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Patents PART I: Protectors of innovative activity or a new class of financial derivatives?

Welcome to a murky world where claim and counterclaim drive litigation – and all this in the name of innovation. This is the world of patents and in particular patent trolls. Although it might seem a world away from the competitive dynamics of a vibrant ICT sector, patent trolls are shaping the way consumers access services, the technologies they can use and the prices they pay. Patent trolls enforce patents – simple, but the consequence of their actions can be far reaching for consumers.

These seemingly innocuous organisations that are naively understood as protecting the rights of innovators (as the well-worn rubric of patent licensing asserts) are perhaps better seen as protectors of monopoly rights and champions of anti-competitive behaviour. Of course, views differ but perhaps the most scurrilous patent trolls are little more than opportunistic organisations extracting (some call it extorting) license fees from high technology firms; the most honourable ‘angels’ protecting individuals and SMEs from the callous disregard of their IPR by large corporate giants.

Patent trolls can simply be seen as organisations that (i) derive a significant proportion of their income from the licensing and enforcement of patents and (ii) the patents are themselves acquired in commercial transactions rather than the result of undertaking innovative activities. Acronyms for patent trolls include NPE (non-practicing entity) and PAE (patent assertion entities).

Companies such as Intellectual Ventures are seen as the doyen of the industry. Founded in 2000 this company reportedly has over 20,000 patents, and commands an investment fund of $5 billion. As noted in the Wall Street Journal as long ago as 2008, Intellectual Ventures conveys a simple message – “pay up”.

Patent trolls are active in many sectors but the high tech sector is particularly at risk. Data presented by Patent Freedom shows that consistently over 50 per cent of all lawsuits pursued by patent trolls were targeted at high tech firms. And according to Patent Freedom the numbers are huge; in the period 2011 to 2013 there were over 10,300 cases, and in the ICT sectors some 5,976 patents were asserted.

As an example of the role of patents in the ICT sector it is worth noting that the smartphone has become an extraordinary battlefield for patent disputes. According to some sources, around 250,000 patents (one in six of all active patents) are at stake in the mobile business and distinguishing between those that are essential and others is a task fraught with complexities. Some estimates have suggested that there are now more than 280 patents for every 1,000 jobs in the computer/mobile telecoms sector compared to less than 112 in the semiconductor industry and 47 in the pharmaceutical industry.

Without doubt the ICT sector has been at the forefront of using patent to not only to protect innovation but also to underscore the competitive dynamics of ‘closed’ eco-systems – companies like Google are obvious proponents of ‘eco-systems’. As a consequence the ICT sector is in the vanguard of what can be seen as a major shift in the use of patents. What is clear is in the ICT sector ownership and the prosecution of patents have become a major battleground and divorced from the innovation process.

What is at stake is not actually innovation but whole eco-systems that drive the profitability of the major players, such as Google. Thus patents have moved from sine qua non of innovative activity to being a strategic resource to secure market positions and counter competitive threats by others. In this melee, patent trolls have emerged seeking rewards through legal challenges and other tactics.

The use of patents to help secure an ecosystem is aptly demonstrated by Google. Its recently announced sale of Motorola Mobility to Lenovo, subject to regulatory clearance, demonstrates the importance of patents even when disassociated from the underlying technologies. In 2011, Google dominated the headlines with its $12.5bn offer for Motorola Mobility, an offer based on $40 valuation per share. Compare that with the recent headlines focused on the sale of Motorola Mobility to Lenovo for $2.9bn – a devaluation approaching some S10bn.

But behind these figures are the more revealing insights – Google extracted $3bn cash, sold the set top box division for $2.4bn and has kept ownership of some 17,000 patents (and many thousands – maybe up to 7,500 – patents are still pending). Significantly these patents are now held for their core strategic value to Google and the Android ecosystem, as noted by Larry Page in the official Google blog: “This move [selling Motorola] will enable Google to devote our energy to driving innovation across the Android ecosystem”.

In a world of highly contested and publicised patent disputes and where claim and counter claim are a significant part of sidelining competitors, and perhaps part of a legal process, a stockpile of patents is now a key strategic resource. Add to this the cross licensing agreement with Cisco and the significance of patents as a basis for building strategic capacities is clear. Patents have become a new currency securing market power rather than allowing firms to reap the rewards of innovation.

Acquiring a mass of patent is also a key resource in gaming patent disputes. Thus on the other side of the coin Google is not unfamiliar with the attacks of patent trolls – it is the primary target of such attacks. Data shows that since 2009 there have been at least 192 patent cases brought against Google by patent trolls. Vast and complex arrays of interlocking patents deflect patent claims and lay the basis for counterclaims.

In the second and concluding pert of this report tomorrow, we look at Patent Pools and the role that governments can play.

Howard Williams is Professor Emeritus at the University of Strathclyde and former Research Fellow at the Oxford Internet Institute.

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