Posts Tagged 'Market-based Solution'
Quantifying the 'Fight Hard' Strategy
February 21, 2013
On January 22, the Federal Circuit invalidated numerous claims from three patents asserted by Soverain Software in its five-year legal battle versus Newegg, relieving the web-based electronics dealer of what would have been a $20-25 million payout. The decision can be seen as delivering a crushing blow in this “mother of all patent battles” (Internet Retailer: "The mother of all patent battles") for the entire online retail community. Newegg and its General Counsel, Lee Cheng, deserve to be congratulated on the victory. In this instance, battling back against a notorious NPE paid off for Newegg – vindicating their position at trial, clearing an eight-figure loss, and reducing huge risk for dozens of their competitors.
This kind of “fight hard” stance against NPEs has always held tremendous emotional resonance. Its economic foundations, however, have been more elusive, and while dodging an approximately $25 million verdict – based on the judgment of $2.5 million and a $.15/transaction running royalty – is always cause for celebration, it is worth noting that Newegg’s victory didn’t come cheap. Total costs through appeal probably exceeded $3.5 million (per AIPLA estimates) – considerably more than the amounts that other Soverain defendants appear to have paid to settle with Soverain (Internet Retailer: "The mother of all patent battles"). In fact, legal costs are so high that one could argue that unless an NPE is demanding eight figures or more, after a patent falls into the hands of an assertion entity, from a purely financial standpoint, there is no way an operating company can “win” by litigating.
Proponents of fighting hard, including Newegg’s Cheng, would argue that operating companies who refuse to settle are actually producing two potential benefits: good case law, and a decrease in future NPE litigations (by making themselves unattractive defendants).
Putting aside whether the underlying premise is supported by the data, (RPX: Does Fighting Hard Reduce NPE Risk?), let’s assume for a moment that fighting hard does cause NPEs to think twice and ask, how much impact would it need to have to justify the expense?
Let’s consider a hypothetical e-tailer with an average of four new NPE cases per year. We will assume it is only possible to establish a “fight hard” reputation by refusing to settle all or nearly all NPE litigation, so the company will take almost every case all the way through trial. Each matter will take about three years and $3 million to conclude (per AIPLA estimates), so our hypothetical company would have 12 open cases each year and $12 million per year in legal costs. Even if we presume a generous 75% success rate at trial and an average verdict of only 1x the litigation costs in losing cases each year, our hypothetical company carries roughly $15 million in NPE litigation expenses – $12 million litigating cases and a $3 million judgment for the case it loses.
Now compare this result if the same company took a “settle sensibly” strategy that assumes an average settlement of $1 million and $100,000 in legal costs per NPE case. With the same level of litigation as above, this strategy would cost our hypothetical company only $4.4 million a year, a 71% annual reduction. Said differently, the “fight hard” strategy would have to reduce the NPE caseload by 71% for that strategy to be more attractive financially. As it happens, since Newegg took Soverain through trial in 2009 and arguably established its “fight hard” reputation, Newegg has actually seen an increase in NPE campaigns from three in 2010 to five in 2012.* While tweaking the presumptions could narrow that gap, the required reduction would still need to be massive to pay for the approach.
Of course there are clear winners in the Soverain v. Newegg case. At the time of the decision by the CAFC, there were 24 active defendants answering suits from Soverain and dozens of others retailers facing the likelihood of being named in successive waves of litigation. For these companies, Newegg’s resolve resulted in the invalidation of pivotal patent claims and saved tens of millions in potential future legal costs. Of course, none of those companies are likely to send Newegg a check for its willingness to fight the battle alone, revealing vividly one of the frustrating asymmetries of NPE litigation: that a company acting alone, either by buying a patent before it can fall into the hands of an NPE or fighting a claim through trial, bears substantial risk and costs while any success is enjoyed throughout the industry for free. Because a single NPE creates risk for an entire sector, the only rational solution is to bind together to share risk, enhance effectiveness, and make sure no one company is left holding the bag.
