Biotechnology is the use of cellular and molecular ...



ANTITRUST AND BIOTECHNOLOGY PATENT POOLS: MOVING TOWARDS A LESS RESTRICTIVE POLICY

Onyinyechi Okoro

Antitrust and Economics

May 9, 2005

EXECUTIVE SUMMARY

The biotechnology industry has become increasingly important to the United States economy since the 1990s. Biological research tools and commercial products have remained indispensable to academic research in the area of natural sciences, but have also become the building blocks of pharmaceutical research and development. However, new laws governing biotechnology patents have lead to the development of patent thickets -- numerous overlapping patents rights – within the industry.

Patent thickets increase transactions costs in two ways. First, they allow upstream patent holders to extort higher than market rents from downstream manufacturers – the hold-up problem, and second, they lead to the under use of patented biological tools – tragedy of the anticommons. In short, the effect of patent thickets in biotechnology is to stifle innovation.

Patent pools may be a way to address and reduce the transaction costs resulting from patent thickets. Patent pools are reciprocal arrangements between patent owners to share patent rights. However, despite the potential benefits of pooling arrangements; patent pools appear to be underused in the biotechnology industry. One reason for this may be antitrust treatment of pooling arrangements.

Traditionally antitrust authorities have been suspicious of pooling arrangements because of the associated risks of collusion and suppression of technology. However biotechnology patent pools are likely to display few of the anticompetitive characteristics typically associated with pooling arrangements because of the dynamic nature of the industry. As a result typical prejudices against prima facie collusive behavior may be misplaced in regards to the industry.

ANTITRUST AND BIOTECHNOLOGY PATENT POOLS: MOVING TOWARDS A LESS RESTRICTIVE POLICY

Biotechnology is the use of cellular and molecular building blocks or processes to make commercial products.[1] The United States biotechnology industry began in the 1980s, but during the 1990s the biotechnology industry became increasingly important to the United States’ economy.[2] From 1993 to 1999, the industry grew from $8 billion to $20 billion in annual revenue.[3] In 2002, there were approximately 100 products on the market derived from biotechnological research.[4]

The biotechnology industry exploded as a result of the Supreme Court’s decision in the case Diamond v. Chakrabarty.[5] Prior to Chakrabarty, products of nature could not be patented, and companies were prevented from gaining exclusive rights to biological organisms and/or DNA. However in the landmark case, which involved the a patent dispute over a man-made organism with lucrative industrial applications, the Supreme Court held that “anything under the sun made by man” was patentable, including forms of natural material.[6]

Following Chakrabarty, biotechnology companies began to increase in numbers. Additionally, and more problematically, the number of patent applications that these firms were filing also increased.[7] For example, during the 1990s it became relatively easy to isolate large numbers of gene sequences which were useful for identifying protein coding regions on a strand of DNA. Once these sequences became patentable, the United States Patent & Trade Office (“USPTO”) was flooded with patent applications. In 2002, there were approximately three million outstanding applications of this type. In many cases competing firms filed overlapping patents on the same gene.[8]

This, and similar situations, has undermined the basic nature of biotechnological research. Biotechnology is a collaborative field where one company is unlikely to possess all the patents, technical information and know-how necessary, regulatory expertise, and manufacturing or distribution capability to develop and market a product.[9] However, the numerous overlapping patents issued for biological tools like gene sequences have resulted in a situation where those seeking to commercialize new technology must obtain licenses from multiple patentees.[10] The effect of this is that in a field like biotechnology where innovation is often cumulative, strong patent rights can stifle rather than encourage innovation.[11]

Carl Shapiro describes this overlapping web of patents as a patent thicket and offers at least two problems that are created by patent thickets. The first is the hold-up problem.[12] The hold-up problem occurs in cases where a manufacturer has identified biological product or process, is at the stage of large-scale production of the product, but has not yet acquired a patent for the product. Additionally, another entity exists that holds a patent on a product or process with a similar/identical application.

Here, even though the timing suggests that the manufacturer has invented his product independently of the patent holder; the manufacturer is in a weak negotiating position when compared to the patent holder.[13] As a result, the patent holder can extort a greater-than-reasonable royalty from the manufacturer.[14] The manufacturer could solve this problem by designing around the patent after the fact, but is unlikely to do so because redesigning the product, “(a) could require a major redesign effort and/or cause a significant disruption to the product, (b) would still leave potential liability for any products sold after the patent issued before the redesigned products were available for sale, and (c) could present compatibility products with other products or between different versions of this product.”[15]

The hold-up problem is particularly acute in industries where numerous patents are granted. The danger that a manufacturer will “step on a landmine in these industries is all too real.”[16] The biotechnology industry is particularly susceptible to these landmines because of the hundreds of patents that can potentially reach any given product.[17] As more patents are allowed, there is an increasing number of potential hold-ups. As a result, manufacturers such as will be subject to the large transactions costs of acquiring the necessary intellectual property rights.[18]

Shapiro describes the second problem as the complements problem[19], but it has also been described as the “tragedy of the anti-commons”[20] in the literature. Unlike the tragedy of the commons, which is a crisis of overuse, the tragedy of the anti-commons is a crisis of under use. This problem is distinct from the routine the under use resulting from deadweight losses that accompany any patent system. The tragedy of the anti-commons refers to obstacles that arise when a user needs access to multiple patents to create a single useful product. Each upstream patent “allows its owner to set up another tollbooth on the road to product development,”[21] adding to the cost and slowing down the pace of downstream innovation.

