Success breeds competition. My previous post also mentioned the formation of the Allied Security Trust, a consortium of large technology companies pooling money together to buy up key intellectual property in order to preempt the threat of patent infringement lawsuits. Members of the trust include Google (GOOG), Verizon Communications (VZ), Cisco Systems (CSCO), Ericsson (ERIC), Hewlett-Packard (HPQ), and many others. Former Intellectual Ventures executives have formed a competing fund called RPX Rational Patent. RPX’s investors include premier venture firms Kleiner Perkins Caufield & Byers and Charles River Ventures. The market for intellectual property assets continues to evolve but I believe this new level of competition will introduce efficiencies and is ultimately good.

At Design Engine Lab, we are affected everyday by intellectual property. We are actively creating new intellectual property; we have dozens of patents and patents pending as a result of our product development efforts. We must carefully research prior art and avoid infringing other innovators’ existing patents. We circumvent other innovators’ patents whenever we can can by designing different or better solutions. Our ability to circumvent adds value not just to our own IP portfolio but also to our client’s products. Clients come to us with a certain design or product specification and oftentimes, we are able to bolster their idea with a stronger workaround design or implementation. Since joining Design Engine Lab, I’ve instituted an IP mining strategy. We actively search for interesting patents and improve upon them with stronger implementations. We also approach patent owners to partner with them and create great products.

The rapidly evolving market for intellectual property raises many questions. I’m especially concerned about the Allied Security Trust (a horrible marketing and branding execution). Will a combination of such heft invite antitrust attacks? Certainly, if only large, well-funded technology companies that already dominate their respective industries can join the trust while keeping small innovators off the membership rolls and at an unfair disadvantage, a case for antitrust actions can be made. Will the stalled Patent Reform Act of 2007, which would have curbed the ability of patent trolls to extract large monetary settlements through patent infringement litigation, find fresh support? Does the renewed focus on innovation and intellectual property that permeates the environment represent a new economic opportunity for an enterprising entrepreneur? Can someone create a new marketplace or exchange where patents can be bid upon by competing players, much like how stocks are traded today? It sounds like an immense challenge and undertaking – which smells to me like great value and profits.

Patents are notoriously difficult to value but it is clear that patents are becoming a viable asset class in themselves. Taking the cue from many other asset classes, could there be a way to “securitize” a portfolio of assets? This could be a fun and challenging opportunity to address. One approach is Nathan Myhrvold’s Intellectual Ventures, a “venture fund” that invests in patents by acquiring those invented by others and developing some internally. There are many in the technology industry who fear Intellectual Ventures will evolve into the best funded and organized patent troll.

Below is an essay I wrote for an investment newsletter published in February 2007 distributed to high net worth clients.

Patent Bridge is Falling Down

Horror of horrors! We almost lost service for our Blackberry communication devices early last year. Also known as Crackberries for their users’ incessant finger-pounding of emails during company meetings, on the subway, and even on vacations, a patent infringement lawsuit filed against parent company Research In Motion (RIMM), threatened to sever the umbilical cord between the gadgets and their addicted users. NTP, Inc., a patent holding company, claimed that RIM infringed NTP’s wireless email patents. Legions of squinty-eyed telecommuters were relieved when RIM finally settled with NTP by paying an extortionary sum of over $600 million.

The Blackberry episode underscores the growing importance of an emergent business model. Disdainfully described as “patent trolls” by detractors, patent holding companies assemble portfolios of patents and wait for other companies to develop infringing products. Profits are then won in the courts and not in the arena of market competition. This form of intellectual blackmail has the potential of drastically altering the economic landscape and the development of innovative new products.

Innovation is the Holy Grail. Harvard Business School professor Clayton Christensen assured us of that universal truth with the publication of a couple of business bestsellers. Large corporations pursue innovation with a newfound zealousness. However, the editors of this publication submit that the innovator’s dilemma is no longer about large corporations’ inability to recognize and take advantage of disruptive technology; it is now about navigating the field of patent landmines.

Who takes the risk? Innovation is inherently a risky endeavor. Impactful advances in technology seldom occur at low cost. Invention, experimentation, testing, and prototyping can require large sums of capital. Furthermore, product evangelism often dwarfs the cost of research and development. Thus, the founding fathers created a patent system to reward the risk taker and incentivize risky behavior resulting in benefits to society in the form of improved goods. They must now be spinning in their graves. Patent trolls are, in essence, excellent risk arbitrageurs, because they have found a way to extract profit without undertaking the bulk of the risk. In the case of NTP v. RIM, although Research In Motion incurred the cost of developing the Blackberry device and bringing it to market, the patent troll almost succeeded in removing a winning product from the marketplace. Who loses? Ultimately, the consumer.

How does one spot a patent troll? Like the monsters of childhood tales, they hide and wait under a bridge until someone attempts to cross. Trolls then exact a toll from the weary traveler for use of the bridge. Only in the real world, the bridge or asset was built or developed by the traveler! Patent trolls are, in the words of the legal cognoscenti, “nonpracticing” patent holders. They have no intention of ever developing and commercializing their patents.

“But we are all patent trolls!” Panglossian defenders of the current patent system point to the huge patent portfolios of large corporations like General Electric (GE), International Business Machines (IBM), Intel Corporation (INTC), and even mundane consumer goods powerhouse Procter & Gamble (PG). In this world of limited resources and talent scarcity, even the most imposing corporate behemoths can ill afford to commercialize all their patents. Yet when the blue chips’ patents are infringed, they pursue legal recourse as vigorously as any litigant. Defenders of the status quo place the burden of diligence on manufacturers. All who aspire to make the next iPod (AAPL), Blackberry, Viagra (PFE), or toaster oven must search the United States Patent and Trademark Office archives for all prior art – just as it has always worked for the last two centuries. They have a point. If manufacturers are not thorough with their homework, why shouldn’t they be sued?

The problem is not whether large or small inventors are practicing or not. The editors submit that the problem is what we call the Goldilocks Paradox. Currently, too many overly broad patents are being awarded. When that occurs, it becomes very difficult to innovate around such widely defined intellectual property. When patents are too narrowly defined, it becomes very easy for competition to design around them.

“Yum yum, these patents are not too broad and not too narrow, they’re just right!” To get to this happy equilibrium, we humbly suggest a remedy. To curb trolling behavior, set a time horizon for making infringement claims. The deliberate strategy employed by patent trolls of waiting for another company to develop a market for a product to then sue for damages is diametrically opposite of the approach taken by most large corporations armed to the teeth with attorneys. After a certain amount of time, claims will either have no merit or will win reduced compensation. We believe this would put a significant chill on trolling behavior and allow everyone to get on with the business of making our lives better.

For all the Blackberry users out there, cling tightly to your beloved devices. On May 1, 2006, Research In Motion was sued by another patent troll, Visto. Ah, as Candide implied, “All is for the best in this, the best of all possible worlds.”