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Context COMMERCIAL STAKES AND THE IPR FACTOR Though many large American companies are active in health care, agriculture, and other applications of "the new biotechnology," most biotechnology sales derive from products initially developed by so-called "emerging companies."5 Many of these firms were founded in the wake of scientific discoveries in the mid- 1970s that allowed for the precise manipulation of genetic materials The development of the industry thus far, while not living up to some of the more optimistic projections made in the early 1 980s, has in many ways demonstrated the technology commercialization power of the venture capital-backed start-up com- pany, an institutional mechanism invented in the United States and still more prominent here than anywhere else. The most successful emerging companies, when they have had access to patient capital, have been able to "put the talent and sFor a more extensive discussion of the structure of the U.S. biotechnology industry and linkages with Japan, see National Research Council, U.S.-Japan Technology Linkages in Biotechnology: Challenges for the l 990s (forthcoming). 6For a comprehensive review of commercial biotechnology in the United States and elsewhere, see U.S. Congress, Office of Technology Assessment, Biotechnology in a Global Economy (Wash- ington, D.C.: U.S. Government Printing Office, 1991). s

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6 resources in place more effectively than organizations designed to deal with prior technologies."7 Indeed, the growth of American commercial biotechnology in the 1980s is particularly noteworthy when juxtaposed with the Japanese commercial and technological challenge to U.S. leadership occurring in a number of industries at the same time. According to George Rathmann, Chairman Emeritus of Amgen and presently the Chairman of ICOS, biotech companies in human health care have moved from discovery, through the regulatory process to manufacturing and marketing with "very little stumbling," confounding skeptics who said that the emerging companies were "too small" to succeed.8 Though the $3.5 billion the U.S. government spends annually on basic research and research training related to biotechnology has played a major role in helping U.S. firms take the lead in product development and commercialization, there is no guarantee that U.S. leadership will continue in the future.9 Challenges to the continued success of the emerging companies stem from the capital-intensive and research-intensive nature of commercial biotechnology. Today, most of the R&D activity and product development in biotechnology is directed toward the human health care market. Like other pharmaceutical products, therapeutics and diagnostics developed or manufactured through bio- technology must undergo a long approval process. In the United States this process is overseen by the Food and Drug Administration (FDA), which has final authority over which products may be put on the market for specific indications. The FDA approval process takes years and costs $100 million or more for a single product.~ Larger companies have the resources to manage this process, but the emerging companies often have to go through a number of rounds of venture capital financing, public stock offerings, and licensing or marketing agreements with larger companies to raise cash and to maintain the development of products in the pipeline. The capital crunch does not end when a company becomes 7Stelios Papadopoulos in his presentation on "Japan's Growing Presence in the U.S." at the Workshop on IPR and U.S.-Japan Competition in Biotechnology. George Rathmann, from his "Industry Overview" at the Workshop on IPR and U.S.-Japan Competition in Biotechnology. 9President's Council on Competitiveness' op. cit., p. 6. Thor a recent estimate that development costs including the time cost of awaiting regulatory approval average $231 million per drug and are rising, see Henry Grabowski, "The Changing Economics of Pharmaceutical Research and Development," in Annetine C. Gelijns and Ethan A. Halm, eds., The Changing Economics of Medical Technology (Washington, D.C.: National Academy Press, 1991), p. 39.

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7 successful: Genentech, one of the largest of the emerging companies with sales of over $400 million, was faced with a choice between cutting back on its R&D or seeing its stock price fall precipitously when it moved to sell a majority interest to Swiss pharmaceutical giant Roche Holdings, Ltd. Where does IPR fit into the picture? Without a strong proprietary position, emerging firms will not be able to attract the financing to keep them afloat during the long product development process. Industry leaders argue that there is no point in developing a potential product if the innovator faces an "IPR risk" in addition to the usual business risks. George Rathmann points out that Amgen spent $250 million before it sold its first dose of product; without adequate protection for IPR emerging firms will be unable to undertake long-term efforts of similar scope. Exclusive, proprietary rights are vitally important to all pharmaceuticals, not just biotechnology products. $~os ($ in Millions) $273 ~0~o ~o~ $243 $372 $~Oo Cal $256 $172 , ~,~e,G~ ~ 0~, o~ oc $~ o~+ FIGURE 1 The Biotechnology Industry: The Top Ten Companies R&D Investment (as of December 1990~. Source: PaineWebber Incorporated "Burrill and Lee, op. cit., p. 1. i2George Rathmann, op. cit. 107 $104 . ~ _ . ~ _ I ~ ~ _ for . ~ _ _ . __ 2 ~ _ ~ _ ' ~ . ~ _ _ ~ _ ~ _ ~ ~ _ ~ ~ _ ~ _ i . . 1 . . l l ~0~

