Competition authorities and FRAND

Disputes arising in wireless SEP FRAND licensing are very rare. But when they do occur, parties normally turn to courts for settlement. In certain instances though, national or international government agencies in the form of competition regulators become involved in one way or another. Without getting into too much detail, I'll here briefly examine the net outcomes of some key rulings and settlements of competition agencies in recent years, relating to wireless SEPs and FRAND licensing. 

Starting in the US, in June 2012 the US Federal Trade Commission (FTC) launched an investigation into whether Google, through its then subsidiary Motorola Mobility, breached FRAND commitments by seeking exclusion orders for SEP infringement against "willing licensees". This investigation concluded on July 24, 2013 with a "consent order" where Google accepted certain restrictions on seeking exclusion orders for SEP infringement against US companies. The consent order set out detailed procedures for Google and willing licensees to timely conclude a global SEP-portfolio license. I won’t go into the details here as it’s a bit lengthy, but essentially there's a six month negotiation period followed by – in case of no agreement - a global FRAND determination by a court or a binding arbitration. See also my earlier post where I discuss this order.

Moving on to the EU, the European Commission (EC) on January 31, 2012 opened an investigation into whether Samsung, by seeking injunctive relief against SEP infringers within the EU, breached FRAND commitments and engaged in abuse of a dominant position. On April 29, 2014, the EC concluded its investigation by accepting certain commitments made by Samsung. For a period of five years Samsung committed not to seek injunctions within the EU on SEPs against infringers that agree to the following licensing framework:

· “a negotiation period of up to 12 months; and

· if no agreement is reached, a third party determination of FRAND terms by a court if either party chooses, or by an arbitrator if both parties agree on this.”

Over in China, in May 2013, the National Development and Reform Commission (NDRC) opened an investigation into InterDigital's SEP-licensing practices. The NDRC  suspended its investigation on May 22, 2014 after accepting InterDigital's commitment including:

“Prior to commencing any action against a Chinese Manufacturer in which InterDigital may seek exclusionary or injunctive relief for the infringement of any of its wireless standards-essential patents, InterDigital will offer such Chinese Manufacturer the option to enter into expedited binding arbitration under fair and reasonable procedures to resolve the royalty rate and other terms of a worldwide license under InterDigital's wireless standards-essential patents. If the Chinese Manufacturer accepts InterDigital's binding arbitration offer or otherwise enters into an agreement with InterDigital on a binding arbitration mechanism, InterDigital will, in accordance with the terms of the arbitration agreement and patent license agreement, refrain from seeking exclusionary or injunctive relief against such company.” 

The net outcomes of these cases are in fact quite similar. They provide a "safe haven" for SEP holders to avoid competition concerns and for infringers to timely obtain SEP licenses without the risk of exclusion orders. SEP holders can avoid competition scrutiny by offering infringers the option of “formally” becoming willing licensees by accepting a process that typically includes timely FRAND determination or arbitration of the global patent portfolio value. Importantly, infringers who choose not to accept such processes continue to be susceptible to exclusion orders. 

We can see that an important common concern of these US, EU and Chinese competition authorities has been the availability of exclusion orders for SEP infringement without proper FRAND scrutiny by a court or arbitration panel. However, it's good to note that the authorities have clearly also considered the risk of so-called reverse patent hold-up. Such behaviour, also known as patent hold-out, is nowadays a common problem in SEP portfolio licensing, leading to reduced R&D investment incentives and increased SEP transfers. Importantly, the net outcomes of these cases emphasize timely resolution of global SEP portfolio licenses and keeping exclusion orders on the table for those who decline the process. These are measures that can help mitigate reverse patent hold-up.

What's also clear is the deferral of the FRAND determination issue to courts and arbitration panels. In other words, the competition authorities acknowledge that they are themselves not suited to handle patent and price-setting issues in SEP FRAND matters. This makes perfect sense in my opinion since courts and arbitration panels are arguably more transparent, independent and experienced with such matters.

An interesting scenario in the light of these net outcomes is the case of an SEP holder who seeks an exclusion order for SEP infringement where the infringer refuses to accept the court's FRAND determination for a SEP portfolio. Given that the competition authorities' concern is related to exclusion orders without proper FRAND review, this type of situation would follow the precedent set by the authorities.

