09) (Pfizer spends 20% of its

revenue on R&D).

OPEN INNOVATION : RESEARCHING A NEW PARADIGM , supra note 7, at 2-3. The model of “open

innovation” discussed here involves technology transfer in and out of firms. It is not limited to

innovation strategies based on open source software, as the term “open innovation” is sometimes used.

See id. at 82-84 (discussing open innovation based on open source software).

Id.

and costs have fallen. As a representative of the company explained, by combining P&G’s

internal innovation with outside sources, “one plus one makes three or five instead of two.”11

Similarly, to create new products, large pharmaceutical and biotechnology companies

often depend upon external sources of technology, including universities, start-ups and

collaborations with other companies.12 Start-ups typically develop early-stage technology,

perhaps obtained from a university, and move it closer to a viable product. If successful, they

may partner with or become acquired by a pharmaceutical company, which tests and

commercializes the product. For many large pharmaceutical and biotech companies, a majority

of their approved drug products begin with externally developed technology.13

Companies in the information technology (IT) sector also acquire new, externally

developed technology.14 As one commentator explained, technologies have become so complex

that it is not feasible for any one company to be the source of all the innovative aspects of a

product. Companies must look outside.15 One panelist reports that open technology

development has “thrived” in the software and internet industries.16 IT companies use a variety

of mechanisms to bring in new technology, including acquisition of start-ups, collaborative

arrangements, and IP licenses.17 For instance, a manufacturing company may take a license

Miller at 148-50, 154 (3/18/09).

Myers at 220-21 (3/18/09).

Graham at 137 (4/17/09); see, e.g., Shafmaster at 214 (3/18/09) (of seven therapies produced by

Genzyme in the last six years, five are protected, in part, by intellectual property in-licensed from

universities, and two are based on intellectual property acquired by Genzyme).

Cockburn at 188-89 (4/17/09); Rogers at 103 (3/18/09) (in the past four years, Qualcomm has acquired

over a dozen companies); Yen at 47 (12/5/08) (Cisco has acquired 130 companies, mostly start-ups, to

bring in new technology); Valz at 236 (12/5/09) (“small entities that are actually producing great

technology along side IP will get noticed and will do really well” in acquisition in the IT sector); Thomas

at 73 (4/17/09) (reporting that “some [of] our most valuable intellectual property has come from smaller

companies”).

Phelps at 244 (5/4/09); Bergelt at 81-82 (4/17/09) (In IT industries, “we’re not doing siloed parlayed

invention of fundamental technologies the way we did 10 or 15 years ago. We’re now inventing higher

up in the stack collaboratively.”); see also BRANSCOMB & AUERSWALD , supra note 2, at 43 (“By the

1990s, firms began to out-source more of their needs for component innovation to small and medium

sized enterprises.”).

Valz at 235-36 (12/5/09).

Crean at 103 (5/4/09) (listing legal tools for importing technology into a large company).

from a design house that develops technology solely in the hopes of licensing it.18 This model

has become increasingly prevalent in the semiconductor industry since the late 1980s with the

emergence of companies that patent their designs and then license them to chip manufacturers.19

In addition to acquiring technology from external sources, a manufacturing company that

pursues an open innovation strategy may also supply its internally developed technology to other

firms. If a company makes a promising invention that does not fit well with its business plan, it

may seek to sell or license that technology to another firm rather than leave it on the shelf.20 That

might occur when a company pursues multiple solutions through R&D but chooses only one to

implement. The other solutions may still show promise for different applications.21 Looking

outside the company for partners to develop and commercialize the otherwise unused technology

provides a return on R&D investment, but it also establishes collaborative relationships that can

lead to more technology development.22

The Role of Small Companies and Start-ups in Open Innovation

Small companies play an important role in an open innovation paradigm.23 Data collected

by the National Science Foundation indicates that from 1981 to 2005, most of the growth in U.S.

industrial R&D spending came from small companies rather than large. In 1981, 70% of R&D

spending in the United States was undertaken by companies with more than 25,000 employees.

Comment of Innovation Alliance at 2 (2/5/09); Millien at 22 (12/5/08) (noting companies, including

AmberWave and Rambus, that have similar business models).

Ziedonis at 260 (5/4/09); Bronwyn H. Hall & Rosemarie Ham Ziedonis, The Patent Paradox Revisited:

An Empirical Study of Patenting in the U.S. Semiconductor Industry, 1979-1995, 32 RAND J. ECON . 10128 (2001); Arora at 31-32 (3/19/09).

OPEN INNOVATION : RESEARCHING A NEW PARADIGM , supra note 7, at 1-3; BRANSCOMB &

AUERSWALD , supra note 2, at 44; Chesbrough at 215-16 (5/4/09); Phelps at 247-48 (5/4/09) (describing

the IP Ventures unit of Microsoft that licenses-out technology for development); id. at 245 (IBM license

to Motorola and Intel of technology it did not use).

Horton at 168-69 (3/18/09) (GE experience); Miller at 165 (3/18/09) (explaining that P&G invented

enzymes useful for detergent that another company licenses for contact lenses).

Griswold at 163 (3/18/09) (3M obtains revenue and develops relationships through out-licensing);

Miller at 150 (3/18/09) (P&G); Stec at 166 (3/18/09) (Ford); Philips at 167 (3/18/09) (Exxon-Mobil).

