More evidence of reverse patent hold-up in SEP FRAND licensing

Today we can dismiss the notion of "patent hold-up" occurring in wireless SEP FRAND licensing. In spite of extensive searches with powerful magnifying glasses, courts and agencies have found no evidence of it, and neither have academics.

On the other hand, when it comes to the opposite behaviour, "reverse patent hold-up" (also called "patent hold-out"), it's unfortunately widespread.

We received yet another example of this in a recent US International Trade Commission (ITC) ruling in IDC vs Nokia/Microsoft. To begin with, the ITC not only concludes that "There is no evidence of patent hold-up" but also provides a beautifully natural explanation for the general absence of actual patent hold-up in the SEP and FRAND context: "In the current state of IP law as it relates to SSOs and IPRs, an owner of a SEP has a long list of government agencies, law professors, and companies watching what the company does and attempting to change the law as to potential outcomes. [Microsoft] stated they are afraid that if IDC obtained an exclusion order, then they would use it to gain undue leverage and obtain compensation above the FRAND rate. This is unlikely because too many hostile eyes are watching. The fact that ITC has been watching since at least 2011, and not found such a violation, makes it unlikely it would happen here for the first time." 

In other words, because patent hold-up is such an obvious and grave concern, there are too many critical and powerful and onlookers to allow it to actually happen.  

On the other hand, for reverse patent hold-up there are clearly too few onlookers. In case after case we see infringers shown to act in bad faith, while comments and discussions on this phenomenon are hardly noticeable. In the above-mentioned case, the ITC concluded that there was again "evidence of reverse patent hold-up" and pointed out that "There is however, one course of action that can clearly demonstrate bad faith, and that is a failure to meaningfully negotiate. ... Other evidence that supports the finding of reverse holdup is the clear gain that occurs daily for [Microsoft]...Each day that the respondents use the patents without taking a license, IDC loses money that it will not be able to recover."

Thankfully, at least some onlookers that really matter in the end - courts and agencies - remain vigilant about reverse patent hold-up.

There are previous examples of similar behaviour and findings as I've discussed in previous posts. For example, such findings may be found in Apple vs. Samsung in the Korean Fair Trade Commission and the US ITC and in Ericsson vs. D-Link in the US Federal Circuit.
 

It's also important to realize that the phenomenon is not limited to those few companies. Reverse patent hold-up is a globally widespread behaviour, with negative consequences for innovation incentivization and licensing efficiency. It's also a major driver behind SEP divestments and so-called "patent privateering" that FOSS Patents' Florian Mueller has started a campaign against. 

So clearly, courts and agencies outside the US need to be as alert and forceful as their US counterparts in properly combating it.

Patent privateering - a comment on the FOSS Patents campaign

In my previous post, I questioned the stance taken by FOSS Patents blogger Florian Mueller on what he calls "patent privateering". It seems like a veritable FOSS Patents campaign has been launched against this phenomenon, with crowd-sourced name-and-shaming and all. 

I feel that this campaign is - at best - unhelpful, since its basis is rather lacking in analysis and it carries an unwarranted presumption of sinister causes on behalf of SEP holders. 
In short, FOSS Patents goes after an effect rather than a cause.

More questioning of the campaign has recently come from Richard Lloyd of IPR newspaper Intellectual Asset Management (IAM): "the notion behind the FOSS Patents initiative - that privateering is bad and should be stamped out – is just plain wrong".

However, in a more recent FOSS Patents post, Mr. Mueller does ask the relevant question "...why companies with such vast resources and enormous sophistication (in-house and externally, in legal and in technical respects) need help from little guys with a controversial business model to do license deals with the very same licensees with which they've already done deals before and do deals with all the time."

But the question was rhetorically put, i.e. still presuming sinister motives. It shouldn't be rhetorical though. It's an excellent question. At least if you really want to try to understand the problem. My answer, as I indicated last year and more recently last week, is that patent holdout is an important driving factor behind SEP sales. So to the extent we need a campaign, patent holdout should be the target. To cite IAM's Richard Lloyd again: "In short, it doesn’t look like the privateer who is being unreasonable and abusive, it is the companies who will not sit down and talk turkey. Maybe this is what we really want to be shining a light on. Anyone want to help IAM put together a list?"

In what looks like an attempt to isolate a particular group of "good guys" from "evil-doers", Mr. Mueller goes on to ask the question "...why a number of major right holders generally don't sell patents to PAEs. For example, I'm not aware of Qualcomm doing this... Or IBM. ... Or even Microsoft".

