1 Getting to “Reasonable” Law Seminars International Standards Bodies and Patent Pools Conference Arlington, Virginia October 2007 Alan Cox Senior Vice President NERA Economic Consulting San Francisco, California Gil Ohana Counsel WilmerHale LLP Palo Alto, California

2 Framing the Issue First: –Standards developers require or encourage FRAND or RAND licensing commitments Then: –Standard is adopted and enjoys success And: –Disputes emerge between owners of essential patents and implementers of standard as what “reasonable” means

3 Smoothwheels v. Kimono Cycles (1) Smoothwheels contributes patented technology to FastRide standard. –Standard is successful, and market for bicycle components grows quickly After standard is finalized, and patents issue, Smoothwheels negotiates licenses with two implementers –5 percent royalty, with cross-license and grantback to improvements

4 Smoothwheels’ negotiation with Kimono: –Smoothwheels seeks same terms it has received from other licensees –Kimono agrees to royalty terms and cross license to related patents, but refuses grantback –Smoothwheels counters: 10 percent royalty One-year grantback –Negotiations are unsuccessful and Smoothwheels sues Kimono Smoothwheels v. Kimono Cycles (2)

5 Issues: “Lost Profits” vs. “Reasonable Royalty” Economic approaches to “reasonable” Applying Georgia-Pacific? –Temporal element –Factor analysis Other evidence: –“Shared Understanding” of participants in FastRide SSO

6 Lost Profits vs. Reasonable Royalty The case for lost profits: –Where contributor of essential patents competes with infringer, it loses sales and profits to infringer The case against lost profits: –Panduit itself rejects limiting damages to reasonable royalty because to do so subjects patentee to “compulsory license”. 1/ –But, where patent that is infringed is one patentee committed to license on reasonable terms, license is not compulsory 1/ Panduit Corp. v. Stahlin Bros. Fibre Works, 575 F.2d 1152, 1158 (6 th Cir. 1978)

7 1.Market Based 2.Use of Comparables 3.Industry Rules of Thumb 4.25% Rule/ Standard Profit Split Ways in Which Analysts Try To Model The Royalty Bargain: Unreasonable (Will Only Be Reasonable With Luck) Reasonable Can Be Reasonable If Done Well (and they exist) Unreasonable

8 Price of Kimono’s Fastwheel Compliant Front Derailleurs Observed Prices of Fastwheel-Compliant Front Deraillerus Made Weight Price Premium for Lighter Front Derailleurs $20 $22 $24 $26 $28 $30 $32 Price Per Part Observed Prices Front Derailleurs Made to the Old Standard 8

9 Price of Kimono’s Fastwheel Compliant Front Deraileurs Weight $20 $22 $24 $26 $28 $30 $32 Price Per Part Price Kimono would have charged for Front Deraileurs of the same weight compliant with the old standard Price Premium for Lighter Front Derailleurs 9

10 Price of Kimono’s Fastwheel Compliant Front Deraileurs Weight $20 $22 $24 $26 $28 $30 $32 Price Per Part Price Kimono would have charged for Front Deraileurs of the same weight compliant with the old standard Price Premium Claimed by Smoothwheels as Due to its Patents Price Premium for Lighter Front Derailleurs 10

11 Smoothwheels Claims that the Value of Patent Is Difference in Amount Market Would Pay for the Attribute Mid - Atlantic Region West Coast Region Price Differences Among Different Standards $100 $150 $200 $250 $300 $350 $400 Price Per Crankset Crankshaft Using Fastspeed Standard Crankshaft Using Previous Standard Prices Observed in: North - East Region Price Premium Claimed by Smoothwheels as Due to its Patents 11

12 What if There is an Alternative Standard? Mid - Atlantic Region West Coast Region Price Differences Among Different Standards $100 $150 $200 $250 $300 $350 $400 Price Per Crankset Crankshaft Using Alternative New Standard Crankshaft Using Fastspeed Standard Crankshaft Using Previous Standard Prices Observed in: North - East Region 12

13 Kimono Claims that the Relevant Difference is with the Next Best Alternative Mid - Atlantic Region West Coast Region Price Differences Among Different Standards $100 $150 $200 $250 $300 $350 $400 Price Per Crankset Crankshaft Using Alternative New Standard Crankshaft Using Fastspeed Standard Crankshaft Using Previous Standard Prices Observed in: North - East Region 13

14 Mid - Atlantic Region West Coast Region Price Differences Among Different Standards $100 $150 $200 $250 $300 $350 $400 Price Per Crankset Crankshaft Using Alternative New Standard Crankshaft Using Fastspeed Standard Crankshaft Using Previous Standard Prices Observed in: North - East Region Price premium over alternatives considered by SSO Kimono Claims that the Relevant Difference is with the Next Best Alternative 14