National Science Foundation, Science and Engineering Indicators 2006, available at

http://www.nsf.gov/statistics/seind06/c4/c4s1.htm; Samuel Kortum & Josh Lerner, Assessing the

Contribution of Venture Capital to Innovation, 31 RAND J. ECON . 674 (2000) (estimating that by 1998,

venture funding accounted for about 14% of U.S. innovative activity). See also Miller at 150 (3/18/09)

(acknowledging that “innovation was increasingly done at small and mid-sized entrepreneurial

companies, universities, government labs and by individuals”); Bright at 21 (5/4/09) (companies look to

start-ups and universities to create new ideas and new solutions that the company can develop).

Only 4.4% was undertaken by companies with fewer than 1,000 employees. By 2005 those

numbers had changed dramatically. Companies with more than 25,000 employees accounted for

only 37.6% of R&D spending while the R&D share of companies with fewer than 1,000

employees had grown to 24.1%.24 Since 1980, small and younger firms have accounted for most

of the rise in research spending.25

With the growing amount of research and invention located in small companies,

technology transfer from small, specialized firms to larger manufacturing firms has become an

increasingly important pathway of open innovation.26 Technology can be transferred, or “spunout” in the other direction too, from a large company to a start-up.27 Universities provide another

important source of early-stage technology that can be transferred to start-ups or large

companies.28 In 2007, over 500 new companies formed based on technology invented in

Chesbrough at 212-17 (5/4/09). For a more complete breakdown of R&D spending by company size

and year, see Henry Chesbrough, Specialization and Markets for IP, presented at FTC Hearing: The

Evolving IP Marketplace (May 4, 2009), available at

http://www.ftc.gov/bc/workshops/ipmarketplace/may4/docs/bchesbrough.pdf.

In the early 1970s, only 70 large, industrial R&D firms accounted for the majority of private R&D

being performed. By 2000, those firms accounted for less than one third of R&D. Hunt at 54-56

(3/19/09); see Robert M. Hunt, The Federal Trade Commission’s Hearing on “The Evolving IP

Marketplace”, presented at FTC Hearing: The Evolving IP Marketplace (March 19, 2009), available at

http://www.ftc.gov/bc/workshops/ipmarketplace/mar18/docs/rhunt.pdf.

Ashish Arora, Marc Ceccagnoli & Wesley M. Cohen, Trading Knowledge: An Exploration of Patent

Protection and Other Determinants of Market Transactions in Technology and R&D, in FINANCING

INNOVATION IN THE UNITED STATES , 1870 TO THE PRESENT 366, 367 (Naomi R. Lamoreaux & Kenneth

L. Sokoloff eds., 2007) (“the available evidence points to a renewal of market exchange of technology”);

Hunt at 57 (3/19/09) (“efficient markets for technology are more important than ever”); Meyer at 68-69

(2/12/09) (observing that “oftentimes [commercialization] doesn’t happen within the context of one

entity”).

Phelps at 247-48 (5/4/09) (describing how Microsoft creates spin-out companies).

Universities are able to license technology developed with government funding through the Bayh-Dole

Act. University and Small Business Patent Procedures Act, 35 U.S.C. §§ 200-212 (2006). See

Soderstrom at 7-9 (3/18/09) (discussing Bayh-Dole Act). Universities may also receive direct funding

from corporate sponsors and enter licensing agreements based on that funding. Mimura at 19-20, 50-55

(5/4/09) (describing $500 million award by British Petroleum to the University of California’s Lawrence

Berkeley Laboratory and the University of Illinois at Urbana-Champaign made in exchange for licensing

options).

universities, leading to over 700 new products.29 In that same year, colleges and universities

were awarded over 3,000 U.S. patents.30

Open innovation based on technology transfer provides significant benefits to consumers.

It allows a division of labor between the creation of new technology and the manufacture and

marketing of new products, with the efficiencies of specialization.31 Commentators report that

small companies are often more creative and agile than large companies when inventing new

technology.32 But a large company may be better able to develop the technology into a

marketable product and deliver it to consumers. This is especially true when the small company

lacks the resources needed for commercialization.33 Thus, the goal of many start-ups is to attract

the investment needed for initial development,34 demonstrate the soundness of its technology,

and become an attractive target for acquisition or collaboration with a larger company.35

Open innovation based on technology transfer also benefits consumers by increasing

sources of new technology and competition among technologies. By removing the need for an

inventor to commercialize his invention himself, technology transfer lowers barriers to entry.

For instance, the ability of semiconductor design houses to license their technology has allowed

them to specialize in one aspect of the semiconductor industry without the need to own

Soderstrom at 8-9 (3/18/09); see also WARF Comment at 1-2 (5/19/09); NATIONAL ACADEM Y OF

SCIENCES , COM PUTER SCIENCE AND TELECOM M UNICATIONS BOARD , INNOVATION IN INFORMATION

TECHNOLOGY 5-8 (2003), available at http://www.nap.edu/html/innovation_in_IT/reportbrief.pdf

(university research in information technology led to new product categories with billion-dollar markets).

