A very small portion of patents generates income for it’s owners.

Take the University of California (UC) system as a case in point.  According to the 2009 Annual Report from the UC Office of Technology Transfer, “UC has received more US patents than any other university in the world.”  During FY 2009, there were 3,617 US patents in the UC system portfolio.  Licensing income (excluding “payments from settlement of litigation”) totaled $98.7M.  Of that, $74.7M or 75.7% came from the “top 25 inventions.”  Assuming 1 invention = 1 patent, that means that during FY 2009, less than 1% of the UC system patents generated over 75% of the system’s licensing income.

This 1% figure jibes with the statement Nathan Myhrvold, former CTO of Microsoft and current Founder of Intellectual Ventures (IV), made  that

Statistics on the true risk of investing in inventions are sketchy, but government reports suggest that just 1% to 3% of patents generate a profit for their inventors.

So why is it so difficult to sell or out-license patents?

Costs of Generating and Maintaining a Patent

First let’s consider the costs associated with generating and maintaining a patent from the inventor’s perspective.  These costs include

R&D Costs

The research and development (R&D) costs associated with generating the idea behind the patent can range anywhere from $0 (you bump your head in the shower and come up with a brilliant idea) to tens of millions of dollars (pharma patents, space patents, etc.) for the machinery, personnel, supplies, etc. required to investigate a phenomenon that leads to a patent.

2.  Patent Drafting and Prosecution Costs

Patent prosecution describes the interaction between applicants and their representatives, and a patent office with regard to a patent, or an application for a patent. Broadly, patent prosecution can be split into pre-grant prosecution, which involves negotiation with a patent office for the grant of a patent, and post-grant prosecution, which involves issues such as post-grant amendment and opposition.

A good ballpark estimate of the costs of drafting and prosecuting a patent is about $10,000.

3.  Patent Filing and Maintenance Costs

According to the latest US patent fee schedule, the costs of filing and maintaining a patent are:

•  Initial filing fees:  About a couple thousand dollars.

•  Maintenance fees

•  Due at 3.5 years:  $980

•  Due at 7.5 years:  $2,480

•  Due at 11.5 years:  $4,110

4.  Patent Monitoring and Enforcement Costs

These include the costs associated with conducting ongoing surveillance of global activities encompassing the technology that is covered by the patent to make sure no one is infringing on the patent, and if they are, the costs of forcing the infringer to stop infringing or take a license.  If you end up litigating a patent, the average cost of doing so is several million dollars.

5.  Patent Licensing Process Costs

These include all the costs associated with marketing the patents, drafting agreements, negotiating terms, and monitoring the licensees’ use of the patent.

The costs of generating and maintaining a patent are therefore substantial.  Only if the owner/inventor of the patent can find a buyer willing to pay a large enough amount of money to purchase or license the patent, will the owner be able to generate a profit from creating and maintaining the patent.

Incentives for In-Licensing a Patent

Carrot vs. Stick Licensing

Now consider the incentives from the buyer’s perspective for in-licensing a patent.  The impetus for patent sales or licenses takes one of two forms: (1) a proactive or “carrot” form, or (2) a reactive or “stick” form.

One needs to look at patent licensing as either “carrot” or “stick” licenses as in the “carrot and stick” analogy.

Carrot License. A carrot patent licensing approach is appropriate when the prospective licensee is not practicing the patented invention and is under no compulsion to take a license. The value proposition here is “my patent technology is better and by licensing it you will sell more products.” Or it may be “my patent technology is cheaper and by licensing it you will make more profit.” Convincing a prospective licensee to take a license is strictly a marketing exercise.

Stick Licensing. On the other hand, a stick patent licensing approach is applied when the prospective licensee is already using your patent technology and, thereby, infringing your patent. The value proposition here is “take a license or else… (I will see you in court).” One needs to keep in mind that every “carrot” license is really a “stick” license in disguise. After all, if there were not the unspoken threat of litigation, who would ever license a patent? 

What I'm interested in here is proactive or carrot licensing.  As such, issues associated with licensing in the following discussion refer only to carrot licensing.

Uncertainty Surrounding Licensed Patents

In general, it is very difficult to out-license patents under the carrot method.  For example,

Carrot licensing is a friendly process. It is a selling process. You've got to convince the licensee prospect that the technology is indeed worth the effort. And you've got to overcome the NIH (not invented here) attitude, which should not be underestimated. Carrot licensing is almost impossible to do without a lot of assistance from knowledgeable engineers or others from the licensor in both the license sales activity (explaining why the prospect should license the technology and to answer technical questions) and, after the license is signed, in effecting the actual "technology transfer".

In fact, many people would never in-license a patent proactively; they would only do so under threat of litigation.  This is at least partly due to the fact that the value of a (licensed or purchased) patent is buried behind a humongous haze of uncertainty. This uncertainty takes many forms, including the following.

•  Is the patent valid?

