Summaries of Recent Studies of SEPs/FRAND by Leading Economists

By TAP Guest Blogger

Posted on January 7, 2014


The following article summaries accompany the “Standard-Essential Patents: The Question of FRAND Licensing and Its Impact on Standard-Setting, Competition and Innovation” post which offers an overview of the Toulouse School of Economics conference held on May 16, 2013. The event, and conference write-up, explore technology patents, licensing through standard-setting organizations (SSOs), and how ‘fair, reasonable and non-discriminatory’ (FRAND) terms impact innovation.

Essential Patents and Standard Dynamics

by Justus Baron, Tim Pohlmann and Knut Blind

presented at the TSE’s TIGER Forum, June 2013

In both Europe and the United States, there are policy initiatives to regulate the use of SEPs to prevent adverse effects of ‘patent thickets’ on the development and use of novel technology. Advocates of the patent thicket theory argue that innovation slows down when a commonly used technology such as a standard includes patents held by various owners. But there is very little empirical evidence of such effects.

This paper aims to fill that gap by investigating the effect of including patented technology in a standard on the rate and direction of subsequent technological progress of these standards. The authors analyze a database of 3,500 ICT standards issued by the most important formal SSOs operating on a worldwide scale. They use the issuance of new standard versions as indicative of continuous technological progress, and control for the overall speed of technological progress in the related field.

The authors find that including essential patents that read on a technological standard has a surprisingly strong positive effect on the rate of continuous technological progress of the standard. But this effect weakens if ownership over patents is increasingly fragmented. Thus, the beneficial effect of patents on continuous progress is strongest if the ownership of patents is highly concentrated.

Fixing FRAND: A Pseudo-Pool Approach to Standards-Based Patent Licensing

by Jorge Contreras

Antitrust Law Journal, Fall 2013

Technical interoperability standards are critical elements of smart phones, laptop computers, digital files and thousands of other products in the modern networked economy. Most such standards are developed in voluntary SSOs that require participants to license patents essential to the standard on FRAND terms.

FRAND commitments are thought to avoid the problem of patent hold-up: the imposition of excessive royalty demands after a standard has been widely adopted in the market. While at first sight, FRAND commitments seem to assure product vendors that patents will not obstruct the manufacture and sale of standards-compliant products, in reality these commitments are vague and unreliable. Moreover, they have proven ineffective for addressing the problem of ‘royalty stacking’, which occurs when multiple patent holders assert rights in – and demand royalties on – the same standard.

The recent surge of litigation in the smart phone and other technology sectors, much of which concerns the interpretation and enforcement of FRAND commitments, has brought these issues to the attention of regulators, industry and the public. Many agree that a better approach to FRAND is needed.

This paper proposes a novel solution to the FRAND problem that borrows from the related field of ‘patent pools’. In patent pools, multiple patent holders agree to charge a single, collective royalty on patents included in the pool. This structure, which has been used in connection with several successful industry standards, allows market participants to manufacture and sell standards-compliant products with a high degree of certainty about their aggregate royalty burden.

While the cost and administrative overhead of patent pools may make them inappropriate for the majority of standards developed in SSOs, salient features of pools can be adapted for use in SSOs under what the author terms a ‘pseudo-pool’ approach.

The proposal encourages joint negotiation of royalty rates prior to lock-in of a standard, conduct that has been viewed with approval by several regulatory agencies and acknowledged as offering various pro-competitive benefits. The proposed structure would eliminate the current uncertainty about royalty levels on standardized products, while at the same time addressing the related issue of royalty stacking.

Standard-Setting Organizations Can Help Solve the Standard-Essential Patents Licensing Problem

by Kai-Uwe Kühn, Fiona Scott Morton and Howard Shelanski

Competition Policy International Antitrust Chronicle, March 2013

IPR were established in both the United States and Europe to protect inventors, to stimulate innovation and to benefit consumers. But specific circumstances affecting some industries like the ICT sector may limit the effectiveness of IPR in achieving these goals. With SEPs, in particular, there are ambiguities in the definition of licensing restrictions as well as weaknesses in the process of IPR enforcement. These seem to contribute to hold-up problems that may threaten innovation incentives and harm consumers.

While these problems are generally difficult to resolve, this paper proposes reforms to the current IPR policies of SSOs (groups of competitors that jointly create standards) that the authors believe would greatly improve efficiency in patent licensing and substantially reduce the problem of hold-up and litigation in this sector.

It is the actions of SSOs that create market power for SEP owners. The SSOs have the responsibility to ensure that this market power is constrained so that consumers can benefit as much as possible from standard-setting activity and so that SEP owners cannot discourage innovation by engaging in hold-up.

Many existing SSO policies are not strong or clear enough to achieve these goals reliably or efficiently. In particular, these authors believe that stronger commitments to a clearer FRAND licensing process can go a long way towards mitigating hold-up problems, reducing litigation costs and speeding innovation. Any FRAND commitment should also be understood to include a commitment to certain processes of dispute resolution and transfer of FRAND obligations.

Standard-Essential Patents: Who Is Really Holding Up (And When)?

by Gregor Langus, Vilen Lipatov and Damien Neven

Journal of Competition Law and Economics, May 2013

This paper analyzes the effect of injunctions on royalty negotiations for SEPs. The authors develop a model in which courts grant injunctions only when they have sufficient evidence that the prospective licensee is unwilling, in line with the way courts appear to operate in Europe.