U.S. PATENT AND TRADEM ARK OFFICE , U.S. COLLEGES AND UNIVERSITIES : UTILITY PATENT GRANTS

1969-2008, available at http://www.uspto.gov/web/offices/ac/ido/oeip/taf/univ/asgn/table_1_2008.htm.

ADAM SM ITH , THE WEALTH OF NATIONS (5th ed. 1905) (providing the fountainhead of economic

thought about the substantial benefits flowing from division of labor and specialization).

ANTHONY BREITZM AN & DIANA HICKS , OFFICE OF ADVOCACY , SM ALL BUS . ADM IN ., AN ANALYSIS OF

SM ALL BUSINESS PATENTS BY INDUSTRY AND FIRM SIZE , at v (Nov. 2008) (asserting that small

companies are more likely to develop an emerging technology and attempt to build a business around it

than are large companies).

Edmund W. Kitch, Elementary and Persistent Errors in the Economic Analysis of Intellectual Property,

53 VAND . L. REV . 1727, 1740 (2000); Arora et al., supra note 26, at 366-67; Arora at 33-34 (3/19/09);

Stern at 39 (3/19/09); Bessen at 45 (3/19/09); Bright at 21-22 (5/4/09); Miller at 155 (3/18/09).

This funding can come from venture capitalists, angel investors and family and friends. Stuart J.H.

Graham, Robert P. Merges, Pam Samuelson & Ted M. Sichelman, High Technology Entrepreneurs and

the Patent System: Results of the 2008 Berkeley Patent Survey, 24 BERKELEY TECH . L.J. 1255, 1306-07

(2010).

James Young Comment (2/5/09); Arora et al., supra note 26, at 367; BRANSCOMB & AUERSWALD ,

supra note 2, at 44 (small companies use joint ventures with large companies for access to manufacturing

and marketing resources).

expensive manufacturing facilities. Lower barriers to entry into the creation of technology can

increase sources of R&D.36 This in turn can increase competition among technologies for

funding to be developed and commercialized. That competitive process allocates resources to

the most promising ideas having the greatest chance of generating products most valued by

consumers.37

III.

PATENTS FACILITATE OPEN INNOVATION AND TECHNOLOGY

TRANSFER

Patent rights facilitate an open innovation strategy, including collaboration and

technology transfer, in multiple ways.38 This can be especially true when start-ups and small

companies are involved. This section examines how patents facilitate open innovation in order

to identify areas of patent law that impact this dynamic and the alignment of patent law and

competition policy.

Patents facilitate open innovation and technology transfer by creating rights based on

intangible concepts, which makes contracting easier and helps create a market for ideas.39 As

one panelist explained, “the IP serves a very valuable function in being a facilitating force in

collaboration with third parties, joint ventures, joint developments. It’s a tool that enables us to

do more business with more players in a more open and collaborative fashion.”40 In a

collaboration, patents can help identify what each party brings to the relationship and how

Chesbrough at 216-22 (5/4/09). See also Maghame at 169-70 (2/11/09) (stating that Tessera, a $1.2

billion company, has signed up over 50 major companies as licensees); Lord at 174 (2/11/09)

(“[Amberware] decided from the outset that the flexibility of the licensing business model made a lot of

sense for the company.”); Ryan at 51 (4/17/09) (predicting an increasing number of pure invention and

innovation companies that license their technologies).

A STRATEGY FOR AM ERICAN INNOVATION , supra note 1, at ii, 6-7; BRANSCOMB & AUERSWALD , supra

note 2, at 35 (arguing that inventions compete for development funding in a “Darwinian Sea” with “big

fish and little fish contending, with survival going to the creative, the agile, the persistent”).

Chesbrough at 216 (5/4/09) (“[I]ntellectual property can enable this division of the innovation labor.”);

Arora at 29-31 (3/19/09) (a market for technology is necessary to establish a division of labor in

innovation); Bessen at 45 (3/19/09).

Stern at 37-41 (3/19/09) (discussing the hypothesis that “effective intellectual property promotes trade

in the market for ideas, and, therefore, enhances the efficient cooperative commercialization of new

technology”); id. at 42 (licensing by entrepreneurs increases dramatically immediately following patent

grant); Meyer at 69 (2/12/09) (patents encourage “the dissemination of knowledge that’s developed by

one set of individuals and then can be used throughout the economy”).

Horton at 147 (3/19/09). See also Kieff at 60-61 (3/19/09) (patents and strong patent rights facilitate

coordination among owners of complementary assets).

products of the collaboration will be managed.41 In a technology transfer agreement, patents can

define the rights to be transferred.

Thus, patent transactions (licensing and sales) form the basis of many technology transfer

agreements.42 Patent transactions that occur as part of a technology transfer agreement can be

considered ex ante because they occur before the purchaser has obtained the technology through

other means. Such ex ante patent transactions accompanied by technology transfer have great

potential for advancing innovation, creating wealth and increasing competition among

technologies.43

Patent Exclusivity Encourages Invention, Development and Disclosure

Patents play additional roles in facilitating open innovation and technology transfer that

go beyond defining rights and supporting ex ante patent transactions. They can encourage sellers

of technology to invent in the first place and buyers of technology to make the purchase and

invest in further development.44 By giving a patent owner the right to exclude others from

making, using or selling the invention for 20 years,45 a patent enables him to capture returns from

R&D investment by preventing others from appropriating the invention and driving down prices

through infringing competition.46

For the patent system to promote innovation effectively, it must do more than encourage

invention. It must also encourage the development of inventions to the point of

Miller at 154 (3/18/09); Griswold at 159 (3/18/09); OPEN INNOVATION : RESEARCHING A NEW

PARADIGM , supra note 7, at 10; Chesbrough at 227-28 (5/4/09); Biotechnology Industry Organization

(BIO) Comment at 2 (5/15/09).

