Tuesday, February 21, 2017

"The Value of the Standard" Is Now Out

The Minnesota Law Review has now published my article, coauthored with Norman Siebrasse, titled The Value of the Standard.  Here is a link to the published version of the article, and 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.
Our experience of publishing with the Minnesota Law Review, by the way, was quite positive.  The journal met all of its announced deadlines, and the editors' suggested edits improved the article.  This is not always the case with student-edited law reviews, but I'm happy to say that the one at my home institution appears to be doing a very good job.


  1. I'm curious about the "sunk cost holdup" argument you raise. My understanding is that "sunk costs" are "the fixed costs of assets that cannot be redeployed elsewhere and thus have no salvage value." Another definition of "sunk cost" is "a cost that has already been incurred and thus cannot be recovered, which differs from other, future costs that a business may face, such as inventory costs or R&D expenses, because it has already happened. Sunk costs are independent of any event that may occur in the future."

    You do define transaction-specific investments as "sunk costs" however, I believe people in the accounting field would characterize those more as fixed and/or variable costs rather than sunk. Do you think you've chosen an appropriate definition of "sunk cost" as understood by Williamson who presented it in the vertical contracting theory involving one buyer and one seller? That's not at all the case in the world of cellular standards, for example.

    With that understanding how can there be a "sunk cost holdup?" I mean how can something that is described as having "no salvage value" or "independent of any event that may occur in the future" as capturing the value of standardization? Put another way, the sunk cost incurred by an implementer of a standard does not capture the value of that standard because that implementer's sunk cost is incurred independently from its ability to produce a product.

    What are your thoughts?

  2. Thanks for your comment. Here are my thoughts:

    1) Perhaps we should have defined the term "sunk costs," but we meant it in the conventional economic (second) sense that you cite, namely costs that have been incurred and can't be recovered (and not in the accounting sense).

    (2) So understood, I think our usage is consistent with Williamson. The holdup problem as we define it can arise in contracting setting like those described by Williamson, but it certainly isn't limited to that setting.

    (3) I don't think I understand the third paragraph of your comment. Our analysis is that in standard setting contexts, if the SEP owner is able to get an injunction it may have the ability to extract not just the value of the invention over alternatives, including some of the value attributable to the invention's being included in the standard (which we think would be okay--it's what we refer to as network value appropriation), but also some portion of the sunk cost that the implementer otherwise would have to "eat" (and also the differential switching cost that would be incurred ex post). On this last point, see our September 24, 2015 blog post titled "Why Switching Costs Are Irrelevant to Patent Holdup."