While there is much uncertainty
about the outlook for standard-essential patent royalty rates in court
determinations, there are plenty of solid benchmarks in well-established comparable
licenses (“comps”). The former rates are thin on the ground and have been made up
based on some dubious and fiercely contested tenets as judges scrabble to set
figures that are fair, reasonable and on-discriminatory. The latter rates have
been agreed in droves through negotiation in licensing programs with dozens of
licensors, hundreds of licensees and many thousands of patents. These are not
meaningless asking prices with no takers —or just one or two
transactions
specifically conceived and executed to establish a desired marker— they are
economically significant because they are underpinned by many billions of
dollars of licensing trade over decades.
And, many
players in the cellular industry have self-servingly colluded to cap aggregate
royalties since the introduction of 3G twenty years ago. Unsurprisingly, these
voices dominate because most, by far, of the interested parties, including
OEMs, must become licensees to implement the standards legally. For only a few
is licensing more an income generator than a cost in manufacturing.
Who is to say how much all the
patents in devices are worth, how that valuation should be derived and how value
should be divided among technology owners, implementers and end users? Weighing
up all of this is significantly a matter of personal judgment—not of simply applying
some supposedly pre-ordained formula. Vacating the District Court Judge Selna’s
bench trial decision in TCL v. Ericsson on appeal,
the
Federal Circuit has prescribed retrial with a jury. This will recalibrate awards
based on the subjective judgement of randomly selected non-experts. It will
likely include consideration of bottom-up valuation methodologies reflecting consumers’
purchasing preferences, price sensitivities and the perceived value for
smartphone features and performance improvements.
The math(s) is not easy or
proven
Even using comps is not straightforward
in many cases because most licenses are cross licenses and so the
prices
and monies paid typically reflect significant netting off between the notional
royalty rates of the parties and also account for the respective trading flows of
their manufactures. Where licensors do not have downstream manufacturing
businesses, that need licensing—such as smartphone manufacturing—royalty rates
can more easily be directly compared among licensees, in many cases, without
adjustment. For example, Qualcomm and InterDigital do not make or sell devices,
which account for most, by far, of the trading value in the cellular products (e.g.
around $500 billion per year for mobile phones). Adjustments are also required
in the comparison of licenses due to up-front lump sum payments, per-device caps,
per device floors, total payment caps and other differences.
So how on earth could something as
seemingly complex and difficult as valuing a portfolio of SEPs be left to a
bunch of jurors?
Judge Selna’s
decision was extensive and 115 pages long. It applied two different
methodologies —"top down” and “comparable license analysis” with the “unpacking”
of two-way licenses—and disregarded a third—a bottom up “Ex Standard approach”
designed to estimate the value of SEPs independent of any
value arising from incorporation of SEPs into a standard.
With his judgement vacated, Judge Selna’s analysis no longer has any legal authority;
but it does reveal some of the methods and arguments that may continue to be
applied in the valuation of SEPs and determination of royalties for these under
FRAND terms.
The wisdom
of lay folk
Perhaps the jurors will see through
all the bluff and complexities, as they do in so many other trials. They can be
unburdened by the weight of consensus, self-interested majorities and
conventional wisdom. The
Seventh Amendment constitutional right to a jury
trial in civil proceedings has served the US well. It is probably one of the
reasons why the nation is for centuries the most successful technological
innovator in the world. If not, the US has evidently not been held back by its
patent law and execution of this right.
Significantly, the
New [December
2019] Policy Statement on Remedies for Standards-Essential Patents Subject
to Voluntary F/RAND Commitments issued by The U.S. Patent & Trademark Office
(USPTO), the National Institute of Standards and Technology (NIST), and
the U.S. Department of Justice, Antitrust Division (DOJ) offers views on
remedies for standards-essential patents that are subject to a RAND or FRAND
licensing commitment. This overturns interpretations of the 2013 policy statement
by the USPTO and DOJ: ‘the
agencies have heard concerns that the 2013 policy statement has been
misinterpreted to suggest that a unique set of legal rules should be applied in
disputes concerning patents subject to a F/RAND commitment that are essential
to standards.’
