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Monthly Archives: September 2014

A Beautiful Mind Nobel Laureate’s Theory is No Good for Calculating Patent Damages

By Stephen B. Schott

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Imagine you own several patents for software related to video calling over wireless networks. And further imagine that a mobile phone manufacturer uses a built-in program that you believe infringes your patents. The question that the Federal Circuit in VirnetX v. Cisco faced was: Is an infringing damages calculation based on the price of the entire phone, or just the smallest salable unit that infringes the patent and is contained in the phone?

VirnetX accused iOS devices that had FaceTime and VPN On Demand of infringing its patents  and at trial, VirnetX’s damages expert offered three theories of damages.

(1) Reasonable rate as applied to the sale price of each device. VirnetX’s theory was that it had a policy of seeking to license its patents for 1-2% of the entire value of products sold.

(2) Bargain theory that the parties would have split between themselves the incremental or additional profits associated with the revenue generated from the technology. This theorem is called the Nash Bargaining Solution named for Nobel Laureate John Nash, portrayed by Russell Crowe in A Beautiful Mind.

The damages calculation under this theory is based on the profits associated with FaceTime from the revenue generated from the front-facing camera. From that revenue, VirnetX’s expert surmised that Apple would be entitled to 55% of the profit generated and VirnetX would be entitled to 45% because of its weaker bargaining position.

(3) Bargain theory based on what “drove sales” of the device. This is also a Nash Solution.  Based on a survey, VirnetX concluded that 18% of all iOS sales would not have occurred without the addition of the allegedly infringing FaceTime program installed. VirnetX again invoked its conclusion that it would be entitled to 45% of Apple’s profits under this theory.

When the district court issued its jury instruction, it instructed the jury to consider not just these theories, but also another possible damages theory based on the smallest saleable unit.

In determining a royalty base, you should not use the value of the entire apparatus or product unless either: (1) the patented feature creates the basis for the customers’ demand for the product, or the patented feature substantially creates the value of the other component parts of the product; or (2) the product in question constitutes the smallest saleable unit containing the patented feature.

This opened up the jury to do its damages math based, potentially, on the revenue generated from the entire iOS device, not just the portions that are the subject of the infringement claim. This, according to the Federal Circuit, was not a harmless error since according to Supreme Court precedent dictates that a patentee “must in every case give evidence tending to separate or apportion the defendant’s profits and the patentee’s damages between the patent feature and the unpainted feature….”

The Federal Circuit’s Take on VirnetX’s Damages Theories

250px-John Forbes Nash, Jr. by Peter Badge

The Federal Circuit considered each of VirnetX’s damages theories and found the reasonable royalty rate based theory acceptable—although based on the wrong base—and the theories based on Nash’s theories wanting.

The Federal Circuit did not criticize Nash’s Solution as wrong, but it did take issue with Nash’s starting place in his Bargaining Solution, namely, that each party in the bargain start with half of the profits, and then there is apportionment up and down from that number based on factors around the bargaining power of the parties. The Federal Circuit criticized this 50-50 starting point as “subject to abuse” and compared it to another “rule of thumb” damages theory that it described as originating from a “flawed premise.”

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The Rise of the Startup Manufacturer

An Article in Schott, P.C.’s IP Law For Start-ups Series
By Stephen B. Schott

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“Some software startup founders are evolving into product startup founders. It’s an interesting trend.” A product startup founder said this to me over coffee a few months ago. Since then, I’ve been giving what he said some consideration. Has the time of the startup manufacturer come? Or, given the pre-70s stereotype of the garage startup business, maybe the question is better put, “Has the time for the startup manufacturer returned?”

Companies like Jawbone and GoPro answer yes, as does a recent Wall Street Journal articlethat estimates over 800 million venture dollars were invested in hardware startups last year, almost double the number from 2012. Why the sudden shift?

Communication. 23 years ago, I was an engineering student with access to cutting edge computers. I encouraged my now wife, a humanities major, to go to her university’s computer department and open a “VAX account” so she and I could email. When she showed, up, she had to convince them that she really needed the account (she didn’t) and then and that she knew how to use it (she didn’t). Thus began her first experience with email. Spring ahead two decades and just last week, I had two videoconferences with India and one with Spain. In one conference, we were marking up drawings as we chatted and even showing and discussing a device that one person had in their hands.

That ease of communication makes discussions with large scale manufacturing centers in Asia not only possible, but easy. This takes the ability to manufacture products out of the hands of giant companies and puts it within anyone’s reach.

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3D printing. I visited a product development company earlier this year whose prototype design process has undergone a dramatic shift in the last few years. Walking though a relatively quiet machine shop, it was striking how much things have changed. Now what once took several days of expert machine work only requires that a designer hit print before going home for the day. In the morning, he has a plastic prototype. And if you haven’t seen a high-end 3D printer, they produce amazing products: items with moving parts, wheels, hinged doors, and detailed articles that approach production quality. As the cost of these printers decreases and the quality improves, manufacturing will become even easier for startups.

Design capability. Computer drawing and modeling is now so straightforward that almost anyone can do it. And the modeling includes being able to test material components and material stresses, which skips expensive rounds of prototype and failure.

Hiring experts. Product teams moving an idea from concept to product require many people: designers and engineers with varied scientific backgrounds, salespeople, business leaders, administrative support, lawyers, and others. The startup’s challenge is that it usually lacks to budget to hire all of these people, so in the past, the startup employees wore many hats: The software engineer might also do sales and design. The administrative support person might be the bookkeeper.

But these days, experts are easier to find and connect with. Even if a startup’s network does not include, say, a regulatory lawyer, a survey through LinkedIn should yield someone who can help just two contacts away. As LinkedIn constantly reminds me: My connections connect me to over 10 million people.

And even better, because the startup can find so many experts, it can probably find more than one and negotiate pricing or question them about their expertise to establish a level of comfort before hiring them.

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Manufacturing startup hubs. Companies like NextFab in Philadelphia provide a co-working and support space for manufacturers, where this business model was once only available to software and services businesses. NexFab offers its clients 3D printer capability, laser cutting machines, textiles, metal and wood shops, a photography studio, and access to expensive design and engineering software.

Availability of goods. If you need a Langstrom 7” gangly wrench, you can probably get it shipped to you next day in quantity. Think of the miracle that as several million people place iPhone 6 orders today; they will ship from Shenzhen China on the same day and be in your pocket two days later.

Venture capital. At least in the US, but as I’ve seen first hand in other countries, it has never been easier to merge a great startup company and the money to back it. The key is still to have the “great” startup company. All the bad ideas that you see on Shark Tank won’t get funded but if you’ve possibly got the next big thing, and have the right combination of passion and business sense, you will find backing.

So what are you waiting for? Go make something…but please be sure to patent it.

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