Trolls are good – they’re key to a well-functioning market for innovative control – that maximizes efficiency, commercialization and innovation incentives

The concept of the market for innovative control is also helpful in understanding the many types of firms that buy or sell patents. Different types of firms are needed for different types of technologies and for different tasks involved in invention, commercialization, and innovation. Christopher A. Cotropia, Jay P. Kesan, and David L. Schwartz point out that many types of companies engage in patent transactions, including universities, individual inventors, mass patent aggregators, failed startups and operating companies, patent holding companies, operating companies, IP holding companies owned by operating companies, and technology development companies.98

Different business models are an important aspect of the market for innovative control. Because the market for innovative control helps to allocate patents to the highest-value users, the types of firms that acquire patents will be those that provide the greatest market value. In a well-functioning market for innovative control, the business model of the acquiring firm acquiring IP will be the best suited to efficient management of that IP, all other things being equal. Restricting IP rights on the basis of the business model of the firm that owns the patent would create inefficiencies in the market for innovative control.

The market for innovative control also allows the entry of specialized intermediaries who can invest in commercialization, innovation, and complementary assets.99 The allocation of patents in the market for innovative control implies that there should not be regulatory restrictions on patent transactions and ownership that are based on the characteristics of companies acquiring patents. Various commentators critically refer to some types of firms that acquire patents as “patent trolls,” “patent monetizing entities” (PMEs), “non-practicing entities” (NPEs), or “patent assertion entities” (PAEs). Some types of firms that acquire patents have a particular expertise as market intermediaries.100 Market intermediaries perform many types of activities that reduce various types of transaction costs, including search costs, bargaining costs, moral hazard, adverse selection, and contracting costs.101 Intermediaries in the market for innovative control reduce transaction costs by evaluating patent quality, handling licensing transactions, or marketing and reselling patents. Intermediaries in the market for innovative control can act as market makers, bringing buyers and sellers together, clearing markets and adjusting prices.102 Andrei Hagiu and David Yoffie identify different types of patent intermediaries.103

The market for innovative control also promotes efficiencies in the organization of firms and industries. Weaker IP protections increase transaction costs for inventors and innovators. Inventors and innovators will have incentives to replace patent protections with other mechanisms including trade secrets, contracts, and vertical integration.104 With stronger IP protections, inventors and innovators can make decisions about transactions, outsourcing, and vertical integration based on other business considerations. The market for innovative control generates differences in patent transfers across industries depending on technologies. Carlos Serrano shows that there are surplus enhancing patent transfers and finds that higher rates of transfers occur in information and communications technology (ICT) and the pharmaceutical and medical industries.105 In some industries, consortia form to exercise innovative control. For example, in 2011, Nortel Networks sold about 6000 patents and patent applications for $4.5 billion to a consortium of companies that included Apple, EMC, Ericsson, Microsoft, RIM, and Sony.106

As with securities markets, the market for innovative control allows separation of ownership and control. The patent owner can obtain returns from the patented invention while delegating control over innovation to licensees who employ the technology. The patent owner does not need to undertake all the transactions needed to apply the invention, but instead can rely on others to manage the IP. Delegation of control to licensees also provides benefits from specialization and division of labor. The patent owner can obtain returns from licensing, and the licensees can apply their expertise to developing, commercializing and applying the invention.

The market for innovative control promotes gains from trade in inventions. Because patents offer divisibility, as well as exclusivity and transferability, companies can engage in specialized R&D and exchange technologies in the market for innovative control. This allows a division of labor in invention, commercialization, innovation, and manufacturing. Specialization allows companies to take advantage of economies of scale and scope and to build capabilities and expertise. Market exchange of patented inventions generates gains from trade by selection of the best inventions and matching inventions with specialized firms.107 The market for innovative control also interacts with the market for corporate control. M&A, including hostile takeovers, provides a mechanism for acquiring patented inventions and improving the management of IP. There is some evidence that complementarities in innovation capabilities help explain M&A.108