You may have heard of a company called VirnetX. It recently sued Apple—once again, the two firms have a long history—for using four security elements in iMessage and FaceTime for which VirnetX says it owns the patents. The payout? $625 million dollars.
But you may be wondering what VirnetX makes or sells. That’s isn’t surprising because it doesn’t actually invent, make, or commercialize anything. Instead, the firm makes money by buying patents then suing large corporations when they infringe upon them. In this case, a jury actually awarded more than VirnetX was asking in damages. (Apple is appealing the court’s decision.)
Do patent assertion entities like VirnetX, sometimes referred to pejoratively as “patent trolls,” get a bad rap? Do these firms buying patents with the sole purpose of enforcing licensing agreements them to generate revenue actually provide a service to the business community?
Very possibly, says Lundquist College assistant professor of management Ralph Heidl. He and coauthors H. Kevin Steensma and Mukund Chari, both of the Foster School of Business at University of Washington, investigate the phenomenon in an article published in the journal Organization Science, “A Comparative Analysis of Patent Assertion Entities in Markets for Intellectual Property Rights.”
Heidl, who has a background in information systems and software development, initially heard about patent assertion entities, or PAEs from technology entrepreneurs and industry professionals. The common narrative associated with PAEs promoted in the media suggests that PAEs delay innovation with unfair fees and frivolous lawsuits, thereby destroying value to the customer while adding no social benefit. Yet these firms exist, are profitable, and are growing. It piqued his interest.
“In the course of conducting this study, we arrived at a more balanced view,” he said. “These organizations may serve a certain purpose in the market of technology.”
In fact, under certain conditions, PAEs can actually help to reduce the cost of transacting intellectual property rights in technology markets. Heidl explained this by noting that no company has all the patents needed to create a complex product, so they license. That scenario generates a lot of transaction costs.
“This could include separate, bilateral licensing agreements with a large number of parties. And you have to negotiate the terms for that intellectual property. It’s very expensive to do this,” he said.
Heidl likened it to driving all over town to many specialty stores for each product on your shopping list, haggling the price for each and every item, then creating a legal agreement for each item, instead of going to a single store that specializes in multiple departments, such as Target or Walmart, and making just one transaction.
This is where PAEs are beneficial. They can bundle intellectual property rights so they are not dispersed across a large number of potential inventors. That is particularly valuable when the assets are highly complementary. (Think smart phones and other complex technologies that require thousands of bits of intellectual property working together.)
Besides the bundling advantage, PAEs also serve as effective monitors and enforcers.
The ethos of tech is to use what you need and ask permission later. But that rarely happens.
“You borrow and copy when prototyping, but that technology never disappears,” Heidl said. “Things move very quickly, and some portions never get cleaned up.”
A small company doesn’t have the resources to monitor this and as a result, often never finds out. Even if it is discovered that a huge company like Apple is using a venture’s intellectual property, the firm likely cannot litigate because it cannot afford what Heidl calls the “high cost of engagement.” In other words, their lawyer doesn’t stand a chance against Apple’s fleet of expert attorneys.
“So you cannot enforce your patent,” he said.
But a PAE can. A PAE has the resources to monitor for infringement and has the firepower to litigate. The inventor or inventing firm gets compensated for the invention earlier in the process, when a PAE purchases the intellectual property.
In this way, it could be argued that PAEs actually incentivize innovation because now the inventing firm sees some remuneration where it was seeing none before. And, therefore, Heidl and his coauthors conclude that for certain widely used technologies, PAE intermediation is more efficient than alternatives in the allocation of intellectual property rights due to its capacity for bundling and enforcement.