Order Code RL33367
CRS Report for Congress
Received through the CRS Web
Patent Reform: Issues in the Biomedical
and Software Industries
April 7, 2006
Wendy H. Schacht
Specialist in Science and Technology
Resources, Science, and Industry Division
Congressional Research Service ˜ The Library of Congress

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Patent Reform: Issues in the Biomedical and Software
Industries
Summary
Congress currently is considering reform of the existing patent system. This
interest in patent policy reflects a recognition of the increasing importance of
intellectual property to U.S. innovation. Patent ownership is perceived as an
incentive to the technological advancement that leads to economic growth. As such,
the number of patent applications and grants has grown significantly, as have the type
and breadth of inventions that can be patented.
Along with the expansion in the number and range of patents, there are growing
concerns over whether the current system is working efficiently and effectively.
Several recent studies recommend patent reform. Other experts maintain that major
alterations in existing law are unnecessary and that, while not perfect, the patent
process can, and is, adapting to technological progress. Thus far in the 109th
Congress, two bills, H.R. 2795 and H.R. 5096, have been introduced which, if
enacted, would make significant alterations in current patent law.
At the present time, the patent laws provide a system under which all inventions
are subject to the same requirements of patentability regardless of the technical field
in which they arose. However, inventors and innovative companies in different
industries tend not to hold identical views concerning the importance of patents,
reflecting varying experiences with the patent system. Innovators in biomedical
industries tend to see patent protection as critically important as a way to prohibit
competitors from appropriating the results of a company’s research and development
efforts. Typically only a few, often one or two, patents cover a particular drug. In
contrast, the nature of software development is such that inventions often are
cumulative and new products generally embody numerous patentable inventions. As
a result, it may be expected that distinct industries might react differently to the
various patent reform proposals currently under consideration by Congress.
This report will be updated if events warrant such action.

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Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Patents and Innovation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Role of Patents in Biomedical R&D . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Role of Patents in the Software Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Concluding Observations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

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Patent Reform: Issues in the Biomedical
and Software Industries
Introduction
Congress currently is considering reform of the existing patent system. This
interest in patent policy reflects a recognition of the increasing importance of
intellectual property to U.S. innovation. Patent ownership is perceived as an
incentive to the technological advancement that leads to economic growth. As such,
the number of patent applications and grants have grown significantly as have the
type and breath of inventions that can be patented. In 1980, 104,329 utility patent
applications were received at the U.S. Patent and Trademark Office (USPTO); by
2005, this number had more than tripled to 381,797 applications. During the same
time period, the number of U.S. utility patents granted grew from 61,819 to 151,079.1
Along with the expansion in the number and range of patents, there are growing
concerns over whether the current system is working efficiently and effectively.
Several recent studies (including those by the National Academy of Sciences and the
Federal Trade Commission2) recommend patent reform. Other experts maintain that
major alterations in existing law are unnecessary and that, while not perfect, the
patent process can, and is, adapting to technological progress. To date, two bills,
H.R. 2795 and, more recently, H.R. 5096, have been introduced in the 109th Congress
which, if enacted, would make significant alterations in current patent law. (The
specific legislative changes contained in H.R. 2795 are discussed in CRS Report
RL32996, Patent Reform: Innovation Issues, by Wendy H. Schacht and John R.
Thomas.)
The issue of patent reform has led to the emergence of several, often opposing,
points of view. While the patent laws provide a system under which all inventions
are treated the same regardless of the technical field, the varying experiences of
companies in different industries often give rise to differing views concerning the
importance and role of patents. Innovators in biomedical industries tend to see patent
protection as critically important as a way to prohibit competitors from appropriating
the results of a company’s research and development efforts. Typically only a few,
often one or two, patents cover a particular drug. In contrast, the nature of software
1 U.S. Patent and Trademark Office, U.S. Patent Statistics, Calendar Years 1863 - 2003 and
U.S. Patent and Trademark Office, Performance and Accountability Report for Fiscal Year
2005, available at [http://www.uspto.gov].
2 National Research Council, National Academy of Sciences, A Patent System for the 21st
Century, (Washington, National Academies Press, 2004) and Federal Trade Commission,
To Promote Innovation: The Proper Balance of Competition and Patent Law and Policy,
October 2003, available at [http://www.ftc.gov].

