Fair Standards Alliance and the licensing point

A grouping that calls itself Fair Standards Alliance (FSA) appears to want to give FRAND a "clearer meaning in order for standards to promote innovation, economic growth, competition, and consumer choice."

FSA has published a position paper outlining some principles to this effect. Several of them seem reasonable and generally in line with the law, competition authority investigation outcomes and established SEP FRAND licensing practices. Others are more dubious, such as an unhealthy emphasis on a chipset royalty base. 

However, a key message from FSA relates to the so-called "licensing point" that I've written about earlier and defined as "the entity among several entities in a product value-chain that obtains a patent license for making or selling products". FSA essentially conveys the message that:

a) an SEP license should be available at any licensing point, and

b) the same royalty should apply regardless of licensing point. 

Now, while a) and b) certainly don't sound unreasonable per se, the irony in this message from FSA should not be missed. It's well-known that there are only a few upstream entities harbouring an expressed desire to become a wireless SEP licensing point in the first place. And this wish typically comes along with the caveat that the SEP royalty must be discounted by something like 99%.

Looking past the irony though, FSA's wish to move the wireless SEP licensing point upstream is worth discussing, including some practical considerations. 

I have previously described how the issue of so-called "grant-back" tends to prevent the licensing point for at least mobile phones from moving upstream, as long as there are SEP-holding mobile phone and/or infrastructure OEMs around. I won't elaborate on that issue further here as it's a bit intricate, so interested readers may check the earlier post for details.

Furthermore, FSA's promotion of an upstream licensing point relies on an implicit assumption. Namely that the SEP-portfolio license value to the end-product is the same regardless of end-product-type. But as I also touched upon in the earlier post, that's not necessarily true. For mobile phones, the cellular SEP-portfolio FRAND license value is well-established by markets and courts. But in principle, there could exist other types of end-products for which this license value could be lower than for mobile phones. This could e.g. be due to significant aspects of the standard, along with their patented features, being less valuable to those end-products.

Take a refrigerator for example, an end-product actually mentioned in the FSA position paper. Many advanced patented innovations for cellular standards relate to ways of being able to communicate effectively in presence of challenging and dynamic radio conditions or with limited available power.  But the fridge isn't going anywhere in particular and it's connected to the power grid day and night. So for the fridge, the value of the cellular standard in itself - and hence of a license to all its associated SEP portfolios - may perhaps be considered lower than for a mobile phone.

In such a case, one could argue that it ought to be possible for SEP-holders to "promote" the standard in question towards such a product-segment by offering a discounted royalty from that of mobile phones. Provided of course that such an offer would still be considered FRAND. As long as it's a sufficiently differentiated end-product category and the same discounted offer would be provided to all providers of such end-products, this would most likely be the case. 

But if the chipset vendor would be the SEP licensing point, such a promotion might become challenging, since chipset vendors typically don't know what end-products their chipsets will end up in. While this could in principle be solved by advanced logistics management and proper contractual follow-up, it may still turn out to be difficult in practice.

On the other hand, the chipset vendor is not the only potential upstream SEP licensing point. For example, module vendors or solution providers within the vehicular or telemetry industries could also be licensing points. In such a scenario, traceability may become less of an issue since there would be stronger end-product control. 

Summarizing all of this, there's actually nothing per se that prevents the SEP licensing point from moving upstream from the end-product OEM. There are certainly practical obstacles that can be identified as I've expressed here and previously, but at the end of the day they're probably not insurmountable. 

Therefore, the biggest reason for the cellular SEP licensing point staying at the end-product OEM level may well be the refusal by upstream entities to accept the FRAND royalty levels established by markets and courts.

For mobile phones, established royalty levels consider the value brought to the end-product and end-user. Thus the royalty can ultimately be seen as a cost distribution issue between the end-product OEM and the end-user. By contrast, upstream intermediate products such as chipsets do not take into account this end-product SEP value at all, which is clearly reflected in their prices. But if - as seemingly desired by FSA - the cellular SEP licensing point is to generally move upstream, relevant FRAND royalty levels would certainly have to be made visible upstream too.

