PATENT ASSERTION AND
`U.S. INNOVATION
` Executive Office of the President
`June 2013
`
`Medtronic and Medtronic Vascular
`Exhibit 1013 - Page 1
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`

`
`
`
`This report was prepared by the President’s Council of Economic Advisers, the
`National Economic Council, and the Office of Science & Technology Policy.
`
`Medtronic and Medtronic Vascular
`Exhibit 1013 - Page 2
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`

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`Executive Summary
`
`
`(cid:153) Some firms that own patents but do not make products with them play an important role in U.S.
`innovation ecosystem, for example by connecting manufacturers with inventors, thereby allowing
`inventors to focus on what they do best.
`
`(cid:153) However, Patent Assertion Entities (PAEs, also known as “patent trolls”) do not play such roles. Instead
`they focus on aggressive litigation, using such tactics as: threatening to sue thousands of companies at
`once, without specific evidence of infringement against any of them; creating shell companies that make
`it difficult for defendants to know who is suing them; and asserting that their patents cover inventions
`not imagined at the time they were granted.
`
`(cid:153) Suits brought by PAEs have tripled in just the last two years, rising from 29 percent of all infringement
`suits to 62 percent of all infringement suits. Estimates suggest that PAEs may have threatened over
`100,000 companies with patent infringement last year alone.
`
`(cid:153) While aggressive litigation tactics are a hallmark of PAEs, some practicing firms are beginning to use them
`as well. (“Practicing” firms use their patents to design or manufacture products or processes.)
`
`(cid:153) PAE activities hurt firms of all sizes. Although many significant settlements are from large companies, the
`majority of PAE suits target small and inventor-driven companies. In addition, PAEs are increasingly
`targeting end users of products, including many small businesses.
`
`(cid:153) PAEs take advantage of uncertainty about the scope or validity of patent claims, especially in software-
`related patents because of the relative novelty of the technology and because it has been difficult to
`separate the “function” of the software (e.g. to produce a medical image) from the “means” by which
`that function is accomplished.
`
`(cid:153) A range of studies have documented the cost of PAE activity to innovation and economic growth. For
`example:
`
`(cid:190) One study found that during the years they were being sued for patent infringement by a PAE,
`health information technology companies ceased all innovation in that technology, causing sales to
`fall by one-third compared to the same firm’s sales of similar products not subject to the PAE-
`owned patent.
`
`
`(cid:190) Another study found that the financial reward received by winning PAEs amounted to less than 10%
`of the share value lost by defendant firms, suggesting that the suits result in considerable lost value
`to society from forgone technology transfer and commercialization of patented technology.
`
`(cid:153) History suggests that it should be possible to address these challenges. Similar cases occurred with
`patents for agricultural equipment and for railroad equipment in the late 19th century, in which there
`was great uncertainty about whether a valid patent had been infringed. Once these underlying conditions
`were changed, this business model was no longer profitable and litigation of this type fell dramatically.
`
`(cid:153) Policies such as the following: fostering clearer patents with a high standard of novelty and non-
`obviousness; reducing disparity in the costs of litigation for patent owners and technology users; and
`increasing the adaptability of the innovation system to challenges posed by new technologies and new
`business models; would likely have a similar effect today.
`
`
`
`1
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`Medtronic and Medtronic Vascular
`Exhibit 1013 - Page 3
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`

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`I.
`
`Introduction
`
`The folks that you’re talking about [PAEs] are a classic example; they don’t actually produce anything
`themselves. They’re just trying to essentially leverage and hijack somebody else’s idea and see if they can
`extort some money out of them... [O]ur efforts at patent reform only went about halfway to where we
`need to go and what we need to do is pull together additional stakeholders and see if we can build some
`additional consensus on smarter patent laws.
`President Obama, February 14, 2013
`-
`
`
`The purpose of the U.S. patent system, according to the Constitution, is “to promote the Progress
`of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive
`Right to their respective Writings and Discoveries” (U.S. Const., art. 1, sec. 8, cl. 8). Giving
`inventors this right provides a powerful incentive for innovation.
