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The Patent Lottery:. Exploiting Behavioral Economics for the Common Good. Shahil Patel & Rani IEOR 190G 5/9/2009. Section 1:. Summary. Overview. Legal studies research paper written by Dennis D. Crouch

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the patent lottery

The Patent Lottery:

Exploiting Behavioral Economics for the Common Good

Shahil Patel & Rani



  • Legal 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 economics
Behavioral Economics
  • Author’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 theory
Expected 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 effect
Patent Lottery Effect
  • Future 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 policy
Application: Patent Law 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 i
Case Study I
  • 2006 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 ii
Case Study II
  • 2007 Supreme Court case: KSR International Co. v. Teleflex, Inc.
      • Court expanded the number of patents that could be invalidated as obvious
  • According 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
  • eBay 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 innovation
  • KSR 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
main objectives
Main Objectives
  • Review 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 reaction
Initial Reaction
  • Provides 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
criticism i
Criticism I
  • Is 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 answer
  • Does 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 vii
Criticism VII
  • Paper 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 viii
Criticism VIII
  • KSRvs. Teleflex case is a weak example
  • Author 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 research
Areas for Further Research
  • Empirical 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