For each patented tool that is required for an investigative process, the user must overcome the transaction costs caused by the strategic behavior of the patent holders. Where the sum of these costs exceeds the expected returns of the experimental process, there is a societal loss resulting from forgone biotechnological innovation.[22]

In their seminal work on this issue, Michael Heller and Rebecca Eisenberg argue that the biotechnology field is particularly vulnerable to the tragedy of the anti-commons for three reasons.[23]

First, given the presence of a large and diverse field of research tool patent holders (so-called upstream rights holders), there is a very high probability that the licensing and transaction costs of bundling those rights will exceed the ultimate value of the final downstream product for a given research endeavor. Second, as a consequence of the diverse nature of the patent holders, there will be heterogeneity in their business practices, norms, and agendas such that negotiation and deal formation will further complicate minimization of transaction costs. The diversity of the rights holders and potential divergence of interests can easily be highlighted by considering the current participants in biomedical research: universities, small start-ups, mature biotechs and pharmaceutical companies, etc. Finally, inability to determine the ex ante value of a research tool will create asymmetric valuations that can lead to breakdowns in the negotiating process.[24]

Essentially, then, innovation in the field of biotechnology is hampered by patent and licensing schemes that encourage the creation of excessive transaction costs.[25]

The dual problems of hold-up and the anti-commons can be addressed in a variety of ways. Solutions that have been mentioned in the literature include: withdrawing the grant of patent protection for biotechnological products and processes[26], granting non-exclusive patents[27], and encouraging biotechnology firms to organize in patent pools.

Of these methods, patent pools have received the most attention. In 2001, the USPTO issued a white paper encouraging the use of patent pools to address the problems caused by patent thickets.[28]

A patent pool is a reciprocal arrangement to share patent rights, and generally consists of a “mutual agreement among patent owners to waive their exclusive patent rights.”[29] In a patent pool, rival patentees will generally transfer their rights into a common holding company for the purpose of jointly licensing their patent portfolios.[30] Pools can be comprised of as few as two patents, or as many as hundreds.[31] Patent pools generally share two common characteristics. First, they consolidate the patent rights into a central, independent entity. The entity then sells licenses to the portfolio of pooled patents, often as a single package. Second, patent pools establish a method for valuing the patents and for dividing up the royalty stream generated through licensing revenues.[32]

The USPTO white paper lists four benefits of patent pools in the area of biotechnology. First, the USPTO anticipated that patent pools would eliminate the problems cause by overlapping patents, because businesses will be able to obtain the licenses that they require from a single entity. This could also facilitate innovation since it allows all members and licensees of the patent pool to more readily improve upon existing technologies.[33]

The second benefit cited in the white paper was the potential of patent pools to reduce the transaction costs associated with the licensing technologies.[34] The need for costly patent litigation between owners of overlapping rights would be reduced because of their shared membership within the patent pool. Also, parties who are interested in licensing patented technologies can license all patents essential to that technology without engaging in lengthy and tedious negotiations with several different patent holders.[35]

The third benefit of patent pools is that they distribute risks to all members.[36] The USPTO likened patent pools to an insurance policy, and suggested that pools will allow members to share the risks associated with research and development, by allowing members to recoup most of their costs. In this way, potentially lucrative projects which would have been too costly to undergo in the absence of a patent pool, will appear more attractive to members of a patent pool. This in turn will spur innovation.[37]

Finally, according to the USPTO, the fourth benefit of patent pooling is the exchange of information not covered under the patent.[38] Patent pools will allow member firms to foster lines of communication and trade secrets could become less prevalent as a result. Instead, members would have an incentive to avoid overlapping efforts, and thus more freely share information.[39]

Based upon their analysis, the USPTO concluded that that use of patent pools in the biotechnology sector would serve as a win-win situation.[40] The public would be served by the ready access to technology which would result from the streamlining of licensing conditions. Patent holders would be served by greater access to licenses for the proprietary subject matter of other patent holders. The end result would be that patent pools, could lead to “greater innovation, parallel research and development, removal of patent bottle necks, and faster product development.”[41]

Despite the benefits of patent pooling, traditionally few pools have formed in the biotech industry. Some reasons for this may stem from the hetereogeneity of the industry and its relative newness. Economists suggest that the length of relationships and the homogeneity of pooling companies increase the likelihood that pools will form.[42] The biotechnology industry is made up of academic research institutions, entrepreneurial start-up companies, large pharmaceutical companies, and even private individuals. Each group sees its position in the industry and has differing motivations. For example, if a university and a pharmaceutical company were to share a patent pool, they would likely have very different ideas about the costs a third party should incur to gain access to the pools portfolio.[43] These differences within the industry make it difficult for pools to form.

Similarly, the large numbers of newly formed companies, and the prevalence of merger activity and failure in the industry, suggests that companies may find it difficult to develop the types of relationship and level of confidence needed to enter into pooling arrangements.[44]

These natural barriers to reaching pooling arrangements has been exacerbated by the treatment patent pools have received from antitrust authorities. Traditionally the courts, the Department of Justice (“DOJ”) and the Fair Trade Commission (“FTC”) have regarded patent pools with some suspicion. Admittedly, in the early years of patents and antitrust, the courts felt that patentees had unbridled rights to assign, exchange, or combine their intellectual property rights.[45] However, courts soon recognized that patents were not exempt from the antitrust laws[46], and adopted a somewhat antagonistic stance towards patent pooling. By the mid-1900s, courts and regulators had established strict per se rules against many patent licensing practices, and had generally condemned pooling behavior.[47]

