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Patent Law

Mark Schultz: Weaker Patent Protection Leads to Less Venture Capital Investment

The following post comes from David Ward, a 2L at Scalia Law and a Research Assistant at CPIP.

a lit lightbulb shatteringBy David Ward

Venture capitalists pouring money into a small startup has become a sort of new American Dream for many innovators. The success stories of big American companies starting with nothing more than an idea have pervaded their way into pop culture, inspiring TV shows, movies, and the like. However, CPIP Senior Scholar Mark Schultz has released a new report for USIJ entitled The Importance of an Effective and Reliable Patent System to Investment in Critical Technologies showing that this dream may be harder to attain today due to recent shifts that have weakened the patent system and driven away venture capital investment.

Background

There has been an ongoing debate in the past two decades about whether patents should be stronger or weaker. Proponents of stronger and more effective patents have made the case that they are more valuable, incentivizing investors and innovators to fund and create valuable innovations. On the flip side, critics of the patent system have stated that stronger patents inhibit innovation since they create a web of restrictions and licenses, inhibiting access to important innovations.

This ongoing debate has resulted in several landmark changes to our patent laws and rules in recent years. Prof. Schultz points out several key changes:

These changes have weakened patents by making them easier to challenge, less accessible for smaller companies, and harder to obtain overall. However, with all these changes, there is now data to explore whether weaker patents really do allow for more innovation as patent critics have contended.

Weak Patents Don’t Attract Funding

The short answer is the data doesn’t support the patent critics’ contention that weaker patents clear the way for more innovation because investors no longer see many patent-intensive industries as a good investment. From 2004 to 2017, the share of funding received in patent-intensive industries dropped from over 50% to about 28%. Prof. Schultz is cognizant of the fact that correlation is not causation, but there is an ever-growing pile of evidence that points to one simple explanation: weaker patents result in less funding for innovation.

Patents and intellectual property are critical to venture capitalists (VCs) who want more certainty of a return on their investments. Pending patents that have a lower chance of being granted or patents that could be challenged at any moment create uncertainty for both the patents’ validity and the future costs of litigation. Hence, the weaker patent laws of recent years have led to a decrease in funding for many patent-heavy sectors.

Prof. Schultz’s report doesn’t just rely on the data to reach this conclusion. It also includes several case studies, surveys, and interviews with innovators and investors alike. Perhaps the most telling is a survey by Prof. David Taylor of SMU Law investigating how recent patent cases changed VC and private equity behavior. Of the 475 investors surveyed, 74% said that patent eligibility is an important consideration in firms’ investment decisions, and 62% said that their firms were less likely to invest if patent eligibility changes make patents unavailable. Almost one-third of investors who knew about recent court decisions said it had affected investment decisions away from biotech, medical devices, and pharmaceuticals.

The data again backs this up, as Prof. Schultz’s report shows that those industries have seen some of the biggest loses in VC funding since 2004. In a world where biotech, medical devices, and pharmaceuticals could quite literally be the most important sectors needing innovation and funding to tackle the COVID-19 pandemic, this is less than ideal. Typically, medical treatments cost hundreds of millions of dollars and have a 10-year road ahead of them. The prospect of reaching the end of the road without being able to protect the investment with a strong and effective patent has spooked many investors to other sectors. As a result, there has been less innovation in live-saving treatments, and more of a focus on safer, quality-of-life investments.

Looking Ahead

There is some trend in the positive direction, however. Prof. Schultz notes that USPTO Director Andrei Iancu has demonstrated strong support for the role of patents in the economy with several policy changes aimed at strengthening patent protection. It is also of note that many policymakers are realizing the changes have gone too far, and there are now several pending legislative proposals aimed at fixing these issues. These realizations, coupled with Prof. Schultz’s quantitative and qualitative data, paint a clear picture that all but proves a single point: strong patents promote innovation more than weaker patents. In the words of Prof. Schultz: “Society needs its most successful people working on its most compelling problems. The patent system should support such work.”

To read the report, please click here.

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Biotech Commercialization Conferences Copyright Innovation Intellectual Property Theory Inventors Uncategorized

The Common Economic Case for Patents and Copyrights

This is the second in a series of posts summarizing CPIP’s 2014 Fall Conference, “Common Ground: How Intellectual Property Unites Creators and Innovators.” The Conference was held at George Mason University School of Law on October 9-10, 2014.  Videos of the conference panels and keynote will be available soon.