Phelps at 250 (5/4/09) (intellectual property rights are the necessary “scaffolding” to build a bridge

between two parties).

Ex ante patent transactions contrast with ex post patent transactions, which occur after the user of the

technology has invested in its independent invention and development, without input from the patentee.

In this case, the licensee/purchaser already practices the patented technology when approached by the

patent owner, so the patent transaction transfers only a legal right, not technology. Chapter 2 discusses

the effects of ex post patent transactions on innovation and competition among technologies.

See Miller at 154 (3/18/09) (P&G’s open innovation model depends on strong patent protection).

35 U.S.C. § 154(a)(2).

FREDERIC M. SCHERER & DAVID ROSS , INDUSTRIAL MARKET STRUCTURE AND ECONOM IC

PERFORMANCE (3d ed. 1990); Kenneth Arrow, Economic Welfare and the Allocation of Resources for

Innovation, in THE RATE AND DIRECTION OF INVENTIVE ACTIVITY : ECONOMIC AND SOCIAL FACTORS 609

(1962). See also Thomson at 88-89 (5/4/09) (patent licensing provides revenues to cover R&D expense

while preventing competitors from copying, “under sell[ing] your price and driv[ing] you out of

business”).

commercialization, either by the original inventor or through technology transfer by another

firm.47 An invention may require extensive development before any commercial application is

possible.48 In a modern economy, development accounts for more than three-fourths of industrial

R&D expenditures.49 One panelist explained, “[t]he creation of an idea is frequently the least

costly and least time consuming aspect of product success. Development budgets vastly exceed

research budgets in R&D intensive companies. Much more time and substantially more

investment is required to commercialize a product or service embodying an invention than to

create the invention in the first place.”50

Through the patent, an inventor or purchaser of technology can carve out an exclusive

area for development and commercialization in the hope of recouping development costs.51 For

instance, the ability of the patent system to protect early-stage invention and allow investors to

recoup development costs is critical to the biopharmaceutical industry, where product

development is lengthy, costly and unpredictable.52 Panelists from a wide range of other

industries, including the pharmaceutical and medical device industries,53 diverse manufacturing

Kieff at 60 (3/19/09).

The period between the basic research generating an invention and the innovation resulting in a

commercializable product has been called the “Valley of Death” to dramatize the practical, technological

and financial difficulties of early-stage development. See BRANSCOMB & AUERSWALD , supra note 2, at

35-41 (detailing those difficulties).

SCHERER & ROSS, supra note 46, at 440.

McCurdy at 43 (12/05/08) (IBM’s development budget was 20 times greater than its research budget).

SCHERER & ROSS , supra note 46, at 444; Edmund W. Kitch, The Nature and Function of the Patent

System, 20 J.L. & ECON ., 265, 271-72, 276 (1977); Katznelson at 22-23 (3/18/09) (describing how

development process evolves and the need to file continuation applications to protect potential products);

Horton at 146-47 (3/18/09) (patent rights are needed to support “a return on the successful investments

sufficient to make up for the unsuccessful investments”).

Shema at 15-16, 25 (5/4/09) (“ZymoGenetics and its products would not exist but for patents and but

for confidence in a strong U.S. patent system.”); Soderstrom at 9-10 (3/18/09) (initial biotech inventions

are “a long way from the marketplace and . . . require a substantial investment over a period of time”);

FED . TRADE COM M ’N , EM ERGING HEALTH CARE ISSUES : FOLLOW -ON BIOLOGIC DRUG COM PETITION 2830 (June 2009) (describing the innovation cycle for biopharmaceuticals); Pharmaceutical Research and

Manufacturers of American (PhRMA) Comment at 5-6 (2/10/09).

Myers at 221 (3/18/09) (“[I]nnovation by our R&D operations and strong patent protection for that

innovation is critical to [Pfizer’s] success.”); Jensen at 218 (3/18/09) (medical device).

industries,54 and the IT sector55 emphasized the importance of patents to a robust innovation

strategy.56

Patents can also facilitate open innovation and technology transfer by disclosing available

technology. The disclosure of scientific and technical information is part of the consideration

that the inventor gives the public in exchange for the exclusive patent right. By offering

protection from appropriation even after the invention becomes public, patents encourage

inventors to make public what they might otherwise keep secret. That disclosure provides

information to potential buyers and helps identify opportunities for collaboration.57 Having

patents and patent applications can also protect start-ups from copying when they must disclose

their inventions to potential investors and collaborators.58

Griswold at 142-43 (3/18/09) (importance of patent system to 3M); Horton at 147 (3/18/09) (at GE,

“we see IP as a very strong motivating force to drive innovation and investment in R&D”); Stec at 152

(3/18/09) (“patents are very important to Ford”); Phillips at 152 (3/18/09) (“But for a strong patent

system in the United States, much of [Exxon’s] technology would not be developed or if developed

would not be licensed.”).

