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Article Excerpt
NOTE CONTENTS
INTRODUCTION I. COMMERCIAL SUCCESS'S KEY ROLE IN PATENT LAW A. The Growing Importance of Commercial Success B. Theoretical Justifications 1. Classical Theory 2. Prospect Theory C. Critiques of Commercial Success II. THE CURRENT MISGUIDED USE OF REVENUE DATA A. Profits Should Prove Commercial Success and Nonobviousness 1. Hypothetical: Lower Volume, Higher Price 2. Hypothetical: Lower Average Costs, Same Marginal Costs B. Lack of Profits Should Exclude Considerations of Commercial Success 1. Classical Theory Sees No Success, No Nexus, and Negated Inferences 2. Prospect Theory Sees Worthless "Contract Rights" C. Why Sue To Enforce an Unprofitable Patent? D. Origins of Commercial Success as Revenues III. IMPLEMENTING PROFITS AS COMMERCIAL SUCCESS A. Simplest Case: Firm Only Markets the Patented Invention B. Multiple Products C. Factors Mitigating the Impact on Judicial Economy D. Judicial Economies, Including Requiting a Threshold Profitability Showing E. Using Profits Creates Few Incentives To Be Inefficient IV. ALTERNATE NORMATIVE REASON TO USE REVENUE A. Normative Argument B. Counterargument: Unclear Tradeoffs C. Counterargument: Inapplicable to Newer Industries, yet Still Inaccurate CONCLUSION
INTRODUCTION
Patent litigation typically involves highly technical issues. (1) Fact-finding responsibility, however, falls to juries and judges who rarely have a technical background and who virtually never have one in the specific field of the patents in question. (2) The vast majority of patent disputes require the fact-finder to determine whether the underlying invention meets the core statutory requirement of not being obvious. (3) Courts have developed a number of nontechnical, "secondary" considerations to aid the nonobviousness inquiry, with commercial success being the most commonly employed. If an invention met with commercial success, the reasoning goes, the likelihood increases that it was not obvious to competitors who otherwise would have been motivated to develop it themselves. But what evidence should prove commercial success?
Ask economists or businesspeople what motivates businesses, and they will tell you profits. The pursuit of profits drives the creation of new businesses and investment in existing ones. Accountants' income statements typically put the profit figure on the "bottom line," which has become a synonym for paramount consideration. (4)
Current commercial success jurisprudence, however, works from the misconception that businesses are motivated by revenue. This Note will show how this flawed economic assumption can easily lead to erroneous determinations of patent validity and encourage abuses of the patent system. Part I traces the origins and rise of commercial success as one of the most important determinants of patent validity--and the justification for using commercial success, a nontechnical variable, as evidence for making an essentially technical decision. Part II describes situations in which equating commercial success with revenues leads to the wrong decision on patent validity, even to the point of encouraging abuse of the patent system. Part III touches on how courts can judge profitability and considers how using profitability could actually further judicial economy. Finally, Part IV refutes a potential normative argument for using revenue instead of profits.
I. COMMERCIAL SUCCESS'S KEY ROLE IN PATENT LAW
A patent is analogous to a deed in real property--but instead of specifying ownership of certain land, a patent specifies ownership of a particular area of technology. (5) While a county recorder's office maintains records of real property deeds, the U.S. Patent and Trademark Office (PTO) examines applications and determines whether and what patents to grant. Just as an owner of real property may sue for trespass, a patentee may sue for infringement.
An accused infringer will almost always counterclaim that the patent in question is invalid, (6) essentially arguing that the patent does not meet the statutory requirements for patentability and that the PTO erred in issuing the patent. Accused infringers have greater incentives and resources to find proof of invalidity than does the PTO. As a result, roughly half of all patent infringement cases result in the invalidation of part or all of the patent, and litigants hotly contest validity. (7)
The most frequent statutory basis for a finding of invalidity is that the patented invention is obvious. (8) The U.S. Patent Act provides:
A patent may not be obtained ... if the differences between the subject matter sought to be patented and the prior [technology] are such that the subject matter as a whole would have been obvious at the time the invention was made to a person having ordinary skill in the ... [relevant] subject matter.... (9)
Commentators have noted that nonobviousness is the greatest hurdle to receiving or enforcing a patent, calling it "the ultimate condition of patentability." (10)
Determining nonobviousness presents two substantial challenges to the judge or jury. (11) First, the fact-finder is virtually never a "person having ordinary skill" in the relevant technology. Second, the point of reference is the time of the invention, while litigation often arises many years later, during which time the field has made substantial progress. (12)
Consider one typical case involving nonobviousness, in which the parties contested a patent on the antibiotic Cipro, invented twenty-one years before the litigation. The fact-finder determined that a "person of ordinary skill" at the time of its invention "would have had a Ph.D. in chemistry, organic chemistry or microbiology," (13) with "several years of work experience in the pharmaceutical industry designing drugs." (14) In this case, the fact-finder not only had to view an invention from the perspective of an extraordinarily skilled scientist, he also had to do so while ignoring twenty-one years of hindsight and progress! While this task would challenge a panel of luminaries in the field, it poses a far greater challenge to a generalist judge or jury of laypersons.