`
`Patent policy must navigate a fine line however, as excessive enforcement of that exclusivity—
`such as through abusive litigation or overly broad patent claims—may dampen incentives for
`future innovation. Innovators who fear inadvertently infringing existing patents may reduce
`innovative activity or take costly steps to defend against lawsuits claiming infringement, leading to
`fewer resources available for wages, job creation, and innovation of new products and services.
`
`Firms that own patents but do not practice1 them can play a useful role in the innovation
`ecosystem. Firms that aggregate and manage patents can play an important intermediary role,
`bringing value to society by more efficiently matching inventors to patent users in an otherwise
`illiquid market, and by developing expertise in legitimately protecting patents from infringement.
`However, some litigation strategies may reduce incentives to transfer or commercialize technology
`by unwarrantedly raising potential innovators’ fears that they will be accused of patent
`infringement if they do so.
`
`This report looks particularly at firms who do not practice the patents they own and instead
`engage in aggressive litigation to collect license and other fees from alleged infringers. A review of
`the evidence suggests that on balance, such patent assertion entities (PAEs) (also known as
`“patent trolls”) have had a negative impact on innovation and economic growth.
`
`The success of the PAE business model in part reflects patent policy challenges created by the
`rapid growth of complex software products. Because of rapid technological change and the special
`characteristics of software, it has been hard to define clear boundaries for patents, and hard to set
`an appropriate bar for non-obviousness, leading to many opportunities that PAEs (and in some
`cases, non-PAEs) have exploited.
`
`
`II.
`
`The Role of Intermediaries in the Patent System
`
`
`
`
`1 Firms that “practice” their patents use them to design or manufacture products or processes.
`
`
`
`2
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`Medtronic and Medtronic Vascular
`Exhibit 1013 - Page 4
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`Patent intermediaries can play a useful social role. Inventors and buyers of patents (such as a
`manufacturer who can commercialize patented inventions) may have a difficult time finding each
`other because the potential usefulness of a patented technology is often not obvious, and often
`depends on the complementarity between the protected technology and the buyer’s own
`portfolio of technology.
`
`In principle, illiquid markets such as the one for patents may benefit from specialized
`intermediaries. These intermediaries bring value to society by more efficiently matching patent
`holders to patent buyers, thereby fostering transfer of technology from inventors to those who
`can use the technology to make products that are valuable to consumers. For example, an
`individual inventor might sell a patented battery technology to an intermediary, who then sells or
`licenses the patent to a cell-phone manufacturer who has both the equipment to make the battery
`in large scale and the ability to market the advantages of the new battery when combined with
`that phone.
`
`This arrangement allows inventors to specialize in innovation and benefit from the specialized
`
`THE LEAHY-SMITH AMERICA INVENTS ACT (AIA)
`
`In September, 2011, President Obama signed into law the Leahy-Smith America Invents Act, historic patent
`reform legislation designed to help American entrepreneurs and businesses bring their inventions to market
`sooner, creating new businesses and new jobs.
`
`The key provisions of the AIA, which went into full effect in 2012, are helping to improve the patent system for
`innovators in all fields by offering a fast-track option for patent processing; taking important steps to reduce the
`current patent backlog; and increasing the ability of Americans to protect their intellectual property abroad.
`
`Several provisions of AIA may help address some of the problematic behavior of PAEs by creating new programs
`at the Patent and Trademark Office to create alternatives to litigation regarding patent validity, new methods for
`post-grant review of issued patents, and major steps to increase patent quality through clarifying and tightening
`standards. Nonetheless, the impact of aggressive litigation tactics by PAEs and others was not widely known
`during the seven years the AIA was under negotiation, and as President Obama said, AIA “only went about
`halfway to where we need to go.”
