The ever increasing valuations in the mobile and telecommunications space signal a deep rooted problem of U.S. patent laws, and its litigious culture. Although some claim the “bubble is over” with Google’s recent acquisition of Motorola; the war is far from being over. However, in the short-term, an early stage start-up can ride the wave by improved valuations and larger venture pay-offs.
Those who believe that the bubble is over, miss out on some key factors driving the recent intellectual-property (IP) arms race in the smart phone industry. These believes cite that Google by acquiring Motorala, has put an end to the race of acquisition craze, because Google’s entrance to the smart phone marketplace will establish the much needed balance of power and will end the IP hoarding race. It is partially true that patent acquisitions and valuations are driven by strategic factors; however, fending off litigation has been at its core.
The basic principle to determine the value of a technology patent is how much it could allow a company to gain price elasticity and market share. When the industry witnesses a flurry of patent suits, the value of a company’s market share will be highly correlated with how well it can protect itself against litigation liability. Hence, the IP valuation and IP litigation become intertwined; patents deriving their value not by how much value they create, or strategic value, but how much negative value (damages to pay in lawsuits) they can defend against, or defensive value.
The rise in litigation is highly due to the complex nature of smart phone technologies that connect different innovations both from computing and the mobile telephony, that have to be interoperable and work together. Google’s chief legal counsel, David Drummond states in one of his blogs a smartphone “might involve as many as 250,000 (largely questionable) patent claims.” Such patent complexity makes the smart phone industry a hot bed for litigation. Although, the slowing of the IP acquisition race may influence valuations, the industry will increase its IP litigation, thus driving up the defensive value of these patent portfolios.
Mr. Drummond is not alone in his assessment of these patents to be “questionable.” The USPTO office has been under attack for loosening up its standards on technology patents. The most famous attacks on the USPTO dates back to 1999 with Amazon’s 1-click patent, which is the technique of allowing customers to make online purchases with a single click. The 1-click patent application has been denied in Europe; while it has been widely contested in the U.S., it still stands as a valid patent and online companies have to pay Amazon for the right to use 1-click purchase technology. Many of smart phone “patents” are claimed to be questionable. With a price tag of $1 million to challenge questionable patents for validity, many of them remain uncontested until they become involved in infringement lawsuits.
But, this is not the only cause. Apple, Miscrosoft, Nokia, Samsung have all used the International Trade Commission (ITC) to file their patent lawsuits, instead of filing in federal court. Although ITC was formed to help companies find speedy resolutions to their claims, it has caused increased litigation by technology companies eager to capitalize on the speed and expertise of the specialized venue. ITC specializes in patent litigation (85% of lawsuits filed at ITC are patent related), making it an attractive venue for the smart phone industry. And, with the lower cost of litigation and speedy resolution of claims, it has attracted lawsuits that the slow federal court system would have otherwise detracted.
More troubling is the size of patent damages awarded. While the average patent award in Chinese courts is $25,000, in the U.S. it has risen to $12M, more than doubling in size since the last decade, although the award in the U.S. can easily be as high as $1.5 billion.
Therefore, the economics of patents encourages litigation - driving up their defensive valuations. Without any serious reform on how patents are granted and litigated, the smart phone industry will remain to be the hotbed of litigation and the defensive value attached to their patents will continue to rise.
However, regardless of the reasons underlying these valuations, if these acquisitions are indeed priced solely on a cost-per-patent basis, as looks likely, it would set a benchmark for valuing intellectual property portfolios, and hence help your early stage start-up valuations. Recent acquisitions of Motorola and Nortel, each give a valuation of $510,000 per patent acquired. And since venture capitalists heavily rely on relative valuation methods, it is good news for the early stage start-up.
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