Assessing Private Costs of Patent LItigation

Often, when policy analysts discuss litigation costs, they only consider the out-of-pocket legal costs of litigation. But legal costs are not the only costs of litigation that affect innovating firms. Business costs of litigation can be much larger and can take many forms:

• Business disruption - document production, testifying in depositions, strategizing with lawyers, appearing in court;
• Firms in a weak financial position might see their credit costs soar because of possible bankruptcy risk created by patent litigation;
• Some products require customers to make complementary investments, and they may not be willing to make these investments if a lawsuit poses some risk that the product will be withdrawn from the market;
• Patent owners can threaten customers and suppliers with patent lawsuits.

James E. Bessen and Michael J. Meurer have issued an updated working paper titled "The Private Costs of Patent Litigation" (link). The paper looks at these and other issues related to the business side of patent lawsuits.

Interestingly, Bessen and Meurer found that patentee litigants do not show a positive response (investment-wise) to a lawsuit filing: "[Patent] lawsuits do not represent simple transfers of wealth on average. Instead, there is dissipation of wealth to consumers, to rivals or to deadweight loss."

Patentee litigants with high liabilities relative to assets (and to a lesser extent, firms with high current liabilities to current assets) have much more negative returns from initiating lawsuits. Because of ongoing debt, shareholders may view the patent holder as being too quick to launch a lawsuit or too vulnerable to a premature settlement, which may decline value.

From the alleged infringer side, companies lose about half a percentage point of their stock market value upon being sued for patent infringement. This corresponds to a mean cost of $28.7 million in 1992 dollars (median of $2.9 million), which is much larger than mean legal fees of about half a million. In aggregate, infringement risk rose sharply during the late 1990s, reaching 19% of R&D spending.

Suits from outside the industry may affect investors more negatively, since many view such situations as incidents of inadvertent infringement. When disputes occur within a narrow industry, the parties may have greater latitude to craft a settlement that benefits both jointly, including, perhaps, collusive settlements.

The paper concludes that something is askew from the risk/benefit side of patent litigation:

We find that, contrary to what is sometimes assumed, the business costs of litigation far exceed the direct legal costs. And we find that by the late 1990s, patent litigation risk was of the same order as, if not larger than, estimates of the private benefits firms receive from patents. Moreover, consistent with the previous literature, the losses to alleged infringers do not correspond to a transfer of wealth to patent holders; instead there is a substantial joint loss of wealth. Our estimates concern private costs rather than the social costs of litigation, nevertheless these estimates tell us something about the effectiveness of patents as a policy tool to encourage investment in innovation.

In the best case, this suggests that the patent system is at present an inefficient form of subsidy or regulation. Thomas Hopkins estimates the total 1992 cost of general regulatory compliance is $389,911 per firm (in 1995 dollars). But the costs of complying with the patent system - annual infringement risk of $4.5 million - are much larger.

In the worst case, the net effect of patents today may be to reduce the profits of public firms and to possibly impose disincentives on innovative activity as well.

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