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development is such that inventions often are cumulative and new products generally
embody numerous patentable inventions. Acknowledging these differences, this
report explores the relationships between patents and innovation and looks at the role
of intellectual property in the biomedical and software industries, two sectors where
U.S. investment in research and development (R&D) has led to market leadership,
a strong export position, and contributed to the Nation’s economic growth.

Patents and Innovation
Patent law is based upon the Patent Act of 1952, codified in Title 35 of the
United States Code. According to the statute, one who “invents or discovers any new
and useful process, machine, manufacture, or any composition of matter, or any new
and useful improvement thereof, may obtain a patent therefore, subject to the
conditions and requirements of this title.”3 Patents are issued by the United States
Patent and Trademark Office (USPTO), generally for a term of 20 years from the date
of filing. The patent grants its owner the right to exclude others from making, using,
selling, offering to sell, or importing into the United States the patented invention.
To be afforded patent rights, an invention must be judged to consist of patentable
subject matter, possess utility, and be novel and nonobvious. The application must
fully disclose and distinctly claim the invention for which protection is sought.
The grant of a patent does not necessarily provide the owner with an affirmative
right to market the patented invention. For example, pharmaceutical products are
also subject to marketing approval by the Food and Drug Administration (FDA).4
Federal laws typically require that pharmaceutical manufacturers demonstrate that
their products are safe and effective in order to bring these drugs to the marketplace.
USPTO issuance of a patent and FDA marketing consent are distinct events that
depend upon different criteria.5
Patent ownership is perceived to be an incentive to innovation, the basis for the
technological advancement that contributes to economic growth. Patent title
provides the recipient with a limited-time monopoly over the use of his discovery in
exchange for the public dissemination of information contained in the patent
application. Award of a patent is intended to stimulate the investment necessary to
develop an idea and bring it to the marketplace embodied in a product or process,
although it does not guarantee that the patent will generate commercial benefits. The
3 35 U.S.C.§101.
4 For more information see CRS Report RL30756, Patent Law and Its Application to the
Pharmaceutical Industry: An Examination of the Drug Price Competition and Patent Term
Restoration Act of 1984 (“The Hatch-Waxman Act”), by Wendy H. Schacht and John R.
Thomas and CRS Report RL32377, The Hatch-Waxman Act: Legislative Changes Affecting
Pharmaceutical Patents, by Wendy H. Schacht and John R. Thomas.
5 For more information see CRS Report RL33288, Proprietary Rights in Pharmaceutical
Innovation: Issues at the Intersection of Patents and Marketing Exclusivities, by John R.
Thomas.

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requirement for publication of the patent is expected to stimulate additional
innovation and other creative means to meet similar and expanded demands in the
marketplace.
Innovation produces new knowledge. However, innovation typically is costly
and resource intensive. Studies demonstrate that the rate of return to society as a
whole generated by investments in research and development (R&D) leading to
innovation is significantly larger than the benefits that can be captured by the person
or organization financing the work.6 Some estimate that the social rate of return on
R&D spending is over twice that of the rate of return to the inventor Ideas often are
easily imitated as the knowledge associated with an innovation is dispersed and
adapted to other products and processes that, in turn, stimulate growth in the
economy. Patents permit novel concepts or discoveries to become “property” when
reduced to practice and therefore allow for control over their use.
Issuance of a patent furnishes the inventor with a limited-time exclusive right,
the benefits of which are mitigated by other factors, particularly the requirements for
information disclosure, the length of the patent, and the scope of rights conferred.
The process of obtaining a patent places the concept on which it is based in the public
domain. In return for a monopoly right to the application of the knowledge
generated, the inventor must publish the ideas covered in the patent. As a disclosure
system, the patent can, and often does, stimulate other firms or individuals to invent
“around” existing patents to provide for parallel technical developments or meet
similar market needs.
Patents may also provide a more socially desirable outcome than its chief legal
alternative, trade secret protection. Trade secrecy guards against the improper
appropriation of valuable, commercially useful information that is the subject of
reasonable measures to preserve its secrecy.7 Taking the steps necessary to maintain
secrecy, such as implementing physical security and enforcement, imposes costs that
may ultimately be unproductive for society.8 Also, while the patent law obliges
inventors to disclose their inventions to the public,9 trade secret protection requires
firms to conceal them. The disclosure obligations of the patent system may better
serve the objective of encouraging the diffusion of advanced technological
knowledge. Patents may also prevent unproductive expenditures of time and money
associated with R&D that duplicates other work.
6 For a list of relevant research in this area see Council of Economic Advisors. Supporting
Research and Development to Promote Economic Growth: The Federal Government’s Role,
October 1995, pp. 6-7.
7 American Law Institute, Restatement of Unfair Competition Third §39, 1995.
8 David D. Friedman, et al., “Some Economics of Trade Secret Law,” 5 Journal of Economic
Perspectives, 1991, p. 61.
9 35 U.S.C. §112 (2000).

