Pricing patents for licensing in standard-setting organizations: Making sense of frand commitments

Antitrust Law Journal

Volumn 74, Issue 3, 2007, Pages 671-706

  Layne Farrar, Anne ^a   Padilla, A Jorge ^a,b,c   Schmalensee, Richard ^d  

^a Law and Economics Consulting Group   (United States)

^b CEMFI   (Spain)

^c CEPR   (United Kingdom)

^d MASSACHUSETTS INSTITUTE OF TECHNOLOGY   (United States)

Author keywords

[No Author keywords available]

Indexed keywords

EID: 39449084376     PISSN: 00036056     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (111)

1. Daniel Swanson and William J. Baumol note: "It is widely acknowledged that, in fact, there are no generally agreed upon tests to determine whether a particular license does or does not satisfy a RAND commitment." 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).
2. Larry Goldstein and Brian Kearsey echo this: "Unfortunately, [RAND and FRAND] are not well defined. Ambiguity in the definition of 'FRAND' is, in our opinion, one of the core problems in the licensing of rights to patents essential for implementation of a written technical standard." LARRY M. GOLDSTEIN & BRUN N. KEARSEY, TECHNOLOGY PATENT LICENSING: AN INTERNATIONAL REFERENCE ON 21ST CENTURY PATENT LICENSING, PATENT POOLS AND PATENT PIATFORMS 27 (2004).
3. Like-wise, Richard Rapp and Lauren Stiroh state: "The typical [standard setting organization] patent policy mandating that a royalty be 'fair, reasonable and non-discriminatory' gives little guidance for royalty determination because 'reasonable' can mean different things to a technology owner and a technology buyer." Richard T. Rapp & Lauren J. Stiroh, Standard Setting and Market Power, Comments Submitted to Joint Hearings of the U.S. Dep't of Justice & Fed. Trade Comm'n, Competition and Intellectual Property Law and Policy in the Knowledge-Based Economy 9 (Apr. 18, 2002), available at http://www.ftc.gov/opp/intellect/020418rappstiroh.pdf.
4. For a survey of the debate surrounding FRAND, see Damien Geradin, Standardization and Technological Innovation: Some Reflections on Ex-ante Licensing, FRAND, and the Proper Means to Reward Innovation (Tilburg Law and Econ. Ctr., Discussion Paper No. 2006-017), available at http://ssrn.com/abstract=909011.
5. Rudi Bekkers et al., Intellectual Properly Rights and Standardization: The Case of GSM, 26 TELECOMM. POL'Y 171, 173 (2002).
6. Firms not making relevant disclosures risk litigation over unfair business practices. See, e.g., Rambus, Inc., FTC Docket No. 9302, 2006 WL 2330119 (Aug. 2, 2006) (Opinion of the Commission), available at http://www.ftc.gov/os/adjpro/d9302/index.shtm.
7. For a discussion of SSO intellectual property rules, see Benjamin Chiao, Josh Lerner & Jean Tirole, The Rules of Standard Setting Organizations: An Empirical Analysis (Harvard NOM Research Paper No. 05-05, 2005), available at http://ssrn.com/abstract-664643.
8. See, e.g., Brian DeLacey, Kerry Herman, David Kiron & Josh Lerner, Strategic Behavior in Standard-Setting Organizations (Harvard Univ., Working Paper No. 903214, 2006), available at http://ssrn.com/ abstract=903214.
9. "Required" may often be too strong a word. See Chiao et al,, supra note 4 (discussing how and why patents get disclosed to SSOs). Moreover, even if a patent is technically essential for implementing a standard, it might be relatively easy to invent around, or it might cover an optional feature of the standard that can be omitted in some applications.
10. Complaint, Broadcom Corp. v. Qualcomm, Inc., No. 05-3350, 2006 WL 2528545 (D.N.J. filed Aug. 31, 2006).
11. The district court granted Qualcomm's motion to dismiss, but the Third Circuit recently reversed the dismissal of the Sherman Act monopolization and attempted monopolization claims, and affirmed the dismissal of the unlawful monopoly maintenance claim. Broadcom Corp. v. Qualcomm, Inc., No. 05-3350, 2006 WL 2528545 (D.N.J. Aug. 31, 2006),