The establishment of these per se rules caused the number of patent pools to decline, however the rise in the prominence of patents during the 1990s brought renewed focus on patent pools by federal antitrust authorities.[48] In 1995, the DOJ and the FTC jointly published the Federal Antitrust Guidelines for the Licensing of Intellectual Property (the "Guidelines").[49]

The Guidelines established three general principles regarding the antitrust treatment of intellectual property issues such as various licensing practices and patent pooling.[50] These three principles were:

1) For the purposes of antitrust analysis, intellectual property is regarded as essentially comparable to any other form of property;

2) Intellectual property is not presumed to create market power in the antitrust context; and,

3) Intellectual property licensing is recognized to allow firms to combine complementary factors of production and is generally procompetitive.[51]

The DOJ and FTC are concerned with identifying arrangements which lead to the accumulation and consolidation of market power or the ability to maintain prices above or output blow competitive levels for a significant period of time. They note that market power that is the result of “a superior product, business acumen, or historic accident” does not violate the antitrust laws.[52] But arguably in recent cases, the market power of unsuccessful defendants could have been characterized as a result of these factors.[53] Further, in the case of patent pools, resulting positions of market strength likely will not be attributed to the aforementioned benign factors, but rather to collusive behavior.

Antitrust authorities have ostensibly adopted a rule of reason analysis to determine the cases in which patent pools generate anticompetitive effects. This analysis includes an examination of the market structure, the coordination within a pool, and whether the pool works to foreclose competitor’s access or increase costs, and whether licensing terms that involve exclusivity. [54] However, even while explaining that each licensing arrangement will be evaluated based upon its competitive effects rather than by more formal considerations; the DOJ and FTC identified four licensing practices which would warrant antitrust scrutiny:

1) Collective price or output restraints in pooling arrangements that do not contribute to an efficient integration of economic activity;

2) Settlement agreements that combine intellectual property assets of horizontal competitors and that have the effect of diminishing competition;

3) Exclusion of competitors from a patent pool when the excluded firms cannot effectively compete in the relevant market, and when the pool participants collectively possess market power; and,

4) Pooling arrangements that deter research and development.[55]

Commentators have suggested that this weighing of relevant factors has generally worked as a per se prohibition on certain forms of pooling arrangements.[56]

Subsequent clarification of the Guidelines in business review letters has only formalized the treatment of patent pools.[57] Therefore, currently a patent pool must be structure as followed in order to meet antitrust standards:

1) Limitation of the portfolio to technically essential patents which, by definition, are not competitive with each other.

2) Portfolio patents are clearly identified and can be licensed individually as well as in a package.

3) Issue of worldwide non-exclusive licenses.

4) Licensee liability for royalties conditioned on actual use of the patents.

5) Freedom of licensees to develop and use alternative technologies.

6) Requirement that licensees grant back non-exclusive, non-discriminatory licenses to use patents that are essential to comply with the technology.[58]

These standards, although a great deal more liberal than previous positions, have not gone far enough in encouraging the formation of patent pools, particularly in the biotechnology field.[59] Although standard setting bodies like the DOJ and FTC should be concerned about potentially anticompetitive activity; the nature of the biotechnology industry is such that there is little threat of anticompetitive behavior, and in fact the real threat is the potential stifling of industry-wide innovation. Thus, a proper analysis for assessing the economic effects of biotechnology patent pools must take into account the special nature of the industry and its likely impact on pro and anti competitive behaviors.

Traditionally two views have existed to describe the relationship between industry structure and innovation. The first view is espoused by economist Kenneth Arrow, who argues that competition is necessary for innovation, particularly where intellectual property protection for downstream products is available and the downstream products can act as substitutes for products already produced by the monopolist.[60]

The other view, is often associated with the work of Joseph Schumpeter, and argues that entities with monopoly power are engines of innovation.[61] Under the Schumpeterian view, monopolies foster innovation, particular risky innovation, because they can more fully appropriate the surplus generated by such an investment. Further, since monopolies are always subject to challenges by new technology, those monopolies that become complacent are likely to be replaced by new monopolies.[62]

Antitrust analysis of patent pools has adopted the first view, and has mainly concerned itself with allocative efficiency, or avoiding the deadweight loss of monopoly attributable the consolidation of market power through pooling arrangements.[63] However, above and beyond the traditional concern with allocative efficiency, antitrust policy should be the concerned with fostering technical innovation or dynamic efficiency.[64] Two mechanisms can be considered when determining whether a particular pooling arrangement promotes innovation or generates dynamic incentives. First the pooling arrangement should encourage initial invention innovation; and second, the pool should encourage follow-on or sequential innovation.[65]

Vianney Dequiedt and Bruno Versaevel suggest that pooling arrangements are generally able to enhance the dynamic incentives for research and development, and in this way promote initial invention innovation.[66] In evaluating the effect of pooling patents on the speed of innovation the pair adopts an ex ante approach. They assume that all patents in the pool are complementary, that is, none of the patents are in a competitive vis-à-vis another; pool members may license their innovations separately; new patents may integrate the pool; and that pool members will not engage in strategic behaviors in order to concentrate the profits generated by the pool. Essentially then, the pool in their model resembles the pool described in the MPEG LA business review letter, and would likely satisfy antitrust authorities.[67]

Using this model, they found that compared to a situation where there is no possibility of pooling, the possibility of a pool enhances the speed of research and development. By increasing the prospective profits of the patents; the pool acts as an additional reward, and thus enhances incentives.[68] Other commentators have also recognized the positive effects that patent pool can have on innovation.[69]

Similarly, pooling arrangements are also likely to enhance sequential invention. Vincenzo Denicolo considers sequential innovation and argues that the prospect of an agreement between owners of competing sequential but non-infringing patents increases investment in the second innovation and may raise general welfare.[70] He argues that collusion may serve to stimulate investment in second generation innovations, and permitting collusion will enable second generation innovators to gain a greater share of the profit, thus increasing investments in second innovations.[71]

Both the Dequiedt/Versaevel and the Denicolo models suggest that patent pools can enhance consumer welfare by encouraging dynamic efficiency. Nevertheless, the DOJ and FTC still harbor concerns about patent pooling. These concerns stem from the underlying concerns about monopolies and a suspicion of Schumpeterian economics.

