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Principles of FRAND Royalties Norman Siebrasse University of Toronto Patent Colloquium 2014.

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1 Principles of FRAND Royalties Norman Siebrasse University of Toronto Patent Colloquium 2014

2 FRAND Royalty Determinations Microsoft Corp v Motorola, Inc, Robart, J Microsoft Corp v Motorola, Inc, Robart, J In re Innovatio, Holderman J In re Innovatio, Holderman J CSIRO v Cisco, Davis J CSIRO v Cisco, Davis J Samsung v Apple, Japan Samsung v Apple, Japan Huawei v InterDigital, China Huawei v InterDigital, China Ericsson v Micromax, India (interim) Ericsson v Micromax, India (interim)

3 MICROSOFT V MOTOROLA “ECONOMIC GUIDEPOSTS FOR ASSESSING RAND TERMS”

4 Economic Guideposts Avoid patent hold-up Avoid patent hold-up Avoid royalty stacking Avoid royalty stacking Ensure reasonable return to patentee Ensure reasonable return to patentee Reflect value of the technology, not value of the standard Reflect value of the technology, not value of the standard Reflect relative importance of individual patent to the standard Reflect relative importance of individual patent to the standard

5 Economic Guideposts Avoid patent hold-up Avoid patent hold-up Two issues, one important, one not important Two issues, one important, one not important Avoid royalty stacking Avoid royalty stacking Ensure reasonable return to patentee Ensure reasonable return to patentee Reflect value of the technology, not value of the standard Reflect value of the technology, not value of the standard Reflect relative importance of individual patent to the standard Reflect relative importance of individual patent to the standard

6 Economic Guideposts Avoid patent hold-up Avoid patent hold-up Two issues, one important, one not important Two issues, one important, one not important Avoid royalty stacking Avoid royalty stacking Important Important Ensure reasonable return to patentee Ensure reasonable return to patentee Reflect value of the technology, not value of the standard Reflect value of the technology, not value of the standard Reflect relative importance of individual patent to the standard Reflect relative importance of individual patent to the standard

7 Economic Guideposts Avoid patent hold-up Avoid patent hold-up Two issues, one important, one not important Two issues, one important, one not important Avoid royalty stacking Avoid royalty stacking Important Important Ensure reasonable return to patentee Ensure reasonable return to patentee Two issues Two issues Reflect value of the technology, not value of the standard Reflect value of the technology, not value of the standard Reflect relative importance of individual patent to the standard Reflect relative importance of individual patent to the standard

8 Economic Guideposts Avoid patent hold-up Avoid patent hold-up Two issues, one important, one not important Two issues, one important, one not important Avoid royalty stacking Avoid royalty stacking Important Important Ensure reasonable return to patentee Ensure reasonable return to patentee Two issues, one important, one not important Two issues, one important, one not important Reflect value of the technology, not value of the standard Reflect value of the technology, not value of the standard Not important Not important Reflect relative importance of individual patent to the standard Reflect relative importance of individual patent to the standard

9 Economic Guideposts Avoid patent hold-up Avoid patent hold-up Two issues, one important, one not important Two issues, one important, one not important Avoid royalty stacking Avoid royalty stacking Important Important Ensure reasonable return to patentee Ensure reasonable return to patentee Two issues, one important, one not important Two issues, one important, one not important Reflect value of the technology, not value of the standard Reflect value of the technology, not value of the standard Not important Not important Reflect relative importance of individual patent to the standard Reflect relative importance of individual patent to the standard Desirable, but difficult Desirable, but difficult

10 HOLD-UP

11 Two Kinds of Hold-Up 55 The ability of a holder of an SEP to demand more than the value of its patented technology and to attempt to capture the value of the standard itself is referred to as patent “hold-up.” 55 The ability of a holder of an SEP to demand more than the value of its patented technology and to attempt to capture the value of the standard itself is referred to as patent “hold-up.” Standard value hold-up Standard value hold-up

12 Two Kinds of Hold-Up The threat of hold-up increases as the standard becomes more widely implemented and firms make sunk cost investments that cannot be recovered if they are forced to forego implementation of the standard or the standard is changed. The threat of hold-up increases as the standard becomes more widely implemented and firms make sunk cost investments that cannot be recovered if they are forced to forego implementation of the standard or the standard is changed. Sunk cost hold-up Sunk cost hold-up

13 Standard Value Hold-Up ([see also Schmalensee Testimony] (explaining that the “essence of hold-up” is that while ex ante competition constrains what a patent holder can obtain for access to its patent, ex post, the technology in the standard does not face that competition).) ([see also Schmalensee Testimony] (explaining that the “essence of hold-up” is that while ex ante competition constrains what a patent holder can obtain for access to its patent, ex post, the technology in the standard does not face that competition).)

