Patent Lotteries: A Question for the Crowd

Long_tailA number of studies have shown that patent valuation is highly skewed.  The majority of patents are barely worth enough to cover prosecution costs, a substantial number have a moderate return, and a few are highly valuable. Chris Anderson just wrote a book on taking advantage of highly-skewed markets — titled The Long Tail.

The effect of this skew in the IP world has been dubbed the “patent lottery” because most of the payout involves a low probability of a high return. 

Lots of people think of the state-run lottery as a total scam because the expected value of a one dollar ticket is only about fifty cents.  The state rakes-in about half of the cost of every ticket and pays the other half out in winnings.  For anyone interested in wealth management and growth — this is not a good investment strategy. But, the state-run lottery is hugely popular with billions of dollars thrown at the system every year by hopeful winners. ($1.8b in Illinois alone in FY2005).  People explain this phenom in many ways — usually some combination of arguments such as: (1) the thrill of playing is worth the fifty-cent loss, (2) we generally don’t do well calculating the return low odds, and (3) we make stupid choices. [Note here that I have purchased a number lottery tickets in the past — especially when the jackpot is very large.]

Unlike the state-run lottery, in the patent system we don’t really know the odds of success very well and we don’t know whether potential innovators are willing to play “bad odds.”  I would like to get some input on this point.  Question for readers:

Would you or your clients 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 less than your original investment?

Comments are open — you can also e-mail me dcrouch@gmail.com.

Of course, there are many reasons why firms go after new innovation — plenty of which have nothing to do with patenting.  They may be receiving customer demands or they may want to be ready for a potential market opportunity.  Many firms go for patents as a defensive measure or to protect their product line as best they can.  That said, I know that some potential innovators dream about the NTP style litigation win or even a six-figure licensing deal.  What I don’t know is how that dream factors into actual innovative and patenting activity.

Notes:

37 thoughts on “Patent Lotteries: A Question for the Crowd

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  4. Even if the expected payout is fifty cents on the dollar, that dosn;t make buying a lottery ticket an irrational act. Utility theory may very well explain someone parting with a small and relatively worthless amount in exchange for a very small chance at a very large award.

  5. I find it interesting that the commercial value of a patent does not appear to correlate to the quality of the patent or the degree of innovation.

    So there must be a huge human factor in the perceived licensing value and evaluation of the commercial potential.

    The same human factors and subjective evaluation of technological and innovative potential will motivate inventors to file patents. It certainly has motivated me, even though I am still waiting for the lottery jackpot!

  6. The cost of a patent frequently pales in comparison with the cost of bringing a product to market. If the patent “lottery ticket” has the chance that it will bring publicity to your company, keep your competitors from immediately copying you, and/or increasing the value of you company, why not make the bet?

  7. I believe the focus should not lie on the patents, but on the projects from which these patents arise. If a company is willing to invest money in a project of which the market value is potentially high, but where there are large risks of failure, then automatically the value of the patents arising out of that project bear the same value expectations. Some companies do indeed entail such projects: one of the bigger oil companies employs people named ‘gamechangers’ who are heading projects, that when succesfull can change the nature of the commercial ‘game’. For these projects the potential market value is huge, but success rates are inversely low. However, starting with such projects is like betting on horses (to use another skewed comparison): the more horses you bet on, the larger the chances that you end up with a winner. And isn’t there an analogy with advertising money: half of the money spent on advertising is wasted, but you do not know which half.

  8. The answer to the question is:no, of course not. People however pursue patents because they believe the patent is valuable.

    The “long tail” is not the right analogy although the long tail and the returns to patents are probably both examples of “power laws”.

    The low value of many patents underscores that having an idea (even a really really good idea) is not enough: the real wealth is generated by the ability to translate the idea into a product selling at a price the public will buy. Even if NTP did have the idea for wireless email (highly doubtful) it was RIM (not NTP) which created wealth by designing and marketing a product.

  9. I don’t think there is a “long tail” for patents — at least not in the sense that Chris Anderson uses the term. In his analysis, there are a few “hits” (i.e. in music sold at Wal-Mart) but, because of the miniscule or non-existent costs of distribution and storage (i.e., with iTunes or Amazon), even products with a relatively low demand can still sell and that money can still be made by selling to these “niche buyers.”

    Personally, I think this should be case with patents, but is not. The market for licensing patents is highly skewed because of frequent necessity of threatening or even bringing litigation to “persuade” companies to license patents. Because most patents are not worth this much effort (or their owners do not think they are) there is not a long tail and many patents languish and are permitted to expire — see new Fed Cir. Judge Moore’s article on “Worthless Patents.”