`
`commercial knowledge and connections of an intermediary. Similarly, it can be costly for
`technology users to find all potentially-relevant patents. Effective brokering of patents by
`intermediaries can therefore increase the value of patents, fostering greater incentives to
`innovate. And finally, potential inventors may not have the resources to protect their patents from
`infringement; their incentives to invent may be increased if they can sell their patents to firms that
`specialize in litigation and other means to collect license fees from those who are using the
`patented technology.
`
`On the other hand, patent intermediaries may also act in ways that reduce innovation. Recent
`years have seen the rapid emergence of PAEs, or “patent trolls.” These firms “use patents
`primarily to obtain license fees rather than to support the development or transfer of technology”
`(Chien 2012). Obtaining these license fees in practice often means aggressive litigation practices,
`3
`
`
`
`Medtronic and Medtronic Vascular
`Exhibit 1013 - Page 5
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`

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`in which PAEs tie up (or threaten to tie up) legitimate innovators in court by charging them with
`patent infringement. The PAE business model is generally seen as combining characteristics such
`as the following (Chien 2012; Bessen, Meurer and Ford 2011; Hagiu and Yoffie 2013):
`
`1. They do not “practice” their patents; that is, they do not do research or develop any
`technology or products related to their patents;
`
`2. They do not help with “technology transfer” (the process of translating the patent language
`into a usable product or process);
`
`3. They often wait until after industry participants have made irreversible investments before
`asserting their claims,
`
`4. They acquire patents solely for the purpose of extracting payments from alleged infringers;
`
`5. Their strategies for litigation take advantage of their non-practicing status, which makes them
`invulnerable to counter-claims of patent infringement.
`
`6. They acquire patents whose claim boundaries are unclear, and then (with little specific
`evidence of infringement) ask many companies at once for moderate license fees, assuming
`that some will settle instead of risking a costly and uncertain trial.
`
`7. They may hide their identity by creating numerous shell companies and requiring those who
`settle to sign non-disclosure agreements, making it difficult for defendants to form common
`defensive strategies (for example, by sharing legal fees rather than settling individually).
`
`
`While intermediaries in general may be non-practicing entities, and generate revenues through
`licensing fees, PAEs go further by masking their identity, and acquiring and asserting broad
`patents, some of questionable validity, in order to extract settlement fees.
`
`For example, one company sued dozens of online retailers, claiming that its patents covered nearly
`any use of online shopping cart technology, leading several retailers to pay settlements worth
`millions of dollars each. Ultimately, one online technology retailer won an appeal that invalidated
`each of the three key patents that were the basis for the original suits. The court found that the
`claims of the patents were obvious in light of products that already existed at the time the patent
`was filed.2 The victory in this case, however, required spending millions of dollars and years in
`court – a risk that other online retailers had been unwilling to take (Mullin 2013a; Mackie, Payne,
`and Stewart 1994). See below for additional examples of PAE tactics.
`
`
`
`
`2 The appeals court held that once the technology existed to do purchasing on a closed network, extending this
`capability to allow purchasing on the Internet, while novel, required only steps that would be obvious to anyone
`skilled in the relevant prior art.
`
`
`
`4
`
`Medtronic and Medtronic Vascular
`Exhibit 1013 - Page 6
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`

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`PAE activity has increased dramatically in recent years (Figure 1). Last year, PAEs brought over
`2,500 lawsuits — 62% of all patent suits. That compares to 1,500 in 2011 (45% of all cases,), and
`731 in 2010 (accounting for 29%) (Chien 2013). Other studies find a similar rise in PAE activity. An
`updated version of a study done for the US Government Accountability Office (Jeruss, Feldman
`and Walker, 2012) finds that PAEs filed 59% of the patent lawsuits in the US in 2012 (Feldman,
`Ewing, and Jeruss (2013).
