Essentiality Rate Inflation and Random Variability in SEP Counts with Sampling and Essentiality Checking for Top-Down FRAND Royalty Rate Setting

Fair, reasonable and non-discriminatory (FRAND) royalty rates for licensing standard-essential patents (SEPs) are increasingly derived “top-down” by dividing a notional aggregate royalty percentage (e.g., 10% of a smartphone’s selling price for 4G LTE) among patent owners based on the proportions of patents they own that are deemed to be standard essential.[1] Other rate-setting methods include use of comparable licenses and measuring value derived from SEPs. However, as stated by Justice Birss in Unwired Planet: “In assessing a FRAND rate counting patents is inevitable.”[2] He used top-down methodology as a cross check. The FRAND rate Decision in TCL v. Ericsson, that was unanimously and entirely vacated on appeal, also relied on a top-down valuation.[3]

Ball colour, not patent essentiality, can be identified
 with 100% accuracy when sampling

Essentiality checking is also proposed by the European Commission and others to improve transparency for prospective licensees.[4]  But transparency is only legitimate if what is being revealed and counted is reasonably accurate and does not mislead. Otherwise, it will likely do more harm than good.

If patent counting with essentiality checking is going to be used in FRAND-rate determinations, then it is vital we understand its dynamics, failings, how to properly interpret its results, and how to design and size essentiality determination studies that are fit for purpose. This research article contributes to that quest.

Figuring out which patents are true SEPs and then counting them is fundamental to top-down analysis. With hundreds of thousands of patents declared possibly standard essential,[5] and the insuperably huge task in checking them all for essentiality, the European Commission and others propose that assessing only samples of patents declared essential to a standard would suffice.

Institutionalising use of patent counting—with or without sampling—is an under-researched and impetuous leap of faith. Different assessors come up with wildly different patent counts. Comparison of two separate assessors determining essentiality on the same sample of patents indicates that assessors tend to inflate true essentiality rates. These over-estimates result from statistical bias with numbers of false positives (i.e., truly not essential patents being found to be essential) exceeding false negatives when true essentiality rates are rather less than 50%.

I also conclude from my simulation modelling and analysis that:

1. The lower the true essentiality rate and the lower the rate of agreement among different assessors, the larger the differences will be between the essentiality rates determined by assessors and the true essentiality rate. For example:

a. If true essentiality rates are 30% and two different assessors agree with each other on 75% of their determinations, they will tend to estimate 36% essentiality rates and be accurate in 85% their determinations. 

b. If true essentiality rates are only around 10% (e.g., for 4G LTE or 5G), as some experts plausibly argue, and if two assessors agree with each other on 84% of their determinations, they will tend to estimate 17% essentiality rates and be accurate in 91% of their determinations. That means there will be nearly as many false positives as correct determinations of essentiality.

2. Therefore, if true essentiality rates are at the lower end of expectations, for example, at around 10% or less, it is imperative assessors are highly accurate in their determinations, otherwise false positives will swamp their correct determinations and make their overall results meaningless.

Sampling reduces the precision of SEP counts with increased variability, which is exacerbated by erroneous essentiality determinations. Sampling theory and simple simulations using results of patent-counting studies already undertaken—including several with sample sizes below a few hundred—reveal unacceptably large ranges in expected essentiality rate determinations (i.e. the percentage of declared-essential patents that are deemed to be essential)[6] at what various study authors regard as the “well accepted bound” of the 95% confidence level.[7]  This variability is particularly large where patent essentiality rates are at low levels, such as at around 10%. For example, 10% ± 1.5% is actually ± 15% variability as a proportion of that 10% figure. The quantitative analysis I undertook for this article measures the extent of diminutions, which should be properly and fully considered before sample sizes are set, and before the short cut of sampling is blindly adopted at all.

Top-down methodology seemingly enables precise assessments of FRAND royalties, but this is an illusion due to various inconsistencies and inaccuracies in patent selection, sampling and essentiality assessment. Key questions are how much precision is adequate and how can that be obtained? The optimal balance between extensive and costly patent-essentiality assessments, that can take days of work per patent, versus reducing the number of assessments by sampling should be decided with due regard to accuracy and confidence levels required, and based on empirical assessments.

