Holdup, royalty stacking, and the presumption of injunctive relief for patent infringement: A reply to Lemley and Shapiro

Minnesota Law Review

Volumn 92, Issue 3, 2008, Pages 714-748

  Sidak, J Gregory ^a  

^a GEORGETOWN UNIVERSITY LAW CENTER   (United States)

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EID: 41349113847     PISSN: 00265535     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (193)

1. See Mark A. Lemley & Carl Shapiro, Patent Holdup and Royalty Stacking, 85 TEX. L. REV. 1991, 1992-93 (2007).
2. Id. at 1993.
3. Id. at 2010-17.
4. Id. at 2035-39.
5. AT&T Corp. v. Iowa Utils. Bd., 525 U.S. 366, 370-77 (1999).
6. Verizon Commc'ns Inc. v. FCC, 535 U.S. 467, 496-507 (2002).
7. See WILLIAM J. BAUMOL & J. GREGORY SIDAK, TOWARD COMPETITION IN LOCAL TELEPHONY 93-94, 108-16 (1994) (noting that the optimal input price of a product should equal its "average-incremental cost, including all pertinent incremental opportunity costs");
8. J. GREGORY SIDAK & DANIEL F. SPULBER, DEREGULATORY TAKINGS AND THE REGULATORY CONTRACT: THE COMPETITIVE TRANSFORMATION OF NETWORK INDUSTRIES IN THE UNITED STATES 319-35 (1997) (arguing that the FCC's rejection of the efficient component-pricing rule (ECPR) as a proper method for setting prices is due to its incorrect definition of opportunity costs);
9. J. Gregory Sidak & Daniel F. Spulber, The Tragedy of the Telecommons: Government Pricing of Unbundled Network Elements Under the Telecommunications Act of 1996, 97 COLUM. L. REV. 1081, 1093-98 (1997) (arguing that the FCC's assessment and rejection of the ECPR was erroneous, and that prices for unbundled network elements should be set according to the market-determined efficient component-pricing rule (M-ECPR), by taking into account the incumbent's opportunity cost of providing the unbundled input). The classic definition of opportunity cost comes from Armen Alchian, who wrote that "the cost of an event is the highest-valued opportunity necessarily forsaken."
10. Armen A. Alchian, Cost, in 3 INTERNATIONAL ENCYCLOPEDIA OF THE SOCIAL SCIENCES 404, 404 (1968).
11. See Jerry A. Hausman & J. Gregory Sidak, A Consumer-Welfare Approach to the Mandatory Unbundling of Telecommunications Networks, 109 YALE L.J. 417, 464-66 (1999) ("Regulators distort the apparent need for mandatory unbundling when they force an [incumbent local exchange carrier] to lease a network element at [total element long-run incremental cost], rather than at a price that incorporates the full option value conferred on the [competing local-exchange carrier].");
12. Jerry A. Hausman, Valuing the Effect of Regulation on New Services in Telecommunications, in BROOKINGS PAPERS ON ECONOMIC ACTIVITY: MICROECONOMICS 1997, at 1, 26-35 (Martin Neil Baily et al. eds., 1998) (arguing that the FCC's pricing framework incorrectly assumes that no technological or economic uncertainty exists).
13. Verizon Commc'ns, 535 U.S. at 495.
14. Id. at 518.
15. Verizon Commc'ns Inc. v. Law Offices of Curtis V. Trinko, LLP, 540 U.S. 398, 407-08 (2004).
16. Ill. Tool Works, Inc. v. Indep. Ink, Inc., 547 U.S. 28, 43 n.4 (2006).
17. Trinko, 540 U.S. at 407 ("To safeguard the incentive to innovate, the possession of monopoly power will not be found unlawful unless it is accompanied by an element of anticompetitive conduct.").
