Tuesday, February 7, 2006

Settlements in patent cases hurt consumer welfare by delaying entry....

Joel Schrag, an FTC economist, has posted an important paper on the effects of settlements in pharmaceutical patent suits on consumer welfare. Here are some important excerpts from the paper:

"A central question that I address is whether such settlements for “time off the patent” serve consumers’ interests.  Given a choice, would consumers accept such settlements, or would they prefer that the parties litigate their cases?  My main finding is that royalty-free licenses for delayed entry do not necessarily serve consumers’ interests, even if the entrants have all of the bargaining power in their negotiations with incumbent patent-holders and can therefore obtain relatively early entry dates through their settlements."

"I find that settlements for time off the patent generally leave consumers worse off than they would be if the firms litigated their cases. This conclusion does not change even if the terms of settlement are very favorable to the potential entrants, whose interests during settlement negotiations are to some degree aligned with consumers’ interests; both consumers and entrants prefer earlier entry."

"My analysis reveals two reasons that settlements can harm consumers’ interests.  First,  the time that consumers expect to benefit from a particular entrant represents a 1ower bound on the expected time that consumers would benefit from some entrant. For example, a particular entrant may have a fifty-fifty chance of winning an infringement case, but a settlement that enables the entrant to sell its product halfway through the remaining patent life could shortchange consumers, because another entrant may emerge if the first loses its infringement case.  Given this possibility, consumers would have a greater than fifty-fifty chance of benefiting from some entrant. "

"Second, the form of patent settlement that I analyze can undermine the entrants’ incentives to invent around the incumbent’s patent. If the entrant that completes its product development first always settles with the incumbent, a slower entrant would likely never have a chance to earn duopoly profits.  If the entrant that completes its product development first always litigates, meanwhile, a slower entrant would possibly have an opportunity to earn duopoly profits, because the first entrant may lose its patent infringement case. The prospect of settlement thus increases the relative importance to an entrant of being the first to develop a competing product, and, therefore, discourages an entrant from undertaking a project that it believes will take a long time to complete."

" The formal analysis does, however, support two broad conclusions.  First, the model highlights the importance of analyzing the effects of any patent settlement on the incentives of the relevant third parties before drawing any conclusions about the settlement’s effect on consumers’ interests."

           " Second, because the model reveals that patent settlements that license entry at a date that is consistent with the expected outcome of the trial are not necessarily beneficial to consumers, it suggests that other settlement terms that help parties reach agreement on a delayed entry license cannot be assumed to be ancillary to a pro-competitive outcome.  If these other terms raise independent competition concerns, a settlement is even less likely to benefit consumers and should therefore be subject to even greater scrutiny."


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