September 2004, Issue 7
Patent pools - the 80% solution
IAM Magazine
By Douglas R. Elliott and James E. Malackowski

Most patents are not worth the paper they are written on. Most R&D is a waste of money. But those companies that commit to building intellectual property portfolios and invest in research do better than those that don't. How does that work?

Only an inventor knows how to borrow, and every man is or should be an inventor - Ralph Waldo Emerson

Chicago, Illinois, 12th July 2004: This issue's column is dedicated to the principle that patents have substantial asset value even if individual patents are unlikely to be valuable. This logic double negative is easiest to explain by reference to the 80/20 Rule, from which we will borrow liberally. The 80/20 Rule states, in general, that 80% of what is valuable arises from only 20% of the available choices. Why should intellectual property be any different? More to the point - it's not. Many of our IP colleagues routinely rely on the 80/20 Rule - sometimes skewed to the 99/1 Rule by the pessimists among us - to explain that the average patent isn't worth the paper it's printed on. In turn, most of the R&D that creates patentable subject matter is even less valuable, since a majority of R&D fails to discover anything useful. Makes one wonder why we bother in the first place.

Because the 80/20 Rule is such a reliable indicator of human ineffectiveness, it begs the question of whether there is an innate law of Nature at work here. Although we seriously considered researching this hypothesis, we suspected that the probability that we would discover anything useful was sufficiently remote that crass speculation appeared to us to be almost as useful as the research itself. Since speculation is the path of least resistance, speculation wins the debate.

The 80/20 Rule predicts that as the number of patents increases the number of useless patents also increases. This is mathematically similar to the notion that the average value of a patent is inversely proportional to the number of patents available from which one can choose. It follows then that the total value of patents from which to choose is the area under the curve, so to speak, and that is an integration operation. This results in the logarithm function which is, coincidentally enough, one statistical representation of the second law of thermodynamics, also known as entropy. Entropy measures the change in randomness in natural systems. Since Nature requires that for any real process, the entropy of the system must increase, it is no small wonder that the pursuit of useful invention must, of necessity, be accompanied by an ever-increasing amount of intellectual garbage.

The IP community often refers to a lognormal distribution of value among patents. This is a collegial way of saying most patents aren't worth the paper they're printed on, except for a few, which are worth millions. From what we've speculated already, this sounds suspiciously like the 80/20 Rule. So again we are confronted with the "why bother at all?" argument. This may be a good time for a couple of thought experiments which have the rather nice property of seeming to create details without actually doing any research. The first thought experiment is try to justify the corporate necessity of R&D when the probability of success follows the 80/20 Rule. If R&D is actually useless, then enterprises doing research should have declining economic performance and companies spending the most on research should be the worst performers. This column would end here but for the fact that it's not true. To the contrary, the largest US spenders of R&D are the among most profitable and valuable companies of the Fortune 500. So what gives?

The relevant detail is that not all R&D fails to produce useful knowledge and, in turn, some of that knowledge produces useful patents. When the number of R&D projects increases, the probability of producing no patent winners decreases asymptotically towards zero. If we apply the 80/20 Rule twice in succession - first to get through the R&D process and second, to produce a really useful patent from the successful R&D - then the reasonable expectation of producing useful patents is around 4%. Maybe the pessimists are right. On the surface, a 4% success rate would discourage all but the foolhardy from undertaking the patent plunge. What are the odds of a successful patent resulting from, say, 17 projects? About 50/50 it turns out (courtesy of the Bernoulli distribution for a 4% patent expectation). If you can support R&D (like Fortune 500 companies) at around 100 projects, the probability of not producing any useful patents is less than 2% - meaning there is a 98% probability that some projects will hit the jackpot. So it would seem to follow that a larger R&D budget that supports more R&D projects (as opposed to the same number of more expensive projects) will reliably produce more winners, which explains why big R&D spenders generally have better results and why R&D can be justified in the first place.

The second thought experiment is to justify keeping the garbage patents. One would suppose that the uselessness of most patents would mean that they should be conspicuously abandoned (at least 80%) to avoid continuing maintenance fees. Except of course that it is only around 20% of US patents that tend to be abandoned before their legal expiration. More to the point, it is not apparent even to inventors which patents are truly useless. Maintenance fees are a small call option to pay for use of an asset that, on average, requires around US$2 million in R&D to create. It is cheaper to float them in the asset pool than to boot them out.

This brings us back to speculation and the not insubstantial role it plays in capital markets. It is inevitable that investment will continue to grow in IP because that is the principal asset of a knowledge economy. If you don't want be your investment strategy to be all wet, you really need to look at investing in the pool and not the single patent. Of that we are 80% sure.

Mr. Malackowski is Chief Executive Officer for Ocean Tomo SLB Partners LLC. The views expressed herein are those of the authors and do not necessarily reflect those of Ocean Tomo, LLC or its affiliates.

jmalackowski@oceantomo.com

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