While there are no set bounds for the acceptably accurate range in determinations, I have considered a reasonable proportionate accuracy requirement for essentiality rate determination to be <± 15% (i.e., a 30% range for the determined essentiality rate as a proportion of the true essentiality rate) at the 95% confidence interval level. With my opinion that true essentiality rates are more like 10% than 30% or 40%, I conclude from my analysis that samples including thousands of patents are required in top-down FRAND-royalty rate setting. For example, if the essentiality rate is only 10%, a sample size approaching 3,000 declared-essential patents per standard, at the very least, would be required.

My full article, including detailed statistical analysis, can be downloaded here.

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[1] These percentages in mobile phone licensing are typically applied to the wholesale selling prices of finished goods products.

[2]  Approved Judgment in Unwired Planet versus Huawei, 5^th April 2017 at 806 (11). https://www.judiciary.uk/wp-content/uploads/2017/04/unwired-planet-v-huawei-20170405.pdf

[3] http://www.ip.finance/2018/04/unreasonably-low-royalties-in-top-down.html and https://www.reuters.com/legal/transactional/ericsson-tcl-settle-long-running-smartphone-patent-disputes-2021-07-19/

[4] https://ec.europa.eu/growth/content/transparency-sep-licensing-how-clarify-possible-exposure-upfront_en

[5] Declaring one’s patents that are possibly standard essential is a requirement for participation in organisations such as 3GPP in the setting of standards such as 4G LTE and 5G.

[6] This is also called the essentiality ratio.

[7] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3752684 at page 4 and https://media.crai.com/wp-content/uploads/2020/09/16163609/Transparency_predictability_efficiency.pdf  at page 38

Independent judiciary requires reliability and factual credibility in economic analysis

In a major ruling that underscores judicial independence, federal judge Richard J. Leon has just unconditionally approved the merger between AT&T and Time Warner, rebuffing the US government’s effort to stop the $85.4 billion deal.

Judge Leon made headlines during the trial when he questioned whether a key Justice Department theory, backed by a well-known testifying-expert economist, was a Rube Goldberg contraption: “a machine intentionally designed to perform a simple task in an indirect and over-complicated fashion.” The UK equivalent of this is a Heath Robinson contraption: “any unnecessarily complex and implausible contrivance.” The Dane Robert Strom Peterson was similarly creative with “comic drawings of machines that perform very simple tasks through an unnecessarily complex and usually humorous series of actions.”

The judge was also quite damning in his written Decision:

Page 149: “After hearing Professor Shapiro’s bargaining model described in open Court I wondered on the record whether its complexity made it seem like a Rube Goldberg contraption. Professor Carlton agreed at the trial that that was a fair description. But in fairness to Mr. Goldberg, at least his contraptions would normally move a pea from one side of a room to another. By contrast, the evidence at trial showed that Professor Shapiro’s model lacks both ‘reliability and factual credibility,’ and thus fails to generate probative predictions of future harm associated with the Government’s increased-leverage theory. Accordingly, neither Professor Shapiro’s model, nor his testimony based upon it, provides me with an adequate basis to conclude that the challenged merger will lead to any raised costs on the part of distributors or consumers — much less consumer harms that outweigh the conceded $350 million in annual cost savings to AT&T customers.” (citation omitted, emphasis already included)

Professor Shapiro’s work on alleged patent holdup has similar failings, as I discussed, here (including my full analysis in a 12-page download), in August 2016, and as follows:

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.” (emphasis added)

It is reassuring that even well-known and widely-cited economists are expected support their opinions with facts when testifying in court. Royalty-stacking theory peddlers should also beware because they are likewise devoid of supporting evidence while there is copious evidence and solid economic analysis to the contrary.

