TITLE: Business Discovers The Value of Patents AUTHOR: Walter Bratic, Patrick McLane and Robert Sterne PUBLICATION: Managing Intellectual Property DATE: September 1998 SOURCE: Euromoney Publications PLC URL: http://www.lawmoney.com BUSSINESS DISCOVERS THE VALUE OF PATENTS More patents are being filed than ever before. Walter Bratic, Patrick McLane and Robert Sterne analyze the trends behind the key statistics from the world's three biggest patent offices. In today's knowledge-based global economy, intellectual property assets have in many cases superseded physical assets as the basis of corporate value. Many industry-leading companies have come to realize that to maximize shareholder value they must excel in providing high profit goods and services and create intellectual property assets that maintain and protect profit margins. For many companies, shareholder value has become a direct reflection of the ability to leverage and extract value from their intellectual property asset portfolio. Intellectual property assets provide a critical and expanding part of the foundation upon which a company's competitive advantage is built: such assets preserve exclusive markets, maintain profit margins and provide market access and freedom to operate. Some industries particularly focused on the development, protection and capitalization of intellectual property assets where companies fiercely compete to develop the next leading edge technology include biotechnology, pharmaceutical, computer, software, telecommunications and other high technology companies. By examining selected statistics, particularly ones related to utility patents, the importance of intellectual property assets now, and more importantly in the future, becomes evident. This article will highlight some of those statistics. Trends in intellectual property Intellectual property assets are given life as ideas, innovations, compilations, and presentations of information, designs, brands, and product/service imaging in which corporations invest intellectual capital, or license from others, to develop and grow their businesses and to deliver shareholder value. Common modes of intellectual property assets are utility patents, design patents, copyrights, trade marks, trade secrets, trade dress and know-how. This article focuses on utility patents because they are the primary legal mechanism for protecting technological innovation that is susceptible to reverse engineering. However, the other modes of intellectual property play a critical and complimentary role in the manufacture, distribution and sale of goods and services. These statistics go beyond the scope of this article. As a starting point, a review of intellectual property statistics compiled by the trilateral patent offices comprising the US Patent and Trademark Office (USPTO), European Patent Office (EPO) and Japanese Patent Office (JPO) will be discussed. From there, observations related to the combined trilateral patent offices will be outlined. Finally, the research and development investment, which is fueling the growth in intellectual property assets, will be examined. The USPTO: promoting the progress of science The USPTO has existed for over 200 years. Its goal has remained the same throughout this tenure: to promote the progress of science and the useful arts by securing for limited times to inventors the exclusive right to their respective discoveries (Article 1, Section 8 of the United States Constitution). This system has allowed US industry to benefit from new inventions, alternative uses for old inventions, and employment opportunities created for millions of citizens and residents of the US. The USPTO is a non-commercial federal entity and one of 14 bureaux in the Department of Commerce. It occupies a combined total of over 1,400,000 square feet, in several buildings in Arlington, Virginia, a suburb of Washington DC. The USPTO employs over 5,000 full time equivalent professionals to support its major functions -- the examination and issuance of patents and the examination and registration of trade marks. Like other organizations, the USPTO has evolved over time into a unique government agency. Since 1991 - under the Omnibus Budget Reconciliation Act of 1990 - the USPTO has operated like a business entity, providing products and services to clients for fees, which pay operational expenses. The USPTO primary services include processing patents, copyrights and trade marks and disseminating patent, copyright and trade mark information. Rapid growth As figure 1 demonstrates, USPTO patent applications increased from 206,276 to 237,045 from 1996 to 1997 -- an increase of 15%. Note that the significant filing increase in 1995 was due to a filing deadline under the General Agreement on Tariffs and Trade (GATT). It is believed that the number of patent applications filed in 1998 will break all records, so this increase continues. The states leading the patent application charge in 1997 were California with 27,046, New York with 9,855 and Texas with 9,692, which are each centres of high technology in the US. USPTO patents granted show a clear upward trend from 1993 to 1997 (figure 2). In fact, the 122,977 US patents granted during the 12 months ended September 30 1997 represented a 5.2% increase over this same period in 1996. For those patents granted in 1997, the average time an application was pending at the USPTO from its original filing date was 26.5 months or 22.2 months from the most recent filing date. Since no enforceable patent rights exist in the US for pending patent applications, in fast-paced industries such as electronics and telecommunications, this significant pendency period is of concern. It is also interesting to note the continuing high percentage of utility patents being issued, which represented approximately 93% of those patents issued in 1997. At the end of 1997, there was a backlog of 373,904 patent applications pending at the USPTO. What is the nationality of