Principles of FRAND
Royalties
Norman Siebrasse
University of Toronto Patent
Colloquium 2014
FRAND Royalty Determinations
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Microsoft Corp v Motorola, Inc, Robart, J
In re Innovatio, Holderman J
CSIRO v Cisco, Davis J
Samsung v Apple, Japan
Huawei v InterDigital, China
Ericsson v Micromax, India (interim)
MICROSOFT V MOTOROLA
“ECONOMIC GUIDEPOSTS
FOR ASSESSING RAND
TERMS”
Economic Guideposts
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Avoid patent hold-up
Avoid royalty stacking
Ensure reasonable return to patentee
Reflect value of the technology, not value of the
standard
Reflect relative importance of individual patent
to the standard
Economic Guideposts
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Avoid patent hold-up
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Two issues, one important, one not important
Avoid royalty stacking
Ensure reasonable return to patentee
Reflect value of the technology, not value of the standard
Reflect relative importance of individual patent to the standard
Economic Guideposts
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Avoid patent hold-up
 Two issues, one important, one not important
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Avoid royalty stacking
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Important
Ensure reasonable return to patentee
Reflect value of the technology, not value of the standard
Reflect relative importance of individual patent to the standard
Economic Guideposts
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Avoid patent hold-up
 Two issues, one important, one not important
Avoid royalty stacking
 Important
Ensure reasonable return to patentee
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Two issues
Reflect value of the technology, not value of the standard
Reflect relative importance of individual patent to the standard
Economic Guideposts
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Avoid patent hold-up
 Two issues, one important, one not important
Avoid royalty stacking
 Important
Ensure reasonable return to patentee
 Two issues, one important, one not important
Reflect value of the technology, not value of the
standard
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Not important
Reflect relative importance of individual patent to the standard
Economic Guideposts
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Avoid patent hold-up
 Two issues, one important, one not important
Avoid royalty stacking
 Important
Ensure reasonable return to patentee
 Two issues, one important, one not important
Reflect value of the technology, not value of the standard
 Not important
Reflect relative importance of individual patent
to the standard
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Desirable, but difficult
HOLD-UP
Two Kinds of Hold-Up
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55 The ability of a holder of an SEP to demand
more than the value of its patented technology
and to attempt to capture the value of the
standard itself is referred to as patent “hold-up.”
Standard value hold-up
Two Kinds of Hold-Up
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The threat of hold-up increases as the standard
becomes more widely implemented and firms
make sunk cost investments that cannot be
recovered if they are forced to forego
implementation of the standard or the standard
is changed.
Sunk cost hold-up
Standard Value Hold-Up
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([see also Schmalensee Testimony] (explaining
that the “essence of hold-up” is that while ex
ante competition constrains what a patent holder
can obtain for access to its patent, ex post, the
technology in the standard does not face that
competition).)
Standard Value Hold-Up:
Example 1
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100 firms that have developed and patented
WiFi technology, A, B, C . . .
All equally good.
 Very cheap to implement
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Each adopted by 10 users in isolated networks
Each user pays royalty = $10
 Total value of the technology = $10k
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Each of the 1000 users would be willing to pay
$100 each if all users were using the same
technology
Standard Value Hold-Up
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SSO chooses A as the standard
A is adopted by all users
 Total value of the technology = $100k
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Recall, each user willing to pay $100 for standardized tech
Difference between ex ante and ex post value =
value of standardization = $90k
If A can get injunction, it can charge $100 each
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A can get full value of the market
Standard Value Hold-Up
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Imagine ex ante auction for privilege of being
chosen being chosen as standard
Patentees make royalty bid to users
 Users choose patentee with lowest bid
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What would be the winning royalty bid?
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$0
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Swanson & Baumol; Layne-Farrar, Padilla & Schmalensee
Royalty constrained by ex ante competition
All of the value of standardization is captured by
users
Standard Value Hold-Up
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Winning patentee should not be able to charge
more ex post than it would have been able to
charge ex ante
The . . . attempt to capture the value of the standard
itself is referred to as patent “hold-up.”
 while ex ante competition constrains what a patent
holder can obtain for access to its patent, ex post, the
technology in the standard does not face that
competition.
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Why not?
