Getting to “Reasonable”

Law Seminars International Standards Bodies and Patent Pools Conference Arlington, Virginia October 2007 Alan Cox Senior Vice President NERA Economic Consulting San Francisco, California [email protected]

Gil Ohana Counsel WilmerHale LLP Palo Alto, California [email protected]

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Framing the Issue

• First:

– Standards developers require or encourage FRAND or RAND licensing commitments

• Then:

– Standard is adopted and enjoys success

• And:

– Disputes emerge between owners of essential patents and implementers of standard as what “reasonable” means 2

Smoothwheels v. Kimono Cycles (1)

• Smoothwheels contributes patented technology to FastRide standard.

– Standard is successful, and market for bicycle components grows quickly • After standard is finalized, and patents issue, Smoothwheels negotiates licenses with two implementers – 5 percent royalty, with cross-license and grantback to improvements 3

Smoothwheels v. Kimono Cycles (2)

• Smoothwheels’ negotiation with Kimono: – Smoothwheels seeks same terms it has received from other licensees – Kimono agrees to royalty terms and cross license to related patents, but refuses grantback – Smoothwheels counters: • 10 percent royalty • One-year grantback – Negotiations are unsuccessful and Smoothwheels sues Kimono 4

Issues:

• “Lost Profits” vs. “Reasonable Royalty” • Economic approaches to “reasonable” • Applying

Georgia-Pacific?

– Temporal element – Factor analysis • Other evidence: – “Shared Understanding” of participants in FastRide SSO 5

Lost Profits vs. Reasonable Royalty

• The case

for

lost profits: – Where contributor of essential patents competes with infringer, it loses sales and profits to infringer • The case

against

lost profits: –

Panduit

itself rejects limiting damages to reasonable royalty because to do so subjects patentee to “compulsory license”.

1/ – But, where patent that is infringed is one patentee committed to license on reasonable terms, license is not compulsory 6 1/

Panduit Corp. v. Stahlin Bros. Fibre Works,

575 F.2d 1152, 1158 (6 th Cir. 1978)

Ways in Which Analysts Try To Model The Royalty Bargain:

1. Market Based Reasonable 2. Use of Comparables Can Be Reasonable If Done Well (and they exist) 3. Industry Rules of Thumb Unreasonable (Will Only Be Reasonable With Luck) 4. 25% Rule/ Standard Profit Split Unreasonable

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Price Premium for Lighter Front Derailleurs

Price Per Part $32 $30 $28 $26 $24 $22 $20 0 20 40 Observed Prices of Fastwheel-Compliant Front Deraillerus Made 60 80 100 120 Observed Prices Front Derailleurs Made to the Old Standard 140 160 180 200 Weight Price of Kimono’s Fastwheel Compliant Front Derailleurs

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Price Premium for Lighter Front Derailleurs

Price Per Part $32 $30 $28 $26 $24 $22 $20 0 20 40 60 Price of Kimono’s Fastwheel Compliant Front Deraileurs 80 100 120 140 160 180 200 Weight Price Kimono would have charged for Front Deraileurs of the same weight compliant with the old standard

9 9

Price Premium for Lighter Front Derailleurs

Price Per Part $32 $30 $28 $26 $24 $22 $20 0 20 Price Premium Claimed by Smoothwheels as Due to its Patents 40 60 Price of Kimono’s Fastwheel Compliant Front Deraileurs 80 100 120 140 160 180 200 Weight Price Kimono would have charged for Front Deraileurs of the same weight compliant with the old standard

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Smoothwheels Claims that the Value of Patent Is Difference in Amount Market Would Pay for the Attribute Price Differences Among Different Standards Price Per Crankset $400 $350 Price Premium Claimed by Smoothwheels as Due to its Patents $300 $250 $200 $150 $100 Crankshaft Using Fastspeed Standard Crankshaft Using Previous Standard Prices Observed in: Mid - Atlantic Region North - East Region

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Price Per Crankset $400

What if There is an Alternative Standard?

Price Differences Among Different Standards $350 $300 $250 $200 $150 $100 Crankshaft Using Fastspeed Standard Crankshaft Using Alternative New Standard Prices Observed in: Mid - Atlantic Region North - East Region Crankshaft Using Previous Standard

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Kimono Claims that the Relevant Difference is with the Next Best Alternative

Price Per Crankset $400 Price Differences Among Different Standards $350 $300 $250 $200 $150 $100 Crankshaft Using Fastspeed Standard Crankshaft Using Alternative New Standard Prices Observed in: Mid - Atlantic Region North - East Region Crankshaft Using Previous Standard

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Kimono Claims that the Relevant Difference is with the Next Best Alternative

Price Per Crankset $400 $350 Price Differences Among Different Standards Price premium over alternatives considered by SSO $300 $250 $200 $150 $100 Crankshaft Using Fastspeed Standard Crankshaft Using Alternative New Standard Prices Observed in: Mid - Atlantic Region North - East Region Crankshaft Using Previous Standard

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Differences in Prices and Market Advantages Converts to Increases in Profits

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Infringer’s Maximum Willingness to Pay

$ Profit from Using the Patent Profit from Using the Next-Best Alternative Extra Profit from Using the Patent

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Applying

Georgia-Pacific: Temporal Element

•

Georgia-Pacific

hypothetical negotiation takes place at time infringement begins.

