LECTURE 1

EDMUND W. KITCH-THE NATURE AND FUNCTION OF THE PATENT SYSTEM-1977

INTRO
This essay argues that the patent system (PS) increases the output from resources used for technological
innovation (in contrast with the antagonist claim according to which, PS reduces the output of the
technology it subjects to exclusive control).
The view of technological innovation is one in which resources are brought to bear upon an array of
prospects, each with its own set of probabilities of costs and returns.
Prospect: particular opportunity to develop a known technological possibility. Each prospect can be
pursued by any number of firms; the activity of each firm need not be disclosed to others.
Prospect theory: PS is able to allocate efficiently the resources among the prospects, allocate the
management of the prospect in the hands of the entity best equipped to manage it, and permits an
efficient information circulation between the firms. PS achieves these ends by awarding exclusive and
publicly recorded ownership of a prospect shortly after its discovery. The prospect theory suggests that
patent rights are useful in channelling and coordinating post-invention development activities. A business
is more likely to pursue post-invention investment and development of a product that falls within its own
sphere of patent exclusivity.
Reward theory: PS is viewed as a device that enables the inventor to capture the returns from his
investments (this theory is not here questioned in its entirety, but considered as incomplete).
I.

1.

a.

b.

c.

2.
a.

b.

3.

PATENTS AS PROSPECTS
The prospect function is the predominant function of American PS as it has operated in fact.
This importance is argued from three features of the PS, described below:
Scope of patent claim (reaching well beyond the reward function scope): a claim is an abstraction and
generalization of an indefinitely large number of concrete, physical objects (invention claimed in the
patent claim and physical embodiment of the invention are two quite different things). Examples:
an inventor who is first to combine a combustion engine with a drivetrain, wheels and steering mechanism
may claim the combination even if that particular application is unreliable under the actual circumstances.
Subsequent inventors of superior automobiles would infringe that claim, even if their contribution to the
car design is what, in fact, made them commercially practicable.
an inventor of a copying process based on the interaction between metal and magnetic fields can claim
the process even if he is just able to make a poor use of the invention. Anyone else making a machine
embodying that process, even though much superior and improved, will infringe that claim.
an inventor of a substance useful as a lubricant has a patent on it, and if is it later discovered to be
invaluable as fuel additive, any such use of the substance will infringe the patent, even if the inventor
never suspected other uses (important PS feature in the drug industry).
Rules forcing early application of invention:
Priority rule: patent awarded to the first inventor (the first to file). The application need not to disclose a
process of commercial value, but only a version of the invention that will work. Consequences of these
rules are significative in the case of multiple inventions of the same thing: second inventor can dislodge
the first one only if can prove that he is the first inventor (within 1y after first patent issue) by the
preponderance of evidence (the rules for establishing first inventor are quite demanding).
Time bar rule: patent is invalid if the application is filed more than 1y after a commercial use or a
publication describing the invention. Therefore whenever a technological innovation has been discovered
it can be risky not to immediately seek a patent, even though the practical or commercial significance of it
may be dimly perceived. Application only requires something that works.
Frequently, first patentable inventions occur years before the first commercial application: a new
innovation may make possible changes in other phases of the process,(or i.e. in the nature of input
materials) envisaging new possibilities that dwarf the original invention considered alone.

II.

1.
2.
3.
4.

5.
6.

The patent and the mineral claim: an institutional analogy

Mineral claim system made it possible to pursue 2 competing objectives: retaining government ownership
of public lands + private firms to efficiently find/ extract minerals they contained. The system allowed the
finder of mineralization on public land to file claim to have an exclusive right to develop claim.
-Analogy between PS and Mineral claim system:
No need to show commercial significance.
Award to the first to file. No regard to near miss, nor to claimants efforts or investments.
Restricted claimable area through rules specifying maximum boundaries per location (PS: applicant has
to limit his claim to his invention).
Need to specifically identify the claim scope and distinguish it from the rest of public domain (PS:
applicant must delimit in claims the legal scope of the invention. If claim exceed his invention, they are
invalid).
Claim maintenance costs: unpromising claims are eliminated (PS: limited term and other requirements for
maintenance payments).
Transferability of claim interests, both before and after the rights to the claim is established.
Such an analogy is useful to understand the patent prospect function; however it does not mean PS and
Mining case work in the same way. In effect demand conditions faced by particular mines and particular
patents vary widely: mines do not face monopoly constraint on production issues, in contrast with patents.
In both cases the effect of property rights on social welfare cannot be assessed without examining the
demand conditions actually faced by owners of the rights and assessing the output increasing efficiency
effects of the property system.