12. rev'd in part, aff'd in part, No. 06-4292, 2007 WL 2475847 (3d Cir. Sept. 4, 2007).
13. See Nokia Corp. v. Qualcomm, Inc., No. 06-509, 2006 WL 2521328 (D. Del. Aug. 29, 2006).
14. Earlier cases have involved similar claims of contract, but settled prior to a ruling. See ESS Tech., Inc. v. PC-Tel, Inc., No. C-99-20292 (N.D. Cal. Feb. 21, 2002) (stipulation and order of dismissal);
15. PC-TEL INC., ANNUAL REPORT 6 (Form 10-K) (Apr. 4, 2001), available at http://www.sec.gov/Archives/edgar/ data/1057083/000089161802001574/f78706e10-k.txt;
16. see also Agere Sys. Guardian Corp. v. Proxim, Inc., No. 01-CV-00339 (D. Del. Sept. 19, 2002) (stipulation and order of dismissal);
17. AGERE SYS. GUARDIAN CORP., ANNUAL REPORT 49 (Form 10-K) (Dec. 5, 2003), available at http://www.sec.gov/Archives/edgar/data/1129446/000120677403000880/d13642. htm.
18. The EC announced the initiation of its formal investigation of Qualcomm on October 1, 2007. European Comm'n, Press Release, http://europa.eu/rapid/ pressReleasesAction.do?reference=MEMO/07/389&format=HTML&aged= 0&language=EN&guiLanguage=en.
19. Georgia-Pacific Corp. v. U.S. Plywood Corp., 318 F. Supp. 1116, 1120 (S.D.N.Y. 1970).
20. Peter Clarke, Updated: Six Phone Firms Ask EU to Punish Qualcomm, EETIMES, Oct. 28, 2005, http://www.eetimes.com/showArticle.jhtml? articleID=172901195.
21. See also Case COMP/C-3/39.247, Texas Instrs. v. Qualcomm (2005);
22. Case COMP/C-3/39.248, Broadcom v. Qualcomm (2006);
23. Case COMP/C-3/39.249, Nokia v. Qualcomm;
24. Case COMP/C-3/39.250, Panasonic v. Qualcomm (2006);
25. Case COMP/C-3/39.251, NEC v. Qualcomm (2005);
26. Case COMP/C-3/39.252, Ericsson v. Qualcomm (2006).
27. Press Release, Ericsson, Leading Mobile Wireless Technology Companies Call on European Commission to Investigate Qualcomm's Anti-competitive Conduct (Oct. 28, 2005), available at http://www.ericsson.com/ericsson/press/ releases/20051028-1018618. shtml;
28. Faultine, Our Patents Are Bigger than Yours, Nokia Tells Qualcomm, REGISTER, Apr. 6, 2007, http://www.theregister.co.uk/2007/04/06/ nokia_qualcomm_patent_spat/.
29. William J. Baumol, Some Subtle Pricing Issues in Railroad Regulation, 10 INT'L. J. TRANSPORT ECON. 341 (1983);
30. Robert D. Willig, The Theory of Network Access Pricing, in ISSUES IN PUBLIC UTILITY REGULATION 109 (Harry M. Trebing ed., 1979).
31. For a recent application of ECPR to FRAND, see Swanson & Baumol, supra note 1.
32. Lloyd S. Shapley, A Value for N-Person Games, in 2 CONTRIBUTIONS TO THE THEORY OF GAMES 307 (H.W. Kuhn & A.W. Tucker eds., 1953).
33. See Christian Ahlborn & Carsten Grave, Walter Eucken and Ordoliberalism: An Introduction from a Consumer Welfare Perspective, 2 COMPETITION POL'Y INT'L 197 (2006);
34. see also DAVID J. GERBER, LAW AND COMPETITION IN TWENTIETH CENTURY EUROPE: PROTECTING PROMETHEUS (1998).
35. For surveys of the theoretical literature, see Morton I. Kamien, Patent Licensing, in 1 HANDBOOK OF GAME THEORY WITH ECONOMIC APPLICATIONS 332 (R.J. Aumann & S. Hart eds., 1992);
36. see also SUZANNE SCOTCHMER, INNOVATION AND INCENTIVES (2004).
37. Russell L. Parr & Gordon V. Smith, Quantitative Methods of Valuing Intellectual Property, in THE NEW ROLE OF INTELLECTUAL PROPERTY IN COMMERCIAL TRANSACTIONS (Melvin Simensky & Lanning G. Bryer eds., 1994).
38. Ariel Pakes develops a model in which patents are compared to options. Ariel Pakes, Patents as Options: Some Estimates of the Value of Holding European Patent Stocks, 54 ECONOMETRICA 755 (1986).
39. For a discussion of the strengths and weaknesses of option value analyses, see Josh Lerner & John Willinge, A Note on Valuation in Private Equity Settings 9 (Harvard Bus. Sch., Working Paper No. 9-297-050, 2002).