David Evans suggests that these concerns are misplaced.[72] He argues that in dynamically competitive industries, such as the biotechnology industry, firms engage in Schumpeterian competition for the market, through sequential winner-take-all races, rather than the static price/output competition within the market that is contemplated by Arrow.[73] Evans calls these dynamically competitive industries, new economy industries[74] and suggests that traditional antitrust analysis fails to take into account the dynamic nature of these industries and thus fails to promote dynamic efficiency.[75]

As a result of the dynamic winner-take-all nature of competition within these industries, industry leaders are likely to be strong and command a majority of the industry’s market share.[76] As stated earlier, this is generally a red flag to antitrust authorities, but Evans suggests that this needn’t be the case. Since competition in dynamic industry is Schumpterian, the true measure of market strength is the robustness of a firm’s research and development efforts and the ability of other firms to produce and market competitive products. Essentially then, the test to determine whether sufficient competition exists between firms is to determine whether “creative destruction can take place as the result of rapid and disruptive technological change.”[77]

Evidence that this type of competition is taking place can be seen in the sequential power changes that have taken place within the pharmaceuticals industry.[78] In 1977 Smith-Kline offered the ulcer drug Tagamet, which was the clear market leader for many years. However in 1983, Tagamet was knocked from its lofty position when GlaxxoWellcome entered the market with Zantac. By 1988 Zantac’s market share had surpassed that of Tagamet, the first mover. By 1993, the drug controlled 55% of the market.[79] However, the introduction of Nexium and other similar drugs may ultimately eat into Zantac’s market share.

Ultimately, then, analysis of pooling behavior in the biotechnology industry should take into account the dynamic nature of the industry and endeavor to encourage rather than stifle innovation. Patent pools in biotechnology are more likely to follow Schumpeterian economics and for that reason current antitrust analysis may unnecessarily stifle innovation.

In the remainder of this paper I will asses and analyze the antitrust Guidelines’ have essentially per se prohibitions on the following behaviors:

1) Collective price or output restraints in pooling arrangements

2) Settlement agreements that combine intellectual property assets of horizontal competitors;

3) Exclusion of competitors from a patent pool when the excluded firms cannot effectively compete in the relevant market; and,

4) Pooling arrangements that deter research and development.

These prohibitions are all targeted towards addressing two problems: collusion to raise prices or shut out competitors and the suppression of innovation and/or entrenchment monopolies through the pooling of substitute or competing patents. While these concerns may be valid in other industries, I will suggest that they are significantly less relevant for biotechnology industry.

Several concerns are raised in the minds of regulators regarding the risks of collusion in patent pools. First, vertical restrictions in licensing terms or agreements that fix prices for unpatented products outright raise traditional antitrust concerns. Also pools can reduce competition by prohibiting firms that have licensed patented products from using unpatented products that substitute for licensed technologies.[80] Second, refusal to license patents on an individual basis can harm competition, by preventing competitors from accessing essential technologies.[81] Finally, networks or systems that are generated as a resent of pooling behavior, and resulting network effects within the pooling population may serve to entrench monopoly positions and prevent meaningful competition.[82]

To get at these concerns, the DOJ and FTC have essentially adopted a pre se prohibition on collective price or output restraints in pooling arrangements and on arrangements that exclude competitors from patent pools which has lead to soft requirements that pools allow patent members to independently license technology. However, this prohibition may not be necessary in the face of the fact that the biotechnology industry is heterogeneous in nature and pooling is likely to take place only within homogeneous subsets of the industry. This suggests that competition will exist between pools for licensing fees. Therefore, pools that adopt excessively restrictive licensing requirements will place itself at a competitive disadvantage. This is not to say that there is no role for antitrust authorities in regulating this type of activity; however, given the seeming availability of market restraints on anticompetitive behavior, it seems that it should be most appropriate for standard setting bodies to limit themselves to remedying clear examples of price-fixing, and allowing the market to address those situations that lie in the margins.

Similarly, a requirement that pools allow independent licensing may not add any additional value.[83] John Lerner and Jean Tirole ask what the cost to pool members is of including these types of provisions and whether it is optimal for antitrust authorities to insist on these provisions. They find that for welfare-enhancing patent pools, independent licensing provisions are irrelevant, and neither harms nor benefits the pool; however, in the case of welfare-reducing pools they find that these provisions may but need not reduce prices.[84] Thus is seems that the benefits independent licensing provisions are limited. Nevertheless, Lerner and Tirole recommend the use of independent licenses as screening devises, noting that in pools with only two patents, independent licensing yields the same outcome as the absence of a pool if the pool is welfare-reducing.[85]

The concerns of antitrust authorities in relation to system effects may also fail to apply to biotechnology firms. In remarks made before the American Bar Association, William J. Baer, then Director of the FTC’s Bureau of Competition, suggests that “networking effects in high tech industries can lead to a winner-take-all market with very little opportunity for any firm to compete with the dominant network.”[86] However, in the area of biotechnology the networking effects that would allow pools to entrench themselves within the market do not seem to exist.[87] Unlike the computer software and telecommunications industries where network effects stem from direct external benefits, which have the double-edged sword of enhancing the products value to those consumer who belong to the network, but also raising the consumer’s inconvenience costs of switching networks and thus more firmly entrenching monopolies.[88]

Any network effects that could result in the biotechnology industry would be informational in nature.[89] Use of a biological product by one firm, a group of firms, or by individuals – both singularly and in groups, is unlikely to experientially enhance the use of other firms or individuals. Instead, network effects, if they occur, would emerge when the use of a product by others influences one’s perceptions about its desirability, and thus affects the products valuation and rate of adoption. This can lead to herd behavior where a product comes to dominate the market, despite the availability of close substitutes.

