By Shaun Larcom
Why does a firm apply for a patent? Using data from an international survey of firms conducted by the European Patent Office, de Rassenfosse answers this question with some interesting results, particularly in relation to how motivations differ by firm size. As expected, he finds most firms, regardless of size, primarily use patents to protect their technology from imitation. However, he finds small and medium enterprises (SMEs) are much more motivated by monetary reasons, while large firms are more motivated by a desire protect their freedom to operate. But perhaps most importantly the paper highlights the importance of patents as a signalling device for SMEs in attracting finance to commercialise their inventions.
The survey analysed by de Rassenfosse asked firms who had applied for a patent to rate a series of statements to determine their motivations. The ratings ranged between 1 (completely disagree) to 6 (fully agree) and included: imitation (I patent mainly to prevent imitation by competitors); secrecy (I will not patent an innovation that I can keep secret); freedom (I patent mainly to protect my freedom of operation); investors (I take patents in order to convince investors or banks of the value of my invention); and licensing (I take patents in view of licensing).
Source: de Rassenfosse (2010), p20.
As expected and visible above, the most popular motivation was to protect against imitation. Taking the mean score, this was followed by freedom of operation, attracting investors, and then licensing. In relation to company size, the share of SMEs taking patents for what de Rassenfosse terms monetary reasons (attracting investors and seeking to licence their products) is considerably higher than larger firms – 40% for SMEs in contrast to 15% for larger firms. In addition to preventing imitation, larger firms were mainly concerned with protecting freedom of operation.
His econometric analysis largely confirms that the firms’ stated motivations for patenting align with their actual behaviour. For instance, he finds that firms that take patents with the motivation of attracting investors have a lower share of their patent portfolio unused and more patents that are used internally, as would be expected. More interesting is his analysis of how firms actually use their patent portfolios. He found that SMEs utilise their patents more than large companies and he provides two explanations. First, SMEs are more selective in what they patent given the costs involved, and second, large companies apply more for freedom to operate motives, therefore leaving a greater percent dormant.
While not the focus of the paper, the importance of freedom to operate is worthy of comment, as it suggests that many firms, particularly larger ones, use patents for defensive reasons rather than to exploit their technology. This supports the tragedy of the anticommons thesis advanced by Professor Michael Heller at Columbia University. His work suggests that too many patents can actually lead to less innovation in fields such as biomedical research due to competing property rights and a lack of co-ordination. Curiously, this dataset suggests that larger firms attempt to deal with the anticommons problem by taking even more patents that they let lie dormant. Apart from the obvious welfare losses brought about by excessive patenting, this dataset confirms that larger firms are more able to defensively patent than smaller firms.
As the title of his paper suggests, de Rassenfosse focuses on analysing the motivations of SMEs, particularly by generating revenues through licensing agreements and in attracting investors. He finds that nearly half of those SMEs sampled take out patents for these reasons.
Worldwide royalty and licence revenues were estimated at around US$100 billion in 2005, and de Rassendosse finds that SMEs have a higher per cent of their patents licensed than larger companies. This result is perhaps not particularly enlightening as it is well known that licensing agreements are a useful method used by smaller firms to generate cash flows, whereas larger firms are more able commercialise and market inventions in-house. Of note however, is the degree licensing differs between Europe and the United States. Considering willingness to licence and the size of the patent portfolio, he finds the share of patents licensed by European SMEs is significantly lower than United States SMEs, which he suggests is due to inefficiencies in the European market for technology.
Perhaps the most interesting element of his paper is the analysis of why using patenting to attract investors is such an important motivator for SMEs rather than larger firms. Citing the literature, he highlights the importance of asymmetric information in the R&D process and the signalling effect of patents, especially for SMEs. The concept of asymmetric information applied to R&D suggests that inventors are more knowledgeable about the likelihood of success and market potential than potential investors. The argument goes that external investors have trouble differentiating between profitable and unprofitable inventions and will therefore not invest in R&D or require a significant risk premium. While large firms have the ability to finance R&D internally, this is often not an option for smaller firms, and as a consequence they must rely on external funders. Here patents can play a significant role. Smaller firms can use patents to serve as a credible signal that reduces information asymmetry.
De Rassenfosse argues that by taking out patents on promising innovations, the inventor can reveal credible information to investors, which helps them differentiate profitable and unprofitable projects. This suggests that the signalling effect for some firms is more important than preventing imitation, and his results support this conclusion. He finds a negative correlation between the motivations of attracting investors and secrecy, suggesting that firms, particularly SMEs, are willing to disclose extra information and bear patenting costs to attract investors even when there is no need in terms of keeping their technology secret. As concluded by de Rassefosse, this makes it all the more important to ensure that the threshold for granting patents is high, and he would no doubt welcome the intentions behind the Intellectual Property Laws Amendment (Raising the Bar) Bill. Raising the bar on patents has the effect of reinforcing the credibility of the signal a patent can provide, which de Rassenfosse has shown to be particularly important for smaller firms in accessing finance. As he concludes: ‘The more informative the signal, the more confident investors and the more information asymmetry is reduced.’ (p.13)
Gaetan de Rassenfosse, How SMEs Exploit their Intellectual Property Assets: Evidence from Survey Data, Intellectual Property Research Institute of Australia Working Paper (IPRIA) No. 8/10, December 2010.
Shaun Larcom is a PhD candidate in Law at University College London’s Centre for Law and Economics