Soverain Software’s 11-year litigation campaign brought in more than $60 million. The portfolio at the heart of the campaign was purchased in a bankruptcy proceeding from a failing E-commerce software start-up in 2003 (five years before RPX was founded) for a mere $590,000. If only the 38 named defendants had joined forces to buy the portfolio in 2004, it would have required an investment of just $16,000 each. Passing the hat to the top 100 online retailers would have reduced the cost to $6,000 for each participating company. Clearly, this would have been a less expensive and more equitable way to eliminate the NPE risk from those patents than relying on a single company to “fight hard.” And because nearly three-quarters of NPEs are asserting patents that, like Soverain’s, were acquired in the open market – often from former competitors or vendors – this proactive buying strategy could prevent the majority of NPE litigations for an entire sector.
The takeaway here is simple: operating companies like Newegg should continue to make a stand against NPEs, but making that stand unilaterally in court should not be the only – or the most common – choice. To do so is neither efficient nor fair nor economically feasible for most companies. Fighting hard must be combined with a broad-based, risk-sharing approach to provide a potent and affordable long-term solution to the NPE problem.
Total Costs ($USD M) of Fight Hard vs. Always Settle Strategies
Fight Hard Assumptions:
- Litigation costs per case = $3 million ($1 million per year, with a duration of 3 years)
- Losing Verdict Payment of 1x litigation costs (75% success rate, lose 1 in 4 cases)
- Litigation costs per case = $100 thousand ($1 million per year, with duration of 0.1 years)
- Settlement costs per case = $1 million
*Obviously there are many assumptions in this analysis (legal costs per case, duration, settlements/verdict amounts, success rate, etc) and the accompanying charts illustrate the sensitivity in the assumptions we’ve made. The particulars will clearly vary by company, and if you would like to develop a similar analysis using assumptions specific to your company, please feel free to contact us.
Tags: Market-based Solution, NPE Costs, NPE Model
Does Fighting Hard Reduce NPE Risk?
September 4, 2012
When it comes to NPE litigation, agreeing to settle can be hard to accept. Fighting back and fighting hard seems attractive – it just feels right. But is it the cost-effective way to deal with a patent assertion? Based on data RPX has been compiling from its clients and public sources the answer seems to be “generally no”.
Consider the two typical arguments in favor of the “fight hard” position:
- Fighting hard earns a company a reputation as a tough target. You will be sued less often.
- Fighting hard saves money. It will reduce settlements by more than the additional legal cost.
As for the first argument, neither our data nor our experience support it. In our frequent negotiations with NPEs to buy assets and/or release RPX clients from litigations, we have never heard that a company’s reputation for fighting or not fighting has ever influenced the NPE’s decision to name a defendant.
Furthermore, we analyze several thousand NPE suits each year, and have never seen compelling evidence that companies that persist in litigation longer are sued less often. In fact, companies that stay in NPE cases longer – a proxy for a “fighting hard” reputation – appear to have the same (or worse) growth in NPE suits compared to companies that resolve cases faster. For example, plaintiffs that averaged more than 370 days in suit saw their NPE caseloads grow at approximately 36% from 2008 to 2011, no different than companies that were resolving NPE cases in less than 370 days.
The second argument also seems to be a fallacy. In our experience, NPEs consistently report that the range at which they would be willing to settle is generally lowest near the start of the case. This makes basic mathematical sense: an NPE seeking a 20% annual return to investors would be willing to accept approximately 30% less for settling now versus two years hence. Moreover, when factoring in costs of plaintiff counsel of 10-25% of the expected settlement, an NPE would probably accept even less now versus two years in the future.
That is consistent with our data. In more than 500 litigations we examined, cases that last longer than one year had all-in costs that were fully five times higher than in cases lasting less than a year.
Skeptics could look at this data and claim that it actually proves a solid legal defense is the only way to achieve a favorable settlement – that defendants need to fight hard for at least a year to establish a strong negotiating position. Some observers might assert that the longer-lasting cases probably had higher initial demands and fighting hard paid for itself by actually reducing the ultimate settlement.
Which raises the question: where should the burden of proof lie in the “fight hard” question? Those with the most to gain from pursuing an aggressive defense strategy should be able to provide evidence that fighting hard pays dividends, either in the form of fewer litigations or lower payouts. Fighting an unreasonable demand is always warranted, but our data indicates that there is little to be gained from being impractically intransigent.