The opening panel of CPIP’s 2014 Fall Conference examined the common economic case for patents and copyrights. Unfortunately, IP policy discussions often include a false narrative that intellectual property produces monopolies that harm innovation and economic growth.  The panelists, Troy Dow (Disney), Professor Stan Leibowitz (University of Texas at Dallas), Jon Santamauro (Abbvie), and Professor Jay Kesan (University of Illinois College of Law), highlighted how this narrative, in fact, ignores the essential role that intellectual property serves in enabling the creation, development, and commercialization of both inventions and creative works.

Kesan explained how patents provide economic benefits from both an ex-ante and ex-post perspective. Ex-ante, a strong patent system provides incentives to create, invest in R&D, and finance further innovation. While there are other ex-ante motivations to invent (such as a first mover advantage, the ability to secure trade secrets, and reputational advantages), Kesan argued that innovation is best facilitated ex-ante by a combination of all of these incentives plus the incentives created by patents. The ideal system incorporates a heterogeneous mix of these incentives to invent—in the absence of patents the level of disclosure decreases and innovation slows down.

Patents also provide numerous ex-post benefits. Patents facilitate coordination with producers and perform important signaling functions. They additionally allow for important private ordering by giving inventors increased control over who uses their invention and under what circumstances. In many industries, this is essential to collaboration, interoperability of products, and the aggregation of complementary benefits.

Jon Santamauro discussed the role of patents in the pharmaceutical industry. The exclusive property rights created by patents encourage R&D and serve as a crucial catalyst for new discoveries and businesses.  Patent protection is particularly important in the pharmaceutical industry due to the high-risk, lengthy, and costly process necessary to develop new, safe, and effective drugs.

Pharmaceutical companies developing new drugs screen thousands of potential compounds over 6-7 years of testing to gain FDA approval, at an average cost of about $1.2 billion per drug. The reasons for the high R&D costs?  Out of 10,000 initial molecules tested, only 6 go to clinical trials, and of these, only 1 is approved by the FDA for use in the healthcare market.  Of the 1 out of 10,000 drugs that make it to market, only 2 out of every 10 medicines produce enough revenues to recoup the initial high costs of R&D and also provide revenue to invest in more R&D. In short, pharmaceutical and biotech firms face very high risk—high R&D expenditures and very few market successes.  Strong IP protection helps offset this risk and encourages further investment and research.

Leibowitz explained that one of the primary criticisms of copyright—that it grants a monopoly, and that monopolies are intrinsically bad for society—is utterly thoughtless. A property right is, by definition, a monopoly of sorts. This criticism is an indictment of property rights on the whole, including real property rights.  This is even more inapt to copyright, as copyright does not restrict entry and does not provide an economic monopoly.

Leibowitz also addressed the common argument that IP isn’t necessary because inventors and creators would continue inventing and creating even if they didn’t get to own the fruits of their productive labors.  While some innovative and creative activity would undoubtedly continue, many innovators and creators do not simply create for creations sake. They need salaries (like everyone else), and strong IP rights allow them to capture the value of what they produce.

Finally, Troy Dow highlighted the benefits of strong copyright protection in the movie industry. Bringing a film to market involves substantial risks that many people do not appreciate.  He explained that studios perform the same market function as venture capitalists: they invest in  films at the birth of the original idea and then provide financing all the way through the final showing in movie theaters. This financing comes from banks, other investors, or other studios in order to spread the risk. Dow analogized a new film project to a new startup company, as each new film has its equivalent of a CEO (producer), COO (director), and thousands of employees and independent contractors.  And just as with startup companies, everyone must be paid before the film makes a single cent in revenue.

A single film can cost over $200 million to produce. While a particularly big hit can gross over $350 million after long-term distribution (including on-demand and DVD sales), only 4 out of every 10 movies recoup their investment at the box office. Copyright thus serves the vital function of making it possible for studios to make substantial, upfront investments with the hope of a return on this investment and a sufficient profit to reinvest in further film projects.

Disney’s IP is enormously valuable and is the dominant driver of their business. Even though only $6 billion of Disney’s $45 billion in revenues last year came directly from movie revenue, the movies, including the stories they tell, are at the heart of the Disney experience.  The movies form the basis for other products, media networks, theme parks, and licensing. A strong copyright regime allows studios like Disney to keep producing both creative works and the myriad other products and experiences that so many of us enjoy.

Together, the four panelists illustrated that the economic foundations of IP are equally applicable to the creative industries as they are to the innovation industries.  By securing for inventors and creators the value of their productive labors, IP provides the economic bedrock of our creative and innovative economy.