‘Lightlab’ and first mover advantage

Issue November 2015 By Philip Saunders Jr.

First mover advantage (FMA) is the market advantage that a firm gains for being first with a product. In LightLab Imaging Inc. v. Axsun Technologies Inc. & Another, SJC-11374, July 28, 2014, the Supreme Judicial Court affirmed a decision to deny lost profits claimed, in part, based upon the plaintiff's assertion of FMA. The trial court had not rejected the FMA concept per se, but found no evidence of loss and the methodology deficient "particularly as to quantification."

Since LightLab, FMA has been argued by a pharmaceutical development company seeking a preliminary injunction in Theravectys SA v. Immune Design Corp., C.A. No. 9950-VCN, Court of Chancery of Delaware, March 9, 2015. The court, in finding failure to establish irreparable harm, observed that the "first-mover advantage argument … fails to establish a non-speculative harm." It will be interesting to see whether the argument will be resuscitated at trial and, if so, with what result.

Other unsuccessful appearances of FMA include a trade secrets case in which the plaintiff argued potential loss of FMA in a failed attempt to obtain an injunction. See Aetna, Inc. v. Bradley M. Fluegel et al, CV0740333455, Sup. Ct., Conn., July 7, 2008. Also, in a case that did not go to trial, in which the author was an expert for the defense, the plaintiff's expert described the advantage of being the first mover but was unable to point to any specific lost profits. The case settled with no money changing hands.

More promising for the first mover concept was a favorable mention at the U.S. Supreme Court: "Firms that innovate often capture long-term benefits from doing so, thanks to various first mover advantages, including lockins, branding, and networking effects." See Bernard L. Bilskey et al v. David J. Kappos, 130 S.Ct. 3218, June 28, 2010. The same Court of Chancery of Delaware that rejected first mover advantage in Theravectys subsequently accepted the theory as the basis for the choice of a growth rate above the rate of inflation, a small part of a much larger company valuation analysis. See Leilani Zutrau v. John C. Jansing et al, C.A. No. 7457-VCP, Court of Chancery of Delaware, July 31, 2014.

There is an extensive literature on FMA. The prevailing view is that being the first mover confers an advantage. Some studies have focused not on FMA per se but on explaining market share. Eleven such studies have found market share and order of entry to be correlated: The earlier a product was in the market, the larger its market share was likely to be.

However, there is general agreement in the literature that the magnitude and durability of the advantage may vary substantially depending upon a variety of factors, some of which are discussed below.

The extent of FMA is different in different product categories. The advantage generally dissipates over time. The size and durability of FMA is affected by advertising (the first mover's and the competition's), pricing and relative quality (or at least customer perception of relative quality) of later-entering products. Sometimes being first mover is more important than being better; followers with superior products don't always succeed in overtaking the first mover.

FMA can be enhanced by having a technology not readily replicated by a competitor, for legal or other reasons; control of scarce resources, which the first mover may own, collect or create (e.g., raw material, IP, location, key employees, key suppliers, customer first impressions, know-how); customer switching costs (i.e., monetary or simply intangible costs of changing habits or organizational practices or of learning new methods); and network effects, which can create a kind of switching cost in situations where customers seek a common standard or the ability to interact with other users.

Market factors are important as well. New product categories seem to attract more followers than old categories. For a brand extension, being first mover can count for more than for a new brand. Rapid market expansion can be a blessing, if the first mover has the resources to keep up, but a curse, if the first mover does not and a follower does. If a technology is disruptive (e.g., the PC), rather than incremental (e.g., new kinds of mainframes), it is harder to predict what will become of the FMA.

In short, whether the first mover can establish and maintain market leadership seems to be highly case specific, depending upon a variety of factors which may or may not be relevant to a particular industry, market or company.

There are definitional issues that would need to be addressed in any successful claim based on FMA.

Is the first mover the inventor or holder of the patent, the first to develop a prototype, the first to market or the first to develop a significant market share? Obviously, the further along the plaintiff is, the stronger the case.

What is the market? A new pharmaceutical effectively treating a disease, with no previous effective treatment, defines the market and is the first mover. If the pharmaceutical treats a disease that has existing remedies, the new product may be the first mover in only a market segment.

What is the time horizon? Plaintiffs like to assume their products will triumph in perpetuity. However, courts are reluctant to award damages based upon projections into a distant future, particularly, as in LightLab, when the projections go beyond some identifiable date certain (e.g., expiration of a lease, contract or patent). It may be enough to demonstrate that, but for the breach or tort, the plaintiff would likely have enjoyed a few years of profitability.

What is the basis for damages? The common claim, as in LightLab, is for lost profits. However, a common end for successful startups is to be bought out, as happened to LightLab, which never made money but sold for $92.8 million. The grounds for damages may need to be reframed from lost profits to something else - say, loss of capital or destruction of value. Doing so would raise legal and economic issues beyond the scope of this brief paper, but to deny the possibility would be to deny a remedy for loss of potential with real economic value.

Netscape can be an example, with 20-20 hindsight, of how these definitional issues might have been addressed had Netscape been in litigation. Netscape did not develop and was not the first to market a browser, but it was arguably the first to develop and dominate a significant browser market (first mover definition). The market was fairly clearly defined: a means of finding stuff on the internet (market definition). The company existed independently for only five years (time horizon). Cumulatively, profits were negative, but AOL purchased Netscape in a deal valued at the time at about $4.2 billion (basis for damages).

The brief history of the FMA concept in litigation makes it clear that merely asserting FMA as the basis for a lost profits claim accomplishes little. However, the extensive work that has been done on FMA outside the courts makes it clear that the advantage is real. FMA may best be thought of not as a sole basis for a damage claim but as a useful framework within which to perform a traditional lost profits analysis. FMA could be a lens through which to examine the facts of a case to assess the magnitude of a FMA and help quantify the damages. With a proper analysis of the relevant factors, FMA may yet play a meaningful role in the courtroom.

This article appeared in the Summer 2015 edition of the ComCom Quarterly, the newsletter of the Complex Commercial Litigation Section. For more articles like these on business litigation, bankruptcy and intellectual property topics, check out the Quarterly at http://is.gd/lFJCJw.