Finally, on July 16, 2015, the Court of Justice of the European Union (CJEU) also offered its guidance on under what circumstances a SEP-holder may or may not abuse a dominant position by seeking exclusion orders. It did this by responding to five specific questions put to it by a German court in the matter of Huawei vs. ZTE. On the face of it, the CJEU's decision seems to be consistent with the above-mentioned agency net rulings. But the ruling deserves some scrutiny in terms of real-world licensing, which I will save for a separate post.

Apple and Ericsson - a first look

On January 12, 2015, Apple filed a complaint in the US District Court for the Northern District of California asking for a declaratory judgment that i) seven Ericsson US patents are not essential to 4G nor infringed by Apple or alternatively, if found essential and infringed, ii) the court sets reasonable royalties using a royalty base of "at most, the component that substantially embodies the alleged invention". It also asked the court to prevent Ericsson from seeking injunctive relief or exclusion orders based on the patents-in-suit.

Shortly after, Ericsson filed a complaint in the US District Court for the Eastern District of Texas asking for a declaratory judgement that i) Ericsson's global license offers have "complied with its FRAND commitment" and ii) Ericsson has "complied with its contractual obligations under its FRAND commitment".

There's been more filings in this dispute since, and of course there could be more to come. But in this post I'll specifically examine certain aspects of this first filing by Apple. There are some parts that I find interesting and related to what I have touched upon in previous posts. Also in relation to both of these first filings, I'll revisit the issue of SEP portfolio license valuation.

The first point in Apple's complaint concerns the "royalty base". Basically, a "royalty base" is the value of "something" that a royalty rate percentage is multiplied by, to arrive at a payable royalty for a licensed product. In its complaint, Apple argues that "the law requires" that the royalty base be selected as "(at most) the smallest salable unit", and explains that such a unit would correspond to "(at most) the baseband processor chip" inside its products. Apple further implies that the "current technological and legal environment" is one where this particular Apple opinion prevails, and that Ericsson has refused to "adapt" to it.

Let's first look at the law. The fundamental basis for US patent damages can be found in 35 USC 284, "...the court shall award the claimant damages adequate to compensate for the infringement, but in no event less than a reasonable royalty for the use made of the invention by the infringer..." (emphasis added). Clearly, there are no limitations of the type advanced by Apple to be found there.

So how about the "smallest salable unit"? Well, the phrase is actually part of the Entire Market Value Rule (EMVR) concept in US patent damages law. But Apple has embraced it in a completely out-of-context manner. The concept, as clarified only recently by the US Federal Circuit in Ericsson vs. D-Link in 2013, is only an "evidentiary principle" to be used to specifically assist a US layman jury to arrive at a reasonable royalty when there is a risk of it being misled (biased) by a higher end-product value. Moreover, in the very same breath the Federal Circuit made it crystal clear that i) licenses are "generally negotiated without consideration of the EMVR" and ii) the "substantive legal rule" is that the “ultimate reasonable royalty”– e.g. the result of multiplying a royalty rate and a royalty base–”must be based on the value that the patented invention adds to the end product” (emphasis added).

And if that's not enough, also the market has rejected Apple's position. It's an indisputable fact that the end-product selling price has been used as a royalty base in cellular SEP licensing for more than 20 years. That is, since more than a decade before Apple even got into the mobile phone business. During all those years, several hundreds, if not thousands, of cellular SEP license agreements were signed using precisely that royalty base.

If those hundreds of licenses would have been so clearly wrong, how could the world's legal systems - including the US legal system - have let such practices flourish for decades? Not to mention the tremendous global growth in the mobile phone business during those 20 years, from virtually zero to 7 billion mobile subscriptions and 2.5 billion devices sold annually today? All that, based on something that's basically against the law? I'm afraid I find that quite hard to believe.

Clearly, Apple's opinions about what "the law requires" and the "current legal environment" on the subject of royalty base do seem quite odd to say the least.

Moving now to the question about injunctive relief. Here Apple asked the court for "a ruling that Ericsson cannot seek injunctive relief or exclusion orders against Apple" based on any of the patents-in-suit found to be infringed and essential.