those applicants receiving US patents in 1997? Of the 124,147 US patents granted during the calendar year 1997 the top three recipients were: (1) US with 69,925 or 56%, (2) Japan with 24,190 or 19% and (3) Germany with 7,292 or 6% (figure 3). Breaking down the figures The technology areas of utility patents being issued by the USPTO provide a clear emphasis on high technology (figure 4). The drug and biotechnology areas received 9,030 utility patents or 7.3% of the total patents issued in 1997. Information processing patents were also a clear leader with 2,820 patents. This is a technology subset of electronic and telecommunications patents, which are experiencing a dramatic increase in filings and where the USPTO is doing extensive hiring of patent examiners to examine patent applications in these technology areas. What technology area had the lowest number of patents issued in 1997? That would be button making with two patents (figure 4). Is this heightened level of patent activity generating income for companies? An emphatic yes. In fact, the 1997 estimated royalties that US companies earned from licensing activity was approaching $100 billion (figure 5). The companies reaping the benefits from their investment in intellectual property included the usual suspects of top US patent recipients in 1997, IBM (number one for the past five years), Canon, NEC, Motorola, Fujitsu, Hitachi, Mitsubishi, Toshiba, Sony and Eastman Kodak respectively. It is interesting to note the non-US dominance of top US patent recipients in 1997 (figure 6). One should not think that only very large companies are seeking utility patent protection. The fastest growth in filings is coming from emerging companies in the biotechnology, electronics and telecommunications areas. These emerging companies are embracing patent protection to a much greater extent than in past business cycles. Tech Web News reported in their March 6 1997 issue that Marshal Phelps, Vice President of Intellectual Property and Licensing at IBM said: IBM invests significant amounts of its time and resources in the research and development of new software inventions. While we believe it is advantageous to the industry and our customers for IBM to make these inventions available through license agreements, we also have a responsibility to protect our investment by enforcing our patents. IBM's investment and the protection of their investment in intellectual property has paid off. In addition to being the leader in patents issued for the past five years, IBM entered into 52 intellectual property agreements with software companies in 1997 and in 1996 generated $900 million in royalty income from licensing activities. IBM has also been successful in settling intellectual property disputes out of court. Of course, the upward trend of patent activity has spawned an upward trend in patent-related lawsuits. In 1997, there were 2,090 patent lawsuits filed, which represented a 16% increase over 1996 and almost a twofold increase of patent lawsuits filed since 1991. This clearly reflects the importance that inventors and companies place on protecting and enforcing perceived intellectual property rights (figure 7). Most patent lawsuits in the US are settled before final decision. The increase in such lawsuits is a barometer of the increased importance and value of US patents and the willingness of patent owners to demand adequate compensation for infringement. The EPO: unifying protection in Europe The EPO has a published mission of promoting the use of patent protection in Europe in order to enhance the innovative strength and competitiveness of European industry by providing an efficient and high quality regional system for patent protection exploiting the potential for synergy between national offices and the EPO. The EPO has been a successful cooperation of many European countries from both a political and economic perspective. As of 1996, the EPO provided patent protection in 23 European countries. EPO patent protection is secured through a unitary grant procedure developed through the signing of the European Patent Convention (EPC) in 1973. The EPO is physically located in Munich where it performs the patent examination process and in Hague where it conducts database searches. EPO examiners are drawn from the national patent offices in the EPC and must have proficiency in English, French and German. As evidence of its success, EPO patent applications have been on the rise. An upward trend in EPO applications can be ascertained since 1993 when 56,978 patent applications were filed to 1996 when 64,035 patent applications were filed (figure 8). What is the nationality of those companies and individuals filing EPO applications? In 1996, the members of the EPC led the race with nearly 50% of the applications. The EPC countries with the most patent applications were Germany, France and the United Kingdom respectively. Outside the EPC, the US was the leader with 29% of patent applications followed by Japan with 18% (figure 9). Although EPO patent applications have been rising, the number of patents granted has shown a slight decrease from 1994 when 42,000 patents were granted to 1996 when 40,069 patents were granted. (figure 10) This may be an indication that the period between patent application and patent issuance has risen at the EPO during the past few years. The JPO: looking towards the 21st century The JPO defines patents, new utility models, designs and trade marks as industrial property rights (IPR). The JPO's stated role is to contribute to the development of industry by securing and protecting the successful and creative development of structures for IPR. The JPO has indicated that the importance of IPR has grown considerably in recent years, as has the importance of science and technology. In April 1997, an advisory commission comprised of top academic and business leaders with a mission of formulating Japan's IPR policy toward the 21st century issued