A Model of OptimalA Model of OptimalSoftware Patent Policy Software Patent Policy
DesignDesign
Professor Matt ThatcherProfessor Matt Thatcher
2
Trade Secret LawsTrade Secret Laws Uniform Trade Secrets Act (UTSA)Uniform Trade Secrets Act (UTSA)
gives right to companies to keep certain gives right to companies to keep certain information secret (to maintain competitive edge)information secret (to maintain competitive edge)
covers formulas, patterns, programs, devices, covers formulas, patterns, programs, devices, methods, processesmethods, processes
Must have the following characteristics:Must have the following characteristics: be novelbe novel represent economic benefit to firmrepresent economic benefit to firm involved some cost and effort to developinvolved some cost and effort to develop is generally unknown to the publicis generally unknown to the public company must show effort to keep the company must show effort to keep the
information secretinformation secret
3
Trade Secret LawsTrade Secret Laws (cont.) (cont.)
Problems:Problems: Software often must be put into the public Software often must be put into the public
realm, making it difficult to keep secret (and realm, making it difficult to keep secret (and generally unknown to the public)generally unknown to the public)
does not protect from independent discoverydoes not protect from independent discovery Economic Espionage Act (1996)Economic Espionage Act (1996)
penalties: up to $10 million and 15 years penalties: up to $10 million and 15 years prison for theft of trade secretsprison for theft of trade secrets
IP lost in industrial espionage IP lost in industrial espionage > $300 > $300 bill / year bill / year
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Trade Secret LawsTrade Secret Laws (cont.) (cont.)
How do you show you are keeping How do you show you are keeping information secret?information secret? identify all information to be protectedidentify all information to be protected label it label it confidentialconfidential educate employees of importance of trade secretseducate employees of importance of trade secrets make only accessible to limited # of people on a make only accessible to limited # of people on a
need-to-know basisneed-to-know basis develop develop non-disclosurenon-disclosure agreements agreements develop develop non-competenon-compete clauses clauses
Compuserv v. IBM (2005)Compuserv v. IBM (2005) technology protectionstechnology protections
firewalls, encryption, secure databases, etc.firewalls, encryption, secure databases, etc.
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Why Do Firms Patent Why Do Firms Patent Software?Software?
Number of Software Patents Issued Per Year [Bessen and Hunt (2004)]
0
5000
10000
15000
20000
25000
Year
Nu
mb
er o
f P
aten
ts I
ssu
ed /
yea
r
1982 2002
6
Patent Height (h)
Patent Width (w =
h - )
Basic Product (s = 0)
Allowable Imitation ()
Patent Height: Protection from improvements
Patent Width: Protection from imitation
Patent Length: Duration of protection
Improvement to the Basic Product
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Patent LawsPatent Laws Requires that innovation under review must Requires that innovation under review must
be:be: new, useful, and non-obvious to a person of new, useful, and non-obvious to a person of
ordinary skill in the relevant fieldordinary skill in the relevant field Once awarded, a patent provides patent-Once awarded, a patent provides patent-
holder:holder: scope of protection from imitation for 20 years scope of protection from imitation for 20 years protects functions/behaviors of the program protects functions/behaviors of the program protects from independent discoveryprotects from independent discovery
Cannot patent Cannot patent abstract ideas, laws of nature, scientific abstract ideas, laws of nature, scientific
principlesprinciples
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Patent LawsPatent Laws (cont.) (cont.)
U.S. Patent and Trademark Office (USPTO)U.S. Patent and Trademark Office (USPTO) patent examiners (~3000) search for patent examiners (~3000) search for prior artprior art
existing body of knowledge that is available to a existing body of knowledge that is available to a person of ordinary skill in the artperson of ordinary skill in the art
what is the problem with this in the software arena?what is the problem with this in the software arena? determine originality and noveltydetermine originality and novelty ~ 25 month application process~ 25 month application process details about patented innovations are placed details about patented innovations are placed
in the public domainin the public domain No limit to monetary penaltyNo limit to monetary penalty
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Debating Patent Policy DesignDebating Patent Policy Design
Why reform the U.S. patent system?Why reform the U.S. patent system? Samuelson (2004)Samuelson (2004)
What is wrong with software patent What is wrong with software patent quality?quality? patent height is too low!patent height is too low! patent width is too wide!patent width is too wide! patent length is too long!patent length is too long!
Economic perspectiveEconomic perspective National Academies(2004)National Academies(2004) Federal Trade Commission(2003)Federal Trade Commission(2003)
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Research QuestionsResearch Questions
What is the What is the targettarget of feasible patent policy of feasible patent policy designs?designs?
Which policy designs in the targetWhich policy designs in the target are good/bad for society? are good/bad for society? are good/bad for consumers?are good/bad for consumers?
Which policy design is socially optimal?Which policy design is socially optimal? How do changes to an established policy design How do changes to an established policy design
affect social welfare? That is, what happens if affect social welfare? That is, what happens if the authoritythe authority increases height? increases height? narrows width? narrows width? shortens length?shortens length?
Should software products be patentable at all?Should software products be patentable at all?