40. Skewness refers to the shape of the distribution curve. In this case, the curve is shifted to the left, with a large peak at very low values and a long "tail" representing a small number of patents with high values. For examples in the literature discussing the skewed distribution of patent value, see F.M. SCHERER ET AL., PATENTS AND THE CORPORATION: A REPORT ON INDUSTRIAL TECHNOLOGY UNDER CHANGING PUBUC POLICY (2d ed. 1959);
41. Jean O. Lanjouw et al., How To Count Patents and Value Intellectual Property: The Uses of Patent Renewal and Application Data, 46 J. INDUS. ECON. 405 (1998);
42. Dietmar Harhoff et al., Citation Frequency and the Value of Patented Inventions, 81 REV. ECON. STAT. 511 (1999);
43. F.M. Scherer & Dietmar Harhoff, Technology Policy for a World of Skew-Distributed Outcomes, 29 RES. POL'Y 559 (2000);
44. Wesley M. Cohen & Stephen A. Merrill, Introduction, in PATENTS IN THE KNOWLEDGE BASED ECONOMY 1, 8 (Wesley M. Cohen & Stephen A. Merrill eds., 2003).
45. GOLDSTEIN & KEARSEY, supra note 1, at 89.
46. Chiao et al., supra note 4, at 5-6.
47. Including strategic decision makers in the team for standard-setting organization meetings is a relatively new phenomenon. See, e.g., Neil Gandal, Nataly Gantman & David Genesove, Intellectual Property and Standardization Committee Participation in the U.S. Modem Industry, in STANDARDS AND PUBLIC POLICY 208 (Shane Greenstein & Victor Stango eds., 2004).
48. Chiao et al,, supra note 4, at 6.
49. European Telecommunications Standards Institute, Intellectual Property Rights Policy, available at http://www.etsi.org/legal/documents/ ETSI_IPRPolicy.pdf.
50. See Wang Labs., Inc. v. Mitsubishi Elecs. Am. Inc., 103 F.3d 1571 (Fed. Cir. 1997);
51. Qualcomm Inc. v. Broadcom Corp, No. 05-CV-1958-B (BLM), 2007 WL 2296441 (S.D. Cal. Aug. 6, 2007);
52. Stambler v. Diebold, Inc., 11 U.S.P.Q.2d 1709, 1988 WL 95479 (E.D.N.Y. 1988),
53. aff'd mem., 878 F.2d 1445 (Fed. Cir. 1989) (unpublished);
54. Potter Instr. Co. v. Storage Tech. Corp., 207 U.S.P.Q. 763, 1980 U.S. Dist. LEXIS 14348 (E.D. Va. 1980),
55. aff'd, 641 F.2d 190 (4th Cir. 1981);
56. Dell Computer Corp., 121 F.T.C. 616, 1996 WL 33412055 (1996) (Statement of the Federal Trade Commission).
57. Of course, other cases brought in U.S. courts have been decided in favor of the defendants, such as Rambus, Inc. v. Infineon Techs. AG, 318 F.3d 1081 (Fed. Cir. 2003).
58. Press Release, European Commission, Competition: Commission Welcomes Changes in ETSI IPR Rules to Prevent "Patent Ambush" (Dec. 12, 2005), available at http://europa.eu.int/rapid/pressReleasesAction.do?reference= IP/05/1565&type=HTML&aged=0&language=EN&guiLanguage=EN.
59. Letter from Thomas O. Barnett, Ass't Att'y Gen., U.S. Dep't of Justice, to Michael A. Lindsay, Institute of Electrical and Electronics Engineers (Apr. 30, 2007), available at http://www.usdoj.gov/atr/public/busreview/222978. htm;
60. Letter from Thomas O. Barnett, Ass't Att'y Gen., U.S. Dep't of Justice, to Robert A. Skitol, VMEbus Int'l Trade Ass'n (Oct. 30, 2006), available at http://www.usdoj.gov/atr/public/busreview/219380.htm.
61. VMEbUs International Trade Association, VITA Patent Policy (Oct. 30, 2006), available at http://www.vita.com/disclosure/ VITA%20Patent%20Policy%20section%2010%20draft.pdf.
62. Press Release, Institute of Electrical and Electronics Engineers, IEEE Enhances Standards Patent Policy to Permit Fuller Disclosure on Licensing (Apr. 30, 2007), available at http://standards.ieee.org/announcements/ stdspatpol.html.
63. Georgia-Pacific Corp. v. U.S. Plywood Corp., 318 F. Supp. 1116 (S.D.N.Y. 1970).
64. Legal scholars appear to agree that the " ' Georgia-Pacific factors' have served as the standard framework . . . for over thirty years." Roy J. Epstein & Alan J. Marcus, Economic Analysis of the Reasonable Royalty: Simplification and Extension of the Georgia-Pacific Factors, 85 J. PAT. & TRADEMARK OFF. SOC'Y 555, 555 (2003).
65. Georgia-Pacific., 318 F. Supp. at 1120.
