Netflix Screens Patent Controversy

The patent dispute between online DVD rental rivals Netflix Inc. and Blockbuster Inc. not only pits two big-name competitors against each other, but it also highlights the ongoing debate over Internet business-method patents.

For years, Congress and legal scholars have argued over what sort of innovation qualifies for legal protection and whether patents should be issued for online business processes. Critics contend that most online processes currently winning patents are neither novel nor innovative. Worse, they argue, some of these patents are so broad that anyone is liable to end up infringing.

Several sizeable judgments in high-profile litigation ' including the $35 million award to patent holding company MercExchange from eBay over a patent involving auction technology and fixed-price trading ' have created a corporate and public backlash against Internet patents.

Against this backdrop, Keker & Van Nest filed Netflix's suit against the brick-and-mortar video giant. Netflix launched its online mail-order DVD rental service in 1999. Four million subscribers later, it doesn't want Blockbuster horning in on its fast-growing market.

The suit, filed in San Francisco federal court, accuses Dallas-based Blockbuster of duplicating key features of Netflix's patented Internet service, including the company's method of sending out movies based on a customer's movie queue and its practice of allowing customers to keep their movies as long as they wish, without a late fee.

So far, Blockbuster has only responded to the suit in a press release, saying the suit is without merit.

The two companies have been fiercely competing for customers since the Dallas-based Blockbuster launched its own online operation in 2004. The video-rental chain came late to the online rental service, but has steadily gained market share, signing up 1.2 million subscribers by 2005. It is also significantly shifting its business online, closing stores as renters turn to the Internet.

Netflix's case, according to some patent attorneys, should give pause to critics of online patents. Key to the company's success is its patented business model, and if the company is unsuccessful in enforcing its patent against a competitor in the same market, it would raise questions about the value of these patents.

'Business-method patents have been vilified because in many cases you're seeing individuals who don't practice their invention sue other businesses,' says patent attorney Neil Smith, a partner at Sheppard, Mullin, Richter & Hampton. 'But in Netflix's case, if their patent is strong, they should be able to use it against their competitors.'

Netflix spokesman Steve Swasey says the company's online service may look obvious to a lot of people now, but 7 years ago the only way anyone could rent a movie was to go to a video rental store.

'It's 2006 now, and our patented service is now being used by 4.2 million subscribers,' Swasey says. 'Of course, it now looks obvious.'

The suit, he says, is not just about competition, it's about protecting innovation.

'The patent laws were written to protect innovative inventors, and that's what we're doing,' Swasey says. 'We like competition and we know it's good, but when someone infringes on our patents, we mean to defend it. From top to bottom, Blockbuster has copied our business method, and we intend to enforce our patent.'

Robert Yoches, a partner at patent firm Finnegan, Henderson, Farabow, Garrett & Dunner, says Internet-related patents already have to go through a more rigorous and stricter scrutiny at the patent office.

As a result, only a fraction of the thousands of patent applications covering business methods are issued each year. In 2004, for example, only 282 patents were issued out of 6200 applications.

'Getting patents in areas where you don't expect them, like video rental or auction, has struck both lawmakers and judges in a strange way, and the patent office has responded by giving them extra scrutiny,' Yoches says.

'The patent office insists that they are applying the same examination standards to business-method patents, but the fact is, they only allow 16% of applications in this area, compared to 50% in other categories,' Yoches says.

In addition, the agency almost routinely invalidates Internet patents during reexamination when other parties bring evidence of prior art.

'Filing a reexamination procedure has become really popular now, and many people are now attacking business-method patents at the patent office,' Yoches says.

Still, even with the higher scrutiny at the patent office and the potential public relations fracas that a company may face when they enforce such patents, both Yoches and Smith predict a wave of e-patent litigation in the coming years. Netflix's case may be just the beginning.

'There is a tremendous backlog in the patent office, and many of these patents are just now issuing,' Yoches says. 'A lot of these patents are just now coming into the forefront and are now being litigated.'

