Why software startups decide to patent … or not

Berkeley Patent Survey finds first-mover advantage trumps patents for some.

Guest blogger Pamela Samuelson is the Richard M. Sherman Distinguished Professor of Law and Information at the University of California, Berkeley. She teaches courses on intellectual property, cyberlaw, and information privacy, and she has written and spoken extensively about the challenges that new information technologies pose for traditional legal regimes. A version of this material is scheduled to appear in the November 2010 issue of Communications of the ACM.

Two-thirds of the approximately 700 software entrepreneurs who participated in the 2008 Berkeley Patent Survey report that they neither have nor are seeking patents for innovations embodied in their products and services. These entrepreneurs rate patents as the least important mechanism among seven options for attaining competitive advantage in the marketplace. Even software startups that hold patents regard them as providing only a slight incentive to invest in innovation.

These are three of the most striking findings from our recently published article, “High Technology Entrepreneurs and the Patent System: Results of the 2008 Berkeley Patent Survey.”

After providing some background about the survey, this column will discuss some key findings about how software startup firms perceive, use and are affected by the patent system.

While the three findings highlighted above might seem to support a software patent abolitionist position, it is significant that a third of the software entrepreneurs reported having or seeking patents, and that they perceive patents to be important to persons or firms from whom they hope to obtain financing.

Survey background

More than 1,300 high technology entrepreneurs in the software, biotechnology, medical devices, and computer hardware fields filled out the Berkeley Patent Survey. All of these firms had been started no more than ten years before the survey was conducted. We drew our sample from a general population of software firms registered with Dun & Bradstreet (D&B) and from the VentureXpert (VX) database that has a rich data set on venture-backed startups. (Just over 500 of the survey respondents were D&B firms; just under 200 were VX firms.)

Eighty percent of the software respondents were either the CEOs or CTOs of their firms, and most had experience in previous startups. The average software firm had 58 employees, half of whom were engineers. Between 10 and 15 percent of the software startup respondents among the D&B respondents were venture-backed firms. Among the software respondents, only 2 percent had experienced an initial public offering (IPO), while 9 percent had been acquired by another firm.

Our interest in conducting this survey arose because high technology entrepreneurs have contributed significantly to economic growth in recent decades. They build firms that create new products, services, organizations, and opportunities for complementary economic activities. We were curious to know the extent to which high tech startups were utilizing the patent system, as well as to learn their reasons for choosing to avail themselves of the patent system — or not.

The basic economic principle underlying the patent system is that technology innovations are often expensive, time-consuming, and risky to develop, although once developed, these innovations are often cheap and easy to copy. In the absence of intellectual property rights (IPRs), innovative high tech firms may have insufficient incentives to invest in innovation insofar as they cannot recoup their research and development (R&D) expenses and justify further investments in innovation because of cheap copies that undermine the firms’ recoupment strategy.

Although this economic principle applies to all companies, early-stage technology firms might, we conjectured, be more sensitive to IPRs than more mature firms. The former often lack various kinds of complementary assets (such as well-defined marketing channels and access to cheap credit) that the latter are more likely to enjoy. We decided it would be worthwhile to test this conjecture empirically. With generous funding from the Ewing Marion Kauffman Foundation, we and two other colleagues designed and carried out the survey and analyzed the results.

Why startups decide to patent — or not to

The most important reasons for seeking patents, as reported by the software executives who responded to the Berkeley Patent Survey, were these:

  1. to prevent competitors from copying the innovation (2.3 on a 4 point scale, where 2 was moderately important)
  2. to enhance the firms’ reputation (2.2)
  3. and to secure investment and improve the likelihood of an IPO (1.96 and 1.97 respectively)

The importance of patents to investors was also evident from survey data showing striking differences in the rate of patenting among the VX and the D&B software companies.

Three-quarters of the D&B firms had no patents and were not seeking them. Because the D&B firms are, we believe, typical of the population of software startup firms in the U.S., their responses may be representative of patenting rates among software startups generally. It is, in fact, possible that the overall percentage of software startup patenting is lower than this, insofar as patent holders may have been more likely than other software entrepreneurs to take time to fill out a Berkeley Patent Survey.