In addition to saying
a lot about how injunctions should become more readily available—an important
issue, but which is outside the scope of my article— the new Policy Statement advises
that ‘with respect to
damages, the Federal Circuit has explained, “We believe it
unwise to create
a new set of Georgia-Pacific-like factors for all cases involving
RAND-encumbered patents.”
The court further stated that “[a]lthough
we recognize the desire for bright line rules and the need for district courts
to start somewhere, courts must consider the facts of record when instructing
the jury and
should avoid rote reference to any particular damages formula.”’
(Emphasis added and citations omitted.)
With the above developments, we are likely to see rather
higher awards for SEPs than, for example, the paltry figure of somewhat
less than one US cent per LTE SEP resulting from Judge Selna’s overturned
decision.
Three different portfolio valuation and
FRAND determination methods where presented by the parties for Ericsson’s 2G,
3G and 4G SEPs in TCL v. Ericsson.
“Reasonable,
maximum aggregate royalties” with “proportionality”
I have already
criticized
at length Judge Selna’s top-down approach and so I provide no more than a
summary of that here. When I wrote my critique of Judge Selna’s subsequently vacated
Decision, I focused almost entirely on his top-down analysis; but indicated I
might return to assess the other methods of FRAND rate determination and his analysis
of them.
Top-down is fundamentally flawed for
two reasons, and thirdly, Judge Selna’s corresponding determinations were
biased and erroneous in his application of the methodology.
Judge Selna justified use of this
approach on the basis that Ericsson and others had in 2008 encouraged the
industry to
allocate
royalties based on a maximum aggregate rate and proportionality among
licensors based on relative patent strength among portfolios. However, there
were several in the industry that never subscribed to such an approach and
were, instead, for good reasons, vociferously opposed to it. For example, in December 2008,
Qualcomm
publicly stated it was against such a formulaic approach because it ‘would
arbitrarily limit the value of standards essential patents, discourage
innovation, encourage the filing of marginal patents, complicate and delay the
standardization process, and be impossible to implement in practice.’ There is
no reason to bind these dissenters to such an approach. It should be possible
for them and others to derive significantly higher royalties, if enough value
is there.
Secondly,
apportionments
among patent holders are inaccurate. For example, patent-portfolio stand-essentiality
determinations are cursory, inconsistent and patent counting methods typically
assume all patents are of equal value, which is antithetical to valuation
principles in patent law. Counting technical contributions to standard-setting
organizations also has the shortcoming of rewarding quantity instead of quality.
Thirdly, Judge Selna erroneously
whittled the rates down for Ericsson in several ways:
I.
Regarding company and aggregate single-mode
rates as multimode rates,
II.
Using inaccurate, unreliable and likely biased
patent assessments in apportionment of the aggregate rate to Ericsson with:
a. inflated
patent counts in the denominator,
b. deflated
patent counts in the numerator,
III.
Regarding
announced rates, including aggregate rates, as US rates rather than global
rates,
IV.
Discounting indicated rates based on patent
expirations, even though indicated rates were based on certain expectations for
these expirations,
V.
Disregarding the value of standard-essential
improvements and Ericsson’s share of these.
While the cap is purportedly to
protect implementers from the “worst case” scenario with a “royalty stack;” in
fact, nobody pays anywhere the maximum figure. On average, as
I
have shown and as others have confirmed,
here and
here,
the aggregate royalty paid on mobile phones including smartphones is no more than
around 5 percent including all generations of cellular SEPs, non-cellular SEPs
and non-SEPs. That is net of cross-licensing,
but even those with nothing to cross license are not paying much more. For
example, TCL managed to hold out payment to Ericsson for 7 years before trial.
There was no evidence presented in that case that TCL was paying anywhere near or
above an aggregate of 10 percent, nor that it would be doing so with payment to
Ericsson at the rates set in Judge Selna’s Decision. I have never seen evidence that anyone has
paid an aggregate figure reaching or even approaching 10 percent for LTE
licensing.