As I've mentioned before, there's no legal support whatsoever for banning the seeking of injunctive relief for infringement of SEPs. In fact, the US Federal Circuit in Apple vs. Motorola in 2014 could not have been clearer on this point: "To the extent that the district court applied a per se rule that injunctions are unavailable for SEPs, it erred." Indeed, "an injunction may be justified where an infringer unilaterally refuses a FRAND royalty or unreasonably delays negotiations to the same effect." Clearly, an SEP holder does have the right to seek an injunction and it's up to the court to decide on a case by case basis whether an injunction is warranted, based on e.g. whether the infringer is deemed to have engaged in patent hold-out. An actual hold-out situation can be very damaging to the SEP holder and especially to other willing and existing licensees, as I discussed in a specific post on that subject. This is presumably why the US Federal Circuit believes that an injunction may be appropriate in such cases.

So, like the royalty base issue, Apple's request about injunctions also seems out of touch with US law.

The last aspect I'll examine here is that of SEP portfolio license valuation, looking at both Apple's and Ericsson's filings.

Apple seems to view the entire issue from a patent-by-patent aspect, and asked the court for declaratory judgements on seven particular Ericsson patents in terms of essentiality and infringement, and assuming those are fulfilled, value.

Ericsson on the other hand appears to treat the issue as a SEP portfolio licensing effort, and asked the court to determine whether its terms for its entire worldwide alleged SEP portfolio as a whole - i.e. not just seven US patents - are to be considered FRAND.

So essentially we have two approaches pitted against each other; i) patent-by-patent license value adjudication and ii) global patent portfolio license value adjudication.

The patent-by-patent approach requested by Apple may be suitable when the matter at hand is a license to a limited explicit set of patents granted in the US. But that's really not the case here at all. The majority of Apple's sales are outside the US, and it sells tremendous volumes on every continent. And an SEP-holder like Ericsson surely has granted SEPs on every continent too. In addition, major standards-contributors tend to obtain new SEPs over time, adding to their portfolios. For at least these reasons, the license scope of the Apple-Ericsson negotiation preceding these court filings must have concerned a global SEP portfolio license. Anything else would have been highly inefficient if not irrational for companies such as these.

As I elaborated in an earlier post, when it comes to a license to a large global SEP portfolio, a  patent-by-patent, country-by-country approach to adjudication can never be a complete solution, and when pursued by an infringer it may in practice amount to a patent hold-out situation. Patent hold-out can in turn lead to the unreasonable result that the SEP-holder cannot efficiently enforce its SEP portfolio simply because it's so large.

Looking now at the "one-stop shopping" approach requested by Ericsson. It does have an obvious attraction point; it directly focuses on the very topic of the actual negotiation between the parties - the value of a license to a global SEP portfolio. And in cases where significant databases of existing license agreements to the very same global SEP portfolio are available as references, this approach should have the potential to be both efficient and fair. In particular if the vast majority of those existing license agreements have been negotiated in good-faith without litigation, something we know is generally true for SEP portfolio licensing. So if Ericsson's public statements about having "more than 100 patent-licensing agreements in place" are to be believed, this case should surely qualify for this approach.

In recent times the "one-stop-shopping" approach has indeed gained support from courts and agencies worldwide. In Microsoft vs Motorola in the US District Court for the Western District of Washington, although some dubious calculation methodology was used as I've mentioned earlier, the court did in fact determine a global FRAND rate to Motorola's SEP portfolio. And the “Request for a FRAND Determination” process endorsed by the US Federal Trade Commission in the consent degree of Motorola vs Google also expressly concerned a global SEP portfolio license. Even the Chinese National Development and Reform Commission (NDRC) in 2014 imposed a similar process on InterDigital for a global SEP portfolio license.

Concluding this review of the initial filings of Apple and Ericsson, I find the argumentation coming from Apple surprisingly unconvincing so far. Its arguments about royalty base and injunctions seem to be at odds not only with US law - including recent US Federal Circuit opinion - but also with decades of regular SEP-portfolio licensing. So for Apple's sake, one would hope that it comes up with some better argumentation as the case continues. Furthermore, the global license value adjudication sought by Ericsson seems to be rather more appropriate for the case at hand - a global SEP portfolio license - as compared to the patent-by-patent approach initiated by Apple.