    What would be better all around is if there were actually a long tail for patents and that patent owners did not have to be as concerned abut the next big “hit” but could license “niche” patents to “niche” users.

    How this paradigm shift happens is unclear as the “distribution” costs of patent licensing are high and the cost of infringement of most patents is usually zero.

  10. A patent proves you invented something novel, not something of value. A different mousetrap is not necessarily a better mousetrap and even if it is, better may not matter. Don’t forget VHS v. Beta.

    I suspect a very large number of patent applications are of the “vanity press” nature: You are an inventor. You are brilliant. You have a patent. You have something to say at cocktail parties. Even if the patent attorney tell inventors the economic realities, the ego may prevail.

    Even if the invention is something of value, most inventors would be better off using the money it takes to get a patent to manufacture and market their product.

  11. I would like to think a patent is more than a’feather in one’s cap’. The fact that the U.S government backs them up with a system and sends you that piece of paper with the USPTO-DOC emblem on it dictates that. Every patent issued has value-but only if the inventor acually manufactures and introduces it into the marketplace will it ever have the chance to garner return either in the form of a licensing or a partnership deal with a competitive company already doing something similar. At that point, the inventor will get the 64 thousand dollar questions answered-Who’s gonna buy it…is it any good….is it good enough to attract VC to go bigtime myself-does it really address a need and simplify a function for a buyer? It is highly unlikely that a company would simply pay you a lot of money for a patent unless it is truly groundbreaking in nature. If one owns a patent that describes a marketable product or method or function, and even if it might be sloppily written, giving the green light to an infringer-if the Doctrine of Equivalents is administered by the DC’s which I believe they do, you have the protection and value that comes with owning one. If you own a patent that is truly marketable-and people will pay to use it or buy the product it describes if you keep the price reasonable- and you have the U.S government backing you up,to boot- to me,that is real value whether you do it overnight or it takes ten years. Something is eventually going to happen with it and its all good.

  12. Adding to all the good comments, and assuming that a market exists for the new product, I might submit that independent inventors can realize a better ROI when we patent attorneys do a good search and draft and prosecute an application with the best possible claim scope. If the inventor understands the claim (and most do not), he/she has a better chance of realizing a high ROI. VC’s, manufacturer’s, and/or distributer’s are always looking for a new product that is protected by a very strong patent: they will seek out the inventors to exploit the patent. I do not think that many attorneys would provide a company with a design-around option knowing that it clearly infringes a well written claim owned by an independent inventor.

  13. As noted above large companies use ptent to:

    “1. To assure the right to produce a product
    2. To block others from making the product”

    I would add they also use them offensively and defensively in research space in order to try to make competitors develop “work arounds” to their patents or to block products by monopolizing research areas or tools. These types of patents are particularly important in regulated industries where methods/research intermediates must be reported to the government agencies.

    Patents have alot of uses as a monopoly can be very strong, and their value is often beyind a simple monetary calculation.

  14. I think some are discounting the emotional component or “psychic income” attributable to patents. I know many independent inventors that love to talk about their patents at cocktail parties, and many scientists who love to talk about their patents at conferences. Being able to say one has a new idea as proven by the patent system has value to many…

  15. Patents are better compared to insurance policies. The expected rate of return is very small but that’s accepted because the patentee is paying for insurance against a major catastrophe where the cost may be very high but probability is low (i.e: copying of a major product by a competitor, trade secret theft by former employees, claimed infringement of later inventions etc.) What’s the expected rate of return on your car insurance? Is it “revenue” when you have an accident and make a claim for damages? Such questions do not make sense to anybody but economists.

  16. Come on, guys…

    You talk about patents in some statistical sense, which doesn’t make any sense to me.
    Everybody knows that there are many many junk patents, but there are also a few Patents making all the difference for some particular industry.
    For example, RSA patent was a PATENT defining the state of the art in cryptography (and thus, the emergence of secure communications and e-commerce, not more and no less…)
    In telecommunications, Townshend’s patent on 56K modem was (and still is) a PATENT, a real pain in the ass of some of the biggest telecom equipment makers in the world.