Fair shares
for all
While the value created in an
invention can be enormous, this is shared among various participants in the
value chain. Ultimately, virtually all the benefits tend to flow downstream to
end users. In the interim, some of the value is rightly captured in profits by
technology developers, OEMs and service providers.
Judge Selna threw out the “Ex Standard”
valuation methodology of Ericsson’s expert David Kennedy because, in Selna’s
opinion, the values it derived were too high:
‘Ericsson's 4G Essential Patents confer
$6.15 to $7.14 of value on a 4G handset. The Court finds that Kennedy's result
are highly suggestive of royalty stacking; i.e, valuing individual components
of a standard in manner that accedes the aggregate value of the standard.’
He also wrote: ‘it is simply not logical
that two features could have a value in excess of Ericsson's entire portfolio.’
These statements confuse the concept of
value to the user with the technology-licensing price to an OEM that is fair
and reasonable or that would be negotiated commercially under market
conditions. The above figures represent maxima — not figures demanded, let
alone expected or likely to be anywhere near realised by licensors.
Consumer surplus is defined as the
difference between the consumers’ willingness to pay for a good and the amount
that they actually pay. On average, producers capture only small percentages of
the total welfare gains from innovation, with consumers capturing the remaining
surplus. Licensing rates determine how the licensors and licensees split the
producers’ share of those total welfare gains.
The FRAND rate licensing price reflects
two factors:
Value to consumer ($) x share of value to be accrued by licensor (%) =
royalty to licensor ($).
Bottom-up valuation methods, including
Ericsson’s Ex Standard approach derive an upper limit to what features are
worth. What licensors may yield from them in licensing fees is a question of rent
splitting and how the economic surplus is shared among licensors, their licensees
and downstream parties including mobile operators, over-the-top service providers
(e.g. Google, Facebook and Netflix) and end users.
Economics and market dynamics tend to
determine outcomes including how economic surpluses are shared. For example,
while
research has shown
that the value a consumer derives from Google search may be tens of thousands
of dollars per year per user, Google is happily making huge profits while
generating,
only, hundreds of dollars per person. Hypothetical choice
experiments can derive consumer values, even for services such as Google that have
zero pricing for consumers. Internet platforms—such as Google— are under
intense scrutiny by competition authorities due to their dominance and how they
might be abusing that rather than for their high profits per se. In litigation,
such as in TCL v. Ericsson, jurors must decide how much of the large economic surpluses
generated by SEP technologies are awarded in licensing fees.
Get
(un)packing
While comparable licenses are potentially
the very best valuation benchmarks because they reflect billions of dollars of trade
with many licensing agreements over many years, not all of these can be employed
directly before significant adjustments. Lump sum payments, differences between
sales forecasts (most applicable because the assumption is that licenses should
have been completed before trading) and actual sales (20:20 hindsight), and assumed
“net present value” discount rates can all have significant effects on
derivation of simple, one-way licensing rates from complex two-way licensing agreements
including multiple terms and conditions.
I also explained the complexities and
difficulties of “unpacking” comparable licenses to derive the effective one-way
licensing rates
in
another article I published last year. One of the issues I discussed there
is that licensing rates tend not always to be proportional to the number of
patents— as assumed by both parties’ experts in TCL v. Ericsson
—in unpacking Ericsson’s cross licenses
to derive simple “one-way” licensing rates. Among many examples of that phenomenon,
is
IBM’s
historic licensing approach, with pronounced non-linearity in licensing
fees for more than five patents:
Number
of Licensed Patents Covering the Product
|
Percentage
of the Selling Price
|
1
|
1%
|
2
|
2%
|
3
|
3%
|
4
|
4%
|
5 or
more
|
5%
|
Bottoms up
In
a
presentation I gave on the topic of top down and bottom up valuation
methodologies at the Patents in Telecoms and the Internet of Things conference at
Tokyo University in November 2019,
I
reused some analysis I have been presenting since 2015 showing how cellular
functionality is priced by Apple at a much higher mark-up than other costs. Apart
from the absence of cellular capabilities, the iPhone Touch 5
th
Generation had very similar specifications to the iPhone 5c. However, the
latter was sold for $450, which was more than twice the price of the former, despite
costing only around $32 more in manufacturing.