Government agencies pursuing policy objectives must be more diligent in their deliberations. Academics and other experts should also be more principled when publishing academic articles and giving speeches. As I recently wrote in another publication on the question of “Economists: Do They Have a Place?” following a conference panel speech on the topic:

Economists need to take responsibility for what their own economic analysis relies upon. We need economists to publish, and as expert witnesses, but we need to flush out inapplicable theories, biases, and nonsense with more empirical testing, public debate including academic peer review, and rebuttal in litigation according to the applicable rules of evidence.

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.

EU Competition Commissioner Vestager is Wrong to Claim Smartphone Royalties are Excessive and Unjustified

I would like to introduce you to guest blogger Trevor Soames, a leading Brussels based antitrust lawyer with extensive experience of major high tech and IP-related investigations and litigation, having represented several major corporations in various cases over the years including Qualcomm, Nokia, Samsung and Microsoft.

The Competition Directorate of the European Commission (DG Comp) has, over the years, become increasingly interested and active in the field of SEPs. 

In a series of cases it has investigated a variety of potential competition law issues arising from the FRAND commitment, including allegations of patent ambush in Rambus, the transfer of FRAND commitments in IPCom, the risk of supposed “hold up” resulting from SEP holders seeking injunctive relief in Samsung, and in Motorola, here, and here. In addition, the European Commission investigated Qualcomm between 2005 and 2009 for, inter alia, alleged excessive pricing regarding its FRAND-committed SEPs. However, the case was terminated by the Commission when the four outstanding complaints were voluntarily withdrawn.

On 21 November 2016, the European Competition Commissioner, Margarethe Vestager, delivered a speech which indicated that the she intended to use the competition law tools at her disposal to deal more aggressively with excessive pricing cases.  She claimed smartphone royalties could be unjustifaibly high. I have already blogged, here, about her use of a defective aggregate royalty figure in support of her claims in this speech.

The following article by written by Trevor, and based on what he posted, here, comments generally on her speech, the policy issues that it raises and the wrongful identification of SEPs as being a supposed example of excessive pricing: 

"The Opening of the Door: is Excessive Pricing Control under Article 102 TFEU coming back into vogue

Commentary on Commissioner Vestager’s speech

Trevor Soames

Commissioner Vestager’s speech deliveredat Chillin’ Competition on 21 November 2016 entitled “Protecting consumers from exploitation,” spent much time discussing the application of Article 102 TFEU to excessive pricing.  A video of the speech is available on the Chillin’ Competition website, here, together with the Q&A in which the Commissioner said that she is taking a door which was almost closed and opening it a little.  The Q&A is at 14.50, my comment and question at 16.30 and the Commissioner’s response thereafter.

This short note provides a brief commentary on the subject of excessive pricing, European Commission enforcement policy, the examples cited by the Commissioner and what all this may mean for the application of Article 102 TFEU.

Excessive pricing control under Article 102 TFEU has been a fraught subject ever since the United Brands judgment of the CJEU. For our US cousins, the very idea that antitrust law could apply to excessive pricing must seem more than passing strange.  The Supreme Court made its views on the subject very clear in Justice Scalia’s Trinko opinion where he argued that 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. 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”.

The European Commission, to its great credit, has exercised great restraint in applying Article 102 TFEU in this area.  A critical step in this process of increasing self-restraint was the adoption of the two Helsingborg complaint rejection decisions in 2014 which, unusually for such decisions, made a finding not merely that there was no Community interest in investigating the case further but rather, and more strongly, that there was “insufficient evidence to conclude that the prices charged…are unfair/excessive and thus constitute an abuse within the meaning of article 82 of the Treaty”. The decisions are worth (re-) reading, see this and this.

Since that time there have been very few cases of excessive pricing at EU level.  Except for a handful of exceptional cases, those which have been investigated as such have been terminated by the Commission without findings of infringement. 