`
`Figure 1: Total number of Patent Cases Commenced, 2006-2012
`
`62%
`
`45%
`
`19%
`
`23%
`
`25%
`
`27%
`
`29%
`
`PAE
`Non-PAE
`
`5000
`
`4500
`
`4000
`
`3500
`
`3000
`
`2500
`
`2000
`
`1500
`
`1000
`
`500
`
`0
`
`2007
`2006
`Source: Chien 2013, using data from RPX Corporation
`
`2008
`
`2009
`
`2010
`
`2011
`
`2012
`
`
`The increased prevalence of PAE suits, and patent suits in general, in recent years stands in
`contrast to the 20th century, when suits for patent infringement were relatively rare. This increase
`is likely due to two factors. First, there are an increasing number of computer and communications
`patents, whose wider breadth makes them more easily abused, as we discuss below. PAE suits are
`concentrated in the IT sphere; according to one estimate, 82% of PAE defendants were sued on
`the basis of a software patent (in contrast to only 30% of those sued by non-PAEs) (Chien and
`Karkhanis, 2013). Software patents are nearly five times as likely to be in a lawsuit as chemical
`patents; business method patents are nearly fourteen times as likely (Bessen 2011).
`
`Second, during the 20th century, patents were primarily held by manufacturers (FTC 2011). Rival
`makers of complex products are likely to be infringing each other’s patents, so they have an
`incentive to settle competing infringement cases by cross-licensing, rather than engaging in
`expensive legal battles that do not add to society’s stock of scientific knowledge. In contrast, a PAE
`has no rival product, so it can’t be counter-sued. PAEs also have few of the reputational concerns
`that might deter
`a well-known
`company
`from
`appearing
`to
`victimize other
`innovators. Furthermore, PAEs can develop economies of scale in suing many firms at once on a
`contingency-fee basis; once the initial legal preparation work has been done, a PAE can send
`
`
`
`5
`
`Medtronic and Medtronic Vascular
`Exhibit 1013 - Page 7
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`

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`demands asserting infringement to numerous companies at low cost, paying legal fees only in the
`event that its assertion is successful.
`
`PAEs often threaten to sue with the intention of extracting license fees or settlement payments.
`The increase in the number of suits filed for patent infringement has thus been accompanied by an
`increasingly large number of suits threatened. PAEs assert broad patent claims against an
`unusually large set of potential defendants; these assertions are often not based on any evidence
`of infringement by an individual defendant, but are instead an attempt to find companies that will
`seek to settle the PAE’s claims rather than risk a trial. Conservative estimates place the number of
`threats in the last year alone at a minimum of 60,000 and more likely at over 100,000 (Chien
`2012). 3
`
`The uncertainty and expense of litigation suggests that many patents might be best viewed as
`“probabilistic property rights” or “lottery tickets” (Lemley and Shapiro 2005). Given this situation,
`many patent owners and users prefer to settle out of court for amounts that have not so much to
`do with the economic value of their patents or the probability that they have infringed. Instead,
`settlements are affected more by the parties’ relative opportunity costs of going to trial and
`attitudes towards risk—factors that favor PAEs, whose legal fees are low (since they do not have
`to provide much evidence to assert that there has been patent infringement), and who do not
`have to pay the fixed costs of a manufacturing operation. Therefore, PAEs have an incentive to
`drag out litigation, to increase pressure on defendants to settle the case (Tucker 2012).
`
`Examples of Abusive Practices in Litigation by Patent Assertion Entities
`
`Above we have argued that Patent Assertion Entities (PAEs) have “over-asserted” their patents,
`pursuing legal action in a way that does not increase incentives for innovation, and in fact reduces
`these incentives and complicates normal business operation. Below are two examples:
`
`Large company example
`
`SAS is the world’s largest privately held software company, providing business and organizational
`customers with advanced analytics. SAS has been a defendant in several suits filed by PAEs. In
`Congressional testimony in March, John Boswell, SAS’s General Counsel, described the PAE
`business model and its impacts on his company:
`
`Here are the basic parameters of what is happening with these suits. A patent troll sets up
`shop in a jurisdiction known to be supportive of patent plaintiffs… It buys patents from
`defunct companies or patents that companies no longer want to keep. It does not hire
`employees; it does not engage in research; it does not even practice the invention—nor
`does it ever intend to practice it. The patent troll then either serves a demand letter on the
`
`
`3 For example, one PAE sent 8,000 notice letters to coffee chains, hotels, and retailers seeking compensation for use of
`Wi-Fi equipment made by several manufacturers that they allege to infringe on its patents. In February, a Federal
`judge dismissed a suit by one of those manufacturers to prevent the PAE from seeking royalties from Cisco customers.
