How Patents Enable Mavericks and Challenge Incumbents

Advocates for “patent reform” have long argued that reducing patent protection will open up markets and accelerate innovation by lowering entry barriers and expanding access to existing technologies. Yet, over 15 years of patent reform since the landmark 2006 decision in eBay, Inc. v. MercExchange LLC, followed by enactment of the America Invents Act in 2011, we have witnessed the rise of a technology ecosystem led by a handful of dominant platforms. In my recently published book, Innovators, Firms and Markets: The Organizational Logic of Intellectual Property, I show that this outcome should not be surprising. Almost 120 years of U.S. patent and antitrust history (1890-2006) indicate that reducing patent protection can often shield incumbents against the entry threats posed by smaller firms that have strong capacities to innovate but insufficient resources to transform innovations into commercially viable products and services.

Patents and the Inventor-Entrepreneur

A secure patent portfolio enables a startup to monetize its innovation through relationships with investors, producers and distributors, rather than having to set up an independent technology supply chain to reach the target market. Edwin Armstrong, the inventor of FM radio technology, earned returns on his patented invention through licenses to equipment manufacturers. The same strategy was pursued by Ray Dolby, the inventor of the ubiquitous audio system technology in theatrical exhibition and consumer electronics markets. The same is true of the founders of Qualcomm, who elected to focus on chip design and monetize their innovations in 3G and 4G communications through licensing relationships with device producers. When patent protection is weak (as it was from the late 1930s through the 1970s), these contractual monetization strategies are foreclosed and innovation retreats to the research labs of industry leaders that can earn returns on R&D within an integrated corporate infrastructure (think GE, RCA or AT&T’s Bell Labs).

Of course, Bell Labs and other corporate labs were responsible (although often assisted by abundant federal funding) for fundamental technological innovations during the postwar decades. However, new product launches at AT&T were infrequent, product diversity was limited, and the firm enjoyed a near-monopoly over the telephone equipment and service markets. That might explain why Bell Labs’ scientists invented some of the fundamentals of cellular telephone communications, but AT&T management failed to bring a successful product to market. The explosion of new communications products and services and the proliferation of new firms following AT&T’s breakup, which coincided with the restoration of a robust patent regime in the early 1980s, contrasts with the delayed commercialization and slow turnover in market leadership under the weak patent policies of the postwar decades.

Contrary to conventional wisdom, over a century’s worth of economic history suggests that patents tend to lower entry barriers and enhance competition by facilitating entry by entrepreneurs who would otherwise have difficulty attracting the outside investments and business partnerships that accelerate progress on the commercialization pathway.

When patent protection has been strongest (the late 19^th and early 20^th centuries and then the late 20^th and early 21^st centuries), robust innovation ecosystems have emerged in which outside risk capital funds small-firm innovators, who then often partner with larger firms to complete the commercialization process. Consistent with this historical tendency, the percentage of small firms in the U.S. innovation economy increased significantly after patent protection was reinvigorated with passage of the Bayh-Dole Act in 1980 and the establishment of the Federal Circuit in 1982. Consider the following data point: in 1966, when patent protection was weak, small firms were responsible for about 5% of private R&D expenditures; in 2006, when patent protection was strong, that figure had risen to almost 25%.

Patents and the Innovation Division of Labor

Promoting innovation by smaller firms, and other entities that excel in R&D and product development but not in production and distribution (for example, the technology transfer division at a research university), operates to the benefit of the economy as a whole.

A vivid illustration is provided by the famous Cohen-Boyer patent for recombinant DNA technology. The technology was developed by scientists at the University of California and Stanford, patented and then initially commercialized through license agreements involving Genentech, then a startup, and Eli Lilly, its production and distribution partner. The result was the first synthetic form of human insulin, released in 1982. Hundreds of additional licensing relationships between Stanford and other firms have yielded a myriad of medical products that have improved human well-being. The simple combination of IP rights plus contract enabled the market to extract the social value from a technological breakthrough.

These symbiotic relationships among academia, startups, and large pharmaceutical firms are now a familiar feature of the biopharmaceutical landscape (see, for example, the partnership between Pfizer and BioNTech to develop a Covid-19 vaccine) and reflect the efficient division of labor between small-firm innovators and large-firm implementers. These same types of relationships run throughout the semiconductor industry, in which R&D-intensive chip design firms partner with capital-intensive chip foundries. In both life sciences and IT environments, IP rights structure cooperative relationships that bring together innovators with sources of capital and commercialization expertise. Without a secure patent system in the background, these firms would have difficulty securely exchanging information and entering into partnerships that can significantly accelerate the timeline from lab to market.

Taking A ‘First-Best’ View of the Patent System

Much of the judiciary and academic and policymaking communities have long characterized patents as a necessary evil that may sometimes encourage innovation but at the price of a “patent tax” that increases entry costs and inflates prices. If that were correct, it would be sound public policy always to minimize the scope of patents. With some exceptions, that is the path that has been advocated by many large technology firms and pursued by the Supreme Court, Congress and antitrust regulators since the mid-2000s. Over a century’s worth of U.S. patent history challenges this “second-best” view of the patent system. Far from depleting value, patents create value by enabling mavericks to capture returns on innovation and disrupt markets that might otherwise remain dominated by incumbents.

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Author: ginasanders
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