On the draft IEEE patent policy

IPR policies of telecoms Standardization Setting Organizations (SSOs) mainly define how patents that become part of the standard should be treated, typically through the principle of a (F)RAND ((Fair), Reasonable And Non-Discriminatory) licensing commitment. These policies have been in place for many years, decades even, but are quite naturally subject to reviews from time to time. In spite of such reviews and occasional calls for more regulatory content though, the policies are more often than not left largely unchanged.

This likely demonstrates that the original policies continue to serve the market rather well. Quite some wide-ranging thought and foresightedness have gone into them in order to carefully accommodate the diverse and complex interests of users and innovators of advanced communication technologies in the marketplace. And ultimately, to make the standards commercially successful in the long-term.

However, a radical IPR policy change is now underway within the Institute of Electrical and Electronics Engineers (IEEE), an SSO responsible for numerous standards including "WiFi", or IEEE 802.11 as it's formally known. Since last year, a proposal for an update of the patent policy of the IEEE Standards Board Bylaws is being worked on by the IEEE-SA (IEEE Standards Association), a body within the IEEE responsible for standards. Compared to previous IPR policies of telecoms SSOs, this proposal is very detailed and far-reaching. At least to me it also gives the impression of being aimed at significantly changing how wireless SEP licensing will work in the future. Let's take a detailed look.

To begin with, the policy states that the determination of a "reasonable rate" for a SEP "should" consider (emphasis added):

a) "the value that the functionality of the claimed invention or inventive feature within the Essential Patent Claim contributes to the value of the relevant functionality of the smallest saleable Compliant Implementation that practices the Essential Patent Claim" (emphasis added),

b) "the value that the Essential Patent Claim contributes to the smallest saleable Compliant Implementation that practices that claim, in light of the value contributed by all Essential Patent Claims for the same IEEE Standard practiced in that Compliant Implementation" (emphasis added)

[and]

c) "existing licenses covering use of the Essential Patent Claim, where such licenses were not obtained under the explicit or implicit threat of a Prohibitive Order, and where the circumstances and resulting licenses are otherwise sufficiently comparable to the circumstances of the contemplated license" (emphasis added).

Requirements a) and b) appear to mandate how the apportionment of the invention's value should be done. The phrase "smallest saleable compliant implementation" must reasonably mean a component or sub-assembly within the end-product, and in my mind the so-called "chip-set" might well be a likely candidate for this. The invention's value to such a component only is all that shall be considered. As I touched upon in my previous post on cellular FRAND royalty levels, this is actually not in line with how damages for patent infringement are, or should be, judged by courts. Indeed, as the US Federal Circuit recently clarified in the D-Link case, it's the value of the patented invention to the end-product that is the yardstick. In clarifying the "Entire Market Value Rule", it stated that according to the “substantive legal rule”, the “ultimate reasonable royalty award” – that is, the result of e.g. multiplying a royalty rate with a royalty base – ”must be based on the incremental value that the patented invention adds to the end product” (emphasis added). Thus, mandating SEP value apportionment to consider only a component within the end-product is not the law.

Requirement c) is even more remarkable. This is because ever since the patent system was created, all licenses - including (F)RAND SEP licenses - have by definition been obtained "under the explicit or implicit threat of a prohibitive order". I say "by definition" because this is quite simply the basic legal right of a patent holder, a right to exclude. And as I elaborated in an earlier post, (F)RAND doesn't change this per se. So in other words, c) simply says that none of the WiFi licenses in existence at the time of adoption of this new IPR policy may be used as a reference for any new WiFi licenses. This "purging" of the historical record of WiFi licenses seems intended to "cement" the component value apportionment mandated by a) and b). Presumably because the royalty considerations of those preexisting licenses may have been based on the value that the SEP portfolio brings to the end-product rather than to a component within. 