In striking contrast to the D&B respondents, over two-thirds of the VX software startup respondents in the sample, all venture-backed, had or were seeking patents. We cannot say why these VC-backed firms were more likely to seek patents than other firms. Perhaps VCs are urging the firms they fund to seek patents; or VCs may be choosing to fund the development of software technologies that VCs think are more amenable to patenting.

Interestingly, the rate of patenting did not vary by the age of the firm (that is, older firms did not patent at rates statistically significant from younger firms).

Why forgo patenting?

The survey asked two sets of questions about decisions to forego patenting: For the last innovation for which the firm chose not to seek a patent, what factors influenced this decision, and then what was the most important factor in the decision?

The costs of obtaining and of enforcing patents emerged as the first and second most frequent explanation. Twenty-eight percent of the software startups reported that the costs of obtaining patents had been the most important factor in this decision, and 12 percent said that the costs of enforcing patents was the most important factor. (They reported that average cost of getting a software patent was just under $30,000.)

Ease of inventing around the innovation and satisfaction with trade secrecy also influenced software startup decisions not to seek patents, although only rarely were these factors considered the most important.

Intriguingly, more than 40 percent of the software executive respondents cited the unpatentability of the invention as a factor in decisions to forego patenting, and almost a quarter of them rated this as the most important factor. Indeed, unpatentability ranked just behind costs of obtaining patents as the most frequently cited “most important factor” for not seeking patents.

It is difficult to know what to make of the unpatentability finding. One explanation might be that the software entrepreneur respondents believed that patent standards of novelty, non-obviousness, and the like are so rigorous that their innovation might not have satisfied patent requirements. Yet, because the patentability of software innovations has been contentious for decades, it may also be that a significant number of these entrepreneurs have philosophical or practical objections to patents in their field.

How important are patents to competitive advantage?

One of the most striking findings of our study is that software firms ranked patents dead last among seven strategies for attaining competitive advantage identified by the survey, as Figure 1 below shows. (The relative unimportance of patents for competitive advantage in the software field contrasts sharply with the perceived importance of patents in the biotech industry, where patents are ranked the most important means of attaining such advantage.)

Figure 1: Measures of Capturing “Competitive Advantage” from Inventions

Measures of Capturing Competitive Advantage from Inventions

As Figure 1 shows, software startups regard first-mover advantage as the single most important strategy for attaining competitive advantage. Next most important was complementary assets (e.g., providing services for licensed software or offering a proprietary complement to an open source program).

Interestingly, these two strategies for getting ahead in the market outstrip the IPRs about which we inquired for software firms. Among IPRs, though, copyrights and trademarks, closely followed by secrecy and difficulties of reverse engineering, outranked patents as means of attaining competitive advantage among software respondents by a statistically significant margin.

What incentive effects do patents have?

The Berkeley Patent survey asked startup executives to rate the incentive effects of patents on a scale, where 0 = no incentive, 1 = weak incentive, 2 = moderate incentive, and 3 = strong incentive, for engaging in four types of innovation: (1) inventing new products, processes, or services, (2) conducting initial R&D, (3) creating internal tools or processes, and (4) undertaking the risks and costs of commercializing the innovation.

We were surprised to discover that the software respondents reported that patents provide only weak incentives for engaging in core activities, such as invention of new products (.96) and commercialization (.93). By contrast, biotech and medical device firms reported just above 2 (moderate incentives) for these same questions.

Interestingly, the results did not change significantly even when focusing only on responses from software entrepreneurs whose firms hold at least one patent or application. Even patent-holding software entrepreneurs reported that patents provide just above a weak incentive for engaging in these innovation-related activities.

Resolving a paradox

If patents provide only weak incentives for investing in innovation among software startups, why are two-thirds of the VX firms and at least one-quarter of the D&B firms seeking patents?

