Unlocking Patents: The Cost of Failure, The Benefits of Success

Robert Litan

Robert Litan is an extraordinarily accomplished lawyer, economist and author. Indeed, through his research and writings he has become a nationally recognized expert in the field of economics. Along with co-author Hal Singer, Litan recently published a study that concluded that modestly increasing the number of patents under license could generate social benefits ranging between $100 and $200 billion per year. See $200 Billion Could Be Added to Economic Output Annually by Unlocking Patents. I caught up with Litan for an interview on December 1, 2014, and published part 1 of our conversation yesterday.

What follows is the final segment of my conversation with Litan, in which we discuss the importance unlocking the patents that are not being monetized. We specifically discuss Jay Walker’s brainchild — dubbed the Patent Utility — and what it could mean for the U.S. economy and innovation more generally.

QUINN: I think that what you said there is definitely a fair point. As you were saying it I recall an interview I did with Manny Schechter, who is Chief Patent Counsel at IBM. I asked him at one point in time about how they constantly stay in front of everybody else with respect to a true commitment to research and development? I asked him if they ever look at what others do and wonder why they haven’t figured it out? And his answer to me was basically — why we would look at what anybody else does, we’re confident in what we’re doing, our management is in tune with our overall IP strategy and objectives, and we just do our own thing, do our research and development on our own. So IBM doesn’t spend time considering the competition.

So I do get the point you raise. The point I was inartfully trying to make is that it strikes me that sometimes the policies in corporate America are, for lack of a better way to say it, a little bit Dilbertesque in that they are so rigid that you lose the point of why you’re doing something.

[Patent-Business]

LITAN: Well, that’s all true. But let’s go back to the main point again from our paper, which is that we need to switch the national conversation about patents to doing a better job of exploiting what we have as opposed to arguing so much about what the standards should be going forward. If we did that, maybe we’d get some greater bang for the buck our of our innovation system. Because there are a lot of unexploited patents out there that could be commercialized. Of course, your point that a lot of patents will drop off because the maintenance fee won’t be paid in the four year period. That’s true for some patents, but certainly not all. In our paper we call the unexploited patents singles and doubles. Our current patent system is set up really only to reward home runs. It’s because of the costs and risks of commercializing the singles and doubles that we don’t see enough of them.

QUINN: That’s right. And that’s unfortunate because there are certainly a lot of singles and doubles out there that are going to be worth something. If you have a system in place that will allow for those singles to be monetized then you’re going to get a lot more people who can spend their time during the day trying to hit those singles rather than working a day job to pay their rent. And I think we’re missing that, we’re losing that opportunity. We should want more people innovating not less.

LITAN: Right. I heard a good story–. Do you know Jim Manzi who founded Applied Predictive Technologies?

QUINN: No. I can’t say I do.

LITAN: I feature Jim Manzi in my book Trillion Dollar Economists, among others. Jim developed a company called Applied Predictive Technologies that basically helps lots of companies do AB testing and other kinds of testing. In fact Capital One, which is now one of the largest credit card companies in the country is built on just a constant daily stream of AB testing. Google is another leader in this field; indeed, every time you go to Google’s search page you are being tested. To make a long story short these are examples of companies that are constantly improving themselves. In fact I would say all companies are pretty much engaged in singling and doubling almost all the time; our economy is built around such incremental innovations and the more of those we can commercialize so much the better, although I wish we had more companies trying to hit home runs.

QUINN: To continue with the baseball analogy, I think most home run hitters who are in the Hall of Fame will probably tell you that they hit more home runs not trying to hit a home run, just trying to make good contact with the ball.

LITAN: That’s absolutely right.

QUINN: And the guys who are trying to hit home runs tend to not wind up being in the Fall of Fame because they strike out a lot.

LITAN: Yes.

QUINN: And I think that that is what we see with innovation. If you try and set out to hit the home run you’ve got a much better chance to not even make any contact whatsoever whereas if you’re just taking good swings at the ball, you make contact and then occasionally you are going to hit that home run.

LITAN: Right. Or to switch the sports analogy if we had more shots on goal we’d have more goals.

QUINN: That’s right. There’s just no two ways about it. No goalie’s going to be able to save everything. And isn’t that really the way an angel investor or an early stage VC will proceed? They know they’re going to miss nine out of ten times, but they want to have ten opportunities so that they hit— when they have a 10% success rate — they can make a lot of money doing that.

LITAN: Agree.

[Varsity-2]

QUINN: So how do we go about encouraging that? I know what you say in your study is we have to unleash and unlock the power of these patents, but what kind of system do you think would get us to the place where we have more innovation?