III.

The value of a PS
This section evaluates the public welfare effects of a PS serving both the reward and prospect functions
in a quite specific context -the advantages of a PS over a system of trade secrecy without patents-. The
authors claim is that a legal system which has both trade secrecy and a PS will better serve the public
welfare than a legal system with only trade secrecy.
-Advantages of PS:
1. Innovation investments efficiency. Barzel: technological information is a resource which will not be
efficiently used absent exclusive ownership. Unlike fisheries, public roads, and the other types of goods
usually considered, technological information can be used without signalling that fact to another. In the
area of technological innovation, it is possible for a firm working in secrecy to enter upon a "prospect,"
investigate it extensively, and depart without a trace. Subsequent investigation of the same prospect by
other firm cannot build on the knowledge of the first searcher, therefore the potential gains from exclusive
ownership are large. No one would invest to improve the commercial value of a patent unless he has
made arrangements with the patents owner. So the owner can coordinate the search for tech and market
enhancement of patents value, so avoiding duplicative investments and ensuring info is exchanged
among the searchers.
2. Patent owner can invest maximizing the patent value, with no fear that the fruits of the investment will
produce unpatentable information appropriable by competitors. Investments can reveal info as to product
manufacture and design in the development stage, and as to market identification and marketing in the
commercialisation stage; such info can be captured by competitors. Only the PS ensures that the firm can
invest to bring the advantages of the product to the attention of the customer without fear of competitive
appropriation if the product proves successful (important as marketing is a major cost in innovation).
3. Lower cost for owner of technological info of contracting with other firms possessing complementary info
and resources. He may need contracts to get knowledge on financing, use of complementary
technologies, specialized supplies and access to market. Under trade secrecy disclosure of the secret
imperils its value, yet the outsider cannot negotiate until he knows what the secret is. PS instead creates

a set of legal rights known to both the parties at the outset of the negotiations. Although seldom the patent
will disclose its real value, such info is protected by the scope of the legal monopoly.
4. Firms can signal each other so reducing duplicative investments in innovation (not possible under trade
secrecy regime). After the patent being issued, other firms can learn of the innovative work of the patent
holder and redirect their work so as not to duplicate work already done. PS give patent holder an
incentive to inform other firms of the new technology, to license it.<-> Under trade secrecy competitors
cannot notice new tech until it is marketed, and during this period possible investments in search of the
tech already invented are wasted. More, after a patent is issued other firms have incentive to search for
substitute technologies even if substitute tech is less efficient than patented tech, but can be produced
cheaper than existing royalty rate. To the extent that the holder of the original patent and his prospective
competitor can agree on the likely prospects of the substitute technology, they can enter into an
arrangement which will forestall the wasteful investment (transactions impossible under trade secrecy).
5. Reduction of costs of maintaining control over technology. Resources to keep tech secret are saved. <->
Under trade secrecy the owner must control access to the tech.
6. Improvement of the structure of the returns to innovation. PS provides an uniform structure of incentives
without regard to the possibility of economic exploitation in secret. <-> Under trade secrecy incentives
regard only processes practiced in secret by a single firm.
IV.

Policy implications
1- The test of invention.
Central PS problem: what is/isnt patentable? Dominant legal issue: which standard of the invention?
Subject matter new (1920s), flash of creative genius (1930s), non-obviousness (1952).
Kitch (1966): court should apply the non-obviousness test to evaluate the magnitude of the costs involved
in a given innovation, so avoiding protection to low cost inventions (these would exist anyway and are
sufficiently rewarded by the innovators head start). Bowman critique: low cost inventors should be not
penalised, inquiry should focus on the kind/type of invention.
- Other approach: deny patentability to those inventions that can be practiced in secrecy -> no
patentability for innovations on industrial processes. Problem: output constraint of a secrecy system is
greater than that of a patent system.
- Courts uncertainty: Courts, influenced by reward theory, viewed the PS as a difficult trade-off between
incentive effects and the output constraining effects. They believed the system can be improved by
weeding out marginal patents (who seeks to build a better mouse trap today has a long path to tread
before reaching the Patent Office).
Courts also encouraged challenges to patent validity by holding that patent licensees are free and
economically incentivised to challenge the validity of the licensed patent.
More, in some cases, commercial success of the patented innovation was relevant evidence in supporting
the validity of the patent. <-> Kitch critique: subsequent commercial success of an innovation said nothing
about the cost conditions of producing the innovation.
->Applying the prospect function: commercial success of a patented innovation tells to the courts that the
patent serves as a foundation for a series of now valuable contract rights. By announcing that the
subsequent value of those rights will be taken into account if the patent leads to a successful product, the
Courts increase the security of the investment process necessary to maximize the value of the patent.
- Why not property rights in all technological information? The arguments for a property right in
technological information all depend on the assumption that investment in the search for ways to enhance
the value of the information is needed. As to static, known information the proper incentives for its
acquisition and use exist without a property right: The person who acquires the information obtains the
benefit from having it. He is not entitled to more, because he did not create the information nor invest in
its improvement. PS will generate property rights along the frontier of tech development, while leaving the
older core free for all to use.

