Patent Outsourcing May Harm US Economy

It has become routine for companies to outsource many business functions. Human resources, customer service, accounting, manufacturing of components – all have been outsourced. Now, however, a growing number of US businesses are outsourcing something new: patent licensing. And this outsourcing may hurt both the US economy and its patent system.

Businesses in the US have plenty of reasons to outsource their patent licensing programs. They know that patent licensing can bring in big bucks, but they are also know that running a successful licensing program is far from simple. A company must identify which of its patents are worth licensing, find potential licensees, negotiate suitable terms, and sue recalcitrant entities that infringe its patents. In short, the company must run a type of business that is very different from its usual activity of making and selling products/services.

Learning to operate this new line of business is no mean feat. It requires a major commitment of time and money. “[E]xperience, expertise and developing a core competency in that [patent assertion] business are critical to success,” said Ron Epstein, CEO of Epicenter IP, a consultancy that helps businesses monetise their patents.

Moreover, patent assertion programs often require deep pockets, because patent enforcement doesn’t come cheap. Infringement litigation in the US can drag on for years and cost a plaintiff millions in legal fees. And while the litigation grinds on, it eats up significant amounts of time from the plaintiff’s executives and researchers – time that could otherwise be spent on pursuing the company’s core goals of making and selling goods/services.

Finally, there’s a significant risk of blowback. When a company seeks to licence its patents, its most likely targets are its “suppliers, customers and competitors,” Epstein said. Suing one’s suppliers and customers, however, is not good for one’s business. Suing customers, moreover, risks an explosion of negative PR that shreds a company’s image and sales.

Suing one’s competitors is more tempting, since it offers the opportunity to distract rivals’ executives, force these competitors to incur costs for litigation and design-around, and possibly require these rivals to take some of their products off the market. But if these rivals have patents of their own, they are likely to countersue, asserting their own claims of infringement. The result could be an expensive, time-consuming battle that leaves all participants poorer – as demonstrated by Apple’s litigation campaign against its smartphone rivals. Suing rivals also can have a PR cost, if customers view the plaintiff as trying to bully competing products off the market.

That’s why, over the last five years, a growing number of patent owners have begun outsourcing their patent licensing and enforcement to specialists, which are sometimes referred to as “patent privateers.” A privateer typically purchases selected patents from an operating company (Opco), works to licence the patents, and shares the resulting revenue with the Opco. If the privateer fails to produce sufficient revenue from the patent at the conclusion of specified time periods – often two and four years – the Opco has the option to repurchase its patents at a nominal fee.

This is an attractive deal for many Opcos. The privateer bear the risks and financial burden of patent litigation and licensing. Meanwhile, the Opco is insulated (at least somewhat) from the negative repercussions of the licensing campaign. If the privateer sues an Opco’s suppliers and customers, the Opco is not responsible. If the privateer sues the Opco’s rivals, these rivals cannot seek to force a settlement by countersuing for infringement, because the privateer is just a patent assertion entity that does not provide goods or services covered by the defendants’ patents. (The rivals could file a separate infringement suit against the Opco, but that wouldn’t stop the privateer’s suit, which the Opco does not control.)

In short, by using privateers, Opcos benefit from the upside of patent licensing while suffering little of the downside. So it’s little wonder that more and more Opcos are turning to privateers. “The outsourcing of patent litigation is a growth industry,” said Thomas Ewing, principal consultant at Avancept LLC, an IP consultancy.

The Effects of Patent Privateers

The growing use of privateers, however, is likely to be a drag on the US patent system. The number of patent infringement lawsuits is likely to rise, taking up scarce judicial resources. These lawsuits could take longer to be resolved, because they cannot be settled by patent cross-licensing deals. (A privateer, unlike an Opco, faces no risk of being countersued for infringement, and thus has no interest in obtaining a licence for a defendant’s patents.)

Yet it is unclear how much privateers will increase the amount or duration of patent litigation. “I guess there will be a little bit more litigation … maybe a bit less cross-licensing,” said Michael Risch, associate professor at Villanova Law School.

It is also unclear whether privateers will ultimately help or harm the Opcos that are their clients. “Privateers both help and hurt large companies,” said David Schwartz, associate professor at Chicago-Kent College of Law. “Privateers allow [Opcos] to sell their patents and make more money, but these companies also are likely to be hit with more [infringement] lawsuits so they may have to pay out more money.”

Some argue that the expected increase in patent litigation and licensing will help promote innovation. By squeezing more revenue from patents, privateers will encourage Opcos to spend on R&D.

However, a paper recently written by two economists at the Federal Reserve Bank of St. Louis casts doubt on the notion that patent assertion promotes innovation. After reviewing “sector-level, national, and cross-national” studies on the effects of patents, the authors write that these studies “fail to provide any clear empirical link from patents to innovation or to productivity.” In another section of their paper, the authors are more direct: “there is no empirical evidence that they [patents] serve to increase innovation and productivity.”

It is thus unclear whether the growing use of patent privateers will benefit anyone other than the privateers (and legal counsel for alleged infringers). The privateers will boost patent litigation to some degree and wring more licensing fees out of companies, but that may simply slow down the courts and increase the financial burdens of firms doing business in the US – without any offsetting benefits to the economy, innovation or the companies that created the patented inventions.

If that is the case, if the growing use of patent privateers does harm the US economy and its patent system, the privateers should not be blamed, according to Risch. The privateers and their client Opcos are just taking advantage of the US patent law, and it’s the law which needs to be reformed. “If privateers thrive because patents are bad [e.g., overbroad or weak], we should look at bad patents. If privateers thrive because litigation is expensive, we should do something about litigation costs,” Risch said. “This latest form of litigation isn’t the problem.”