The European Commission emphasised its cautious and restrained approach to the application of Article 102 TFEU to alleged excessive pricing in its written submission to the OECD of 7 October 2011. The paper provides a useful summary of its enforcement policy, the rationale behind its emphasis on exclusionary practices and the problems that would be encountered in taking on excessive pricing cases.  Given that this subject has raised its head again, re-reading this carefully written paper is well worthwhile.  The position was well summarised at para. 42, as follows:

“It seems that enforcement action against excessive prices has only been considered as a last resort, in markets where high prices and high profits do not have their usual signalling function to attract entry and expansion because of very high and long lasting barriers to entry and expansion. This recognises that even though in many markets prices may be temporarily high, due to a mismatch of demand and supply or the exercise of market power, it is preferable to give market forces the time to play out and entry and expansion to take place, thereby bringing prices back to more normal levels. We have not seen enforcement activity in such markets, recognising that it would be unwise to run the risk of taking a wrong decision and furthermore spend enforcement resources on solving a problem that would solve itself over time anyway. This is so even in markets characterised by sufficient entry barriers where there can be dominant firms. Of course, it may be that a dominant firm tries to prevent this process of entry and expansion taking place by artificially raising entry barriers. However, in such a situation it is more efficient for the competition authority to tackle the raising of these entry barriers directly since this will likely amount to an exclusionary abuse. If, however, the market is characterized by such entry barriers that it is unlikely that market forces over time will bring prices down, enforcement actions aimed directly against excessive prices may indeed be appropriate.”

We have seen, however, a greater willingness by some member states with less self-control than the Commission to develop cases in this area.  We have also seen other non-EU competition jurisdictions which look to the EU for inspiration in the area of dominance control seeking to utilise their domestic Article 102 equivalents to attack what they see as excessive pricing or unfair terms.  Some of these cases have been notorious in terms of the intellectual contortions and use (sometimes misuse) of EU case law relied on to reach their conclusions.

Although the Commissioner identified a few limits to the application of excessive pricing control, she gave a clear message.  Namely, that the European Commission is open for business in this area in a manner not seen for many years.  In response to my question, she confirmed that a door which had been almost closed has now been opened, at least to some degree.   She said “...we’re still bound to come across cases where competition hasn’t been enough to provide a real choice. Where dominant businesses are exploiting their customers, by charging excessive prices or imposing unfair terms”.  Rightly, she emphasised caution saying that “we have to be careful in the way we deal with those situations. Because sometimes, a company is dominant simply because it’s better than its competitors. And when that’s the case, it’s only fair that it should get the rewards of its efforts. But we also need to be careful that we don’t end up with competition authorities taking the place of the market. The last thing we should be doing is to set ourselves up as a regulator, deciding on the right price”.

However, “there can still be times when we need to intervene”.  In closing the Commissioner said that “we need to act carefully when we deal with excessive prices. The best defence against exploitation remains the ability to walk away. So, we can often protect consumers just by stopping powerful companies from driving their rivals out of the market.  But we still have the option of acting directly against excessive prices.  Because we have a responsibility to the public. And we should be willing to use every means we have to fulfil that responsibility”.

For me, it is those last two sentences that gave some cause for concern and indicated that the door was being opened, as was indeed confirmed.

Now, it is true, that the Commissioner stated that excessive pricing control should only be used where there is no ability for the customer/consumer to “walk away”. The product or service being charged for does not need to be an essential facility in the manner normally used, namely whether access to the deemed essential facility is denied to a competitor, or is granted only on discriminatory terms, but rather whether the customer/consumer has a choice (note that the Commissioner didn’t use the essential facility concept, the application of which has been limited after the Oscar Bronner case).  Furthermore, the Commissioner says that although there may be future cases where alleged excessive pricing may be investigated and, indeed, decided upon, the Commission would not be a price regulator and would not decide on “the right price”.  That is all very well and it sounds comforting, but what it really means is that the Commission would merely decide that the price charged was unlawful, explain the grounds on which it so held and no doubt order that the price be adjusted so that it was reasonable. Little guidance may be provided by the Commission as to what it considers reasonable in the particular circumstances and if the allegedly dominant company gets its pricing wrong, it will be fined for having failed to comply with the Commission’s order without being able to seek clarity from a Court.  So, although the Commission would indeed not “set” the price, its actions would undoubtedly change the pricing levels set and the impugned and allegedly company would need to be cautious. De facto the Commission will therefore be a price regulator, whatever it may claim.