18. In re Rambus, Inc., 2006-2 Trade Cas. (CCH) ¶ 75,364, at 105,476 (FTC July 31, 2006), available at http://www.ftc.gov/os/adjpro/ d9302/060802commissionopinion.pdf (finding Rambus liable for monopolization).
19. 15 U.S.C. § 2 (Supp. IV 2006).
20. 15 U.S.C.A. § 45 (West 1997 & Supp. 2007).
21. In re Rambus, 2006-2 Trade Cas. (CCH) at 105,476.
22. See Trinko, 540 U.S. at 407 ("The mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free-market system.").
23. Treaty Establishing the European Community, Dec. 29, 2006, 2006 O.J. (C 321E) 37, 74-75 [hereinafter EC Treaty].
24. See Case 27/76, United Brands Co. v. Comm'n, 1978 E.C.R. 207, ¶ 250, at 301 (stating that a price is excessive when it "has no reasonable relation to the economic value of the product supplied");
25. David S. Evans & A. Jorge Padilla, Excessive Prices: Using Economics to Define Administrable Legal Rules, 1 J. COMPETITION L. & ECON. 97, 98 (2005) ("[A] dominant firm violates Article 82(a) if it charges unfairly high prices to its customers."). Article 82 provides, among other things, that firms with a dominant position are prohibited from "directly or indirectly imposing unfair purchase or selling prices or other unfair trading conditions." EC Treaty art. 82(a).
26. See supra text accompanying note 9.
27. Trinko, 540 U.S. at 407 ("The opportunity to charge monopoly prices-at least for a short period-is what attracts 'business acumen' in the first place; it induces risk taking that produces innovation and economic growth."
28. (quoting United States v. Grinnell Corp., 384 U.S. 563, 570-71 (1966))).
29. See Lemley & Shapiro, supra note 1, at 2008.
30. eBay Inc. v. MercExchange, L.L.C., 126 S. Ct. 1837, 1839 (2006).
31. Id. at 1839 ("These familiar principles apply with equal force to disputes arising under the Patent Act.").
32. Id. at 1842 (Kennedy, J., concurring) ("[A]n injunction, and the potentially serious sanctions arising from its violation, can be employed as a bargaining tool to charge exorbitant fees to companies that seek to buy licenses to practice the patent.").
33. Broadcom Corp. v. Qualcomm Inc., 501 F.3d 297, 301 (3d Cir. 2007) (acknowledging the inefficiencies produced by patent holdup).
34. See Lemley & Shapiro, supra note 1, at 2025-27 (discussing the royalty stacking problem in 3G cellular technology using empirical evidence).
35. See Damien Geradin, Anne Layne-Farrar & A. Jorge Padilla, Royalty Stacking in High Tech Industries: Testing the Theory 29-32 (May 31, 2007) (unpublished manuscript, available at http://ssrn.com/abstract=949599).
36. See Damien Geradin & Miguel Rato, Can Standard-Setting Lead to Exploitative Abuse? A Dissonant View on Patent Hold-Up, Royalty Stacking and the Meaning of FRAND 25 (Apr. 2006) (working paper, available at http://ssrn.com/abstract=946792).
37. See infra Part II.A.
38. See infra Part II.A.
39. See infra Part II.B.1.
40. See infra Part II.C.
41. See eBay Inc. v. MercExchange, L.L.C., 126 S. Ct. 1837, 1842 (2006) (Kennedy, J., concurring) (noting that injunctions "can be employed as a bargaining tool" allowing companies holding patents to charge high fees).
42. Id.
43. See Lemley & Shapiro, supra note 1, at 1994-2010;
44. Carl Shapiro, Injunctions, Hold-Up, and Patent Royalties 6 (Competition Policy Ctr., Working Paper No. CPC06-062, 2006), available at http://faculty.haas.berkeley.edu/shapiro/royalties.pdf.
45. See Lemley & Shapiro, supra note 1, at 1996 ("If the patent is ruled invalid or not infringed, the downstream firm . . . owes nothing to the patent holder . . . but if the patent is ruled valid and infringed, the downstream firm must pay reasonable royalties [and] the court enters an injunction. . . .").