66. This is by necessity a hypothetical exercise, since in each patent infringement case there is no willing licensee and no willing licensor; otherwise there would be no case. This is a point recognized in the Georgia-Pacific decision and by subsequent courts, such as the Sixth Circuit in Panduit. See Panduit Corp. v. Stahlin Bros. Fibre Works, Inc., 575 F.2d 1152 (6th Cir. 1978). The exercise is worthwhile nonetheless since it casts the reasonable royalty question in the specific circumstances of the firms and patents involved.
67. See, e.g., Smithkline Diagnostics, Inc. v. Helena Labs. Corp., 926 F.2d 1161, 1164 n.2 (Fed. Cir. 1991).
68. Fauldine, supra note 13.
69. Anne Layne-Farrar & Josh Lerner, To Join or Not to Join: Examining Patent Pool Participation and Rent Sharing Rules (Working Paper Nov. 11, 2006), available at http://ssrn.com/abstract-945189.
70. See GOLDSTEIN & KEARSEY, supra note 1, at 88-135.
71. Patents are complex legal and technical documents. The reviewer would need to be well-versed in both patent law and the technology at hand.
72. See GOLDSTEIN & KEARSEY, supra note 1, at 88-135.
73. Participants may be unwilling to review competitors' claims of essentiality. See Chiao et al., supra note 4, at 6 n.3 ("In fact, U.S. legal rules mandating trebled damages for willful infringement lead firms to discourage their engineers from even examining the patent portfolios of their competitors.").
74. That is, it would be both unfair and unreasonable since companies with large portfolios of relatively unimportant patents would capture the most royalty earnings, while firms with a smaller number of critical patents would receive less.
75. It would thus exacerbate any worries over patent proliferation and patent thickets, already hotly debated in the academic literature and popular press. For influential papers on patent thickets, see Carl Shapiro, Navigating the Patent Thicket: Cross Licenses, Patent Pools, and Standard-Setting (Competition Pol'y Ctr., Paper CPC00-011, 2001), available at http://repositories.cdlib.org/iber/cpc/CPC00-011/,
76. reprinted in I INNOVATION POLICY AND THE ECONOMY (Adam Jaffe, Joshua Lerner & Scott Stern eds., 2001);
77. Michael Heller & Rebecca Eisenberg, Can Patents Deter Innovation? The Anticommons in Biomedical Research, 280 SCI. 698 (1998);
78. see also Danny Bradbury, Canadian Innovation Choked by U.S. Laws, NAT'L POST, NOV. 17, 2003, at FE1.
79. See Parr & Smith, supra note 18;
80. Richard S. Toikka, Patent Licensing Under Competitive and Non-Competitive Conditions, 82 J. PAT. & TRADEMARK OFF. SOC'Y 279 (2000).
81. Layne-Farrar & Lerner, supra note 35.
82. Swanson & Baumol, supra note 1.
83. While Swanson and Baumol define options in terms of cost, the analysis is unchanged if we instead hold cost constant and maximize the quality or performance of the technology. Id. at 19.
84. Id. at 32-33. Compliance with ECPR is necessary for a license fee to satisfy the non-discriminatory component of FRAND when the licensor also participates in the down-stream market. As noted above, the ECPR was developed in die context of pricing the services of public utility bottlenecks, like local telephone networks, when the owner of the bottleneck is in competition (in long-distance services, for instance) with a rival to which it sells the bottleneck's services.
85. Id. at 32. For simplicity, we set the recurring cost of licensing IP equal to zero. Adding licensing costs does not alter the conclusions of die model at all, but does make for more complicated equations.
86. Id. at 33. This result is denoted as the "'Level-Playing- Field' Theorem."
87. Id. at 39.
88. 50As measured by declared essential patents, issued worldwide, posted on ETSI's Web site for UMTS and other 3G projects. See ETSI IPR Database, http://webapp.etsi.org/ipr/. Note that while many more thousands of patents are listed for these projects on the Web site, as of March 20, 2006, a great many of these are duplicate entries. After duplicate patent numbers are eliminated, about 4,650 patents remain, covering patents issued across the globe.
