Understanding the valuable role played by Patent Trolls

By Gene Quinn
March 17, 2015

Stephen Haber, professor in political science.The term “patent troll” is a loaded term. Over time it has largely come to mean “anyone who is suing me.” Truthfully, however, the over use of the term patent troll has played a significant public relations advantage for those who continue to push for still more legislative patent reform. After all, who can be in favor of a troll?

I use the term “patent troll” with great frequency because I want those who are predisposed to believe the PR narrative of the infringer lobby to be forced to ask themselves whether someone like an American hero turned inventor is really a patent troll. While the term “patent troll” no doubt turns opinions and fuels sentiment in the sound-bite era in which we live, once you get beneath the initial 7 second summary the use of the term falls apart.

Enter Stephen Haber, a political scientist from Stanford University. He recently published the results of a study he completed that explains exactly why so-called patent trolls play a vital role in the innovation ecosystem. As you will read in our conversation below, patent trolls play an intermediary function. They are necessary because large, well-funded corporate infringers ignore inventors and small businesses. These innovators then must either allow their creations to be stolen from them, or they must turn to an intermediary for assistance. Thus, while patent trolls may be a nuisance to infringers, they play a critical role assisting innovators. To some extent the very fact that infringers gleefully refuse to deal is what has caused the need for the intermediary that they now vilify.

 

QUINN: Thanks, Stephen, for taking the time to chat with me today. I really appreciate it. I know that you have come out with a recent study that comes to the conclusion that patent trolls or patent monetizers are providing a good service and a benefit to the patent system and for innovation in general. So I thought maybe we could start with you telling us a little bit about your study and what the findings were that you came up with.

HABER: My coauthor, Seth Werfel, and I were curious about the patent assertion entity literature because what one can’t help but observe an obvious paradox: some scholars point to the deleterious effect of PAEs on the innovation ecosystem, but yet we observe so many PAEs and we observe that individual inventors assign their patents to those PAEs. This suggests that PAEs are serving an intermediary role in the market.

Permit me to explain what intermediaries do. A classic example of an intermediary is a bank, which connects savers and borrowers who would have difficulty writing and enforcing loan contracts directly: the savers don’t know anything about the borrowers, and they are not expert at the legalities of writing and enforcing financial contracts. The borrowers do not know the savers, and they have no way of credibly committing to repay the loans, because they know that the savers are not experts at contract enforcement. The bank does, however, know both groups and it is expert at contract enforcement. Note that it does not produce anything: it serves an intermediary function between the savers and the borrowers. So this basic principle of economics motivated us to look at the potential intermediation role played by PAEs.

What we did was develop a survey experiment where we surveyed actual inventors and entrepreneurs who are either current or former members of accelerators or incubators at Stanford and UC Berkeley. We gave them a hypothetical scenario in which subjects were then told to imagine that they had been awarded a patent for this idea that they estimated was worth approximately $1 million. All subjects were then informed that a large corporation saw their idea and decided to infringe the patent without paying for it. Each subject was then randomly assigned to either a control or treatment condition. Subjects in the control condition were given two options: sell their patent to a PAE for a guaranteed $100,000, or hire a lawyer to assert their patent in court for $1,000 per hour with no limit on the number of hours. Subjects in the treatment condition were given the same two options, except that the lawyer worked on a contingent fee basis of one-third of the total award if they won the case and zero dollars otherwise. Therefore, the only feature that varied across groups was that treated subjects were no longer constrained by upfront costs or the prospect of net losses. Subjects were then asked whether they wished to sell their patent to a PAE or hire the lawyer, and the responses to this question served as the dependent variable for our analysis. Differences in responses to this question across the control and treatment groups allow us to draw inferences about the extent to which financial constraints affect the demand for PAEs.

We then test the hypothesis that the shift in demand for PAEs is driven by individuals who tend to be financially constrained. If this hypothesis is correct, then we should observe relatively larger treatment effects for subjects who self-identify as inventors than for those who self-identify as entrepreneurs, because the former tend to be more financially constrained than the latter. The results of the experiment confirm the hypothesis: the contingent fee treatment had an effect only on inventors. In fact, it reduced the percentage of inventors who chose to sell to a PAE by nearly three-fold, while the effect on entrepreneurs was trivial.   The implication is that inventors chose to sell to PAE s because, from the point of view of the inventor, the PAE provides them with insurance against potential losses from litigation and liquidity.

QUINN: It’s interesting that you put it like that because I had not really thought about the intermediary aspect. Although if you talk to inventors and to startup companies as well you hear that they would prefer to be able to just pick up a phone or write a letter and get an audience with somebody who they think is an infringer to talk to them about taking the license or buying the patent and then you to these conferences, I go to a lot of these conferences and you get attorneys who work for would be what we could call the infringer group, the high tech companies that are constantly being alleged to be infringers, and they talk all the time about how they get these letters and they just throw them away. They do not take any of them seriously. They do no due diligence on them to see whether they are infringing or not. And they simply do not take anything seriously until they get sued. So it does strike me that there is a breakdown in the arm’s length negotiation model between those who have patents and those who are infringing patents. That is exactly the gap that they fill because they create equalization, whether you want to refer to them as a monetizer, a troll or a non-practicing entity, or assertion entity. They level the playing field so rather than a big company going against an individual inventor it is now big company going against a well-funded patent savvy licensing company.