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8 An emerging firm's patent position has an impact on financing no matter what the source. A strong IPR position for a compound or manufacturing process that targets a large marketer a strong patent position combined with protection under the Orphan Drug Act in the case of smaller markets gives the firm a choice of going to the capital market and getting favorable terms there or licensing its marketing and manufacturing rights to a larger pharmaceutical company. Emerg- ing companies have followed both paths. The larger the potential market, the easier it is for firms to access capital markets and gradually build independent capability in downstream activities rather than license. Because of the direct impact on financing, IPR has an effect on all other aspects of the operation, such as the quality of personnel the firm is able attract and retain. There are significant differences between Japan and the United States in market structure and in other elements underlying commercial biotechnology. There is no large group of "emerging companies" in Japan. The Japanese government and Japanese companies consider biotechnology a key technology for the future and both have made a commitment to support R&D and the application of biotechnol- ogy to numerous industries.~3 While funding for basic research by the Japanese government makes up a more limited share than in the U.S., a number of Japanese ministries support commercially-oriented biotechnology research at significant levels.~4 Despite the absence of the elements that have been vital to the development of the U.S. industry, and despite the fact that the Japanese pharmaceutical industry has not been as internationally competitive as the electronics, automobile, steel, or machine tool industries, it is widely believed that Japan's commercial biotech '3Biotechnology is generally included in lists of technologies and industries expected to be critical to the 21st century economy that appear in Japanese government publications and business maga- zines. See Ministry of International Trade and Industry, Sangyo Gijutsu no Shiko to Wadai (Trends and Topics in Industrial Technology) (Tokyo: Tsushosangyosho, 1988), p. 34. Also MITI, 21 Seiki Sangyo Shakai no Kihon Koso (Basic Planfor 21 st Century Ind ustrial Society) (Tokyo: Tsushosangyosho, 1986),p.47. '4Support comes from the Ministry of Health and Welfare, the Ministry of Education, Science and Culture, the Science and Technology Agency, the Ministry of International Trade and Industry, the Ministry of Agriculture, Forests and Fisheries, and the Environmental Agency. Estimates of the Japanese budget for biotechnology should be taken with caution because they generally include all research related to life sciences and biomedical fields. See Robert T. Yuan and Mark D. Dibner, Japanese Biotechnology, A Comprehensive Study of Government Policy, R&D and industry (College Park, Md.: Biotechnology International, 1990), p. 24, for their biotechnology budget estimate of 83.3 billion yen (or $617 million at 135 yen per dollar) for Japan Fiscal Year 1989. In addition to direct subsidies, tax incentives for R&D have been structured with biotechnology in mind. See MITI, Haiteku Zeisei no Kaiketsu (Explanation of the High Tech Tax System) (Tokyo: Tsushosangyosho, 1990).

