Market ambivalence provides perspective on patents

Recently Louis Carbonneau wrote on the IP Watchdog blog about the demise of the US patent. In his article Carbonneau cites statistics that, post-Alice, the federal courts have invalidated 15 out of 19 patents in cases presented to them. In his mind this represents the destruction of the US IP system and hands a massive competitive advantage to non-US jurisdictions such as Europe, where patent protection appears to be on the rise. Carbonneau comments that: "anyone working around innovators or who plays in the IP space has seen these forces at work and fully understands that adequate IP protection is a prerequisite for driving innovation."

I agree with Carbonneau that IP protection is valuable in driving innovation by providing investors and management teams with some degree of commercial protection – certainly in the early stages of corporate growth. But what he misses is that intellectual property is far more than patents – and even where intellectual property is patents, in my experience it is a rare investor which will commit investment capital based on a patent (even a good one). It is not that patents are unimportant, but studies that correlate the possession of patents with enhanced corporate performance are questionable, at best. A simple Bloomberg analysis of patent numbers with stock price shows no correlation, and most studies I have read are full of statistical errors such as survivor bias and sampling error. Execution of a focused business strategy around an innovative idea protected by an integrated IP strategy is the key to commercial success, not patents. 

Product lifecycles are shortening, technology stacking is increasing and the convergence of technologies across industry boundaries (eg, life sciences and semiconductors) and multi-disciplinary approaches to problem solving with crowd-sourced resources are now becoming mainstream. In this environment the ritualistic reliance on patent judges to provide Delphic decisions based on often obscure arguments is old-world thinking.  Simply put, counterintuitive though it may seem, IP professionals need to wean themselves off patents.

I am often reminded that a patent is a sword, not a shield. If an innovative business is looking for protection and wants a solution in keeping with its culture of innovation, often built with open-sourced resources and within a limited budget, often patents may not be the way to go. For example, in technology, the cloud is becoming increasingly critical for the delivery of software as a service. One consequence of this delivery model is that the mechanism of service delivery need never be disclosed. Software is built in modules, which are more easily tested, upgraded and deployed, and each module may be held in a different cloud (or even jurisdiction), making patent enforcement almost impossible. Notwithstanding Alice and subsequent decisions, increasingly the keys in these businesses are trade secrets, employee agreements and subscription business models. In my work with emerging software companies, I see this every day.

Pharmaceuticals are often held out as the one industry where patents are vital, and indeed the patent cliff illustrates clearly the fundamental importance of intellectual property in this industry. But even in pharmaceuticals, things are changing as research migrates away from small molecule chemistry into more difficult scientific areas of research that require highly differentiated know-how and culture (eg, biologics), and where patents are not so easy to come by (as illustrated by Myriad Genetics). Outside of cutting-edge science, however, perhaps the area of greatest activity is the repurposing of old drugs whose safety history is proven. This is highly attractive to investors as although patents are valuable, the regulatory barriers to roll-out are so high that once a drug has been approved, the value of keeping it alive for almost any condition is meaningful. However, new patents for extended or repurposed drugs are increasingly being challenged by generic manufacturers, and the impact and cost of these challenges are increasing the friction on this part of the ecosystem. It turns out that Food and Drug Administration exclusivity is more valuable than US Patent and Trademark Office protection.

In the area of plant biology, Monsanto’s strategy of protecting its intellectual property through contractual stipulations with customers that they may use Monsanto seeds only for a single crop (after which they must buy new ones) is an excellent example of innovative thinking in how to generate an effective monopoly commercially. Of course, Monsanto files many patents, but its message to customers reinforces the idea that the conversation about intellectual property is a commercial one, not purely a legal one. In other words, intellectual property is about business.

In my view, the growth of IP protection in Europe and China should be thought of differently from the way that Carbonneau considers it. The focus is on the word 'protection' in an economic sense as creating a legal system that maintains the status quo. IP law underpins government agendas of international competitiveness, employment and sometimes grandstanding. Protectionism through the clever use of IP law is a powerful way to create a barrier to competition.

The United States remains the home of global innovation in the 21st century. The US patent system is a part of this, but an overreliance on patents provides provides false security and mitigates against real strategic thinking in intellectual property. Many IP professionals view the patent reforms enacted by Congress as an anti-competitive measure driven by the lobbying of incumbents that will make innovation harder. My view is a little different: as the global economy continues irrevocably towards disruption and the rapid deployment of technology (underpinned by a large domestic customer base), patents are increasingly marginal in the generation of sustainable corporate value. 

The tendency of companies to file patents or acquire them before an initial public offering is intriguing in this respect (the most recent notable example being Alibaba). The message I am hearing is not that there is a causal relationship between innovation, success and patents, but that the usefulness of a patent is limited to providing a credible threat to aggressors once the spotlight is turned on. This changes the value, positioning and discussion about patents quite significantly.

As a closing thought for 2014, a UK fund manager recently observed to me that the market capitalisation of Apple and Microsoft is now bigger than the entire German stock market (the DAX index). The last time I looked, Microsoft had around 20,000 patents and Apple around 5,000, and both companies were sensitive to IP protection.  For readers unfamiliar with the German market, the DAX comprises the 30 largest German companies, including Siemens, BMW, Mercedez Benz, Merck, VW, Thyssen-Krup, BASF, Bayer and Infineon. Judging from the stock price of these companies, the markets do not seem overly concerned about the demise of the US patent system and its impact on US tech. But then again, the markets are often slow to catch up with reality.