14 Standard Value Hold-Up: Example firms that have developed and patented WiFi technology, A, B, C firms that have developed and patented WiFi technology, A, B, C... All equally good. All equally good. Very cheap to implement Very cheap to implement Each adopted by 10 users in isolated networks Each adopted by 10 users in isolated networks Each user pays royalty = $10 Each user pays royalty = $10 Total value of the technology = $10k Total value of the technology = $10k Each of the 1000 users would be willing to pay $100 each if all users were using the same technology Each of the 1000 users would be willing to pay $100 each if all users were using the same technology

15 Standard Value Hold-Up SSO chooses A as the standard SSO chooses A as the standard A is adopted by all users A is adopted by all users Total value of the technology = $100k Total value of the technology = $100k Recall, each user willing to pay $100 for standardized tech Recall, each user willing to pay $100 for standardized tech Difference between ex ante and ex post value = value of standardization = $90k Difference between ex ante and ex post value = value of standardization = $90k If A can get injunction, it can charge $100 each If A can get injunction, it can charge $100 each A can get full value of the market A can get full value of the market

16 Standard Value Hold-Up Imagine ex ante auction for privilege of being chosen being chosen as standard Imagine ex ante auction for privilege of being chosen being chosen as standard Patentees make royalty bid to users Patentees make royalty bid to users Users choose patentee with lowest bid Users choose patentee with lowest bid What would be the winning royalty bid? What would be the winning royalty bid? $0 $0 Swanson & Baumol; Layne-Farrar, Padilla & Schmalensee Swanson & Baumol; Layne-Farrar, Padilla & Schmalensee Royalty constrained by ex ante competition Royalty constrained by ex ante competition All of the value of standardization is captured by users All of the value of standardization is captured by users

17 Standard Value Hold-Up Winning patentee should not be able to charge more ex post than it would have been able to charge ex ante Winning patentee should not be able to charge more ex post than it would have been able to charge ex ante The... attempt to capture the value of the standard itself is referred to as patent “hold-up.” The... attempt to capture the value of the standard itself is referred to as patent “hold-up.” while ex ante competition constrains what a patent holder can obtain for access to its patent, ex post, the technology in the standard does not face that competition. while ex ante competition constrains what a patent holder can obtain for access to its patent, ex post, the technology in the standard does not face that competition. Why not? Why not?

18 Standard Value Hold-Up: Example 2 No firm has developed WiFi technology No firm has developed WiFi technology Value of the market = $0 Value of the market = $0 Firm A develops and patents WiFi technology Firm A develops and patents WiFi technology No other firm does the same No other firm does the same A is adopted by all users A is adopted by all users Each user pays $100 to A Each user pays $100 to A Total value of the technology = $100k Total value of the technology = $100k A captures the entire value of the market = $100k A captures the entire value of the market = $100k

19 Standard Value Hold-Up Why should A be able to capture entire value of standardization in Example 2, but not in Example 1? Why should A be able to capture entire value of standardization in Example 2, but not in Example 1? When the standard becomes widely used, the holders of SEPs obtain substantial leverage to demand more than the value of their specific patented technology. This is so even if there were equally good alternatives to that technology available when the original standard was adopted. When the standard becomes widely used, the holders of SEPs obtain substantial leverage to demand more than the value of their specific patented technology. This is so even if there were equally good alternatives to that technology available when the original standard was adopted. What is wrong with that? What is wrong with that?

20 Fairness Objection Not fair that A should be able to demand more ex post than it could have ex ante Not fair that A should be able to demand more ex post than it could have ex ante But also not fair that patentees should get $0 in Example 1, but everything in Example 2 But also not fair that patentees should get $0 in Example 1, but everything in Example 2 Cf Shapley value pricing, in which patentees capture entire value of standardization, regardless of the amount of competition ex ante: Layne-Farrar et al Cf Shapley value pricing, in which patentees capture entire value of standardization, regardless of the amount of competition ex ante: Layne-Farrar et al Why should users capture 100% of the value of standardization, when they have contributed nothing? Why should users capture 100% of the value of standardization, when they have contributed nothing?

