Monday’s post about the RPX IPO attracted some great comments from Kyle Jensen (of PriorSmart) and Ron Riley (of Professional Inventors Alliance) with thoughts on the sustainability of the patent aggregation business model, and RPX’s problem with potential “free riders” (see post: Why Is RPX Going Public? Ask Willie Sutton). Fundamentally, the vesting nature of RPX’s membership scheme squarely puts securing membership renewals in direct conflict with cost control. RPX recognizes this in their own SEC filing. Further, this leads to a potential “free rider” problem, amplified by RPX’s promise to “never” use its patents offensively. Naturally, RPX also recognizes these problems, but the solutions may raise other problems (including potentially attracting the attention of law enforcement). Ultimately, this high stakes gamble may not pay off.
The “free rider” potential is recognized by RPX itself, as it cites “reduced incentive for companies to become clients because we do not assert our patent assets in litigation” as as known business risk. The risk can be tempered by a catch and release acquisition strategy. If RPX gets a reputation for divesting patent assets to enforcement entities, naturally companies would be more easily convinced to join. However, those memberships would be useless to mitigate risks associated with already divested patents, so RPX would have to present a realistic threat of additional relevant patents that may soon go on the auction block. Of course, this brings up another business risk identified by RPX–public perception over whether their business model would change to one that relies on patent assertion.
Beyond that, to close a deal, RPX likely needs to convince clients that identified threats are both real and imminent. This might mean identifying specific patents, explaining the risk proposition (i.e. explain how the client is known to be infringing), and at least suggesting that there are interested buyers, perhaps among enforcement entities that regularly RPX regularly conducts business with. So, with all due respect to RPX’s claim that its service is “analogous to insurance,” my State Farm agent never once suggested that, if I didn’t buy their product, he might leak the location and description of my car to a known chop shop. Nevertheless, unless anyone knows of any specific examples, RPX has yet to “release” any of its catch, so this discussion may be a bit premature.
RPX’s other way of addressing free riders is through the purchase of sub-license rights rather than buying patents outright. In the sub-license acquisition model, RPX would only buy the right to grant non-exclusive licenses to its members, as well as the right to provide additional licenses for an additional fee, while the ownership of the patent would remain with, perhaps, an enforcement entity. This is one way for RPX to simultaneously control acquisition costs while encouraging membership. When Joff Wild specifically asked RPX about “piggy backing,” John Amester reportedly said “you should not count on it.” Amester went on to explain the sub-license concept:
Amster cited the theoretical example of a litigation involving 10 companies – five of which were RPX members, five of which were not – up against an NPE asserting a patent. “We might well buy a sub-licence to the technology for our members and leave the other five to their own devices,” he explained. It would not be something RPX would always do, and there are reasons why they would not want to do it, but it is there as an option.
While this may be, as Amester says, “an option” rather than their regular practice for acquiring patents, the sub-license purchase is “an option” it has used in half of RPX’s purchases. This, coupled with the “release” pitch could end up spelling trouble for RPX, and anyone they do business with, but more on that later.
Turning to Ron Riley’s comments, he suggests that RPX’s success depends on exploiting uninformed patent owners, and also hints at a study of how aggregators operate:
It seems to me that patent aggregators cannot protect their clients from any inventor who is smart enough to seek out patent enforcement entities.
Once we publish our findings I think that aggregators will find it much more difficult to buy IP far below it’s real value. Their business model only works when they are dealing with inventors who lack information.
I do not think that as structured that their business model is sustainable.
Ron does have a point. It is very easy to strike a favorable deal when you know more than your adversary. However, the information disclosed in the S-1, not to mention the regular reporting on RPX’s activities should provide a lot more insight into how these types of companies operate. Over time, any informational advantage RPX holds could be eroded away. In other words, RPX cannot continue to count on keeping purchase prices low, and will increasingly rely on other means for encouraging membership while controlling costs.
Turning attention back to the methods described above, RPX can encourage continued patronage of its membership services by offering protection from the possibilities that it will (1) sell its patents to enforcement entities keen on suing RPX’s potential clients and/or (2) only acquire limited sub-license rights, while NPE’s aggressively pursue non-members like an unblocked, free rusher tearing after a quarterback. As it engages in these activities, RPX’s relationships with patent enforcers should be closely scrutinized. A gentle suggestion to a potential client that a specific NPE has expressed interest in a patent (as well as the client) might trigger enough suspicion to warrant inquiry into RPX’s relationship and control over the NPE.
An enterprise offering to sell protection from a threat that it simultaneously imposes might be interpreted as a racketeering enterprise (18 USC 1952 (b)(2)), the operation of which is subject to both civil and criminal penalties. Doing business with such an enterprise is not without an element of risk in itself, as transactional partners might be interpreted as participants or co-conspirators.
In a team sport, a player commits the foul, and the team is penalized. Often times, business is no different. When it comes to patent risk management, the difference between a perfectly legal licensing business and an illegal racketeering enterprise may be subtle nuances in execution of the day-to-day operations, rather than the stated policies and objectives of the organization. Words mean nothing. Its the actions that count.