The patent dispute between online DVD rental rivals Netflix Inc. and Blockbuster Inc. not only pits two big-name competitors against each other, but it also highlights the ongoing debate over Internet business-method patents.

For years, Congress and legal scholars have argued over what sort of innovation qualifies for legal protection and whether patents should be issued for online business processes. Critics contend that most online processes currently winning patents are neither novel nor innovative. Worse, they argue, some of these patents are so broad that anyone is liable to end up infringing.

Several sizeable judgments in high-profile litigation ' including the $35 million award to patent holding company MercExchange from eBay over a patent involving auction technology and fixed-price trading ' have created a corporate and public backlash against Internet patents.

Against this backdrop, Keker & Van Nest filed Netflix's suit against the brick-and-mortar video giant. Netflix launched its online mail-order DVD rental service in 1999. Four million subscribers later, it doesn't want Blockbuster horning in on its fast-growing market.

The suit, filed in San Francisco federal court, accuses Dallas-based Blockbuster of duplicating key features of Netflix's patented Internet service, including the company's method of sending out movies based on a customer's movie queue and its practice of allowing customers to keep their movies as long as they wish, without a late fee.

So far, Blockbuster has only responded to the suit in a press release, saying the suit is without merit.

The two companies have been fiercely competing for customers since the Dallas-based Blockbuster launched its own online operation in 2004. The video-rental chain came late to the online rental service, but has steadily gained market share, signing up 1.2 million subscribers by 2005. It is also significantly shifting its business online, closing stores as renters turn to the Internet.

Netflix's case, according to some patent attorneys, should give pause to critics of online patents. Key to the company's success is its patented business model, and if the company is unsuccessful in enforcing its patent against a competitor in the same market, it would raise questions about the value of these patents.

'Business-method patents have been vilified because in many cases you're seeing individuals who don't practice their invention sue other businesses,' says patent attorney Neil Smith, a partner at Sheppard, Mullin, Richter & Hampton. 'But in Netflix's case, if their patent is strong, they should be able to use it against their competitors.'

Netflix spokesman Steve Swasey says the company's online service may look obvious to a lot of people now, but 7 years ago the only way anyone could rent a movie was to go to a video rental store.

'It's 2006 now, and our patented service is now being used by 4.2 million subscribers,' Swasey says. 'Of course, it now looks obvious.'

The suit, he says, is not just about competition, it's about protecting innovation.

'The patent laws were written to protect innovative inventors, and that's what we're doing,' Swasey says. 'We like competition and we know it's good, but when someone infringes on our patents, we mean to defend it. From top to bottom, Blockbuster has copied our business method, and we intend to enforce our patent.'

Robert Yoches, a partner at patent firm Finnegan, Henderson, Farabow, Garrett & Dunner, says Internet-related patents already have to go through a more rigorous and stricter scrutiny at the patent office.

As a result, only a fraction of the thousands of patent applications covering business methods are issued each year. In 2004, for example, only 282 patents were issued out of 6200 applications.

'Getting patents in areas where you don't expect them, like video rental or auction, has struck both lawmakers and judges in a strange way, and the patent office has responded by giving them extra scrutiny,' Yoches says.

'The patent office insists that they are applying the same examination standards to business-method patents, but the fact is, they only allow 16% of applications in this area, compared to 50% in other categories,' Yoches says.

In addition, the agency almost routinely invalidates Internet patents during reexamination when other parties bring evidence of prior art.

'Filing a reexamination procedure has become really popular now, and many people are now attacking business-method patents at the patent office,' Yoches says.

Still, even with the higher scrutiny at the patent office and the potential public relations fracas that a company may face when they enforce such patents, both Yoches and Smith predict a wave of e-patent litigation in the coming years. Netflix's case may be just the beginning.

'There is a tremendous backlog in the patent office, and many of these patents are just now issuing,' Yoches says. 'A lot of these patents are just now coming into the forefront and are now being litigated.'