A Model of Patent Trolls Jay Pil Choi and Heiko Gerlach Very - - PowerPoint PPT Presentation

A Model of Patent Trolls

Jay Pil Choi and Heiko Gerlach Very Preliminary 2nd ATE Symposium UNSW December 15 , 2014

Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 2nd ATE, UNSW 1 / 24

Non-Practicing Entities (NPE), Patent-Asserting Entities (PAE), and Patent "Trolls"

Recent years have seen a dramatic increase in the number of patent applications and patents granted Non-Practicing Entities (NPE) as the most controversial patent intermediaries (Hagiu and Yo¢e, 2013) In 2011, NPEs brought 1211 lawsuits targeting 5,031 operating companies. "Patent Trolls"

I Coined by Intel’s Lawyer Peter Detkin (who later co-founded

Intellectual Ventures)

Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 2nd ATE, UNSW 2 / 24

Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 2nd ATE, UNSW 3 / 24

Di¤erent Patent Troll Business Models

Lemley and Melamed (2013)

I "Lottery Ticket" Trolls F $612.5 Million Settlement between Research in Motion and NTP I "Bottom-Feeder" Trolls F quick, low value settlements F rely on the high cost of patent litigation F sue lots of defendants, forcing multiple settlements I "Patent Aggregators" Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 2nd ATE, UNSW 4 / 24

Information Externality and NPE’s Incentives to Litigate

Each PE’s pro…t :π1 = π2 = π. Without any information revelational role of patent litigation, NPE has a credible threat to litigate if θ π 2 L .where θ =infringement probablility, L=litigation costs Suppose that there is perfect correlation across litigation outcomes and θ π 2 < L < π 2 NPE has a credible threat if θ[π 2 + π 2 ] = θπ > L

Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 2nd ATE, UNSW 5 / 24

Literature

Information Externalities in Litigation

I Che and Yi (1993) I Daughety and Reinganum (1999) I Choi (1998)

Choi and Gerlach (2013)

I "Patent Portfolio" Races I analyze how the relative position of patent portfolios vis-a-vis

competitors in‡uences:

F Incentives to Litigate F Incentives to Develop a New Product

Lemus and Temnyalov (2014)

I the e¤ect of patent "privateering" on litigation and R&D investments Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 2nd ATE, UNSW 6 / 24

Model

One NPE and Two PEs NPE has a patent portfolio of size S. PEs’ Infringing probabilities = θ, which can be interpreted as the strength of NPE’s patent portfolio. Sequential Bargaining between NPE and PEs. PEs are not direct competitors. PEs use related technologies.

Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 2nd ATE, UNSW 7 / 24

Technological Overlap between Two PEs

Four Possible Litigation Outcomes: (I, I), (I, NI), (NI, I), and (NI, NI) : Pr(I, I) = θ2 + ρθ(1 θ) Pr(I, NI) = Pr(NI, I) = (1 ρ)θ(1 θ) Pr(NI, NI) = (1 θ)2 + ρθ(1 θ) ρ : correlation coe¤cient in litigation outcomes across the PEs.

I ρ = 1 : perfect correlation between the litigation outcomes. I ρ = 0 : the litigation outcomes are independent.

Updated beliefs: Pr(IjI for the other …rm) = Pr(I, I) Pr(I) = θ + ρ(1 θ) θ Pr(IjNI for the other …rm) = Pr(I, NI) Pr(NI) = (1 ρ)θ θ

Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 2nd ATE, UNSW 8 / 24

Updated Beliefs

Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 2nd ATE, UNSW 9 / 24

Benchmark: No Information Externalities

NPE’s incentive to litigate against PE i can be analyzed in isolation. πi= PEi ’s pro…t L = litigation costs for all parties. The probability that the NPE will prevail in the court is θ. In such a case, the court grants an injunction. NPE will litigate against PEi if θ πi 2 L When NPE’s litigation threat is credible against PEi, the two …rms can settle out of court to save litigation costs. We assume that both NPE and PEi engage in Nash bargaining with a licensing fee of θ πi

2 .

Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 2nd ATE, UNSW 10 / 24

NPE’s Litigation Incentives with Related Technologies

Sequential Bargaining with an Exogenous Order: The NPE …rst negotiates with …rm 1 and then with …rm 2. the belief that …rm 2 infringes based on the outcome of the NPE’s interaction with …rm 1 is given by ˆ θ 2 fθ, θ, θg. Three scenarios:

I NPE wins in court: ˆ

θ = θ

I PE1 wins in court: ˆ

θ = θ

I No litigation: ˆ

θ = θ

The NPE will have a credible threat to litigate against …rm 2 if and

• nly if

ˆ θ π2 2 L The value of NPE’s patent portfolio with respect to …rm 2 is given by V (ˆ θ) = (ˆ θπ2/2 if L ˆ θπ2/2,

• therwise.

Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 2nd ATE, UNSW 11 / 24

Litigation Incentives against PE1

Ψ = the information externality of litigating the …rst …rm in terms of expected pro…ts with the second …rm. Ψ = θV (θ) + (1 θ)V (θ) V (θ).