Interestingly, in the above-mentioned D-Link case, the defendant argued for disqualification of existing license evidence on those very grounds, but the Federal Circuit rejected this: "In short, where expert testimony explains to the jury the need to discount reliance on a given license to account only for the value attributed to the licensed technology, as it did here, the mere fact that licenses predicated on the value of a multi-component product are referenced in that analysis—and the district court exercises its discretion not to exclude such evidence—is not reversible error."  In fact, licenses "predicated on the value of a multi-component product" are perfectly normal in practical wireless SEP licensing. And incidentally, they're also in harmony with the law.

To me, a), b) and c) seem to be specifically designed to usher in a brand new era of very low royalty rates for WiFi. Clause c) makes all old licenses irrelevant as references. And clauses a) and b), while not necessitating it, certainly encourage a significant lowering of the absolute royalty rate by mandating consideration of the SEP's value to (at most) the chip-set only, thus creating a low-product-value bias with regards to the absolute royalty. I'm not sure how much support there will be for such a change, but it's not in line with what the US Federal Circuit has said about the law.  

However, there's more of interest in the proposed new IEEE patent policy, relating to prohibitive orders:

"An accepted ...[RAND licensing commitment] ... precludes seeking, or seeking to enforce, a prohibitive order except as provided in this policy." (emphasis added),

where "as provided in this policy" means:

"The submitter of ... [a RAND licensing commitment]... agrees that it shall neither seek nor seek to enforce a prohibitive order ...unless the implementer fails to participate in, or to comply with the outcome of an adjudication, including an affirming first-level appellate review, if sought by any party within applicable deadlines..." (emphasis added).

At first glance, this actually looks a bit similar to the process used e.g. in the US Federal Trade Commission's Consent Order in the Google/Motorola case. As a potential "softer" means to combat the very destructive"patent-holdout" behaviour, I myself saw that as a quite interesting path. However, when looking more in detail at the wording, it doesn't look like that's the purpose here. The phrase "an adjudication, including an affirming first-level appellate review" gives the distinct impression that an affirming first-level appellate review is actually a requirement. This makes it quite a different story from the quoted US FTC process. Unless I misunderstood the phrase, the whole thing looks like an attempt to in practice ban prohibitive orders altogether in SEP portfolio cases. Of course, also this is something that the Federal Circuit has clearly declared an error, as I mentioned in my earlier post on portfolio licensing and patent hold-out.

So overall I'd say that the patent policy changes proposed by IEEE-SA represent large steps in wrong, unmotivated and even unsupportable directions. What appears to be a ban on prohibitive orders is not in line with US Federal Circuit precedent and would only worsen the patent hold-out problem and put artificial downwards pressure on royalty rates. The mandating of value apportionment based on only a component and the explicit disqualification of old license agreements as references also don't align themselves with Federal Circuit precedent. When stripped down to its bare essentials, the proposal looks rather like a path-clearing for a drastic cut of the absolute SEP royalty level for WiFi.

But isn't that good? Well if it had been shown that there was a clear problem with royalties being too high, affecting the market in negative ways, then the IPR policy could definitely be in need of a review and as a consequence possibly even an update. But evidence of concrete problems to that effect yet remain to be demonstrated. We can again look at the D-Link case, a case that was specifically about SEP licensing for the IEEE standard 802.11 ("WiFi") and which involved several prominent implementers of that standard. The Federal Circuit confirmed that no evidence of royalty stacking or patent hold-up - two phenomena sometimes claimed to create 'too high' SEP royalties - was presented and that they should never be presumed to exist just because they are theoretical possibilities: "The district court need not instruct the jury on hold-up or stacking unless the accused infringer presents actual evidence of hold-up or stacking. Certainly something more than a general argument that these phenomena are possibilities is necessary. Indeed,“a court should not instruct on a proposition of law about which there is no competent evidence.""

There are others who have questioned the purpose of this new proposed policy. For example, the IEEE USA board (!) recently sent a letter to the IEEE board, straightforwardly asking for an explanation of exactly what's wrong with the existing patent policy and what concrete problems the new policy proposed by IEEE-SA is supposed to solve.

The SSO IPR policies set the delicate basis for achieving a long-term balance between incentive for innovation and incentive for implementation. This balance is for the common good of technological innovation, a healthy marketplace for implementers, and ultimately consumer choice. However, it seems to me that in the new draft patent policy for IEEE, shorter-term business interests of implementers may have been allowed to take on rather more weight than they should have. To my knowledge, no obvious market need has been demonstrated for any of the changes proposed. Nor is there any legal mandate for them and in fact, some changes even tend to run contrary with US Federal Circuit opinion.

