Beware of Trolls

Last week I was attending the MaCCI Annual Conference at our institute. There were a lot of bright ideas and interesting presentations. One of my personal highlights was Jay Pil Choi from Michigan presenting a model of patent trolls. There is no paper available yet but I found some slides online.*

Patent trolls are companies which acquire patents and which have the business model to sue other firms for patent infringement in order to make a profit on royalties or settlement payments. The defining feature of trolls is that they are usually not active in the same business as the firms they sue. And, in most cases, they aren’t the inventor of a patent but rather acquired it on the market. Therefore, the less figurative name of Non-Practicing Entities (NPE).

Patent trolls are considered to be a problem because nowadays high-tech products such as smart phones rely on hundreds of patented technologies and the uncertainty that a troll might “pop out of the box” somewhere could prevent firms from developing innovative devices. Also, the troll’s business model takes the orginal intent of the patent system ad absurdum. Patents ought to protect inventors from cheap imitation by competitors in order to allow them to make a profit from their inventions. However, NPEs are not inventive. They buy the intellectual property of relatively insignificant technologies and aim to make a multiple of the price in settlement deals with operating companies.

As a textbook case we have the settlement between Research in Motion, the producer of BlackBerry, and NTP Inc., with an agreement to pay $612.5 million because of infringement in 2006. It is believed that this settlement was part of the reasons for the declining market share of the BlackBerry system in the smart phone business. These are the big cases which get a lot of attention from the public and business scholars. But the more significant harm might be caused by what Lemley and Melamed (2013) call “bottom-feeder”; trolls that file a lot of law suits involving small amounts of money.

Because there aren’t hundreds of million dollars involved, fighting back usually does not pay off. The sued companies rather opt for settlement directly and the troll can go on to the next target, since the validity of his patent claims is never challenged in court. This becomes especially problematic, from a welfare point of view, when start-ups become the victim of this practice. The involved settlement payments could easily force them to cease their business.

On the other side of the coin, however, the patent troll also faces litigation costs. And especially when there is a chance that patent claims might be invalid, litigation costs could be higher than the profits to be made from small lawsuits. So why can’t you then, as a practicing company, not simply ignore the letters you receive from a troll? He won’t go to court anyway, right? In economics jargon, this refers to the question of when trolls have a credible threat to litigate?

Choi and Gerlach emphasize the crucial role of information externalities. The money to be made from a single lawsuit might be too small to justify litigation. But when there are several firms using (and possibly infringing) the same (or related) technologies, winning in court suddenly allows the troll to squeeze money from all of them. A rational firm has to take these externalities from repeated litigation into account.

Since this introduction to the business of patent trolls already got quite long, I will save the economics for a part 2. Thus, to be continued…

UPDATE: Read part 2 here

References

Lemley, M. A., and A. D. Melamed (2013): “Missing the forest for the trolls,” Columbia Law Review, 113(8), 2117–2189.

* Should you be one of the authors and not wanting to have these slides distributed, leave me a note and I will delete the link immediately.