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The patent system thus has dual policy goals — providing incentives for
inventors to invent and encouraging inventors to disclose technical information.10
Disclosure requirements are factors in achieving a balance between current and future
innovation through the patent process, as are limitations on scope, novelty mandates,
and nonobviousness considerations.11 Patents give rise to an environment of
competitiveness with multiple sources of innovation, which is viewed by some
experts as the basis for technological progress. This is important because, as Robert
Merges (now at the University of California, Berkeley) and Richard Nelson
(Columbia University) found in their studies, in a situation where only “... a few
organizations controlled the development of a technology, technical advance
appeared sluggish.”12
Not everyone agrees that the patent system is a particularly effective means to
stimulate innovation. Some observers believe that the patent system encourages
industry concentration and presents a barrier to entry in some markets.13 They
suggest that the patent system often converts pioneering inventors into technological
suppressors, who use their patents to block subsequent improvements and thereby
impede technological progress.14 Others believe that the patent system too frequently
attracts speculators who prefer to acquire and enforce patents rather than engage in
socially productive activity such as bringing new products and processes to the
marketplace.15
Some experts argue that patents do not work as well in reality as in theory
because they do not confer perfect appropriability. In other words, they allow the
inventor to obtain a larger portion of the returns on his investment but do not permit
him to capture all the benefits. Patents can be circumvented and infringement cannot
always be proven. Thus, patents are not the only way, nor necessarily the most
efficient means, for the inventor to protect the benefits generated by his efforts. A
study by Yale University’s Richard Levin and his colleagues concluded that lead
time, learning curve advantages (e.g. familiarity with the science and technology
under consideration), and sales/service activities were typically more important in
exploiting appropriability than were patents. That was true for both products and
processes. However, patents were found to be better at protecting products than
10 Robert P. Merges, “Commercial Success and Patent Standards: Economic Perspectives
on Innovation,” California Law Review, July 1988, p. 876.
11 Kenneth W. Dam, “The Economic Underpinnings of Patent Law,” Journal of Legal
Studies, January, 1994, pp. 266-267. Scope is determined by the number of claims made in
a patent. Claims are the technical descriptions associated with the invention. In order for
an idea to receive a patent, the law requires that it be “...new, useful [novel], and nonobvious
to a person of ordinary skill in the art to which the invention pertains.”
12 Robert P. Merges and Richard R. Nelson, “On the Complex Economics of Patent Scope,”
Columbia Law Review, May 1990, p. 908.
13 See John R. Thomas, “Collusion and Collective Action in the Patent System: A Proposal
for Patent Bounties,” University of Illinois Law Review, 2001, p. 305.
14 On the Complex Economics of Patent Scope, p. 839.
15 Elizabeth D. Ferrill, “Patent Investment Trusts: Let’s Build a Pit to Catch the Patent
Trolls,” 6 North Carlina Journal of Law and Technology, 2005, p. 367.