To the extent that there's an actual need for an update of its patent policy, hopefully the IEEE will eventually come up with a more balanced proposal than the present one.

Cellular FRAND royalty levels

What's a fair and reasonable royalty for a cellular Standards Essential Patent (SEP) portfolio license, and how is it determined? This sounds like a simple enough question, but actually it's not. In this post I'll share some of my experiences and thoughts in relation to this much debated subject.

To tackle this subject, I believe one should start by assessing values. Let's first look at the value of the cellular standard to a mobile phone. To say that the cellular standard itself is absolutely crucial for a mobile phone is hardly controversial. In fact, the cellular capability defines the phone as a commercial product: an iPhone wouldn't be an iPhone without cellular capability. Apple is able to sell its iPhone at a price of several hundred US$ more (!) than the price of its iPod, a very similar product but without cellular capability. This price difference demonstrates the tremendous value of adding standardized cellular technology to an otherwise similar device.

So yes, the cellular standard is definitely fundamental to a mobile phone. But what about a cellular SEP portfolio, what's the value of that? Before looking at a given SEP portfolio though, let's start by considering the cumulative. What's the license value of all SEP portfolios taken together. After all, that's the ultimate concern of the Original Equipment Manufacturer (OEM) selling the product. How is this "total mass" of cellular SEP portfolios related to the standard?

To address those questions, let's first assume that we'd like to create a brand new cellular 5G standard as a successor to 4G, but - for whatever reason - we want it to be completely void of SEPs. What could that correspond to in practice? Well, since patents live for up to 20 years, only standardized technical solutions older than 20 years would be completely "safe" to include. So we might actually end up selecting the first (1990) version of GSM (2G) as our 5G standard. This certainly feels like a very bad idea indeed. But why exactly? Because a 2G standard can't possibly fulfil the technical requirements placed on a 5G standard. The example might seem a bit extreme, but I want to illustrate an important point. The value of a standard strongly relates to new pieces of technology added to it. This is because a new cellular standard is subject to more harsh technical requirements - with respect to supported data rates, delay, capacity, flexibility, new services, efficient data compression and so on -  than previous standards. Having own experience from standardization, I know that these new requirements are there to make the new standard as future-proof as possible. While many consumers may accept to change phones quite often, mobile network operators make tremendous investments in infrastructure and will hardly be amused about having to replace it after only a couple of years because it's gone obsolete. In order to fulfil these tougher requirements of a new standard, brand new technological innovations are very often required, and these are also typically patented. So, while all cellular SEP portfolios together may not be strictly equivalent to the standard itself, they represent the value of the standard since they include the technologies that allow the standard to fulfil its specific requirements.

So how about the license value of all cellular SEP portfolios in terms of actual money? And who decides it for that matter? Here I'd first like to point out that the consequences of "wrong" pricing can be tremendous. If too high, then consumer demand will suffer. If too low, then incentives for standards innovation will suffer. But in fact, we can all see mobile device sales and usage expanding strongly and new state-of-the-art standards continuing to be created. So clearly, the market must have somehow managed to settle at a balanced pricing. But at what level? In my experience from working with cellular SEP licensing for quite some time, I can see an established cumulative royalty cost for all cellular standards up to 4G somewhere around 10% of the OEM selling price of a mobile phone. Note that this is not my opinion of what it "should" be. This is the reality that I see.

I'd like to make two important comments in relation to this 10% figure:

1) High-end phones often have advanced screens, cameras etc. that may be argued to be unrelated to the cellular standard. According to such argument, the percentage-principle leads to an unfairly high royalty for these products. But in reality, those attributes actually increase the usage of the cellular standard. In fact, the 3G and 4G standards were even specifically developed with the performance of such devices in mind. So the value of at least 3G and subsequent standards - and hence of all SEP portfolios relevant to those - is higher for high-end phones. Nevertheless, high-end phones are still often subject to "royalty caps" in order to address the perceived concern. Conversely, at the other end of the spectrum, the percentage-principle may cause very-low-end phones to devalue SEP portfolios. In such cases "royalty floors" may be used as well.