`See Jones (2013).
`
`
`
`6
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`Medtronic and Medtronic Vascular
`Exhibit 1013 - Page 8
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`

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`victims, or effects legal service of a complaint. The troll then pursues settlement by
`threatening massive and costly discovery,… of every electronic document that might touch
`upon the alleged claims, by any person inside the defendant’s operations. …[In one recent
`case], the number of electronic documents that we had to collect exceeded 10 million....
`SAS won summary judgment in this case and it is now on appeal to the Federal Circuit. So
`far this case has cost us in excess of $8 million [in legal fees alone].
`
`If SAS ultimately wins this case it will be a Pyrrhic victory at best. We spent $8 million and
`huge amounts of developer time and executive time etc., for what? This victory does not
`resolve the other patent troll cases that we face, or will face in the future. This $8 million
`and the millions more we are spending on other cases is money SAS no longer has to invest
`in people, facilities, research, or product development; and we are a relatively small player
`in this world. .. It does not cost much to be a troll and to make broad, vague demands. On
`the other hand, the risk to the company receiving a troll threat is enormous.(Boswell 2013)
`
`Small company example
`
` A
`
` PAE sent letters to hundreds of small businesses alleging infringements of patents if the
`businesses have document scanners integrated into their computer networks, and demanding a
`“good faith payment” of $900-1,200 per employee for a license. The letter provides no specific
`evidence against the recipient; it argues instead that general research “has led us to the
`conclusion that an overwhelming majority of companies like yours utilize systems that are set up
`to practice at least one of scenarios A through C” that are covered by the patents. In May, the
`State of Vermont sued the PAE for unfair and deceptive practices, alleging that the letters were
`targeted to businesses and non-profits unlikely to be familiar with patent law, that they “shifted
`the entire burden of the pre-suit investigation onto the small business that received the letters”,
`and that despite repeated threats to sue if the payment is not made, no such suits had been filed
`(see Fisher, 2013).
`
`“Functional Claiming” and Uncertain Infringement
`
`III.
`
`To be awarded a patent, an inventor must disclose the invention in sufficient detail to enable
`skilled practitioners in the relevant field to understand it and potentially build upon it. Patent
`applicants must also articulate the specific claims as to the scope of the patent. Understanding
`which products and processes are, in fact, protected by the patent is essential to avoiding
`infringement upon that patent. Moreover, such clarity enables patents to serve the socially
`beneficial purpose of promoting technology transfer. The Patent and Trademark Office grants
`patents only if the claims are novel (have not been made before) and are not obvious to a person
`skilled in the relevant art.
`
`Setting an appropriate bar for novelty and non-obviousness is particularly important in a new field;
`if the bar is not set high (something difficult to do in a new field), firms may well find themselves
`inadvertently infringing patents, both because of the sheer number of patents and because
`commercial need is driving many inventors to create similar inventions near-simultaneously
`(Lemley and Melamed 2013). Many practitioners of such technologies (such as railroads in the 19th
`
`
`
`7
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`Medtronic and Medtronic Vascular
`Exhibit 1013 - Page 9
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`

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`century and software today) find it more profitable to focus on expanding the overall market for
`their products by technological cooperation with rivals, rather than working to clearly delineate
`property rights (Boldrin and Levine 2013).
