Patent Wars

Von Clausewitz famously wrote that "war is state policy by other means." We can go further and say that economics is war by other means; wealth is power that a country can use to fulfill state policy without mobilizing its military forces. The wealth of corporations, by use of corporate law and trade agreements, complements direct government action in these policy endeavours. In effect the state operates through the private sector by proxy much as two world powers have often funded other countries as proxies to fight their fights in furtherance of their own policies.

Patents and patent law are important parts of economic warfare. It is often a means to extract wealth from other countries by using international agreements to prevent cheaper competitive products that these countries would either import or manufacture themselves. Think of generic pharmaceuticals, genes, machinery, GMOs, among many others. It all works in a manner similar to the way Britain once forced its colonies to import products from British factories even though they could manufacture these themselves from the same raw materials that they exported to Britain. For example, Indian cotton and clothing.

Patents can only be used in this fashion by a country when its citizens and corporations have more and better patents than those countries it wishes to target. This ration can be improved by combining a low standard for granting patents and a judicial system that is loathe to question weak patents. By also allowing corporations a means to request import restrictions by the government on products that are alleged to violate patents, the power of domestic patents is increased. The US today does all of these things.

For this reason I was quite interested to read in The Economist that China is finally catching up to the US with its patent portfolio. The chart they show (from WIPO data) clearly demonstrates the trend. With China's rapid growth, large population and strong national desire to elevate their status among the great countries of the world, this is wholly unsurprising. A good example is their space program. Since the end of the cold war the US space program has drifted, having no clear objective for exploration beyond science. In contrast, China recently announced a new unmanned Moon mission that failed to make more than a small media ripple in this part of the world. The US and Russia are no longer one-upping each other to get to the Moon and beyond, but China is aggressively advancing their space program in a manner somewhat similar to what we saw in the 1960s and 1970s. They feel they have something to prove, and perhaps they do.

With respect to modernization and technological advancement, China is catching up, and patents are only one measure of their progress.

The question for America is not the influx of cheap but what do we do when cheap is gone and China starts to make the expensive stuff, too.

With let up in the trend, the quality and quantity of Chinese patents will pass Europe and the US very soon. As the innovation balance gradually shifts east there will be some profound impacts on the US and Europe, and their private sectors. As this article began, if patents are a battlefield the advantage will shift east as well. Patent law, which currently favours the US due to their larger and stronger portfolio, will, perhaps as soon as 2020, begin to benefit the China more often. Since old patents expire and the majority of new patents will belong to Chinese companies, the winner of more and more patent lawsuits will be won by Chinese companies.

When this happens I think we may finally see patent reform. At first in the US and then, if they negotiate wisely, internationally. If the bar is not set higher so that weak patents cannot be used as weapons in the court, US companies will suffer. Until this happens I suspect that Congress will not change course. However, this is a large ship that changes course only very slowly. Even so it is unlikely to change the outcome, especially so if the US continues to turn out fewer engineers and scientists, or just at a slower rate of growth than the competition.

Nortel Patents Still Have Legs

It seemed that the last time I wrote about Nortel and their wireless patents that I'd never again have reason to mention that company. They are after all in the process of being dismembered and disbursed to others. I saw little reason to think that the patents would still have any independent life apart from being parcelled off with the business lines. I was not the only one to think that.

Now I see that the situation was not quite as simple as I thought. If this article is correct, Ericsson agreed to short-term rights on a patent portfolio that would appear to impact on their business assets purchase.

"According to sources, wireless giants such as Nokia Corp. and Telefon AB LM Ericsson have privately expressed interest in acquiring the patents to protect their purchases last year of various Nortel wireless assets. It is believed that the new owners have short-term licensing rights to the patents."

On the surface, this situation would appear to confound the calculation of the price Ericsson paid since it would be uncertain how much they would have to separately pay over the long run for those patents to get the value out of the products they now own. I can only conclude that I simply do not know enough about the dynamics that are playing out in this never-ending saga. However, I can make a guess.

When there is carrier business on the table, vendors with the requisite technology and products jockey for position to win the business. The wireless sector is hot so there is a lot of money at stake, so every vendor wants the lion's share of the business. The carriers, all of which are pretty sharp at this game, do all they can to avoid single-sourcing, either by explicitly demanding a multi-vendor solution or citing standards compliance in the RFP, and often both; keeping two or more vendors on the hook is used as leverage to negotiate lower prices and more features.

This is a game that has played out many times in the telecommunications business, and I've been a part of it more than I care to remember. When there is no urgency to roll out services, this game can go on for years. When there is urgency -- when the carriers feel compelled, for whatever reason, to roll out services quickly -- the game proceeds much faster since vendors avoid spending time and resources fighting each other when there's big money on the table. How it all plays out generally looks something like what follows:

1. Each vendor has its own unique technology and patent base that it promotes as the best. They try to have the carriers write their RFPs in such a way as to favour their own technology.
2. The carrier points to an industry forum or standards body to hash out a common technology base and feature set, which they would then reference in their RFP. Carriers with similar interests will typically cooperate under the auspices of that forum or standards body to the extent that they all push vendors in the desired direction.
3. Vendors work hard to skew the standard to incorporate their own technology's features, hoping to slow their competitors' ability to bring their own products into compliance. If they are successful, they can also hope to reap patent licensing royalties from other vendors, either directly (if those vendors successfully win bids) or indirectly (by making their competitors' products too expensive to win bids).
4. Vendors and carriers block adoption of standards -- they're typically consensus bodies -- until the company holding relevant patents agrees to sensible royalty rates or waives them entirely. Many standards bodies make it a condition of participation -- legally binding, usually -- that this must be done.

In the case of wireless infrastructure equipment, including LTE, relevant patents are held by all of the largest vendors. Since these same companies often enter into global or sector-specific bilateral cross-licensing agreements among themselves, there may not be a serious issue with which of these vendors ultimately buys this batch of Nortel patents. Even if Nortel were to stay in business as an NPE (non-practicing entity) -- licensing patents as its primary business -- there may not be an issue; however this latter scenario is unlikely since creditors rarely agree to take an equity position in the bankrupt company, preferring to sell and put the proceeds towards the debts. Where the matter gets interesting is if the patent portfolio is sold to a company that is not one of the cabal of wireless infrastructure vendors.

For example, if the patents go to RIM, since they are not in that infrastructure business today, they have no incentive to cross-license and would most likely choose to build a royalty business or litigate against LTE vendors. From, say, Ericsson's point of view, they may not value the portfolio highly if it were to go to Alcatel-Lucent -- where by high value I mean make a higher-priced bid for the portfolio -- but they might do so if RIM were to bid. Either way, I doubt that the federal government will get involved if a non-Canadian company bids on the patents.

While I have no idea if this is the way it will play out, it seems to me a likely outcome in comparison to some others. The situation is interesting enough that I'll pay some attention to see if I've gotten it right.