How to derive and apply aggregate royalty rates for SEP FRAND determinations

Among numerous legal, economic and commercial concerns about the European Commission’s proposed legislation for Standard Essential Patent (SEP) licensing, its plans for aggregate rate setting and mandatory Fair, Reasonable and Non-Discriminatory (FRAND) rate determinations in various technology standards raises all kinds of issues and alarms.

Following publication of the proposed legislation and impact assessment on April 27, the Commission has been seeking online feedback submissions by August 10, 2023.

In a previous posting here and in my initial feedback submission the Commission 14th June, I have argued against the Commission’s apparent intention to abandon the established approach of using comparable licensing agreements directly as benchmarks in FRAND rate determinations, and instead apportion rates among SEP owners based on their respective shares of total SEPs using the top-down approach.[1] For example, I was critical about use of patent counting methods. My new feedback submission to the Commission focuses on aggregate royalty rate setting.

Any aggregate royalty rates set must be precisely defined, derived and applied. Aggregate rate setting for standards, as proposed by the Commission, will enable proposed rates to be depicted and manipulated in ways which are anticompetitive, unfair and will under-value patented standard-essential technologies. According to the proposed legislation, “‘aggregate royalty’ means the maximum amount of royalty for all patents essential to a standard.”[2] The Commission also indicates “uncertainty about the SEP royalty burden” and that “Stakeholders consider that the FRAND licensing concept could benefit greatly from some clarification, notably with regard to the determination of an aggregate royalty burden.”[3]

Aggregate royalty rates proposed to or set by the EUIPO could be in quantification of the total payment burden to be paid or of the rate to be used in determining individual FRAND royalty rates with the top-down approach.[4] The latter should be a higher figure than the former to allow for SEPs that remain unlicensed and for which there is no payment.

Either of these aggregate royalty rate percentages might be derived somehow from among various different formulations of aggregate rates reported. However, these reported rates vary enormously, for example, global rates from more than 35% to less than 5% of a smartphone’s selling price. The maximum aggregate rate burden implementers will have to pay and the correct Aggregate Royalty Rate for Apportionment (ARRFA) in a top-down approach FRAND determination will fall well within those two extremes.

An alternative approach in aggregate rate setting is to estimate value in standards with use of techniques including hedonic pricing or conjoint consumer preference analysis, and then apportion value somehow between SEP licensors and implementers.

If aggregate rates are to be set at all—as they are for patent pools in their rate cards, but in the opinion of many is unnecessary and dysfunctional in bilateral licensing[5]—such rates must be derived in the applicable context. Collective action—such as in patent pools—where some major licensors are typically also major licensees will tend to set rates that are lower than would be agreed bilaterally. Another crucial difference is that patent pool aggregate rates are the rates licensees actually pay.

In FRAND determinations for bilateral licensing there is always a shortfall between the ARRFA and what is actually paid because the SEPs in any given standard are never fully licensed. The aggregate rates from which bilateral licensing rates are derived are never fully paid due to notional royalty allocations to patents that remain unlicensed. Any aggregate royalty setting must recognize this difference if such rates are to be used to determine FRAND rates using the top-down approach.

To mitigate shortcomings in rate setting, some guiding principles must be established on what the “SEP royalty burden” and ARRFA should include and exclude, as well as how and by whom such rates should be derived and applied. The interests of both SEP owners and implementers must be safeguarded while reflecting industry realities with the many factors that shape varied financial and other terms in established licenses. Application of economic theory must have full and proper regard for what royalty figures reported in the industry represent and how licensing actually gets done.

My full submission to the Commission can also be downloaded from WiseHarbor.

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[1] Feedback on draft EU legislation by Keith Mallinson, WiseHarbor; June 14, 2023

[2] Article 2 (10).

[3] Proposed regulation (page 8) and Impact Assessment (2.3.2)

[4] “A SEP holder or an implementer may request the competence centre for a non-binding expert opinion on a global aggregate royalty.” Article 18

[5] Various court decisions including Unwired Planet v. Huawei and  InterDigital v. Lenovo have avoided or explicitly rejected aggregate rate setting, while others including Optis v Apple, also in the UK, have also primarily used comparable licensing benchmarks in their FRAND determinations.

DG GROW seeks to replace established FRAND valuation and licensing practices with top-down rate setting

In case you missed it or were unable to access my paywalled article in IAM on 5th April 2023, here it is with my analysis of the draft Proposal for Regulation of the European Parliament and of the Council establishing a framework for transparent licensing of standard essential patents, including an associated Impact Assessment report (IA) that were leaked ahead of their anticipated public launch on 26 April.