2) Most major SEP-holders are practicing entities, i.e. they sell standards-compliant products themselves. When such an SEP-holder offers a license to its SEP portfolio to an OEM, it typically also needs a license to the OEM's SEP portfolio. This is known as a "grant-back" license. In these cases, there will be a "royalty-netting" effect. One party pays a net royalty to the other based on their respective SEP portfolio strengths and net product sales. Therefore, SEP-holding OEMs ultimately pay a lower net cumulative royalty rate than non-SEP-holding OEMs. Importantly, this is not a violation of the Non-Discriminatory ("ND") part of FRAND since the value of a license is transferred back in place of some royalties. An OEM either makes large investments in basic R&D - resulting in innovations and patents - or pays full license fees. After all, there are no free lunches. 

Some OEMs new to the market have recently started to argue that the cumulative royalty should instead be no more than a fraction of the cost of a "baseband chip". This is a component inside the mobile phone that includes cellular connectivity functions. Such a change would actually make the cumulative royalty about an order of magnitude lower than what it is today. This argument doesn't make sense to me because it doesn't go to the value of using the cellular connectivity, but rather to the cost of a component necessary for that connectivity. Patent damages, i.e. the royalties determined by a court, are based on the value for the use made of the invention (e.g. in the US according to 35 USC 284).

As a parallel, one could look at a movie DVD. The entire component and manufacturing cost is probably no more than US$0.50. Yet nobody would seriously argue that the IPR value for the product as a whole, including the movie script, production, direction, screenplay, music, acting and so on, should be a fraction of that amount. It's the value of the IPR to the end product that's important. Arguing for a 90% de-valuation of cellular SEPs when there's been an established and well-working SEP valuation regime in place for decades seems irrational to me and would certainly disrupt the market balance, and for sure not in favour of innovation.

Having discussed the cumulative royalty at some length, I can now return to the original question: What's a fair and reasonable royalty for a given cellular SEP portfolio license, and how is it determined? Or in other words, how much should a given SEP-holder obtain within the cumulative budget and how is that fraction actually decided?

Most market participants agree that there has to be some form of proportionality at play here, in keeping with general principles of fairness and reasonableness. SEP-holders with "stronger" portfolios are entitled to larger royalty fractions. But using what metric? Counting SEPs? Valuing the SEP portfolios in terms of "innovation value"? This is not an easy question. Still, the actors in the market - the SEP-holders and established OEMs - over time "get to know" the overall value of each other's portfolios. They do this through license negotiations as well as by gaining knowledge of each others' R&D, standardization activities and patenting quality. The main challenge arises for someone who's inexperienced with this market.

Take as an example a willing licensee OEM new to the market and without standardization involvement or SEPs. It needs to allocate around 10% of its product price to cellular SEP license royalties, but how does it determine the fractions? Are there ways to find at least estimates of the distribution of those 10%? Well there are indeed some commonly discussed methods, which I'll briefly explain here:

1) ETSI IPR database declarations
Due to its apparent simplicity, it's very tempting to look at various patent holders' SEP declarations on ETSI's IPR database and to estimate royalty fractions based on them. However, such results are actually totally unreliable, since neither the declarer nor ETSI has any obligation to verify essentiality. The original purpose of the database was to ensure that there would be no hidden surprises in terms of unknown patents turning up at a later stage as SEPs. For this reason, patents "believed" to be essential could be declared, even though they might turn out not to be. As a result, significant over-declaration regularly takes place. This leads to gross over-estimates of the total SEP holdings and distorts the distribution of SEPs. So at best, this kind of study may be used to get a picture of potential SEP-holders rather than estimates of actual SEP holders' relative fractions.

2) Third party evaluations
Some instead turn to SEP evaluations performed by third parties. Unfortunately many such evaluations tend to be based on "keyword searches" in patent databases, which make them about as useful as horoscopes. More serious evaluation attempts actually try to look at the patent claims in some detail and compare them to the standard. Although those evaluations could in principle give indications of actual SEP-holder fractions, they also tend to suffer from reliability restrictions. Besides the obvious concern of bias, their accuracy is also limited due to time and cost constraints in combination with the large mass of potential SEPs to go through.