15 Differences in Prices and Market Advantages Converts to Increases in Profits 15

16 Infringer’s Maximum Willingness to Pay Profit from Using the Patent Profit from Using the Next-Best Alternative Extra Profit from Using the Patent $ 16

17 Applying Georgia-Pacific: Temporal Element Georgia-Pacific hypothetical negotiation takes place at time infringement begins. 1/ –Infringement typically does not begin until after standard has been approved. Debate over whether in cases involving infringement of essential patents, “hypothetical negotiation” should instead be seen to occur at time of decision to include patented technology in standard –In Rambus remedies opinion, FTC favors determining reasonable royalty from ex ante perspective..2/ 1/ Wang Lab Inc. v. Toshiba Corp., 993 F.2d 858, (Fed. Cir. 1993) 2/ Matter of Rambus, Inc., No (FTC, Feb. 5, 2007) at

18 Applying Georgia-Pacific: Relevant Factors Because patentee has committed to license, Georgia- Pacific factor 1 (royalties received for licensing same patent) likely to be important –“ND” element of RAND: should it limit ability of patentee to distinguish other licenses it has given? –How to value non-economic components of license? E.g., cross-licenses, grantbacks, defensive suspension provisions Georgia-Pacific factor 4 (patentee’s policy of refusing to license) drops out.

19 Modeling the Hypothetical Negotiation Extra Profit from Using the Patent Maximum Royalty = Lifetime Expected Extra Profit Lifetime Expected Total Revenue = 6% 19

20 Determining the Bargaining Range in a Hypothetical Negotiation in a Patent Case 0% Based on: Added Profits Due to Being Able to Sell Product at Higher Price Potential Licensee’s Maximum Willingness to Pay: 6% 20

21 Hypothetical Negotiation Analyzed in Light of Georgia-Pacific Factors 14:Testimony of experts 13:Portion of profit credited to alleged infringer 12:Customary portion of profit 11:Extent of alleged infringer’s use of invention 10:Nature/benefits of the patented invention 9:Utility/advantages of invention 8:Profitability of the patented product 7:Duration of the patent and term of license 6:Convoyed sales 5:Commercial relationship 4:Licensor’s licensing policy 3:Nature and scope of license 2:Rates paid for other comparable patents 1:Royalties paid for licensing of the patent 15:Hypothetical negotiation 21

22 1:Royalties paid for licensing of the patent 9:Utility/advantages of invention 15:Hypothetical negotiation Hypothetical Negotiation Analyzed in Light of Georgia-Pacific Factors 14:Testimony of experts 13:Portion of profit credited to alleged infringer 12:Customary portion of profit 11:Extent of alleged infringer’s use of invention 10:Nature/benefits of the patented invention 8:Profitability of the patented product 7:Duration of the patent and term of license 6:Convoyed sales 5:Commercial relationship 4:Licensor’s licensing policy 3:Nature and scope of license 2:Rates paid for other comparable patents 15: Hypothetical negotiation 1: Royalties paid for licensing of the patent 15:Hypothetical negotiation 1:Royalties paid for licensing of the patent 22

23 Determining the Bargaining Range in a Hypothetical Negotiation in a Patent Case Minimum Patent Owner Would Accept: 0% Based on: Added Profits Due to Being Able to Sell Product at Higher Price Based on: Lost Profits Due to Increased Competition and Lost Licensing Opportunities Potential Licensee’s Maximum Willingness to Pay: 1% 6% Bargaining Range 23

24 Agreed-Upon Rate Within Bargaining Range 1%6% If firms have equal bargaining power, bargain might split the difference. Other factors, including Georgia-Pacific Factors, influence the final rate above or below mid-point. 24

25 A royalty tends to be is unreasonable if: There is no link between the royalty and the value of the patent (or standard) There is no consideration of non-infringing alternatives There is no consideration of work-around alternatives A royalty tends to be reasonable if: It applies market-based economic analysis in the Georgia-Pacific framework It considers the value of the patent to both parties to the negotiation It takes into account the availability of non- infringing alternatives Economically: What Tends to Make a Royalty Reasonable?

26 Shared Expectations of Participants If views of participants in standards development is informative as to meaning of rules of SDO (Rambus), should they be similarly informative as to meaning of RAND? –Where views of participants are based on past licensing practices for similar technologies, may be probative under Georgia-Pacific factor 2, royalty rates for comparable technologies –What if views are specific to particular standards development effort?