To aid fact-finders presented with such thorny challenges, courts have developed the nontechnical "secondary considerations" of nonobviousness. These include long-felt need, failure of others, professional approval, and, most importantly, commercial success. (15) Although a patent case could proceed without invoking any of these secondary considerations, in practice, litigants often marshal all possible arguments, including commercial success.
A. The Growing Importance of Commercial Success
The Supreme Court has recognized commercial success as a possible determinant of patent validity since 1876. (16) In 1966, with the landmark decision of Graham v. John Deere Co., (17) the Court reaffirmed the vitality of secondary considerations "[a]s indicia of obviousness or nonobviousness." (18) The Court listed commercial success as the first secondary consideration. (19)
In 1982, Congress created the Court of Appeals for the Federal Circuit and gave it exclusive appellate jurisdiction over patent cases from any federal district court. (20) Congress aimed to create national uniformity in patent law, which had previously suffered from circuit splits that distorted investment decisions. For example, a company deciding where to build a factory that could arguably infringe on a competitor's patent might choose a location within a circuit with more favorable patent law jurisprudence. (21) Commentators agree that the Federal Circuit's jurisprudence has vastly increased the weight given to commercial success. (22)
In one of its earliest rulings, the Federal Circuit found that a district court committed reversible error by excluding consideration of commercial success. (23) One commentator writes, "the Federal Circuit has transformed commercial success from a tiebreaker to a virtual trump card." (24) Moreover, "[s]everal Federal Circuit judges have waged a prolonged campaign to discredit the 'secondary' label" (25) assigned to factors such as commercial success by Graham.
B. Theoretical Justifications
Commercial success has huge practical advantages as a mode of proof in patent litigation, particularly because of its accessibility to nontechnical judges and juries. It also has strong theoretical justifications under the two economic theories of patent law with the widest acceptance in scholarly writings and case law: classical theory and prospect theory. (26)
1. Classical Theory
The classical economic theory of patents sees them as a mechanism for inducing inventive activity and disclosure by providing the reward of monopoly protection. The potential for commercial success presumably provides incentives for others to try to perfect the invention, and the failure of others to do so suggests nonobviousness. Put most simply, the classical theory-based argument goes, "if an invention is both obvious and lucrative, why wasn't it thought of earlier?" (27)
If one breaks down this reasoning into component parts, commercial success implies nonobviousness with the aid of four inferences:
First, that the commercial success is due to the innovation. Second, that if an improvement has in fact become commercially successful, it is likely that this potential commercial success was perceived before its development. Third, the potential commercial success having been perceived, it is likely that efforts were made to develop the improvement. Fourth, the efforts having been made by [persons skilled in the field], they failed because the patentee was the first to reduce his development to practice. (28)
Arguably, the first inference--that the commercial success is due to the patented invention--is the weakest of the four. Courts have responded to this by requiring that a patentee show a nexus between the commercial success and the patent itself. (29) To have probative value, the commercial success cannot result from nontechnical business prowess or from technical features not covered in the patents-in-suit. (30) For example, courts have found the nexus severed by factors such as superior advertising, market power, or unpatented features. (31) With these logical inferences and the requirement of a nexus, commercial success provides a proxy for nonobviousness.
2. Prospect Theory
Prospect theory (32) posits that the patent system acts like the system for assigning mining rights to U.S. public lands. (33) Just as granting mineral rights on tracts over public lands encourages prospecting and mining, granting property rights on an area of technology encourages its development. (34) Patents give assurances of the exclusive right to develop and market a technology without the danger of free riding by others.