Let us turn (briefly) to the three examples of excessive pricing identified by the Commissioner, Gazprom, pharmaceuticals and Standard Essential Patents (SEPs):

• Gazprom: this is not a pure excessive pricing case at all and seems a strange example to choose.  The Commission’s allegations revolve around a series of exclusionary behaviours, territorial restrictions and market partitioning including export bans, destination clauses and measures that prevent the cross-border flow of gas, the combination of which has resulted in higher gas prices and the segmentation of gas markets along national borders.
  
• Pharmaceuticals: the Commissioner seemed to be focussed on a number of examples of off-patent drugs having been subject to significant price increases.  A notorious example was the 5,000% price increase implemented by Turing Pharmaceuticals and its CEO Martin Shkreli for Daraprim, a 62 year old medication. In addition there have been a number of NCA investigations as referred to by the Commissioner, including the recent Article 102 TFEU decision of the UK CMA regarding alleged excessive pricing for phenytoin sodium capsules (Pfizer/Flynn). These cases warrant a lengthier discussion than is possible in this note, but there are special circumstances at play in the pharmaceutical sector due to Government imposed price regulation that create a somewhat unique environment within which competition law operates.  One might have thought, along the lines of Justice Scalia’s reasoning in Trinko, that an off-patent drug which is subject to a substantial price increase would incentivise new entrants to generate competitive alternatives.  This would be consistent with para. 61 of the European Commission’s 2011 OECD paper where it stated that “enforcement against excessive prices is generally only contemplated in markets with an entrenched dominant position where entry and expansion of competitors cannot be expected to ensure effective competition in the foreseeable future, that is markets where high prices and high profits do not have their usual signalling function to attract entry and expansion.”
  
• SEPs: this is yet another strange example to have been included in the Commissioner’s list as it relates to an alleged phenomenon (royalty stacking and hold-up) for which there is no evidence at all.  Unlike the Gazprom and pharmaceutical examples cited by the Commissioner, the claimed phenomenon is entirely hypothetical and there is no empirical evidence that shows or proves that it exists.  The speech claims that a recent study “shows that 120 dollars of the cost of each smartphone comes from paying royalties for the patents it contains.”  This is untrue.  The study cited by the Commissioner is based on a purely hypothetical analysis as its authors themselves said when they caveated the report by stating that “we estimate potential patent royalties in excess of $120 on a hypothetical $400 smartphone.” Even Professor Carl Shapiro, one of the leading proponents of the royalty stacking and hold up theory was unable in his 2015 IEEE paper to provide any such evidence, see the note I posted on this subject, here. There are multiple recent studies on this subject that elaborate on the utter and complete absence of any empirical evidence and, indeed, in the case of one important paper by Padilla and Llobet on “The Inverse Cournot Effect in Royalty Negotiations with Complementary Patents” seeks to explain, in a rigorous manner, why royalty stacking is not observed in real, as opposed to hypothetical, life. In other words, the Commissioner’s SEP example of alleged excessive pricing is no example at all.

In conclusion, I cannot recall a Competition Commissioner’s speech on excessive pricing in recent times.  It was clearly delivered for a purpose and as the Commissioner confirmed it would seem that “a door which was almost closed” has now been opened “a little”.  But what does that mean?  Some of the statements made, as well as examples used, give cause for concern.  We will have to wait and see how this policy initiative develops, both at the Commission and at member state level.  My sense is that there is a greater potential for investigation and intervention in this area than for many years and a political willingness to go into territory only rarely entered into previously.

© Trevor Soames

Avocat au Barreau de Bruxelles

Solicitor-Advocate & Barrister"

Patently Faulty and Discredited Smartphone Licensing Cost Figure in Commissioner Vestager's Speech on Excessive Prices

It was irresponsible of European Competition Commissioner, Margrethe Vestager, to say in a speech about excessive prices last month that “[o]ne recent study shows that 120 dollars of the cost of each smartphone comes from paying royalties for the patents it contains.”

Commissioner Vestager is alleging that licensing prices for standard-essential patents are too high, and she would like them reduced. Nothing could be more important than having reliable support for her allegation. She did not provide this.