Standard Value Hold-Up:
Example 2
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No firm has developed WiFi technology
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Firm A develops and patents WiFi technology
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Value of the market = $0
No other firm does the same
A is adopted by all users
Each user pays $100 to A
 Total value of the technology = $100k
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A captures the entire value of the market =
$100k
Standard Value Hold-Up
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Why should A be able to capture entire value of
standardization in Example 2, but not in
Example 1?
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When the standard becomes widely used, the holders of SEPs
obtain substantial leverage to demand more than the value of
their specific patented technology. This is so even if there
were equally good alternatives to that technology available
when the original standard was adopted.
What is wrong with that?
Fairness Objection
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Not fair that A should be able to demand more
ex post than it could have ex ante
But also not fair that patentees should get $0 in
Example 1, but everything in Example 2
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Cf Shapley value pricing, in which patentees capture entire
value of standardization, regardless of the amount of
competition ex ante: Layne-Farrar et al
Why should users capture 100% of the value of
standardization, when they have contributed
nothing?
Efficiency Objection
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From user perspective, no difference between
Example 1 with hold-up and Example 2
Hold-up has no adverse effect on user
behaviour
Incentive Problem
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Two firms develop and patent different
technologies for use in valuable standard
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Under auction pricing model, each will get $0
royalty
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Each technology is equally good
Insufficient to induce creation of technology
Auction model considers pure static efficiency
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Does not consider incentive to innovate
Legal Counter-Argument
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Swanson-Baumol is an auction model
An auction is not a negotiation
Auction drives patentee down to minimum
willing to accept
Negotiation splits difference between minimum
willingness to accept and maximum willingness
to pay
Standard Value Hold-Up
Summary
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Allowing standard value “hold-up”
Has no adverse effect on user behaviour
 May have positive effect on incentive to innovate
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Conclusion
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Standard value hold-up is not an important problem
Sunk Cost Hold-up
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A holds patent for piling for offshore oil
platform
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User builds $10m platform using patented
method
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$100k to license ex ante
Anticipates $11m revenue for $1m profit
A sues ex post
User will pay $10m to avoid injunction ex post
 Net profit = Negative $9m
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Sunk Cost Hold-up
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Threat of ex post injunction with sunk costs
increases risk
User will invest in less risky projects
 Social loss from sunk cost hold-up is avoidance of
positive value investments
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Cf standard value hold-up
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Users will not avoid WiFi even if they have to pay
$100 ex post
Sunk Cost Hold-Up
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The threat of hold-up increases as the standard
becomes more widely implemented and firms
make sunk cost investments that cannot be
recovered if they are forced to forego
implementation of the standard or the standard
is changed.
Same in principle as non-SEP sunk cost hold-up
Though more of a problem in practice
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Ex ante licensing may be impractical
Distinguish Sunk Cost and
Standard Value Hold-up
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Sunk cost hold-up
Does not require a standard
 Requires sunk costs
 Makes user less likely to adopt
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Standard value hold-up
Requires a standard
 Does not require sunk costs
 Does not affect ex ante user decision to adopt
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Hold-Up Summary
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Standard value hold-up unique to SEPs
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But not an important problem
Sunk cost hold-up a serious problem
But not unique to SEPs
 Though very important in SEP context
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ROYALTY STACKING
Royalty Stacking
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The payment of excessive royalties to many
different holders of SEPs is referred to as
“royalty stacking.”
The RAND commitment also addresses royalty
stacking and the need to ensure that the
aggregate royalties associated with a given
standard are reasonable.
Royalty Stacking
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Technical problem
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Cournot complements
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Many patentees with complementary patents negotiating
independently with user will charge more than single
patentee holding all of the patents
Practical problem
Excessive demands
 Motorola asked 2.25% of product price
 Implies $150 royalty on $300 Xbox, for video
standard alone
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Royalty Stacking
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Royalty stacking only occurs when there is more
than one SEP
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Often 100s of US SEPs, thousands worldwide
Cf hold-up (both kinds) which can occur when
there is only one SEP
PATENT POOLS
Patent Pools
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Group of patentees pool patents and offer single
licence to users
Solves
Royalty stacking
 Sunk cost hold-up
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Does not solve
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Standard value hold-up
Patent Pools
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Robart J used a patent pool comparator to set
FRAND rate
As discussed with relation to SSO policy,
RAND is informed by two prevailing concerns:
preventing stacking and eliminating hold-up.
The court finds that, among these two goals, the
anti-stacking principle is the primary constraint
on the upper bound of RAND.
