The patent system is a key government instrument for providing innovation incentives. However, there is growing concern among academic scholars and policymakers that patent rights are becoming an impediment, rather than an incentive, to innovation. These dangers have been prominently voiced in public debates on patent policy (Federal Trade Commission 2011, The Economist 2015), and have resulted in the Leahy-Smith America Invents Act of 2011, the most significant statutory change to the US patent system in half a century.
Critics claim that the problems with the patent system arise in large part from ineffective patent office screening, granting patents to obvious inventions that do not represent a substantial inventive step. This view is widely held and buttressed by anecdotes of egregious cases (Jaffe and Lerner 2004). One poster child for the issues caused by low patent quality is Amazon's ‘one-click’ patent, which expires this year. It was widely licensed and highly profitable, yet despite widespread scepticism of its validity, it was never challenged in court. There is, however, very little direct evidence on the extent or the sources of the patent-quality problem.
A framework for improving patent screening
Is the criticism about low-quality patents correct, or mistaken conventional wisdom? And if it is correct, how can we formulate and evaluate proposals for patent reform? In recent research, we develop an analytical framework to study how policymakers can improve patent screening, focusing on four key policy instruments (Schankerman and Schuett 2017).
- the intensity of patent office examination;
- pre-grant (application) fees paid before patent examination;
- post-grant (issuance/renewal) fees paid by inventions that have passed examination; and
- review by the courts for patents challenged by a competitor.
We also simulate the welfare effects of a variety of counterfactual reforms, including increasing the intensity of screening by the patent office, moving to a pure registration system with no examination at all (as with copyrights), and capping litigation costs at half their current level.
From an economic perspective, patent rights should only be given to inventions which would not be profitable to develop in the absence of a patent. Granting a patent to an invention that would be developed even without one – which we refer to as an ‘obvious’ invention – imposes social costs with no corresponding gain. Courts have made clear that legal criteria of patentability are an attempt to implement this idea. In this research, ‘low-quality patents’ refers to those granted on obvious inventions.
Our framework allows us to identify the severity of the patent-quality problem. Empirically, it is hard to know how many low-quality applications and patents there are. The quality of applications in the economic sense is not directly observable. Grant rates do not directly tell us how good a job the patent office is doing in screening out obvious patents, nor whether it is applying the appropriate standards to do so. Second, because litigated patents are highly selected, litigation outcomes may not be reflective of the general population. In particular, invalidity rates do not directly tell us what share of all patents is of low quality. By putting structure on the problem and exploiting an equilibrium framework, our approach allows us to get around both of these issues.
We develop a model in which an inventor is faced by a competitor. The inventor is endowed with an idea for an invention which can be either obvious (‘low type’) or non-obvious (‘high type’). The invention type is private information to the inventor. An obvious invention is profitable to develop in the absence of a patent, whereas a non-obvious one requires patent protection to be profitable. Since patent protection increases the profit for both types, however, owners of obvious inventions also have a private incentive to seek a patent. There is a net social cost (benefit) of granting patents for obvious (non-obvious) inventions, so effective screening is important for welfare. The inventor chooses whether to pay a pre-grant fee and, if subsequently approved (screening by the patent office is imperfect), whether to pay a post-grant fee to activate the patent. If the patent is activated, the inventor may choose to license the invention to the competitor, and the competitor chooses whether to challenge the validity of the patent in court.
In the baseline model, we assume that the patent office always grants valid patents but screens out invalid patents imperfectly, but that the court is perfect and always invalidates an obvious patent and upholds a non-obvious one. The theoretical and simulation results are robust to allowing for both the patent office and the court to make two-sided errors –granting/upholding an obvious patent and rejecting/invalidating a non-obvious one.
Our key results
- First, we show that if the patent office makes no examination effort (a pure registration system), or if the pre-grant fee is zero and examination is imperfect, complete screening (where no low types obtain patents) cannot be achieved.
