Patent Reform without Congress

Paul Graham is an accomplished entrepreneur and is the founder of Y-Combinator — perhaps the most successful of the start-up incubator projects in recent times. (Here is a write-up from Wired.) His essays and thoughts about the tech sector are always worth reading.

Graham’s latest focus is patent reform. Why does the patent system need reforming? Well, just listen to this This American Life podcast or read books like this one from Adam Jaffe and Josh Lerner.

In a paper published in Management Science this month, economists Iain Cockburn and Megan MacGarvie put some numbers to these stories. When you increase the number of patents in a sector by 10 percent, entry can fall by around 8%. That’s a big effect. Small start-ups face a patent thicket of such proportion — insoftware and elsewhere — that it has become an increasing barrier to entry as patent protection itself has strengthened.

This shows that there’s certainly demand for reform, but as Graham points out, the supply of such reform is problematic. Sclerosis has hit the U.S. legislature, so he calls for such reform to be taken private. The idea is for established firms to take the following pledge:

“No first use of software patents against companies with less than 25 people.”

It is admittedly brief and possibly arbitrary. Why a 25-person threshold? What is a person anyway? An employee (easy), a contractor (probably), a funder (harder)?

But that is not the point. The idea is that patent holders shouldn’t pick on the small.

Will it work? A pledge is not legally binding, but Graham makes the case, somewhat convincingly, that pledges can create a social norm, even in business and especially in a business where good labor migrates to “non-evil” corporations. Google has ridden that wave. That said, the companies that have signed up thus far are established start-ups not established firms. But it is early days yet.

Is this a good idea? Would this be a good policy if Congress enacted it? Let’s look at the outcome if this took off. A small start-up would be shielded from an injunction until they grew larger. That’s good news in the sense that they can start-up without the transaction cost or fear of legal action. But it doesn’t protect them fully: eventually they may grow large and on the day of the hire of the 26th employee face those very same threats. So while the first effect will promote more entry and experimentation, the threat of a “success toll” still exists.

Compared to the world where start-ups face tolls from the very beginning, a policy like this is likely to promote entry. But one can imagine that venture capitalists still won’t be thrilled to see a legal liability risk on the two-year-out business plan.

What does have merit here is the basic premise. It will take some doing for established firms to undertake a pledge like this. In part, it is an admission that they do not need protection from smaller firms in their fledgling stages. That itself may have a cultural impact and assist in moving the debate forward. But corporations might fear that signing the pledge could engender and legitimize still more patent reform — which could prevent them from signing in the first place.

[Note: this post was originally published on HBR Blogs on 3rd October 2011]