    But the vast majority of the patents owned by the likes of IBM and MS are really pieces of junk, not worth the paper they are written on. I talked to many of those corporate scientists and engineers, some of them having dozens of US patents in their name.
    They would admit (in a private conversation, of course) that their patents are junk, but they get something like 1000 (!!!) bucks from their company for each patent application filed.
    And I think that most of them would trade all of their junky patents for just one PATENT.
    This is beyond money, by the way,
    it’s a matter of pride – to have some groundbreaking PATENT and assert it against some fat and dishonest corporate infringer…

  17. “Would you or your clients 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 less than your original investment?”

    No, just as I would not make a financial investment in any enterprise having the above as the likely outcome. ROI is the name of the game in business, and you posit a business situation with an ROI that is almost certainly negative.

    Might a “little guy” be tempted? Of course, but then he/she is typically more willing to buck the odds. VCs and others uninitiated in what a patent actually represents are usually impressed when the word “patented” is bandied about, but that impression is thereafter quickly tempered by what the patent covers, the market for the “innovation”, and the expectation of a positive ROI that meets their usually stringent financial criteria.

    BTW, I have been able to help clients create successful businesses backed by significant VC financing based solely on know-how/show-how (no trade secrets, no copyrights, no patents, no [fill in the blank]). In the final analysis the decision always comes down to money, and not the presence or absence of legal “protective walls”.

  18. Would you or your clients 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 less than your original investment?

    The answer is absolutely yes because they believe in their innovations.

    Investing in a patent is similar to investing in a stock option. You are buying the right, but not the obligation, to do something in the future. For stocks, you are buying the right to buy or sell at a given price. For a patent you are buying the right to stop someone from making, using or selling the invention.

    Most stock options are never exercised. That doesn’t mean they are bad investments. They serve their purpose of mitigating risk. That, in and of itself, has value.

    Likewise with patents. Most patents are never licensed. Only about 1% are ever litigated. Yet they serve their purpose of mitigating the risk of having an invention pirated and thus eroding the value of the much larger investment required for commercialization.

  19. I know of very few small companies that go into the patent world to obtain licensing revenue. That is not how to value patents. Most of my clients want patents because:

    1. VCs care. I do due diligence evaluations for VCs and having reasonable IP protection is reflected in the valuation, especially in the first few rounds.
    2. They want to demonstrate that an outside agency considers their innovation novel.
    3. Marketing people love to use the existence of patents to reinforce the uniqueness of the solution in their pitch.
    4. They want a potential shield in case they do get sued.
    5. They want to reward their innovators and encourage them to continue innovating.

    The possibility of licensing revenue is far, far down the list of things they’re concerned about. I consider patents closer to a “My kid is student of the year” bumper sticker. It shows off your skills, but isn’t actually going to produce revenue.

  20. A lottery is a game of chance. You make money from a lottery only by the luck of the draw. Your ROI is based on probabilities, which can be easily calculated (but rarely is by the participants). Nothing the lottery ticket holder does will increase the odds of winning (within the rules, that is. Malcomb’s idea deviates from just buying a lottery ticket and waiting to win).

    Making money from a patent requires work and skill, and maybe a little luck. The success of a patent is dependent upon what the patent owner does. A patent is a business asset and, like other business assets, only has a reasonable ROI when used properly.

    Although many independent inventors pay for a patent and expect to make money, it does not happen according to the principles of chance and probability. Patents involve risk, which can be influenced by the actions of the patent owner to some degree. Get a patent, don’t do anything for 20 years except complain that no one wants to buy the patent, and, SURPRISE!, another losing lottery ticket. Get a patent and do all the right things (business plan, market analysis, etc.), and the risk of losing your shirt may still be high, but not nearly so high as not doing anything.

    What we have are two realities. Patents in the business world have a risk associated with obtaining a ROI. That is the life of an entrepreneur. Many independent inventors think they have a million dollar idea and all they have to do is get a patent. They are playing the patent lottery.

    I think your question, Dennis, is biased by being posed in terms of a probability. Although there is a component of chance (or luck) in patent success, there are other factors that influence the return on a patent. I prefer to operate with the business model rather than the lottery model. So, I would pose the question as:

    Would you or your clients be willing to invest a lot of time and effort into developing a new innovation that has a high level of business risk but, also, a huge reward if successful?

  21. Of course, the sophisticated lottery player would buy 100 tickets for $1 each then, before the lottery winner was announced, would go door-to-door telling a select group of mostly uneducated people how SPECIAL and IMPRESSIVE these particular lottery tickets were and how, for a mere $5, they could buy a chance to win $25,000 from the pool of any lottery winnings above $1,000,000 dollars.

    The point being: the value of the typical patent APPLICATION is in the ability of the application owner to shake down investors.