Who needs a license to standard essential patents?

Having recently discussed some specific court cases and hot topics, I thought it might be time for a more generic post on licensing concepts and principles. Specifically, I'd like to talk about what I call the "licensing point" for patents in general and Standard Essential Patents (SEP) in particular. Simply put, I'll try to answer the question; "Who needs an SEP license"?

By "licensing point" I mean "the entity among several entities in a product value-chain that obtains a patent license for making or selling products". We know that in the case of mobile phones, the Original Equipment Manufacturer (OEM) - the entity that puts a ready-to-use end-product on the market with a brand name belonging or licensed to it - is the SEP licensing point. In this post I'll discuss why this so, and also whether it's likely to stay that way going forward. 

Generally speaking, the licensing point is ultimately selectable by the patent holder, and could be virtually any entity in the value chain whose product encompasses the inventions covered by the licensed patents. It could be the end-product OEM, a component manufacturer or an entity in-between those. It could even be a point downstream from the OEM, like a whole-seller or a high-street- or Internet retailer. The royalty parameters just need to be properly adjusted in every case to reflect the ultimate license value to the end-product. For sure there can be practical complications in implementing some of these licensing points, but they should be perfectly permissible per se.

But that's more of a theoretical observation, now let's look at specifics. As stated, the OEM happens to be the cellular SEP licensing point. But why is that exactly? As it turns out, there are several reasons. 

We can start with a simple historical reason. Up until the end of the 1990's, the only OEMs that existed on the mobile device market were all vertical OEMs. So in fact there was only one possible licensing point.

So that was easy. But as we know today, this market structure changed a lot since then, so an interesting question is why the licensing point did not change with it. 

Indeed, the mobile device industry went through a structural change during the first decade of this century. From consisting of only a handful of vertical OEMs, it became more diverse, including a value-chain of specialized entities. This change was initially led by Qualcomm on the chipset level and further downstream by Taiwanese "notebook ODMs". 

  

However, in spite of increased specialization, some vertical or near-vertical OEMs still remained and new ones even emerged. Today there are pure mobile device vertical OEMs (Samsung, LG), pure infrastructure vertical OEMs (Alcatel-Lucent, Ericsson, Nokia) and combined mobile device and infrastructure vertical OEMs (Huawei), all doing pretty well in the marketplace. These companies have substantial in-house knowledge and control of the chain from components or chip-sets all the way down to the manufactured finalized product. So to maintain that position there's a need for these OEMs to invest rather heavily in R&D and standardization, which in turn will also generate SEP portfolios.

Now, for all such SEP-holding OEMs, an interesting question arises; would it be appropriate for the mobile device SEP licensing point to move upstream from the OEM level to e.g. the chipset manufacturer level?

While such a move might seem plausible at first glance, it could lead to complications. To understand this, let's first look at a hypothetical example scenario, but using real-world entities for ease of explanation. Take a SEP-holding mobile device OEM like Samsung. Assume that Samsung would license its SEP portfolio at a point upstream from the OEM level, let's say to chipset maker Mediatek.
Now as long as another SEP-holding OEM, for example Huawei, located downstream from Mediatek would not assert its SEP portfolio against Samsung, this would be just fine. But if it would - and it likely would because Huawei would have a FRAND commitment as an SEP holder - then Samsung might have reasons for concern. In the example scenario, while Samsung needs an SEP license from Huawei, things are not as obvious regarding Huawei's need of an SEP license from Samsung. In many jurisdictions, Samsung's license to Mediatek can be seen as inherently providing certain rights to Huawei under Samsung's patents, for products that include Mediatek's chipsets. So in effect, Samsung's license to Mediatek could limit its own defenses against an SEP portfolio assertion by Huawei against Samsung's products.

