View Keynote Speech by Hank Barry of Sidley Austin.
Secondary markets for buying and selling patents are an important yet understudied phenomenon. Unlike patent license agreements, patent sales transfer ownership rights from sellers to buyers. According to Joe Chernesky, President of iPotential and a speaker at the event, sales of U.S. patent rights in secondary markets—whether through patent auctions or specialized intermediary organizations—climbed from $200 million to $1.5 billion between 2000 and 2008 but declined in 2009.
What types of deals take place in patent markets? What are the motives of buyers and sellers? What legal and economic factors drive growth or contraction in markets for patent-protected inventions? Do patent markets promote efficiency in the development of new technologies? Or, do they set the stage for patent hold-ups?
To investigate these questions, the University of Michigan (UM) held a one-day research symposium (Markets for Patents: Emerging Practices and Directions for Research) with industry leaders in buying, selling, and licensing patents and an interdisciplinary mix of innovation scholars. The event was organized by Professors Rebecca Eisenberg of the UM Law School and Rosemarie Ziedonis of Michigan’s Stephen M. Ross School of Business, who co-direct the UM Program in Law, Economics, and Technology. The Microsoft Corporation provided financial support through a grant to the Program.
Margaret Levenstein, an economic historian from the Ross School of Business, provided a fascinating glimpse into the buying and selling of patents during the Second Industrial Revolution, activities that were orchestrated primarily by enterprising attorneys and patent agents. By highlighting the deleterious effects of the Great Depression on small firms, Professor Levenstein’s presentation raised broader questions about how the current economic downturn will affect entrepreneurial firms as sources of innovation. Are innovative regions like Silicon Valley at risk of decline? In ongoing work, Professor Levenstein and colleagues hope to glean lessons from the past by investigating how capital constraints in the 1930s altered sources of innovation across American cities.
Providing added historical perspective, Arvids Ziedonis of the Ross School’s Strategy Department traced the rise to prominence of U.S. universities as suppliers of patented inventions. Synthesizing findings reported in his 2004 book, the Ivory Tower and Industrial Innovation (with David Mowery, Richard Nelson, and Bhaven Sampat), Professor Ziedonis attributed the increase in university patent holdings and technology licenses to numerous factors, including the Bayh-Dole Act of 1980, federal funding for biomedical research, and a few “big hit” discoveries like recombinant DNA technologies.
Interestingly, Robin Rasor, Director of Licensing at UM’s Technology Transfer Office, noted that few universities sell patents outright. Instead, universities tend to retain legal title to inventions and pursue bilateral licensing agreements. Retaining ownership rights helps ensure that sufficient effort is devoted toward commercializing (rather than “shelving”) the technology and confers greater control over enforcement decisions. Ms. Rasor also said there are different “norms” regarding patent sales in Life Science-related sectors, where the bulk of university licensing activity takes place. To date, secondary patent markets are primarily used to sell Information Technology (IT)-related inventions.
University of Toronto Economist Carlos Serrano shared findings from his studies of modern U.S. patent markets. Using data on patent ownership changes from 1980-2001, Professor Serrano has conducted one of the first systematic analyses of transfers and renewals of U.S. patents. According to estimates in his forthcoming Rand Journal of Economics article, the market for patents is quite large, with 13.5% of all U.S. patents being reassigned at least once. Not surprisingly, this estimate is considerably higher for more valuable inventions. More striking, Professor Serrano finds that patents in drugs and medical fields have higher rates of trading than patents in computing and electronics sectors. These trends raised unresolved questions about how and why patent trading differs across industries.
A panel on “the Business of Buying and Selling Patents,” featured executives from intermediary organizations: Joe Chernesky of iPotential, Ron Laurie of Inflexion Point Strategy, and Mike Lasinski of Capstone Advisory Group and formerly of Ocean Tomo.
Those panelists agreed that trade in secondary markets is primarily driven by the dynamics of patent assertion within the IT sector. As Ron Laurie put it, “patents trade only if they create pain or remove it.” For operating-company buyers, the calculus then becomes whether to participate in the market indirectly --via patent “aggregate” organizations like Intellectual Ventures or “defense funds” like Allied Security Trust -- to “self-insure” through unilateral purchases and internal patent filings, or to diversify through a combination of approaches. Trade-offs among these strategic options clearly exist but have not been systematically examined in prior research.