LITAN: We discuss several market examples in the study, three in particular: RPX, Lotnet, and now the U.S. Patent Utility, which has been launched by Jay Walker and his team. The first two, Lotnet and RPX, are solutions that seem to be targeted primarily toward large companies and the idea is assemble some kind of package of licensable patents, put them in a bundle and offer them to members of the network and that will reduce the risk that any of them would be sued because they all have licenses to the items in the bundle. In addition, the inventors who have the patents earn royalties. That’s one business model. The U.S. Patent Utility model is a bit different, and is aimed at companies of all sizes, which can go out and get a license to a bundle of patents that in the patent utilities offering would be statistically related to what it is the company does. So if a company makes a widget U.S. Patent Utility can run a statistical algorithm and find all the patents that are closely related to your widget. And then the Utility will go out and assemble a package of licenses for you that will be specifically tailored to your widget. You’ll pay a modest royalty for the package and using the same statistical algorithm U.S. Patent Utility will distribute the proceeds to all the owners of the patents in that package. In general, the system operates very much like what BMI and ASCAP does for songwriters and for performers, and should substantially cut transactions costs of trying to find all those people who could potentially be filing infringement lawsuits against me. The U.S. Patent Utility does all that work for me and comes to me and says here is basically a package license for a modest fee. Go ahead and if you want to take the deal take it. I think it’s a very innovative approach and we’ll see if the market accepts it or not.

I’m not saying that the Patent Utility model is the last word. The key point is there finally has been a lot of innovation in the innovation market. It’s taken I don’t know how many decades, if not more, for people to figure this out that there is a crying need for firms of all sizes to be able to license packages of patents so you end up with a win/win. A, you immunize yourself from lawsuits, and B, the amount of money you pay gets distributed to a lot of people who would otherwise never see a dime from their innovations.

QUINN: To tie this back into with something we were just talking about, if you really are concerned with willful damages and/or attorney’s fees, or conduct engaged in before litigation, licensing a portfolio of statistically relevant patents ought to show extraordinary good faith.

LITAN: Yes. Absolutely.

QUINN: So it seems like a company like the Patent Utility has a real opportunity to benefit a lot of people and firms. But now I suppose one of the questions is how do we go from where we’re at now to a point where we can unlock those patents? If you look at the U.S. over the last, I don’t know, six or eight years, we’ve had this economic downturn with relatively slow growth. It seems to me this is tied to the fact that we haven’t really had a breakthrough innovation in the innovation market that is going to lead us to faster growth.

LITAN: Well, we’re going to need more than one, you know, because we had fantastic productivity growth after the war with a lot of pent up innovations that changed America. We had the spread of air conditioning, and huge advances in telecommunications and information technology, which sort of changed the world after the war and then into succeeding decades.   There are also technologies now on the shelf that are waiting to be disseminated throughout the economy. The driverless car is a good example. When it does happen, it will fundamentally change America, in much the same way that the car itself has done. I hate to focus solely on Google but Google’s involved with some amazing things and so of course is Elon Musk. So you have some home run hitters out there who could change the world. But we need more than just two of them.

QUINN: We definitely do. But I think we need to start somewhere with one. Innovation has historically always led us out of bad times and on to a path to better growth, in large part because of the conditions a downturn creates. You have a lot of engineers and scientists who are very creative, very intelligent people, many of whom lose their jobs during these downturns, and one of the things companies cut first is research and development. These creative people have all kinds of ideas they’ve never been able to pursue on their own. And engineers and scientists are an enormously frugal group that usually has money saved up. So when you see these downturns you see a lot of people who are freed up to go in a direction that they’ve always wanted to pursue but can’t because they have been locked into their paying job. Now pursuing their own creative path is suddenly an option. So we get typically see this breakthrough innovation and I just haven’t seen that. And I don’t know exactly why that is.

LITAN: Nor does anybody else. And I think humble economists will tell you that they have no way of predicting whether or not this will change.

QUINN: That’s depressing.

LITAN: Well, it’s true. Alan Blinder wrote a piece of the Wall Street Journal in November on productivity growth in different decades since World War 2 and he showed huge variations. He basically said economists have no clue as to whether or not we are condemned to suffer secular stagnation for decades as Larry Summers and other economists have argued. There are some, like Robert Gordon of Northwestern, who are even more pessimistic, asserting that we’re in the process of returning to a pre-industrial age of no innovation at all, implying zero productivity growth in the years ahead.