However, if Samsung would instead continue to consistently license the last point in the chain -  in this example Huawei - then no such issue would occur. Then Samsung could procure a maximally efficient SEP portfolio cross-license with Huawei because it's 100% clear that Huawei needs a full license from Samsung, regardless of what chipsets happen to reside in its products. This so-called "grant-back" issue is one reason why the cellular SEP licensing point prevails at the OEM level also in today's more specialized world.

Now those particular companies were used only as examples, and I don't know the real licensing situations among them. But the example illustrates that at least as long as there remain SEP-holding mobile and/or infrastructure OEMs - which tend to be verticals - generally healthy and successful in the global marketplace, this will be a continuing factor that tends to keep the SEP licensing point for mobile devices at the OEM level.

But there are also other reasons for the OEM being the licensing point. Like the issue of "patent value apportionment". A license to an SEP portfolio needs to be priced based on the value the technical inventions therein bring to the end-product. In US law this has been made clear in e.g. the well-known CSIRO vs. Cisco and Ericsson vs. D-Link et. al. cases. And the easiest point to observe the value the inventions bring to the end-product is - not surprisingly - at the end-product level, i.e. the OEM level.

We can look at the illustrating example of the iPod Touch vs. the iPhone. These products are very much alike, with the difference largely being that one has cellular connectivity and the other one doesn't. The products have similar specs and both carry the "brand magic" of the OEM, Apple. Yet today's price difference between the two is around $250. 

As I mentioned in another post, the price difference not only illustrates the tremendous value of adding standardized cellular technology to an otherwise similar device. It also indicates the value of a license to the SEP portfolios covering it. Due to the way standards are created, the SEP portfolios covering a standard include those innovative technologies that won the competitive race to allow that particular standard to fulfil its specific requirements. Therefore the accumulation of SEP portfolios for a standard do in fact drive the value of the standard itself.

The market has established the accumulated SEP portfolio license value for a mobile device to be somewhere close to 10% of the OEM selling price of the end-product. This is a fraction of the value the standard itself brings to the end-product, but also more than the cost of a chipset. Clearly, when component suppliers don't account for SEP license costs, the component prices don't reflect the value of SEP portfolio licenses to the end-product at all. Another way of viewing this is that if the licensing point would hypothetically move to the chipset level, the chipset cost would have to increase many-fold. That may seem odd at first, but remember that this is accounting for the value to the end-product.

There are some recent and quite loud voices in the industry that - notably without rational or legal support - advocate that basing wireless SEP license royalties on end-product price is "non-FRAND", and that such royalties "must" be based on the chipset value. Actually, such calls are not always explicitly about moving the licensing point to the chipset level per se. Indeed, licensing point and royalty base are separate things. With the licensing point kept at the OEM level, a chipset value royalty base could still be possible in principle, by setting the royalty rate to some hundreds of percent. Ultimately, the royalty base is just a parameter in a certain calculation model, and what matters in the end is the value to the end-product. 

Another related factor driving the OEM licensing point is that the value of the standard may be different for different end-products. Since the value of licenses to the accumulation of SEP portfolios is proportional - but not equal - to the value of the standard, the license value can also vary between different end-products. For a mobile phone the value is very obviously large, but there are end-products for which the value might be considered smaller. For a vending machine or utility meter for example, the standardized cellular connectivity - and a license to all patented inventions therein - might for various reasons not necessarily be considered as tremendously valuable as for a mobile phone. Now if the licensing point would be moved to the chipset level, there'd be an issue with chipset tracability, or rather the lack of it. In fact, chipset manufacturers don't always know what type of end-product their chipsets ultimately end up in. Consequently it can be hard to determine the appropriate end-product license value at the chipset level. 

In this post, I've outlined some rational reasons for why SEP-holding OEMs conclude SEP portfolio licenses at the end-product OEM level. While it's certainly possible that this might change in the future, my guess is that some factors that make it rational to keep the licensing point at the OEM level will prevail for some time to come.