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9 nology capability and competitive potential are now second only to the United States.'5 Some observers believe that the scientific base and the corporate resources are in place for a drive to industrial prominence in the future.'6 Besides differences in industry structure and government support, the commer- cial foci of the two countries are different. The Japanese commercial R&D effort is not as heavily concentrated in human health care as the effort of the U.S. industry today. Not only the major Japanese pharmaceutical companies, but firms in food processing, cosmetics, electronics, and other industries are conducting R&D aimed at applying biotechnology to their core businesses. Many of these non- health care efforts have fairly long time horizons. Biotechnology products aimed at health care will, however, still command the lion's share of the market for years to come. It is therefore likely that major intellectual property disputes will arise in the health care context. Japanese firms have abundant capital and the capability to manage patent applications, regulatory approval by the Ministry of Health and Welfare (Koseisho), and marketing. Do the American biotechnology companies have what it takes to compete with the Japanese in Japan their own turf? Only a few U.S. fins have been able to do so independently. IPR is one of the most important elements that may affect global biotechnology competition in the future. In the opinion of the biotechnology companies, gaining adequate patent protection is more difficult in Japan than it is in either Europe or the United States. 'ssee Yuan and Dibner, op. cit., p.13. '6One indication of the steady improvement in Japan's basic scientific capability in biology comes from an analysis of the numbers of Japanese articles published in life science journals. The Institute for Scientific Information reports that in the five biology journals that it monitors, the Japanese share of articles has risen from 3.9% in the 1980-1984 period to 5.2% in the 1985-1989 period. See "Japanese Scientists Increase Their Presence in World-Class Journals," Science Watch, May 1990, p. 7. For a discussion of Japanese industry's commitment to biotechnology, see Yuan and Dibner, op. cit., pp. 1 07- 1 08.

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11 INTELLECTUAL PROPERTY RIGHTS IN THE UNITED STATES AND JAPAN Just as IPR protection in the United States is critical for emerging U.S. biotechnology companies, patent protection is important in Japan's large pharma- ceutical market. With secure patent rights in Japan, a U.S. company has the option to manufacture and market its products in Japan. Also, if the emerging company does decide to license to a Japanese firm, it will be able to drive a harder bargain than it would with weaker patent protection. Further, with clear control over basic process or product innovations, the firm can experimentally use those innovations to develop second generation products. Finally, with the guarantee of some income from the Japanese sales of its product, whether in the form of direct sales or royalties, the film will have better access to capital markets. The treatment of intellectual property rights has been an issue of increasing contention between the United States and Japan.'7 Disagreement is not limited to biotechnology. Many representatives of American industry and policymakers believe that the Japanese patent and legal systems do not protect IPR adequately.' A good illustration of U.S. frustration with the Japanese system is the Fusion Systems case against Mitsubishi Electric. Fusion has complained loudly in the media and before Congress that the Japanese system is manipulated in favor of large Japanese corporations.'9 Another example is the dispute over amorphous metals, in which Allied-Signal charged that the Japan Patent Office (JPO) delayed consideration of their most crucial patent applications while the Ministry of International Trade and Industry (MITI) mounted a "catch up" campaign to help Japanese companies develop the product themselves.20 It might be useful to enumerate the major differences in the respective legal frameworks for IPR protection and then consider some of the most common Although the term "intellectual property" covers trademarks, copyrights, and trade secrets as well as patents, it is patent issues that are most relevant to biotechnology, and U.S.-Japan IPR disagree ments in general revolve around patents. '~See Epstein and Jones, op. cit., pp. 87-95. '9See Donald M. Spero, "Patent Protection or Piracy A CEO Views Japan," Harvard Business Review, September/October 1990, pp. 58-67. resee "Low tricks in high tech," The Economist, September 29, 1990, p. 78. Administratively, the JPO is under the jurisdiction of MITI, just as the U.S. PTO is under the jurisdiction of the Commerce Department. Japan avoided a U.S. investigation of the charges by agreeing to buy transformers containing Allied's amorphous metals, but did not agree to extend Allied's Japanese patent protection beyond the 1993 and 1997 expiration dates. See "Japan and U.S. Settle Allied-Signal Dispute," Asian Wall Street Journal, October 1, 1990, p. 7.

