Patents are as American as mom and apple pie. Maybe more so. Mom and apple pie aren't mentioned in the Constitution. Find out how the software patent system is affecting the companies, and the profits, you love.
Patents are such a fundamental part of American economic culture that the Founding Fathers saw fit to address them in the Constitution. But in the software industry, patents may be doing more harm than good -- stifling innovation, hijacking the bottom line, and siphoning shareholder value.
We the people establish the patent system
"The Congress shall have power ... To promote the progress of science and useful arts, by securing for limited times to authors and inventors the exclusive right to their respective writings and discoveries."
--Article I, Section 8, U.S. Constitution
Up until 1980, the U.S. Patent and Trademark Office thought of software like language, i.e., you could copyright the code, but not patent the whole idea. The U.S. Supreme Court supported this view. In the 1981 case of Diamond v. Diehr, the court reversed its thinking, ruling that software patents could now cover the whole software invention, not just the code used to make the invention function.
Diamond v. Diehr led directly to State Street v. Signature, a 1998 federal appeals court case that allowed the possibility of patenting "business methods." A term as wide open and generic as it sounds, business methods can describe applications as wide ranging as financial data processing methods, computing techniques, online bookselling, and online auctions.
State Street v. Signaturebroke down the door that Diamond v. Diehr nudged open, and a flood of software patents followed.
Even software engineers don't like software patents
"I worked on a whole bunch of patents in my career," Silicon Valley programmer Stephan Brunner recently told NPR, "and I have to say that every single patent is nothing but crap." Brunner includes the patents he holds in that category.
The problem? Software patents can be so broad that almost anyone who writes a program can be guilty of infringement and therefore subject to suit. This presents an obvious potential problem for any innovative, high-tech company.
Mutual assured destruction
In response, companies started amassing patent hoards, not to build anything new or to innovate with them, but to defend themselves against potential lawsuits.
It's mutual assured destruction. A company with a large patent portfolio can say, "Sue me with your patents and I'll sue you with mine." But instead of nuclear arsenals, it's patent arsenals, and companies are spending big money to build them.
A recent auction of 6,000 patents from the bankrupt Nortel Networks ended with a winning bid of $4.5 billion and went to a consortium of companies that included Apple (NAS: AAPL) , Microsoft (NAS: MSFT) , and Ericcson. Google's (NAS: GOOG) mere $3 billion offer didn't cut it. But the action didn't stop there.
Google goes nuclear
Speculation grew to a fever pitch that mobile patent specialist InterDigital (NAS: IDCC) would be bought by a larger player seeking to bolster its own patent portfolio. Hopes of an impending buyout spiked InterDigital's shares by more than 100% in the month between mid-June and July.
Then, the patent buyout to end all patent buyouts finally happened: Google bought Motorola Mobility (NYS: MMI) for $12.5 billion. While Motorola does have a large mobile division, the real prize was its 17,000 granted patents, a patent treasure chest nearly three times the size of Nortel's.
To be fair, patents do have a place in the high-tech economy, particularly in the mobile industry. Qualcomm (NAS: QCOM) , for example, may get criticized for having a "patent stranglehold" over the mobile industry, but also spends $2.5 billion annually in research and development. And Qualcomm was integral in the core development of the CDMA technologies that now form the basis of today's data networks.
A recipe for less innovation
This brings us back to the larger problem with today's patenting process in technology, i.e., companies are all too often are able to patent generic ideas without creating any of the specifics that make them commercially viable.
So now, as many new patents are being used as defensive weapons by companies that haven't innovated, many others are being used as offensive weapons by companies that simply want to stall the growth of their more successful peers. That's a recipe for less innovation, as any new technology must navigate a minefield of overly generic patents that add no real value.
And it's not just companies getting caught up in the patent melee. Microsoft co-founder Paul Allen recently filed a far-reaching lawsuit against companies including Google and eBay (NAS: EBAY) for violating patents on overly generic ideas like "news aggregators."
The only ones getting rich are the lawyers
The money to buy these patents come out of a company's cash reserves. Will the patents keep the company lawsuit-free? Maybe. If they're as broad and unfocused as claimed, who knows whose patents will have the final word in court?
Those profiting most here are lawyers. Those profiting least are shareholders. The billions spent amassing a patent portfolio could be reinvested in the company, to develop new products and stay competitive, or be issued as a dividend.
Size really does matter
As in other spaces affected by excessive litigiousness, the current software patent system is feeding on itself and growing worse. It is what it is, but it's a shame to see good shareholder money thrown after bad.
For the big high-techs, a few billion here and there aren't going to exhaust their cash hoards. So if you have a position in one of those, stay put, Fools -- there's no need to run out and sell your shares.
But for the smaller high-techs, the kind that don't have a few billion extra lying around to get in on a big-time patent auction or hire a team of lawyers to sue for patent infringement, the ongoing patent wars are something you may need to factor in to any potential or existing position.
What's your take on the patent wars? Tell us in the comments section below.
At the time thisarticle was published Fool contributorJohn Grgurichis not currently building a patent arsenal or a nuclear arsenal, nor does he own shares of any of the companies mentioned in this article. The Motley Fool owns shares of Microsoft, Google, and Apple.Motley Fool newsletter serviceshave recommended buying shares of Apple, Google, and Microsoft.Motley Fool newsletter serviceshave recommended creating a covered collar position in Microsoft.Motley Fool newsletter serviceshave recommended creating a bull call spread position in Apple. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.
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