The answer may lie in the perception among software entrepreneurs that patents may be important to potential funders, such as venture capitalists (VCs), angel investors, other firms, commercial banks, and friends and family. Sixty percent of software startups that had negotiated with VCs reported that that they perceived patents to be an important factor in VC decisions about whether to make the investments. Between 40 and 50 percent of the software respondents reported that patents were important to other types of investors, such as angels, investment banks, and other companies.

How well is the patent system working?

While most of the Berkeley Patent Survey questions focused on what firms had actually been doing vis-à-vis patents, we decided to ask a few questions to gauge the perception of high tech entrepreneurs about the patent system. We asked, for example, how well the entrepreneurs perceive the patent system to be working for them and for their industry. The scale for responses ranged from 0 = very poorly to 4 = very well, and 2 = neither poorly or well.

The software entrepreneurs’ for-my-industry rating was 1.6 and their for-my-firm rating was 1.7. Both results tend toward the poorly end of the scale (in contrast to the biotech and medical device firms that reported above 2 ratings on both questions).

It is interesting is that the VX firms were slightly less positive about the patent system than the D&B firms, although the difference was not statistically significant. We also tested to see if the responses were bipolar (that is, did some software firms rate the patent system very poorly and their ratings canceled out by some positive responses?), but discovered that the ratings fell into a normal distribution, suggesting that we had drawn a sample from a cross-section of the population.

Conclusion

Over the next several years, we expect to engage in further analysis of the results of the 2008 Berkeley Patent Survey and to report new findings about the roles that patents play in the software industry. The initial findings reported here and in the larger article suggest that software entrepreneurs do not find persuasive the canonical story that patents provide strong incentives to invest in technology innovation. These executives regard first-mover advantage and complementary assets as more important than IPRs in conferring competitive advantage upon their firms. Moreover, among IPRs, copyrights and trademarks are perceived to be more important than patents. Still, about one-third of our software entrepreneur respondents reported having or seeking patents, and their perception that their investors care about patents seems to be a key factor in decisions to obtain patents.

Related:


References:

Stuart J.H. Graham, Robert P. Merges, Pam Samuelson, & Ted Sichelman, High Technology Entrepreneurs and the Patent System: Results of the 2008 Berkeley Patent Survey, Berkeley Technology Law Journal, 25:4, pp. 1255-1327 (2010), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1429049.

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  • Alex Tolley

    Let me add a couple of reasons to help explain a few of the results above.

    VCs like the “barrier to entry” meme. A patent is a simple signal that the base is covered for a core technology.

    Patents as trading chips. A portfolio of patents is often treated as an asset that can be traded, and importantly is usually independent of the employees of a firm. Since most VC funded firms die, the expertise could be freely transferred to other firms as key individuals leave. A patent constrains this and can be used to retain value in in a company’s husk for sale to firms wishing to add to their patent portfolio.

    Software engineering and biotechnology are very different with regards to IP. With software, the IP may be locked up in code and distributed. It is hard to reverse engineer key algorithms, so the risk is in losing key personnel to competitors. With biotech, the IP cannot be kept as a trade secret in most cases, it must be shared with customers or regulatory agencies to validate the product or service. The longer lead times to develop the IP and longer sales cycles result in higher risks on not protecting the technology via patents.

  • Don Marti

    Is there any data on differences in R&D spending for companies seeking patents and companies not seeking patents?

  • Pam Samuelson

    I agree with Alex’s comments about why VCs might care about software patents.

    The survey did not directly ask about R&D spending, so we do not have data that directly responds to Don’s question. (There were lots of questions we would have loved to ask that ended up on the cutting room floor because we were advised to keep the number of questions to 30 so that our respondents could finish the survey in 15 minutes.)

    We do have data about firm revenues and sources of revenues (products v. services v. licensing of IP). We are in the early stages of analyzing the software firms’ responses, with special attention to differences between patent holders and non-patent holders. So we will eventually be able to offer some insights about this.