89. This is a simplifying assumption that does not change the main results. The results still hold true in the general case, with n IP components produced by the same company, or n IP components produced by z companies.
90. A Nash equilibrium, named after the mathematiclan who proposed it - John Forbes Nash of A Beautiful Mind fame - is a game theory concept. A Nash equilibrium is a solution to a game involving two or more players in which no player has anything to gain by changing only his or her own strategy unilaterally. In other words, if I take your possible actions into account and pick my best strategy, and you do the same, neither one of us has any incentive to change our strategies unless something else changes, like new informa tion. John Nash, Equilibrium Points in n-Person Games, 36 PROC. NAT'L ACAD. SCI. 48 (1950). An equilibrium is subgame perfect if it represents a Nash equilibrium of every subgame the original game can be divided into. Since our purpose is to lay out the possible tools that courts and competition authorities can use to define FRAND, we do not go into detail on the derivation of any equilibria.
91. We assume for simplicity that in case of a tie in the royalty rates quoted by the owners of components a and c, the SSO selects the component with a greater absolute contribution to the standard: component a.
92. See Ahlborn & Grave, supra note 16;
93. see also GERBER, supra note 16.
94. "Cooperative game theory does not set out to describe the way individuals behave. Rather, it recommends reasonable rules of allocation, or proposes indices to measure power." Eyal Winter, The Shapley Value, in 3 HANDBOOK OF GAME THEORY WITH ECONOMIC APPLICATIONS 2025, 2049 (Robert Aumann & Sergiu Hart eds., 2002).
95. See Shapley, supra note 15.
96. Winter, supra note 55, at 2033.
97. For useful expositions and discussions of the Shapley value, see R. DUNCAN LUCE & HOWARD RAIFFA, GAMES AND DECISIONS (1957);
98. MARTIN SHUBIK, GAME THEORY IN THE SOCIAL SCIENCES: CONCEPTS AND SOLUTIONS (1983);
99. and GUILLERMO OWEN, GAME THEORY (2d ed. 1982).
100. H.P. Young, Individual Contribution and Just Compensation, in THE SHAPLEY VALUE: ESSAYS IN HONOR OF LLOYD S. SHAPLEY 267 (Alvin E. Roth ed., 2005)
101. [hereinafter THE SHAPLEY VALUE].
102. In a standard-setting context, this condition implicitly assumes that while patent holders need to be given incentives to develop their IP, this is not so for downstream manufacturers. Moreover, unlike the analysis of the previous section, it is assumed here that the total value captured by IP owners in aggregate is independent of the extent and nature of IP competition ex ante. Relaxing this assumption would not alter our conclusions regarding the relative compensations of patent holders with different average marginal contributions to the standard.
103. Sui denotes the set of all patents in S plus patent i.
104. THE SHAPLEY VALUE, supra note 58, at 4-7.
105. LUCE & RAIFFA, supra note 57, at 250;
106. SHUBIK, supra note 57, at 181;
107. OWEN, supra note 57, at 197.
108. See infra Part IV.A.2.
109. 1,even though its patent has no perfect substitutes. Case 3 in Part IV indicates that a similar property is satisfied by the Swanson-Baumol ex ante auction approach.
110. The royalty payments do need to be incentive-compatible for IP owners to license their technology, so b' s license fees should cover the incremental costs of licensing, which we have neglected for simplicity.
111. Note that under the ECPR an IP owner will get reimbursed for his incremental costs irrespective of how small the marginal contribution of his technology is, as long as it is sufficient to cover those costs. Likewise, under the Shapley value, owners whose marginal contributions are positive on any arrival sequence receive royalty payments.