Resolution of Blocking Patents

Preliminary Results

Paul Laskowski – John Chuang

George Lemmon’s Circuit Breaker

Drop Down Fuse Housing

Solenoid

Southern States Equipment Corporation

• Patent 2,150,102 – George Lemmon, 1939

• “In a circuit breaker, an expulsion tube, a flexible conductor within the tube and completing a circuit therethrough, automatic means to open the circuit within the tube upon overload conditions in the circuit together with non-automatic means operable at will to break the circuit within the tube without rupturing said container.”

Line Material Company

Schultz and Steinmayer, Inventors

Patent 2,176,227, 1939

Patent as a Negative Right

“Except as otherwise provided in this title, whoever without authority makes, uses, offers to sell, or sells any patented invention, within the United States or imports into the United States any patented invention during the term of the patent therefor, infringes the patent.”

- 35 U.S.C § 271 (a)

Blocking Patents – Toll View

Public Domain

Lemmon Fuse

Shultz Fuse

Southern Line

Southern & Line Licenses

Southern

Line

General Electric

Kearney

Westinghouse

Schweitzer & Conrad

Railway & Industrial Engineering

Mathews Corp.

Porcelain Products

Pacific Electric Manufacturing

Right to produce under Schultz

Right to produce under Lemmon, exclusive right to sublicense

Rights to produce under both Lemmon and Schultz

Sets sale price of Schultz fuse for all manufacturers

U.S. v. Line Material Co. (I)

• District Court: U.S. v. General Electric Co. controls. If one patent holder can control sale price, so can two.

• General Electric Court (1926): “If the patentee goes further and licenses the selling of the articles, may he limit the selling by limiting the method of sale and the price? We think he may do so provided the conditions of sale are normally and reasonably adapted to secure pecuniary reward for the patentee's monopoly.”

U.S. v. Line Material Co. (II)

• Supreme Court: “Where two or more patentees with competitive, non-infringing patents combine them and fix prices on all devices produced under any of the patents, competition is impeded to a greater degree than where a single patentee fixes prices for his licensees. The struggle for profit is less acute. Even when, as here, the devices are not commercially competitive because the subservient patent cannot be practiced without consent of the dominant, the statement holds good.”

Licensing Restrictions

Scotchmer and Maurer (2004)• Requirements for Legal Licensing

(1) Profit Neutrality and (2) Derived Reward with (3) Minimal restrictions.

• Must Southern and Line fix prices to derive full value of inventions?

• Price fixing may be necessary to distribute manufacturing efficiently.

Consumer Model

• A continuum of consumers with mass normalized to 1

• Each consumer has a quality sensitivity, θ

• Each consumer buys either one good, or no goods. If a consumer pays price p for a good of quality q, she enjoys utility θq-p

• Consumer sensitivity is distributed according to some density, f(θ)

Firm Model

• Focus on behavior after 2 firms already have patents. Assume no ex ante agreements

• Firm 1 has invented product 1 of quality q1,

which it sells at price p

• Firm 2 has invented product 2 of quality q1 + q2, which it sells at price r

Consumer Behavior

p/q1 (r-p)/q2r / (q1+q2)

no prod. prod. 1 prod. 1 prod. 2

p/q1(r-p)/q2 r/ (q1+q2)

no prod. prod. 2prod. 2no prod.

A.

B.

Patents Consolidated in one Firm

• One firm chooses r and p to maximize profit,

• Solution: p/q1=r/(q1+q2). The firm sells only the superior product at its monopoly price

BConfigdfr

AConfigdfrdfp

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Possible License Types

• Firm 2 pays a lump-sum for right to make any amount of the superior product

• Firm 2 pays a flat royalty for each unit of product 2

• Firm 2 pays a percentage of profits from selling product 2

Lump-Sum License

• Revenues from product 1 are lower than they would be if firm 1 blocked firm 2 from the market.

• Total profits are suboptimal, and approach zero for small q2

2

2

1

2

/1

q

pr

q

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Lump-Sum License

Solutions:

1. Firm 1 contracts to keep product 1 off market

2. Firms contractually set prices for both products

– Fixing just one price may improve total profits, but short of the optimum

Flat-Rate License• Firm 1 charges a fee, a, for each unit of product

2 that firm 2 sells.

• Firm 2 charges the monopoly upgrade price if and only if a=p. The upgrade is double marginalized if firm 1 has full discretion over a.

• For a<r, Firm 1 always undercuts Firm 2 to sell product 1.

2

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2

/1

q

pr

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dfpadfp

Flat-Rate License

Solutions:

1. Set a=p, and contract to fix p

2. Contractually fix both product prices

3. Firm 1 pays Firm 2 a fee for sales of product 1? Coming soon…

Percentage Rate License

• Say firm 1 takes a percentage, α, of firm 2’s revenue.

• For α<1, firm 1 always undercuts firm 2 and sells some of product 1

• For p>0, firm 2 always sets the upgrade price under the monopoly upgrade price

2

2

2

1

12

/1

q

pr

q

prq

pr

qp

dfr

dfrdfp

Percentage Rate License

Solutions:1. Firm 1 pays royalties 1-α on sales of

product 1:

2. Contractually fix prices of both products.

2

2

1

2

2

1

11/2

/1

q

prq

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Conclusions

1. Royalties typically do not guarantee optimal profits, unless royalties on sales of inferior good are allowed

2. Price fixing is one additional contract element that can optimize profits, but the prices of both goods must be fixed

3. The Line Court’s economic reasoning is flawed, but given the complexities of the case, the correct outcome is uncertain

References• 35 U.S.C § 271 (a) • Denicolo, V., Zanchettin, P. “How Should Forward Patent Protection be

Provided?” International Journal of Industrial Organization. 20 (2002): 801-27.

• Grossman, G., Helpman, E. “Quality Ladders in the Theory of Growth.” The Review of Economic Studies. Vol. 58 No. 1 (1991): 43-61.

• Maurer, S. & Scotchmer, S. Profit Neutrality in Licensing: The Boundary Between Antitrust Law and Patent Law. Working paper 10546, National Bureau of Economic Research (2004).

• Mussa M. and S. Rosen. "Monopoly and Product Quality." Journal of Economic Theory 18(1978): 301-17.

• O’Donoghue, T., Scotchmer, S., Thisse, J. “Patent Breadth, Patent Life, and the Pace of Technological Progress.” Journal of Economics and Management Strategy. Vol. 7 No. 1 (1998): 1-32.

• U.S. v. General Electric Co., 272 US 476, 47 S.Ct. 192, 71 L.Ed. 362 (1926)• U.S. v. Line Material Co. 333 US 287, 68 S. Ct. 550, 92 L.Ed. 701 (1948)• Scotchmer, S., Green, J. "On the Division of Profit between Sequential

Innovators", The Rand Journal of Economics 26, pp. 20-33, spring 1995