Note: I thought I published this post on Friday, and was dismayed to discover today that it wasn't up. Sorry for the technical glitch!
Today, Professor Siebrasse and I offer some further comments to conclude this series on Gregory Sidak’s recent article on FRAND.
Cotter:
I could probably write several more posts on various aspects of
Professor Sidak's paper, but to wrap matters up I’ll focus on just one:
the use of appropriate heuristics as a proxy for the ex ante incremental value
of a patent.
As I mentioned
in my previous post, I agree with Sidak—and have stated elsewhere—that it is
often impractical to quantify ex ante incremental value (that is, the value
that a user would expect to derive from the use of patent X in comparison with
the next-best available noninfringing alternative). Litigation occurs
months or years after the relevant date (typically the date on which
infringement began, though in the SEP context the date just before the standard
at issue was adopted is preferable). It may be difficult to determine
what the next-best alternative was; what it would have cost to acquire it (and
here I agree with Sidak that this should be a relevant consideration, and have
so stated in previous work); what its expected net benefits would have been;
and so on. Matters are only compounded if the value of the patent depends
in large part on the adoption of other complementary technologies, as in the
SEP context. Nevertheless, I think it is important to recognize the ex
ante incremental value (or, in the present context, the “ex ante contingent
incremental value,” as discussed in the two previous posts) as the ideal
starting point: it is the standard that renders neither the patentee nor
the infringer any better or worse off than they would have been, but for the
infringement. (Further modifications can then be made to provide for
adequate deterrence or to satisfy other goals, if that is desirable.)
Recognizing that it may be difficult or impossible to meet the ideal, one can
then try to find alternative measures that might be reasonable
substitutes. Here, the point is to use substitutes that come as close as
we think we reasonably can to approximating ex ante contingent incremental
value, and to avoid substitutes that would inflate FRAND (or reasonable)
royalties to capture ex post value.
Oddly enough,
then, I agree with much of what Sidak has to say about such substitute measures
as comparable licenses (pages 1002-07) and (at pages 1011-14) Greg Leonard’s
“top-down” approach as employed in the Innovatio IP Ventures LLC
litigation (which I blogged about here).
I need to think more about Sidak’s endorsement of “approved contributions” as a
better way of estimating the value accruing to an individual SEP owner, over a
methodology that applies Marc Shankerman’s 1998 estimate that 10% of all
electronics patents accounted for 84% of the value of all such patents. I
understand his objections to the latter (the study is relatively old and
doesn’t involve SEPs), but I’m not sure I would sign off on the proposition
that all of the patents contributed by a firm with a large number of approved
contributions (e.g., Ericsson) should be classified as falling into the top
10%, rather than considering them individually (see p.1039). On the other
hand, Sidak’s critiques of some of the other possible approaches (e.g., Shapley
values, reliance on patent pools that simply divide up royalties by counting
patents rather than by estimating their strength) seem at first blush to be
pretty sound.
Bottom
line: while I disagree strongly with much of Sidak’s theoretical
analysis, I concur with a fair amount of his practical advice. Perhaps
that puts me in company with Judge Robart, whom Sidak castigates time and again
for assuming that the ex ante approach is theoretically correct—only to concede
(at p.986) that Judge Robart also concluded that the ex ante approach “lack[s]
. . . real-world applicability.” At the end of the day, I still don’t
find a huge difference between what Judge Holderman (whom Sidak praises) and
Judge Robart (whom he criticizes) were trying to do. Compare In re
Innovation IP Ventures LLC Patent Litig., 2013 WL 5593609, at *4-8 (N.D. Ill.
Oct. 3, 2013) (adopting Judge Robart’s methodology, with modifications
reflecting the differing postures of the two cases, i.e., breach of contract
versus patent infringement), with Microsoft Corp. v. Motorola, Inc., 2013 WL
2111217, at *20 para. 113 (W.D. Wash Apr. 23, 2103) (“reasonable parties in search
of a reasonable royalty rate under the RAND commitment would consider the fact
that, 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”).
Siebrasse: I also agree with much of what
Sidak says about specific heuristics, but in this final comment I will look at
one point where I disagree with Sidak, and perhaps also with Professor Cotter.
The question is whether the cost of the next-best alternative should be taken
into account in determining a reasonable royalty.
Sidak
says (936):
to measure a
licensee’s willingness to pay for the patent accurately, the profit generated using
A must be compared with the profit from using B, including the costs of acquiring the rights to technology B.
He provides the
following example (937):
Suppose that, relative to using a non-patented
alternative, the use of patent A leads to increased revenue of $300, patent B
leads to increased revenue of $200, and patent C leads to increased revenue of
$100 [but] the licensing cost of patent B is $150, whereas the licensing cost
of patent C is only $25.
Sidak concludes
that Patent C, not B, is the next-based alternative to A, because C is more
profitable net of acquisition costs, and “[i]f one neglects to include the
costs of acquiring the lawful rights to use the next-best alternative in the
calculation of the incremental value, then the analysis could understate or
overstate the prospective licensee’s actual willingness to pay” (937-38).
But why is B
asking $150? Suppose A does not exist, and the choice is between B and C. B
asks $150, and the licensee (L) says no because C is more profitable net of the
acquisition costs of B. But that means A walks away, and B gets $0. In
principle, B would revise its offer downwards to incrementally less than $125,
so that L would licence from B rather than C, making both L and B better off
than if B licensed from C for $25. C would presumably respond by lowering its
price, but in the end C would not be able to match B, and L would licence from
B for $100. More fundamentally, the point of considering the non-infringing
alternative is to capture the economic value of the patented invention, which
is the economic value of the invention over the next best alternative. This
requires ignoring the cost of licensing the alternative in determining which
technology is the alternative.
Consequently, my
view is that in principle the cost of acquiring the next-best alternative is
irrelevant in assessing the patentee’s willingness to pay. But what difference
does this make to the reasonable royalty determination? As Sidak points out, it
affects the licensee’s maximum willingness to pay, which sets the upper bound
on the bargaining range in the hypothetical negotiation. If the reasonable
royalty determination turns on a mechanical split between the maximum
willingness to pay and the minimum willingness to accept, as in a 50/50 split
proposed as a Nash bargaining solution by some experts post-Uniloc, then
whether the cost of the non-infringing alternative is included does directly
impact the reasonable royalty. But a Nash bargaining solution is very
artificial (and has been rejected for that reason by at least some courts).
There is no particular reason, other than the lack of better evidence, for any
particular split between the licensee’s maximum willingness to pay and the
licensor’s minimum willingness to accept. It may be that on the facts, B
charged $150 for transaction cost reasons, the costs of negotiating an
individual royalty with L are greater than the benefits (if L is using only a
small volume), so that in fact L’s next-best alternative is to licence from C –
and yet A has little bargaining power, so that in fact A would have ended up
with a royalty of only $30, and L would have captured the vast majority of the
incremental value of the patent. For example, perhaps it is clear that A
routinely licensed to all comers for $30. That would be the reasonable royalty,
regardless of L’s theoretical maximum willingness to pay, and regardless of
what a licence from B or C might have cost.
The larger point
is that there is an important difference between principles, heuristics and
facts. If we have little or no factual evidence, and must decide a reasonable
royalty on the basis of principles alone, then my view is that the cost in fact
of the next-best alternative should not be taken into account, because in
principle, that cost might be bargained down. On the other hand, if we have a
rich set of facts, then the principles become little more than a sanity check,
and it probably doesn’t matter whether or we take the cost of the
non-infringing alternative into account.
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