Highlights‎ > ‎

The hidden stakes and challenges of patent wars

posted Aug 27, 2013, 5:04 AM by Julien Pillot

Although patent litigations are commonplaces in innovative industries, there is very little occurrence of cases whose fame spreads beyond the borders of Courts to reach and interest a wide audience of non-specialists, from users to politicians. The ongoing patent war which involves the main smartphones manufacturers (especially Apple and Samsung) – culminating in the veto ruled on August 3 by Barack Obama over a decision held by the International trade Commission (ITC) –ought indubitably to be put in this category. Behind such legal disputes lie massive economic stakes which provide little ground for rapid resolution of a systemic conflict.


An exceptional measure for an exceptional conflict? President Barack Obama’s intrusion in the legal conflict between Apple and Samsung – that seeks to overturn an ITC decision adverse to Cupertino’s interests – is a fine evidence of the economic and somewhat politic importance of the patent war. In essence, the vetoed decision provided an import ban in the US of Apple products that infringe Samsung’s patents. There is no intending to comment Obama admin’s decision here, while most of the experts would like to see in this veto protectionism tendencies. Rather, this article aim at shedding a specific light on the real stakes hidden behind such a global and systemic legal battle which directly or indirectly involves every multinational technology and software corporations (Apple, Samsung, Microsoft, Nokia, HTC, Motorola, RIM, etc…). This must be done through a two-step analysis.


Hindering competitors


In the suitable identification of the different markets impacted by the patent war probably lies the first instinct of the economist seeking for the real motives of such legal quarrels. In the present case, the economic dimension of the conflict is much larger than the sole smartphone market and encompasses the wider sector of wearable connected devices. As a preliminary point, it is worth to distinguish the smartphone market from the operating system (OS) one. 


Presenting an over-increasing number of connected mobile devices (smartphones, tablet PCs, while smartglasses and smartwatches are coming) whose worldwide sales tend to overshoot the ones of traditional computers (including laptops), saying that the device market skyrockets would be an understatement. However, most of the added value does not flow from this market but from ecosystems (mobile apps and commerce) for which devices are just the gateway. Although inter-related, the number of connection requests via a certain type of OS or internet browser is now seen as a major performance index just like sales of devices and softwares. Indeed, built on mobile operating systems (mainly proprietary such as iOs, Android, Windows Phone 8, etc.) featuring some interoperability restrictions, these ecosystems grant manufacturers (of both mobile terminals and compatible accessories) and apps developers’ the adequate alignment of their objectives. As for the consumer, he is basically urged to acquire ecosystems-friendly devices in order to benefit from network effects. It is therefore not surprising to observe the fierce competition in which manufacturers are engaged to make their ecosystem dominant: once the consumer has entered the ecosystem, he will probably “stay” for a long period. Each new specific (irrecoverable) investment made during this period tends to increase the switching costs and, then, strengthen the lock-in effect.


As an integrated operator, Apple is active on the two complementary sides of the market. As for Samsung, albeit not an exclusive supplier of Google products (such as Android), the Korean firm is now Mountain View’s first growth driver on the OS market, so that commercial successes of the former on the devices market partly found the leadership on the latter on the OS market. Then, it is not unconceivable to consider such a patent war as series of proceedings which does not aim so much to assert IPRs than hindering rivals’ competitiveness in strategic markets. Actually, the global dimension of the conflict, in which majors bring lawsuits in the world’s largest marketplaces (USA, Japan, South Korea, France, Germany, Great Britain …), has probably to be seen as forum shopping, e.g. a practice adopted by plaintiffs to have their legal cases heard in the court thought most likely to provide a favorable judgment. One might see in such overexposed proceedings a sort of nuisance suits whose main objective is to obtain rulings likely to significantly hinder rivals’ market strategies (damages, products’ ban…) as well as harming their image and reputation.


Although the strategic significance of achieving a dominant position in industries characterized by strong network effects is now well established (Windows is a perfect example), patent wars are nonetheless destructive schemes for undertakings’ resources… which will not be invested in productive activities. Rivalry on judicial grounds rather than competition on the merits naturally leads the economist to the second stake of such legal battles: the (economic) exploitation of patents known as essentials.   


The essential patents case


It is indeed necessary to draw a distinction based on the nature of disputed patents. While most of Intellectual Property litigations are about substitutable patents, some of them involve standard-essential patents, e.g. patents that claim inventions that must be used to comply with a given technological standard. In a nutshell, standardization is vastly profitable in high-tech and innovative industries as it can help both to avoid diseconomies and the slowdown in the rate of technological diffusion flowing from format wars. At the opposite, consumers have to accept a certain degree of concentration of economic power and freedom of choice limitations in order to plainly benefit from network externalities.


The definition of standards – which mostly results from the pooling of numerous technological patents – is most of the time endorsed by standards bodies. In order to prevent any logjam in the standard-setting process (or the innovation one), the most fundamental patents are referred as “essential patents” and are basically submitted to FRAND licensing. As a reminder, FRAND policies are licensing obligation under which patent holders are required to license third-parties under Fair, Reasonable and Non-Discriminatory terms. The purpose of such policy is to provide innovation incentives. License fees are therefore (and somewhat ideally) set to ensure that third-parties are not excluded from the innovation process while patent holders can take advantage of previous R&D investments. However, a major difficulty flows from standardization since the market value of essential patents is very likely to be disconnected from the value related to the pioneering effort.


Indeed, essential patents are technological monopolies which grant holders an important coercion power. Such a power is somewhat an inherent element of the standard-setting process since, once the standard designed and promulgated, the whole production chain will make specific investments (called sunk costs) structured around some essential patents… which results in a rise of the market value of the latter and encourage holders to increase expected license fees (introducing the notions of patent hold-up or patent ambush). Disputes eventually results in negotiations and commitments between parties; resolution of claims before the courts constitutes the exception rather than the rule.


Conclude the patent war: looking for the appropriate remedy

This article is mainly about essential patents. To date, the various controls and safeguards put in place by Courts in order to limit opportunistic lawsuits have apparently dropped the ball while legislative arsenals (sometimes very heavy) supposed to prevent patent infringements do not seem dissuasive enough vis-à-vis the huge economic stakes. However, such a latent legal uncertainty distorts competition, curbs innovation and may hinder employment. In a sense, President Obama’s intervention has probably been driven by the importance of these economic stakes. It is nevertheless true that such patent disputes involves economic issues relative to the valuation of innovative efforts for which economics seem the most likely to find suitable and operational solutions. Research works carried out by economists in recent years gave rise to some interesting guidelines to limit patent misuse, from the most restrictive (ex ante contractual commitment on the license fee) to the most “liberal” (implementation of an ex ante auction scheme in which every single bidder indicates its own willingness to pay).    


Finally, it is even possible that the appropriate remedy flows from the market itself. Indeed, some undertakings suggest innovative solutions in order to avoid situations characterized by legal uncertainties. For instance, the social network Twitter formed in 2012 a very interesting private initiative named « Innovator’s Patent Agreement » (IPA). This real alternative approach aims at restricting patent misuses. In a nutshell, IPA holds that companies can only use patent for defensive purposes and as the original inventors intended. Although this agreement have already seduced innovative companies (such as Facebook or Foursquare), in the other hand its very recent implementation still does not presume the real impact of IPA on high-tech industries. Whereas the emergence of such agreements is undoubtedly a key step towards business moralization –for which patent abuses might be seen as some of the darkest shortcomings – some major hurdles (including political impulsions, consumers’ awareness, and strengthening of tools both dedicated to economic assessment and legal control) have yet to be overcome. Far from having delivered its verdict, the patent war is still in its early stages.