An ex ante theory of patent valuation: transforming patent quality into patent value.

• Author: Perel, Maayan
• Position: I. Introduction through III. The Objectives of the Proposed Method, p. 148-196

TABLE OF CONTENTS I. INTRODUCTION II. EXISTING PATENT VALUATION METHODS A. The Existing Patent Valuation Methods 1. Rules of Thumb 2. The Cost Method 3. The Market Method 4. The Competitive Advantage Valuation (CAV) Method 5. The Discounted Cash Flow Method 6. The Option Pricing Method B. The Common Characteristics of Existing Valuation Methods 1. A Positive-Economic Perspective of Patent Valuation 2. An Ex Post Perspective of Patent Valuation 3. Defining a Fixed Licensing Price 4. No Regulatory Intervention III. THE OBJECTIVES OF THE PROPOSED METHOD A. Improving Patent Quality B. Downgrading Patent Trolling C. Combatting Abusive Acts Of Price Manipulations D. Reducing Litigation and Related Costs IV. AN EX ANTE, SOCIAL-NORMATIVE PERSPECTIVE OF PATENT VALUATION: VALUING PATENTS ACCORDING TO THEIR QUALITY TRAITS A. What Is Patent Quality? B. The Bases For Proposing A Social-Normative Perspective C. The Proposed Quality Indicators 1. Indicators of Subject Matter Eligibility 2. Indicators of Utility 3. Indicators of Novelty and Non-Obviousness 4. Indicators of Clarity and Definiteness V. DEFINING FLEXIBLE PRICE LIMITATIONS A. Rules Of Thumbs B. The Rules Governing The Determination of Reasonable Royalty C. Databases Concerning Patent Licensing, Patent Licensing Statistics and Surveys VI. REGULATING THE PROCESS OF PATENT VALUATION A. Establishing a Regulating Body 1. The Patent and Trademark Office Is The Most Suitable Regulating Body To Implement the Proposed Theory 2. Forming A Special Division For The Purpose of Price Valuation 3. The Quality Assessment Process 4. Financing the Establishment of The Special Division B. Justifying The Regulation of Patent Pricing 1. Public Goods, Innovation and Exclusive Rights 2. Compulsory Licensing As a Limitation Over The Patentee's Freedom of Contract 3. The Justified Objectives of Compulsory Licensing According to the Agreement on Trade-Related Aspects of Intellectual Property Rights 4. Examining The Proposed Price Limitations' Compliance With Article 30 VII. CONCLUSION I. INTRODUCTION

Our patent system affords patentees with an exclusive right of limited duration over a new, non-obvious invention. (1) This limited period of exclusivity bestows upon patentees an exclusive control over the invention's price and, in turn, gives them a mechanism by which they can recoup their research and development costs. (2) Generally, our patent system does not interfere with the patentee's right to freely negotiate the licensing price of his patent. (3) Despite exceptional instances of compulsory licensing, (4) patent licensing is governed by the rules of free competition: the licensor and the licensee independently negotiate the price of the patent, hoping to maximize their respective profits. (5) Indeed, "there are gains to trade from licensing, and the patentee can design contracts that split these gains between itself and potential licensees." (6)

Under this regime of free competition, different methods of valuing patents for licensing purposes were developed. (7) Assuming a positive-economic perspective, these existing methods essentially purport to predict "the value of the potential extra profits obtainable from fully exploiting the invention ... compared with those obtainable without patent protection." (8)

At least four characteristics are shared by existing patent valuation methods that value patents for licensing purposes. (9) First, they adopt a pure economic perspective, in that they apply different mathematical calculations to determine the patent's future financial gains. (10) The quality traits of the patent, or its social benefit are rarely, if ever, considered under these calculations. (11) Second, existing valuation methods become effective only after a patent turns into a desired commercial product. (12) In this sense, they implement an ex post perspective--valuing patents that are ripe for licensing purposes. (13) At that point, it becomes clear who the exact parties negotiating the license are, their respective financial capacities, as well as, what are the specific circumstances surrounding the licensing agreement. (14) All of these inevitably affect the ultimate licensing value. (15) Third, existing valuation methods attempt to determine a fixed licensing price. (16) And fourth, they are governed by competitive market powers. (17) No regulating body is involved in electing the appropriate method of valuation and managing its implementation. (18) The parties negotiating the license elect their preferable valuation method, and are thus fully accountable for its resulting value. (19)