Even more remarkable from an economic
perspective was the fact that sales volumes for iPhones in 2014 were more than
12 times greater volume terms and 46 times greater in revenue terms than for
all iPods. Apple is free to price at any
level it wishes and so its prices are only an indirect indicator of consumers’ perceptions
of value. Relative sales performance is an outcome of its pricing. According to
basic economic principles, if two products are close substitutes a much lower
price for one would tend to result in much greater demand for versus the other
product. The much higher demand for the
cellular devices— despite the much higher price— underlines the premium value
in cellular and that no iPods are close substitutes for iPhones.
Out on the
range
FRAND rates are not as range bound or
unique, as many might imagine they should be. It all depends on the circumstances,
other licensing terms and market developments over the years. On appeal, Justice
Birss’ Decision in Unwired Planet v. Huawei was largely upheld and partially annulled.
The higher court ruled several different sets of rates and terms could all be FRAND
and that there did not have to be only a single FRAND rate, as Birss had ruled.
I
have been arguing here since 2013 that the FRAND rate range should be quite
wide because, for example, patent pool participants legitimately tend to agree
on relatively low rates in the interests of their downstream-oriented members
versus legitimately agreed bilateral FRAND rates. I have not yet come across
anyone arguing that royalty-free patent pools or “platforms”, such as that for
the Bluetooth and USB standards, have rates that are non FRAND. Common sense suggests that royalty free is not
an isolated incidence of what is FRAND where other licensing arrangements set a
significant non-zero FRAND rate. The range of rates that are FRAND must at
least span between these figures, subject to other licensing terms and conditions.
In
my
abovementioned Tokyo presentation, I also showed that FRAND rates for video
codecs have varied enormously over time and between competing patent pools. It is
remarkable that the maximum licensing cost (set in dollars rather than as a
percentage of the product selling price) for the MPEG 2 standard technology pool
was 10 times higher than the 20 cents maximum for its higher-performing
successor MPEG 4 (AVC/H.264)—even over the years in which use of the two standards
was substantially overlapping. Many commercial factors were at play, including
the fact that the latter standard was adopted in much higher volumes by being
software based rather than hardware based and being used mostly in smartphones
rather than in the domestic CE products including TVs, set top boxes and DVDs
into which MPEG 2 was primary introduced.
Have we had enough of
experts?
As a testifying expert witness, I would
be one of the last to propose getting rid of them: but none of them, nor their sponsors
or acolytes, nor those who are swayed by them have a monopoly on wisdom or are
infallible. Following those with prevailing views is a safe bet for those in
the firing line of scrutiny with tricky and contentious decisions to make. But
that does not make those views right. Bias towards consensus or the majority is
not justice. As the New Policy Statement identifies, courts have misguidedly
tended to follow a unique set of rules in dealing with FRAND disputes.
On account of it
finally
being Brexit Day, today, it is most fitting to
paraphrase
British Member of Parliament and outspoken Brexiteer Michael Gove—who maintains he was misrepresented
when it was reported he had said ‘people have had enough of experts’ in the
highly contentious debate about the merits and costs of Brexit. Rather than do
away with experts, one should always look for the dissenting voice. When there
appears to be a settled consensus, look at the people who are challenging it.
If their arguments are well constructed, then pay close attention; if you think
it is just bogus nonsense then reject it— but test alternative propositions.
The notion that things should be taken simply on trust because of someone’s
position is an invitation to intellectual conformity and what we need is a
vigorous, debating, dissenting culture.
While all but a relatively small
proportion of SEP portfolio licenses are negotiated to completion between or
among parties, it is time for some fresh thinking and judgement on where value
lies and how it should be shared when there is dispute. I am looking forward to
seeing what jurors will come up with.