  • Kenneth Younger III

    As Alex mentioned, there are also regulatory effects in medical and bio-tech, whereas not so in pure software fields (for the most part).

    Having such a time lag such as going through the FDA for approval is a significant investment time frame, making patents more attractive for keeping others off the technology.

    Contrarily, software developers can many times even release early versions of their projects (hello beta mania), and continuously develop them. This changes the economics of the deal.

    I also think the average size of the startup listed here as 58 is huge compared to a lot of the startups I know locally. It would be interesting to see the results with startups under a dozen people (of course this is again easier with software).

    Overall, very interesting article. Thanks.

    Also interesting that defensive patents were not mentioned.

  • Frank Daley

    Why not also ask musicians and writers what they think of the idea of patenting music and writing genres, in addition to the copyright protection already in place?

    That might begin to help the ordinary person understand the absurdity of software patents, and how they actually work against innovation rather than foster it.

  • Zubin Wadia

    Thanks for the summary and analysis!

    Wondering if you were able to cluster the software start-ups into sectors such as Healthcare / Consumer / Manufacturing / Enterprise etc.?

    That might reveal more insightful patterns on patent priorities vs. bundling all of them into ‘software start-ups’.

  • Pam Samuelson

    In the next round of analysis of the software results of the survey, we do expect to do some of this. Among the VX firms, we know that Internet content companies are patenting at lower rates than e-commerce companies, for example.

    There are some limits to how well we will be able to slice and dice the software firms by sector, as D&B does not have highly refined categories for software firms. We also expect a problem with small numbers. We have only 700 software firms in the sample, and by the time one clusters them by sectors, there may be too few per cluster to draw conclusions that would be statistically significant.

  • John

    //More than 1,300 high technology entrepreneurs in the software, //

    I don’t think this much high technology entrepreneurs found, how are you telling this, can you please give me any source.

    John
    software engineering services

  • Pam Samuelson

    I suggest that John may want to look at the full article cited early in this post to get more info on the sampling and response rates that yielded the 1300+ high tech entrepreneur survey respondents (only about 700 were software companies).

    As to Frank’s point, it is significant that the software respondents considered copyrights and trademarks as significantly more important than patents as a way to attain advantage. Musicians and authors generally do not look to patents at all, but of course they do not typically seek funding from VCs so they are not subject to the nudging that some VCs might give to software developers to make use of patents.

  • Mike

    It would be interesting to see the result based on how successful start-ups are.

  • Ted Shelton

    Having just written about this topic regarding one of my clients (http://tedshelton.blogspot.com/2010/07/rethinking-software-patents.html) I was very interested in seeing your study results. But I came away with two big questions that I hope you might address:

    1) Could it be that software startups see first mover advantage as being more important than software patents precisely because the system for software patenting is so fundamentally broken?

    2) One previous author asked about how different types of software startups (e.g. healthcare, vs…) might think about patents. I’d ask this question a different way — software can be used in a wide variety of ways in different markets: as stand-alone product, as an add-on to someone else’s product, as an integrated part of another product. And when it is used in these different ways there tend to be different kinds of competitors — other startups, existing large tech firms, non-tech firms… So it would be very interesting to understand how the competitive landscape results in different decisions about patenting.

    Thanks for your work in this area, I do think it is a very important topic for our industry to be considering as we continue to hope that innovation will come from these small players.

    best

    Ted Shelton

  • Darryl

    Seems like a very limited world view, from reading the report, my take is that as long as they have some form of IPR protection. If it gets the job done, its is far more important combined than anything else.

    In fact protecting your Intellectual property, be it by trademarks, copyright, patents or secrecy. Is the PRIMARY mover for innovation, and progress.

    The reason IMO that biotech rate patents higher at the moment, is due to the age of the technology fields.

    Software has been around for a long time, and most of the important idea’s have allready been invented, and have allready entered the public domain, so its harder to gain patents on software algorithms, than it is to gain patents on new genes or new technologies.

