How to Slay the Patent Trolls

Startup companies that power growth are the most vulnerable to baseless intellectual property lawsuits.

Not really cute, even in an ugly way..

Photographer: Tim Graham/Getty Images

In a recent episode of HBO’s sitcom “Silicon Valley,” a lawyer tries to extort money from a struggling startup by threatening to sue it for patent infringement. The troll, who understands nothing about the underlying technology, owns a patent so broad as to be unenforceable, but knows that the victims of his perfectly legal extortion scheme lack the financial resources to fight him in court.

A recent research paper by economists Ian Appel, Joan Farre-Mensa and Elena Simintzi shows that the show’s humorous scenario isn't that far from real life. Appel et al. note that patent infringement lawsuits have increased by a factor of 10 since 2000, and that so-called non-practicing entities -- basically, companies that own patents but don’t use them to produce anything -- account for more than two-thirds of the increase. The cases that go to court obviously represent just a fraction of the times that NPEs put pressure on tech companies -- their more typical mode of operation is to send threatening letters. Small businesses are the most common targets. Most of the time, companies cough up the cash, viewing the trolls as merely one more cost of doing business.

This could be very bad for the economy. Startups -- small, fast-growing businesses -- are engines of job creation. New businesses tend to create a lot more jobs than established ones, and their employment levels tend to hold up better in recessions. But since 2000, the U.S. economy has been creating fewer and fewer startups:

Where's That Entrepreneurial Spirit?

New companies play a shrinking part in the U.S. economy

Source: Ryan Decker, Federal Reserve

NPEs, or patent trolls, could be one of the forces crushing dynamism in the U.S. A large body of research documents the potential harm that they can do to young, growing companies.

But state governments are fighting back. As of 2016, 32 states had passed laws aimed at limiting NPEs' use of demand letters. Typically, if courts decide a patent holder’s demand letter was unreasonable, it can impose penalties on the person or company making the threats.

Appel et al. study the impact of these laws on small businesses. The results look encouraging. States that adopted these laws saw a 2 percent increase in employment at small, high-tech companies, and a 14 percent increase in the number of companies receiving venture-capital funding. In states with a larger VC presence -- for example, California -- the increase in the number of tech startups was particularly pronounced. Information-technology companies -- just the kind depicted in “Silicon Valley” -- were particularly helped by the laws.

This suggests that anti-troll laws are working as designed. That’s good news, but it raises a larger question. If patent trolls have this large of an impact, what about other patent holders? The chilling effect of trolls on startup formation doesn’t seem like it would depend on the claimants being NPEs -- an infringement claim by a large company such as Apple Inc. or Microsoft Corp. would probably be just as deadly for a struggling startup.

Take Apple, the world’s largest company by market capitalization -- a behemoth among behemoths. The company is most famous for creating beloved consumer products like iPhones and iPads, but it’s also known for persuading courts to grant it some pretty questionable patents. In 2012, the company patented the use of rounded corners on rectangular electronic devices -- hardly a brilliant technological breakthrough. Apple has patented the design of its packaging, the glass staircases in its stores, its 60 percent recyclable bag, and the shape of the icons in its operating system. It has even patented the design of its music icon -- just two eighth-notes on a blue or white background.

But Apple is far from unique in its intellectual property adventurism. Inc. patented the practice of taking product photos on white backgrounds. IBM recently patented the “out-of-office” email system, despite the fact that everyone has seemingly been using similar systems forever. Alphabet Inc. (Google) patented a baseball cap with a camera on it.

Lots of these patents might not hold up in court. A variety of existing patent laws are set up to prevent unreasonable patents -- for example, if you can prove that you were implementing an idea long before someone else patented it, you’re often safe. But these laws have a lot of uncertainty in their application. A big company has the deep pockets and existing legal infrastructure to take a gamble on a patent lawsuit, while a small startup typically doesn’t. Patents have gotten so important in the tech business that multibillion dollar corporate acquisitions are made just so big companies can get more patents. That’s a game that small startups just can’t play.

The spread of intellectual property could be stifling not just job growth, but innovation. The rise of design patents and software patents has greatly increased the number of things corporate giants can lay claim to. Design patents, for example, have increased by more than a factor of six since 1980:

Overdoing It

Number of design patents granted

Source: U.S. Patent and Trademark Office

Meanwhile the size of the economy has grown by less than a factor of three, and productivity growth has slowed down in recent years. All this patent activity doesn’t seem to be giving innovation much of a boost.

Intellectual-property reform needs to happen. There have been some encouraging signs in recent years -- for example, courts seem to be less willing to enforce patents on business methods, one of the most egregiously abused categories. The state anti-troll laws are another good move. But the health and dynamism of the U.S. startup ecosystem might require larger-scale action. Intellectual property in the U.S. has probably gone past the point of encouraging innovation, and both courts and legislators should think about how to further curb the patenting craze.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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