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January 28, 2008

Dr. PatentLove

ScaledStrangelove.JPG or: How I learned to Stop Worrying and Love Proposed Damages Apportionment Law

The blawgosphere is alive with discussion of proposed patent reform.  Patent Troll Tracker today mocked Dennis Crouch for his support of the status quo.  Here at Patent Prospector, we maintain a healthy amount of skepticism about the proposed legislation.  Patent Hawk earlier pointed out how the new damages apportionment rules could potentially raise the cost of litigation for accused infringers by requiring the disclosure of more (highly proprietary) information about the cost, revenue, and profit of accused products and processes.  For my part, in an earlier post I called the new damages apportionment rules "the crudest and most error-prone way to handle bad patents."  The worry is that judges and juries will tend to "split the baby" by lowering some damages awards, which in may cases are properly justified by the economic value of a patented technology.  The political reality is that a Congressional amendment to the law suggests the inference that current reasonable royalty awards have been too favorable to patentees.  (See, for example, how many injunctions have been awarded to non-practicing entities since Mercexchange v. eBay.)  Information asymmetries between judge or jury and the expert witnesses and parties should be part of the equation in designing the rules, as some recent antitrust law scholarship suggests.

Despite this skepticism, I cannot agree with Dennis that "the proposed patent reforms now being debated by the Senate do virtually nothing to address these serious problems and instead potentially cause harm to the current regime."  Specifically, Dennis points out "massively overlapping claims" as a problem for the current patent system.  Since earlier posting strong criticism of the proposed damages apportionment rules, I've come around to seeing how the proposed rules could actually improve the efficiency of patent markets afflicted with the transactions costs associated with "massively overlapping claims."  Here's how:


First, to define the problem, a patent thicket can arise when multiple patents cover a product, and each of the multiple patentees (rationally) tries to encompass as much of the profit as possible.  The multiple patentees may behave this way even without fraudulent intent because each patentee tends to have more information about the value of their own invention than does any other patentee or the accused infringer.  All the accused infringer can do is try to pay as little as possible for each license.  But in some (perhaps many) cases the result is either underproduction of the patented product or a feast for the earlier licensors and famine for the later.

More generally, this problem can be identified in markets in which complementary inputs are provided by multiple firms to a producer selling in a competitive market.  French mathematician and economist A.A. Cournot pointed out that the producer will tend to underproduce in these circumstances because each complementary input supplier will try to encompass all of the profit.  Profs. Lemley and Shapiro have argued (with empirical support) that "stacked" patent royalties can resemble Cournot complements in their economic effect on production.

How do proposed damages apportionment rules help untangle patent thickets? The new rules explicitly provide that patentees seeking a "reasonable royalty" (i.e., the proposed rules don't change how damages for "lost profits" are calculated) may receive only a portion of the profits from a patented invention when neither the "entire market value" nor the "marketplace licensing" measures of damages appear to provide an accurate measure of the economic value a claimed invention has contributed to an infringing product or process.

By definition, where a patent thicket exists, the "entire market value" measure for "reasonable royalties" does not apply.  The problem of Cournot complements remains, however, even when existing "marketplace licenses" are available as a measure of reasonable royalties.  Thus, the "apportionment" provision of the proposed rules is useful to the extent that it tells judges and juries to think about how big or small the slices of the pie need to be to ensure that everyone who contributed to its baking gets a slice.

Here's another way to look at it:  From the point of view of everyone in the market for ideas (except, perhaps, the opportunistic few  who help themselves to the pie first), patent thickets are bad.  Because no participant in the market has complete information; nobody is going to agree about how the pie gets sliced.  Cournot knew that markets could solve his problem: owners of complementary inputs can integrate.  In patent markets, this can be achieved through patent pooling.  But patent pools often cannot be formed; transaction costs go up as fast as N(N-1)/2 where N is the number of patentees in the market.  And when patent pools are not formed, the difficult job of deciding how the pie will be sliced up must be done by other institutions in society, including, as a last resort, the judicial system.

