Wednesday, 11 May 2011

Fruits of Labour not Windfall Gains in Standardization

In pursuance of its policy of strengthening its content relating to intellectual property as a value-generating asset with standards-setting bodies, IP Finance is pleased to host this piece by Keith Mallinson (WiseHarbor):

Fruits of Labour not Windfall Gains in Standardization Basic economic principles that underpin the IP system—such as being able to make a return on the capital, labour and time invested in what are typically risky developments of patented technologies—are as applicable with standards-based technologies as they are elsewhere. Many companies invest a significant percentage of their revenue, amounting to millions or even billions of dollars per year, in R&D of technologies that are then contributed for possible inclusion in industry standards.
While many companies primarily reap their rewards by selling products that implement the standards—with much of the standards-essential IP contributed by others— other companies rely on licensing to generate their investment returns. Large numbers of patents are often included within the definition of technical standards, raising a concern amongst some that the standard may not be generally available to companies for implementation on (Fair), Reasonable and Non-Discriminatory (FRAND or RAND) terms.

Those who implement standards in their equipment are typically more interested in minimizing licensing out-payments than in maximizing cash licensing fees received and so may prefer relatively low rates all round. Accordingly, some of the implementing companies and their
advocates have been vocal in calling for regulatory involvement in licensing terms for standards-essential patents, including proposals to “define” the exact meaning of (F)RAND, impose limits on the aggregate licence fees for all essential patents, or to limit such fees to levels achieved before standardization (“ex ante” terms). However, if regulatory authorities were to impose such limits, the impact would likely be to impede incentives to contribute those technologies to standards or even to invest in such innovations. Imposing constraints, such as limiting licensing fees to “ex ante” levels or other arbitrary limits, will not only short-change those who relied on licensing fees to fund their developments, but discourage high-risk technology investments in follow-on standards upgrades.

Regulatory price-setting in the arena of innovative technologies neither reflects the market reality of commercial negotiation nor is it related to the costs, efforts and technical or commercial risks involved in developing those technologies. Defining (F)RAND according to an imposed pricing structure would severely limit the ability of licensors and licensees to negotiate bilateral commercial terms that reflect their respective positions and needs. There are many uncertainties involved in investing in R&D of innovative technologies.

Many technologies developed are never adopted. Even those technologies that are contributed to a standard and selected for inclusion, on the basis of merit, might never generate return on investment because of the standard failing or being overtaken by a competing standard. Further, minimizing the cost of licensed technologies may not result in a minimum cost solution. In addition to providing higher performance and improved features, incorporating patented IP into a standard may actually reduce the cost of implementing the standard. For example, patented IP might reduce the total cost of ownership to the end consumer of a product such as a mobile phone – including phone acquisition costs (with costs of design, development, bill of materials and assembly) and network service charges (reflecting costs of bandwidth acquisition, network equipment, operations, and maintenance).

The impact of such cost reductions may far exceed any additional costs in licensing fees. Market forces are best at determining the value to be attributed to any input component in such a system, including technology licences. Regulators should be careful to avoid favouring particular business models or making decisions on which part of the value chain deserves to make the greater profit, especially where dynamic innovation is concerned.

Commercial negotiations between companies are the most effective way to balance the interests of the parties and to establish an agreement that takes into account their particular incentives and business relationships. Arbitrary pricing limits or ex-ante terms cannot take such factors into account and fail to recognize the inherent difficulty in determining a “value” for a certain technology early in a standards process or in the case where no competing technology exists. If regulated pricing principles were enforced, it could make patent owners leery of licensing technologies until incorporated in a major standard or of participating in the standards process at all, resulting in inferior and ultimately more costly standards.

The principle of (F)RAND licensing has been broadly adopted to ensure that patent owners who contribute technology to standards agree to make licences available to their standards-essential IP to all comers on terms that are reasonable and free from unfair discrimination, while maintaining the ability to achieve adequate reward for their innovations. There will at times be significant contention between the patent owner and implementer about what constitutes reasonable licensing terms, but this is to be expected as with commercial negotiation on any input cost component and has, for the most part, been readily resolved through bilateral negotiations. In the rare instances where such negotiations have not been successful, contract
law is applicable to the (F)RAND commitment and the courts are able to deal with such disputes (although some cite examples of apparently outrageously high court award of damages to patent holders, such examples are extremely rare as have been demonstrated by independent academic researchers. See eg "Are Patent Infringement Awards Excessive?: The Data Behind the Patent Reform Debate" by Michael J. Mazzeo, Kellogg School of Management, Northwestern University, Jonathan Hillel, Skadden, Arps, Slate, Meagher & Flom LLP and Samantha Zyontz, George Mason University School of Law, available on SSRN here).

However, in the vast majority of cases, the (F)RAND regime and bilateral licensing agreements have enabled the successful deployment and rapid growth of standards-based products and systems. Some notable examples of such successful deployments include the GSM (with four billion users) and WCDMA (with approximately one billion subscribers expected by yearend) wireless telecommunication networks. The flourishing market for mobile phones, which have transformed our business and daily lives, is evidence of the success of the economic incentives created by the IP system and the market-driven FRAND framework for licensing standards-essential IPR.

In summary, there has been no evidence of “windfall gains” to patent owners impeding the adoption of any technology-based standard. On the contrary, the rapid and extensive adoption of WCDMA and earlier GSM telecommunication standards have demonstrated the success of the FRAND discipline employed by standards setting bodies such as European Telecommunications Standards Institute (ETSI) in promoting widespread deployment of networks and products utilizing the adopted standards".

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