Fans queue for iPhone 5 at the Apple store in London. Demotix/Bimal Sharma. All rights reserved.

How innovation works in the ICT industry

The information and communications technology (ICT) industry has a number of characteristics that make the way innovation works quite peculiar. Each electronic device includes different technological elements, which in turn contain a myriad of smaller pieces of technology and so on. The way in which ICT production is organized is also called modularization. Take a cell phone, break it up into hundreds of single modules which can be produced separately, and eventually put them together thanks to standardized interfaces. What you have is not a new technology, but a system of technologies closely tangled, a platform combining operating system, hardware, and applications.

Thus, when you bring out a new cell phone, you are basically building upon a number of small pieces of technology and making them work together as a system. This has clear cut implications in terms of intellectual property rights, namely patents. In fact, each of these atoms of technology is likely to be covered by numerous patents. As I was told by an engineer, “when you are developing a new cell phone or a similar product you are very well aware that you are going to infringe some amongst the existing thousands of patents”. Now you have two options. The first is to go door by door to other companies to ask for their permission to use their patents against the payment of a fee, i.e. licensing. The second is to focus on your innovation and forget about patents. [1] The only way compatible with the fast pace of innovation is the second, and this, in fact, is what happens in this industry. After you have developed your new phone, infringing perhaps hundreds of patents, you sit at the table with other companies having the same problem with your patents and settle the issue by cross-licensing patents you are infringing with your patents that your competitors are infringing.

Something does not quite fit here!

Therefore in this industry, cross-licensing agreements between firms are common practice. Even when companies go to court, they seldom go through the whole legal process to the verdict. They have usually preferred to come to an agreement before putting the case in the hands of an unpredictable jury. But this has been changing over recent years (see here). In the case of Apple and Samsung, and despite pressure from the judge, the two companies were fiercely determined to go for the judgment. And not only in the US. Just a few days before the American one, a verdict came out in South Korea, and later in Japan. Others are about to come out in the following weeks in other countries. One has the clear feeling that the two companies want to make headlines all over the world, and this they did achieve.

What could justify this unusual behaviour? Actually, the main message here is addressed to those who are considering entering the market of smartphones and tablets. These are going to represent the key markets in the coming years for the ICT industry. Today, for each smartphone or tablet sold, these companies make huge profits, for the difference between price and cost is extremely wide. What can break the spell in the future is an attempt by other companies to enter these same markets. Economists refer to markets in which firms can freely intervene as contestable markets. The latter are important as they prevent the incumbents from charging excessive prices to consumers, because high profits will encourage other companies to enter the market, driving the prices (and thus the profits) down through competition. But the patent war is making these markets less contestable. Those firms who dare to step in are warned: they will be pursued through every court around the world, adding a great deal of uncertainty, and costs - patent attorneys are by no means cheap these days.

... because one size does not fit all

A lot of effort has been directed over past years to build a global harmonized system of intellectual property protection. The most prominent attempt is that of the TRIPS Agreement. The ‘Trade Related Aspects of Intellectual Property Rights’ (TRIPS) Agreement, signed in 1994, is a founding element of the WTO. TRIPS constitutes the most important attempt to establish a global harmonisation of Intellectual Property protection and enforcement, creating international standards for the protection of patents, copyrights, trademarks and design.

This case shows that we are quite far from this objective. Samsung sued Apple in South Korea, while Apple did it in the US, more precisely in San Jose, California.[2] The verdicts were quite different, and not surprisingly more favourable to Apple in the US, and vice versa in South Korea. The last verdict in Japan came out with yet another outcome – in favour of Samsung this time. Far from being as objective as one might imagine, technologies seem to have a highly subjective nature, particularly in this industry in which they are intertwined with the form – design – and the experience of using a product. Courts around the world are very likely to produce different outcomes. Furthermore, their verdicts will come in time-spans which are hardly compatible with those of innovation. Even the one recently reached by the jury in the Californian city of San Jose is hitting Samsung products that will soon be history, as they will be displaced by newer models. On the whole, it will progressively become almost impossible to tell who copied who, as well as what was eventually copied.

Losers and winners

Whoever wins the legal battle between Apple and Samsung, even if it is likely we will never know for sure, it is certain that both have much to gain from all this fuss. They will have made it clear that the game in these markets will be extremely tough. Any firm is not going to came out with a “new” tablet unless it is ready to spend a fortune in legal wars whose results are unpredictable. I do not foresee a patent war to the death here. These markets are big enough for both Apple and Samsung to enjoy substantial profits over the next years. Potential competitors and potential innovators are the losers, and along with them, the consumers, who are already paying for the costs of lawyers when they buy their smartphone. But the ultimate loser seems to be patent law itself. It is hard to imagine any benefits from patents in these conditions. Does the ruthless exploitation of patent law for corporate gain mean that it needs to be amended or even substantially reformed (read abolished)?  

Notes

[1] A third option often used in this industry is patent pools. The latter is basically a company that exists only to license patents. The patents get 'poured in' to the pool by various competitors, and are organized by technology to make licensing easier. In practice, if you wanted to make, say, a DVD player, then you don’t have to go door to door and license hundreds of patents. There’s already a pre-defined 'DVD player' pool that you can license. You pay the licensing fee to the patent pool, who then divides the fee up among the different people who have patents in the pool. For some example see here or here. However, there is currently no such pool for smartphones. In addition, Apple generally does not license its patent.

[2] To be sure, in the US patent law is exclusively federal, so patent law in California is the same as patent law in New York. Yet, Apple decided to go to court at home.