Sunday, 29 May 2022

Practicalities and Problems in Comparing and Setting FRAND Royalties for SEPs

I was a speaker last week at the Patents in Telecoms & the Internet of Things conference in London. This is an excellent biennial event, organized this year by Professor Sir Robin Jacob of UCL Laws and James Marshall of Taylor Wessing. It focuses on the topic of licensing Standard-essential Patents (SEPs) on Fair, Reasonable and Non-Discriminatory terms. I was on a panel among economists Jorge Padilla, Avantika Chowdbury, Tim Pohlman and Mark Schankerman in one of two sessions on FRAND Determination Methodologies: Principles, procedures and problems. The other session focused on comparable licenses. Our session also considered top-down and value-based methods as well as the economics in bargaining agreements.

I have received some requests from conference attendees asking for my panel session talking points. I am posting these here for access by all. My spoken remarks were slightly different, so as not to duplicate what had been said earlier at the event and to save some time. I have added several hyperlinks —mostly to articles of mine—to provide support to some of my assertions.

Value of SEPs in a large ecosystem downstream

Patented intellectual property in products and services such as cellular is clearly very valuable. In an ecosystem that is only 40 years old for voice services, 30 years old for text messaging and just 25 years old for Internet services, more than 6 billion of the world’s 8 billion population have a mobile phone. There are now more cellular connections than there are people on the planet. For most of these people their mobile phone is their primary or only means of calling or accessing the Internet for communications, information, entertainment and commerce.

According to a new report prepared by Kearney for the GSM Association of mobile operators, the Internet value chain was worth $ 6.7 trillion in 2020, with 28% of that value through connectivity services and devices and the vast majority of that in cellular.

Notwithstanding all that, a big question for us here today is what proportion of that value is attributable to cellular SEPs, as distinct from other SEPs and other forms of intellectual property. What are fair shares of value vertically down the supply chain from SEP owners to implementers in device manufacturing and further downstream. And, in the case of SEPs, what are fair and non-discriminatory charges horizontally among different patent owners and licensees?

Patent policies and business models

SEP licensing occurs with different patent policies among different standards setting organizations, and with differing business models among patent owners and voluntary licensing groups.

Some technology standards such as Bluetooth, USB and DOCSIS for cable modems are largely licensed royalty-free by mutual consent among most patent owners. With no patent fees, the only opportunity to monetize intellectual property  is downstream, for example, by implementation along with others’ IP in products.  

In the case of video standards such as AVC/H.264 the vast majority of SEPs are monetized through patent pooling. This voluntary private solution with licensing costing no more than around 20 cents per device divides royalties among patent owners, most of whom are also implementers.

Monetizing SEPs in cellular

In the special case of cellular, SEP owners justifiably seek rather higher royalties, in partial compensation for multi-billion dollar annual R&D investments for innovation and standards development, for example, by the likes of Ericsson, Nokia and Qualcomm at around $5 billion apiece annually. These fees are charged at the handset level at an average aggregate of approximately $10, which is 4% of the $250 average wholesale selling price for mobile phones.

In my previous presentation at this conference series— in Tokyo at the end of 2019— I showed that the economic value added of cellular connectivity, after incremental product costs, in a 4G smartphone was more than 20 times higher than that aggregate royalty rate percentage of 4%. I showed the example of an iPhone model that was priced by Apple at an additional $250 over that for a $200 iPod Touch with near identical functionality apart from the cellular capability costing $32 in manufacture. I also emphasized the significance of this beyond price setting by Apple in what economists call consumers’ “revealed preferences” with 12 times the volume and 46 times the value in sales of iPhones over all iPods.

While there is no cellular SEP licensing further downstream, SEP technologies also generate value in the extended ecosystem of Internet services and beyond including externalities (e.g. human health and safety).

Cellular SEP licensing in mobile phones is almost entirely bilateral among parties with various business models in developing standard-essential technologies and implementing them in devices.  Companies like Qualcomm and InterDigital are more dependent on out-licensing to generate revenue than are vertically-integrated SEP owners like Samsung that is more interested in protecting its downstream handset business with cross-licensing, and in minimizing licensing out-payments for its leading market share of handset sales.

Licensing frameworks

Licensing cellular SEPs is a complex matter given all the above and with FRAND commitments.

So now to the heart of the matter: including practicalities and problems with techniques employed in comparing and setting royalties.

There are various ways of: 1. Defining royalty prices and 2. Determining levels for these.

1.Price definitions

Pricing royalties can be ad valorem – i.e. a percentage of the device cost, or in dollars-per-unit charges, or with a hybrid of the two including dollar floors and caps. Lump sum prepayments are also common. Making comparisons among all these can be tricky and can be presented to give various impressions.

We tend to refer to percentage rates when, for example, talking about aggregate royalties.

