Pedigo, Cox Square Off on the Analytical Approach

Although courts in the United States most frequently apply the willing licensor-willing licensee approach to calculating reasonable royalties, there is a less frequently used alternative known as the analytical approach.  The Federal Circuit has described this approach as

focus[ing] on the infringer's projections of profit for the infringing product. See TWM Mfg. Co. v. Dura Corp., 789 F.2d 895, 899 (Fed.Cir.1986) (describing the analytical method as “subtract[ing] the infringer's usual or acceptable net profit from its anticipated net profit realized from sales of infringing devices”); see also John Skenyon et al., Patent Damages Law & Practice § 3:4, at 3–9 to 3–10 (2008) (describing the analytical method as “calculating damages based on the infringer's own internal profit projections for the infringing item at the time the infringement began, and then apportioning the projected profits between the patent owner and the infringer”).

Lucent Techs., Inc. v. Gateway, Inc. 580 F.3d 1301, 1324 (Fed. Cir. 2008).  

In March, Mark Pedigo published on Law360 a short article titled Determining Reasonable Royalties with Analytical Approach, advocating greater use of the analytical approach in calculating reasonable royalties.  Mr. Pedigo argues, among other things, that although "the analytical approach may not be appropriate for every case," it can help to "isolate the value of the benefit (i.e., profitability) provided by the infringed features by comparing the infringing product profitability to noninfringing alternatives . . . (or other measures of normal profit)."  He also states that "In the cases where the analytical approach has been used, expected profit was used at times and actual profit was used at times (typically when expected profit or pre-infringement profit was not available). Normal profit has been based on profitability from the infringer’s industry or other products (other nonaccused products or noninfringing alternatives to the infringing product). An infringer’s target (not specific to the infringing product) profit has also been used as a proxy for its normal profit."

More recently, Alan Cox has published a response on Law360 titled The Limited Role of Analytical Approach to Reasonable Royalty.  Dr. Cox argues, among other things, that the analytical approach

arbitrarily awards the entire incremental profit to the patent owner. . . . A principal legal objection appears to be that the method does not allow for apportioning, nor does it accommodate a negotiation between a willing patent owner and a willing licensee. Instead, it awards all of the infringer’s incremental profits to the patentee, rather than calculating an award based on the harm suffered by the patentee. The calculation of the incremental profit, however, is sometimes used as a cap to a reasonable royalty calculation, as is implicitly suggested in the analytical approach article.

Whatever the legal objections, the analytical approach is an economically unreliable measure of the value of a feature, and the method generally cannot be used to apportion the residual between patented and nonpatented contributions to a feature.

Dr. Cox's principal economic objections are that the concept of "normal" or "target" profit is not very precise; that the approach doesn't account for various other factors that can explain a divergence from the normal rate of return, or for the fact that different products can have different profit margins; and that the approach can unfairly penalize an infringer who has a higher profit rate due to efficiencies in production.

For other critiques of the analytical approach, see William Rooklidge Infringer's Profits Redux:  The Analytical Method of Determining Paten Infringement Reasonable Royalty Damages, 88 BNA Pat., Trademark & Copyright L. Daily 1 (Nov. 5, 2014), which Dr. Cox cites in his paper, and Martha Gooding Analyzing the “Analytical Method” of Calculating Reasonable Royalty Patent Damages, BNA Pat., Trademark & Copyright L. Daily 4, May 14, 2012.  For what it's worth, I find the critiques more persuasive.