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12 objections to the Japanese system made by Americans. Many of these objections arise from interactions between formal elements of the Japanese system and its administrative and judicial interpretation in practice. There is nothing in Japanese patent law that discriminates against foreigners or conflicts with principles of "national treatment" per se. In contrast, foreign firms accused of patent infringement in the United States may face legal challenges before the International Trade Commission as well as before the courts, and parties to an interference proceeding are not allowed to introduce evidence related to foreign activity before the foreign filing date.2' There are several substantial differences in the two systems. Perhaps the most obvious one is that Japan's, like most of the world, is a "first to file" system, which means that the first to file an application will receive the patent (provided the claim set forth in the application meets the other requirements, such as novelty, for patentable subject matter). The United States is almost unique in having a "first to invent" system in which the inventor who can prove that he or she was first will obtain the patent rights. A second point of disparity is that the Japanese system provides for the opening of patent applications to the public eighteen months after filing (kokai). This is also an area in which the Japanese system is more consistent with the rest of the industrialized world than is U.S. practice. Two final differences are the Japanese provisions for pre-grant opposition, in which pending patents can be challenged, and the timing of grants and their effective lives.22 In the United States, the patent is good for 17 years from the date of the grant. The effective life of a Japanese patent is twenty years from the date of filing, but no more than fifteen years from the date of the grant. Most American objections arise from administrative factors in the Japanese IPR environment and how these interact with provisions of the law. Perhaps the administrative area perceived to have the most pervasive negative impact is the amount of time it takes for the JPO to act on applications and grant patents. The process often takes five to six years, and even longer in some cases.23 The comparatively small number of examiners in the JPO and the large number of patent applications filed in Japan are to blame. JPO has plans to increase its examiner staff to 1,000 by 1993. The U.S. Patent and Trademark Office, which 2'An interference proceeding is held before the Patent and Trademark Office to determine who was first to invent. 22The U.S. system only allows opposition after the patent is granted. See Epstein and Jones, op. cit.. p. 89. 23See Epstein and Jones. op. cit. p. 88.

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13 received half as many patent applications in 1989, has an examiner staff of more than 2,000. The long waiting period can cause problems for innovators. One consequence is that after five years the applicant's "patent clock" starts ticking because further delay shortens the effective life of the patent. In industries in which innovation is particularly rapid, the invention may already be obsolete by the time the patent is granted. American critics cite two further practical difficulties. The first is the alleged failure of the JPO to enforce provisions in Japanese patent law for a "doctrine of equivalents," which stipulates that in addition to the elements claimed in the application, elements that perform essentially the same function in essentially the same way as those claimed are covered as well. The practical effect is that patent grants in Japan tend to be much narrower than in the U.S. Many observers also point to the failure on the part of the JPO to enforce requirements for applicants to disclose previous work in the field of invention known to them, or "prior art."24 The interaction of the patent and legal systems plays a role as well. Japanese judges do not have as much authority to overrule the JPO as American judges do over the PTO.25 In addition, some observers claim that the lack of a "discovery" mechanism to collect evidence against an alleged infringer makes litigating in Japan more difficult.26 Because of the narrowness of grants, competitors of the initial innovator are encouraged to surround a patent with their own applications, making slight modifications in the original invention.27 Competitors can also lengthen the review of the innovator's application through pre-grant objections. Combined with the difficulties in distinguishing between innovation and imitation that may arise because applicants are not required to disclose prior art, the initial inventor may ultimately be granted a patent that is so narrow and so long delayed that it is of little value. Faced with this eventuality, American innovators may choose to cut their losses and license their basic inventions to Japanese competitors. Critics charge that the system is designed to "benefit industry at the expense of patentees."28 They argue that in practice the system is tilted against smaller U.S. companies and innovators generally because large Japanese firms can afford 24See Epstein and Jones, op. cit., p. 89. 25See Samson Helfgott, "Cultural Differences Between the U.S. and Japanese Patent Systems," Journal of the Patent and Trademark Office Society, March 1990, p. 235. 26Epstein and Jones, op. cit., p. 96. 27Helfgott, op. cit., p. 234. 2XIbid.

