IP Strategy: Deterrence in the Face of Patent Expiration

We were very fortunate to have Duane Valz from Google join us last week for an informative talk on how start-ups and patent applications. Valz walked us through a comprehensive look at patent definitions, cost-benefit analysis, trends, threats, and opportunities for start-ups with regards to filing patents. I would like to highlight his point on patents and deterrence. In particular, through a study conducted by the National Bureau of Economic Research on how businesses implement deterrence strategies in the face of patent expiration in the pharmaceutical industry.

Let's start with why businesses use patents: patents protect unique value propositions in the intersection between software, hardware, and user experience, thereby enhancing valuation. They signal innovation to the marketplace, and can serve as collateral for financing, or "failure insurance." While it usually costs start-ups 8000-12000 USD to file a patent, it is worth the time and money to invest in cost-effective counsel to pursue your first patents properly. Of course, if you're a college student like me with a great idea but less than great capital base, you could consider filing a provisional patent too. I will explain that in a blog later.

I learned that patent usage can generally be categorized into 5 buckets, ranked by (1) defensive to offensiveness, and (2) low effort to high effort. In the list before, the topmost use requires least effort and is most defensive, and as you go down the list, they require more effort (in terms of time and investment) and are more offensive.

1. Deterrence- focus on volume and public presence deters other firms from suing the patent-holder
2. Counter-assertion- focus on threats from other inventors
3. Cross-licensing- this more collaborative strategy gives the bi/multi-laterally cross-licensed firms more freedom of action. This is uncommon for biotech firms. See my previous post for a full explanation of cross-licensing.
4. Monetization- focus on markets
5. Strategic offensive- focus on competitive differentiation

In a nutshell, Ellison and Ellison's NBER paper investigates strategic entry deterrence by investigating how a panel of 63 drugs that lost their U.S. patent protection between 1986 and 1992 dealt with the threat of generic entry. I suppose this is not exactly using patents for deterrence, but more so behavioral shifts influenced by a deterrence motive as patent expiration approaches, but it is an interesting case nonetheless.

In Ellison and Ellison's model, it observes a difference in the initial investment pattern (paper calls it "nonmonotonicity) of incumbent firm 1 with strategic entry deterrence motives as opposed to the level of investment made by the same firm without such motives.  Firm 2, which enters the market later, would observe 1's initial investment level before entry rather than afterward if 1 had intended to impact future entering firms' cost of entry.

The first two of three key behavioral changes that deterrence-minded pharma companies show before patent expiration are detail advertising and journal advertising. An incumbent might reduce detail in advertising levels to reduce the attractiveness of the market to potential entrants, thereby deterring entry. The study used advertising-to-sales ratios to measure this metric. The third action observed is presentation proliferation. The entry-deterrence motive gives incumbents an incentive to increase the number of presentations in which the drug is sold to make it more costly for entrants to match the incumbents' full product line. Lastly, firms mightd distort prices downwards to deter entry.

Why did I find this study interesting? The expiration of a pharmaceutical patent and the subsequent opening of a drug market to generic entrants is a significant event for drug companies. The Waxman-Hatch Act of 1984 in particular reduced regulatory barriers to generic entry. For example, when Prozac lost patent protection, within 18 months it had lost over 80% of market share to 21 generic competitors. Similarly, Merck performed a reverse acquisition on Schering-Plough in order to strengthen its patent portfolio as key drug patents faced expiration in 2009.

I'm sure changes in strategic behavior regarding patents are broad across other industries too and would love to hear your thoughts. Thanks for reading.