Lemma

If θπ2/2 < L < θπ2/2, the information externality Ψ is negative. If θπ2/2 < L < θπ2/2, then the information externality Ψ is positive. Otherwise, Ψ = 0. The NPE has a credible incentive to litigate the …rst …rm if θ π1 2 L + Ψ 0. (2)

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Equilibrium of the Benchmark Model

Proposition

Consider the equilibrium of the benchmark model with sequential litigation. (i) The NPE and the …rst PE never litigate. (ii) When the information externality is negative, there exist parameter values such that the NPE has no credible litigation threat with respect to the …rst …rm although litigation would be credible if it would deal with this …rm in isolation. (iii) When the information externality is positive, there exist parameter values such that the NPE has a credible threat to litigate against …rm 1 although it would not be credible to sue that …rm in isolation. (iv) Compared to the case with unrelated technologies, the NPE may be able to extract higher (lower) total licensing fees when the information externality is positive (negative).

Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 2nd ATE, UNSW 13 / 24

Figure: Credible litigation threat with information externality

Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 2nd ATE, UNSW 14 / 24

Endogenous Target Choice

Proposition

Suppose the NPE can choose which …rm to target …rst. If the technologies are su¢ciently closely related and litigation against …rm 2 as …rst target credible, then the NPE prefers to target the more pro…table …rm 2 …rst.

Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 2nd ATE, UNSW 15 / 24

Figure: Strategic Targeting of PEs

Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 2nd ATE, UNSW 16 / 24

Competition among PEs

πm =monopoly pro…t πd = duopoly pro…t, where 2πd πm. Sequential Negotiations with PE1 and then with PE2. Consider the bargaining with the second …rm.

I Suppose …rm 1 bought a license or did not infringe. The updated belief

that …rm 2 is infringing is ˆ θ, and the NPE gets

V d(ˆ θ) = (ˆ θπd/2 if L ˆ θπd/2,

• therwise.

I If the …rst …rm was found infringing and did not obtain a license, the

NPE gets V m(ˆ θ) = (ˆ θπm/2 if L ˆ θπm/2,

• therwise.

Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 2nd ATE, UNSW 17 / 24

Negotiation with PE1

Suppose the NPE decides to litigate for infringement and wins the court case. The NPE can either license the technology or exclude …rm 1 from the

• market. Licensing will occur if

πd + V d(¯ θ) V m(¯ θ). (1)

Lemma

Suppose the …rst …rm has been found infringing on the NPE’s patent. If product market competition is weak and the updated probability of infringement of the second …rm is low, the NPE sells a license to the …rst …rm. Otherwise, the NPE excludes the …rst …rm and negotiates a license fee with the second …rm only.

Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 2nd ATE, UNSW 18 / 24

Product Market Competition without Information Externalities

Proposition

Suppose …rm 1 and 2 are product market competitors using unrelated technologies. (i) If product market competition is strong and litigation cost su¢ciently low, the NPE litigates against the …rst PE and, if successful, sells a license to the second …rm. (ii) There exist parameter values such that the NPE has a credible litigation threat with respect to the …rst …rm although litigation would not be credible if it would face two …rms with pro…ts πd operating in di¤erent product markets.

Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 2nd ATE, UNSW 19 / 24

Figure: Litigation incentives with product market competition and unrelated technologies

Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 2nd ATE, UNSW 20 / 24

Interaction between Market Competition and Information Externalities

Proposition

Suppose …rm 1 and 2 are product market competitors. When the technologies are perfectly related, the NPE has a credible litigation threat with the …rst …rm if L θπm/2. Proof: For ρ = 1, we have θ = 0 and ¯ θ = 1. Condition (2) becomes θ πd 2 L + ( θ(πm 2πd)/2 if L θπd/2, θ(πm πd)/2 if θπd/2 < L θπm/2. 0 which always holds.

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NPE with Weak Patent Rights

assume α is probability that court upholds validity of NPE’s patent four di¤erent outcomes of interaction with PE1: belief PE2 infringes ˆ θ 2 f0, θ, θ, αθg NPE has a credible threat to litigate PE1 if αθ π1 2 L + αθV (θ) + α(1 θ)V (θ) V (αθ) 0. (2-weak) suppose that θπ2/2 < L θπ2/2 and (2) does not hold: with ironclad patent, no credible threat to litigate PE1 due to negative information externality suppose that L αθπ2/2: with weak patents, NPE has no credible threat to litigate PE2 and V (αθ) = 0 weaker patent turns information externality positive

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with weak patents: NPE makes pro…ts with PE1, with ironclad patents: pro…ts with PE2

Proposition

For intermediate values of the technology relation ρ and intermediate values of the ratio of litigation cost to PE pro…ts, a NPE may bene…t from having weaker patents.

Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 2nd ATE, UNSW 23 / 24

Further Extensions

N (> 2) PEs Imperfect Information about Past Settlements Imperfect Information about Patent Portfolio Size/Strength Defensive Aggregators (RPX, Allied Security Trust) Welfare Analysis

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