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14 to take the time and resources necessary to monitor patent applications by competitors and then submit applications for minor modifications. Japanese firms are said to defend themselves by using the eighteen month period during which their application remains secret to file their own "second wave" of applications incorporating changes in the initial innovation, creating a "mosaic" of patents around their invention. Those skeptical about the complaints of U.S. firms assert that foreign companies could pursue similar patent strategies in Japan if they were willing to devote the necessary resources. It has been suggested that many of the disparities between the two systems reflect philosophical and cultural differences over the purpose of the patent system. Systems that protect intellectual property are fundamentally designed to encourage the development and diffusion of technology by giving innovators temporary monopolies on their inventions in exchange for publication. Some argue that the United States and Japan emphasize opposite sides of this exchange, with the American system giving stronger protection to the patentee, and the Japanese system more focused on teaching industry new innovations and diffusing technology. But the Japanese point to the similarities between their system and European practices, such as the publication of applications, or kokai, and the option of delayed examination. Some Japanese also criticize the American system for its "excessive protection," which slows technological innovation and the diffusion of technology to developing countries. Foreign critics concede that much of the Japanese patent system was adopted from the German system. But they point to more recent changes such as the elimination of deferred examination in the unified European system. Deferred examination was dropped because it was recognized that the combined effect of the delay and publication features tipped the scales too heavily toward imitators. The unified European system also has substituted post-grant for pre-grant oppo- sition for the same reason- to expedite the patent grant.29 While there is no doubt that the American system is more favorable to innovators, to individual rights and to small companies than is the Japanese system, the question of"fairness" and "unfairness" is complex. For some time, IPR has been an important element in U.S. international trade policy, evidenced in U.S. insistence on the inclusion of intellectual property rights in international negotiations such as GATT. Criticism of the Japanese patent system has been part of the SII discussion (Structural Impediments Initiative). The basic thrust of these efforts is to harmonize differences across national systems in order to provide similar treatment for innovators around the world. At the same time, some in Japan 29Ibid.. p. 237.

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15 see the American emphasis on IPR as a policy designed to stem technological and industrial decline by charging Japanese fimns higher fees for licenses.30 The American push to strengthen IPR protection internationally has been paralleled by domestic movement in the same direction. The Court of Appeals for the Federal Circuit makes the enforcement of patents more uniform across regions of the United States than it was before the l980s.31 The Federal Circuit is also widely perceived as being more "pro-patent" than many of the Circuit Courts of Appeal that previously decided patent cases. More lenient policy from the Justice Department on licensing practices and the greater ease with which injunctions can be obtained in infringement cases have also served to increase the value of the intellectual property right represented by a U.S. patent. INTELLECTUAL PROPERTY ISSUES RAISED BY BIOTECHNOLOGY Changes have been introduced into U.S. patent practices to cope with the special IPR problems posed by biotechnology itself. Issues such as the patentabil- ity of living matenal, multicellular organisms, and transgenic animals have been resolved in the United States over the years in ways that generally give greater protection to inventors than previous practices.32 But there are still some issues that remain unresolved. For example, patenting genes found in nature poses certain problems, such as whether patents should be granted for the introduction of a gene into a species in which the gene occurs naturally. Other issues relate to the proper scope of a patent claim. Examples of the latter include whether patent protection granted on plants or animals should extend to progeny, whether patent holders should have the power to limit the use of patented organisms in subsequent research, and the breadth of claims.33 As we mentioned above, the Japanese system generally grants narrower claims than the American system in any case, and the modifications toward greater protection for 30Two examples from the popular business press are "Nichi-Bei Haiteku Masatsu no Shiren" (The Agony of Japan-U.S. High-Tech Friction), Ekonomisuto, June 27, 1989, p. 97; and "Bakuhatsu! Chikyu Kibo Henkaku" (Boom! Transformations on a Global Scale), Daiyamondo, June 24 1989, p. 18. 3'David Brook, from the "Roundtable on Future Prospects," at the Workshop on Intellectual Property Rights and U.S.-Japan Competition in Biotechnology. 32See U.S. Congress, Office of Technology Assessment, New Developments in Biotechnology, Part S: Patenting Life (Washington D.C.: U.S. Government Printing Office, 1989). 33See John H. Barton, "Patenting Life," Scientific American, March 1991

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16 biotechnology IPR in the United Slates have opened a considerable gulf between the two systems In the most controversial and widely publicized biotechnology patent disputes between U.S. and Japanese has, the breadth of the claim has been a point al issue. 34See Bacon, op. Cil., pp. 44-46.