RIETI Report June 2006

Development of Japanese Firms' Patent Strategies

Greetings from RIETI

Inventors in Japan can take credit for numerous scientific and technological discoveries. Kokichi Mikimoto discovered and patented a process for cultured pearls in the late 19th century. Taiwan-born Momofuku Ando brought the modern instant noodle (ramen) to market in the late 1950s. At the head of the pack is the man known as the "Edison of Japan," Yoshihiro Nakamatsu (a.k.a. Dr. NakaMats) who lays claim to over 3,000 inventions, a world record, and licensed a record 16 patents to IBM. Dr. NakaMats was recognized by the U.S. Science Academic Society as one of the five greatest scientists in history, along with luminaries such as Marie Curie and Nikola Tesla.

Japan is a powerhouse of invention and every year since 2003 has filed the world's second highest number of international patent applications. Thus patent policies are a vital issue to Japan. This month RIETI Report interviewed RIETI Faculty Fellow MOTOHASHI Kazuyuki on his research surrounding licensing trends, innovation and the future direction for Japanese patent policy.

RIETI Featured Fellow

Dr. Motohashi is a Professor at the Research Center for Advanced Science and Technology at the University of Tokyo and previously Assistant Professor from 2004-'06. He joined RIETI as a Senior Fellow in 2002 and has been a Faculty Fellow since 2004. As an expert in economic and statistical analysis of innovation systems, Dr. Motohashi has held a number of academic and governmental posts, including Associate Professor of Institute of Innovation Research at Hitotsubashi University (2002-'04); Executive Deputy Director, Research and Statistics Department, METI (2000-'04); Head of Public Affairs and Information Office International Trade Policy Bureau, MITI (1999-2000). Additionally, he served as Economist at the Directorate for Science, Technology and Industry of the Organisation of Economic Co-operation and Development (OECD) from 1995-'98. Dr. Motohashi holds a B.E. and M.E. in Civil Engineering from the University of Tokyo, MBA from Cornell University and Ph.D. in Business and Commerce from Keio University. His recent publications include "The IT Revolution's Implications for the Japanese Economy, in Japan: Moving Toward a More Advanced Knowledge Economy," (T. Shibata ed.), World Bank Institute, Washington, D.C., 2006; "The Changing Autarky Pharmaceutical R&D Process: Causes and Consequences of Growing R&D Collaboration in Japanese Firms," Journal of International Technology Management, February 2005; "University-industry collaborations in Japan: The role of new technology-based firms in transforming the National Innovation System," Research Policy, vol. 34, no. 5, 2005; Empirical Analysis of IT Innovation: Has IT Changed Long-term Japanese Economic Performance?, Toyo Keizai Inc., 2005.

Interview

RIETI: In your paper "Licensing or Not Licensing?: Empirical Analysis on Strategic Use of Patent in Japanese Firms," you have focused on licensing activities in order to analyze intellectual property (IP) strategy at a firm level. What motivated you to initiate this research?

Motohashi: I have been working on the Japanese innovation system for a long time. Innovation is created by enterprises but they need a good economic environment. The Japanese government has been spending a great deal on R&D. For example, Japan's overall R&D expenditures in fiscal 2004 totaled approximately ¥17 trillion, ¥5 trillion of which was spent by the government. So the means of capitalizing on public spending in terms of industry R&D is very important. In this context, a university-industry linkage is critical. The Japanese innovation system has been characterized as a "large company-dominated system." Private R&D spending in 2004 was roughly ¥12 trillion, but the top 10 Japanese companies' R&D expenditures accounted for 40% of the total private spending, which means large companies have deep pockets. They can carry out all kinds of research in-house; from fundamental to applied. Therefore large companies do not have strong incentive to work with universities. However, a lot of changes are happening to the innovation environment. For instance, we can see South Korea, China and some other East Asian countries have been improving their technological competitiveness in recent years. As large Japanese companies can no longer sustain basic R&D by themselves, they are now motivated to collaborate with universities and other public research institutions.