- Prospect function explains why a novelty test of invention is workable. The system should not concern of
the appropriate reward. The test question can be: is this information whose significance should be further
investigated? Answer is Yes In case of substantially new tech info, as it could not have been (by def.)
previously investigated. Such a substantial novelty is an economically rational test of patentability.
2- The patent term
Absent the limited term, all commercially relevant tech info would be in time subject to patent rights.
How long should the term be? Reward theory: perpetual term. <-> critique: inventor contribution is not the
invention itself (eventually been made by others), but the time of the invention.
Prospect theory requires that the owner have most of present value of the invention for the investment
period.
3- Unification of control
Problem: unification of control of patents that perform competing functions and have a significant market
share, could lead to loss of competition in an factor of production
Ownership of different parts of what can be most efficiently exploited as one prospect may be in different
hands, or two patents may be so closely related that it makes sense to look for improvements to both at
once. In this case unification of control may provide the most efficient solution.
Courts agree: "An interchange of patent rights ... is frequently necessary if technical advancement is not
to be blocked by threatened litigation."
Problem of efficient management and coordination of efforts by the firms to increase value of patents: can
it maybe be solved by making all patents available to all firms with an important position?
4- Compulsory licensing
Frequently proposed in the economic literature. Purpose: to preserve reward while reducing output
constraints of PS. However any form of compulsory licensing destroys prospect function: patent owner
loses ability to control who can use the patent.
5- Government Patent Policy
Debate in USA about making all patents free of charge or offer exclusive licenses.
Reward function: free use of inventions (viewed as already made)
Prospect function: granting exclusive licenses (viewed as in need of further development)
6- Patent disclosure
- Reward theory: focus on the disclosure role of the patent. Inventor get a monopoly period, but only if
disclosure of the invention in the patent enables others to use it. Apparent failure of PS to perform
disclosure: PS requires disclosure of invention at the time of the application, which may occur years
before its commercialization.
- Prospect function: prospect creates an incentive in the owner to efficiently disseminate information about
the invention himself, directly, not through a formal patent description. The purpose of the description in
the patent is not to disclose the commercially relevant technology, but to provide a context in which the
legal limits of the claim acquire meaning.
7- Trade secrets
Basic framework of technology is protected by patent, while less important but still valuable info can be
protected by trade secrets, but exchanged and disclosed within the protective framework of the patents.
This reduce incentives to apply for patent on this less important info -> reduction number of patents->
reduced cost of the PS.
In addition, rules that permit the patentee to retain important info makes patents that can be infringed in
secrecy more enforceable.
8- Government subsidy of applied research
Seen as way to create incentives for research while avoiding output constraint of patent. It may though
reduce the rate of techn improvement: indeed Government may identify and manage patents in a less
efficient way than a private firm.
9- Organisation of basic research

PS cant perform prospect function in the basic research because of its inability to fashion meaningful
property right around an explanation. Yet basic research faces the same problems of coordination among
searchers that applied research does.
V.

Conclusion
Literature has always seen the PS as a trade-off between gains of patent incentive and output constraints
of existing patents.
Literature:
- Incentive effects: incentives dissipated by competition for it; some patents are awarded for info that
wouldve been developed anyway.
- Output constraints: important because :
Transmission of info between firms: costless
Reward theory suggested that valuable patents must be the important class. <-> Prospect function:
patents facing competition from alternative approaches to the technological and market problem may in
fact be the important class, and that such patents may perform a useful social function even though many
are of little value to their owners.
- Info provided by legal culture for an authoritative assessment attempt of PS:
How defined property rights in information lower costs of transactions concerning such information
The frequency of interferences within PS indicate problem of duplicative search isnt negligible in techn
development