A high-profile example of the “self-insurance” route is Novell’s $15 million purchase of Commerce One patents in 2004. Concerned that the electronic commerce patents would fall into the hands of an “assertion company” at bankruptcy proceedings, Novell safeguarded itself (and presumably its customers and other potential adopters) by preemptively purchasing the patents. In a later presentation, Robert Glushko, an inventor of the Commerce One patents and co-founder of the startup that produced them, recalled the tremendous relief he felt when news of Novell’s purchase was announced. The prospect that his patents could hold up users of the architecture was a “disaster,” Mr. Glushko said. He added that he tried to form a consortium to bid for the patents but was unsuccessful. It “takes time” to pull such deals together, he noted—a luxury ill afforded by strict deadlines in a bankruptcy process.
Several panelists consistently characterized the process of identifying, valuing, and negotiating patent sales as costly and difficult. Is the patent encumbered by licenses? Is it likely to be held valid, if infringed? How large a market is covered by the invention? According to Ron Laurie, the cost to perform “due diligence” on large patent portfolios can exceed $1 million. More generally, qualified patent brokers typically charge commissions of 20-25 percent. Due to the inherent riskiness of the transactions, high discount rates typically apply when calculating returns anticipated on investments. Unless patents cover large (more than $100 million) markets, these expenditures can be difficult to justify.
Do the costs of transacting in patent markets consume all gains from trade? Not necessarily. Low-quality deals appear to get “filtered out” by intermediaries and savvy buyers. Other times, large sums of money can change hands. Consider the case of Longboard in Joe Chernesky’s presentation. Strapped for cash, the private company raised over $5 million by selling its patents for voice-over-internet protocol (VOIP) technologies. The amount far exceeded the company’s initial expectation of $1.5 million. Absent comparable statistics from other patent sales, it is difficult to know whether $5 million is typical or in the upper tail of the value distribution for patents traded through secondary markets.
Panelists agreed that patent markets have changed dramatically. Exactly when and why that change has occurred was less clear. Relative to the “frothy” period of the early 2000s, the current environment was portrayed as a buyer’s market—with a corresponding shift toward fewer, higher quality deals. Michael Lasinski attributed part of the shift to judicial action, including Supreme Court decisions in the KSR and eBay/MercExchange cases that reduced the bargaining power of patent owners. Mr. Laurie and Mr. Chernesky further credited the shift to greater sophistication among corporate buyers, the severity of the current recession, and an explicit shift in policies at Intellectual Ventures (a dominant purchaser of patents) toward more selective purchasing.
Hank Barry of Sidley Austin, in a lunch presentation, provided a wonderful overview of patent markets and the different types of businesses that serve them. Mr. Barry, an experienced Silicon Valley attorney and investor, is perhaps best known as the former CEO of Napster. Since working with several colleagues on a proposed “patent defense” fund in 2006, he has followed patent markets with great interest.
Building on points from the morning panels, Mr. Barry took a closer look at alternative business models for buying and selling patents, including that of Intellectual Ventures. Mr. Barry also called for greater disclosure requirements in patent markets. In principle, requiring buyers and/or sellers to disclose information about prices and deal terms in patent acquisition and licensing transactions could be a boon for academic researchers. Unlike public equity markets or M&A transactions, prices in patent-related transactions are rarely made public, thus making it more difficult to track and analyze behavior. The proposal ignited considerable debate among attendees at the conference, as captured in the video of Mr. Barry’s remarks.
Another panel solicited input from “R&D performers” on the opportunities and challenges created by secondary patent markets. Panelists included senior executives from several large IT companies, including Microsoft (Taylor Hawes, CFO of IP Licensing), IBM (Joyce Koontz, Director of IP Programs), and Analog Devices (Jason Fiorillo, Senior IP Counsel). Robert Glushko, co-founder of multiple software companies, and Robin Rasor, UM’s Director of Licensing and the President-Elect of the Association of University Technology Managers (AUTM), also served on the panel.
Why buy patents? The most common motive appeared to be defensive in nature, to diffuse threats of actual or anticipated litigation by, for example, using acquired patents in counter-assertions of infringement. Panel members also cited a desire to strengthen in-house portfolios when moving into new product segments. Perhaps surprisingly, corporate representatives rarely mentioned “further commercialization” as a motive for purchasing patents. When the goal is to further develop and commercialize outside inventions, technology licenses and M&A transactions -- where human capital is typically bundled with the rights-- seem better suited for the task.