Also, we have a so-called "valley of death" in the innovation process. When you lay out R&D projects, there is a funding shortage, a kink, between government-financed fundamental research and application research financed by the private sector. This area is dealt with primarily by small companies to fill the gap between science and technology. As I wrote in the RIETI column "Regaining Japan's Competitiveness Based on Scientific and Technological Creativity," Japanese innovation policy is shifting its focus from a large company-dominated system to a network-based one by activating the university-industry linkage players. Large companies need at least a ¥1 billion market to start an R&D project and are not interested in a small market, say with a value of ¥100 million. Such a small market is covered by startup companies. In this sense, small and startup companies play a very important role in the science and technology linkage.

This is the whole motivation. When companies have in-house R&D facilities, intellectual property management, including licensing, is not so important because they can use their ideas to develop marketable products by themselves. So they do not have to apply for a patent. However, most small companies do not have enough resources to bring new technologies to market. As they often lack production facilities and marketing channels, they want to sell their ideas, in most cases, to large companies that already have sufficient managerial resources. Therefore, small firms need to apply for patents. Otherwise, their ideas will be copied by large companies for free. Creating a technology market - a good environment to appropriate a new idea by its patent right (pro-patent) is essential. In this area, there are many case studies but few empirical and econometric studies based on large quantitative data. That is why I try to analyze what is happening to the technology market. Hopefully, I will get some policy implications out of this study.

RIETI: Other prior studies suggest that the smaller a firm's size, the higher its propensity to license. However, you have found that there is a nonlinear relationship between a firm's size and its propensity to license. What factors contributed to your new findings?

Motohashi: My initial expectation was that the smaller a firm is, the more it licenses. As I mentioned earlier, small firms that do not have enough managerial resources to appropriate rent out of their unique ideas, particularly high-tech and biotechnology startups, have strong incentive to license out. I have also found that large companies have a high propensity to license. It is prominent in the IT area, particularly in the electronics industry. Those companies' levels of technological sophistication are higher than others and their technologies are becoming very complex. For example, one mobile phone requires more than 100 patents; for each part and function including the liquid crystal display (LCD), communication devices from the analog to digital transformation, connection with the PC board, manufacturing technologies and batteries. Even large electronics companies cannot create a mobile phone by themselves. If a firm does not have enough technological capability in LCD, it may license from another company. If the other company's technology is superior, the licensing cost is smaller than a firm's own development cost. In this case, it makes sense to license in. Thus, there are many instances of licensing in and licensing out. But licensing is a costly process. A firm has to understand what exactly this technology is, estimate how much the market value is, and then negotiate with licensors to get a better term. In order to reduce the transaction costs, almost all electronics companies conduct cross-licensing. Under a cross-licensing agreement between two parties (Firm A and B), Firm A can use Firm B's patent without an exchange of license fee, and vice versa. They broadly define the area of technology but do not specify details such as a patent number. I have been conducting case studies on cross-licensing in flash memory between some Japanese electronics companies and Korean companies. There are about 10,000 patents but they do not know which one is used for a specific technology. Thus, cross-licensing is trust-based, aiming to reduce transaction costs. These developments, increased patents, complex technology and increased cross-licensing, are key factors to explain that the propensity to license is high for large companies.

RIETI: You have given us an example from the electronics industry to explain cross-licensing. Could you speak about licensing activities in other industries?

Motohashi: In the electronics industry, multiple patents are involved to commercialize new technology. Large electronics companies apply for thousands of patents every year. They have to rely on a lot of technologies to come up with a final product. This is known as "cumulative innovation."

Another type of innovation is "discrete innovation," which is often observed in the pharmaceutical and chemical industries. For one pharmaceutical firm, its core product, with more than a ¥10 billion market, is based on one chemical compound. In order to develop one such product, the firm initially has many lead chemical compounds and has to narrow them down. In the screening process, it researches further to determine which is the most effective for a specific disease, and then moves into animal testing and clinical trials. Thus one compound is finally selected and patented, and that can be used for a final product. The number of its patent applications is small relative to that of electronics companies. In the case of discrete innovation, a firm relies on only one technology. Accordingly, cross-licensing is not common in the pharmaceutical industry.