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processes. The novel ideas associated with a product often can be determined
through reverse engineering — taking the item apart to assess how it was made. That
information then could be used by competitors if not covered by a patent. Because
it is more difficult to identify the procedures related to a process, other means of
appropriation are seen as preferable to patents, with the attendant disclosure
requirements.16
Role of Patents in Biomedical R&D
The pharmaceutical industry perceives patents as critical to protecting
innovation. Several studies over the years have demonstrated the important role
patents play in the pharmaceutical sector. Of the 18 major manufacturing industries
analyzed by Richard Levin and his colleagues, only drug companies rated product
patents the most effective means of insuring that firms can capture the profits
associated with their innovations.17 Later research by Professor Wesley Cohen (now
at Duke University) and his colleagues demonstrated that patents were considered the
most effective method to protect inventions in the drug industry, particularly when
biotechnology is included.18 These studies reinforce earlier work by Edwin
Mansfield that indicated 65% of pharmaceutical inventions would not have been
brought to market without patent protection in contrast to the 8% of innovations
made in other industries.19
Patents may be particularly important in the pharmaceutical sector because of
the relative ease of replicating the finished product. Imitation costs vary among
industries. For example, while it is expensive, complicated, and time consuming to
duplicate an airplane, it is relatively simple to chemically analyze a pill and
reproduce it.20 The degree to which industry perceives patents as effective has been
characterized as “... positively correlated with the increase in duplication costs and
time associated with patents.”21 In certain industries, patents significantly raise the
costs incurred by nonpatent holders wishing to use the idea or invent around the
patent — an estimated 40% in the pharmaceutical sector, 30% for major new
16 Richard C. Levin, Alvin K. Klevorick, Richard R. Nelson, and Sidney G. Winter.
“Appropriating the Returns for Industrial Research and Development,” Brookings Papers
on Economic Activity, 1987, in The Economics of Technical Change, eds. Edwin Mansfield
and Elizabeth Mansfield (Vermont, Edward Elgar Publishing Co., 1993), p. 254.
17 Ibid., pp. 255 and 257.
18 Wesley M. Cohen, Richard R. Nelson, and John P. Walsh, Protecting Their Intellectual
Assets: Appropriability Conditions and Why U.S. Manufacturing Firms Patent (or Not),
NBER Working Paper 7552, Cambridge, National Bureau of Economic Research, February
2000, available at [http://www.nber.org/papers/w7552].
19 Edwin Mansfield, “Patents and Innovation: An Empirical Study,” Management Science,
February 1986, pp. 173-181.
20 Federic M. Scherer, “The Economics of Human Gene Patents,” 77 Academic Medicine,
December 2002, p. 1350.
21 Appropriating the Returns for Industrial Research and Development, p. 269.

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chemical products, and 25% for typical chemical goods — and are thus viewed as
significant. However, in other industries, patents have much smaller impact on the
costs associated with imitation (e.g., in the 7%-15% range for electronics), and may
be considered less successful in protecting resource investments.22
The costs associated with imitating pharmaceuticals “... are extremely low
relative to the innovator’s costs for discovering and developing a new compound.”23
Studies by Dr. Joseph DiMasi of Tufts University and others indicate that the
capitalized cost of bringing a new drug (defined as a “new molecular entity” rather
than a new formulation of an existing pharmaceutical product) to the point of
marketing approval is $802 million (2000 dollars).24 Additional research done by
analysts at the Federal Trade Commission found the costs to be even higher; between
$839 million and $868 million (2000 dollars).25 At the same time, the total
capitalized costs appear to be growing at an annual rate of 7.4% above general price
inflation.26
A large portion of new drug costs (in terms of money and time) are associated
with the size and breath of clinical trials necessary to obtain FDA marketing
approval. According to a study supported by the Federal Reserve Bank of Boston,
only 10% of potential drug candidates reach the human trial phase and only a small
portion of these actually reach the market.27 In research presented at a conference
sponsored by the Federal Reserve Bank of Dallas, Duke University’s Henry
Grabowski found that only 1% of drug compounds reach the human trial stage and
22% of those entering clinical trials receive FDA approval.28 Professor Iain
Cockburn (Boston University) notes that “as drug discovery became more science-
intensive, ... it became not just more expensive but also more difficult to manage.”29
22 Edwin Mansfield, Mark Schwartz, and Samuel Wagner, “Imitation Costs and Patents: An
Empirical Study,” The Economic Journal, December 1981, in The Economics of Technical
Change, p. 270.
23 Henry Grabowski, “Patents and New Product Development in the Pharmaceutical and
Biotechnology Industries,” Duke University Economics Working Paper, July 2002, available
at [http://www.econ.duke.edu/Papers/Other/Grabowski/Patents.pdf], p. 4.
24 Joseph A. DiMasi, Ronald W. Hansen, and Henry G. Grabowski. “The Price of
Innovation: New Estimates of Drug Development Costs,” 22 Journal of Health Economics,
2003. Capitalized cost includes the “time cost” associated with an investment and the cost
of testing drug products that fail.
25 Christopher P. Adams and Van V. Brantner, Estimating the Costs of New Drug
Development: Is it Really $802m?, Federal Trade Commission, December 2004, available
at [http://media.romanvenable.net/images/drugCost.pdf].
26 The Price of Innovation: New Estimates of Drug Development Costs, p. 180.
27 Carrie Conway, “The Pros and Cons of Pharmaceutical Patents,” Regional Review,
Federal Reserve Bank of Boston, March 2003, available at [http://www.findarticles.com].
28 Henry G. Grabowski, “Patents, Innovation, and Access to New Pharmaceuticals,” Journal
of International Economic Law, 2002, p. 851.
29 Iain Cockburn, “The Changing Structure of the Pharmaceutical Industry,” Health Affairs,
(continued...)