This is important because it emphasises that patent office fees cannot completely screen in a pure registration system, and that pre-grant fees and examination are complements, not substitutes. Complete screening can be achieved by a combination of a pre-grant fee and an examination that is sufficiently rigorous. We also show that, despite our assumption that courts are mistake-free, they cannot eliminate all bad patents that are issued. This is because in equilibrium not all low-type patents are challenged by the competitor. This result raises serious doubts about over-reliance on the court system to weed out obvious patents.
- Second, we study the optimal structure of fees and show that a social planner would always frontload fees (i.e., rely on pre-grant rather than post-grant fees).
The intuition for frontloading of fees is that the low type has a stronger preference for post-grant fees than the high type because the low type has a smaller chance of passing examination. This result calls into question the current structure of fees at the major patent offices around the world, which often backload fees through post-grant charges for issuance and renewal.
- Third, we show that the private incentives to challenge a patent can be either too high or too low relative to the socially optimal level.
This is noteworthy because the conventional wisdom suggests that the private incentives to challenge are inadequate due to the public-good nature of challenges (Farrell and Merges 2004, Farrell and Shapiro 2008). While this point is valid, it is also incomplete. We show that in the presence of asymmetric information on the type of invention, there are other factors that can either reinforce or counteract this effect. In particular, the private gains from a successful challenge, given by the challenger's incremental profit from invalidation, can be either larger or smaller than the social gains, given by the deadweight loss that is eliminated.
Finally, we simulate the model, calibrated to match key features of US patent and litigation data. The simulations have two purposes: first, to characterise the severity of the current problem with patent quality and screening; second, to study the welfare impact of various counterfactual policy reforms. We simulate the model both with a perfect court and an imperfect court (weighted average of PTO and perfect screening – with weights of 1/3 and 2/3, respectively, for high quality courts and the reverse for low quality). In both court settings, we find that about 75-85% of patent applications are made on inventions that would be developed even without patent rights, and that the patent office is relatively ineffective at screening them out, as it does so with a probability of about 30% (this reflects some mix of patent office efficiency and inappropriately lax standards). The results are robust to the characterisation of the courts. This implies that about 65-85% of granted patents are invalid. These findings highlight the current crisis in patent screening, and the need to develop effective policies to address it.
Table 1 Welfare impacts of revenue-neutral counterfactual policy reforms
% change in welfare from innovation relative to status quo
We also use the simulations to quantify the effects of policy reforms including frontloading fees, intensifying patent office examination, introducing a cap on litigation costs, and replacing examination with a pure registration system. Table 1 summarises the key findings with regard to welfare (more details are available in the paper). The simulations indicate that frontloading patent office fees, capping litigation costs, and intensifying patent office screening (screening out obvious inventions with probability of 70% as compared to the status quo of about 30%) all significantly increase the welfare gains from innovation, while a registration system reduces it. These results suggest that an effective strategy for improving patent screening may require both patent office and court reforms.
We believe our framework can be used to study welfare impacts of court reform and patent litigation insurance, both of which have featured prominently in the public debate. In principle, the simulations of the model, or suitable extensions of it, could also be calibrated for other patent systems. This might allow one to analyse the welfare effects of more ambitious, international patent reforms, such as harmonised screening.
Farrell, J and R Merges (2004), “Incentives to challenge and defend patents: Why litigation won't reliably fix patent office errors and why administrative patent review might help”, Berkeley Technology Law Journal 19(3): 943-970.
Farrell, J and C Shapiro (2008), "How strong are weak patents?”, American Economic Review 98: 1347-1369.
Federal Trade Commission (2011), The Evolving IP Marketplace: Aligning Patent Notice and Remedies with Competition, Washington, DC: Government Printing Office.
Jaffe, A and J Lerner (2004), Innovation and Its Discontents: How Our Broken Patent System is Endangering Innovation and Progress, and What to Do About It, Princeton: Princeton University Press.
The Economist (2015), "Time to fix patents", 8th-14th August: 9.
Schankerman, M and F Schuett (2017), “Screening for patent quality: Examination, fees, and the courts”, CEPR Discussion Paper 11688.