The system benefits of pooling which would encourage the sharing trade secrets and reduce the risks of speculative research could potentially exacerbate a problem that is already present in a dynamic industry like that of biotechnology. However, this type of network effect is generally a product of being the first to market, and should be a predictable consequence of Schumpeterian economic competition where business organizations, in this case patent pools, are competing for the market. Fast-paced innovation in the industry then obviates the need for antitrust regulation, since the threat of competition will (a) prevent the monopolist from setting overly high prices, and (b) force the monopolist to continue to innovate in an effort to retain its market position.

Additionally, and on a side note, the fact that informational network effects can be readily addressed through advertising and methods of information dissemination may suggest that the threat of network effects in this area is not a threat at all.

The FTC and DOJ have felt that patent pools that include substitute or competing patents may also have ant-competitive effects. One concern is that pools of this type may, in some instances, lead to the suppression of innovation.

Absent a pool, firms have an economic incentive to invest in R&D because the discovery of patentable inventions can provide them with an advantage over competitors in the marketplace. However, depending upon its provisions, a pool in which competitors agree to pool competing patents can dull this incentive. The pooling of potentially weak or invalid patents and/or the pooling of future patent rights potentially have similar effects.[90]

Lerner and Tirole also examined the effects of pooling weak and substitute patents. They model inclusive patent pools – those that containing competing patents – and non-inclusive pools – those that do not, and conclude that inclusiveness does not affect profits and welfare so long as there is no alternative stand-alone use for the patent. This suggests the inclusion of weak patents in a pool can be appropriate. However, with respect to inclusive pools of competing patents, Lerner and Tirole suggest that they may be welfare-reducing if at least a small number of users are interested in the technology on a stand alone basis.[91] They suggest that independent licensing requirements can be used to address this problem.[92] Finally Lerner and Tirole look at the assignment of future patents, and suggest that while the practice may have anticompetitive effects, it also responds to the hold-up problem.[93]

The data generated by Lerner and Tirole while not overwhelmingly in favor of inclusive pooling arrangements, seems to suggest that these arrangements can be welfare enhancing. Similarly, Louis Kaplow argues that a per se rule against the pooling of competitive patents may be inappropriate. He notes that the analysis analysis which supports automatic prohibitions against the pooling of competing patents are ex post – the concern identified is the loss of competition between two technologies, taking as given, (a) that the competing technologies were developed in the first place, and (b) that the both competing technologies should have been developed in the first place.[94]

Kaplow suggests that if in the absence of a pooling arrangement, much of the rewar to both innovators would be competed away; then preventing the pooling of competing patents would tend to reduce innovation.[95].

A similar, but slightly different point, is that the costs of developing redundant technologies may also be welfare-reducing.[96] Since pooling patents would encourage communication between firms, fewer resources would be expending in developing competing technologies once a successful target had been isolated. Since the second version of an invention is only valuable to the extent that is better than the first; resources spent on developing redundant technologies would likely be put to use in developing and or addressing more novel problems and thus enhancing innovation.[97]

One response to this position is that a patent pool which contains competing patents, and to a lesser extent, weak patents, will have no incentive to improve on an existing product once a successful product has been created, and this is true. However, when considered in light of the biotechnology industry this concern carries little weight.

Biotechnology developments are traditionally one shot. For example, once a gene has been isolated; there is no way to improve upon the gene. All work that could be done on that area has been essentially completed. Therefore, the fear that future improvement patents will be stifled is unwarranted. Instead, the more critical concern should be the wasting of resources through duplicated research. Currently many firms engage in race to be the first to patent a gene or a particular section of a gene in order to be granted the grant. Thus, coordination through inclusive patent pools would reduce the need for that type of strategic behavior.

The pooling of substitute patents may be offer welfare benefits. Atsushi Kato suggests that allowing substitute patents to reside within one pool may not merely be tolerable, but may also enhance social welfare in some instances.[98] Kato suggests that because licensors determine both licensing fees and the number of licenses, prohibiting the pooling of substitute patents will lead to an increased number of patent pools, and force these pools to compete for licensing fees.[99] Because firms will wish to maintain higher licensing fees, they will behave strategically and license to fewer firms; and thus detrimentally limit the number of firms to have access to proprietary technology. In Kato’s view this would be welfare-reducing.[100]

However, if substituted pools are permitted, less competition occurs in the licensing market and licensing fees remain high which in turn induces licensors to license to more firms.[101] Kato maintains that since licensing fees are just a transfer within the economy high fees will not affect general welfare. Instead, the significant issue is the number of firms that are able to use the low marginal cost technology.[102] Therefore higher welfare is obtained when the substitute patent pool is used.