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Furthermore, returns to new drug introductions vary widely and the median new drug
does not bring in sufficient profits to cover the costs of bringing the product to the
marketplace.30 According to research by Professors Grabowski, John Vernon (Duke
University), and DiMasi, only 34% of new drugs (new chemical entities) introduced
generated profits that equaled the industry average R&D cost.31
The significant costs of pharmaceutical R&D, coupled with the uncertainty of
the clinical trial process, lend consequence to patents in this area because “... the
disparity between the investments of innovators and those of imitators is particularly
large in pharmaceuticals — almost as large as when software pirates simply copy the
diskettes of an innovator.”32 While the capitalized cost of developing a new drug to
the point of market approval is over $800 million, it takes only between $1 million
and $2 million to obtain approval for a generic version of the pharmaceutical.33 This
difference is a result of the costs associated with clinical trials needed to demonstrate
the safety and efficacy of a new drug, data that could be utilized by generic
companies if not protected by a patent.34 A generic company does not have to fund
these studies to get FDA marketing approval; under the provisions of the Hatch-
Waxman Act generic firms only have to prove that their product is “bioequivalent”
to the innovator drug.35
While patents are designed to spur innovation, some experts maintain that
certain patents, particularly those on research tools36 in biotechnology, hinder the
innovation process. Professors Rebecca Eisenberg (University of Michigan) and
Richard Nelson (Columbia University) argue that ownership of research tools may
“... impose significant transaction costs” that result in delayed innovation and
possible future litigation.37 It also can stand in the way of research by others:
29 (...continued)
Janurary/February 2004, p. 15.
30 Henry G. Grabowski, “Patents and New Product Development in the Pharmaceutical and
Biotechnology Industries,” Science and Cents: Exploring the Economics of Biotechnology,
Proceedings of a 2002 Conference, Federal Reserve Bank of Dallas, pp. 95-96 available at
[http://www.dallasfed.org/research/pubs/science/grabowski.pdf] and Henry Grabowski, John
Vernon, and Joseph A. DiMasi, “Returns on Research and Development for 1990s New
Drug Introductions,” 20 Pharmacoeconomics, 2002.
31 Returns on Research and Development for 1990s New Drug Introductions, p. 23.
32 The Economics of Human Gene Patents, p. 1352.
33 Patents, Innovation, and Access to New Pharmaceuticals, p. 852.
34 The Economics of Human Gene Patents, p. 1352.
35 For more information see CRS Report RL30756, Patent Law and Its Application to the
Pharmaceutical Industry: An Examination of the Drug Price Competition and Patent Term
Restoration Act of 1984 (“The Hatch-Waxman Act”), by Wendy H. Schacht and John R.
Thomas.
36 A biotechnology research tool is a cell line, reagent, or antibody used in research.
37 Rebecca S. Eisenberg and Richard R. Nelson, “Public vs. Proprietary Science: A Fruitful
Tension?,” Daedalus, spring 2002.