Rodgers at 136 (3/18/2009) (“Qualcomm’s “R&D is dependent on a strong patent system.”); Lutton at

90 (5/4/09) (“Patents do allow [Apple] to quantify, capture, protect, and in some cases license the value

of our innovations.”); Harris at 72 (3/18/09) (AOL holds 500 patents and uses patents to encourage

innovation); Guitierrez at 93, 129-30 (5/4/09) (IP, including patents, is important for protecting

innovation in the software industry where barriers to copying are low).

As documented and discussed at length elsewhere, however, the role that patents play in protecting a

company’s technology and how that role compares to other means of recouping R&D costs varies by

industry and by the particular circumstances of the company and technology involved. For instance, first

mover advantage and trade secrets are often important methods of recouping R&D investments,

especially in the IT sector and software industry. See 2003 FTC IP Report, ch. 3, at 1-3; JAM ES BESSEN

& MICHAEL J. MEURER , PATENT FAILURE : HOW JUDGES , BUREAUCRATS , AND LAW YERS PUT

INNOVATORS AT RISK (2008); DAN L. BURK & MARK A. LEM LEY , THE PATENT CRISIS AND HOW THE

COURTS CAN SOLVE IT (2009); W.M. Cohen, R. R. Nelson, & J.P. Walsh, Protecting Their Intellectual

Assets: Appropriability Conditions and Why U.S. Manufacturing Firms Patent (or Not), (Nat’l Bureau of

Econ. Research, Working Paper No. 7552, 2000).

SCHERER & ROSS , supra note 46, at 444. See Katznelson at 40-42 (3/19/09) (reviewing patents

provides technical information and leads to design-around); F. Scott Kieff, Coordination, Property, and

Intellectual Property: An Unconventional Approach to Anticompetitive Effects and Downstream Access,

56 EM ORY L.J. 327 (2006) (patents encourage collaboration).

Katznelson at 27, 34 (3/18/09); Van Pelt at 119-20 (5/4/09) (start-ups in the IT sector may also seek

patents to provide protection against a large firm adopting its technology); Arora et al., supra note 26, at

18-19; Hall at 204 (5/4/09).

Patenting by Small Companies and Start-ups

The ability of patents to play several roles in facilitating open innovation can be

particularly important to small companies and start-ups because they often transfer their

technology to larger companies for commercialization. That dynamic, coupled with the dramatic

growth in the amount of R&D conducted by small companies, warrants a closer examination of

how small companies pursue and use patents to further innovation. That information can help

identify the issues that should inform any attempts to align patent and competition policy.

In some sectors, patenting by start-ups appears to be common. One study of start-ups

founded between 1987 and 1999 revealed that patenting by start-ups was common in the medical

device and semiconductor sectors.59 A 2008 survey of high-technology entrepreneurs also found

that patent ownership was widespread among responding venture capital-backed start-ups in the

biotechnology, medical device and IT hardware industries, although less common in the software

industry.60 Patenting may be common because start-ups view it as an important means of

securing competitive advantage from their technologies.61

Panelists representing start-ups explained that having patents was important to their

ability to attract investment capital.62 Without a product, one of a start-up’s most valuable assets

may be its patent estate, and investors may view patents as important for recouping their

investment, according to panelists.63 Investors may also view patents as a signal of technical

Among those that had received venture capital funding, for every $10 million invested, medical device

start-ups filed an average of nine patents, semiconductor firms an average of 6.5 patents, and software

firms an average of about three patents per $10 million invested. Ziedonis 188-93 (12/4/09); Rosemarie

Ziedonis, Startups as Sources of New Technologies . . . and Patents, presented at FTC Hearing: The

Evolving IP Marketpace (May 4 2009), available at

http://www.ftc.gov/bc/workshops/ipmarketplace/may4/docs/rziedonis.pdf. In each of the three sectors,

larger, publicly traded firms have similar patenting rates per R&D spending dollar as do the start-ups of

this study. Hall at 200-01 (5/4/09); see Bronwyn Hall, FTC Panel on Markets for IP and Technology,

presented at FTC Hearing: The Evolving Marketplace (May 4, 2009), available at

http://www.ftc.gov/bc/workshops/ipmarketplace/may4/docs/bhall.pdf.

Graham et al., supra note 34, at 1277 tbl.1 (2010) (97% of responding, venture capital backed

biotechnology start-ups sought patents; 94% for medical device; 91% of IT hardware; 67% of software).

Start-ups without venture-backing were less likely to hold patents. Id.; see also BREITZM AN & HICKS ,

supra note 32 (reporting on patenting rates by small companies).

Graham et al., supra note 34, at 1287-90.

Sousa at 89, 116-17 (5/4/09) (explaining that investors in solar cell technology company wanted to see

that a start-up has patents, but not all are sophisticated about the content and quality of individual

patents); but see Devore at 43 (5/4/09) (“Most venture capitalists use attorneys who are trained . . . to

actually look through the portfolios . . . freedom-to-operate analysis is getting more and more savvy.”).