This theory, of course, assumes that there are a number of patent pools with similar portfolios of patents competing for license fees, and that even in the situation where competition is reduced, licensing fees are still low enough to not present significant transactions costs. For these reasons, it is likely that Kato’s theory is overly optimistic.

However, despite this fact, his findings suggest that we needn’t dismiss the prospect of allowing competitive patents to pool out of hand. Particularly in a diffused and heterogeneous industry like the biotechnology industry in which firms are more likely to organize as a number of small patent pools, rather than a few more comprehensive pools, and also where there is like to be some overlap of technology between pools.

Per se rules prohibiting substitute patents may also be welfare-reducing because they may exacerbate the effects uncertain patent rights and thus works to stifle pool formation overall.[103] As discussed earlier, the hold-up problem is in part, the result of actors not have clear rights ex ante. Firms who develop products independently may have sufficiently different products to not be infringing, but that cannot be known without litigation. Similarly, in many cases firms cannot know whether their patents are substitutes without under going litigation. Since firms are risk-adverse, they will avoid entering into potentially beneficial transactions because of the possibility that they could run afoul of antitrust laws. When this is further coupled with the nature of the biotechnology industry and it’s reluctance to pool in the first place, it becomes clear that per se rules against substitute pooling work to stifle economically advantageous behavior.[104]

The forgoing analysis suggests that antitrust authorities should take a relatively laissez-faire approach to biotechnology patent pools. Traditional antitrust concerns relating to collusion and price-fixing are less likely to become problematic given the dynamic nature of biotechnology firms, and in some cases collusion between firms may be welfare-enhancing. Similarly, the traditional reluctance to allow substitute or competing patents to pool may also be unfounded. Further, the Lerner and Tirole model suggests that the adoption of independent licensing provisions like those outlined in the MPEG/DVD business review letters will cure many of the anticompetitive effects associated with the pooling of competitive patents.

Thus three of the four caveats that were identified by antitrust authorities seem unnecessary. However, obvious and egregious price-fixing within a patent pool should remain a per se violation of antitrust laws. Although, as I have suggested that collusive price-fixing within pools is unlikely to diminish innovation within firms so long as the price is not set significantly over the marginal value of the license, and as a result is unlikely to diminish competition between firms However requiring authorities to perform that kind of calculation under conditions where anticompetitive results can be reasonably assumed is a needless burden regulation- setting bodies. Further, despite Kato’s assertions, the increase in license fees that would result in such cases is likely to manifest as higher priced consumer goods and thus would likely negatively impact consumer welfare.

However, concerns about the bundling of competing patents as a result of settlements and the bundling of competing patents in general seem to be misplaced, and should not be a regulatory barrier to the formation of welfare-enhancing patent pools. Similarly, the caution against pooling arrangements that reduce innovation seems to make little sense in light of data that suggests that most if not all pooling arrangements will enhance innovation. Fears about technology suppression and the stifling of follow-on innovation just do not seem to be supported by the weight of economic literature.

This has important implications for antitrust economic analysis. First, significant market power for some period of time is a necessary condition for dynamic competition to exist in the biotechnology industry. Therefore, the presence of short-run market power should not act as a signal of market failure to antitrust authorities. Further since static competition will rarely be vigorous in new economy industries, the key determinant of competition within these industries should be dynamic competition, or the presence of robust investment in and production of innovation products.

This suggests that the use of simple rules in this area will be welfare-reducing and instead antitrust authorities should favor the widespread use of detailed rule-of-reason analysis. However, since rule of reason analysis is time-consuming and knowledge intensive, certain presumptions should be adopted in order to mitigate the administrative hurdles associated with adopting standards versus rules analyses.

I suggest the following presumptions would be appropriate in the case of biotechnology patent pools. First, market share should not be considered a proxy for market power. Instead the presence of viable current and potential competitors should signal whether there is sufficient distribution of power and thus opportunity for competition. Second, collusive behavior within patent pools should be presumptively procompetitive, providing that activities do not take the form of price-fixing and/or preventing competitors from producing their products, and that the pools adopt licensing provisions which allow for independent licensing. Pools containing substitute or competing patents should be considered presumptively procompetitive, but the presumption should shift if (a) the pool does not allow independent licensing, (b) there is not a competitive market of similar patent pools, and/or (c) viable substitutes do not exist outside the pool.

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[1] Bradley J. Levang, Evaluating the Use of Patent Pools in Biotechnology: A Refutation to the USPTO White Paper Concerning Biotechnology Patent Pools, 19 Santa Clara Computer & High Tech. L. J. 229, 231 (2002) [hereinafter “Levang”].

[2] Stephen G. Kunin, Preface to Patent Pools: A Solution to the Problem of Access in Biotechnology Patents?, January 19, 2001 at ; See Levang, supra note 1, at 231.

[3] Levang, supra note 1, at 231.

[4] Id.

[5] Id; see Diamond v. Chakrabarty, 447 U.S. 303 (1980).

[6] Chakrabarty, 447 U.S. at 310.

[7] Id. at 232.

[8] Id.

[9] Id; see Jeanne Clark et al, Patent Pools: a Solution to the Problem of Access in Biotechnology Patents?, United States Patent and Trademark Office, 2-3 (2000) [hereinafter “White Paper”].

[10] Carl Shapiro, Navigating the Patent Thicket: Cross Licenses, Patent Pools and Standard –Setting, NBER Conference on Innovation Policy and the Economy 1-2 (2001)[hereinafter “Shapiro”].

[11] Id. at 2.

[12] Id. at 7.

