Over-rewarding patenting: you get what you pay for.

• Author: Melamed, A. Douglas
• Position: Thirty-Fourth Annual Federalist Society National Student Symposium

Patents are intended to create incentives for innovation and invention. (1) Whether they serve that purpose depends not only on how and under what circumstances patents are issued, but also on how and to what extent they are protected. Sound patent policy thus depends not only on the articulation of the boundaries of the patents, but also on the remedies that are provided when patents are infringed. If the remedies are inadequate, patents will provide insufficient incentives for invention. Remedies are inadequate if they do not prevent infringement when infringement is undesirable or do not provide sufficient compensation for patent holders when infringement does occur.

Assume patent holder P invents a new process for making widgets that is worth one dollar per widget more than the next best alternative (perhaps because it reduces per-unit manufacturing costs for widgets by one dollar). Assume further that, for any of a number of reasons including P's decision to license all manufacturers or equitable considerations that make it inappropriate to preclude manufacturer M from using the technology, the law permits M to use the patented technology as long as M pays an appropriate royalty. On these assumptions, a royalty in excess of one dollar per widget would require M to pay more to use the patented technology than the technology is worth and more than M would agree to pay in a market transaction in which both P and M were free to walk away from the deal. One dollar per widget is thus the maximum royalty that could be regarded as appropriate. Anything in excess of that amount would pay P more than the invention is worth. While the excess remedy might create additional incentives for invention, the incentives would be inefficient because inventions that depend on such excess remedies would be worth less than their cost to technology users.

In fact, a royalty less than one dollar per widget might well be adequate. For one thing, P might have been unable to obtain that much in a negotiated deal with M. If, for example, M has an alternative to P's technology that is worth one dollar less and P has no way to replace M's royalties, both P and M stand to lose one dollar if they fail to reach an agreement and M chooses the non-infringing alternative. In that event, the parties would likely agree on a royalty of less than one dollar per widget, even assuming that there is no uncertainty about validity or infringement. In addition, if, as recent studies suggest, patent protection is not necessary to induce invention in many circumstances, (2) a damage remedy that paid P less than the full value of the invention to M would leave P with sufficient incentives to invent. These complications are ignored in the discussion below.

A damages remedy or required royalty of more than one dollar per widget would make the cost of widgets higher than if the alternative process were used. The patented technology would reduce manufacturing cost by one dollar, but that savings would be more than offset by the royalty payment. The increased cost of the widgets would presumably increase the price of the widgets and thus reduce output of widgets. By increasing the cost of using the patented technology, the remedy would also tax and thus deter follow-on inventions. In short, excessive remedies for patent infringement not only overcompensate patent holders, but also reduce both product output and invention itself. Excessive infringement remedies thus directly undermine the purpose of the patent system to promote invention.

1. REMEDIES FOR PATENT INFRINGEMENT ARE EXCESSIVE

   Patent remedy law, sometimes explicitly but often implicitly, is based on an assumed paradigm in which there is a "guilty infringer." Imagine that Thomas Edison invents the incandescent lightbulb and obtains a patent on the invention. At that point, Edison has three options: (1) he can ignore the patent; (2) he can exploit the patented technology himself and permit no one else to use his invention; or (3) he can license others either selectively or broadly to exploit his technology. If he chooses the licensing option, potential licensees themselves have options: (1) they can take a license; (2) they can try to design around the patent (for example, by inventing a different kind of lightbulb); or (3) they can decide not to invest in lightbulbs. If the patentee chooses to take a license, he or she will be willing to pay no more than, and, as explained above, perhaps less than, the value of the patented technology compared to the next best alternative. If the patent holder insists on more than that, the potential licensee will walk away from the deal. If the parties reach an agreement, the price can be said to be a "market price." (3) If the parties do not reach an agreement and the potential licensee nevertheless infringes the patent, the infringer can be said to be "guilty" in the sense that it could have obtained a license before infringing (that is, ex ante) but infringed without having done so.

   This is the paradigm on which patent damages law is based, but there is much in the patent world, especially in the information technology (IT) sector, to which it does not apply. In the IT sector and others, it is generally not realistic or desirable to expect technology users to obtain licenses before using the technology. IT products include technologies claimed by hundreds, sometimes hundreds of thousands, of patents. (4) There is no way that an IT product manufacturer can be expected to discover all of the relevant patents (including unpublished patent applications), identify the current patent holders, and negotiate licenses with all of them before practicing the patented technologies. (5) As a policy matter, it would not be desirable for the manufacturer to...