Patent holdup and royalty stacking

Texas Law Review

Volumn 85, Issue 7, 2007, Pages 2163-2173

  Lemley, Mark A ^a   Shapiro, Carl ^b,c  

^a STANFORD LAW SCHOOL   (United States)

^b UNIVERSITY OF CALIFORNIA   (United States)

^c CRA International ^*

Author keywords

[No Author keywords available]

Indexed keywords

EID: 34547804732     PISSN: 00404411     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Note

References (49)

1. Mark A. Lemley & Carl shapiro, Patent Holdup and Royalty Stacking, 85 TEXAS L. REV. 1991 (2007).
2. John M. Golden, Commentary, "Patent Trolls" and Patent Remedies, 85 TEXAS L. REV. 2111 (2007).
3. Id. at 2114.
4. Id.
5. Lemley & Shapiro, supra note 1, at 2036.
6. Golden, supra note 2, at 2136 (quoting Lemley & Shapiro, supra note 1, at 2044).
7. Id. at 2155-56.
8. Id. at 2116.
9. Id. at 2137.
10. OLIVER WILLIAMSON, THE ECONOMIC INSTITUTIONS OF CAPITALISM: FIRMS, MARKETS, RELATIONAL CONTRACTING (1985).
11. The Department of Justice and the Federal Trade Commission recently emphasized the benefits of ex ante negotiations in mitigating the effects of patent holdup. See U.S. DEP'T OF JUSTICE & FED. TRADE COMM'N, ANTITRUST ENFORCEMENT AND INTELLECTUAL PROPERTY RIGHTS: PROMOTING INNOVATION AND COMPETITION 33-56 (2007), available at http://www.usdoj.gov/atr/public/hearings/ip/222655.pdf.
12. Golden, supra note 2, at 2137-38.
13. See, e.g., MASSIMO MOTTA, COMPETITION POLICY: THEORY AND PRACTICE (2004).
14. In the model used by Farrell and Shapiro, the patent holder has the ability to make a take-it-or-leave-it offer, which implies that B = 1, so the benchmark becomes V×θO. Joseph Farrell & Carl Shapiro, How Strong Are Weak Patents? (Jan. 2007) (unpublished manuscript), available at http://faculty.haas.berkeley.edu/shapiro/weak.pdf. Our article is more general in terms of bargaining skill. However, the Farrell and Shapiro model is more general in that it models the interactions among competing downstream users, which leads to excessive royalties for weak patents even in the absence of holdup or royalty stacking.
15. Golden, supra note 2, at 2139.
16. Id. at 2140.
17. Lemley & Shapiro, supra note 1, at 1999. Golden claims that we have misrepresented current law. Golden, supra note 2, at 2141. He observes that the Patent Act specifies that patent damages should compensate the patent holder for the infringement, and such compensation may be larger than reasonable royalties in cases involving lost profits. Id. But we stated in our original article, "[o]ur analysis applies to cases involving reasonable royalties but not lost profits." Lemley & Shapiro, supra note 1, at 1991.
18. Carl Shapiro, Patent Reform: Aligning Reward and Contribution, in 7 INNOVATION POLICY AND THE ECONOMY (Adam B. Jaffe et al. eds.) (forthcoming 2007) (manuscript at 18-19), available at http://faculty.haas.berkeley.edu/shapiro/align.pdf.
19. This idea is explained and developed in Shapiro's Patent Reform: Aligning Reward and Contribution. Id. (manuscript at 14-18).
20. By our reading, Golden would be much less exercised had we used the benchmark of V×θ rather than B×V×θμ. So far as we can tell, Golden does not object to the notion that the benchmark for assessing negotiated royalties should reflect patent strength, i.e., the probability that the patent is valid and infringed, or the technical contribution of the invention. It appears to be the sharing of that value between the inventor and the implementer that bothers him.
21. Shapiro derives an optimal splitting formula with two complementary innovators. Shapiro, supra note 18 (manuscript at 14-18).
22. Brett M. Frischmann & Mark A. Lemley, Spillovers, 107 COLUM. L. REV. 257 (2007); see also Mark A. Lemley, Property, Intellectual Property, and Free Riding, 83 TEXAS L. REV. 1031, 1046, 1046-69 (2005) ("We do not permit producers to capture the full social value of their output.").
23. This point is developed in Joseph Farrell et al., Standard Setting, Patents, and Holdup, ANTITRUST L.J. (forthcoming 2007), available at http://faculty.haas.berkeley.edu/shapiro/standards2007.pdf.
24. Golden does not dispute this point: "Lemley and Shapiro successfully use a theoretical model for licensing negotiations to illustrate how a patent owner's ability to obtain a permanent injunction can produce licensing fees that are driven not by any value specifically contributed by the patented invention, but instead by the cost of implementing a noninfringing 'design-around' ...." Golden, supra note 2, at 2114.