RIETI: Given considerable differences across industries, what type of patent system would be desirable for Japan? Does Japan need a differentiated system to meet the industry-specific requirements?

Motohashi: A major issue is the length of patent right. The international rule, the WTO's Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) says that the available term of patent protection is at least 20 years from the date of filing the application. However, the effective period of patent protection of new drugs is less than the full 20 years because it takes so much time to obtain approval from the public health regulatory bodies. For this reason, many developed countries apply exemptions in the pharmaceutical industry whereby the protection period can be prolonged.

In the electronics industry, firms do not have to worry about the length of patents because technology is advancing very quickly. They can use one technology for only three or four years. Companies need to pay an annual fee to sustain their patent right. Of course, they have a choice to stop using the technology. So if companies do not want to use it, they can cease the payment and give up their patent right. On the other hand, some companies want to keep their patent right in order to block other firms' innovation, even though they are not in fact using the patent. In order to prevent such blocking patent behavior, patent length might be differentiated depending on the field of technology.

Another policy issue is again related to blocking patents. If blocking patents are really economically inefficient or socially harmful, under the compulsory licensing clause, a government can ask the initial patentee to license out the technology to others. For example, if the Japanese government used this clause against a U.S. monopolistic company, Japanese competitors would effectively be able to use the technology under license. Compulsory licensing was one of the key issues discussed at the Structural Impediments Initiative (SII), which was a series of bilateral talks between the U.S. and Japan from 1989-1994. Japan's patent protection was weak at that time. Then the U.S. government asked Japan to strengthen its patent protection and stop using the compulsory licensing clause. Since then, the compulsory licensing clause has never been used. But now, it is time for us to reconsider this clause, and we need to start discussion on the guidelines of this rule. A manager at a Japanese pharmaceutical company told me that some patents on general purpose research tools may hinder downstream innovations in the development of new drugs. The rule should be modified depending on the nature of innovation and the field of technology.

Customizing a patent system for each technology and industry is an enormously complex task. The length of patent right is codified under the TRIPS Agreement. If we wish to change it, we have to change the law. However, it would entail high social costs and make the patent system too complicated. In addition, companies have a choice to stop using the patent before its rights expire. We can deal with them by using the compulsory license clause without changing the length of patent protection. Therefore, at this moment, I do not think the patent law needs to be changed. Instead, actual implementation should be tailored to reflect on the circumstances of various technology fields. For instance, the Japanese Patent Office and related regulatory bodies can change the guidelines on how to use compulsory licensing.

EVENTS INFORMATION

Brown Bag Lunch Seminars

All BBLs run 12:15 - 13:45, unless otherwise stated.

06/29 12:15-13:30
SHIRAISHI Shigeaki, Director, Policy Planning and Research Division, Trade Policy Bureau, METI
Title: "White Paper on International Economy and Trade 2006 - Toward Sustained Potential for Growth: Enhanced Productivity through Globalization and Japan as an Investment Powerhouse" (in Japanese)

07/06 
Daniel M. PRICE, Partner, Sidley Austin LLP
Andrew W. SHOYER, Partner, Sidley Austin LLP
Title: "Foreign Investment Protection under International Treaties"

07/07
ANDO Yasushi, Chief Investment Officer, Phoenix Capital Co., Ltd. / CEO, Horizon Holdings Co., Ltd.
Title: "An Approach for the Business Turnaround and its Implication" (in Japanese)

07/10 
AGATA Atsunobu, Senior Vice President, Information Technology, AEON Co., Ltd.
Title: "Aeon's Business Innovation - Making the Most of Information Technologies" (off the record, in Japanese)

07/13 
AHN, Se-Young, Professor, Dean, Graduate School of International Studies, Sogang University
Title: "Korea's FTA Policy: Focusing on the Japan-Korea FTA and US-Korea FTA"

For a complete list of past and upcoming BBL Seminars, http://www.rieti.go.jp/en/events/bbl/index.html


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RIETI Report is published monthly.

This month's featured article

Development of Japanese Firms' Patent Strategies

MOTOHASHI KazuyukiFaculty Fellow, RIETI

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Fellow titles and links in the text are as of the date of publication.

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RIETI Report is published monthly.