21 Efficiency Objection From user perspective, no difference between Example 1 with hold-up and Example 2 From user perspective, no difference between Example 1 with hold-up and Example 2 Hold-up has no adverse effect on user behaviour Hold-up has no adverse effect on user behaviour

22 Incentive Problem Two firms develop and patent different technologies for use in valuable standard Two firms develop and patent different technologies for use in valuable standard Each technology is equally good Each technology is equally good Under auction pricing model, each will get $0 royalty Under auction pricing model, each will get $0 royalty Insufficient to induce creation of technology Insufficient to induce creation of technology Auction model considers pure static efficiency Auction model considers pure static efficiency Does not consider incentive to innovate Does not consider incentive to innovate

23 Legal Counter-Argument Swanson-Baumol is an auction model Swanson-Baumol is an auction model An auction is not a negotiation An auction is not a negotiation Auction drives patentee down to minimum willing to accept Auction drives patentee down to minimum willing to accept Negotiation splits difference between minimum willingness to accept and maximum willingness to pay Negotiation splits difference between minimum willingness to accept and maximum willingness to pay

24 Standard Value Hold-Up Summary Allowing standard value “hold-up” Allowing standard value “hold-up” Has no adverse effect on user behaviour Has no adverse effect on user behaviour May have positive effect on incentive to innovate May have positive effect on incentive to innovate Conclusion Conclusion Standard value hold-up is not an important problem Standard value hold-up is not an important problem

25 Sunk Cost Hold-up A holds patent for piling for offshore oil platform A holds patent for piling for offshore oil platform $100k to license ex ante $100k to license ex ante User builds $10m platform using patented method User builds $10m platform using patented method Anticipates $11m revenue for $1m profit Anticipates $11m revenue for $1m profit A sues ex post A sues ex post User will pay $10m to avoid injunction ex post User will pay $10m to avoid injunction ex post Net profit = Negative $9m Net profit = Negative $9m

26 Sunk Cost Hold-up Threat of ex post injunction with sunk costs increases risk Threat of ex post injunction with sunk costs increases risk User will invest in less risky projects User will invest in less risky projects Social loss from sunk cost hold-up is avoidance of positive value investments Social loss from sunk cost hold-up is avoidance of positive value investments Cf standard value hold-up Cf standard value hold-up Users will not avoid WiFi even if they have to pay $100 ex post Users will not avoid WiFi even if they have to pay $100 ex post

27 Sunk Cost Hold-Up The threat of hold-up increases as the standard becomes more widely implemented and firms make sunk cost investments that cannot be recovered if they are forced to forego implementation of the standard or the standard is changed. The threat of hold-up increases as the standard becomes more widely implemented and firms make sunk cost investments that cannot be recovered if they are forced to forego implementation of the standard or the standard is changed. Same in principle as non-SEP sunk cost hold-up Same in principle as non-SEP sunk cost hold-up Though more of a problem in practice Though more of a problem in practice Ex ante licensing may be impractical Ex ante licensing may be impractical

28 Distinguish Sunk Cost and Standard Value Hold-up Sunk cost hold-up Sunk cost hold-up Does not require a standard Does not require a standard Requires sunk costs Requires sunk costs Makes user less likely to adopt Makes user less likely to adopt Standard value hold-up Standard value hold-up Requires a standard Requires a standard Does not require sunk costs Does not require sunk costs Does not affect ex ante user decision to adopt Does not affect ex ante user decision to adopt

29 Hold-Up Summary Standard value hold-up unique to SEPs Standard value hold-up unique to SEPs But not an important problem But not an important problem Sunk cost hold-up a serious problem Sunk cost hold-up a serious problem But not unique to SEPs But not unique to SEPs Though very important in SEP context Though very important in SEP context

30 ROYALTY STACKING

31 Royalty Stacking The payment of excessive royalties to many different holders of SEPs is referred to as “royalty stacking.” The payment of excessive royalties to many different holders of SEPs is referred to as “royalty stacking.” The RAND commitment also addresses royalty stacking and the need to ensure that the aggregate royalties associated with a given standard are reasonable. The RAND commitment also addresses royalty stacking and the need to ensure that the aggregate royalties associated with a given standard are reasonable.