To be absolutely clear: in my view, the proposed rules regarding damages apportionment could be improved.  In particular, I would much prefer to see the magic words "availability of non-infringing alternatives" somewhere in the statute.  (There is still no better way to define the economic value of an invention than by comparison to its alternatives.  Why not make that explicit in the statute?)  Nonetheless, I felt a desire to clarify some of my earlier overstatements.  The proposed damages apportionment rules may not, in fact, be disastrous for the emerging market for ideas.  In instances where a patent thicket has developed, apportionment could conceivably lead to more efficient production, and more efficient allocations of profit among all patentees who have contributed to the product or process sold.

Posted by Michael Martin at January 28, 2008 4:43 PM | Damages

Comments

Aren't judges (and juries) pretty free to apportion damages even now? Aren't massive damages assessments being overturned on a regular basis? Isn't Microsoft enjoying record profits in spite of all those alleged "trolls"? If it ain't broke, don't fix it.

Posted by: bierbelly at January 29, 2008 11:41 AM

bierbelly,

I agree with the "if ain't broke, don't fix it" philosophy. In a sentence, my point is that if someone's going to go ahead and "fix" it anyway, it's not so terrible to expressly permit apportionment of profits generated by a product or process covered by multiple patents.

Posted by: Michael Martin at January 29, 2008 1:33 PM

Mike, I don't have a lot of disagreement with you on this, but I do disagree with the "if it ain't broke, don't fix it" philosophy here.

In so far as I can see, the argument is that judges and juries *can* already apportion and *sometimes* overturn the massive malapportioned damages awards when they reach some sort of political breaking-point. The implicit assumption is that apportionment is a good idea, but we shouldn't mandate it because . . . it is done already! Sometimes.

This makes no sense to me, none. If it is a good idea, it should be done consistently, not only whenever the district judge feels like it or when the Federal Circuit has the political spotlight turned on it once-in-a-blue-moon. Aside from logistical difficulty, I have yet to see an argument against apporitionment. But saying that "preventing overcompensation through apportionment is too logistically difficult, and so we shouldn't bother" is like saying "preventing undercompensation through patent enforcement is too difficult, so we shouldn't bother." Logistical difficulty is a wonderful objection in that it can be used to object to just about anything, and would work just as well to repeal 271 altogether. I sure don't see that being advocated by the anti-apportionment crowd.

Posted by: TJ at January 29, 2008 1:55 PM

One big problem with making a major statutory change right now is that the Supreme Court has changed the patent world and it’s too early to understand exactly how those changes are going to impact the validity and value of patents.

My bet is that smart defense counsel are going to figure out a killer strategy for obviousness that will decimate most, if not all of the overlapping patents that cause tech giants so many headaches. If I’m defending an infringement suit, I’m going to slide hindsight bias into the case in some way. If I’m dealing with something that’s commonplace today, I’ll make it obvious yesterday.

I’ll have my expert walk through the ease with which he/she could have developed the same device/method/system at the time the inventor was doing so by simply assembling pre-existing concepts. When the expert is asked why he/she didn’t make the development, the answer will be that it was such a trivial and obvious step that it wasn’t worth the time to do it.

Posted by: dvan at January 29, 2008 2:02 PM

"...the answer will be that it was such a trivial and obvious step that it wasn’t worth the time to do it."

Isn't the logical response to that argument, "Well, patentee thought it was worth doing, and once defendant saw patentee doing it, defendant copied it"?

In other words, why wouldn't patentee's counsel simply explain to the jury that copying is evidence of non-obviousness?

Or, "If it's so trivial, why can't defendant stop doing it and/or take the feature out?"

Posted by: DJ at January 30, 2008 8:04 AM

One more thing: Barnes and Noble tried that in the case over Amazon's one-click patent. BN's "expert" testified that the one-click patent would have been obvious to anybody who'd read some text book he wrote years before. When he was asked directly, "Did you ever think of doing it?" his answer was a lame, "Well, no." So unless you're prepared to coach your "expert" to lie on the witness stand, you may want to rethink your strategy.

Posted by: DJ at January 30, 2008 8:13 AM

TJ,

Inconsistency is bad, but "logistical difficulty" should be evaluated with relative institutional competencies in mind. The fact is that executives managing companies that actually invent or sell products are far better situated both in terms of information and training to decide how profits should be apportioned.

But your point is sound that if we're going to rely on courts to resolve disputes (and patent thickets tend to drive parties to last resorts like the courts), then we should demand that they resolve them consistently.

Posted by: Michael Martin at January 30, 2008 7:44 PM