Singer at 228-29 (3/18/09) (“[W]ithout that patent estate, there’s really nothing for the venture firm to

make an investment in.”); Devore at 31 (5/4/09) (venture capitalists seek “the ability to claim the ongoing

merit and promise, or as a defensive measure supporting freedom to operate where the patents of

competitors present a risk.64 The founder of a medical device company elaborated, “the patent

was very important because significant investment was necessary. . . . Every time we got serious

with a venture capitalist, they wanted to understand if our patents had teeth, if we could really

protect our innovation, and fortunately we did.”65 Panelists representing IT start-ups stated that

those companies often needed patents to attract investment,66 although the importance of having

patents depended on the business model of the start-up.67 A survey of start-up companies

confirms that patents play an important role in attracting all types of investment, but in particular

venture capital,68 although the degree of importance appears to vary by industry.69

For some start-ups, one important feature of the patent system’s exclusive right is that it

can allow a new entrant to obtain and maintain a competitive advantage in the market. In some

cases, when a new entrant challenges an entrenched incumbent with market power, the new

entrant’s patents may be critical to its ability to survive and inject competition into a product

market. For instance, one panelist described how patent protection allowed him, as an

independent inventor, to develop a medical device invention into a start-up and ultimately a

NASDAQ-traded company. His product quickly took market share from the market leader

because of its significant advantages. But that market leader began infringing his patent in an

rights to any of the IP that comes from the future research”); Bellon at 227-28 (3/18/09).

See Graham et al., supra note 34, at 1306-07; Graham at 217 (4/17/09); Cockburn at 218 (4/17/09); Van

Pelt at 87 (5/4/09) (IT start-ups see patents as a risk factor as well); Lutton at 123 (5/4/09) ( “The patent

value and its necessity to an enterprise is judged really in relation to the business options that it

creates.”).

Kiani at 13 (3/18/09); Bright at 30-31 (5/4/09) (At a medical device start-up, “the amount of time that I

spend answering questions on the IP is significant.”).

Woolston at 33 (3/18/09) (“the world definitely changes when a patent issues”); Soderstrom at 35

(3/18/09) (in the IT sector, you “don’t even have a conversation” with potential licensors and investors

until a patent issues).

Van Pelt at 118-19 (5/4/09) (explaining the role of patents in different business models).

Graham et al., supra note 34, at 1306-07. See also PhRMA Comment at 6-7 (2/10/09); BIO Comment

at 1-2 (5/15/09); American Intellectual Property Law Association Comment at 1-2 (5/15/09); Lasersohn

at 185 (2/11/09). Patents appear less important but not irrelevant for attracting investment in software

start-ups. Graham et al., supra note 34, at 1308-1309.

Patents appear more important for attracting investment to biotechnology and medical device start-ups

compared to software and Internet start-ups. Graham et al., supra note 34, at 1282-83; Lemley at 194

(4/17/09) (patents may help attract venture capital for software, but investors place less emphasis on

validity and scope of the patents). See also Ronald J. Mann & Thomas W. Sager, Patents, Venture

Capital, and Software Start-ups, Research Paper No. 057 (2006), available at

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=802806; R. J. Mann, Do Patents Facilitate Financing

in the Software Industry?, 83 TEX . L. REV . 961 (2005).

attempt to win back customers. Patent litigation, although long and arduous, was successful. He

explains, “we had many obstacles, and despite the frustrations we had with the patent system,

without it, we wouldn’t be here today.”70

Many start-ups seek patents with less focus on entering the market alone and more to

improving their chances of entering a successful acquisition or collaboration agreement with a

larger firm.71 For instance, panelists report that a biotech start-up’s patent position is critical to

the acquisition decision. Before making the acquisition, the larger company will evaluate

whether the start-up’s patents provide sufficient protection for an exclusive market position and

whether it will have freedom to operate.72 Panelists report that a start-up’s patent position is

important to acquisition decisions in the medical device industry also.73

Several factors may motivate the acquisition of a start-up in the IT industry, but panelists

report that patents can sometimes be a significant element of the acquisition decision.74 The

more an acquisition focuses on obtaining and developing new technology, the more important a

start-up’s patent position will be.75 One IT panelist described attractive acquisition targets as

forward looking, with good technology, and a good patent position.76 Patents can establish the

“bona fides” of the acquisition target, especially when the acquiring company seeks to use the

new technology to differentiate its product.77 Another panelist explained the patent protection

also gives the acquiring company “the opportunity to determine the future course of that

technology beyond just what’s inherent in trade secret and knowhow protection.”78

Kiani at 12 (3/18/09); see also id. at 11-16; Masimo Home Page, http://www.masimo.com.

Graham et al., supra note 34, at 49-51.

Watt at 48 (5/4/09) (noting that Amgen will not invest in a start-up if the patents are not viable, if they

do not afford freedom to operate, or if they cannot create sufficient exclusivity to reward the investment).

Bright at 21-22 (5/4/09) (utilizing start-ups’ intellectual property is efficient).

Thompson at 107 (5/4/09); Lutton at 124 (5/4/09) (start-ups want to obtain patents because they

preserve options that a later-acquiring entity may want to exploit).