32 Royalty Stacking Technical problem Technical problem Cournot complements Cournot complements Many patentees with complementary patents negotiating independently with user will charge more than single patentee holding all of the patents Many patentees with complementary patents negotiating independently with user will charge more than single patentee holding all of the patents Practical problem Practical problem Excessive demands Excessive demands Motorola asked 2.25% of product price Motorola asked 2.25% of product price Implies $150 royalty on $300 Xbox, for video standard alone Implies $150 royalty on $300 Xbox, for video standard alone

33 Royalty Stacking Royalty stacking only occurs when there is more than one SEP Royalty stacking only occurs when there is more than one SEP Often 100s of US SEPs, thousands worldwide Often 100s of US SEPs, thousands worldwide Cf hold-up (both kinds) which can occur when there is only one SEP Cf hold-up (both kinds) which can occur when there is only one SEP

34 PATENT POOLS

35 Patent Pools Group of patentees pool patents and offer single licence to users Group of patentees pool patents and offer single licence to users Solves Solves Royalty stacking Royalty stacking Sunk cost hold-up Sunk cost hold-up Does not solve Does not solve Standard value hold-up Standard value hold-up

36 Patent Pools Robart J used a patent pool comparator to set FRAND rate Robart J used a patent pool comparator to set FRAND rate As discussed with relation to SSO policy, RAND is informed by two prevailing concerns: preventing stacking and eliminating hold-up. The court finds that, among these two goals, the anti-stacking principle is the primary constraint on the upper bound of RAND. As discussed with relation to SSO policy, RAND is informed by two prevailing concerns: preventing stacking and eliminating hold-up. The court finds that, among these two goals, the anti-stacking principle is the primary constraint on the upper bound of RAND.

37 ENSURE REASONABLE RETURN TO PATENTEE

38 Reasonable Return to Patentee To induce the creation of valuable standards, the RAND commitment must guarantee that holders of valuable intellectual property will receive reasonable royalties on that property. To induce the creation of valuable standards, the RAND commitment must guarantee that holders of valuable intellectual property will receive reasonable royalties on that property. Encourage standards Encourage standards Requires that return to patentee must be higher than return to outside option Requires that return to patentee must be higher than return to outside option

39 Reasonable Return to Patentee Moreover, since licensing through SSOs under the RAND commitment is, at least for some entities, an important component of profitability, reducing that component would reduce the incentive to innovate and thereby slow the pace of innovation in the economy Moreover, since licensing through SSOs under the RAND commitment is, at least for some entities, an important component of profitability, reducing that component would reduce the incentive to innovate and thereby slow the pace of innovation in the economy Preserve incentive to innovate Preserve incentive to innovate Requires that return to patentee is sufficient to cover costs of innovation Requires that return to patentee is sufficient to cover costs of innovation

40 Reasonable Return to Patentee These are distinct concerns These are distinct concerns Preserving the incentive to innovate is NOT generally a concern Preserving the incentive to innovate is NOT generally a concern If a patentee spends $100m to develop a worthless product, it should not be rewarded If a patentee spends $100m to develop a worthless product, it should not be rewarded Encouraging creation of standards is a basic goal of the FRAND commitment Encouraging creation of standards is a basic goal of the FRAND commitment A return sufficient to induce patentee to join standard may not cover the cost of innovation A return sufficient to induce patentee to join standard may not cover the cost of innovation This concern emphasized by Robart J This concern emphasized by Robart J

41 Reasonable Return to Patentee Lower bound of FRAND rate should be value of outside option Lower bound of FRAND rate should be value of outside option Patent pool comparator addresses this problem Patent pool comparator addresses this problem Patent pools need to attract patentees as well as licensees Patent pools need to attract patentees as well as licensees

42 REFLECT VALUE OF THE TECHNOLOGY, NOT VALUE OF THE STANDARD

43 Reflect Value of the Technology See above re Standard Value Hold-Up See above re Standard Value Hold-Up

44 REFLECT RELATIVE IMPORTANCE OF INDIVIDUAL PATENT TO THE STANDARD

45 Relative Importance of Patent [A] patent that is extremely important and central to the standard would reasonably command a higher royalty rate than a less important patent. [A] patent that is extremely important and central to the standard would reasonably command a higher royalty rate than a less important patent. What does “important” mean? What does “important” mean?