A 2004 paper by Michael J. Shuster, Daniel Flamm, and Sasha Blaug indicates that

Statistics compiled by the University of Houston Law Center report the number of times patent owners and accused infringers prevailed on various validity issues. Http://patstats.org. During the three-year period from 2000 through 2002, accused infringers prevailed overall 38% of the time in proving invalidity (under the current “clear and convincing” standard).

If there is a nontrivial chance the patent is not valid, then there could be no penalty for using the invention without taking a license.  Of course, even if the patent may not be valid, many developers will still pay for a license to use the invention at issue.  This will be the case when the potential costs of defending oneself against a charge of infringement are greater than the costs of taking a license, even if the patent ends up being invalidated.

•  Is use of patent infringing?

According to the US Patent and Trademark Office (USPTO) (emphasis mine)

The right conferred by the patent grant is, in the language of the statute and of the grant itself, “the right to exclude others from making, using, offering for sale, or selling” the invention in the United States or “importing” the invention into the United States. What is granted is not the right to make, use, offer for sale, sell or import, but the right to exclude others from making, using, offering for sale, selling or importing the invention.

Even if a developer has a license to use someone else’s patent, it is still possible that using the patent in the way the developer wants to use it will end up infringing on someone else’s patent.   In other words, it is often the case that a developer will need to in-license multiple patents to do what he wants to do.  In this case, given the costs of in-licensing multiple patents, it might not end up being cost-effective to continue on with the project.

•  Does the patent do what I need it to do?

Nowadays, many patents are extremely specialized.

Say I’m a developer, and I need to incorporate a staple remover into my technology.  I know there must be a patent out there for a staple remover, so instead of trying to come up with a novel staple remover on my own, I decide to look into in-licensing a patent from someone who has already invented one.  I go to the USPTO database and search patent titles and abstracts for the  words “staple” and “remov*" (remov* includes any variant on remov, including remove, remover, removal, removing, and so on).  What do I get?  As of Oct 20, 2009, there are

•  398 issued US patents with the words “staple” and “remov*” in the title or the abstract;

•  133 issued US patents with the words “staple” and “remov*” in the title;

•  112 issued US patents with the words “staple” and “remover” in the title or the abstract;

•  97 issued US patents with the words “staple” and “remover” in the title;

•  36 issued US patents with the phrase “staple remover” in the title.

So as a developer with a need for a patent for a staple remover, I have to be much more specific in my needs to determine which one or several, if any, of these 398 patents meet my needs.  That is, just because I need a staple remover and Mr. Jones has a staple remover does not mean that his patent will meet my needs.  What this means more generally is that it can be a very difficult and expensive process to match a buyer to a seller for a particular patent.

•  How much effort will it take to adapt the patent to meet my needs?

When patents are purchased or in-licensed, their commercialization requires the purchaser to integrate the patent into an existing framework or into a new business model.  In either case, it can take a considerable amount of time and/or resources to adapt the patent to fit into the system from which it will generate income.  The greater the effort required to adapt the patent, the less valuable it will be, and so the less of an incentive the potential user will have to in-license the patent.

•  How long will it take to negotiate licensing terms?

According to one participant in an intellectual property forum,  regarding proactive or “carrot” licenses:

Depending on the scale of the project involved and whether or not the license is exclusive or non-exclusive negotiations may take several months. As a practical matter, it is my experience that negotiations which extend past 6 months are either headed for derailment, or someone is not working diligently.

This does not include the time it takes to find the appropriate patent, only the time required to negotiate a license after the two parties have met and agreed to negotiate.  After converting these time costs into money costs, the negotiation costs of acquiring a license can thus be nontrivial. 

•  Is the patent’s sale/license fee less than the costs of working around patent?

Just as there are many ways to skin a cat, there are many ways to accomplish most other objectives.  As such, given the extensive time and resource costs associated with finding the right patent, negotiating a license, and adapting the patent to fit the requisite circumstances, it generally does not pay a developer to purchase or in-license a patent, if he can find a way to do what he needs to do or otherwise work around the patent in a faster or more cost effective manner. 

•  Are there other opportunities than the patent project at issue for generating income?

While a particular patent may provide a particular developer with an opportunity to generate income, one must also consider all the other opportunities available to the developer to pursue.  The more and better alternative opportunities available to the developer at issue, the less will be the chance that the project that encompasses the patent at issue will prove to be the best of all the opportunities and thus be pursued.

There is thus an enormous amount of uncertainty facing a potential developer contemplating in-licensing a patent that encompasses both the legal rights being gained from in-licensing a patent, as well as the resources required to get the patent in-house and adapted to meet his needs.  Unless the buyer has few alternative investment opportunities and/or the patent at issue presents a particularly good opportunity, it will be difficult for the seller to convince the buyer to proactively license or buy the patent.

In my next blog entry I will discuss the value of a patent from the buyer’s and seller’s perspective and why it is often difficult for parties to a negotiation to agree on a price.

Continue on to Part 2