    There are people out there willing to give you money for just about anything that looks like an official patent application. You just need to believe in St. Barnum’s teachings, exorcize yourself of all shame, and ask.

  22. One thing that I wonder about is how much of the valuation of a patent comes from the fact that it has been asserted against a particular market participant. Many patents that have earned their owners substantial revenue have been “hidden” patents- i.e.: patents whose value was unappreciated until someone decided to assert them against a company with a valubale product. Given the number of “diamonds” (I use this term losely) that have been discovered, one might wonder how many ‘low value’ patents might not really have such a low value if they were actually asserted.

    In terms of the lottery analysis, in order to really understand whether this is like a traditional ‘lottery,’ we’d need to perform an analysis of what the average return for investing in a patent is. If the average return is less than 1 (i.e.: for every dollar you put in, you expect to get back less than 1 risk-adjusted dollar), the lottery analogy may be appropriate. On the other hand, if the average risk-adjusted return is greater than 1:1, the lottery comparison breaks down, because a rational player might very well decide to invest- especially if they can buy enough “patent tickets” to have a high chance of winning.

  23. OIB, as counsel for individual inventors, I share your concern about public perceptions. Still, there are similarities between lotteries and the situation an individual inventor faces. Both involve initial expenditures made in the hopes of large future returns. The likely result in the vast majority of lottery tickets and such patents is a complete loss of principal.

    The most striking difference, of course, is that the outcome for the inventor will depend a great deal on his/her inventiveness, market perceptions, negotiating skills and quality of counsel. Nevertheless, dumb luck (good or bad) also plays a large role in the inventor’s fate.

    I fully agree with you that should the individual inventor ultimately prove the value of the invention, he/she should not be seen as a lottery winner. Better analogies would be a baseball player who makes it to the big leagues after working his way through the minors, or a Broadway star who spent years toiling in the ensembles.

  24. Some businesses treat a patent like an insurance policy that protects them in the event that their technology becomes valuable and competitors start to copy it. For these businesses, they know that many ideas won’t be commercially valuable and that they may not get a good return on their investment (if viewed on a patent-by-patent basis). But they also know that a consistent practice of filing patent applications will provide at least some assurance they’ll be protected when a product becomes a commercial success.

  25. Of course, winning the lottery doesn’t necessarily mean that the patent holder gets hundreds of millions of dollars. There are really not very many patents worth even $1m.

    Andrew — good comment regarding obtaining patents to impress VC and acquirers. VC’s are getting much more sophisticated about valuing patents.

    OIB — If there is no lottery, why do so many people file patent applications that turn out to be worthless? It seems to me that they may have been gambling up-front that the technology might turn out to be important.

  26. If collaboration, web 2.0 mash-ups and ‘open innovation’ are truly increasing (and not just a bunch of hype), then we should not only use our rear view mirror as a guide. Increasingly, IBM and P&G have begun to forge a path that is much more dynamic in the future. If there is a currency to technology, it is in patent claims. As with any currency or market, the patent technology market is no less a lottery as can be found in the stock market. The connection to profitability, consumer interest and sustainable differentiation are all critical factors to this equation.

    Interestingly, while the amount of interest in technology sharing slowly increases through use of open source software and open licensing programs, we can all look to the self-policing actions of those like Creative or NTP and say that something is wrong when companies don’t agree on terms and go the distance causing big fees and big settlements.

    With the large number of competitive cross-licenses that occur, how can one truely assess whether there are only home runs in this market? Without the research to know for sure, I’d suggest that perhaps a lot of the game just doesn’t get or warrant the same press attention.

    In my experience, I do agree there is a long tail to patent revenues which requires careful analysis to ensure adequate rewards.

  27. The use of the word “lottery” in the same sentence as the word “invention” or “patent” tends to contribute toward the legitimacy of the unfair connection – even if only subliminal, between lotteries and the inventive arts!

    Then when some patent is is suddenly reported in the news “to be worth millions or billions”, and when that patent doesn’t belong to say, IBM, then immediately everybody and their grandmother-in-law pounces out of nowhere to complain that “that dirty conniving fraudulent crooked patent troll dog-kicking cat-killing anti-Christ seems to have WON the patent LOTTERY”. And “oh how the system is so broken! This is just sickening!”

    There is NO LOTTERY (with patents)! Except in some purely academic, number cruching statistical sense!