25. Lemley & Shapiro, supra note 1, at 2001.
26. Id. at 2044.
27. Golden, supra note 2, at 2136.
28. Id.
29. Id.
30. Id.
31. Lemley & Shapiro, supra note 1, at 1999 n. 16. The more technical paper on which we rely, Carl Shapiro, Injunctions, Hold-Up, and Patent Royalties 1 (Competition Policy Ctr., Working Paper No. CPC06-062, 2006), available at http://faculty.haas.berkeley.edu/shapiro/royalties. pdf, provides formulas for the negotiated royalty rate with and without holdup as a function of the litigation costs of the patent holder and the alleged infringer.
32. Golden, supra note 2, at 2125.
33. Id. at 2132-33.
34. Id. at 2137.
35. Shapiro, supra note 31, at 7, introduces the variable T to denote the length of time required for patent litigation to produce a final decision as a fraction of the remaining patent lifetime.
36. Golden, supra note 2, at 2146.
37. Lemley & Shapiro, supra note 1, at 2020-25.
38. Id. at 2034.
39. Golden, supra note 2, at 2147.
40. The term "discrimination" is sometimes used by economists to mean any differential treatment, even differences in treatment justified by differences in circumstances. "Price discrimination" is an example. See Molly Shaffer Van Houweling, Distributive Values in Copyright, 83 TEXAS L. REV. 1535, 1570-71 (2005) (describing the use of price discrimination in copyright-where publishers are charged higher prices than consumers-that facilitates the needs of poorly financed creators). We agree that the eBay Inc. v. MercExchange, L.L.C., 126 S. Ct. 1837, 1841 (2006) approach "discriminates" in this specialized sense, which is the same sense in which a tort rule that compensates victims for lost wages "discriminates" against poor people by paying rich people their (higher) lost wages. But there is nothing wrong with discrimination in this neutral sense.
41. Cf. Monsanto Co. v. Ralph, 382 F.3d 1374, 1382-84 (Fed. Cir. 2004) (holding that the trial court's determination of reasonable royalties was supported by the evidence).
42. Golden notes correctly that patent holders are entitled to lost profits when these are larger than reasonable royalties. Golden, supra note 2, at 2141. Based on this observation, he suggests that reasonable royalties are an underestimate of what the patent holder is entitled to. See id. ("In fact, what the Patent Act explicitly says is that a reasonable royalty is the lower bound, not the upper bound, for what a patent holder should receive ...."). We strongly disagree. For a patent holder who does not compete against the infringing party, reasonable royalties are the courts' best estimate of what the patent holder is entitled to.
43. Lemley & Shapiro, supra note 1, at 2017.
44. Cf. Golden, supra note 2, at 2116 (expressing skepticism about a rule under which courts would retain a presumption of injunctive relief only for practicing, competing patent holders and stating that such a rule would amount to "categorically discriminating among patent holders based on their business model").
45. Id. at 2150-52.
46. Lemley & Shapiro, supra note 1, at 2029-35.
47. See, e.g., Mark A. Lemley & Philip J. Weiser, Should Property or Liability Rules Govern Information?, 85 TEXAS L. REV. 783 (2007) (elaborating on this point).
48. Golden, supra note 2, at 2116.
49. While injunctions in lost-profits cases may also cause holdup problems, we do not see a practical and general way of avoiding these problems while providing adequate compensation to patent holders for infringement. There is a fundamental difference between cases involving reasonable royalties and those involving lost profits. In reasonable-royalty cases, the joint profits of the patent holder and the infringing firm are increased by the infringing firm's use of the patented invention, so the hypothetical ex ante negotiation concept makes good economic sense. In lost-profits cases, the joint profits of the patent holder and the infringing firm may well be decreased by the infringing firm's use of the patented invention. In such cases, the hypothetical ex ante negotiations concept is not helpful for assessing damages and it is not possible to find licensing terms that are commercially acceptable to the downstream firm and adequately compensate the patent holder.