[13] Id. See Scott Iyama, The USPTO’s Proposal of a Biological Research Tool Patent Pool Doesn’t Hold Water, 57 Stan. L. Rev. 1223, 1228 (2005) [hereinafter “Iyama”] (offering the following illustration of hold-up in the biotechnological context, “Suppose that a biotech corporation, Watson, has successfully developed a monoclonal antibody that can be used in the treatment of cancer. To mass-produce this antibody Watson has devised a cloning scheme using a line of Chinese hamster ovary ("CHO") cells. However, unknown to Watson, researcher Crick has a pending patent application for CHO cells that the USPTO grants after Watson has begun production. If the IP right had been known to Watson at the time of development, Watson could have easily designed around the patent. However, because the production scheme has been implemented, a new design would simply be too costly; thus, Watson is vulnerable to a royalty rate in excess of the fair market value of the IP right. Specifically, Crick can easily "hold up" Watson by exercising his right to exclusively practice the patent and thereafter demand a royalty rate up to the cost of Watson's implementing a new scheme that does not otherwise use the relevant IP right.”)

[14] The uncertainty of patent rights prior to litigation also compounds this problem. Even though the manufacturer’s product may not in fact infringe on the patent in question, the costs associated with losing a court battle will generally be higher than the rents that the patent holder will be able to extract.

[15] Shapiro, supra note 11, at 7.

[16] Id. at 8.

[17] Iyama, supra note 14, at 1228.

[18] Id.

[19] Shapiro, supra note 11, at 4.

[20] See e.g. Michael Heller & Rebecca Eisenberg, Can Patents Deter Innovation? The Anticommons in Biomedical Research, 280 Science 698, 698-99 (1998); Levang, supra note 1, at 234; Iyama, supra note 14, at 1227.

[21] Levang, supra note 1, at 234

[22] Iyama, supra note 14, at 1227.

[23] Michael Heller & Rebecca Eisenberg, supra note 20, at 699 cited in Iyama, supra note 14, at 1227.

[24] Id.

[25] Id.

[26] E.g. Oren Bar-Gill and Gideon Parchomovsky, The Value of Giving Away Secrets, 89 Va. L. Rev. 1857 (2003)(suggesting that while inventors my favor broad patent grants from an ex post perspective, and ex ante analysis of the patent grant suggests that a broad patent grant and subsequent hold-up will stifle innovation. Authors suggest a publication model which they suggest will maximize gains in both ex post and ex ante calculations.)

[27] E.g. Stephen Maurer and Suzzane Scotchmer, The Independent Invention Defense in Intellectual Property, 69 Economica 535 (2002) (suggesting that nonexclusive patent grants resulting from the exercise of an independent invention defense may reduce the economic inefficiencies associated with monopoly rights. Authors argue that if patent law were changed to permit independent invention, then there would be more competition (through patent licensing), lower prices and more benefit. And as long as the costs of independently inventing are not too low, this policy would not inhibit innovation from occurring.)

[28] See generally, White Paper, supra note 10.

[29] Joshua A. Newberg, Antitrust, Patent Pools, and the Management of Uncertainty, available at opp/intellect/020417joshuanewberg.pdf, retrieved on March 22, 2005. p. 2

[30] Steven Carlson, Patent Pools and the Antitrust Dilemma, 16 Yale J. on Reg. 359, 367 (1999).

[31] Id.

[32] Id.

[33] White Paper, supra note 10, at 8.

[34] Id.

[35] Id. at 9.

[36] Id.

[37] Id.

[38] Id. at 10.

[39] Id.

[40] Id. at 11.

[41] Id.

[42] Levang, supra note 1, at 248.

[43] Id.

[44] Id.

[45] Richard J. Gilbert, Antitrust for Patent Pools: A Century of Policy Evolution, 2004 Stan. Tech. L. Rev. 3 at *8 (2004); see E. Bement & Sons v. Nat’l Harrow Co., 186 U.S. 70, 91 (1902) (stating that “The general rule is absolute freedom in the use or sale of rights under the patent laws of the United States. The very object of these laws is monopoly, and the rule is with few exceptions, that any conditions which are not in their very nature illegal with regard to this kind of property, imposed by the patentee and agreed to by the licensee for the right to manufacture or use or sell the article will be upheld by the courts. The fact that the conditions in the contacts keep up the monopoly or fix the prices do not render them illegal.”)

[46]See Standard Sanitary Mfr. v. United States, 226 U.S. 20 (1912)(upholding the breakup of a joint licensing arrangement for patents on the ground that the pool violated the antitrust laws); Standard Oil Co. (Indiana) v. United States, 283 U.S. 163 (1931) (reversing the district court, and finding that patent pool contained none of the terms held to violate the antitrust laws in Standard Sanitary). See also United States v. Line Material Co., 333 U.S. 287 (1948).

[47] Steven Carlson, Patent Pools and the Antitrust Dilemma, 16 Yale J. on Reg. 359 (1999) (stating that by the late 1960s, the DOJ had begun applying a presumption of market power to the grant of a patent. DOJ also gave little weight to efficiency considerations of licensing restrictions. Opposition to patent licensing culminated in a list of nine practices, referred to as the "Nine No-Nos," that were considered per se violations of the antitrust laws.); Antitrust Enforcement and High Technology Markets, Prepared Remarks of William J. Baker, Director Bureau of Competition Fair Trade Commission, November 12, 1998 at (mentioning former inference of market power and use of “Nine No-No’s”).

[48] Gilbert, supra note 45, at *88.

[49] Carlson, supra note 30, at 376.

[50] United States Dept. of Justice and Federal Trade Comm., Antitrust Guideline for the Licensing of Intellectual Property 2 (April 6, 1995) [hereinafter “Guidelines”].