HABER: Exactly. I come at this not as a guy who spent my life studying patents but as a guy who spent my life studying finance. And one of the things that was striking to me when I started to read the literature was that it was almost innocent of the question of how the PAEs come to own the patents in the first place. Why wouldn’t an inventor assign her patent directly to a manufacturer for 100 cents on the dollar, instead of assigning it to a PAE for less than 100 cents on the dollar? The evidence from Michael Risch’s work is that PAEs hold a disproportionately large percentage of the patents filed by individual inventors, and an obvious implication is that individual inventors feel that they do not stand on equal footing against a manufacturer that is infringing their patent. So, its hardly surprising that they go for what, from their point of view, is the next best option, take something less than 100 cents on the dollar but for sure get something—and leave enforcement to a firm that not only specializes in it, but that can go to the securities markets and raise the capital to level the playing field.

The U.S. economy is full of intermediaries everywhere you look. But for some reason we have demonized the intermediaries in the market for innovation. Think of it this way. Most people buy their groceries at a grocery story. That grocery store does not grow any of the vegetables, raise the meat, nor catch the fish. It is simply an intermediary.

Now I can see why from the point of view of a manufacturer the PAE may be a nuisance. But from the inventor’s point of view the PAE is a valuable intermediary.

QUINN: Right. And it is the only way that inventors, in many cases, are ever going to be able to have their grievance attract any attention or even be considered. So basically, what I am hearing you say, is that if in a marketplace there is an intermediary and the intermediary is not functioning and providing an important role then that intermediary just will cease to exist at some point in time.

HABER: Yes. A classic example would be travel agents. We used to book virtually all travel through a travel agent. But when was the last time you used one? Travel agents did not own any airplanes. He or she simply booked your ticket—and prior to the internet that was an extremely useful service that both consumers and airlines were willing to pay for. But once the cost of information fell such that consumers could book tickets directly over the Internet the intermediary we call the travel agent largely disappeared.

QUINN: They likely morphed their business model as well. So now the travel agents that are still in existence are really putting together packages that are attractive and it is a turnkey kind of an operation. So really it is a totally different model than what it used to be.

HABER: Yes, exactly. It follows that you should not observe the proliferation of an intermediary that serves no useful purpose. When we observe the proliferation of an intermediary it implies that it is serving some role in mitigating an imperfection in a market.

QUINN: That is very interesting. I am almost speechless because in economic terms this suggests quite directly that there is an important role being played here because this marketplace continues to grow. There continues to be more players in the marketplace and even still there are many more inventors who would love nothing more than to find somebody that they could work with. Whether it is a patent monetization company or an attorney that is going to take the case on a contingency basis. What I see and hear is people who have assets that are being infringed and they want help. Maybe the amount of money that is potentially obtainable is not quite enough to attract those other entities for the amount of effort that is involved. Based on what I am hearing you say together with what I have observed it seems that the marketplace has not yet reached maturity.

HABER: There is a wonderful a series of papers, by Naomi Lamoreaux and Kenneth Sokoloff, and also by Zorina Khan, on what happened in the United States in the 19th Century with the arrival of the disruptive technologies associated with electricity and mechanical power. During that period there were also intermediaries who emerged, who at the time were derisively called “patent sharks.” These patent brokers and patent lawyers were denounced for promoting a lot of litigation, but no reasonable person today thinks that the proliferation of lawsuits and patent sharks in the latter half of the 19th century impeded U.S. economic development or the rate of innovation.

I think that you are inevitably going to have intermediaries of various kinds in a market. We are just at the beginning of seeing the development of specialized entities assert and litigate and allow other people to do what they do well, which is invent. Indeed, I imagine that we are going to see a proliferation of different kinds of entities, such as those that provide insurance against litigation.

QUINN: During this conversation you have helped me put my finger on what it is that I guess I’ve been struggling to articulate for so long now with defending the role that these entities play. Because I’m a lawyer and I’ve always described the role of a lawyer, whether it be when I’m teaching law students or just explaining it generally, is not to do anything in the first instance. The role of the lawyer is to take your position as the client and move forward to do what you could do yourself if you had the knowledge that I have as a lawyer. I am representing you. It strikes me that that really is what is going on with the patent assertion entities. And yet some of them quite directly because they do not buy the patents, will partner with the small company, the startups, the innovators and share in the backend. Sometimes they will acquire the patent portfolio directly themselves if the innovator wants to just sell and move on. But they are really just doing what the smaller players could do themselves if they had the wherewithal to do it, really vilifying the messenger it seems. We always have these jokes; do not kill the messenger who is just bringing the bad news. But that really is what is going on.

