The Diaper Wars

That sound you heard, just now, was my jaw falling from my skull and drop-drop-dropping onto the floor after finishing Stephen Moore’s recent NRO article on Bush’s anti-trust policy. “Extraordinarily underwhelming” doesn’t begin to do justice as a desciption. (And, so we’re clear, I disfavor most forms of antitrust regulation; i.e., I’m putatively on Moore’s “side.”) The key passage, from which the rest of Moore’s analysis flows, is the following:

Antitrust actions may have made sense during the era of Theodore Roosevelt, when firms like Standard Oil could truly monopolize local markets. But in the 21st century, where markets are global, the idea that firms can gouge consumers on prices is as antiquated as the stage coach. Consumers are more fickle and cost-conscious than ever before. If prices get out of line in any market where there are no barriers to entry, competitors swoop in and lower costs so that monopoly rents disappear.

(Emphasis added.) The problem with this paragraph (and the highlighted sentence in particular) is not merely that it betrays a profound misunderstanding of the practicalities of “entry barriers” — though it does — but that it also demonstrates no appreciable concern for the realities of the present-day marketplace. This is the kind of passage a sociology major might write, between bong hits, and having learned all of his economic theory from Krugman’s New York Times columns. (‘Tis true that Krugman is an economic genius, but the evidence for it is of a super-Times-ular nature.)

As a threshold matter, there is no such thing as a market “where there are no barriers to entry.” Every market has entry barriers. Even with the most ephemeral or fungible products, you have to hire someone to create it, build some sort of office (or telecommuting) environment, pay for start up marketing, etc. Indeed, even if these entry costs did not exist (and they always do), entry into a new market at a minimum costs the sum of your next best opportunity. (Tom, in comments, notes that the economic (as opposed to actual) costs of entry may still be zero if the next best opportunity is not as good as the proposed market-entry; he’s right, of course, and my phrasing of this sentence is confusing. For the moment, consider it withdrawn.)

So Moore is simply silly on this first point. But Moore’s also wrong on a second, admittedly more sophisticated point. The very markets that Moore highlights as having small or nonexistent entry barriers — software companies — in fact usually have fairly high entry barriers. (Here, Yglesias’s analysis of Moore’s article also stumbles.) Meet the modern patent regime: wherein even “clearly” invalid patents have value.

Most are aware of the mad rush by various companies to try to patent the seemingly obvious and non-novel — Amazon’s one-click patent is probably the most familiar. (For the record, I don’t think Amazon’s patent is necessarily invalid; I’m merely repeating the common wisdom.) We lament the USPTO for allowing such monstrosities to issue. But we seldom ask why a company would pay thousands of dollars (even tens or hundreds of thousands of dollars in extraordinary cases) to try to patent something that “everyone knows” is invalid. After all, neither patent prosecution nor patent infringement litigation is a “sure thing” (or cheap).

Here’s why: few, if any, patents give a company anything close to a guaranteed right to exclude competitors from a field. To the contrary, many software (and other) patents either have invalidity problems or, to avoid invalidity problems, are drawn so narrow that they leave ample room for competitors. In the parlance, significant “design around” options exists. Despite, this, these patents are (usually) worth the expense. Why? Well, even a narrow or weak patent creates — wait for it — significant entry barriers to the marketplace.

Indeed, a potential competitor eyeing a market filled with even questionable patents has several difficult and expensive tasks to complete before it proceeds. It needs to engage patent counsel to make sure it doesn’t infringe the patents, and may need to design-around certain of the patents to strengthen its noninfringement and/or invalidity case(s). It needs to weigh the possibility that the patent holder will, despite its efforts, nonetheless file suit — and most patent lawsuits have the potential to cost millions of dollars, even if the newcomer wins. Moreover, in order to protect its own technology and prevent other competitors from entering the marketplace, the newcomer will likely feel pressure to develop its own patent portfolio. This can result in something like an arms race between the original company and the newcomer, as each prepares strategic patent portfolios to limit and vex its foe and, above all else, keep other competitors out. (Better to have a market divided twice than thrice.)

Indeed, sophisticated patent consumers have long understood that the primary value of many patents is not that they allow you to dominate market for a period of time on the merits of the patents themselves — though sometimes they might — but because they allow you to dominate a market for a period of time by limiting your current competitors and imposing significant entry costs on potential competitors. This is why you see an explosion of seemingly-shoddy software patents. This is why companies spend millions getting — and sometimes trying to enforce — patents that “everyone knows” are invalid.

The patent-to-create-entry-costs strategy, by the bye, is not merely limited to software patents. There’s been a veritable explosion of patents on all manner of consumer goods, most of which the public would never guess would be worth a patent: Diapers, for instance (indeed, this post’s title references a long and extraordinarily expensive series of cases litigated in the early- and mid-1990s over diaper patents). Paint rollers and pans. Frozen sandwiches. Pens. These patents exist don’t merely exist to protect a novel and nonobvious design; they also exist to impose entry costs on potential competitors eyeing the market.

Now, none of this is to say that every patent out there is a paper tiger. Many aren’t. (And included in the non-paper-tiger category is each of the patents on which I’ve filed suit: My firm(s) don’t bring baseless claims.) But the public needs to understand how patents and other intellectual property rights — primarily copyright, though to a lesser extent trademark as well — serve to shape the marketplace. Modern patent practice, at least at the big-firm level, is far more strategic and subtle than many folks suspect. It’s time to pull back the curtin door, and meet the man behind.