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.

Federal Circuit dismisses SSPPU "rule"

Readers of this blog will know that I've frequently questioned the idea that there's a "rule" mandating that royalty or damages for infringing multi-component products be calculated using a "Smallest Salable Patent-Practicing Unit" (SSPPU) as a value-base. The idea of this "rule" has attracted quite some powerful followers and in February 2015 it was even codified into the new IEEE patent policy (!).

Well, on December 3, 2015, in an appeal decision in the CSIRO vs. Cisco case, the US Federal Circuit made it crystal clear that no such "rule" exists.

The decision includes other interesting opinions too, but I'll limit this post to royalty-base aspects. 

This statement from the decision sums things up quite nicely:

"The rule Cisco advances — which would require all damages models to begin with the smallest salable patent-practicing unit — is untenable. It conflicts with our prior approvals of a methodology that values the asserted patent based on comparable licenses. ...Such a model begins with rates from comparable licenses and then “account[s]for differences in the technologies and economic circumstances of the contracting parties.” Finjan, 626 F.3d at 1211. Where the licenses employed are sufficiently comparable, this method is typically reliable because the parties are constrained by the market’s actual valuation of the patent."

In other words, an SSPPU royalty-base "rule" would e.g. conflict with the use of comparable licenses as evidence of damages value. Given the importance placed on comparable license evidence in US law, an SSPPU royalty-base "rule" can therefore not exist.

Besides the square dismissal of the imaginary SSPPU "rule", the Federal Circuit also noted that:

"The choice of royalty base — which is often the focus of the apportionment analysis—is irrelevant to the district court’s analysis. The particular rates relied on by the district court were contemplated as cents per end unit sold by Cisco, but they could equally have represented cents per wireless chip without affecting the damages calculation.",

and:

"Because the parties’ discussions centered on a license rate for the ’069 patent, this starting point for
the district court’s analysis already built in apportionment. Put differently, the parties negotiated over the value of the asserted patent, “and no more."".

It's good to also see this point being made. People - oddly - seem to forget that payments for legitimate use of others' IPR are not made in "percent", but in real money, i.e. Dollars, Euros, Yuan etc. So what's ultimately relevant is the value - in real money - that a patent portfolio brings to the end-product. In this sense, a too strong focus on a specific model parameter such as a royalty-base is arguably irrational.

Hopefully, this Federal Circuit decision can bring any ongoing debate about SEP FRAND license value in line with actual law. 

FOSS patents and the royalty base

In a recent FOSS patents post, blogger Florian Mueller continues to advocate that the SEP license royalty base for cellular mobile devices should be changed from the end-product to the "smallest saleable unit", i.e. the chipset. In the post, quite some disappointment is expressed regarding Judge Robart's "failure" to mandate a chipset royalty base in Microsoft vs. Motorola. 

As I mentioned in a previous post, the royalty base is a parameter in a specific royalty calculation model. What matters in the end is the absolute payable royalty, and that it considers the value that the patent portfolio in question brings to the end-product. I believe that judges adjudicating patent cases are generally well aware of this.

But there's a statement in the FOSS patents post that specifically caught my attention: "Apple's position is that the difference between the price of an iPhone and that of a cheap "feature" phone (colloquially also called "dumbphone") is unrelated to wireless communications standards. I support Apple on that one"

I'm not sure I'd support that statement. The difference in price between a "dumbphone" and a "smartphone" most certainly appears to be related to wireless communication standards. 

Imagine a "smartphone" that only includes 2G wireless communication standards. Such a "smartphone" would hardly command a high price on the market, if indeed it could be sold at all. But simply add 3G/4G to it and suddenly it becomes a very attractive product. Clearly, the 3G/4G wireless communications standards bring tremendous value to a "smartphone" device. 

But while we're at it, why not compare Apples to Apples?

I'll simply quote myself from an earlier post: 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. 

Surely that's a more interesting price difference.

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.

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.

China and Qualcomm - a new reference

On Feb 9, US chip maker and wireless SEP-holder Qualcomm reached a concluding settlement with the National Development Reform Commission (NDRC) of China, under the Anti-Monopoly Law investigation it has been subject to.

In practice, the settlement results in Qualcomm's cellular SEP portfolio royalty rate being 3.25% of the net selling price of 3G- or 3G/4G-compliant devices sold in China. Clearly the Chinese authorities deemed Qualcomm's original rate to be unreasonably high, since the imposed discount is almost 35%.

But besides that specific message to Qualcomm, a broader message can also be detected here. China tells the world that it does not embrace market disruptiveness with respect to the cellular SEP FRAND licensing model per se. It confirms the applicability of long-standing basic SEP-portfolio licensing principles, with the end-product price as the royalty-base and royalty rates in the order of lower single-digit percentages for strong SEP-portfolios.

This message from China is actually a powerful endorsement of the importance of basic wireless R&D to the ecosystem. Hopefully regulators and policy makers worldwide will consider this input when confronted with various SEP-devaluing proposals popping up in recent times.