Effective royalty rates paid (what I call royalty yields) including aggregate figures have fallen as royalty caps have been exceeded with increasing handset average selling prices as smartphone sales have surged since the mid-2000s.

2.Determining charges

Three commonly used methods include top-down, comparable licenses and value-based methods.

Top-down valuation

Use of top-down methods is inevitable, but I do not like them because of the way the aggregate is set and because of the way this is apportioned. Top-down is increasingly popular with the courts because it is simple and easy to apply. Serious shortcomings include:

Comparable licenses

These are seemingly ideal if they are well established with years of substantial licensed sales volumes and royalty payments. But we can have a chicken and egg problem with new standards such as 5G and some agreements have too little trading associated with them, or are associated with side deals and other actions that make them of dubious applicability.  In my experience with litigation, parties usually differ on which licenses are suitable comps. Some licensees object to use of agreements that were signed under the threat of alleged "patent hold-up". Comparing percentage rates with capped, dollar-per-unit or lump sum figures in different agreements is tricky.

Cross-licenses need to be unpacked to derive one-way rates, which is also problematic including because unpacking calculations tend to use SEP counts that are subject to similar shortcomings as where patent counts are used in top-down methods.

Implementers with small numbers of SEPs can have disproportionately strong leverage against major vertically integrated players with both large SEP portfolios and large downstream businesses to protect from patent infringement claims. Unpacking these cross-licenses underrates the major party.

Value-based methods

These methods are in accordance with patent law and are commonly used where few patents are involved. They seek to measure and apportion economic value. Techniques can include use of hedonic pricing models and consumer preference measurements with conjoint analysis.  I’ve used such techniques as a testifying expert witness in a non-SEP case and in cartel price-fixing litigation.

But judges seem less inclined to consider such methods in FRAND cases where they have misplaced concerns about alleged and unproven patent hold-up and royalty stacking, because they now have the crutch of top-down valuation methods to use in addition to comparable licenses. For example, in the TCL v. Ericsson Decision (which as unanimously and entirely vacated on appeal), Judge Selna threw out an Ericsson expert’s so called “Ex-Standard” valuation approach for lacking fundamental credibility and because the judge thought it suggestive of royalty stacking, even though the judge agreed that TCL did not challenge the methodology, but rather the inputs to the calculations.

I believe that value-based methods should be increasingly employed — not disregarded.  Imperfect though they all are, various different techniques should be explored to figure out where and how much real economic value is generated, and to set royalties accordingly.

Monday, 23 May 2022

Fair Use and the Future Explored: Chip N' Dale: Rescue Rangers Movie

Yesterday, my kids and I watched the new movie, Chip N’ Dale:Rescue Rangers.  This is probably the funniest Intellectual Property law related movie I’ve seen.  Disney takes on IP Law doctrine and policy in a very humorous way.  As an exercise in understanding U.S. IP law, the facts the movie raises are very nice.  Here’s a few examples: ET v. Batman; Ugly Sonic; Chippendales; and on and on.  They also take on: a glimpse at the future of augmented reality; artificial intelligence and creativity; culture wars; Hollywood nostalgia reboots (talk about bootlegging); and the future of counterfeiting. There are so many references my brain almost exploded from overload. As a tip, be sure to take in the background materials, e.g., advertisements. Lol. They take some pretty nice shots at competitors, but I wonder what’s going to come back.  Interestingly, the Pirates of the Caribbean ride at Disneyland has been closed for “refurbishment.”  [In full disclosure, I am a very big fan of Disney and may be extremely biased.]

Friday, 20 May 2022

White Hat Hackers Safe from CFAA Prosecution?

The U.S. Department of Justice announced yesterday that it will not prosecute white hat researchers under the Computer Fraud and Abuse Act!  However, white hat hackers beware: There are many state laws that criminalize such behavior.  The press release states:

The Department of Justice today announced the revision of its policy regarding charging violations of the Computer Fraud and Abuse Act (CFAA). 

The policy for the first time directs that good-faith security research should not be charged. Good faith security research means accessing a computer solely for purposes of good-faith testing, investigation, and/or correction of a security flaw or vulnerability, where such activity is carried out in a manner designed to avoid any harm to individuals or the public, and where the information derived from the activity is used primarily to promote the security or safety of the class of devices, machines, or online services to which the accessed computer belongs, or those who use such devices, machines, or online services. 

“Computer security research is a key driver of improved cybersecurity,” said Deputy Attorney General Lisa O. Monaco. “The department has never been interested in prosecuting good-faith computer security research as a crime, and today’s announcement promotes cybersecurity by providing clarity for good-faith security researchers who root out vulnerabilities for the common good.”

