Whenever it comes time to scapegoat someone in the IP world, “patent troll” is the pejorative of choice. Even in polite company, “non-practicing entities” (NPEs) are seldom held in favorable light. The “dark side,” with Nathan Myhrvold as their symbolic leader, argues that the NPE model serves an important role in the IP marketplace, protecting the “little guys” and their ability to monetize their inventions. What’s more, they may have a point--but only in theory.

In practice, however, most would agree that NPE profits far exceed the value they bring to the IP system. Because in the end the discussion seems to filter down to the question of what a patent is worth, and even this is far from straightforward. In the past decade we’ve learned the hard way that this is actually the wrong question--what’s much more important is the value of a collection of patents (the plurality is key here). Once a collection of patents can become more valuable than the sum of its parts, the non-practicing model is inevitable. Problems arise when MOST of the value the patent system generates comes from aggregates of patented inventions rather than individual inventions themselves.

Defensive v. offensive patent strategies

The best defense is a good offense. Traditionally, practicing companies focus on what they practice. That is, these entities primarily strive to invent and sell their products. These companies are clearly motivated to patent their inventions in the interest of preventing other companies from selling similar products, but in this simple case have few other motivations to obtain patents. What makes the case not-so-simple is the fact that the USPTO erroneously issues patents with arguably significant overlapping content. Now that practicing entity, though legitimately innovating and patenting exactly as they are supposed to, could be successfully sued for patent infringement by another company in exactly the same position. Both companies should have a legitimate right to the invention so they go to court to work it out. But going to court is very costly, especially when you lose, so a practicing company wants to go out and purchase all issued patents that could be used by others to sue for infringement. This is known as “defensive” patenting, and the main goal is to not get sued and if you are, not to lose.

The more patents a company accrues like this, the stronger their portfolio becomes. The stronger a portfolio becomes, the more likely that company is to succeed in infringement litigation. If a company can be fairly certain that they will win most infringement cases with their increasingly robust portfolio, seeking litigation against companies with similar products can become a lucrative strategy. The next logical step is building a large patent portfolio for the sole purpose of making money by suing other companies for infringement. This is known as offensive patent aggregation, an increasingly viable corporate strategy, and the NPE model follows naturally.

Non-practice a non-starter for innovation

The NPE argument goes that the individual inventors can’t afford to play this legal game of accruing patents and constantly suing to make a profit. Instead the NPE buys patents from inventors, providing an immediate payout for the inventor without having to worry about lawyers, legal fees, and all the other headaches of going to court to protect an invention. The NPE, on the other hand, becomes an expert at collecting patents and using them to litigate.

Everybody wins. Unless things get out of hand. This model is profitable because of the difference between the value of the individual patents (ideally what’s paid to the inventor for the patents) and the value the portfolio as a whole (that can consistently win in litigation cases).

Two notes. First--where does this extra value come from? Typically, other innovators who haven’t yet licensed their products with the NPEs. Second, because of complex and non-standard patent valuation, there is theoretically no limit on how big, powerful, and valuable their portfolios can become.

As corporation, NPEs are uniquely focused on growing larger and larger and making more and more money. The money they make comes exclusively from practicing entities, most of which are the true innovators of our economy. There is currently no limit on how much power, and therefore how much value, NPEs can generate by building larger and larger portfolios. So at what point does this imbalance become unfair to the practicing innovators? I leave that as an exercise for the reader.