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 2 nd ATE Symposium UNSW December 15 , 2014 2 nd ATE, UNSW Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 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) 2 nd ATE, UNSW Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 2 / 24

2 nd ATE, UNSW Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 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" 2 nd ATE, UNSW Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 4 / 24

Information Externality and NPE’s Incentives to Litigate Each PE’s pro…t : π 1 = π 2 = 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 2 nd ATE, UNSW Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 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 2 nd ATE, UNSW Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 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. 2 nd ATE, UNSW Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 7 / 24

Technological Overlap between Two PEs Four Possible Litigation Outcomes: ( I , I ) , ( I , NI ) , ( NI , I ) , and ( NI , NI ) : Pr ( I , I ) = θ 2 + 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 ( I , I ) Pr ( I j I for the other …rm ) = = θ + ρ ( 1 � θ ) � θ Pr ( I ) Pr ( I , NI ) Pr ( I j NI for the other …rm ) = = ( 1 � ρ ) θ � θ Pr ( NI ) 2 nd ATE, UNSW Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 8 / 24

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

Benchmark: No Information Externalities NPE’s incentive to litigate against PE i can be analyzed in isolation. π i = PE i ’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 PE i if θ π i 2 � L When NPE’s litigation threat is credible against PE i , the two …rms can settle out of court to save litigation costs. We assume that both NPE and PE i engage in Nash bargaining with a licensing fee of θ π i 2 . 2 nd ATE, UNSW Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 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 f θ , θ , θ g . Three scenarios: I NPE wins in court: ˆ θ = θ I PE 1 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 only if θ π 2 ˆ 2 � L The value of NPE’s patent portfolio with respect to …rm 2 is given by ( ˆ if L � ˆ θπ 2 / 2 θπ 2 / 2 , V ( ˆ θ ) = 0 otherwise . 2 nd ATE, UNSW Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 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 = θ V ( θ ) + ( 1 � θ ) V ( θ ) � V ( θ ) . Lemma If θπ 2 / 2 < L < θπ 2 / 2 , the information externality Ψ is negative. If θπ 2 / 2 < L < θπ 2 / 2 , then the information externality Ψ is positive. Otherwise, Ψ = 0 . The NPE has a credible incentive to litigate the …rst …rm if θ π 1 2 � L + Ψ � 0 . (2) 2 nd ATE, UNSW Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 12 / 24

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

Figure: Credible litigation threat with information externality 2 nd ATE, UNSW Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 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. 2 nd ATE, UNSW Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 15 / 24

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

Competition among PEs π m = monopoly pro…t π d = duopoly pro…t, where 2 π d � π m . 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 ( ˆ θπ d / 2 if L � ˆ θπ d / 2 , V d ( ˆ θ ) = 0 otherwise . I If the …rst …rm was found infringing and did not obtain a license, the NPE gets ( ˆ θπ m / 2 if L � ˆ θπ m / 2 , V m ( ˆ θ ) = 0 otherwise . 2 nd ATE, UNSW Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 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 π d + 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. 2 nd ATE, UNSW Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 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 π d operating in di¤erent product markets. 2 nd ATE, UNSW Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 19 / 24

Figure: Litigation incentives with product market competition and unrelated technologies 2 nd ATE, UNSW Jay Pil Choi and Heiko Gerlach () A Model of Patent Trolls 20 / 24