To the contrary, the quoted sentence is reprehensible for several reasons:

• The $120 figure, equivalent to a 30 percent aggregate royalty rate on a $400 phone, is wide of the mark. Nobody is paying anywhere near as much. Actual figures paid are, on average, less than one sixth that figure, at under $20 or below 5 percent of total handset costs.
• Her source is not cited. It is obvious to those who focus on smartphone licensing charges that she has plucked the figure from the much-criticized, here, and, here, “Smartphone Royalty Stack” paper by Intel and Wilmer Hale. Without her including any reference to help listeners and readers find the study or those who rebut it, folk might take the greatly-inflated figure at face value.
• The study is not recent and provides no fresh perspective. It was published two and a half years ago, in May 2014.
• It misrepresents the study’s findings. Commissioner Vestager has either ignorantly and unwittingly or sinisterly disregarded how the study cunningly characterizes this $120 figure. That figure does not represent what is actually paid in cash or recorded in financial or management accounts as licensing revenue or licensing expense. It is a notional cost that is not adjusted for what is netted-off in cross-licensing. The study is weasel worded: “setting aside off-sets such as ‘payments’ made in the form of cross-licenses and patent exhaustion arising from licensed sales by component suppliers, we estimate potential patent royalties in excess of $120 on a hypothetical $400 smartphone” (underling added for emphasis). This is flawed economics, as well as misleading and disingenuous.
• The study includes various additional systematic errors in its analysis including disregard for clear public evidence that much lower rates are being paid than those it includes in its calculations in most cases.
• Despite seeking and receiving external inputs, the European Commission continues to ignore logical and facts-based assessments of aggregate royalty rates that are in marked disagreement with the study by Intel and Wilmer Hale. The Commission’s DG GROW ran a consultation on patents and standards commencing 2014. My initial estimate of 5 percent aggregate mobile phone royalties was included in my submission to that consultation in February 2015 (pages 21-22). That finding has been reinforced in my subsequent publications and validated by other reputable experts.

Lies, damn lies and misleading or defective analysis

The recent US presidential election and Brexit referendum campaigns were significantly blighted by use of defective or highly misleading “facts” and figures. This “post-truth politics” tactic is nothing new or unique to those seeking votes. It is particularly troubling that public officials are also so inclined to unquestioningly adopt certain figures and ignore others solely based on what supports policy positions, popular beliefs or prejudices, and with disregard for scientific and evidentiary principles in quantitative research.

My extensive analysis shows the Smartphone Royalty Stack paper’s 30 percent royalty rate was defective. In IP Finance, here, in September 2014, I explained how this study was flawed, and, here, in August 2015, I showed in detailed analysis that average aggregate royalty payments were at most around 5 percent and were probably substantially less on mobile phones overall, including smartphones that dominate that product category. The faulty “royalty-stacking” theory upon which this paper by Intel and Wilmer Hale is based, has also been debunked by others. Adding up all the licensors’ listed maximum royalty rates does not provide a suitable indication of royalty costs, let alone an accurate measure of what is actually being paid in licensing fees.

Two separate eminent academic authorities in economics, Criterion Economics and the Hoover Institution, have validated the methodology in my 2015 article in their recent publications since mid-2016. Both studies calculate the majority of royalties in exactly the same way as I have and are broadly in agreement with the results I derived by “following the money,” as authors of the latter study, Haber, Galetovic and Zaretzki, characterise it. They also agree with me that only net royalty payments, after cross-licensing, should be included in aggregate royalty amounts and rates.[1]  Gregory Sidak of Criterion Economics independently checked my assessments and compared these with his own, step-by-step. These studies find that aggregate royalties are approximately 3.3 percent (Hoover Institution) and 4.5 percent (Criterion Economics).