At the other end of the spectrum, other economists claim we are on the verge of explosive technological change largely due to the spread and use of IT in all other parts of the economy. So for example Google is using advances in computer chip technology in nanotech of the body. They’re trying to figure out ways to implant things in you that will monitor your health full time and alert you and more importantly your doctors that you’re about to get sick even before you even get sick.  And then fix you before that even happens.

Now just multiply that example throughout the economy and think about all the ways in which computer chips are being embedded in literally all kind of products, and will be even more so in the next ten or 15 years – from cars, to airplanes, to houses, smart this, smart that, the internet and things. The optimists say the whole world is going to be completely changed by IT. And since everything operates by Moore’s Law, it’s exponential. Andrew McAfee and Erik Brynjolfsson at MIT have written this book called The Second Machine Age in which they argue that we’re on the verge of just incredible and explosive innovation and technological growth.

The official government forecasters — at the Federal Reserve and the Congressional Budget Office – are in the middle between these two extreme positions, taking a rather pessimistic stance that productivity growth will only increase by maybe 1-1/2—2% annually in the future. This rate of growth used to be about 3% a year.

I run through all these different camps to reinforce what Blinder said in his op-ed, which s there’s huge disagreement even among economists about where we’re headed. I don’t get unusually depressed by this because I think the course of innovation is something that is just inherently impossible to predict. You know, this is probably an apocryphal story from what I’ve read, namely that the head of the patent office in the year 1900 said that we would have no more inventions so the government might as well close the patent office down. Of course, this prediction turned out to be absolutely, completely ridiculously wrong.

But I think if you were to survey scientists or even talk to them now and get them to talk privately I think they will all candidly say that they have no idea how fast innovation is going to proceed in the future. All we can do as a society and as policymakers is try to make it as easy as possible for innovators to do their thing. That’s all we can do. And also for people and firms to commercialize what innovators come up with. We not there yet completely. Hopefully the market as I said will develop ways to commercialize our existing patents. And hopefully we’ll do a better job as a society to facility startups that actually commercialize a lot of these disruptive technologies. But that’s the best we can do.

QUINN: I agree with everything you just said. I go back and forth between whether or not I should be depressed or I should be hopeful because I do think from a scientific standpoint there are an awful lot of good things happening. There’s an awful lot of good research going on that could be applied in many different situations and that the world could over the next generation look so different than it does today, so different that you wouldn’t almost recognize it. But then I know we need to set the policies in a way that facilitates this and doesn’t get in the way. And I’m afraid we’re going to fail there and I think we’re failing there at the moment both on the patent side and just generally speaking on the innovation side. We don’t have any solution to the immigration issue where we need to hire more competent workers.

LITAN: Right.

QUINN: We have an education system that in a lot of ways is broken in the United States so we don’t have the domestic talent that we need. And I look across the board and I see an awful lot of hurdles and obstacles and frankly I don’t think our leaders really understand what they’re doing. They don’t understand the issues. And they seem more intent on setting up additional hurdles and obstacles than they do about trying to make it smooth sailing and easy to move forward.

LITAN: Well, I’m going to certainly agree with you on immigration. I think our current policy is clearly anti-innovation from that standpoint. There are so many more high skilled immigrants that we could have and foreign entrepreneurs that we could use that other countries are going to get instead unless we change our immigration laws. And frankly, you know, the world would be better off if high-skilled workers came here. Because they’d be plugged into a system that is already ahead of the world, though we’re not destined to stay there unless we do affirmative things to make sure that we stay ahead. But immigration policy is the clearest case where we could make some improvement. I think in the area of patent policy, I don’t think we have enough empirical evidence to know what tweak of the current system is going to be best for the economy and what’s going to be harmful. Finally, the mounting volume of regulation at the federal, state and local level almost certainly doesn’t help startups, which historically have been critical to introducing disruptive technologies.

QUINN: Well, that’s right because you know these big companies get so big that they just—the bureaucracy internally weeds out good ideas before they can ever get to the point where there’s a chance to green-light them.

LITAN: Exactly.

QUINN: In a startup the innovators are frequently the decision maker sand even in the growing startups the innovator is one or two levels away from the decision maker at most.

LITAN: Yes, that’s right. And that’s been the history in the United States. I’ve written about this during the last ten years or so of my career. I’ve frequently noted that the major innovations that characterize our modern society — the airplane, the car, air conditioning, computing, software for computing, internet search, to name just a few technologies – all were introduced by an entrepreneur, not a well-established firm.

QUINN: Well, and that’s probably a good place to end on that note. I really appreciate you taking the time to chat with me today.

LITAN: Terrific. I reapply appreciate it. Thanks.