46. Id. at 2001-02.
47. Id. at 2008-10.
48. Id. at 2010-11.
49. Id. at 1995-98.
50. Id. at 1995.
51. Id. at 1995-96.
52. Id. at 1999 ("[T]he royalty rate that would be reasonable and expected in the ideal patent system without any element of holdup.").
53. Id. at 1997-98 (assigning B as the "[bargaining skill of the patent holder, as measured by the fraction of the combined gains from settling," instead of litigating).
54. Id. at 1996 (assigning V as the "[v]alue per unit of the patented feature to the downstream firm in comparison with the next best alternative technology").
55. Id. at 1999.
56. Id.
57. Id. at 1996 (describing the strength of the patent as "the probability that litigation will result in a finding that the patent is valid and infringed by the downstream firm's product").
58. Id. at 2000.
59. Id. at 2001.
60. Id. at 2001-02.
61. Id.
62. See Verizon Commc'ns Inc. v. Law Offices of Curtis V. Trinko, LLP, 540 U.S. 398, 407 (2004) (stating that monopolists may charge "monopoly prices" so long as they do not engage in anticompetitive conduct).
63. See id. at 407-08 (holding that the ability to charge "monopoly prices" increases the incentive to innovate, but "forced sharing" would decrease that incentive).
64. Lemley & Shapiro, supra note 1, at 2001.
65. Id.
66. Id. at 2001-02.
67. Id. at 2002.
68. Id.
69. Id.
70. Id.
71. Id.
72. This use of Θ is confusing. The variable is the probability of patent validity. But the "no infringement" scenario would entail a legal conclusion regarding the defendant's actions toward a valid patent-such as the conclusion that the defendant's product acts outside the scope of the valid patent. The Lemley-Shapiro analysis depends on whether the patent can be enforced. But if Lemley and Shapiro are emphasizing lack of validity specifically, then it is inappropriate for them to let Θ serve a larger purpose in their model. If one's objective is to drive the probability of an enforceable property right in an invention as low as possible, there are numerous policy levers that one might choose to manipulate. As discussed below, Lemley has made numerous recommendations to this effect, using other levers in patent law.
73. Lemley & Shapiro, supra note 1, at 2002.
74. Id. at 2003.
75. Id. at 2003-04.
76. Id. at 2004.
77. Geradin & Rato, supra note 30, at 7.
78. See 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);
79. Geradin et al., supra note 29, at 2-3.
80. Lemley & Shapiro, supra note 1, at 2004-05. This aspect of the model explicitly relies on the earlier Lemley-Shapiro analysis of probabilistic patents.
81. See Mark A. Lemley & Carl Shapiro, Probabilistic Patents, 19 J. ECON. PERSP. 75, 95 (2005) (arguing that the scope of a patent right is uncertain).
82. Lemley & Shapiro, supra note 1, at 2005. The "overcharge" that Lemley and Shapiro discuss in this context is only an "overcharge" if one considers any deviation from the hypothetical benchmark that they have defined as an overcharge. In some sense any royalty is an overcharge because the marginal cost to the patent holder is zero.
83. Id.
84. Id. at 2001-02.
85. Id. at 2002.
86. Id. at 2010.
87. Id. at 2010-11.
88. Id. at 2011-12.
89. Id. at 2012-13.
90. Id. at 2013 ("The Cournot Complements effect arises when multiple input owners each charge more than marginal cost for their input, thereby raising the price of the downstream product and reducing sales of that product.").
91. Id. at 2015-16.
92. Id. at 2019.
93. Id. at 2017.
94. Id. at 2020-21.
95. Id. (citing Seymour v. McCormick, 57 U.S. (16 How.) 480, 491 (1853)).
96. See id. at 2021-22.
97. Id. at 2025-29. All of these are newer technologies that incorporate many different patented components. 3G cellular technology allows the transmission of both voice and data over cellular networks.
