FRAND licensing needs a taxonomy: valuation absent context is misvaluation

The World Intellectual Property Organization's recent report on SEP valuation methodologies provides a useful overview of comparable licences, bottom-up valuation and top-down approaches. However, in my view, the most important issue in FRAND valuation remains underexplored: the need to distinguish between fundamentally different categories of licensing and commercial arrangements.

This article argues that much FRAND analysis suffers from false commensurability. Bilateral licences, cross-licences, collective licensing platforms, patent pools, paid-up lump-sum settlements and royalty-free regimes are frequently converted into common metrics such as ad valorem rates or dollar-per-unit royalties and then treated as directly comparable. In the process, critical commercial context can be lost in translation.

Using examples including Nokia's agreements with Apple and Microsoft, Avanci's $32-per-vehicle automotive licensing model, public licensing programmes from Qualcomm and InterDigital, and recent FRAND decisions including Samsung v ZTE, Optis v Apple and InterDigital v Lenovo, I examine how royalty metrics, payment structures, bargaining conditions and strategic objectives can materially affect negotiated outcomes.

I also discuss the risks associated with cross-licence unpacking, portfolio-strength-ratio methodologies, patent counting, manufactured comparables, and the tendency to treat complex licensing agreements as if they can be translated mechanically into equivalent royalty rates.

My central thesis is simple:

The first question in FRAND valuation should not be "Which methodology should we use?" but "What exactly are we trying to value?"

The resulting rates may appear objective and comparable, but instead still reflect the bargaining asymmetries, strategic objectives, risk allocations and other distortions that shaped the original deal.

Download the full article from SSRN, here.

Adjusting the Balance in SEP Evaluations and Licensing

A European Commission DG Growth initiative described in its Roadmap on Standard Essential Patents for a European digitalised economy aims to increase information on SEPs so implementers can get a better idea about which of these they might be infringing. Additional disclosures on how patent claims might read on the standards could be beneficial. Requirements should reflect the dynamics and uncertainties in standards development and patent prosecution and must not be onerous to patent owners. These are issues for standards development organisations to consider.

A report DG Growth commissioned in support of its initiative entitled Transparency, Predictability, and Efficiency of SSO-based Standardization and SEP Licensing (the CRA report) proposes that SDOs or the European Patent Office could also help meet this objective by being appointinted the central assessor that would screen patent disclosures to determine and count which patents are truly essential. This would be undesirable intervention with various adverse consequences. As I wrote here for IP Finance in detail very recently, third-party determinations on large portfolios are inherently subjective, inconsistent and unreliable.

The creation of this EC-ordained “patent counting” database would also lend it to being used as an interventionist means of valuing SEP portfolios. In conjunction with the unwarranted imposition of maximum cumulative rates (i.e. royalty caps), this could facilitate the ill-conceived price regulation alluded to by the Competition Commissioner.

The CRA report also embraces defective patent hold-up and royalty stacking theories. General theories on hold-up and “Cournot complements” are misrepresented and do not apply to patents. There is a lack of supporting evidence on alleged patent hold-up, royalty stacking and much of it to the contrary including that for opposing effects from patent hold-out (i.e. patent trespass). 

SDO IPR policies are commonly misrepresented with the bogus notion that patent owners should be deprived a share of value from use of patents in standards. Neither the economics nor the law is settled here. Sharing in the “gains from trade” incentivises risky investments.

Private ordering has worked very well in 2G, 3G, 4G and it will continue to work well in IoT including 5G. Prospects are no more uncertain now than they were when these previous-generation standards were introduced and helped transform the communications markets. Decades of fruitful progress indicates it is not “too soon to tell” how things are playing out. By all measures these markets are extraordinarily competitive and successful, with large research and development investments, extensive resulting innovation, massive growth in subscribers and data consumption, reducing quality-adjusted prices, and dramatic shifts in market shares with new market entry, market exits, low and decreasing concentration in supply. I have been showing this with facts and figures here, here and here for many years, and as others have confirmed.

The CRA report is right to reject a mandatory switch to chip-based royalty rates and licensing, and to recognise the legitimacy of charging different royalties depending on “field-of-use” (e.g. an IoT lightbulb versus an augmented reality headset or a self-driving car). This well-established principle aligns costs with functionality used and value generated.

IoT is expected to be worth up to the teens of trillions of dollars to the global economy by 2025. That is 500 times more than the cost of licensing the communications technologies that are already providing the growth fulcrum for IoT developments. Undercutting royalties will diminish gains that could otherwise be obtained widely by leveraging reinvestments in intellectual property.

With it being much more difficult to obtain injunctions than it used to be, as the CRA report and Justice Birss in Unwired Planet v. Huawei also observes, the scales have already been tipped significantly in favour of implementers versus technology developers in terms of bargaining power. The balance here needs to be redressed here not swayed further. Royalties are flat or declining while opportunities and demands to invest in R&D for the good of all in IoT and 5G are increasing.

DG Growth should not interfere with SDO governance or try to pick winners among these or their IPR policies. Rather than speculating about how much aggregate licensing costs could be, costs should be measured by asking licensees what they are actually paying in cash royalties. Compare that with the value the resulting technologies deliver in the market.

Private ordering is preferable to public ordering and intervention is unnecessary. SDOs, patent pools, other licensing platforms and bilateral licensing under FRAND conditions can continue to serve the industry well and to the benefit of consumers.