Again rhetorical, and again it needn't be. This one is particularly easy to explain. To begin with, in a cellular SEP context we can forget about IBM and Microsoft since neither is a significant SEP holder. So let's look at Qualcomm. It's the only significant SEP holder that sells chipsets and not end-user products. And not just any old chipsets, but the most popular ones on the market. So for Qualcomm, SEP-licensing is more straightforward than for other SEP-holders since there's already an established and keen business interest on the part of its potential licensees. Indeed, Qualcomm hardly ever initiates SEP infringement lawsuits, and yet it has the industry's highest SEP license royalty revenue. Clearly, Qualcomm has so far been subject to far less patent holdout than other significant SEP-holders, and therefore hasn't felt the need to engage in SEP selling for "patent privateering".

So, while perhaps contrary to Mr. Mueller's intention, his Qualcomm example is the perfect corollary to my own conclusion: SEP selling is largely a rational response to patent holdout. 

New IEEE patent policy approved

On February 9, new IEEE bylaws with radical changes to the patent policy were adopted by the IEEE board. I commented on the alarming content of that policy in an earlier post.

If the policy is allowed to stay this way, I fear that IEEE will over time become irrelevant as a telecoms standards setting organization due to its sudden anti-innovation stance.

A key clause of the policy describes factors for determining a reasonable rate, and the final wording "should include, but need not be limited to, consideration of" was used. But if both "new" and "traditional" factors are to be considered, I think there can be confusion, if not contradiction. For example, the new policy essentially says that the value contributed to the chipset, or perhaps even only a part of it, should be considered. So how can you also consider the value contributed to the end-product, which is something entirely different. And for that matter, are you supposed to compare or combine these valuations, and if so, how? 

In its recently issued Business Review Letter, the US Department of Justice (DoJ) appeared to base its decision to clear the content of the policy on a broad and theoretical reading of that very clause; "Significantly, the Update makes clear that the determination of Reasonable Rates 'need not be limited to' these factors. The Update, then, does not mandate any specific royalty calculation methodology or specific royalty rates.";

I for one don't agree with the US DoJ. I rather predict that "should include, but need not be limited to" followed by an exhaustive list of factors, will - in practice - be at the exclusion of other factors that cause confusion or contradiction, as mentioned above. Which is why I reviewed the clause from that viewpoint.

Unfortunately the DoJ clearance may ultimately be to the detriment of US consumers, as the innovation content of WiFi and other standards is likely to be diluted. In fact, it may already have begun, considering e.g. Qualcomm's recent statement to not abide by the new policy.

For IEEE to stay relevant, it needs to be inclusive with regards to the world's top innovators and innovations. It should be focusing on making the world's most technically advanced and future-proof standards. It can't be wasting its time designing around technology that would ultimately have been beneficial for consumers.

Follow-up on cellular FRAND royalty levels

Recently, a Fierce Wireless article by Keith Mallinson discussed the issue of cellular SEP FRAND royalty rates and in my opinion made some very good points on the cumulative level, based on a practical rather than theoretical argumentation.

In the article, there's an estimation of cumulative royalty rates, where the actual combined licensing revenues of the world's major cellular SEP licensors are basically divided by the actual number of phones sold. Based on such a calculation, it was estimated that "a total aggregate SEP royalty across all handsets worldwide is most likely to be no more than a mid-single-digit percentage". That estimation is probably quite accurate, and I find the "reality-check" approach very refreshing. Not least considering the amount of dubious theoretical argumentation one can find on this subject. 

But since I myself mentioned the figure of "around 10%" in an earlier post on cellular FRAND royalty levels, I felt that a clarification might be needed to remove any potential confusion. Mr Mallinson's calculation method gives a high-level view; a global average estimation of the cumulative royalty rate. On the other hand, my post focused on the  question: "What cumulative SEP FRAND royalty does an OEM without own basic R&D or SEP holdings have to pay?". These are two different things. Let me explain.

Essentially, there are three categories of mobile phones sold on this planet:

1) Phones sold by OEMs with own basic wireless R&D and SEP portfolios.

Many (other) asserting SEP portfolio holders are themselves implementers, and thus need a "grantback" license to these OEMs' SEP portfolios. Therefore, this subset of phones is subject to lower SEP royalty rates due to "royalty netting". As I described in my post and is also clear from Mr Mallinson's article, this is not discriminatory, due to fair value transfer. The cumulative royalty for this category of phones is somewhere in the 0-10% interval.

2) Phones sold by OEMs without own basic wireless R&D and SEP portfolios.

Instead of doing heavy investments in cellular wireless R&D, these OEMs have chosen to focus their business efforts on e.g. design, brand management, localization, feature development, marketing or logistics. The basic cellular technology is procured through the SEP FRAND licensing regime. This is the category of phones I addressed in my post, and in my experience, its cumulative royalty is around 10%.

3) Phones sold by OEMs that are "unwilling licensees".