ENSURE REASONABLE
RETURN TO PATENTEE
Reasonable Return to Patentee
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To induce the creation of valuable standards, the
RAND commitment must guarantee that
holders of valuable intellectual property will
receive reasonable royalties on that property.
Encourage standards
Requires that return to patentee must be higher
than return to outside option
Reasonable Return to Patentee
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Moreover, since licensing through SSOs under
the RAND commitment is, at least for some
entities, an important component of
profitability, reducing that component would
reduce the incentive to innovate and thereby
slow the pace of innovation in the economy
Preserve incentive to innovate
Requires that return to patentee is sufficient to
cover costs of innovation
Reasonable Return to Patentee
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These are distinct concerns
Preserving the incentive to innovate is NOT
generally a concern
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If a patentee spends $100m to develop a worthless
product, it should not be rewarded
Encouraging creation of standards is a basic goal
of the FRAND commitment
A return sufficient to induce patentee to join
standard may not cover the cost of innovation
 This concern emphasized by Robart J
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Reasonable Return to Patentee
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Lower bound of FRAND rate should be value
of outside option
Patent pool comparator addresses this problem
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Patent pools need to attract patentees as well as
licensees
REFLECT VALUE OF THE
TECHNOLOGY, NOT VALUE
OF THE STANDARD
Reflect Value of the Technology
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See above re Standard Value Hold-Up
REFLECT RELATIVE
IMPORTANCE OF
INDIVIDUAL PATENT TO
THE STANDARD
Relative Importance of Patent
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[A] patent that is extremely important and
central to the standard would reasonably
command a higher royalty rate than a less
important patent.
What does “important” mean?
Relative Importance of Patent
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1) Function is important to the value of the
standard
WiFi transmission technology is important
 Power management functions less important
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2) Many other options for achieving the same
function
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WiFi transmission has several good technologies
which compete ex ante
Relative Importance of Patent
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Both may be assessed by incremental value
Microsoft contends that the economic value of
patented technology isolated from the value
derived from incorporation into the standard
would be determined by calculating the
incremental value of the technology compared
to the alternatives that could have been written
into the standard.
Relative Importance of Patent
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If function is important, but many competing
technologies, incremental value of the patent is
small
If only one technology, but function is relatively
unimportant, increase in incremental value of
the standard is small
Relative Importance of Patent
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In practice, approaches linking the value of a
patent to its incremental contribution to a
standard are hard to implement.
SSOs do not use incremental value
Patent pools do not use incremental value
Courts do not use incremental value
Relative Importance of Patent
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Pure incremental value approach is difficult to
implement
But importance of patent in question may be
assessed in relation to comparator
Robart J considered patent pool comparator
Assessed patents in question as not being of more
than average importance
 Did not adjust pool rate upwards
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REFERENCES
Articles
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Daniel G. Swanson & William J. Baumol,
Reasonable and Nondiscriminatory (RAND)
Royalties, Standards Selection, and Control of
Market Power, 73 Antitrust L.J. 1, 5 (2005)
Anne Layne-Farrar, A. Jorge Padilla & Richard
Schmalensee, Pricing Patents for Licensing in
Standard Setting Organizations: Making Sense of
FRAND Commitments, 74 ANTITRUST L.J.
671 (2007).
Cases
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Microsoft Corp v Motorola, Inc, (WD Wash, Apr 25,
2013) Robart, J
In re Innovatio IP Ventures, LLC Patent Litig, (ND
Ill, Oct 3, 2013) Holderman J
CSIRO v Cisco, (ED Tex, July 23, 2014) Davis J
Samsung v Apple, 2013 (Ne) 10043 (IPHC, Japan,
May 16, 2014)
Huawei v InterDigital, Shenzhen Intermediate
People's Court, aff’d Guangdong High Court
A New Framework for Determining
Reasonable Royalties in Patent Litigation
Siebrasse & Cotter
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“Contingent ex ante” hypothetical negotiation
Ex ante negotiation with full ex post
information
SEPs
 Regulatory Uncertainty
 Non-Infringing Alternatives
 Unexpected Exogenous Events
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A New Framework for Determining
Reasonable Royalties in Patent Litigation
Siebrasse & Cotter
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“Contingent ex ante” hypothetical negotiation
Ex ante negotiation with full ex post
information
Lump-Sum Versus Running Royaltiess
 Bargaining Weakness
 Separate and Distinct Infringements
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