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Broad claims on early discoveries that are fundamental to emerging fields of
knowledge are particularly worrisome in light of the great value, demonstrated
time and again in history of science and technology, of having many independent
minds at work trying to advance a field. Public science has flourished by
permitting scientists to challenge and build upon the work of rivals.38
Eisenberg and her colleague at the University of Michigan Law School, Michael
Heller, contend that in the future scientists might need to obtain numerous patent
licenses in order to undertake basic research.39 Similar concerns were expressed by
Harold Varmus, President of Memorial Sloan-Kettering and formerly the Director of
the National Institutes of Health. In July 2000 prepared testimony, he spoke to being
“...troubled by widespread tendencies to seek protection of intellectual property
increasingly early in the process that ultimately leads to products of obvious
commercial value, because such practices can have detrimental effects on science and
its delivery of health benefits.”40
However, other experts dispute this assertion. A study by Professors John
Walsh (University of Illinois, Chicago), Ashish Arora (Carnegie Mellon University),
and Wesley Cohen found that although there are now more patents associated with
biomedical research, and on more fundamental work, there is little evidence that
work has been curtailed due to intellectual property issues associated with research
tools.41 Scientists are able to continue their research by “... licensing, inventing
around patents, going offshore, the development and use of public databases and
research tools, court challenges, and simply using the technology without a license
(i.e., infringement).” According to the authors of the report, private sector owners
of patents permitted such infringement in academia (with the exception of those
associated with diagnostic tests in clinical trials) “... partly because it can increase the
value of the patented technology.”
Role of Patents in the Software Industry
Over the past 25 years, there has been a demonstrable and sustained increase in
the number of software patents granted in the United States. Research by James
Bessen and Robert Hunt for the Federal Reserve Bank of Philadelphia noted that the
1,000 software patents issued annually in the early 1980s42 had increased to an annual
total of 5,000 by 1990. Today over 20,000 software patents are granted each year.
38 Ibid.
39 Michael A. Heller and Rebecca S. Eisenberg, “Can Patents Deter Innovation? The
Anticommons in Biomedical Research,” 280 Science, 1998, pp. 698-701.
40 U.S. Congress, House Committee on the Judiciary, Subcommittee on Courts and
Intellectual Property, Hearings on Gene Patents and Other Genomic Inventions, July 13,
2000, available at [http://www.house.gov/judiciary/seve0713.htm].
41 John P. Walsh, Ashish Arora, Wesley M. Cohen, “Working Through the Patent Problem,”
Science, February 14, 2003, p. 1021.
42 There is no official USPTO category for “software” patents; Bessen and Hunt use their
own definition.

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While software patents comprised approximately 2% of all patents awarded in the
early 1980s, they now account for approximately 15% of the total number of U.S.
patent issued each year.43
Experts differ as to their assessment of the role of patents in promoting
innovation in the computer software sector. This discussion centers around the issue
of whether the increase in the number of patents is a result of inventive behavior
generated by intellectual property protection or a result of changes in law during the
1980s and 1990s that made patents on software easier to obtain. Some experts argue
that patent protection is not a significant factor in the development of computer
software programs. Other analysts maintain that they play an important role in
generating new technologies, particularly for small firms in the marketplace.
The nature of software development is such that inventions often are cumulative
and new products generally embody numerous patentable inventions. This has led
to what has been described by some observers as a
... poor match between patents and products in the [software] industry: it is
difficult to patent an entire product in the software industry because any
particular product is likely to include dozens if not hundreds of separate
technological ideas.44
This situation may be augmented by the multiplicity of patents often associated with
a finished computer product that utilizes the software. It is not uncommon for
thousands of different patents (relating to hardware and software) to be embodied in
one single computer. In addition, ownership of these patents may well be fractured
among hundreds or thousands of different individuals and firms.
Studies by Bessen and Hunt explored the characteristics of software patents and
determined that most are not owned by software companies but by large
manufacturing companies. They found that
Firms in just three manufacturing industries (machinery, electronics, and
instruments) alone accounted for 66 percent of software patents [yet]...Firms
outside the manufacturing sector employed 90 percent of computer programmers,
but together they accounted for only 25 percent of software patents.45
This data leads the authors to the conclusion that patents may not be closely tied to
the development of new software technologies. Ownership of such patents is
concentrated in sectors that have large patent portfolios and use them for strategic
43 James Bessen and Robert M. Hunt, An Empirical Look at Software Patents, Working
Paper No. 03-17/R, Federal Reserve Bank of Philadelphia, March 2004, p. 3, available at
[http://www.phil.frb.org] and Robert Hunt and James Bessen, “The Software Patent
Experiment,” Q3 2004 Business Review, p. 24, available at [http://www.phil.frb.org].
44 Ronald J. Mann, “Do Patents Facilitate Financing in the Software Industry?,” Texas Law
Review, March 2005, p. 979.
45 The Software Patent Experiment, p. 26.