Although difficult to quantify, corporate “buyers” of patents appear to have grown more sophisticated over time. Taylor Hawes, for example, brings an accounting and finance background to his role as CFO of IP Licensing at Microsoft. His presentation revealed methods used internally to quantify the defensive and strategic value of patent holdings and acquisition options. Joe Chernesky noted that Intel launched its “patent purchasing program” in 1999, with other IT firms following suit on an ad hoc basis.
Joyce Koontz of IBM discussed some of the challenges associated with selling patents. Which patents should you sell? Who are potential buyers? What price should you charge? For a firm like IBM with 40,000 patents, answering these questions can be costly. One option is to view patent sales as an alternative to abandonment. Instead of failing to pay maintenance fees required on the patent, why not offer it for sale in hopes of recouping some costs on the initial investment? If this decision rule is common among corporate sellers, it raises obvious concerns of Akerloff-type “lemons” problems long studied in economics. Alternatively, patents could be considered for sale on an ad hoc basis, such as when outsiders express interest in particular patents for use in counter-assertions.
Echoing points made earlier, speakers on the R&D performer panel felt that dynamics in patent markets have changed considerably over the past five years. Several panelists observed an apparent increase in the supply of patents available for purchase from failed or struggling companies. More broadly, the U.S. Supreme Court decisions in KSR (on obviousness requirements) and eBay/MercXchange (on criteria for granting preliminary injunctions) were mentioned as key events that eroded the bargaining power of some outside patent owners. Jason Fiorillo of Analog Devices explained how recent procedural rulings by the Federal Circuit regarding venue choice had lowered the cost of combating allegations of patent infringement. Mr. Fiorillo said the rulings make it easier to transfer patent cases out of the Eastern District of Texas and other jurisdictions with “plaintiff-friendly” reputations.
Wrapping up the event, Professors Rosemarie Ziedonis of the Ross School, Pam Samuelson of the Law and Information Schools at UC Berkeley, and Rebecca Eisenberg of the UM Law School identified unresolved issues that surfaced throughout the day and discussed opportunities for further study.
Returning to historical examples, Professor Ziedonis drew parallels between the modern IT sector and the railroad industry of the 1800s. By the mid-1800s, railroad companies faced an “expanded minefield of potential lawsuits and financial liabilities” due to outside patents. Struggling to respond, the railroad companies first did nothing, then dealt with conflicts on a case-by-case basis, then cooperated with one another. When the Western Railroad Association was formed in 1876, its primary role was to provide a common defense against patent asserters. Why hasn’t a similar institutional solution emerged within the modern IT industry? One can imagine several reasons, antitrust concerns among them. (The Sherman Antitrust Act was not enacted until 1890.) Instead, IT firms have responded with a wide range of private and collaborative initiatives, and their effectiveness remains unclear. Whether greater liquidity in patent markets alleviates or amplifies hold-up problems in the IT sector is a related question worthy of further investigation.
More broadly, Professor Samuelson discussed the value of “joining forces” across academic disciplines to investigate topics related to patents and innovation. To illustrate the advantages of this cross-disciplinary approach, she discussed a survey that she and colleagues at the Berkeley Center for Law and Technology (BCLT) have conducted on the perceived value and use of patents among entrepreneurial firms. The survey was conducted with Professor Robert Merges (also at UC Berkeley’s Law School), Ted Sichelman (a former Microsoft Fellow at BCLT, now on the faculty at UC San Diego School of Law), and Stuart Graham (a Strategy Professor at Georgia Tech). This large-scale initiative is providing the basis for a series of important papers, and provides a useful role model for future research.
In conclusion, Professor Eisenberg revisited conference themes and reflected upon questions left unanswered. Among them, “Do patent markets help or hinder technological progress?” is perhaps the most important. This question also is exceedingly difficult to answer within the context of a single study. In light of this challenge, the most promising pathway for future research may be to strive first toward gaining a better understanding of the forces affecting behavior in patent markets, ideally in both IT and non-IT sectors. Although this event provided a valuable glimpse into such behavior, it could be analyzed more fully through case studies, structured interviews, and/or surveys.
Secondary patent markets are an understudied phenomenon. We hope that this event, the video of Mr. Barry’s remarks, and this summary stimulate ideas for research on this important topic.
By Rebecca Eisenberg and Rosemarie Ziedonis
Co-Directors, UM Program in Law, Economics, and Technology