Due to factors such as patent hold-out and the emergence of major localized OEMs in jurisdictions with less effective IPR enforcement regimes, a number of phones sold globally today are unlicensed. That is, they constitute infringing devices and no royalty at all is payed for them.

So a new OEM has two legitimate choices: a) get into basic wireless R&D to contribute to the standards and in the longer term pay somewhere between 0% and 10% or b) let others do all that and pay around 10%. As is worth repeating, there are no free lunches.

Considering that the phones in the three categories are subject to cumulative royalties of something like 0-10%, 10% and 0% respectively, it's perfectly possible that the global average might end up somewhere around 5% as indicated by Mr. Mallinson's calculation. Having said that though, it's important - for new OEMs but also for courts and agencies - to appreciate that the global average is not necessarily a relevant reference per se for a given OEM. 

Finally, it's of course quite alarming that a subset - and probably a sizable minority - of phones sold globally are currently not covered by SEP portfolio FRAND licenses and corresponding royalty payments. Or to put it more bluntly, are sold by OEMs who "willfully infringe" other's SEP portfolios. Partly a result of the "patent hold-out" challenges discussed in a previous post, this is a grossly under-reported problem that I hope to return to in another post.

Royalty stacking

I'll begin by sharing some thoughts around the concept of “royalty stacking”. This term is generally “buzzing around” in patent licensing circles, and is sometimes brought up as being a problem for Standards Essential Patent (SEP) licensing in the mobile wireless communications sector. In this context, "royalty stacking" basically means that manufacturers/sellers of standards-compliant products (whom I will call “OEMs”, Original Equipment Manufacturers) need to obtain licenses from several SEP holders, and the aggregate royalty then becomes the sum of the individual royalties paid to the different SEP holders.

So why does an OEM need several licenses in the first place? Well, it's a consequence of how the wireless standards are created. Different entities from the industry come together to research and create a standard in a way that's simultaneously collaborative and competitive. By competing on technical merit for the various solutions within the standard, this quite ingenious process promotes the overall creation of a widely accepted, state-of-the-art and future-proof standard. As a result of this, SEPs will also be generated, and each individual SEP covers a specific part of the standard. In other words, all SEPs are complementary and an OEM must therefore by necessity obtain licenses to all SEP portfolios in order to be fully licensed.

So the first thing to note is that royalty stacking is not a problem in itself. Royalty stacking naturally occurs as a logical consequence of the wireless standardization process.

I guess that those who talk about royalty stacking as a “problem” actually refer to a potential consequence of royalty stacking; namely the cumulative SEP license royalty fee becoming too high for an OEM to bear while maintaining a reasonable profit margin. In these circumstances, references are sometimes made to royalty rates published by various (alleged) wireless SEP holders. And if those “published rates” are added up, the cumulative figure can indeed look rather unappealing. In a recent working paper by Intel and law firm Wilmer Hale, precisely this approach was taken, leading them to conclude a theoretical wireless SEP stack of more than US$100 for a smartphone (!). For sure, I for one do expect the authors to be aware that such a figure has very little to do with reality.

Potential negative consequences of royalty stacking are surely valid concerns, but as is often the case, it's advisable to also consider actualities before drawing conclusions based on theoretical analysis.

So how to assess whether royalty stacking has led to problems or not in the mobile wireless business? To begin with, I'd suggest looking at some aspects of the actual wireless device market and the SEP licensing situation.

During the last 25 years of 2G to 5G wireless cellular standardization, the SEP licensing technology sharing process has been governed by the well-known FRAND (Fair, Reasonable And Non-Discriminatory) regime. Also during this time, there's been an exponential increase of wireless device sales, to the extent that there are now close to a mind-boggling two billion new devices sold annually. So from a consumer point of view, it's not easy to detect any actual prohibitive pricing effects resulting from “too high” cumulative SEP royalties. Looking at the mobile device businesses too, evidence of problems from SEP royalty stacking is not exactly abundant. Consider that the vast majority of the top OEMs today were hardly even in the business only a decade or so earlier (e.g. Samsung, Apple, HTC). And conversely, many of those that were highly successful back then - also traditionally strong SEP holders - are all but gone from the device business today (e.g. Ericsson, Siemens, Alcatel1). Regarding WiFi, considering that it's a more recent wireless standard, the market has similarly exploded and perhaps even more spectacularly than cellular. There's now WiFi connectivity in virtually every device around us, including game consoles, cameras, TVs and vehicles. At the very least, these market developments suggest a low entry-barrier, and for sure I see no suggestion of the wireless SEP royalty stack being too high; this reality might even support the notion of a too low royalty stack (!).

From my own experience of wireless SEP patent licensing, I'd say that serious OEMs with few or no own SEPs are typically well aware - through their own license negotiations with various SEP holders - that the cumulative wireless SEP royalty rates are in general reasonable. And for sure that they're nowhere near e.g. the sum of all “published rates”. 

