Trouble Ahead for Tech’s Patent-Crazy Giants?

by Brad Moon | October 26, 2012 11:13 am

Apple (NASDAQ:AAPL[1]) and Google (NASDAQ:GOOG[2]) have traditionally been two very different companies. One focuses primarily on computers and consumer electronics, the other on wringing ad revenue out of a ubiquitous search engine. More recently, they’ve begun to overlap in some areas, primarily mobile and tablets, but one adjective applied equally to both: innovative.

They gained a reputation for taking risks and introducing what became game-changing technologies. However, they now share another, more dubious distinction. According to a recent New York Times article[3], both Apple and Google now spend more on patent lawsuits and patent purchases than they do on research and development.

What does that say about their future — and the future of the tech industry in general?

Personally, I think it marks the point where Apple and Google are at risk of beginning to lose their leadership positions. I’m also worried that this patent warfare culture is damaging innovation at all levels (including with start-ups), at least in countries that recognize U.S. and European patent law.

I’m going to pick on Apple for a bit, because it’s the one with more history, and it’s been down this path before.

Litigation has always been a part of the tech game. Apple spent much of the 1980s and 1990s suing Microsoft (NASDAQ:MSFT[4]) over the “look and feel” of Windows[5], so it’s not like this is new behavior. The Apple Computer of that era was not a healthy company. Suing its primary rival, especially at a time when its own products had slipped from cutting-edge to also-ran, reeked of desperation.

The Apple of 10 years ago — the company beginning a run of must-have computers, breaking into brand new markets and dominating the existing leaders — valued R&D. You don’t come up with a string of successful products like the iMac, MacBook, iPod, iPhone and iPad without investing in R&D. In the crucial 2001-2003 time frame during which Apple began turning around its computer business, launched the iPod and started contemplating smartphones — Apple was spending 8% of annual revenue on R&D[6].

Today, it seems locked into a cycle of releasing incremental upgrades to existing products. Nothing wrong with that in the short term (it’s certainly profitable), but Apple hasn’t released a truly new product since 2010’s iPad, and that had roots in a prototype that predated the iPhone[7].

Apple’s current R&D budget has withered to around 2.2% of revenue. History has proven repeatedly that when tech companies stop innovating, stop taking risks with radical new products and cut back on R&D, they’re vulnerable to being overtaken.

Overtake is exactly what Apple did to Research In Motion (NASDAQ:RIMM[8]) when it came out of nowhere to destroy the once-dominant BlackBerry. Samsung did that to Sony (NYSE:SNE[9]) when it shifted from being a bargain-basement TV maker to break Sony’s hold on the premium flat screens. Microsoft caught both Sony and Nintendo napping when it suddenly entered the video-game console market with the Xbox. And Google did that to AltaVista, Ask Jeeves, HotBox (really, does anyone even remember these?) and other, once-popular search engines.

Beefing up on patents may be a necessary defensive measure, but switching a company’s offensive firepower from innovation to the courtroom can be harmful in the long term. While Apple is focused on spending billions of dollars and untold days of time in legal battles with Samsung all over the world[10], other competitors have a window of opportunity to move in.

They also have every incentive to leapfrog over current products because with so much technology tied up by patents, the only way to be safe (especially if you can’t afford to spend billions of dollars on lawyers) is to go way beyond what’s out there now. Having a competitor come out of nowhere and steal your market with a product that’s light years beyond your own is difficult to recover from — just ask RIM.

On the flip side of the tech giants buying patents as a weapon are the companies selling theirs. In many cases, they’re the ones that have been blindsided by new technology and are often approaching their end game. Look at Kodak (PINK:EKDKQ[11]). At one time it ruled the photography world: It controlled 90% of U.S. film sales and 85% of the U.S. camera market in the 1970s. But it failed to recognize how quickly digital cameras could render a century-old film-camera industry obsolete.

Kodak failed to innovate and paid the price. Now it’s in bankruptcy and desperately trying to sell off patents for the cash to eke out an existence[12] selling something — maybe inkjet printers, or specialized film for commercial movie cameras or maybe even solar cells[13].

Or take AOL (NYSE:AOL[14]). Another one-time tech titan that fell on hard times, AOL made news recently because of its $1 billion sale of patents to Microsoft[15].

Do companies need to protect their intellectual property? Absolutely. Filing patents, acquiring patents and defending products in court when necessary is unavoidable. The trouble begins when companies get to the stage that Apple and Google have reached, where legal expenditures overtake R&D, and the courtroom becomes more important that the lab.

It’s also bad for the industry’s future. Given the current patent morass in the U.S. and the European Union, American start-ups have to be worried. It can’t be pleasant watching a company like Apple deploying its lawyers at the slightest provocation to make a start-up think twice about bringing new technology to market, even if it’s a potential giant slayer.

Given the current state of affairs, I have occasional doubts about whether either Apple or Google is now in a position to reach the potential that seemed possible a year ago. While Apple could still come up with yet another hit that carries it to even greater growth, Cook & Co. especially seem at risk of sliding into a slow, Microsoft-like decline.

And the next technology titan — the one that eventually knocks the current industry leaders down a peg — may well come out of China, where it will not only have a massive market, but it will also have a fighting chance of avoiding extinction by litigation[16] before it can establish itself.

As of this writing Brad Moon didn’t own a position in any stocks mentioned here.

  1. AAPL:
  2. GOOG:
  3. New York Times article:
  4. MSFT:
  5. “look and feel” of Windows:
  6. Apple was spending 8% of annual revenue on R&D:
  7. that had roots in a prototype that predated the iPhone:
  8. RIMM:
  9. SNE:
  10. in legal battles with Samsung all over the world:
  11. EKDKQ:
  12. trying to sell off patents for the cash to eke out an existence:
  13. maybe even solar cells:
  14. AOL:
  15. $1 billion sale of patents to Microsoft:
  16. avoiding extinction by litigation:

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