Van Pelt at 105, 118-19 (5/4/09); Rogers at 103-04 (3/18/09) (start-up’s patent position is “absolutely

critical” to acquisition decision); Sarboraria at 104 (3/18/09) (agrees); Krall at 106-07 (3/18/09)

(acquisition strategy of adding complimentary technology requires an examination of the target’s patent

position).

Rogers at 103 (3/18/09).

Guitierrez at 102-03 (5/4/09).

Lutton at 102 (5/4/09).

IV.

AREAS OF PATENT POLICY THAT AFFECT OPEN INNOVATION AND

TECHNOLOGY TRANSFER

The patent system contains multiple areas of law and policy that affect the ability of

patents to facilitate open innovation, technology transfer and ex ante patent transactions. Chief

among the attributes of a well-functioning patent system in this regard are appropriately granted,

valid rights with well-defined boundaries that provide clear notice of what technology is

protected and what is not. Panelists were clear about the importance of these attributes,79 but

they expressed concern about the uncertainty that pervades throughout the patent system and its

effect on innovation and competition.80

Panelists identified the uncertain validity of issued patents as an important problem.81

Purchasers of technology often want dependable patent coverage before investing the funds

necessary for development and commercialization. They may decide against an investment if not

sufficiently confident of the protection provided by key patents, according to some panelists.82

Moreover, patents of questionable validity can distort competition and inhibit innovation by

discouraging firms from conducting R&D in areas that the patent improperly covers and raising

costs through litigation or unnecessary licensing.83 The FTC’s 2003 IP Report discusses the

importance of patent quality for achieving a proper balance between exclusivity and competition.

Because that report makes recommendations for improving patent quality,84 this report will not

See e.g., Phelps at 250 (5/4/09); Crean at 96-97 (5/4/09); Stern at 42-43 (3/19/09) (clear and timely

patent rights are needed to facilitate a market for ideas); Horton at 164-65 (3/18/09) (clear patent rights

are needed to define technology to be transferred and facilitate collaborative relationships); Bessen at 7475 (3/19/09) (same).

Wagner at 192 (4/17/09); Cockburn at 192-93 (4/17/09); Graham at 142-43 (4/17/09) (uncertainty over

the scope and validity of patents adds transaction costs to technology transfer and injects inefficiencies

into developing markets for IP).

Id.; Chesbrough at 228 (5/4/09); Stern at 40-41 (3/19/09).

See DeVore at 31 (5/4/09); Shema at 32 (5/4/09).

2003 FTC IP Report, Exec. Summ., at 5-7.

For instance, the report recommends that Congress establish a post-grant review procedure for

challenging patent validity and change the standard of proof for invalidating patents from clear and

convincing to preponderance of the evidence. 2003 FTC IP Report, Exec. Summ., at 5-7. Some panelists

suggested a post-grant review procedure for patents as one way to address the problem of patent quality.

Graham at 143 (4/17/09). Other panelists argue that a validity challenge to a start-up’s patent can “shut

down” its ability to raise the capital needed to develop an invention. Woolston at 57-60 (3/18/09)

(discussing the problems of a start-up whose patent is undergoing re-examination in the patent office);

Soderstrom at 60 (3/18/09).

delve into that issue. Patent quality remains vitally important for achieving the balance of

exclusivity and competition that best enhances consumer welfare, however.

Panelists also identified ill-defined patent boundaries as an important issue for the patent

system’s ability to facilitate technology transfer and ex ante patent transactions.85 Patents that do

not clearly identify and define the protected technology undermine attempts at contracting and

prevent potential licensors from finding available technologies through a patent search, according

to panelists.86 One panelist explained, “if you don’t have IP rights that are understood by the

purveyor of them and the receiver of them, you don’t have the necessary scaffolding to build a

good . . . bridge there between the two sides.”87 These concerns directly implicate the patent

system’s notice function, meaning the ability of a patent to inform the public of what technology

it protects. Thus, improvements in the notice function, proposed in Chapter 3, can enhance the

ability of the patent system to promote innovation through technology transfer.88

Remedies (damages and permanent injunctions) awarded following a finding of patent

infringement presented another area of concern for panelists who represent small companies,

start-ups and others that frequently engage in technology transfer. These panelists worried that

recent proposals, described in Chapter 6, concerning damages could lead to systematically lower

damage awards. They argued that reducing the value of patents or injecting additional

uncertainty and complexity into damages calculations would undermine the patent system’s

incentives to invest in risky R&D. Lower damages would also encourage infringement rather

than licensing, they argued.89 Chapter 2 presents the competing concerns of other panelists that

inflated damage awards distort competition among technologies and encourage unproductive

litigation. Chapters 4 through 7 attempt to align patent damages law with competition policy by

Chesbrough at 228 (5/4/09); Stern at 40-41 (3/19/09).

Lemley at 147-48 (4/17/09) (observing that notice problems contribute to “leav[ing] a lot of

transactional money on the table in the sense that transactions that should have occurred, that would

benefit both the buyer and seller, don’t occur”); Bessen at 50 (3/19/09) (“deals don’t happen that could

happen”); Wagner at 192 (4/17/09) (“every bit of uncertainty . . . undermines” the ability to engage in

technology transfer).

