Last November, in Kirkbi AG v. Ritvik Holdings Inc. the Supreme Court of Canada dismissed Lego's case against Mega Blocks.
The plaintiff was the manufacturer of the well-known LEGO construction bricks for children. It had obtained patent protection for the locking system of interlocking studs and tubes that held the bricks together. On expiry of the patents, the defendant had commenced the manufacture and sale of its Mega Blocks, similar construction bricks using the same locking method. The plaintiffs had commenced an action for passing off, claiming trade-mark rights in the orthogonal pattern of the raised studs distributed on the top of each brick (the 'LEGO Indicia'). The trial judge had found that the LEGO Indicia was purely functional and dismissed the action, a finding that was upheld by the Federal Court of Appeal. The plaintiffs obtained leave to appeal to the Supreme Court of Canada. The SCC held that the appeal should be dismissed.
Lebel, J. writing for a unanimous court ended the decision with the following paragraph:
"Granting [Lego's] claim in these circumstances would amount to recreating a monopoly [after the expiry of the patent] contrary to basic policies of the laws and legal principles which inform the various forms of intellectual property in our legal system. The appellant is no longer entitled to protection against competition in respect of its product. It must now face the rigours of a free market and its process of creative destruction."
It seems to me that this paragraph, and especially its finale, possesses the quality of highly quotable sentences. The kind of which lawyers and judges would love to quote when they dismiss IP owners' claims, or otherwise tell monopolists that their game is over.
Regrettably, however, the Court misapplied the concept of creative destruction. The expression "creative destruction" was introduced into economic discourse by Joseph Schumpeter in his book, Capitalism, Socialism and Democracy, first published in 1942 (see an excerpt here). Schumpeter was critical of economists' focus on the inefficiencies created by monopolies and argued that they are missing the point. While monopolies do create inefficiencies, the crucial issue is not which products compete with each other within a single time period, but rather how new products compete with each other over time.
For Schumpeter, the focus should be on the process in which new products displace old ones, and which themselves will be later displaced by the next generation of products. Schumpeter described this process as a “perennial gale of creative destruction” in which monopolies are common, but frequently swept aside by new ones. The competition that such monopolies face does not come from many close substitutes but rather from
“the new commodity, the new technology, the new source of supply, the new type of organization … competition which commands a decisive cost or quality advantage which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives.”
Schumpeter's description of the process of Creative Destruction was not limited to cases involving intellectual property. In fact, his analysis barely mentioned intellectual property. He believed that this model generally describes capitalist markets; that this process was “the essential fact about capitalism”, and that the benefits from such system far outweigh the cost of any occasional monopolistic practice. Nevertheless, the logic of Schumpeter’s model is the same logic of intellectual property. When Schumpeter spells out the benefits of this system, his language sounds familiar to an ear trained to the language of intellectual property. He argues that
"a system… that at every given point in time fully utilizes its possibilities to the best advantage [a system that seeks to promote perfect competition] may yet in the long run be inferior to a system that does so at no given point of time, because the latter’s failure to do so may be a condition for the level or speed of long-run performance.”
The same logic of intellectual property.
In contrast, the kind of competition that develops when a patent expires is not the kind of competition Schumpeter described when he talked about Creative Destruction. When Mega Blocks use the same construction bricks with the same locking method, they clearly strike at the margins of Lego's profits and its outputs, but not at Lego's foundations. Not that there's anything wrong with that. Presumably, at this stage preserving Lego’s monopoly would create inefficiencies without any countervailing benefits. The Court was right in telling Lego that its exclusive game is over, and that now it’s time to compete. But it's simply not the kind of competition about which Schumpeter talked when he introduced the concept of Creative Destruction.
