The Patent Lottery: The Patent Lottery: Exploiting Behavioral Economics for the Common Good

Shahil Patel & RaniIEOR 190G5/9/2009

SUMMARYSUMMARYSection 1:

OverviewOverviewLegal studies research paper written

by Dennis D. Crouch

Main Idea: “The benefits of using intellectual property as an innovation incentive must be balanced with concerns of holdup costs and potential monopoly harms. The lottery effect provides a tool that may help weaken the connection between these otherwise linked pros and cons.”

What is a “Lottery Effect”?What is a “Lottery Effect”?Objective of “State Lottery” is to collect

funds from people for public spending / social benefit

Statistics show that investors are sensitive to the size of the jackpot but insensitive to the probability of winning

Thus, State Lottery increases its “house rake” by marginally increasing the size of the jackpot

“Lottery Effect”: people are overly-optimistic and ignore the odds of success

Behavioral EconomicsBehavioral EconomicsAuthor’s arguments are founded in

behavioral economics

Branch that applies scientific research on social, cognitive and emotional factors to better understand economic decisions

Inventors treated in this paper as investors

Example – Availability heuristic News reports of an event’s occurrence increases a

person’s prediction of the frequency of the event Reports of successful innovation may increase the

perception of large payout, and neglect of low odds of future success

Expected Utility TheoryExpected Utility Theory You have two options:

Take $3,000 now with 100% certainty Or, you have an 80% chance at getting $4,000 vs.

20$ chance at $0

Expected payout of second option is higher, yet most people choose the first

Investors are assumed to be risk-averse

Then why are inventors not averse to taking such large risks by filing patents?

Patent Lottery EffectPatent Lottery EffectFuture payout, or “jackpot size” is the

primary motivation behind innovation

Inventors will over-estimate the payout of their inventions, but disregard their low probability of success

Same may hold true for “sets” of patents (i.e. patent portfolios)

Important distinction: inventors are insensitive to probability of success, but this probability MUST remain greater than zero

Application: Patent Law Application: Patent Law Policy Policy To increase social benefits, policymakers must

adjust patent rights by using policy levers Length of patent term Level of nonobviousness required for patentability Type of relief available against infringers

Goal is to maximize the upside (promote innovation) and minimize downside (monopolistic business activities, excessive litigation etc…)

Certain levers may increase an incentive to innovate with only a small increase In monopoly harm, while others may decrease monopoly harm with only small decrease on innovative activity

Case Study ICase Study I2006 Supreme Court case: eBay,

Inc. v. MercExchange, L.L.C eBay is the infringer MercExchange is not practicing its patent,

but still demands injunction Court decisions go back and forth

Ultimately, case is settled but court reduces the probability of injunction

According to author, this is decision follows the lottery effect model

Monopolistic rents minimized, while impact on private investor is small

Case Study IICase Study II2007 Supreme Court case: KSR

International Co. v. Teleflex, Inc. Court expanded the number of patents

that could be invalidated as obviousAccording to author, the decision

reduced the probability of obtaining a successful patent in the invalidated domain to zero

Decision also left ultimate potential payout unchanged

This violates the lottery model

ComparisonComparisoneBay case reflected positive

application of the lottery model Payout is the primary driver – by reducing

this, court minimized social rents Probability of success is decreased, but this

has minimal impact on innovationKSR reflected a negative

application by Supreme Court Payout is left unchanged – no effect on

social rents Probability of success is decreased to zero –

this has huge negative impact on innovation

PROJECT OVERVIEWPROJECT OVERVIEWSection 2:

Main ObjectivesMain ObjectivesReview this paper from analytical

perspective

Evaluate claims made by author

Closely examine the patent lottery effects model

Is the theory adequately supported by the provided model?

Initial ReactionInitial ReactionProvides an interesting new perspective on

inventor investment behavior through a creative application of behavioral economics

Adequately explains analogy of lottery effects

However, fails to make strong connection between lottery effects model and applications to patent law policy

Also, many ideas are either too simplistic or inadequately supported

CRITICAL ANALYSISCRITICAL ANALYSISSection 2:

Criticism ICriticism IIs INVENTOR behavior actually

similar to INVESTOR behavior?

Expected (Value of State Lottery) = Function of ($1 tkt price, jackpot payout,

probability)

Expected (Value of Innovation using Patent Lottery) =

Function of (price, payout, probability)

House rake clearly defined with state lottery, but not with patent lottery

Difficult to find EXPECTED VALUE using patent lottery because none of these variables are known

Criticism II Criticism II Small inventors have high affinity for risk-

taking, while “boldest technological innovations” happen outside of corporate culture

Thus, patent lottery effects only apply to small inventors

Further, this only helps us to understand “most valuable patents”

Is this a good enough sample of the population?

Criticism III Criticism III Patent lottery effect is only a

partial answerDoes not take into account

extrinsic motivations Desire to be first to market Shareholder value (i.e. impress VCs &

other investors) Insurance against future competition

Only briefly mentions these aspects

No substantial data

Criticism IV Criticism IV Author claims that the balance of

the variety of positive and negative social impacts "finance" the patent system and hence serve as "house rake" of patent lottery.

It is not clear exactly how one would calculate this house rake, or increase it.

Criticism V Criticism V Model i=J*P is too simplistic

It only has incentive I Only two levers are large payout J and the probability P

Author mentions both jackpot volatility and risk as aspects of patent lottery, but these measures are not accounted for in model

Hard to deduce how to maximize positive innovative activity, & minimize negative rents

There is no mention of how his model can be "tweaked” for a specific scenario.

Criticism VI Criticism VI Patent lottery construct is not the

only way to treat the adjustment of patent law policy

Author does not address these constructs, or specifically explain why his model is superior

Criticism VIICriticism VIIPaper cannot answer the following

question:

"Would you be willing to invest time and/or money in developing a new innovation that had only a small chance of reaping huge rewards, if you knew that the expected and most likely return would be less than your original investment?"

This is what every inventor wants to know.

Criticism VIIICriticism VIIIKSR vs. Teleflex case is a weak

exampleAuthor states that court decision to

expand invalidation of patents discourages innovation

This implies that court should not constrain innovation, even if it is unnecessary and unobvious

Also, the author does not address the minimization of rents associated with elimination of future litigation regarding the invalidated patents

Areas for Further Areas for Further ResearchResearchEmpirical results are needed to support

the claim that this model can be applied

Also assumptions for the model should be stated

For example, are there factors that would minimize litigation using this formula?

This research could be an inter-disciplinary effort so that the modeling approach is more thorough