    ….However, I strongly believe that there should be an option where inventors get to assign their patents to the US governemnt, in exchange for not having to pay fees (whatsoever) for obtaining and maintaining any patent issued to them. And if it turns out that their patent is at some point worth a lot, then the US government pays them some percentage of the royalties collected by Uncle Sam himself. It can be a small percentage; even a very small percentage. Your “partner” is, afterall, the goverment of the United States of America so don’t be greedy, you are contributing to the common good! That way infringers in court are faced with “Infringer versus the United States of America” no less.

  28. The post by GS does show where patenting is most like a lottery — the individual inventor’s application. Assuming that the individual has no realistic means of commercially practicing the invention, there is a high probabilty of famine, a small chance of feast (i.e., successful sale/licensing), and not much in between.

  29. My completely unscientific thoughts:

    Big companies USUALLY (not always) obtain patents for one of two purposes:

    1. To assure the right to produce a product
    2. To block others from making the product

    Only a few major corporations see licensing revenue as a reason to patent.

    Small companies obtain patents:

    1. To attract capital
    2. To be acquired
    3. As a revenue source

    Individuals obtain patents almost entirely as a revenue source.

    With this in mind, it appears clear that more “value” would come from the small company or individual inventors’ patents, since there is less value placed on non-revenue generating activities.

  30. I remember not long ago, I approached a patent attorney and asked him if he is interested in taking a case of mine. The first word out of his mouth was “Ah-haah, you want to enter the world of patent lottery”. This person is a noted patent attorney. You attorneys have know it for a long time that to some extent, patenting is like a lottery.

  31. As noted above, the analogy to a lottery is not very useful in many if not most patenting decisions. Often, small and midsize companies intend to be acquired as their long-term business plan. Having patents covering the products and services of these companies can be critical to this acquisition strategy.

    We might all agree that a particular company’s patents are too narrow or are of dubious validity. Still, the acquiring company can at least point to them as something it is buying. This would be a common example of a patent having a much higher perceived value than its true, stand-alone fair market value.

  32. Dennis-

    I find your question “Why is there no patent valuation blog?” intriguing. Wikipatents.com offers user based judgements of value and there are several manual and automated techniques for judging patent valuation but there seems to me a lack of a well accepted measure or standard for individual patent valuation.

    Currently I’m developing an automated system for my blog link to tinytechip.blogspot.com
    designed to sort patent claims based on claim breadth of nanotechnology related patents using word count algorithms focused on the independent claims. While I’m currently just using this to make a review of large sets of patents easier you’ve got me thinking about how this may be applied to patent valuation.

  33. Boston Prosecutor: Interesting you bring up the point of individual inventors and small companies.

    The skew in patent valuation tends to be the greatest for small companies and individual inventors.

    A recent study by a group of law professors (Allison, Lemley and Judge Moore) found that “valuable patents” tended to be “issued to individuals or small companies, not large companies.” At the same time, the average value of a patent issued to a small company is much smaller than than the average value of a patent owned by a larger company.

  34. For a small company who will only likely produce a small number of patents, my answer to the question as stated is “no.” For the same reason, I’ve never purchased a lottery ticket, no matter how big the jackpot was.

    However, the question is a little unfair:

    If I (a solo inventor, let’s say) invented something, I would not make the decision to patent or commercialize it based on such a broad statement like “the majority of patents aren’t worth it.” Instead, I would convince or delude myself that my invention, on its merits, really is in that small group of profitable inventions. I would convince myself that my patent lawyer, unlike most patent lawyers, is so carefully chosen and so skillfull at drafting patents that he’ll avoid all the mistakes that make the other patents worthless.

    In other words, the problem is that I apparantly have too much control over the process. In contrast to the bona-fide randomness of a lottery, not all inventions or patents are equal. (Or, at least, it’s much easier for even a sophisticated inventor to convince himself of this.)

    In fact, I’ve heard similar justifications for why people play the lottery: “It’s not just picking random numbers… I’m *very good* at the picking winners. I have a surefire system.”

  35. Blaise, I agree with you that there are many non-lottery reasons to file for patent protection. You mention the patent thicket idea, there are also many defensive strategies, to protect a particular product, signaling to investors and competitors, etc.

    However, Don’t you think that there are some patentees who file with the jackpot in mind?

  36. I think the comparison between patents and lottery tickets is a particularly bad analogy. Lottary tickets are binary in nature, you either win or lose with no middle ground. Patents on the other hand are cumulative in value. For example, the formation of large patent pools based on a high number of lower value patents may gives larger corporations an edge over a smaller corporation who may have one or two high value patents if the combined effect of the many lower value patents is to provide an enabling platform for the few high value patents.

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