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purposes.46 Instead, they believe that companies are utilizing patents as a means to
protect or leverage their investments rather than to generate more innovation through
R&D spending.47
In industries where innovation is sequential and complementary, as with
software and computers, some experts argue that strong patents interfere with the
innovation process.48 Inventions in these sectors typically are built upon earlier
technologies and are integrated into existing systems. Commentators pose that
patents inhibit or prevent enhancements to existing products because the patent
owner may not have the interest or capability necessary to generate improvements at
the same time that other firms cannot advance the technology without infringing on
the original patent.
Not everyone agrees with this assessment. Professor Robert Merges maintains
that patents have not hindered innovation in the software industry and that the
significant ownership of title to inventions by large companies in this sector has not
resulted in the demise of small firms developing new technologies.49 Analysis of
software companies by Professor Ronald Mann (University of Texas, Austin)
indicates the importance of software patents to small companies, particularly later-
stage start-ups firms. He notes that the software industry is comprised primarily of
small businesses and “the data suggests a different picture, one in which software
R&D is impressively robust.”50 Mann’s research indicates that small firms spend
proportionally more on software R&D than large companies. Research and
development spending by software firms “...tends to be relatively stable over time as
a percentage of sales. Indeed, company size seems to be more important in explaining
variations in R&D spending within the industry.”51
Mann’s research also indicates that the importance of software patents is
dependent on where the firm is in its development process. Patents play a more
significant role in later-stage start-up companies when firms can generate revenues
through licensing.52 At that point, “... patents are useful as “barter” in cross-licensing
agreements that the firm enters if it reaches a sufficiently mature stage to be a
46 An Empirical Look at Software Patents, p. 4.
47 The Software Patent Experiment, p. 26.
48 James Bessen and Eric Maskin, “Sequential Innovation, Patents, and Imitation,”
Massachusetts Institute of Technology Working Paper, Department of Economics, January
2000, p. 2 available at [http://www.researchoninnovation.org/patent.pdf].
49 Robert P. Merges, “The Uninvited Guest: Patents on Wall Street,” Federal Reserve Bank
of Atlanta Economic Review, 4th Quarter 2003, p. 9.
50 Do Patents Facilitate Financing in the Software Industry?, p. 1002.
51 Ibid., p. 1003.
52 Ibid., p. 985.

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significant player in the industry.”53 Patents may allow a firm to differentiate its
areas of expertise and innovative activity.54
Patents enable a company to transform ideas into a tangible form of property
that can provide value. This can be useful in negotiations for the acquisition of the
firm. While intellectual property is important to some investors but not to others, it
is considered a significant factor when a company is involved in acquisition
negotiations or in an IPO.55 It can prevent large companies from appropriating a
small firm’s technology. Bradford Smith and Susan Mann, writing in the University
of Chicago Law Review, concur with the argument that patents are beneficial for
small, software firms. They maintain that patents prevent larger companies from
utilizing the technologies developed by small businesses while allowing these
companies to attract venture capital.56
The multiplicity of patents involved in computer-related products has resulted
in the extensive use of cross licensing in these industries such that one commentator
argues: “licensing of software patents has become an industry unto itself.”57 Instead
of promoting innovation, some experts maintain that the ownership of intellectual
property has become an obstacle to the development and application of new ideas.
The expansion in the number of patents associated with software is a consequence
of the changes in patent law that make these patents easier to obtain, rather than an
indication of increased innovative activity. There are indications, according to
Bessen and Hunt, that patents are being substituted for increases in R&D.58 The
substitution occurs in industries that patent strategically but not in other sectors.59
The propensity to patent software appears to be related to the utilization of the
software by companies rather than to the R&D resources expended in developing the
product.60 This is of interest because a rationale behind the patent system is that it
provides incentives for the additional investments necessary to bring a product to the
marketplace.

