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.