98. See Lee Garber, Will 3G Be the Next Big Wireless Technology?, COMPUTER, Jan. 2002, at 26. Wi-Fi is the term used to describe a particular technology for wireless networking using low power and an unlicensed spectrum.
99. Randall Stross, Wireless Internet for All, Without the Towers, N.Y. TIMES, Feb. 4, 2007, § 3, at 3. DVD media, or digital video discs, enable the storage of large amounts of information (originally, primarily movies) on a single compact and portable disc.
100. See Press Release, Toshiba Corp., DVD Format Unification (Dec. 8, 1995), available at http://www.toshiba.co.jp/about/press/1995_12/pr0802. htm. Radio frequency identification (RFID) technology has numerous applications in both payment systems and tracking technologies and involves a chip that emits a unique radio signal for identification purposes.
101. See Jeremy Landt, Shrouds of Time, the History of RFID 3 (Oct, 1, 2001) (unpublished manuscript, available at http://www.transcore.com/pdf/ AIM%20shrouds_of_time.pdf).
102. Lemley & Shapiro, supra note 1, at 2025.
103. Id. at 2026. Although they do not state so explicitly, Lemley and Shapiro are citing the price of the cell phone to the service provider and not the price of the phone to the end consumer.
104. See Michael R. Franzinger, Latent Dangers in a Patent Pool: The European Commission's Approval of the 3G Wireless Technology Licensing Agreements, 91 CAL. L. REV. 1693, 1704 n.69 (2003). Furthermore, Lemley and Shapiro do not cite to any source for this statistic.
105. See Geradin et al., supra note 29, at 22-23.
106. Lemley & Shapiro, supra note 1, at 2030.
107. Id. at 2032.
108. Id. at 2033.
109. Id. at 2032.
110. Id. at 2034.
111. Id.
112. Id. at 2035.
113. Id.
114. Id. at 2036.
115. Id.
116. Id.
117. Id. at 2039.
118. See id. at 2035-39.
119. Id. at 2036-37. Lemley and Shapiro limit application of their analysis to situations where "the patent holder's predominant commercial interest in bringing a patent infringement case is to obtain licensing revenues" and do not apply their analysis where "the patent holder suffers significant lost profits as a result of the allegedly infringing activities of the downstream firm and seeks to use the patent to exclude a competitor from the market in order to preserve its profit margins."
120. Id.
121. Id. at 2001-02.
122. See id.
123. Id. at 2003.
124. Id. at 2037-38.
125. Id. at 2038.
126. Id.
127. See id. at 2002 (discussing the "Redesign and Litigate" strategy).
128. Id. at 2038.
129. Id. at 2008.
130. Id. at 2038-39.
131. Id. at 2038.
132. Id.
133. Id.
134. Id.
135. Id. at 2035-36.
136. Id. at 2035.
137. See id. at 2035-36.
138. See id.
139. Id. at 2036-37.
140. See id. at 2036-37.
141. See id. at 1991.
142. See id.
143. See id. at 2021.
144. Id. at 1993.
145. See RICHARD A. POSNER, ECONOMIC ANALYSIS OF LAW 24 (7th ed. 2007).
146. See id. (discussing how economic analyses can be used to create a more efficient system for achieving social objectives).
147. Lemley & Shapiro, supra note 1, at 1999.
148. See id. at 1991.
149. See WILLIAM H. GREENE, ECONOMETRIC ANALYSIS 156 (3d ed. 1997).
150. This assumption is not necessary for the analysis. In general, the probability of either type of error will not be a function of the error cost.
151. Lemley & Shapiro, supra note 1, at 2044.
152. See id. at 1991, 1993, 1997, 2009, 2010, 2012 (twice), 2015, 2024.
153. Id. at 2013 (first emphasis added).
154. See id.
155. Id. at 2016.
156. Grain Processing Corp. v. Am. Maize-Prods. Co., 185 F.3d 1341, 1356 (Fed. Cir. 1999) (holding that an infringer may claim that it would have adopted noninfringing technology despite the fact that the infringer had never done so).