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Model of Duopoly CompetitionModel of Duopoly Competition(R&D Race / Product Improvements / Price)(R&D Race / Product Improvements / Price)
Pre-gamePre-game posit a basic, well-known software productposit a basic, well-known software product
where quality of basic product is normalized to where quality of basic product is normalized to zerozero
Free Market Competition (No Patent Model)Free Market Competition (No Patent Model) Stage 1Stage 1: two firms compete in R&D to develop a novel : two firms compete in R&D to develop a novel
ideaidea Stage 2Stage 2: the innovator (: the innovator (nn) transforms a novel idea ) transforms a novel idea
into an improvement (into an improvement (ssnn > 0) to the basic product at > 0) to the basic product at substantial fixed cost, C(substantial fixed cost, C(ssnn)=k)=kssnn
22 /2 /2 Stage 3Stage 3: the imitator (: the imitator (mm) observes the innovator’s ) observes the innovator’s
product improvement and decides to what extent it product improvement and decides to what extent it will imitate at zero fixed cost, will imitate at zero fixed cost, ssmm [0, [0,ssnn]]
Stage 4Stage 4: the firms simultaneously set prices and offer : the firms simultaneously set prices and offer products, where MC(products, where MC(ssnn) = MC() = MC(ssmm) = 0) = 0
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Individual’s utility function: Individual’s utility function:
Individuals’ purchase decisions:Individuals’ purchase decisions:
Solving for product demands:Solving for product demands:
Vertically Differentiated Vertically Differentiated Demands Demands
(Stage 4)(Stage 4)
1,0~ where psU ii
m
mimmi
mn
mnimminni
s
pps
ss
pppsps
0
m
m
mn
mnm
mn
mnn s
p
ss
ppQ
ss
ppQ
and 1
13
npns ms mp mnmnsspp
nnsp
Graphical Representation of Graphical Representation of Demand Demand
(Stage 4)(Stage 4)
np
ns
ms
mp
mn
mn
ss
pp
m
m
s
p1 0
14
nRnpns ms mp mnmnsspp
nnsp
Graphical Representation of Graphical Representation of DemandDemand
(Stage 4)(Stage 4)
np
ns
ms
mp
mn
mn
ss
pp
n
n
s
p1 0
mRnR
CS
CS
DWL
DWL
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Solving for Prices Solving for Prices (Stage 4)(Stage 4)
mn
nmnm
mn
nmnn
mn
mnmmnm
mn
mnnmnn
mnm
nmmn
m
m
mn
mnmn
n
n
mnm
n
m
m
mnn
n
mmmnnn
ss
sssQ
ss
sssQ
ss
sssssp
ss
sssssp
sss
psps
pss
ppss
p
sss
s
pssp
QpCQp
4),( and
4
2),(
4
)(),( and
4
)(2),(
02
and 02
02
and 02
and
2
2
2
2
n
Firms’ profit functions: Firms’ profit functions:
Profit functions (given quality levels) are concave Profit functions (given quality levels) are concave in prices:in prices:
First Order Conditions (F.O.C.s):First Order Conditions (F.O.C.s):
Solving the F.O.C.s gives:Solving the F.O.C.s gives:
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Performance Measures Performance Measures (Stage 4)(Stage 4)
242
212
,,,,
)4(2
)54(,
4, and
24
4,
2
2
22
2
2
2
2
2
2
n
mn
mmnnn
mnmnmmnnmn
mn
nmnmn
mn
mnmnmnm
n
mn
mnnmnn
ks
ss
sssss
ssssssss
ss
sssss
ss
ssssss
ks
ss
sssss
Firms’ profit functions (after substitution): Firms’ profit functions (after substitution):
Consumer surplus function:Consumer surplus function:
Social welfare function:Social welfare function:
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Solving for Imitator QualitySolving for Imitator Quality(Stage 3)(Stage 3)
7
4
0)4(
)74(
0)4(
)87(2
4,
3
2
4
2
2
2
2
nnm
mn
mnn
m
m
mn
nmn
m
m
mn
mnmnmnm
sss
ss
sss
s
ss
sss
s
ss
ssssss
Imitator profit function: Imitator profit function:
Profit function is concave in quality:Profit function is concave in quality:
F.O.C.:F.O.C.:
Solving the F.O.C. gives the imitator’s Solving the F.O.C. gives the imitator’s best best response function:response function:
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Solving for Innovator QualitySolving for Innovator Quality(Stage 2)(Stage 2)
kss
kss
kss
kss
kkpp
kkss
kss
ks
mnmn
mnmmnn
mnmn
nn
n
n
n
4608
259),( and
4608
196),(
4608
14),( and
4608
49),(
)96
1,
192
7(),( and )
12
1,
48
7(),(
048
7
0 2
2
Innovator’s profit function is concave in quality: Innovator’s profit function is concave in quality:
F.O.C.:F.O.C.:
Solving the F.O.C. gives the Solving the F.O.C. gives the free market outcome free market outcome (MO) values:(MO) values:
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The Patent ModelThe Patent Model
Patent policy is set before the game Patent policy is set before the game begins: begins: patent height (h)patent height (h) patent imitation level (patent imitation level ()) patent length (t)patent length (t)
where 0 < where 0 < < h and t < h and t [0,1] [0,1] Which policies give the innovator profit Which policies give the innovator profit
incentive to seek a patent?incentive to seek a patent?
hshthtth
ssth
mnnPOn
mnnPOn
,1,,, where
,,,
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ConclusionsConclusions
The POR is the The POR is the targettarget of feasible patent policy of feasible patent policy designsdesigns
Impact of changes to established policy design on Impact of changes to established policy design on social welfare social welfare patent length patent length social welfare social welfare
but contracts the POR and eliminates good policy but contracts the POR and eliminates good policy optionsoptions
patent width patent width social welfare social welfare patent height patent height social welfare if patent is long and high social welfare if patent is long and high
Optimal patent policy designOptimal patent policy design max length and set height/width to intermediate levels max length and set height/width to intermediate levels if length is short if length is short set the highest, widest policy in the POR set the highest, widest policy in the POR reduces R&D incentives to discover a novel ideareduces R&D incentives to discover a novel idea
Is policy too low, too wide, and too long?Is policy too low, too wide, and too long? it depends!!!!it depends!!!! many factors may prevent the policymaker from identifying many factors may prevent the policymaker from identifying
the POR or hitting a goodthe POR or hitting a good
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Questions?Questions?
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