Richard Melson

What is RIETI?

The Research Institute of Economy, Trade and Industry (RIETI),

RIETI Report
June 22, 2006, No.071

Development of Japanese Firms' Patent Strategies
RIETI Featured Fellow MOTOHASHI Kazuyuki
for full text-http://www.rieti.go.jp/en/rieti_report/071.html

### 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"
(http://www.rieti.go.jp/en/publications/summary/06040013.html), 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,"
(http://www.rieti.go.jp/en/columns/a01_0185.html) 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

*****************
Don't forget to keep checking the RIETI English website for updates.
http://www.rieti.go.jp/en/index.html
*****************

RIETI Report is published monthly.
To subscribe, please click here:
http://www.rieti.go.jp/en/mailmaga/mailmaga.html

You can read back issues of RIETI Report at:
http://www.rieti.go.jp/en/rieti_report/backissues.html

To unsubscribe, please click here:
https://www.rieti.go.jp/en/mailmaga/stop.html

To change your subscription details, please go to:
https://www.rieti.go.jp/en/mailmaga/mailmaga.html

Research Institute of Economy, Trade and Industry (RIETI)