A revised version of my paper with Norman Siebrasse, The Value of the Standard, is now available on ssrn, here. We've benefited immensely from feedback received at several conferences over the past year, including conferences in Tokyo and Fukuoka in which I participated last June; the IEEE's 9th Annual Conference on Standardization and Innovation in Information Technology last fall in Silicon Valley; the Tilburg Law and Economics Center's Conference on Competition, Standardization and Innovation in Amsterdam this past December; and most recently the American Law and Economics Association’s 2016 Annual Meeting at Harvard Law School. Here is the abstract:
Standard-setting organizations (SSOs) often require member firms to license their standard-essential patents (SEPs) on undefined “fair, reasonable, and nondiscriminatory” (FRAND) terms. Courts and commentators in turn have proposed various principles for calculating FRAND royalties, among them that the royalty should not reflect “the value of the standard.” As we show, however, this principle could be understood to mean any or all of three distinct concepts, namely that the royalty should not reflect the implementer’s sunk costs; that the patentee should not be able to extract any of the value resulting from network effects; or that the royalty should be proportionate to the patent’s contribution to the standard.
This Article proposes, as an alternative benchmark, that a FRAND royalty should reflect the incremental contribution of the patent to the value of the standard to the user. This principle combines two related ideas: first, that royalties should reflect the hypothetical bargain the parties would have struck ex ante (prior to incurring sunk costs), in view of the incremental value of the technology over unpatented alternatives as revealed ex post; and second, that multiple patents reading on a standard should be valued in proportion to their marginal contribution (“ex post Shapley pricing”). Our proposal would prevent patentees from extracting sunk costs or a disproportionate share of standard value, but (contrary to some approaches) it would enable them to draw some of the increased value resulting from network effects. We show that our approach is more consistent with sound innovation policy, and suggest some practical applications.