RPX Corp Large-scale NPE Economics: License or Litigate?

Much of the debate about patent reform – certainly the coverage in the mainstream media – has focused on the economic impact of nuisance litigation: Can legislation or regulation lower risk for operating companies in cases where the cost to fight may far exceed the cost to settle up front? (As we’ve argued in previous blog posts on patent reform, RPX supports government-driven efforts to improve patent quality, but we are skeptical that legislation can change the high costs of the patent licensing market.)

Very little, however, has been written about the economic logic at the other end of the cost spectrum, where “aggregate-and-assert” NPEs amass large portfolios and seek license payments that can run into the high tens or hundreds of millions of dollars. The scale of these license fees makes this a highly strategic risk-management decision for operating companies.

Interestingly, while the inefficiency of the legal system can often make fighting NPEs with small portfolios and small demands (regardless of the merits) seem economically unattractive, the opposite may be true for “aggregate-and-assert” NPEs with large portfolios and eight- or nine-figure demands. Fighting could often be the correct economic choice.

We would argue that the crucial first step in that decision-making process is to determine the nature of the NPE because they fall into two distinct categories: (1) NPEs with coherent, homegrown portfolios; and (2) NPEs that have built portfolios from patents of disparate provenance.

Where portfolios in the first category more likely comprise higher-quality patents, large portfolios of disparate provenance are often purchased from individuals or entities seeking cash for non-core and/or non-strategic assets. There are, of course, exceptions to this rule, and every portfolio is unique on its merits, but based on our analysis of the public data and a great deal of anecdotal evidence, the average cost-per-patent in these “aggregate-and-assert” portfolios is generally quite low.

This fact is clearly visible in a simple fight-versus-settle analysis. Because “aggregate-and-assert” NPEs source their sub-portfolios from the same pool of deals as everyone else does, the cost of fighting these sub-portfolios in court can be quantified by reviewing data from a variety of public sources (and RPX’s NPE Cost Study results). So it is a relatively straightforward task to determine the range of total costs – legal fees plus settlements (or judgments) – that these kinds of portfolios might represent to operating companies.

Number of suits to generate expected present value cost equal to the fees sought by the NPE

Assumes suits are filed all at once (in parallel)

With this in mind, we built an informal model incorporating a variety of factors including the historical average legal costs of fighting a case in court, the typical verdicts (or resolution costs) from NPE cases of various strengths, the chances of success on the merits, and the time value of money. The results are captured in the table below in terms that matter to an operating company deciding whether to (1) pay an “aggregate-and-assert” NPE a substantial high-eight-figure or nine-figure license fee; or (2) incur the costs of fighting the expected litigations generated by that portfolio.

Consider a portfolio with a $200 million price tag for a perpetual license. That amounts to the resolution cost of 370 typical/median litigations (which cost an average of about $600,000 each to resolve). But more importantly, since reaching multiple, individual resolutions with a large NPE may not be an option, that also equals the estimated cost of utilizing the strategy of never settling and paying judgment and ongoing royalty costs (in the case of a loss) of 45 median quality lawsuits. Alternatively, the $200 million price tag is the equivalent of the estimated cost of fighting three all-time most expensive suits to judgment (something historically rare and even rarer for an NPE).

While large NPE portfolios may have higher quality assets than small nuisance-level patents, it seems extremely unlikely that the economic risk of fighting in court would support asking prices in the nine figures. In other words, an argument can be made that the high transaction costs that drive many one-off settlements to the benefit of small NPEs also work to the advantage of potential defendants facing demands for large licensing fees. Is it practical for a larger NPE to initiate the number of litigations needed to win the licenses they are seeking?

It’s food for thought. Obviously one would want to understand other factors like quality, relevance, revenue-at-risk, injunction/exclusion order risk, and executive distraction due to litigation. Nevertheless, an in-house IP team that advises its CEO to take a license today must believe that the portfolio in question is likely to spawn tens or even hundreds of suits of middling quality or that the NPE is capable of identifying, acquiring, and successfully litigating multiple suits of ‘historic’ strength.

At the end of the day, it is about making an economic decision. If a company knows it is going to be facing litigations from a portfolio (large or small) of high-quality assets, it may very well make sense to do the math and pay an appropriate amount to clear that risk sooner than later. But do that math first.

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The model supporting this analysis and an explanation of the underlying assumptions are available by contacting us at contact@rpxcorp.com.