HABER: There’s a well-known result in social science that goes back to Mansur Olson’s The Logic of Collective Action. The point of Olson’s book was that small well-organized groups will almost always beat large diffuse groups. Having large numbers is not an advantage in getting what you want in the world of politics, because a small, concentrated group can solve problems of coordination much more effectively than a large group. Individual inventors are in the position of being in a large, diffuse group. And so, when it comes to patent reform we have mostly been getting the point of view of a small group of large manufacturers. I am not saying that they do not have a valid point of view. From their point of view, a PAE is indeed a nuisance. It is just we have not considered the point of view of the inventor in most of the discussion that has taken place. And when I talk to individual inventors they tell me a story much like you are telling me which is “I’d rather sell to a manufacturer but the problem is they show me the door or won’t even respond to my letter.”

QUINN: They will show you the door if they get that far.

HABER: So, in much of the academic literature and in much of the public discourse we’re only looking at half of the ecosystem, the part between the PAE and the manufacturer, not the part between the inventor and the PAE.

QUINN: You know this is fascinating. Let me ask one more question about what you were just talking about because I have lamented for a very, very long time and I am convinced that there are far more people supportive of strong patent rights and a strong patent system than there are on the other side. I just haven’t been able to understand why it is that the people who want to weaken the patent system have been able, with such laser precision, to drive the PR campaign to a point where now Average Joe would think it is self evident that patents are bad. And it strikes me about this study is that the small, more nimble group will always have an advantage. I wonder how much of that is due to the fact that the larger the group that you have the more disparate view you have and that waters down the message.

HABER: In part, I think that the views of inventors are more disparate, but I also think that whenever you have a really large group it is difficult to coordinate. Think about committees: if you have a committee of 20 people you can be assured that unless 17 of them don’t show up for the meeting no work will get done. If you start out with a committee of three, on the other hand, there is a high probability of getting something accomplished.

QUINN: Oh, I know. Years ago there was a committee I was involved with for a short while. I thought the committee was going to do an awful lot of good to help high tech inventors. It was an accelerator-type project. And there must have been 40 people on this committee. It seemed like all we did was sit there and talk. We would get to the end of the meeting and essentially all we did was table the discussion for the next time having reached no conclusion or even come up with a single action item.

HABER: You know, that sounds about right with 40 people. This is not inevitable but it is very common. When you have large diffuse groups it is very hard for them to coordinate simply getting together and agreeing on what they want to do and how they are going to do it. It becomes increasingly hard, the larger the group. And when you are talking about a community that may be hundreds of thousands it become extremely hard to coordinate the efforts of the group. Whereas if you are talking about a small number of players it is very easy to coordinate the activities of the group. This was Olson’s key insight, and its an insight that has stood the test of time.

QUINN: This again I keep saying this is so interesting but it is answering a whole lot of questions. Because one of the ways the groups that are fighting against reform typically seem to operate is they try and get a generic letter and try and get hundreds of people to sign onto this generic letter and then say look at all of the people who are supporting us and then it really doesn’t go anywhere. It’s not terribly specific, it’s generally big, very broad first principles that everybody can agree with and then I think you also have the situation where now everybody thinks that they’ve done something when in fact all they did was send a letter. I mean sending a letter is an important part of this process and if you’re not willing to send a letter than we’re lost I think because if your level of involvement can’t be to sit down and write a letter explaining why this matters to you then the other side is just going to prevail. But that cannot be enough.

HABER: It takes a concentrated and concerted effort to convince populations and legislators to enact particular pieces of legislation. I want to be clear here: I am not for or against any particular piece of legislation that is currently pending or being considered. I do not see that as my role. I see my role as using social science research to provide a way for people to think about the information that they get. And then people should make up their own minds. But what you are saying is consistent with what Olson would have predicted. You have a large number of inventors spread across the United States. They are not likely to be very good at coordinating among themselves to speak in a concerted and organized way.

QUINN: Yes, and that is exactly what we wind up seeing. Obviously I have opinions about all this stuff and I have expressed them. But at the same time I completely understand why the groups that are trying to get more reform are trying to do what they are doing. That is what they perceive to be in their best interests. I personally do not have any problem with that. I think that everybody should have the ability to advocate for what is in their own best interest. I’d just like to think that Congress would take the time to consider the other side and that is the part that gets a little bit infuriating.

I really appreciate you taking the time to chat with me today. This conversation was very informative for me, and I think it will be for others as well.

HABER: It was my pleasure to chat with you. I look forward to the next time.

The Author

Gene Quinn

Gene Quinn is a Patent Attorney and Editor and founder of IPWatchdog.com. Gene is also a principal lecturer in the PLI Patent Bar Review Course and an attorney with Widerman Malek. Gene’s specialty is in the area of strategic patent consulting, patent application drafting and patent prosecution. He consults with attorneys facing peculiar procedural issues at the Patent Office, advises investors and executives on patent law changes and pending litigation matters, and works with start-up businesses throughout the United States and around the world, primarily dealing with software and computer related innovations. is admitted to practice law in New Hampshire, is a Registered Patent Attorney and is also admitted to practice before the United States Court of Appeals for the Federal Circuit. CLICK HERE to send Gene a message.

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