Harvard Business School Alumni

LERNER: Congress won’t address needed patent reforms until CEOs get involved in lobbying for change.

Photo by Webb Chappell

Professor Josh Lerner, who holds a joint appointment in the School’s Finance and Entrepreneurial Management units, is best known as an authority on the venture-capital industry. The coauthor (with HBS professor Paul A. Gompers) of two influential books in this field, The Venture Capital Cycle (second edition 2004) and The Money of Invention (2001), Lerner also created the popular second-year elective Venture Capital and Private Equity, which attracts hundreds of MBA students each year.

Some fifteen years ago, as a doctoral candidate in Harvard’s Economics Department, Lerner was collecting data on the role of VC funding in the biotechnology industry. Before long, he also became intrigued by the concept of intellectual property and concerned about the sad state of the U.S. patent system. The result of that abiding interest is his new book, Innovation and Its Discontents (Princeton University Press), which he cowrote with Professor Adam B. Jaffe of Brandeis University.

Why do we need a patent system in the first place?

Unless there is a way to allow people to protect their ideas, no one would be willing to invest in research for fear that imitators who had not spent a dime on R&D would become competitors and drive down profits. By protecting innovations, patents are an essential incentive for the development of new ideas.

According to your research, the U.S. patent system, which was proposed in this country’s Constitution and codified in its modern form in 1836, began to have serious problems in 1982. What went wrong?

Two fundamental changes occurred that weakened the system considerably. The first had to do with the way patent cases are litigated. Before 1982, they were, for the most part, heard like any other case. If you had a dispute about something like an infringement or a royalty demand, you’d file in a district court. If you lost and wanted to appeal, you’d go to a federal circuit court. And if you wanted to appeal that, you’d go to the U.S. Supreme Court.

Unfortunately, there were huge discrepancies in the way circuit courts resolved these cases, so lawyers used to game the system to end up in front of a judge who they thought would be favorable to their case. Beyond that, Supreme Court justices were not enthusiastic about hearing patent cases, which they found legally uninteresting. The supposed solution was the creation of a new, centralized appellate court to hear all patent cases — the Court of Appeals for the Federal Circuit (CAFC). But it didn’t solve anything in terms of fairness. Staffed with many former patent examiners and patent lawyers, the CAFC has ruled largely in favor of patent holders.

What about the second change for the worse?

The role of patent examiners was significantly compromised. Struggling with budgetary issues in the early 1990s, Congress decided to turn the Patent and Trademark Office (PTO) into a “profit center.” Instead of subsidizing this agency, Congress wanted the PTO to generate significant revenues for the government. As a result, starting salaries for examiners fell far behind the private sector, and it became difficult to recruit and retain qualified candidates with advanced degrees. At the same time, examiners were rewarded for issuing more patents, since that brought in more money. The quality of examiners’ work decreased accordingly.

This change, combined with the creation of the CAFC, put sand in the system. Patents became too easy to get. Between 1983 and 2002, the number granted annually soared from 62,000 to 177,000. Swamped with about 350,000 patent applications each year, examiners are overwhelmed and unable to devote enough time to check out the validity of each one. And thanks to the CAFC, once a patent is issued, it’s hard to lose it, even if the claim for patent protection is weak.

Can you give us an example?

A patent has been granted for a “sealed crustless sandwich” filled with peanut butter and jelly; another for a “Method for Swinging on a Swing.” But these are just noise in the system. No one takes them seriously. What does worry me is the ability of someone to obtain patents of questionable merit that force other firms to pay a royalty, which in turn restricts the resources they have available for research. Similarly, some royalty demands are no better than extortion. For instance, someone has been issued a series of patents dealing with the operation of a call center, although he had little to do with the invention of the telephone or computer. Financial and software firms will probably end up paying this fellow several billion dollars in royalties. Fighting his lawsuits would not only be expensive but futile in light of the CAFC’s proclivity to rule for the patentee.

So, ironically, patents have been turned into weapons against innovation and competition?

Unfortunately, yes. One of the themes we heard repeatedly from practitioners was that the current patent system has created two sets of competitors — those who actually invent and make a product and so-called paper competitors who have intellectual property rights but aren’t involved in the industry in any real sense. This abuse of the system certainly wasn’t what the Founding Fathers had in mind when they gave Congress the right “to promote the progress of science and useful arts” through patent protection.

Why have attempts to reform the system failed so far?

There are a number of reasons, including the fact that patent lawyers benefit from an arcane system that fosters expensive litigation. A former patent commissioner once told me that this problem will never be addressed in Washington until the issue’s visibility moves from the level of the assistant general counsel of a corporation to the level of the CEO. We hope this book will contribute to that process by making these matters more accessible to chief executives and venture capitalists and by providing a road map to some of the areas where reform ought to be initiated.

— James E. Aisner