Aggregate Licensing Fee Estimates for Mobile Phones Including Smartphones
in Two Totally Different Ballparks (Applicable Year 2014 or 2015)

Some elements in my 2015 paper were extremely conservative. For example, whereas I used the asking prices of LTE patent pools to derive my estimate of annual royalty payments of less than $4bn (equivalent to 1 percent of aggregate royalties), I note that these pools still seem to have very few or no licensees, and so I conclude the actual figure was and remains much, much closer to zero than it is to $4bn.

Whereas these two recent studies also show that aggregate royalties are conservatively in the “ballpark” of around 5 percent or less, rather than at 30 percent as estimated by Intel and Wilmer Hale, these two recent studies build on my work and seek to estimate the aggregate royalty rate with greater precision while also maintaining a conservatively-high bias in estimates. There are some differences among studies with respect to inclusion of non-mobile SEPs and non-SEPs, feature phones and tablets. These have only secondary effects on overall results and the aggregate percentages estimated.

We have been here before

Other wildly-exaggerated and yet widely-quoted cost figures have included $83 billion in social costs and $29 billion in direct costs annually to patent infringement defendants for the alleged “patent troll” problem estimated by academics James Bessen and Michael Meuer in 2011 and 2012. Such figures were much contested for years and I, among others, was most critical of the adoption of such figures by public bodies including the White House in 2015.

A 2016 study on Patent Assertion Entities by the US Federal Trade Commission presents much lower and far more reliable figures. It found study PAEs generating a total of only $4 billion in licensing over the six-year study period from 2009 to 2014. This is equivalent to less than $700 million per annum. Whereas the FTC study is not exhaustive in scope, it is nevertheless quite broad including 22 responding and 2,500 affiliated entities with 327 of these engaged in “active assertion behaviour” and it appears to have captured a large proportion of PAE licensing transactions. The more than forty-fold difference between annual totals based on extensive documented evidence submitted to the FTC and the estimates in these other studies is irreconcilable.

Post-“post-truth” please

Public officials should be more transparent about where the “facts” and figures they use to support their arguments and wishes come from. They should take the trouble to understand and not misrepresent their sources, even unwittingly. They should make the effort to consider opposing facts, figures and analyses. Some balance might help, but this should not be simply a case of reflecting differing or opposing positions without merit. Public authorities have a duty to find the truth of the matter with accurate and reliable figures, and present this in their public communications. Approximately correct might be fit for purpose and acceptable, whereas precisely wrong is no good at all. Scientific and evidentiary principles must apply.

For a broader critique of Commissioner Vestager’s entire speech, with respect to the competition law and policy issues it raises, I recommend you read this this article by Trevor Soames.

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[1] See footnote 7: “we do not include the opportunity cost borne by a manufacturer that buys patents to prevent claims of infringement, or the opportunity cost borne by manufacturers who cross license their patents (in a cross licensing agreement firms may forego some or any royalty payment in exchange for access to another firm’s portfolio), or the membership subscriptions paid to defensive aggregators of patents. Such expenditures will increase a firm’s fixed costs. They will not, however, affect marginal costs of production, and thus not influence production and pricing decisions at the margin.”

Cumulative mobile-SEP royalty payments no more than around 5% of mobile handset revenues

As indicated in the recent IP Finance guest posting about the US Court of Appeals judgment in Microsoft Corp. versus Motorola Inc., by Kevin Winters, in some cases there can be a massive difference between what a licensor asks for and what a licensee ends up paying in fees and royalty rates for standard-essential patents. My latest blog posting assesses cumulative royalties paid on SEPs in mobile phones, including multiple licensors, by adding up what is actually paid and what is conservatively the maximum likely to be paid, where actual payment figures are not publicly available. This total is far lower than that calculated by simply piling-up every licensor's rate demands. Expressed as a yield on total mobile handset sales revenues, it is a much smaller percentage than this speculative and defective "royalty stack" calculation.