DG GROW is proposing various ill-conceived interventions — processes that have not yet even been designed or properly budgeted, let alone tested. These will upset a standards development and patent licensing system that has been effective in enabling the world’s fastest growing and largest ever technology ecosystem serving more than five billion people and 16 billion connections with cellular worldwide.

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I have feared but anticipated in my publications that the EC might try to build some kind of Ministry of Patent Counting with the purported aim of helping SEP implementers including SMEs in particular in Fair Reasonable and Non-Discriminatory (FRAND) licensing. DG GROW now proposes to do that in spades by building a large “competence centre” bureaucracy at the European Union Intellectual Property Office (EUIPO). No, this is not the non-EU European Patent Office (EPO) that 63% of respondents to a DG GROW survey last year stated they preferred conduct the checks. This EU organisation has no expertise in patents, let alone in SEPs. It was selected because “the body needs to be aligned with the EU’s overarching political values and current policy priorities (e.g. support for SMEs)”,“accountable to the EU Public and European Parliament”, and “subject of a review by the CJEU".

The new centre will become a white elephant, even if it can acquire the required competences and get away with making the industry, and ultimately consumers, pick up the tab.

A recipe for hold-out and short-changing SEP owners

DG GROW’s unconscionable mission, which will undermine SEP licensing and enforcement (eg in Germany), is without legal or evidential support. The status quo purportedly exposes European companies to more litigation than “foreign producers that might fly under the radar", however patent infringement and exposure to enforcement occurs in both the location of manufacture and of sales. Unlicensed products manufactured outside Europe are more susceptible to being excluded through customs seizures as well as injunctions in Europe than are unlicensed European manufacturers. The Impact Assessment presents much anecdotal rather than quantitative evidence that European implementers are systematically and significantly disadvantaged. Rather than racing to the bottom by crushing European royalties and enforcement to level-down with foreigners’ alleged infringing sales, all suppliers in and to Europe should be held to the same high standards of patent protection.

If the reforms proposed in the leaked draft are accepted, this will do more economic harm to licensors, including EU’s leading innovators Ericsson and Nokia — that are highly dependent on SEP income to fund R&D — than it will to speculatively benefit implementers including SMEs who are purportedly those most in need of these changes. DG GROW also complains of “insufficient transparency on SEP ownership and essentiality; lack of information about FRAND royalties; and a dispute settlement system not adapted for FRAND determination”.

And yet, for most European implementers, including SMEs in particular, there is only limited exposure to unexpected SEP licensing or litigation costs because virtually all phones are manufactured outside of the EU and most SEP patents are exhausted in, for example, IoT modules that are also overwhelmingly manufactured elsewhere. The significant exception is cars.

Avanci has very successfully created a solution that is licensing all European manufactures at the modest cost of up to $15 (before the increase to $20) for the vast majority of patents declared essential to 2G, 3G and 4G, while its upcoming 5G program is in the works.

A centre of insufficient competence for DG GROW

DG GROW is unsatisfied with ETSI’s IPR database of declared essential patents. Its declaration process exists only to ensure technology standards are not blocked by unavailable IPRs. Essentiality of declared patents is not checked, let alone updated to reflect whether declared patents end up staying or becoming essential through patent prosecution and to finalisation of standards. ETSI also refuses to participate in commercial matters, such as setting royalty rates — even in aggregate, let alone for individual licensors and licensees — because its members do not want to compromise ETSI’s technically-focused functions, because ETSI does not have that competence and because it would be a violation of competition law.

Consequently, DG GROW apparently wants to expand administrative scope by edict through the EUIPO with new competences including:

• Registration of SEPs and access to the electronic database established by the competence centre. It seems this will largely duplicate what the ETSI IPR database does for patents declared essential to cellular standards, while also providing updates on patent status.
• Essentiality checks, including peer evaluation. The proposed process is fraught with all kinds of issues that will lend to manipulation, favouritism, bias and also subject checks or patents to subsequent challenges. SEP owners have shunned a system like this in Japan.
• Aggregate royalty determinations. Despite many claiming expertise, there is no consensus on methodology, let alone on applicable figures. The Unwired Planet Decision assumed patent value proportionality only to imply — not set — aggregate figures in cross-checking comparable license valuations due to the uncertainties. Even defining aggregate is debateable: is this total a theoretical maximum that nobody would ever pay, a typical or average figure actually paid after caps and discounts, or something in between?
• FRAND determinations. DG GROW is incredibly abandoning the industry’s prevailing comparable licenses valuation method. Its proposed top-down approach is unsubstantiated and has floundered in the courts. The recent InterDigital v Lenovo Judgment in the UK “f[ound] no value in InterDigital’s Top-Down cross-check in any of its guises”, despite huge amounts of expert work. The entirety of the TCL v. Ericsson FRAND Decision including its shaky top-down valuation was unanimously vacated on appeal. The IA acknowledges “persistent differences of opinion on key aspects of the FRAND concept such as royalty evaluation methods”. The EUIPO’s experts will have to build trust in their top-down competence from the ground up.