However, if EC decides to intervene there should be impact assessments before intervening and empirical analysis of effects thereafter. DG Growth should also measure the results previous rulings— including those affecting the availability of injunctions— have already had on royalty rates and how long it takes to complete licensing agreements.

DG Growth’s analysis should be as open and transparent as possible, for scrutiny by all.

The above is a summary to my full article, here. This supplements my response to the DG Growth consultation on this topic in 2015.

"Patent holdup" allegations encourage SEP free-riders

Despite many years of speculation and recently adjusted claims, there is no empirical support for the theory of “patent holdup.” Various eminent experts refute allegations of systemic “patent holdup.” It is likely that “patent holdup” has not occurred in the context of standards and licensing of standards essential patents (SEPs) because of the fair, reasonable and non-discriminatory (FRAND) licensing contracts and available recourse to the courts have ensured that licensees cannot be forced to pay “excessive” licensing fees. 

Free Riders Abound

“Patent holdout,” which is also sometimes referred to as “reverse holdup,“ rather than “patent holdup” may instead be a prevalent problem; although calls for remedies have largely been in response to “patent holdup” allegations. Beguiled courts, antitrust authorities, government policy makers and even a standards development organisation (SDO) are tipping the scales in favour of “patent holdout” by infringing implementers of SEPs. This is destabilising the equilibrium between the interests of the licensors and licensees forged by consensus over decades in the IPR policies of SDOs such as ETSI with Fair, Reasonable and Non-Discriminatory licensing.  As leading academics note, “FRAND Implies Balance” and “FRAND [is not] a one-way street.”  Whereas alleged “patent holdup” supposedly results in excessive royalties, “patent holdout” is undermining licensors attempts even to achieve FRAND terms or to complete any licensing at all in many cases. Licensors are therefore losing their ability to make a fair return on their investments in SEP technologies. This discourages ongoing investments in standard-essential technologies, participation in SDOs and contribution to the standards.

Free-riders who are not paying for the IP they use are gaining an unfair advantage over other implementers who are paying FRAND royalties as well as stealing property rights from technology developers. There is significant evidence of some infringers flourishing while avoiding paying patent licensing fees on their manufactures and product sales for many years. They can, for example, typically challenge FRAND offers in lengthy litigation before paying any royalties. In some jurisdictions, even the royalties ultimately awarded can be derisorily low.[1] In particular, various Asian OEMs accounting for a substantial proportion of global smartphone sales remain significantly unlicensed for at least some of the many SEPs they implement in the devices they manufacture or sell.

On the other hand, Alcatel-Lucent, Ericsson, Nokia and Qualcomm have exited the mobile phone market over the last 15 years while ramping-up R&D in 3G and 4G technologies. These and other technology-development oriented companies can only sustain these risky R&D investments if they can make direct returns on their patent portfolios through licensing. Former network equipment market leader Ericsson has recently ousted its CEO due to poor growth and weak profits despite cost reductions, including in R&D.

“Patent holdup” is manifestly not a systemic problem. There is no empirical evidence of harm to markets or consumers, and such abundant proof of market success—particularly for innovative smartphones and the extensive 3G and 4G networks to which they are connected—including seven billion cellular connections and modest licensing costs totalling only around five percent of device prices. 

Unmentionable claims

I came upon a paper entitled “Patent Holdup: Myth or Reality?” by Carl Shapiro, dated 6^th October 2015, which was circulated as a hard-copy and presented at an IEEE-SIIT conference at the Intel-sponsored key-note address. In this, the author concedes that there are “few documented instances of actual holdups” and that they are “exceedingly difficult for researchers to detect and reliably quantify.” He has backed off from his previous claims of prevalence of “patent holdup” where he stated “patentees regularly settle with companies in the information technology industries for far more money than their inventions are actually worth. These companies are paying holdup money to avoid the threat of infringement.”  Shapiro has retreated due to lack of empirical support for these original claims which is because portfolio licensing among many licensees on FRAND terms together with the courts ensure that holdup royalties are rarely demanded and are never paid. However, Shapiro takes another position where there is also no supporting evidence. He now claims that the social costs caused by the alleged “patent holdup” problem are in the actions taken to prevent holdup and in the opportunities forgone under the threat of “patent holdup.”

His 2015 paper is labelled a preliminary draft that should not be quoted, yet the verbatim thesis of this most outspoken author is evidently being adopted elsewhere; including in a speech by the US Department of Justice’s Chief Economist, Nancy Rose, at a George Washington University conference on “Patents in Telecoms” in November 2015. In this, she analogises that “patent holdup” is like dark matter in the universe – something that cannot itself be detected but is present. She said that the existence of dark matter can be inferred from effects on visible matter.

With the passing of ten months since Shapiro presented his paper at the IEEE event and with the DoJ’s name endorsing this latest development in “patent holdup” theory, I believe it is high time to shine some light on the flaws in arguments made by Shapiro and Rose by making their writings available and by rebutting them here. I do not see why they should enjoy the privilege of being heard and given the opportunity to persuade, while also indefinitely being able to shield their postulations from scrutiny or criticism.

My full analysis on Shapiro's paper and Rose's presentation can be found in a pdf here.

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[1] For example, a Chinese court awarded InterDigital in patent litigation against Huawei a mobile SEP royalty rate of only 0.019 percent of device sales. This is extremely low given that InterDigital’s overall royalty yield (i.e. its total royalty income divided by total device market sales revenues) including licensed and unlicensed sales globally is five times higher at around 0.10 percent.