Concerns have been expressed in the academic community that the propensity
to patent and the extensive use of cross licensing has resulted in a “patent thicket”
where ownership of patent title is used to block others from innovating. According
to Bessen and Hunt, “This may have increased the attractiveness of a strategy that
53 Ibid., p. 990.
54 Ibid., p. 985.
55 Ibid., p. 978.
56 Bradford L. Smith and Susan O. Mann, “Innovation and Intellectural Property Protection
in the Software Industry: An Emerging Role for Patents?,” University of Chicago Law
Review, winter 2004, p. 206.
57 Mark H. Webbink, “A New Paradigm for Intellectual Property Rights in Software,” Duke
Law and Technology Review, 2005, pp. 12 and 16.
58 The Software Patent Experiment, pp. 28-29.
59 An Empirical Look at Software Patents, p. 34.
60 The Software Patent Experiment, p. 27.

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emphasizes patent rights over a strategy based on R&D.”61 However, other experts
maintain that this might not be a true assessment of the situation. In an article for the
Virginia Journal of Law and Technology, David Evans and Anne Layne-Farrar argue
it is not clear that a patent thicket exists. “Other industries with longstanding histories
of patenting could be categorized as having cumulative and sequential R&D, yet they
do not display signs of innovation gridlock.”62 There are additional ways to prevent
the use of patents to block innovation including the use of pro-competitive patent
pools and antitrust enforcement.
Others agree that innovation in the software industry is not hindered by a patent
thicket. In one study where actual software companies and investors were surveyed,
the analyst found new companies were not concerned with existing patent portfolios
as a barrier to their work as “none of the startup firms [interviewed] suggested a
practice of doing prior art searches before beginning development of their
products.”63 Because the software industry is so diverse, it is “... difficult for any
single patent or group of patents to control a major part of the whole industry.”64
Concluding Observations
Innovators in the biomedical and software industries tend to view patents
differently and thus may exhibit divergent positions on the issues surrounding patent
reform. Patent protection is critically important to the pharmaceutical and
biotechnology sectors as a way to prohibit competitors from appropriating the results
of a company’s research and development efforts. However,
...patents are not among the key means used to protect innovations in either the
computer or semiconductor industries. In those two industries, firms rely more
heavily on secrecy, lead time and complementary capabilities to protect their
inventions.65
A difference between the role of patents in the biomedical community and their
role in the computer software sector lie with the dissimilar composition of the
respective products. Typically only a few, often one or two, patents cover a
particular drug. In contrast, the nature of software development is such that
inventions often are cumulative and new products generally embody numerous
patentable inventions. While few companies other than those that manufacture drugs
need to deal with the relevant pharmaceutical patents,
61 Ibid., p. 30.
62 David S. Evans and Anne Layne-Farrar, “Software Patents and Open Source: The Battle
Over Intellectual Property Rights,” Virginia Journal of Law and Technology, summer 2004,
p. 23.
63 Do Patents Facilitate Financing in the Software Industry?, p. 1004.
64 Ibid., p. 1007.
65 Protecting Their Intellectual Assets: Appropriability Conditions and Why U.S.
Manufacturing Firms Patent (or Not), p. 8.

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...computers are ubiquitous — and as a result, so is software authorship...Thus,
a patent on a drug creates potential liability for those companies in the
pharmaceutical business, while a software patent creates potential liability for
any company with its own website or software customizations, regardless of its
business.66
At the present time, the patent laws provide a system under which all inventions
are subject to the same requirements of patentability regardless of the technical field
in which they arose. However, as discussed in this paper, inventors and innovative
companies in different industries may not hold identical views concerning the role
of patents and may have had varying experiences with the patent system. As a result,
it may be expected that distinct industries might react differently to the various patent
reform proposals presently under consideration by Congress
66 Ben Klemens, The Computer-Shaped Hole in the Patent Reform Act, The Brookings
Institution, July 28, 2005.

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