3) Accepted standards contributions
A newer method, originally explored by Ericsson, is not to look at patents at all (!), but instead at "accepted standards contributions" to the 3GPP standardization process. That essentially refers to technical solution proposals accepted into the standard. It's assumed that this metric has a strong correlation with SEP-ownership over time and that significant standards contributors all have similar "patenting rates" and "patenting quality". Since these assumptions are actually quite reasonable and the contribution data is all publicly available, this method is potentially accurate. Interestingly, it also aligns itself with incentivizing technical contributions to the standard. However, with this method becoming more widely used, its accuracy may suffer in the longer term since some standards-participants can be tempted to make numerous proposals on relatively trivial technical solutions solely to increase their "accepted contribution rate".

In practice though, these kinds of estimations are mainly used only as tools to roughly gauge the SEP portfolio landscape. Our new OEM will obtain the most accurate information about the SEP-holders' portfolios and FRAND royalty requests simply by conducting licensing negotiations with different SEP-holders in parallel. In this way the OEM can scrutinize the different SEP portfolios down to whatever detail it sees fit. This may be done through examining and discussing so-called claim-charts detailing the patents' relation to the standard in question. If needed, OEMs sometimes even employ external experts for such evaluations. Over time, these negotiations typically do result in a fair and reasonable royalty partitioning.

In this context I'd also like to point out that OEMs don't always fully appreciate the restrictions that the non-discriminatory ("ND") part of FRAND places on the SEP-holder. Many SEP holders have a multitude of already signed SEP portfolio license agreements in place and simply can't discriminate against existing licensees in favour of a new OEM. It's also inappropriate for a new OEM to compare itself with unwilling licensees - i.e. those essentially not wanting to pay anything - in terms of how much royalty it should pay. Doing so further exacerbates the "patent hold-out" problem discussed in my previous post.

In this post I've tried to describe the realities surrounding cellular SEP royalty levels for mobile phones, based on my own SEP licensing experience. Under the FRAND regime, I believe that the market has managed to strike a balance between innovation value and consumer value and established a cumulative royalty rate at around 10% of the mobile phone OEM selling price for all cellular standards up to 4G. I'm aware that some still believe that cumulative royalty rates are too high, that there's too much litigation going on and that radical changes to the system are urgently needed. I'll end this post by addressing these issues one by one.

Are cumulative royalty rates "too high"? I can't really tell for sure, but at least I don't see any obvious support for that notion. As I mentioned in an earlier post, consumer choice and new future-proof cellular standards hardly seem to be lacking. Also, among the top-10 global mobile phone OEMs of today, virtually none of them had sold a single mobile phone only a decade ago, and some of them didn't even exist a that time. So at least entry barriers are low. Margins may be getting lower for some OEMs, but that can be an effect of fierce global competition thanks to those low entry barriers (!) and perhaps partly even the result of patent hold-outs, i.e.some other OEMs paying  - ironically - too low (i.e. zero) cumulative royalties.

Is there "too much litigation"? Well, with some high-profile litigation cases going on in recent times, one might think that most cellular SEP portfolio license negotiations end up in court. But actually, this is a classic example of an availability error - "if you see it, it must be common". The truth is that most such negotiations are successfully concluded in good faith, far from the limelight, and only a small fraction end up in court. Actually, the most visible litigation case, Apple-Samsung, is fundamentally not about SEPs at all but rather about Apple's attempts to protect its proprietary smartphone user interface functions.

Are changes to "the system" needed? Well no system is perfect, so improvements are always needed. For example, new ideas for improving the transparency of the various fractional ownerships of the total SEPs could be welcomed, especially by new OEMs.  But I can't see an obvious need for any radical changes, since the FRAND technology sharing regime largely works the way it's supposed to work. Policies should continue to encourage successful cellular SEP portfolio licensing through good faith FRAND negotiations, which is still the norm today as it has been for decades. It's important that the cumulative rate and SEP portfolio proportionality principles are respected by all market participants. Any policy adjustments should work within the current framework and in a balanced way continue to make sure that it's difficult for individual SEP-holders to seek too much royalty as well as for OEMs to hold out for too little royalty.