157. See generally Jerry A. Hausman, Gregory K. Leonard & J. Gregory Sidak, Patent Damages and Real Options: How Judicial Characterization of Noninfringing Alternatives Reduces Incentives to Innovate, 22 BERKELEY TECH. L.J. 825 (2007) (discussing Grain Processing Corp., 185 F.3d at 1341).
158. BLACK'S LAW DICTIONARY (7th ed. 1999).
159. For an application of this real-option analysis to legal and regulatory rules, see Hausman & Sidak, supra note 8 and Hausman, supra note 8, at 13-24.
160. See, e.g., F. Scott Kieff, Property Rights and Property Rules for Commercializing Inventions, 85 MINN. L. REV. 697, 708-09 (2001) (noting the frequently enjoyed competitive advantages of second movers).
161. J. Gregory Sidak, A Consumer-Welfare Approach to Network Neutrality Regulation of the Internet, 2 J. COMPETITION L. & ECON. 349, 357 (2006).
162. SEE AVINASH K. DIXIT & ROBERT S. PINDYCK, INVESTMENT UNDER UNCERTAINTY 153 (1994).
163. See id.
164. See Hausman & Sidak, supra note 8, at 462-63.
165. DIXIT & PINDYCK, supra note 146, at 3.
166. See id. at 3, 135.
167. Id. at 4.
168. Id. at 6-7.
169. See id.
170. See Lemley & Shapiro, supra note 1, at 1999.
171. Id. at 1996.
172. See id. at 2040 (noting, for example, that it is important "that the fact finder has the information necessary to assess the contribution of a component invention in the context of the value of the entire product").
173. See id. at 1999-2000.
174. An additional case not considered by Lemley and Shapiro is when the patented feature adds no value to the consumer but makes it significantly less costly to produce the good. In this sense the focus of the hypothetical benchmark calculation in the Lemley-Shapiro model is incorrect from the outset. Focusing only on value to consumers ignores the other valuable aspects of the patent feature, including cost savings and the value of the real option created.
175. Cf. Lemley & Shapiro, supra note 1, at 2036 (acknowledging that "some injunctions will not lead to a risk of holdup").
176. To my knowledge, the option-value approach to solving the optimal royalty rate has not been developed in a formal model. Two other methods that economists have proposed are an ex ante auction based on the ECPR, see generally Swanson & Baumol, supra note 71, and the Shapley value in cooperative game theory,
177. see generally 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, 693 (2007).
178. Lemley & Shapiro, supra note 1, at 1999;
179. see also supra Part I.A.1 (discussing the Lemley-Shapiro model for holdup).
180. Lemley & Shapiro, supra note 1, at 1999.
181. Id.
182. See, e.g., id. at 1998 ("[T]he model will produce similar results with any value of B.").
183. Id. at 2001.
184. Id. at 2002.
185. Id. at 2001.
186. Id. at 2001-02.
187. See, e.g., id. at 2001.
188. See Geradin et al., supra note 29, at 39.
189. See id.
190. See Giuseppe Dari-Mattiacci & Francesco Parisi, Substituting Complements, 2 J. COMPETITION L. & ECON. 333, 340 (2006). They write in a more general context than the specific two-party bargaining context considered by Lemley and Shapiro, but their result is nevertheless important in terms of assessing the plausibility of the Lemley-Shapiro model.
191. See id. at 337 ("It is important to note that the legal problems to which the complementary oligopoly and anticommons theories have been applied have the common characteristic of the uniqueness of the complements. Fragmented owners face an anticommons problem to the extent that the complementary rights that they seek to acquire cannot easily be substituted with other rights.").
192. See Geradin & Rato, supra note 30, at 21.
193. Id. at 24-25.