DG GROW advocates exemptions from royalty payments for low sales volumes in FRAND licensing. This is appropriate and already common practice in many bilateral and pool licenses. However, while DG GROW calls this “royalty-free licensing”, its ambiguous use of this term, while also referencing examples of Bluetooth and USB standards, dangerously implies reciprocity that prevents counter-parties from generating any royalties. This undermines the business model neutrality in an open and competitive market DG GROW should be preserving.

Disregarding facts

It’s staggering that DG GROW disregards plain facts and maths. No wonder it’s being accused of being so one-sided. While it professes to cherish transparency and balance, and claims to conduct literature analysis, it has not cited any of my articles among the hundreds cited in its IA. This is despite mine being widely cited elsewhere for my seminal research on key SEP issues including aggregate royalties and inaccuracies in patent sampling and essentiality checking. On the latter, in 2021, I identified a mathematical howler in a 2016 report for the EC by CRA that is cited eight times in the IA. CRA hugely understates — by a factor of much more than 10 — the estimated sample size of only 30 it claims provides “quite a good precision”. Neither a rebuttal to my claim, nor erratum has ever been produced. Sample size and time spent per patent are the two biggest cost drivers in essentiality checking.

And, as highlighted by FOSS Patents, DG GROW is also wrong to assert that “false positive and false negative random errors tend to cancel each other out” because more of the former creates systemic bias.

Nevertheless, my findings that accurate samples of several thousand are required have got through. The IA anticipates the need to check 10,000 to 99,500 patents at a cost of €4,000 or €5,000 each for a total of €40-498 million, plus claim chart, office IT, administration and depreciation costs. Ouch!

This empire-building framework defies common sense and smacks of agency capture by Big Tech and Auto lobbyists seeking to minimise licensing charges. It disregards the proven efficacy of standard-essential technology development, established licensing FRAND practices, economic realities and the interests of innovators. Bureaucratised and centralised essentiality checking, patent counting and rate setting will be burdensome and costly. Internal processes and external challenges to what these deliver will only exacerbate existing patent hold-out and further delay licensing payments.

The technology standards ecosystem has evolved and flourished in a free market. European SEP licensing is overwhelmingly a European net export worth billions of Euros per year including major earners Ericsson and Nokia. Its reckless to jeopardise that and saddle the European industry with the additional costs of these proposals. These set a terrible example that will encourage jurisdictions seeking to benefit from erosion of SEP value. Rather than having most of EU’s estimated 1,500 experts in the field check others’ patents at an estimate cost of €500 per hour, it would be more fruitful for them to spend their time innovating and patenting themselves.

EIPO and EPO Study on Financial Impact of Patents, Design Rights and Trademarks

The European Intellectual Property Office and the European Patent Office conducted a joint study analyzing the impact of patents, design rights and trademarks on firms.  Interestingly, the study finds that firms with patents, design rights and trademarks pay more to employees and generate more revenue per employee than those firms without those rights.  Notably, firms with patents outperform firms with only design rights or trademarks in both areas: employee pay and employee generated revenue.  Interestingly, firms with combined trademarks and design rights, or combined patents and trademarks, or combined patents, trademarks and design rights, outperform firms only with patents in revenue generated per employee. 

The Executive Summary notes:

The positive association between IPR ownership and economic performance is particularly strong for SMEs. At the same time, less than 9% of SMEs in the sample own one of the three IP rights included in the study. The reasons for the low uptake are explored in the EUIPO survey of European SMEs (EUIPO, 2019). This study (as well its earlier edition from 2015) indicated that barriers faced by SMEs include lack of knowledge about IPRs, a perception that registration procedures are complex and costly, and the high cost of enforcement of those rights, a particular burden for SMEs (EUIPO, 2017). Given this, and the importance of SMEs in the European economy, the EPO and the EUIPO are taking steps as IP offices to address those concerns so as to enable European SMEs to take full advantage of their innovation and intellectual property, in the context of the EPO’s Strategic Plan 2023, the EUIPO Strategic Plan 2025 and the European Commission’s SME strategy formulated in early 2020 (EC, 2020).

The study may be found, here.