1/ – Infringement typically does not begin until after standard has been approved.

• Debate over whether in cases involving infringement of essential patents, “hypothetical negotiation” should instead be seen to occur at time of decision to include patented technology in standard – In

Rambus

remedies opinion, FTC favors determining reasonable royalty from

ex ante

perspective.

.2/ 1/ 2/

Wang Lab Inc. v. Toshiba Corp.,

993 F.2d 858, 869-70 (Fed. Cir. 1993

) Matter of Rambus, Inc.,

No. 9302 (FTC, Feb. 5, 2007) at 16-17.

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Applying

Georgia-Pacific

: Relevant Factors

• • Because patentee has committed to license,

Georgia Pacific

factor 1 (royalties received for licensing same patent) likely to be important – “ND” element of RAND: should it limit ability of patentee to distinguish other licenses it has given?

– How to value non-economic components of license?

•

E.g.,

cross-licenses, grantbacks, defensive suspension provisions

Georgia-Pacific

factor 4 (patentee’s policy of refusing to license) drops out.

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Modeling the Hypothetical Negotiation

Extra Profit from Using the Patent Lifetime Expected Total Revenue Maximum Royalty = Lifetime Expected Extra Profit Lifetime Expected Total Revenue

= 6% 19 19

0%

Determining the Bargaining Range in a Hypothetical Negotiation in a Patent Case

6% Potential Licensee’s Maximum Willingness to Pay: Based on: Added Profits Due to Being Able to Sell Product at Higher Price

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Hypothetical Negotiation Analyzed in Light of

Georgia-Pacific

Factors

6: 7: 8: 9: 10: 11: 12: 1: 2: 3: 4: 5: 13: 14: 15:

Royalties paid for licensing of the patent Rates paid for other comparable patents Nature and scope of license Licensor’s licensing policy Commercial relationship Convoyed sales Duration of the patent and term of license Profitability of the patented product Utility/advantages of invention Nature/benefits of the patented invention Extent of alleged infringer’s use of invention Customary portion of profit Portion of profit credited to alleged infringer Testimony of experts Hypothetical negotiation 21 21

Hypothetical Negotiation Analyzed in Light of

Georgia-Pacific

Factors

2: 3: 4:

Nature and scope of license Licensor’s licensing policy

1: 5: 6: Royalties paid for licensing of the patent

Convoyed sales

7:

Duration of the patent and term of license

15: 8: 9: 10: 11:

Profitability of the patented product Nature/benefits of the patented invention Extent of alleged infringer’s use of invention

12:

Rates paid for other comparable patents Customary portion of profit

13:

Portion of profit credited to alleged infringer

14:

Testimony of experts 22 22

Determining the Bargaining Range in a Hypothetical Negotiation in a Patent Case

Bargaining Range 0% 1% Minimum Patent Owner Would Accept: Based on: Lost Profits Due to Increased Competition and Lost Licensing Opportunities 6% Potential Licensee’s Maximum Willingness to Pay: Based on: Added Profits Due to Being Able to Sell Product at Higher Price

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Agreed-Upon Rate Within Bargaining Range



If firms have equal bargaining power, bargain might split the difference. 1%



Other factors, including Georgia-Pacific Factors, influence the final rate above or below mid-point.

6%

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Economically: What Tends to Make a Royalty Reasonable?

A royalty tends to be reasonable if: A royalty tends to be is unreasonable if:

• It applies market-based economic analysis in the Georgia-Pacific framework • It considers the value of the patent to both parties to the negotiation • It takes into account the availability of non infringing alternatives • There is no link between the royalty and the value of the patent (or standard) • There is no consideration of non-infringing alternatives • There is no consideration of work-around alternatives 25

Shared Expectations of Participants

• If views of participants in standards development is informative as to meaning of rules of SDO (

Rambus

), should they be similarly informative as to meaning of RAND?

– Where views of participants are based on past licensing practices for similar technologies, may be probative under

Georgia-Pacific

factor 2, royalty rates for comparable technologies – What if views are specific to particular standards development effort?

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