    Plus, software, really is not a really innovative field, I know some will argue that is not true, but the same basic archeture and design of the 4004 4-bit cpu and the latest cpu’s are not that different, just bigger and faster.

    Software progress is also quite slow, especially compared with genetic R&D progress.
    And medical systems developed from that.

    Linux for example, based on UNIX is VERY OLD, over 40 years or more. The underlying understanding of these concepts are not advancing that fast.

    So first to market is important, and protection of your intellectual property in some way is critical…

    And you can copyright, or secret things you cannot patent, the end result is the same. IPR

  • Gary F. Wittting

    The various forms of Intellectual Property should not be considered as isolated types of protection but, rather as an integrated whole. That is to say, that not all things should be handled the same way. In certain cases, a patent is the most appropriate form of protection, whereas in other cases, both a patent and a copyright is the correct selection. And still in other cases, a trade secret is appropriate. It all depends upon the specific facts, goals, and needs of the situation.

    Gary F. Witting

  • Gary F. Witting

    The various forms of Intellectual Property should not be considered as isolated types of protection but, rather as an integrated whole. That is to say, that not all things should be handled the same way. In certain cases, a patent is the most appropriate form of protection, whereas in other cases, both a patent and a copyright is the correct selection. And still in other cases, a trade secret is appropriate. It all depends upon the specific facts, goals, and needs of the situation.

    Gary F. Witting

  • David Nofziger

    Looks like many companies will repeat the mistakes of Research in Motion.

    The patent litigators will have many years of good fortune ahead straightening out the patent problems of the startup that go on to be successful.

    Perhaps patent litigators are just a cost of doing business, like dealing with discrimination lawsuits.

  • Pam Samuelson

    Ted asked whether software entrepreneurs may not be seeking patents because the patent system is broken for software. It is surely true that it is easy to find software-related patents that should not have issued. But if this were so, we would have expected the software entrepreneurs to have rated how the patent system was doing as more strongly to the poorly end of the scale. So I don’t think that’s the right explanation.

    Ted’s point is also well-taken about different types of firms having different IP strategies because they face different kinds of competition. In the followup more in-depth study we plan to undertake of the software respondents, we expect to have more to report about this.

    Mike, we will also be looking at the success of firms in relation to patenting in our followup study.

    I agree with Darryl and Gary that one should not consider each strategy for attaining competitive advantage in isolation. First mover advantage, copyrights, trademarks, and secrecy each have a complementary role to play in helping firms succeed.

    Darryl is right that software has been around for decades, and much of software development is not inventive, but the standard of invention for patenting is not so high that software innovations cannot qualify. I believe there are far more inventions in software than there are software patents.

  • Jose_X

    Missing from this analysis is that software patents are presumed to be valid. If we assume for a moment that they will be struck down as unconstitutional at some point (or simply that, for whatever reason, they won’t always exist), then even the issue of using a patent as a trading chip disappears. In a world where others have patents, it makes at least some sense to have one for self-defense reasons. When this is the primary reason, we need not consider anything else further and know already that we have a wasteful system which could easily be abolished (unlike with real weapons).

    Not to get into a long discussion of the many problems with software patents, but as a starting point, they fail in that they pre-empt the more delicately balanced copyright law (which protect expression but not concepts in order to respect the first amendment (eg, with independent creation) and in recognition of trying to promote the progress). Patents may make sense when you want to reduce or eliminate competition from mostly a *few* *very wealthy* competitors, but make no sense when you have perhaps over millions of people that can participate on a competitive basis as the costs are close to zero. [Never mind that the huge cost to acquire patents means that the benefits of this system are mostly limited to the very wealthy that can afford to patent or buy many ideas, while the vast majority cannot do so even for a single idea yet must pay the full price of all the granted monopolies now limiting what otherwise was a given liberty and opportunity.] For laughs, we can consider this last point: the main criteria for patentability in the US, non-obvious to a PHOSITA, means that we might have millions of above ordinary skill practitioners around the world (implied by the bell curve) that are having their hands tied for 20 years on what they consider to be obvious. That’s our best minds (!!), many many thousands of them, tied down simply because of a horrible (unconstitutional) monopoly grant from someone that had the pleasure to encounter that specific problem already in their line of work, had a bunch of money and desire to stifle competitors, and managed to be the first to the patent office (with what very well could have been an obvious idea even to that person). HAAAA Haaaaa Haaaaaa Haaaaaaaaaaaaaaa!!!! It’s so sad it hurts.