[51] Id.

[52] Id. at 4

[53] See United States v. Microsoft Corp., 147 F.3d 935 (DC Cir. 1998). See , for comprehensive information about the case.

[54] Guidelines, supra note 50, at 18.

[55] Id. at 22. The Guidelines advance one additional proposition not stated directly in the text. One of the Guideline's examples asserts that patent pools, and associated licensing practices, are lawful when they comprise blocking patents. Patentees may engage in otherwise prohibited practices, such as joint setting of royalty rates and package licensing, when the patents involved in the transaction are blocking. This rule will heretofore be referred to as "the blocking patents exception."

[56] See e.g. Josh Lerner and Jean Tirole, Efficient Patent Pools, NBER Working Paper Series, at 14 (2002), at papers/w9175.

[57] See Gilbert, supra note 45, at *1. Through a series of business review letters that were issued to MPEG LA group in connection with the joint licensing patents necessary to comply with the MPEG-2 standard, and DVD group in connection with proposals to offer package licenses for patents necessary to manufacture DVDs and players in compliance with the DVD-ROM and DVD video formats. The DOJ reacted favorably to both the MPEG and DVD proposals. Id.

[58] Id.

[59] The DOJ business review letters provided a template for patent pooling arrangements and embodied a new way of thinking in economics and law by shifting the presumption that patent pools were anticompetitive. In this way they contrast sharply with early judicial opinions about the legality of patent pooling arrangements. See generally Guidelines, supra note 50; Gilbert, supra note 45.

[60] Arti K. Rai, Fostering Cumulative Innovation in the Biopharmaceutical Industry: The Role of Patents and Antitrust, 16 Berkeley Tech L. J. 813, 819 (2001).

[61] Id.

[62] Id.

[63] Newberg, supra note 29, at 2.

[64] Id.

[65] Id. at 3.

[66] Vianney Dequiedt and Bruno Versaevel, Patent Pools and Dynamic Incentives to R&D, at 1(2004), available at .

[67] Id. at 4. Note, however, the patent pool modeled by Dequiedt and Versaevel complies with antitrust policy, however there is no reason to believe that pooling is likely to provide fewer incentives under a more laissez-faire regime. The reduction of regulatory barriers should make it easier to capture profits and thus nake patent pools more attractive.

[68] Id. at 16.

[69] See generally e.g., Shapiro, supra note 10; David Lin, Research vs. Development: Patent Pooling, Innovation and Standardization in the Software Industry, 1 J. Marshall rev. Intell. Prop. L. 274 (2002); Kazuyuki Motohashi, Does Active Use of Technology Market Spur R&D?: Empirical Analysis of IP Strategy of Japanese Firms, at

[70] Vincenzo Denicolo, Sequential Innovation and the Patent-Antitrust Conflict, 54 Oxford Economic Papers 649, 665 (2002).

[71] Id. at 650-51.

[72] See David S. Evans, Some Economic Aspects of Antitrust Analysis in Dynamically Competitive Industries, NBER Working Paper Series (2001), at .

[73] Id. at 2, 15-17.

[74] Id. Evans identifies several characteristics that are shared by new economy industries. These firms generally:

(1) have high fixed costs and low marginal production costs;

(2) are labor and capital intensive overall;

(3) display network and system effects;

(4) experience competition as a series of winner take all races; and,

(5) have extremely profitable industry leaders with large market shares.

[75] Id. at 2

[76] Id.

[77] Id. at 4.

[78] The biotechnology industry is relatively new, so data of this type pertaining solely to these products is scarce. However, a great deal of information has been generated about its close cousin -- the pharmaceutical industry.

[79] Evans, supra note, at 22.

[80] Richard J. Gilbert, Antitrust for Patent Pools: A Century of Policy Evolution, 2004 Stan. Tech. L. Rev. 3, at *91 (2004).

[81] Id. at *92.

[82] See generally, Carl Shapiro, Setting Compatibility Standards: Cooperation or Collusion (2000), at http:// haas.berkeley.edu/~shapiro/standards.pdf.

[83] Josh Lerner and Jean Tirole, Efficient Patent Pools, NBER Working Paper Series, at 14 (2002), at papers/w9175.

[84] Id. at 14-17.

[85] Id. at 38. In pools with more than two patents independent licensing gives rise to a number of equilibrium creating outcomes. Id.

[86] Antitrust Enforcement and High Technology Markets, Prepared Remarks of William J. Baer, Director Bureau of Competition, Federal Trade Commission (Nov. 12, 1998).

[87] See Ernst R. Berndt, et al., Network Effects and Diffusion in Pharmaceutical Markets: Antiulcer Drugs, NBER Working Paper Series, at .

[88] Id. at 1.

[89] Ernst R. Berndt, et al, supra note 87, at 1.

[90] Roger B. Andewelt, Analysis of Patent Pools under Antitrust Laws, 53 Antitrust L.J. 611, 627 (1985).

[91] Lerner and Tirole, supra note 71, at 18.

[92] Id. at 20.

[93] Id. at 38.

[94] Louis Kaplow, A Note on Antitrust Issues in the Licensing of Intellectual Property 6, at

[95] Id. at 6.

[96] Id. at 7.

[97] See id.

[98] Atsushi Kato, Patent Pool Enhances Market Competition, 24 Int’l Rev. Law & Econ. 255, 259 (2004).

[99] Id. at 257.

[100] Id. at 266.

[101] Id.

[102] Id.

[103] See generally, Newberg, supra note 29.

[104] Id.

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