`
`An additional reason that the issue of overbroad patents is particularly salient in software is due to
`the prevalence of “functional claiming” in these patent classes (Lemley 2012). A claim term is
`“functional” when it recites a feature by “what it does rather than by what it is” (In re Swinehart
`1971).4 Functional claiming involves claiming exclusive rights over any device that performs a given
`function, regardless of how that function is performed.
`
`Functional language can therefore lead to very broad and/or vague claims. These problems are
`especially acute for software patents. For these patents, it has been argued that the code is the
`function, with the implication that a software patent arguably excludes any other code that
`performs that same function. In contrast, in pharmaceuticals, the distinction between a function
`and the means used to perform that function is generally clear. For example, several patents have
`been awarded for the function of reducing cholesterol; each patent covers a different chemical
`compound—a different means of providing that function.
`
`Compounding the problem is the fast-moving, interdependent nature of technical change in the
`software industry. Functional claims can be used to ‘over-assert’ a patent by attempting to cover
`products and processes that were never contemplated by the inventor or the examiner as being
`within the claim scope at the time of the invention. For example, a patent claim about a
`programmed processor could be asserted broadly to cover any and all devices that achieve the
`claimed result, rather than being limited to a device programmed with the specific software used
`by the inventor.
`
`In addition, a single piece of software or website might have several thousand “functions” that
`could be claimed in as many patents. It is also difficult for an outsider to judge what an inventor
`meant by a claim and to know what sort of invention would be “obvious” to a skilled practitioner
`and thus unworthy of a patent. For example, in the case discussed earlier, the appeals court had to
`consider detailed features of twenty-year-old technologies to determine whether the shopping
`basket patents in fact made novel claims.
`
`Thus, it can be very difficult to know if one is infringing patents. These broad, functionally-defined,
`and intertwined patents are therefore a key part of the PAE business model. These intermediaries
`acquire broad patents and threaten suit, in hopes of extracting settlements. If even one patent in a
`complex product is held to be infringed, the product cannot be legally sold (Lemley and Shapiro,
`2005). This situation can lead to problems for practicing firms both large (note that a single
`smartphone may read on over 100,000 patents) and small (the basis of the demand letters
`discussed in the examples above is the alleged interaction between components of a computer
`
`
`4 For example, functional language is often used to add further description to a structure or step, e.g., a claim may
`recite a conical spout (a structure) that allows several kernels of popped popcorn to pass through at the same time (a
`function). In re Schreiber, 128 F.3d 1473, 1478(Fed. Cir. 1997).
`
`
`
`8
`
`Medtronic and Medtronic Vascular
`Exhibit 1013 - Page 10
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`

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`network found in most offices). The stakes are particularly high when the venue for an
`infringement dispute is the U.S. International Trade Commission (ITC), given the ITC’s inability to
`award damages and reliance instead on exclusion orders barring import of products deemed
`infringing into the United States.
`
`The Economic Cost of PAE Activity
`
`IV.
`
`While most patents are not litigated and are properly practiced and enforced, the harassing
`litigation tactics of some PAEs, combined with substantial litigation costs (ranging from a median
`of $650,000 for smaller cases, to a median of over $5 million per case where the amount in
`controversy exceeds $25 million) (AIPLA 2013), have added significant costs to the innovation
`ecosystem and sapped investments in research and development, causing great harm to society.
`These costs are of several types.
`
`Direct costs to firms that practice patents. James Bessen and Michael Meurer (2012) find that
`defendants and licensees paid PAE’s $29 billion in 2011, a 400% increase from 2005; they estimate
`that less than 25% of this money flowed back to innovation.5 In addition, in the majority of PAE
`cases, the legal cost of the defense exceeds this settlement or judgment amount (Chien 2012c).
`
`Private costs of lost opportunities to commercialize technology. One might argue that the
`losses to defendants accused of infringement would be offset by gains to the owners of patents.
