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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

IEOR 190G

5/9/2009


Summary

Section 1:

Summary


Overview
Overview

  • 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


  • Comparison
    Comparison

    • 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


  • Project overview

    Section 2:

    Project overview


    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


    Critical analysis

    Section 2:

    Critical Analysis


    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