Phelps at 250 (5/4/09).

There is a trade-off between clear notice and the scope of patent protection, however. Changes that

might significantly increase notice might not fully protect an invention and decrease incentives to

innovate. Chapter 3, Section IV.B.1, infra, discusses this trade-off.

Rhodes at 196 (2/11/09) (if you “decrease damages, you do lose part of the deterrent [e]ffect against

infringement”); Lasersohn at 183 (2/11/09) (“If you do not allow inventors to capture the full economic

value of their invention . . . . the amount of [projects] that will qualify for venture capital financing will

decrease.”); NanoBusiness Alliance Comment (2/15/09) (“Changes which reduce our ability to receive

adequate compensation for infringement of those patents will make it difficult to protect our intellectual

property, and therefore will discourage investment in our field.”).

balancing these concerns and recommending principles that courts should apply when calculating

damage awards.

Similarly, some panelists worried that under the Supreme Court’s 2006 decision in eBay,

Inc. v. MercExchange, LLC,90 firms engaged in patent licensing might not be able to obtain a

permanent injunction following a finding of infringement. In that case, the Court rejected a

“general rule” supporting a permanent injunction and instead announced four equitable factors

that a patentee must satisfy to obtain an injunction. Without the ability to obtain a permanent

injunction, some panelists argued, their technology might be taken by manufacturing companies

without a license.91 This possibility could decrease the ability of start-ups and technology

transfer companies to attract investment and enter into ex ante patent transactions, according to

some panelists.92 Others welcome eBay’s flexibility because it decreases the ability of “nonpracticing entities” to extract inflated royalties that distort competition among technologies based

on the threat of preventing all sales of an infringing product.93 Chapter 8 presents an analysis that

balances these concerns and aligns injunction law with competition concerns.

CONCLUSION

The growth of open innovation, especially as evidenced by the dramatic rise in R&D by

small companies, involves technology transfer. This trend benefits consumers in multiple ways,

including increased levels of innovation and more competition in markets for technology. The

patent system supports open innovation and technology transfer by encouraging investment in

invention and development, by providing protected disclosure of technology and by defining

rights that facilitate contracting.

The notice function of patents and remedies following infringement both implicate how

well the patent system can fulfill these roles and promote innovation. Both areas of law also

have a significant impact on how the patent system affects competition. The following chapters

describe that impact. They also make recommendations for balancing concerns about the

importance of patent exclusivity with competition and achieving the proper alignment of patent

law and competition policy.

547 U.S. 388 (2006).

Cassidy at 165-67 (2/12/09); Lord at 174-75 (12/11/09); Rhodes at 165 (2/11/09) (effective remedies

for infringement needed to prevent free-riding on others’ R&D).

Ware at 148 (2/12/09) (expressing concern that “venture capitalists will take their funds elsewhere, and

small biotech companies will shrink and die rather than grow”); Ware at 456 (2/12/09) (eBay could have

an adverse effect on university licensing); Katznelson at 53-54 (3/18/09) (describing the effect of eBay

on start-up licensing and business models); Lasersohn at 184 (2/11/09) (injunctions are critical to

promoting investment in new technology).

Chapter 8, Section III.C.

CHAPTER 2

THE EVOLVING PATENT MARKETPLACE:

EX POST PATENT TRANSACTIONS

INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

II.

CONCERNS WITH EX POST PATENT TRANSACTIONS . . . . . . . . . . . . . . . . . . 51

III.

IV.

Beneficial Effects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52

Detrimental Effects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52

CAUSES OF EX POST TRANSACTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54

Patent Notice Problems and Patent Quality . . . . . . . . . . . . . . . . . . . . . . . . . . 54

Patent Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57

DEVELOPMENTS IN SECONDARY PATENT MARKETS BASED ON

EX POST PATENT TRANSACTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58

Increasing Litigation and Patent Sales in the IT Industry . . . . . . . . . . . . . . 58

Evolving Patent Assertion Business Models . . . . . . . . . . . . . . . . . . . . . . . . . 62

EFFECT OF SECONDARY PATENT MARKETS AND PAE ACTIVITY ON

INNOVATION AND COMPETITION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67

VI.

CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71

CHAPTER 2

THE EVOLVING PATENT MARKETPLACE:

EX POST PATENT TRANSACTIONS

INTRODUCTION

While open innovation and technology transfer are important pathways of innovation, not

all patent licensing and sales occur ex ante as part of a technology transfer agreement. In many

cases, the licensee or purchaser already uses the patented technology when approached by the

patent owner. What it lacks is a patent license to use the technology. These patent transactions

occur ex post, after a firm has invested in creating, developing or commercializing the patented

technology. It needs the ex post license to avoid liability even if it invented the technology

independent of the patentee because patent infringement is a strict liability offense. A firm that

makes, uses or sells patented technology is liable as an infringer, regardless of how it obtained

the technology and whether it knew about the patent.1

The ability of patentees to assert their patents against infringers is important to the patent

system’s role in promoting innovation and facilitating technology transfer. The threat of a patent

infringement suit deters infringement and safeguards the exclusivity that is the heart of the patent

system. A business model based on invention followed by technology transfer can only succeed

if a firm can prevent copying and recoup its investment in research and development (R&D).