their report to the Commissioner of the Japanese Patent Office. The report stated that the next century would be a completely new era, with such developments as the rapid spread of the Internet and the general transition from the hard age to the soft age. Globalization and information technology will be the key to success. However, the world will also have to solve complex obstacles such as environmental deterioration, food supply problems and new energy sources. The report also contained a section entitled 'The Crisis Facing IPR in Japan' This section of the report highlighted several issues that Japan will have to face and overcome in the next century. From 1986 to 1995, Japan had a deficit of about ¥ 4 trillion ($38.5 billion) in terms of technology trade (technology imported less technology exported). More than half of the JPO patent applications in 1994 were from entities of foreign origin. In Japanese firms, IPR have not been a priority for senior management. The report advises that IPR will have to be regarded as the most important assets for Japanese firms to remain profitable. The Japanese government must strengthen IPR protection and accelerate the creation of IPR by facilitating a comprehensive infrastructure for IPR in every sector, while giving careful consideration to the balance between competition policy and IPR policy. The JPO is located in downtown Tokyo in a specially built office building wired for computer database searching and electronic filing of patent applications. The number of JPO patent applications exceeds any other patent office in the world. In 1996, there were 619,049 patent applications filed at the JPO. One main reason for the greater number of filings at the JPO versus the USPTO and the EPO is the Japanese practice of filing multiple patent applications covering each aspect of a technological innovation, as opposed to a single patent application covering all of them. The average number of applications from 1994 to 1996 was just above 600,000 (figure 11). From 1993 to 1995, the number of JPO patents issued was slightly above half of the number of applications filed in those same years indicating a significant backlog of applications under review. However, there was a significant 49% increase in patents issued from 1995 to 1996 when 524,327 were issued when the JPO had a strong push to reduce the backlog of pending patent applications (figure12). The combined trilateral offices The 1996 Trilateral Statistical Report indicated that at the end of 1995, a total of 3.84 million patents were in force and that the trilateral patent offices covered approximately 81% of these patents: EPC = 34%; US = 29% and Japan = 18%. Worldwide demand for patent rights, as expected, shows a strong upward trend. Patent applications reached 2.6 million in 1995 and achieved a 15% compound annual growth rate from 1991 to 1995. This growth is partly attributed to the exponential effect of one patent filing leading to 3.3 subsequent filings for patent rights in another area. Other noteworthy statistics are: - Domestic filings as a percentage of total applications at each trilateral office: JPO = 90%; USPTO = 55%; and EPO = 49%. - Classes of patents: Human necessities are higher in the USPTO (17%) than in the EPO (14%) and in the JPO (9%). The EPO leads in the area of chemistry and metallurgy and the JPO leads in the area of physics and electricity. - Percentage of high technology (computer, microorganism/genetic engineering, aviation, communications, semi-conductors and lasers) applications: EPO = 17.2% (Filers: EPC = 38%, US = 34%, JP = 24%); JPO = 13.4% (Filers: JP = 89%, US = 6%, EPC = 3%); and USPTO = 22.5% (Filers: US = 56%, IP = 25%, EPC = 10%). - Percentage of patents maintained based on age of patent: Year 5 = 86%; Year 10 = 63%; and Year 15 = 38%. Will the trend continue? There are many indicators that substantiate the continuation of intellectual property asset growth for the foreseeable future. Non-defence research and development (R&D) for seven industrialized nations hovered near $300 billion during the 1993 to 1995 period and has increased 64% from 1982 to 1995 in real dollars (figure 13). The R&D spending in the high technology sector is phenomenal. Many high technology companies invest heavily in R&D, well exceeding the average for US industry (figure 14). Biotechnology companies are no exception, also investing heavily in R&D (figure 15). The investment is paying off. The high technology stocks have outperformed other stock indexes in every major stock exchange worldwide. This reflects the continued and growing importance that financial markets and investors place on companies that invest in and are heavily dependent on technology to create shareholder value (figure 16). All of these factors lead to the conclusion that the development, protection and enforcement of intellectual property assets will continue to grow at an exceptional rate. A changing playing field The playing field is changing for many industries worldwide and intellectual property assets are fuelling the change. As the trends discussed in this article indicate, intellectual property assets are quickly becoming the most coveted assets for many companies. Companies are investing monumental resources in identifying, procuring and protecting intellectual property assets. As the competitive edge hinges more and more on intellectual property assets, companies will be faced with the challenge of developing and/or acquiring, protecting, managing and exploiting these crown jewel assets. Managing Intellectual Property September 1998, pp. 72-77 © PricewaterhouseCoopers LLP. Walter Bratic is a partner and Patrick McLane is a director in the Financial Advisory Services practice of PricewaterhouseCoopers LLP in Houston. Walter Bratic is the product director of intellectual property services. Robert Sterne is a founding partner of the Washington, DC-based intellectual property law firm of Sterne, Kessler, Goldstein, Fox.