The Golf Ball Wars

Mike Stachura and E. Michael Johnson are the chief gearheads at Golf Digest and have filed this quite interesting analysis of what could be the Hundred Years War between Costco and Acushnet.  I will excerpt liberally and offer my thoughts, but if the business side of the game is of any interest you'll want to read the entire thing for yourself.

We'll start with this overview:

In layman’s terms, Costco’s suit for what’s called a declaratory judgment against

Acushnet is essentially a preemptive strike, a lawsuit aiming to prevent a lawsuit. In actuality, it’s probably not going to work that way. 

In its complaint, Costco references a “threatening letter” it received from Acushnet accusing the Kirkland Signature ball—the $15-a-dozen multilayer, urethane-cover tour-type ball that’s been a bit of a cult sensation—of violating 11 patents. Costco is asking the court to rule that the Kirkland Signature not only does not violate the 11 patents but that the 11 patents themselves are invalid. 

That’s a bold ask in the world of golf ball patents, especially where Acushnet is concerned. Acushnet holds more U.S. patents in golf ball technology than any other company (more than 1,200), and its latest tour-dominant Pro V1 and Pro V1x multilayer urethane cover balls continue to rule the golf ball marketplace at nearly $50 a dozen.

That bit about avoiding a lawsuit is amusing, as the Tirleist golf ball business is the single most valuable book of business in the golf world.  Acushnet is going to defend that business to the death....

Costco finds itself in an awkward position to the extent that it's uncertain whether its golf ball violates Acushnet's patents, and thus a declaratory judgement would tell them where they stand.  However, word on the street is that Costco is prepared to resume selling its golf ball (set aside, for the moment, whether it will be the same golf ball sold in small quantities last year), and this process could take a decade or more....

Complicating matters is the portion of the motion that requests that the patents be invalidated, which is a declaration of war.  The authors analogize the lawsuit to a game of chicken, and I can see that here....  Obviously, were Acushnet willing to stipulate that the Costco balls don't infringe on their patents, Costco would logically withdraw its action to attack the underlying patents.  The problem is that if I can see that play, so can the other guys and their quite unlikely to play....

The other dilemma for Costco is that this is far more important for Acushnet than for the plaintiff.  The authors do offer this useful background:

Costco’s business model is driven on finding extreme savings on quality goods for its members. Although it recently delivered disappointing second quarter sales numbers, it remains relentlessly successful, moreso than any other retailer, in pursuing its mission statement “to continually provide our members with quality goods and services at the lowest possible prices.” It’s shown that to do so it will go to court to defend that right, even if that means years worth of trials. It once went more than a decade, including an appeal to the Supreme Court, fighting for the right to sell gray-market Omega watches purchased overseas for less than what an authorized U.S. dealer was allowed to charge—and won.

OK, but is that really applicable here?  Grey market goods are a far different issue than intellectual property, and for a category in which Costco has never competed.  As the author's recount, Acushnet has a long history of aggressively litigating to protect their market position, and of doing so successfully....   

But I should add that Costco is not only a good company in terms of its long-term growth, but also has a great reputation for its relationships with its suppliers.  That said, it may be that the company has reached a stage where continued growth is hard to sustain, and this push into a new category may have more to do with Costco itself than the golf industry.  But if a company struggling for growth covets a spot in the golf world, that's irony on steroids....

So, why go after the King?

“It’s a problem for the alleged infringer if the patent holder doesn’t sue them, so this does two things,” said Rochelle C. Dreyfuss, the Pauline Newman Professor of Law at New

York University School of Law. “It accelerates the lawsuit, which sometimes the alleged infringer wants, and it also gives the alleged infringer a choice of court.” 

Rather than let Acushnet’s so-called “threatening letter” linger, Costco decided to assert that the Kirkland Signature ball among other claims, does not infringe Acushnet patents for the relative hardness of the ball’s cores, the springiness of the core, and the dimples’ surface coverage. It also is asking the court to declare the 11 Acushnet patents invalid. 

“Costco finally said ‘Screw you, you want to play this as a game? Well, we’re actually going to bring a lawsuit and now you’re going to be forced to defend a lawsuit,’” said Dreyfuss, who has co-authored books on intellectual property law and international intellectual property law.

Fine, but "Screw you" is an emotional response, and when you go after the King you better kill him:

“Once Acushnet files an answer [to the suit], and probably a motion to dismiss the lawsuit, Costco is likely to seek a summary judgment ruling that they don’t infringe the patents to try to dispose of the matter,” he wrote in an email. 

What’s not clear is just how strong a case Costco can make in its effort to detail the invalidity of Acushnet’s patents, or whether, given its limited knowledge base in golf ball technology (the Kirkland Signature is its first private label golf ball), it can stand toe-to-toe with the industry leader. Invalidating patents is not easy and it will take a lot of time, especially when it comes to the kind of golf ball patents developed by Acushnet, the kind that have stood the test before. 

Moreover, Costco has to navigate a difficult timeline. Although it’s already on record saying it will return to selling the Kirkland Signature in limited quantities next month, those sales could be problematic if it’s not granted a declaratory action, or worse if Acushnet files a counter claim. In that case, if Acushnet ends up the winner, damages would be trebled.

Treble damages?  The authors see it much like I do:

And therein lies the question. Although this might be “a matter of principle” for Costco, one has to wonder how much stomach it has for a protracted—and perhaps extremely costly—legal tussle with an opponent known to fight such matters to the end. For all the media hype and the cult-like status afforded the Kirkland Signature ball, fact is its contribution to Costco’s bottom line is likely no more than an accounting rounding error due to its inability to produce more than limited quantities of the ball.

There's a tremendous amount that we don't know.  I would have liked the authors to provide a bit more on the action to invalidate the patents, and some sense of whether they seem to have anything there.

But what I find fascinating is that we don't even know what ball is under discussion.  Remember that the original K-Sig ball came about because a manufacturer had excess cores from the discontinued Nike ball business, and sold them on the cheap to Costco...  That's the limitation on upside to which the authors are seemingly referring in that last excerpt above.

But the USGA's list of conforming balls reportedly includes a new K-Sig ball, and one logically assumes that this ball can be produced in quantities sufficient to meet demand.  But also unknown are the economics of this ball, though logically they won't be able to match their aggressive pricing of last year's ball.  And that "cult-like status" wasn't because they produced a ball as good as the ProV1, there are quite a few of those...  It was the $15/Dozen retail price....

To the extent that this goes forward, we will undoubtedly learn a lot more about the golf ball business.  No doubt the margins are substantial, and that the price of Tour balls is artificially high, at least as relates to the direct manufacturing costs.  The business does have heavy R&D and promotional costs, but undercutting the price will bring down the wrath of Khan....

This conclusion seems inarguable:

It might not be fun to be in the middle of such a confrontation, but it ought to be fun to watch.

And yet, argue I shall....  I see where Costco can do golfers quite a bit of good....  I'm just having trouble seeing a scenario that's good for the shareholders of Costco.