`However, very little such transfer of value appears to take place. For example, in the years 2000
`through 2010, a set of fourteen publicly-traded PAEs followed by Bessen, Meurer, and Ford (2011)
`had total revenues of $7.6 billion.6 Patent suits initiated by those fourteen entities were associated
`with a decline of $87.6 billion in defendant company share value over the same period, implying
`that the financial award experienced by winning PAEs amounts to less than 10% of the lost share
`value in this sample.
`
`While drops in the share value of a defendant companies may reflect other economic factors (e.g.
`the now-raised expectation of losing future suits or making settlement payments), the 90% of lost
`defendant share values that simply vanishes suggests considerable lost value to society from
`forgone technology transfer and commercialization of patented technology. Aggregating to all
`suits by PAEs yields lost wealth of over $300 billion in four years starting in 2007. That is, the stock
`
`
`5 In their papers, Bessen and Meurer define PAEs as firms with each of the following characteristics: they "do not
`produce goods, rather they acquire patents in order to license them to others," they "seek to derive the majority of
`their income from the enforcement of patent rights," and they file lawsuits.
`6 These revenues may include revenues from sources other than litigation, and therefore may overstate the value of
`transfers from defendants to these PAEs. Note that the $7.6 billion does not include payment streams received after
`2010 related to settlements won during the study period. Future payment streams are unlikely to be large given that
`settlements tend to be paid in lump sums. Also, the “event study” method used by the authors controls for the impact
`of the recession on firm valuations, because the method looks at changes in a firm’s share value around the time of a
`lawsuit filing.
`
`
`
`
`9
`
`Medtronic and Medtronic Vascular
`Exhibit 1013 - Page 11
`
`

`
`market values the lost opportunities for technology commercialization as significantly greater than
`the direct payments from defendants and licensees to PAEs.
`
`Even if patent assertion entities do not prevail in the courtroom, their actions can significantly
`reduce incremental innovation while litigation is ongoing, a situation that can persist for years. The
`reason is that such action could be viewed by courts as an evidence of “willful infringement” if the
`plaintiff’s patent is upheld, making the firm liable for treble damages. For example, one study
`found that during the years they were being sued for patent infringement by a PAE, health
`information technology companies ceased all innovation in that technology, causing sales to fall by
`one-third compared to the same firm’s sales of similar products not subject to the PAE demand
`(Tucker 2013).
`
`Social costs of reduced innovation. A great deal of economic literature shows that firms do not
`capture all the value created by the research and development they do (Mansfield 1968). Thus,
`the losses caused by excessive litigation exceed even the large stock market losses described
`above, including lost value to consumers who are not able to buy innovative products, and
`reduced income for workers whose pay is lower because they are unable to work with more
`productive new processes.
`Range of Victims
`
`Although PAEs often target major, household-name and deep-pocketed technology companies,
`they also target start-ups and small companies. In fact, though the most substantial settlements
`are often extracted from large entities, the majority of PAE suits target small and inventor-driven
`companies (Bessen and Meurer 2012).
`
`Recent surveys provide evidence for the negative impact of PAE litigation on innovative
`companies. The impact on smaller startups is particularly acute. In a recent survey of 223
`technology company startups, 40 percent of PAE-targeted companies reported a “significant”
`operational impact (e.g. change in business, exit from the market, delay in milestone, change in
`product, etc.) due to the suit or threat thereof (Figure 2).7 In another recent survey of 116 in-
`house counsels, primarily from firms with over $100 million in annual revenue, nearly all firms
`reported that PAE demands had affected them financially or distracted them from their core
`business, with nearly 40 percent stating that PAE activity had led them to make changes to an
`underlying product (McBride 2013).
`
`PAEs have also sent infringement notices to “downstream users” of technologies, who are often
`small companies, as in the scanner and Wi-Fi cases discussed above. Although the amount of
`money extracted from each company is small, the number of potential defendants makes this
`strategy potentially profitable overall.
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`7 “PAE” was defined as “an entity that does not offer products/services” and makes a “demand” regarding patents
`(