The simplest and most logical approach is to treat a patent assertion as what it is: a business transaction. Before calling legal counsel, open a dialogue with the NPE to find out what the financial demands are. Conduct a cost/benefit analysis of fighting versus settling. Again, if the demands are unreasonable, defendants can and should be ready to fight. But in the great majority of cases, making a reasonable counter-offer is likely to produce a settlement that is a more cost-effective result than a “fight hard" stance. Building a reputation for being tough on NPEs is expensive and the reputational benefits are elusive, at best.
Tags: Market-based Solution, NPE Costs, NPE Model
Caveat Lector (Let the Reader Beware).
May 23, 2012
As we noted in our last post, patents have become the topic du jour for business commentators and leading media outlets. The opinions continue to flow, and one of the notable entries came from Vivek Wadhwa, a fellow at Stanford’s Rock Center for Corporate Governance, who published a recent piece on the Washington Post Op/Ed page (Where are the Jobs? Ask the Patent Trolls).
The good news is that the patent market and its current shortcomings are stimulating a lot of ideas. The bad news is that so many of those ideas are fundamentally misguided.
Wadhwa makes some good observations about how the growing cost of patent litigation is diverting capital from corporate R&D, and he argues that patents should be more rigorously analyzed and narrowly defined. He’s right. The number of vaguely worded patents that overlap other issued IP has indeed allowed some NPEs and other patent owners to assert arguably low-quality assets with a high degree of legal success.
But the rest of his article illustrates just how poorly understood the patent market still is, even by sophisticated observers. For example, Wadhwa claims that patents no longer foster innovation (or stimulate job creation) because NPEs have incited “an arms race of sorts … that is sapping billions out of the economy and crushing tech startups.” As examples, he points to the $12.5 billion Google spent on Motorola Mobility (ignoring the fact that MMI is a successful, established operating company, not just a patent portfolio), the Apple/Microsoft consortium that paid $4.5 billion for Nortel’s patents, and the recent billions invested by Microsoft and Facebook for AOL patents.
But these patents weren’t acquired to fend off NPE attacks. (Wadhwa seems to have forgotten that NPEs don’t make or sell products; they can’t be countersued.) They were acquired to create a credible threat of legal response to another operating company threatening an infringement lawsuit. As we’ve written in previous blogs, the patent “arms race” is driven by corporate operating strategies; it has nothing to do with the NPE threat.
Wadhwa also makes much of a 2010 study by Mark Lemley, John Allison and Joshua Walker that seems to show that NPEs have a lower win rate in litigation than do plaintiffs in company-vs.-company patent trials. While this is indeed an encouraging data point for operating companies, RPX’s data shows that fully 98% of NPE cases resolve before ever going to trial. So the focus for operating companies facing NPE risk should not be on whether they can win an expensive litigation; it should be on avoiding that litigation altogether by preventing patents from getting into the hands of NPEs in the first place.
Wadhwa’s ultimate prescription for “this system [that] is enriching patents trolls” is simple and draconian: eliminate or curtail patents. While this certainly would eliminate patent litigation, it would also be … well, un-American. Patents are explicitly delineated in the United States Constitution, Article 1, Section 8. They have always existed in US law as a way to protect – and promote – innovative ideas.
This protection has been at the heart of ground-breaking commercial inventions over the centuries. Would the Wright Brothers have been as creative if they didn’t trust that their ground-breaking ideas had value in and of themselves? Remember, the original Wright Flyer itself wasn’t commercialized. Others built upon the innovations at the heart of the brothers’ machine and perfected them into commercially viable, profitable airplanes. But the original ideas were protected by patent law, and the inventors (eventually, after a great deal of litigation) benefitted financially from their inventions. Patents matter and they absolutely should exist.
But the problem isn’t really patents anyway. Patents are simply assets – some more valuable, some less so. The problem, which Wadhwa and other commentators fail to understand, is how these assets are being monetized. Today, NPEs and operating companies are transacting this value transfer primarily through the legal system – an inefficient, imprecise, time-consuming and highly risky way to price any asset.
The real problem, then, is not the assets themselves. It is the need for a broad-based, transparent and orderly market for the exchange of value between the owners and users of intellectual property. And that is precisely the problem that RPX is focused on solving.
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