It's also somewhat interesting to look at e.g. the Apple vs. Motorola case, where Apple apparently refused to be bound by a potential judicial order of FRAND royalty payment, when such order presumably would have considered e.g. the actual payable cumulative royalty. It seems to me that Apple might have had the opportunity to demonstrate any real royalty stacking problems, but chose not to do so. This could perhaps suggest that any such problems may not have been that overwhelming.
 
It's true that some significant OEMs are said to operate on much lower profit margins than Apple, and sometimes royalty stacking problems are blamed for OEM's profit margins even being "too low". However, this is far from obvious, as there can be many different reasons for low profit margins. In fact, low profit margins may - ironically - be at least partly due to some competing OEMs not obtaining necessary IPR licenses in the first place. By being unlicensed for prolonged periods of time, such OEMs may in effect compete unfairly in the market, potentially forcing legitimate OEMs to reduce their profit margins. The truth of the matter is that some OEMs enter the market without including necessary SEP license costs as part of their original business case. It might be initially tempting to see this as being “good” for consumers due to potentially lower prices, but it's actually detrimental in the longer term. It skews the market in favour of infringers and globally undermines incentives for investments into technological innovation. 

So while evidence of problems from royalty stacking do need to be taken seriously, it's not clear that we've actually seen any in reality. However, if courts, agencies and lawmakers would simply assume that there are such problems where there are in fact none, there could actually be a potential risk of royalties being set unfairly low (!). This could unjustifiably harm the market and cause R&D “disincentivization”, which in the longer term can lead to limitations on consumer choice. Because of this risk, allegations of royalty stacking problems should in my view always be properly scrutinized, wherever they may turn up. So how good are courts and agencies at scrutinizing? Well, it's a mixed bag it seems.

In the Ericsson vs. D-Link et. al. case, defendants brought up royalty stacking as being a problem and at one point argued that the stack could amount up to “$23.30”. There was a lot of argumentation on this, but the defendants ultimately failed to convince the court of any real evidence of harmful stacking. As a result the court dismissed their arguments. In this particular case, sound skepticism to alleged stacking problems was apparently clearly expressed by the court. I understand that this case is currently on appeal, but this particular observation from the court has not been challenged.

Looking at the case of Motorola vs. Microsoft, the court in that case did appear less critical of allegations of royalty stacking problems, and made assumptions in view of that. Consequently, it e.g. essentially capped the cumulative rate at the selected rate of the Via Licensing WiFi patent pool, even though the patent holder's and others' patents were not part of the pool, and inspite of concluding that patent pools tend to produce lower rates and that a rate higher than a pool rate could still be FRAND. In the Innovatio case, again in apparent consideration of alleged royalty stacking problems but without real evidence of such, the court chose to determine the FRAND rate ultimately based on the profit margin of a chip manufacturer. Although this touches on another topic - the question of a relevant royalty base - this choice of reference is in my opinion actually quite arbitrary. In these two cases courts appear to have presumed cumulative rates being "too high" without any convincing evidence to that effect, while still ultimately determining royalty rates based on such presumtions.

While SEP royalty stacking can potentially cause market disruption, claims of such problems should be thoroughly scrutinized to determine if they are genuine. After all, in the last 25 years, the wireless device market has seen a virtually astronomical development in terms of cutting-edge technology and standards development, consumer choice and successful new businesses. Some companies complain about negative effects of royalty stacking, but have been unable or unwilling to demonstrate any actual problems. Others may blame royalty stacking for low profit margins while reasons may rather be found elsewhere, including unlicensed price-cutting competitors. One may in fact wonder if "royalty stacking problems” is sometimes used as an argument to avoid paying what would in fact be perfectly fair and reasonable royalties for wireless SEP licenses.

For sure, SEP FRAND determination cases are often complex, and courts, agencies and lawmakers mostly do a formidable job in trying to bring clarity and fairness to the situation at hand. Even with good intentions though, less well-founded assumptions and theoretical models ought to be minimized in favour of looking at real facts and requiring entities to substantiate claims of problems resulting from royalty stacking. Otherwise, SEPs and ultimately R&D investments actually run the risk of being devalued without addressing any real problem.


 1 “Alcatel”-branded phones seen on the market today are by Chinese company TCL under trademark license from Alcatel-Lucent.

This blog

In this blog I'll occasionally provide observations, opinions and comments on various issues related to patents and patent licensing; in particular in the telecoms sector. I've had the opportunity to work hands-on with patents in virtually all aspects; from invention to litigation and just about everything in-between. So my viewpoints will tend to be based on my own experience from business realities, and somewhat less on theoretical ponderings. Hopefully this side of things can be interesting and informative to those who enjoy reading about this rather complex and sometimes controversial topic.