  • Jose_X

    >> Patents may make sense when you want to reduce or eliminate competition from mostly a *few* *very wealthy* competitors, but make no sense when you have perhaps over millions of people

    Wanted to clarify. Of course it makes sense to use patents if you are a firm not worried about stifling. What I meant was that it makes no sense as a society to support such a market distorting and liberties abridging law.

    As someone mentioned earlier, ask writers, musicians, lawyers, if they would like patents in their line of work. They make no sense as a social benefit (ie, to promote the progress while respecting liberties etc) when they allow so much of more valuable and detailed original works to be made illegal. Someone can always be the first to the patent office. Always. Have that one person stifle the rest of the entire industry on a broad http://en.swpat.org/wiki/Software_is_too_abstract,_patent_quality_is_bad idea (non-obvious to a PHOSITA).. and for 20 years! That is ridiculous.

    We will look back at this from the future and laugh at how silly humans can be sometimes with their laws. Yes, there was actually a time when women could not vote, and this was considered rather normal and perhaps proper by the enfranchised bunch at the time. It actually took decades after Susan B’s stand in court in order to fix our Constitution in those respects. Today, most people are disenfranchised when it comes to patents. This is tolerable so long as we limit these tools to few cases not directly affecting the majority and where arguably progress is promoted, particularly where heavy capitalization is required. Of course, with the expanded access to information, collaboration, and sophisticated tools we now have, all patents should be cut down in size if we aim to promote the progress. [And digitalization has meant that many “machines” of today http://en.swpat.org/wiki/Just_a_Use_of_the_Patented_General_Purpose_Computer can have much better brains; however, patenting brains is not really acceptable as this is just information processing anyone can partake in (as fiction writers, mathematicians, etc, have been doing for centuries, for example). We don’t want to stifle or abridge free speech. We don’t want to “steal” copyrighted works from people for the exclusive benefit of a concept patent monopolist. We don’t want to hand-cuff many thousands collaborating on superior solutions in order to please one.]

    The patent winners are the firms with an extensive gathering of patents (quantity is leverage, especially when almost any product must implement many existing patented inventions given the very low bar to patenting), meaning the already established and wealthy are the winners. Alternatively, those not producing can seek money through suits or threats of suits without fear of retaliation. These people are not executing or implementing anything, yet have full control over many that do (and, unfortunately, currently implement a check on the very large companies, a check/balance necessary because of this horrible patent granting practice by the USPTO and unclear law). Finally, the legal profession has beneficiaries, but I hope those people start being honest and institute patents for their profession as well. [No disrespect intended for anyone that respects others and is not abusing the system.]

  • Jose_X

    Ted Shelton expressed concerns that some software vendors might be able to produce a product without violating patents perhaps (eg, a small software component to be integrated into something else) and could gain from taking out patents themselves to prevent large firms from simply leveraging their work (under the assumption these firms would not be able or likely to independently derive a similar product).

    One important point brought to mind with this is of a possible change in patent law (or a Court ruling) that would make software patents actionable only in high revenue/capitalization situations. Such a change might allow such software patents to promote the progress by stifling a much smaller number of groups and abridging very little voluntary free expression. This would also align us with the romantic version of patents where the little guy uses it to keep well capitalized imitators at bay, rather than have the patents be used (eg) by wealthy companies owning many patents as a tool to control, suppress, or heavily tax competition, while removing many inventors and innovators from service (especially vulnerable being those working under low capitalization conditions collaborating on open source and generally any small firm leveraging such software).