This state of affairs, under which existing valuation methods focus exclusively on the prospected financial gains from a given patent, while disregarding the patent's quality without imposing any meaningful limitations on the ultimate licensing value, fuels several intertwined problems. (20) First, it encourages low patent quality. (21) This is so because our patent system effectively affords low quality patents with the same reward it affords high quality patents. (22) Indeed, all patentees enjoy the same exclusive rights over their inventions, including the right to freely set their value based on their elected valuation method. (23) Hence, assuming it is generally easier to develop low quality inventions than high quality ones, patentees may be better off applying for low quality patents. (24) By disregarding the quality traits of the underlying patent, the current, ex post regime of patent valuation effectively supports low patent quality. (25)

Second, the current regime of patent valuation provides very few opportunities for weaker inventors and severely undercuts their ability to operate in the licensing market. (26) Even when these inventors succeed in obtaining access to licensing opportunities, they still face significant barriers in negotiating favorable licensing terms with potential licensees. (27) As a result, some small inventors who lack the means to commercialize their inventions resort to "patent trolling" (28) --a phenomena associated with the generation of income not through commercialization but through aggressive licensing and litigation of patents. (29) Through diverging investment from research and development to potentially unwarranted licensing fees or litigation, such patentees, often referred to as "patent trolls," practically hinder innovation. (30)

Third, the current regime of patent valuation, which imposes no meaningful limitations on the ultimate license value, allows strong patentees to manipulate the licensing price in such a way that ultimately decreases the social benefit of the public. (31) Often times, patentees with strong bargaining power manipulatively use injunction threats as means of obtaining more licensing fees than the true value of their inventions. (32) Consequently, they hamper the ability of downstream innovators to fully commercialize the benefit of their knowledge and hold-up follow-on innovation. (33) When the downstream firm faces injunction threats from multiple patent owners (a concept often referred to as "royalty stacking" (34)), these harmful consequences are perceptibly magnified. (35) In a different context, patentees may manipulate the licensing price to secure their market share by setting a value that is lower than the patent's real contribution. (36) By engaging in such a manipulative tactic, incumbent firms may reduce the incentive of potential entrants to develop their own, possibly better, technology. (37) The detrimental impact of this tactic over progress and innovation is patently obvious. (38)

To change this state of affairs, this Article presents a novel method of patent valuation for licensing purposes. (39) Essentially, it suggests that the value of patents should correlate with their technological contribution so that the patent system could efficiently reward innovation. (40) This Article thus proposes to "price tag" patents ex ante, upon issuance, in accordance with their inventive value and ability to benefit the public. (41) Essentially, it advances a two step method of valuation: First, determining the quality of a given patent according to the proposed quality indicators, and then, assigning flexible price limitations that correlate with the patent's quality. (42) Such a social-normative method of patent valuation, this Article contends, would improve patent quality. (43) It would also downgrade patent trolling and prevent abusive acts of price manipulations. (44) In the long term, the proposed method of patent valuation would also reduce litigation costs and decrease litigation rates. (45)

Accordingly, the remainder of this Article proceeds in five sections. (46) Section II expands on the literature concerning patent valuation. (47) Particularly, it describes the main existing valuation methods, including the rules of thumb often used to predict patent value, the cost method, the market method, the competitive advantage valuation method (known as the CAV method), the discounted cash flow method and the option pricing methods. (48) It also shows how these economic methods by and large fail to consider the patent's quality traits when determining patent value. (49) Afterwards, Section II explains the common characteristics of existing valuation methods that value patents for licensing purposes. (50) Particularly, it proves that they adopt a positive-economic perspective; that they implement an ex post perspective; that they set a fixed licensing price, and that they are governed by competitive market powers. (51) No regulating body is involved in managing their implementation. (52)

Section III explains the key goals of the proposed method of patent valuation. (53) Four intertwined objectives are hence presented. (54) The first relates to improving overall patent quality. (55) In this regard, it is argued that bolstering the correlation between patent quality and patent value would...