In such a framework, prospective licensees have a powerful strategic tool: the offers that they make to a patent holder will affect the royalty rate that the court may adopt as well as the probability of being subject to injunctions (and the liability for litigation costs). The authors find that despite the availability of injunctions, the holder of a sufficiently weak patent will end up accepting below FRAND rates, in particular when litigation costs are high.

They also find that the prospective licensee will sometimes prefer to litigate and the holder of a sufficiently strong patent will always end up in litigation by rejecting offers below FRAND. This arises in particular when the prospective licensee has little to fear from being found unwilling, namely when the trial takes time (so that the threat of injunctions is less powerful) and when litigation costs are low. The authors thus find that hold-up (royalties above the fair rate) as well as ‘reverse hold-up’ (royalties below the fair rate) may arise in equilibrium.

A Simple Approach to Setting Reasonable Royalties for Standard-Essential Patents

by Mark Lemley and Carl Shapiro

forthcoming in Berkeley Technology Law Journal

SSOs typically require their members to license any SEP on FRAND terms. Unfortunately, numerous high-stakes disputes have broken out over just what these FRAND commitments mean, and how and where to enforce them. SSOs have been unable to clean up and clarify their IP rules, even though many of the ambiguities and flaws in these rules have been recognized for a decade or more.

This paper proposes a simple and practical set of rules that SSOs can adopt to achieve the goals of FRAND commitments far more efficiently with far less litigation. Under the proposed approach, if a SEP owner and an implementer of the standard cannot agree on licensing terms, the SEP owner is obligated to enter into binding baseball-style (or ‘final offer’) arbitration with any willing licensee to determine the royalty rate.

This obligation may be conditioned on the implementer making a reciprocal FRAND commitment for any SEPs it owns that read on the same standard. If the implementer is unwilling to enter into binding arbitration, the SEP owner’s FRAND commitment not to go to court to enforce its SEP against that party is discharged.

The authors explain how their proposed FRAND regime would work in practice. Their hope is that several forces will now combine to make progress possible: first, a desire by many market participants to avoid the growing legal costs and uncertainty associated with existing rules; second, the availability of a package of reforms that will greatly reduce these costs while promoting the basic goals of FRAND regimes; and third, the growing risk that failure to act will create antitrust liability, as competition authorities increasingly signal their willingness to intervene.

Standard-Essential Patents

by Josh Lerner and Jean Tirole

Harvard Business School Working Paper 14-038, November 2013

Standards play a key role in many industries, including those critical for future growth. IP owners vie to have their technologies incorporated into standards, so as to collect royalty revenues (if their patents dominate some of the functionalities embodied in the standard) or just to develop a competitive edge through their familiarity with the technology. But it is hard to know in advance whether patents are complements or substitutes – that is, how essential they are.

Thus a major policy issue in the standard-setting process is that patents that seem relatively unimportant may, by being included into the standard, become SEPs. In an attempt to curb the monopoly power that the standard creates, most SSOs require the owners of patents covered by the standard to grant licenses on FRAND terms. But such loose price commitments can lead to intense litigation activity.

In a formal analysis of SEPs, the authors build a framework in which ‘essentialization’ and regulation functions can be analyzed and provide a precise identification of the inefficiencies attached to the lack of price commitment. They suggest a policy reform that restores the ex ante competition called for by researchers and in the policy debate.

The authors note that price discussions within the standard-setting process run the risk of expropriation of IP holders, as even balanced SSOs will ‘blackmail’ owners to accept low prices in exchange for their functionalities being selected into the standard. At the same time, the ability to engage in ‘forum shopping’ enables IP owners to shun SSOs that force them to charge competitive prices: this suggests imposing mandatory structured price commitments on SSOs.

The Meaning of FRAND, Part 1: Royalties

by Gregory Sidak

Journal of Competition Law and Economics, November 2013

Many legal and economic proposals would define what it means for a patent holder to commit to an SSO to license its SEPs on FRAND terms. Drawing from both legal theory and economic theory, this paper examines the meaning of FRAND.

The author’s interpretation reconciles a number of conflicting definitions of FRAND and provides courts with a practical approach to determining FRAND royalties. A proper understanding of a FRAND royalty requires recognizing the combinatorial value of SEPs. That recognition reveals the fallacy in attempting to apply the ‘ex ante incremental value’ rule to the determination of a FRAND royalty. FRAND royalties divide the aggregate royalties generated by the standard among the holders of patents essential to the standard.

Such a division should maximize the surplus resulting from the creation of the standard. It must also satisfy an individual-rationality constraint for the patent holder and the licensee, thereby encouraging continued participation in the setting and implementing of open standards, as opposed to greater reliance on proprietary standards.

Blogs Discussing the Latest News on SEPs/FRAND

The Essential Patent Blog

The source for standard-essential patent litigation.

FOSS Patents

This blog covers software patent news and issues with a particular focus on wireless, mobile devices (smart phones, tablet computers).

Patently-O Blog

TAP (Technology - Academics - Policy) Blog

The preceding was written by Romesh Vaitilingam, and is re-published on TAP with permission by the Toulouse Network for Information Technology (TNIT). “Summaries of Recent Studies of SEPs/FRAND by Leading Economists” was originally published in TNIT’s December 2013 newsletter and accompanies TNIT’s article, “Standard-Essential Patents: The Question of FRAND Licensing and Its Impact on Standard-Setting, Competition and Innovation”.