For example, in 1976 the Supreme Court considered a patent on an automated system for using water to clean cow droppings from barns. (35) The Court found the patent obvious as a simple use of water and automation. Prospect theory would justify upholding the patent because it would have enabled a manufacturer to invest in designing a marketable system and proving its value to America's dairy farmers. Without the assurances of exclusivity granted by a patent, a manufacturer would be less likely to make investments in this socially beneficial system. Why invest in demonstrating the value of automated cleanup to dairy farmers without assurances that others could not sell cheaper versions of the same system once dairy farmers were sold on it?
Prospect theory strongly supports the use of commercial success to demonstrate nonobviousness because it indicates that the patent serves as the "foundation for a series of now valuable contract rights" formed in reliance on its validity. (36) Prospect theory accepts commercial success to prove patent validity for normative, reliance-based reasons, not because commercial success actually proves nonobviousness. (37) Of course, prospect theory would still require a showing of nexus to prove that the patented invention itself--not extraneous factors--serves as the basis of the valuable contract rights. Some commentators have suggested that prospect theory provides the underpinnings for the expanded role of commercial success in the Federal Circuit's jurisprudence. (38)
C. Critiques of Commercial Success
The convenience of commercial success for nontechnical fact-finders and its grounding in theory have led to its increased use, but it has also drawn significant scholarly criticism. In a 1966 article noting the four inferences (39) required to deduce nonobviousness from commercial success, Professor Edmund W. Kitch argues that each of these inferences could be quite weak. (40) Of course, courts have responded to the weakest of these inferences--that commercial success is due to the claimed invention--by requiring proof of nexus. (41) Even here, however, Merges notes that the nexus requirement marked a significant softening from the earlier requirement that the proof of a link must be "positively clear ... that the commercial success asserted was the direct result" of the invention. (42)
Merges also reviews theoretical models and empirical studies of invention and innovation, (43) finding that they undermine each of the four inferences between commercial success and nonobviousness. (44) For example, firms act on incomplete information, with differing approaches to research and development (R&D) and varying levels of responsiveness to market demands. (45) Firms with entrenched products will not find certain innovations profitable, although other firms might. (46) Competing researchers may proceed in different directions, driven by academic pressures rather than financial incentives. (47) Overall, most scholarly attention on commercial success has attacked its use, rather than addressing ways to improve its accuracy. (48) The courts, however, continue to place great weight on commercial success, (49) and it remains a heavily litigated issue. (50)
II. THE CURRENT MISGUIDED USE OF REVENUE DATA
Despite the growing importance of commercial success in patent cases, courts use the wrong metrics for proving it. The Federal Circuit's jurisprudence clearly holds that commercial success is "usually shown by significant sales in a relevant market." (51) Sales, of course, equal revenues. Courts have also found other metrics related to revenue to be probative of commercial success, including market share (i.e., revenue divided by market size) and unit sales (i.e., revenue divided by unit price). (52) By contrast, when opinions do refer to profitability, they do so merely as an afterthought to revenue data. (53) As a result, lower courts typically do not permit discovery of profit data even in cases centered on commercial success. (54)
This Part begins by arguing that profits and not revenues should be the measure of commercial success. It then considers what role a lack of profits should have in the nonobviousness inquiry and concludes that a lack of profits should exclude any consideration of commercial success entirely. This conclusion has no value if patentees would never sue to enforce an unprofitable patent, so the Part explains why holders of unprofitable patents do indeed have incentives to bring suit. This Part finishes by suggesting possible explanations for how revenue became so entrenched in the case law.
A. Profits Should Prove Commercial Success and Nonobviousness
Current commercial success jurisprudence works from the flawed presumption that businesses aim to maximize revenue rather than profits. In many--but not all--cases, higher revenues will indeed result in higher profits for a firm, provided it can keep its costs sufficiently under control. As the two following hypothetical situations demonstrate, however, in a number of situations, measuring commercial success by revenue will lead to an incorrect conclusion about nonobviousness.
1. Hypothetical: Lower Volume, Higher Price
Assume that the mousetrap market is highly competitive, with several manufacturers, each selling three million mousetraps at one dollar apiece. With average costs of $0.90 per trap, each manufacturer makes a profit...
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