46 Relative Importance of Patent 1) Function is important to the value of the standard 1) Function is important to the value of the standard WiFi transmission technology is important WiFi transmission technology is important Power management functions less important Power management functions less important 2) Many other options for achieving the same function 2) Many other options for achieving the same function WiFi transmission has several good technologies which compete ex ante WiFi transmission has several good technologies which compete ex ante

47 Relative Importance of Patent Both may be assessed by incremental value Both may be assessed by incremental value Microsoft contends that the economic value of patented technology isolated from the value derived from incorporation into the standard would be determined by calculating the incremental value of the technology compared to the alternatives that could have been written into the standard. Microsoft contends that the economic value of patented technology isolated from the value derived from incorporation into the standard would be determined by calculating the incremental value of the technology compared to the alternatives that could have been written into the standard.

48 Relative Importance of Patent If function is important, but many competing technologies, incremental value of the patent is small If function is important, but many competing technologies, incremental value of the patent is small If only one technology, but function is relatively unimportant, increase in incremental value of the standard is small If only one technology, but function is relatively unimportant, increase in incremental value of the standard is small

49 Relative Importance of Patent In practice, approaches linking the value of a patent to its incremental contribution to a standard are hard to implement. In practice, approaches linking the value of a patent to its incremental contribution to a standard are hard to implement. SSOs do not use incremental value SSOs do not use incremental value Patent pools do not use incremental value Patent pools do not use incremental value Courts do not use incremental value Courts do not use incremental value

50 Relative Importance of Patent Pure incremental value approach is difficult to implement Pure incremental value approach is difficult to implement But importance of patent in question may be assessed in relation to comparator But importance of patent in question may be assessed in relation to comparator Robart J considered patent pool comparator Robart J considered patent pool comparator Assessed patents in question as not being of more than average importance Assessed patents in question as not being of more than average importance Did not adjust pool rate upwards Did not adjust pool rate upwards

51 REFERENCES

52 Articles Daniel G. Swanson & William J. Baumol, Reasonable and Nondiscriminatory (RAND) Royalties, Standards Selection, and Control of Market Power, 73 Antitrust L.J. 1, 5 (2005) Daniel G. Swanson & William J. Baumol, Reasonable and Nondiscriminatory (RAND) Royalties, Standards Selection, and Control of Market Power, 73 Antitrust L.J. 1, 5 (2005) Anne Layne-Farrar, A. Jorge Padilla & Richard Schmalensee, Pricing Patents for Licensing in Standard Setting Organizations: Making Sense of FRAND Commitments, 74 ANTITRUST L.J. 671 (2007). Anne Layne-Farrar, A. Jorge Padilla & Richard Schmalensee, Pricing Patents for Licensing in Standard Setting Organizations: Making Sense of FRAND Commitments, 74 ANTITRUST L.J. 671 (2007).

53 Cases Microsoft Corp v Motorola, Inc, (WD Wash, Apr 25, 2013) Robart, J Microsoft Corp v Motorola, Inc, (WD Wash, Apr 25, 2013) Robart, J In re Innovatio IP Ventures, LLC Patent Litig, (ND Ill, Oct 3, 2013) Holderman J In re Innovatio IP Ventures, LLC Patent Litig, (ND Ill, Oct 3, 2013) Holderman J CSIRO v Cisco, (ED Tex, July 23, 2014) Davis J CSIRO v Cisco, (ED Tex, July 23, 2014) Davis J Samsung v Apple, 2013 (Ne) (IPHC, Japan, May 16, 2014) Samsung v Apple, 2013 (Ne) (IPHC, Japan, May 16, 2014) Huawei v InterDigital, Shenzhen Intermediate People's Court, aff’d Guangdong High Court Huawei v InterDigital, Shenzhen Intermediate People's Court, aff’d Guangdong High Court

54 A New Framework for Determining Reasonable Royalties in Patent Litigation Siebrasse & Cotter “Contingent ex ante” hypothetical negotiation “Contingent ex ante” hypothetical negotiation Ex ante negotiation with full ex post information Ex ante negotiation with full ex post information SEPs SEPs Regulatory Uncertainty Regulatory Uncertainty Non-Infringing Alternatives Non-Infringing Alternatives Unexpected Exogenous Events Unexpected Exogenous Events

55 A New Framework for Determining Reasonable Royalties in Patent Litigation Siebrasse & Cotter “Contingent ex ante” hypothetical negotiation “Contingent ex ante” hypothetical negotiation Ex ante negotiation with full ex post information Ex ante negotiation with full ex post information Lump-Sum Versus Running Royaltiess Lump-Sum Versus Running Royaltiess Bargaining Weakness Bargaining Weakness Separate and Distinct Infringements Separate and Distinct Infringements


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