The new policy states explicitly the longstanding practice that “the department’s goals for CFAA enforcement are to promote privacy and cybersecurity by upholding the legal right of individuals, network owners, operators, and other persons to ensure the confidentiality, integrity, and availability of information stored in their information systems.” Accordingly, the policy clarifies that hypothetical CFAA violations that have concerned some courts and commentators are not to be charged. Embellishing an online dating profile contrary to the terms of service of the dating website; creating fictional accounts on hiring, housing, or rental websites; using a pseudonym on a social networking site that prohibits them; checking sports scores at work; paying bills at work; or violating an access restriction contained in a term of service are not themselves sufficient to warrant federal criminal charges. The policy focuses the department’s resources on cases where a defendant is either not authorized at all to access a computer or was authorized to access one part of a computer — such as one email account — and, despite knowing about that restriction, accessed a part of the computer to which his authorized access did not extend, such as other users’ emails.

However, the new policy acknowledges that claiming to be conducting security research is not a free pass for those acting in bad faith. For example, discovering vulnerabilities in devices in order to extort their owners, even if claimed as “research,” is not in good faith. The policy advises prosecutors to consult with the Criminal Division’s Computer Crime and Intellectual Property Section (CCIPS) about specific applications of this factor. 

All federal prosecutors who wish to charge cases under the Computer Fraud and Abuse Act are required to follow the new policy, and to consult with CCIPS before bringing any charges. Prosecutors must inform the Deputy Attorney General (DAG), and in some cases receive approval from the DAG, before charging a CFAA case if CCIPS recommends against it. 

The new policy replaces an earlier policy that was issued in 2014, and takes effect immediately.

Thursday, 5 May 2022

How Europe can build on strengths in SEPs to reclaim leadership in cellular with 5G and 6G

 The EU is in grave danger of “throwing out the baby with the bathwater” in its prospective attempts to reform SEP licensing with interventions for the purported benefit of European Small and Medium-Sized Enterprises (SMEs) in IoT. 

Europe was once preeminent in cellular communications with 2G GSM—including standard-essential technology innovation, product developments and sales, network deployments, and operator services adoption by consumers. Since its heyday in the in the late 1990s, Europe has declined through a succession of falls from various leading positions in cellular.

Revenue growth captured in cellular by newcomers from outside Europe

Source: Companies’ yearend reports and average annual exchange rate figures

The European Commission’s initiatives to regulate standard essential patents (SEPs)—most significantly in cellular technologies and ostensibly for the benefit of SMEs and other technology implementers—are oblivious to this bigger picture. It is vital for all Europeans that the region’s remaining major players in the cellular ecosystem can flourish profitably and are able to continue investing in R&D for innovation, new products, network deployments and services growth. That means ensuring standard-essential technology developers including the European Union’s Ericsson and Nokia can make fair and adequate returns on their SEP investments. The SEP licensing system needs to be reinforced, not weakened with prospective interventions that are inconsistent, contradictory or that have weak factual justification and would jeopardise Europe’s competitiveness.

Re-establishing European strength in cellular also requires reregulation of operator and other services markets so that European mobile network operators can become profitable leaders in the mobile ecosystem once again. Hopefully the EU’s new Digital Markets Act (DMA) that seeks to reign-in the dominant and abusive behaviour of Big Tech companies such as Apple, Alphabet and Meta will help European mobile operators and others improve their competitive positions and abilities to become leaders rather than remain followers with new technologies and services. Anticipated measures against these Big Tech “gatekeepers” include restrictions on bundling and self-preferencing between complementary services (e.g. search versus shopping), and mandating interoperability among different messaging platforms. 

The European Commission, with its call for evidence for an Impact Assessment regarding a new framework for standard-essential patents closing May 9, 2022, follows the US Department of Justice and the UK’s Intellectual Property Office with public consultations on the topic of SEP licensing. These focus on various issues including improved “transparency” with the counting of essentiality-checked patents in setting royalty rates, prospective new collective licensing arrangements and purported problems such as opportunistic behaviour by patent owners and implementers.

While the European Commission threatens to meddle with SEP licensing, a paper I have written for 4iP Council considers the broader strategic issues on Europe’s competitiveness in cellular. This longer read shows that virtually all the $14 billion in SEP royalties to Europe’s world-leading innovators Ericsson and Nokia over the last 5 years— that were vital to fund their R&D at a total cost of around $10 billion in 2021—were export revenues generated on smartphone sales by Apple and Asian OEMs. Royalties generated from SEPs in Europe are tiny in comparison: most IoT modules are produced by a top five manufacturers that are Chinese, and there is no requirement for software application developers to take SEP licenses. 

Licensing costs pale in comparison to total revenues and profits derived as the cellular ecosystem expands to be worth many trillions of dollars in products, services and applications including IoT.

This summary article was originally Published in RCR Wireless on 4th May 2022.