Patent Settlements as a Barrier to Entry

Authors


  • We thank two anonymous referees, Alexei Alexandrov, Emanuele Giovannetti, Christos Kotsogiannis, Mark Lemley, Lawrence Lessig, Michael Meurer, Debapryia Sen, Georges Siotis, and seminar participants at the Athens University of Economics and Business, Brunel University, the University of Exeter, Ryerson University, CRESSE 2009 (Crete, Greece), CRETE 2009 (Tinos, Greece), EEA-ESEM 2009 (Barcelona, Spain) and ALEA 2010 (Princeton University) for helpful comments and suggestions. We are responsible for all errors.

Abstract

We formulate a model of entry with two incumbent firms—a patent holder and an infringer—and a potential entrant, with asymmetric information about the validity of the infringed patent (patent strength) between incumbent firms and the entrant. Within this framework we show that patent settlements between the incumbent firms can be mutually beneficial even when the cost of trial is zero and the settlement agreement takes the form of a simple fixed license fee. For patents of intermediate strength, settlements are a tool for entry deterrence. The two parties agree on a high settlement amount which sends acrediblesignal to “outsiders” that the patent is not weak and therefore entry will not be profitable. This provides a novel explanation for the role of settlements and to the recent observation of high license fees negotiated in settlement agreements. It suggests that firms should disclose the settlement amount if they want to keep out further entrants. We also show that even nonreverse settlements that entail only a fixed fee can be anticompetitive because they are used to block entry.

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