Cumulative mobile-SEP royalty payments no more than around 5% of mobile handset revenues

Vested interests including leaders at the mobile operator-dominated NGMN Alliance promote the notion that patent licensing fee rates are “perceived” to be too high in mobile technologies; but without substantiation for such claims. Speculation that patent fees, largely for mobile SEPs, may total 30 percent of smartphone costs are projected by Intel and others.[1]  This grossly inflated figure is based on theories of hold-up and royalty stacking that lack empirical support and it ignores marketplace realities including cross licensing and discounting rates for other reasons in patent-licensing agreement negotiations, as I have already noted here and here.  That percentage would equate to more than $110 billion being paid per year in patent fees based on total global handset revenues estimated by Morgan Stanley and IDC to be  $377 billion in 2013 and $410 billion in 2014.

Actual payments are much smaller than such perceptions and projections. The following table summarizes fairly exhaustive analysis of significant mobile-SEP licensing costs based on reported licensing revenues from the audited financial reports of major licensors and other public sources including patent pool rate-card charges.  Based on these figures, it is implausible that total royalties actually paid, including lump sums and running royalties, for standard-essential 2G, 3G, and 4G technologies, amount to more than approximately $20 billion per year. This figure represents a cumulative royalty yield for licensors of around five percent on mobile handset revenues.

Mobile SEP Licensing Fee Revenues and Royalty Yields on Global Handset Market

	2014
	Revenues	Yield*
Major SEP owners with licensing programs: Alcatel-Lucent, Ericsson, Nokia, InterDigital, Qualcomm	$10.6 billion	2.6%
Patent Pools: SIPRO (WCDMA), Via Licensing (LTE), Sisvel (LTE)	<$4 billion	<1%
Others: including Apple, Huawei, RIM, Samsung, LG	<$6 billion	<1.5%
Cumulative maximum:  fees and yield for mobile SEPs	~$20 billion	~5%

* Yields are total licensing fee revenues including lump sums and running royalties as a percentage of $410 billion in total global handset revenues

The majority of mobile-SEP licensing fees are earned by five companies with licensing programs who have collectively contributed most patented technologies to 2G, 3G and 4G standards.  Alcatel-Lucent, Ericsson, InterDigital, Nokia and Qualcomm altogether generate $10.6 billion per year in licensing fees for these and other technologies. Also collectively, this represents a yield of significantly less than three percent of total global revenues for mobile handsets including smartphones.

Cumulative mobile-SEP fees paid also include less than around one percent of total handset revenues to the three mobile-SEP patent pools plus, at most, one percent or so more to other companies licensing mobile SEPs bilaterally. Patent pools lay out their prices and so these indicate the maximum they might be able to collect with willing and responsive licensees and a lot of licensing effort on the part of the pool administrators. The remaining significant mobile-SEP owners are predominantly handset manufacturers who mainly cross-license to reduce royalty out-payments rather than generate royalty income, and so their royalty fee revenues are relatively small. With each percent of royalty yield on total handset revenues now representing more than $4 billion per year in patent fees, there is insufficient evidence and no justification to conclude that opportunists not included in any of the above categories, including so-called patent trolls, patent-assertion entities and other non-practising entities, yield more than a fraction of a percent of total handset costs.

As a percentage of all consumer charges, including handset costs and $1.13 trillion in mobile operator services (GSMA Wireless Intelligence figures), which are also highly dependent on SEP technologies, the cumulative royalty yield shrinks to 1.3 percent.  Deriving this lower percentage yield figure from the broader revenue base is also applicable because it is the innovative and relatively new SEP-based technologies including 3G HSDPA/HSPA and 4G LTE which enable and drive mobile broadband data service growth. Operator revenues in mobile data services (other than basic SMS text messaging) grew from single-digit percentages of total service revenues until the introduction of HSDPA a decade ago, to around 40 percent across the entire Vodafone Group with many different national operators, for example, in 2015, according to the company's annual reports.

My more detailed and much lengthier analysis is in a pdf here.

[1]  A working paper entitled The Smartphone Royalty Stack: Surveying Royalty Demands for the Components Within Modern Smartphones was published by one in-house lawyer at Intel and two outside counsel from WilmerHale. Intel Vice President and Associate General Counsel Ann Armstrong and Wilmer Hale's Joseph Mueller and Timothy Syrett argue that aggregate patent licensing fees including SEPs and non-SEPs are excessive at around $120 per $400 smartphone.