In Search Of The Privately Optimal Patent Breadth

Innovating firms choose to patent their innovations when patenting allows the appropriation of more rents than do other forms of intellectual property protection (e.g., trade secrecy). The level of innovation rents that can be captured by the patent is mainly determined by the breadth of patent protection. Thus, once the decision to patent has been made, the innovator needs to make another important decision, namely, how broad of a patent protection to claim. While the innovator's decision to patent the innovation or to keep it a secret has been examined in the literature (Horstmann et al. 1985, Waterson 1990), there is no formal framework of analysis of the innovator's patent breadth choice. Instead, the traditional assumption in the economic literature is that the innovator has an incentive to claim 'as much as possible'. The effectiveness of this strategy in maximizing the rents that can be appropriated by the patentee is questionable, however. A patent that is too broad increases the likelihood of both infringement and patent validity challenges by competitors and/or third parties (Merges and Nelson 1990). Consequently, broad patent protection may reduce the effective patent life and thus the innovation rents that can be captured with the patent, since patents are often revoked during infringement trials and patent validity challenges (Merges and Nelson 1990, Barton 2000). This concern is especially critical given the increase in patent litigation during the last decade, particularly in the field of biotechnology, and the increase in the number of patents that are invalidated after being challenged. While the broadest possible patent may not be optimal, neither is a very narrow patent, since narrow patents make it easier for rivals to enter the patentee's market and may not allow the patentee to capture enough returns to cover her R&D costs. The purpose of this paper is to theoretically examine the patenting behavior of innovators that have generated patentable process innovations and have decided to seek patent protection. In specific, the paper determines the privately optimal patent breadth for process innovations when the innovator faces the probability of a direct patent validity challenge by a third party and potential entry in her market by competitors that provide technologically equivalent processes. The paper also examines the affect of patent breadth on the competitors' incentive to generate a competing process (i.e., on the competitors' R&D spending), on the competitors' probability of success in the R&D process (i.e., the patentee's ability to deter entry) and on the timing that success is realized by competitors (i.e., the pace of future innovations). The innovating firm's patent breadth decision is determined in a sequential game between an incumbent innovator who decides on the breadth of patent protection claimed and potential entrants who, having observed whether the patent was challenged or not, decide on whether to generate competing processes and how much to spend on R&D. The game is solved by backwards induction. Results show that the optimal patent breadth depends on the affect of new entry on the incumbent's profits, the incumbent's legal costs incurred when the patent is challenged and on whether the incumbent operates under a short term or a long term horizon. A key result of the paper is that, even when a patent breadth that deters entry exists, it might not be profit maximizing for the incumbent to choose this patent breadth to deter entry. As well, claiming the maximum breadth of patent protection is never an optimal strategy for the incumbent patentee in this model. The analysis shows that the nature of the instantaneous probability of success is a critical factor in determining the optimal patent breadth as well as the affect of patent breadth on the rivals' R&D spending, the probability of success by rivals and the timing that success occurs.