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Canstandardsettingorganizationsaddresspatenthold­up?Commentsforthe

FederalTradeCommission

TimothySimcoe,BostonUniversitySchoolofManagement

Standardsettingorganizations(SSOs)areforumswherefirmsnegotiateovershared

designparameterssotheirproductscanworkwelltogether.Thisprocessproduces

manybenefits:usersmayshareinformation,or“mixandmatch”components;the

costofmarketentrydeclines;andthereisadivisionoflabor,enablingspecialization

incomponentproductionandinnovation.Whileinter‐operabilitycanbeachievedin

otherways,suchasdecentralizedtechnologyadoptionortheactionsofadominant

firm,SSOsareperhapsthemostcommonpathtocompatibility.1

AntitrustauthoritieshavegenerallyviewedSSOsasaformofpro‐competitive

horizontalcooperation.Forexample,theUnitedStates’StandardsDevelopment

OrganizationAdvancementActof2004(H.R.1086)providesthatSSOsare

evaluatedunderanantitrustruleofreason,andaresubjecttoactualratherthan

trebledamages.However,thereisconcernamongacademics,policy‐makersand

practitionersthatpatent‐holderscanexploitthecooperativestandardsetting

processtoextractexcessiveroyaltiesfromstandardsimplementers.

Whenapatentisnecessarilyinfringedbycompliantimplementationsofanindustry

standard,itiscalled“essential.”Essentialpatentscanbeveryvaluable,sincea

successfulstandardreducescompetitionfromsubstitutetechnologies.Thus,while

SSOsmayhavegoodreasonstoincludepatentedtechnologyinanindustry

standard,doingsoplacesessentialpatentownersinaverystrongbargaining

positionifthestandardsucceeds.Thisisaspecialcaseofwhateconomistscallthe

“holdup”problem.1 Biddle, White and Woods (2010) identified over 500 compatibility standards used in a prototypical laptop computer and found that 80 percent were developed by consortia and formal standards developing organizations. See Farrell and Simcoe (2011) for one discussion comparing alternative paths to compatibility.

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Patenthold‐upproblemscouldbesolvedbydisclosingpatentsandnegotiating

pricesbeforechoosingastandard.Butuncertaintyovertheexistence,validityand

scopeofpotentiallyessentialpatentsmakesitdifficulttonegotiatealicensepriorto

implementation.Asanalternative,manySSOsaskpatent‐holderstocommitto

reasonableandnon‐discriminatory(RAND)licensingterms.However,many

observersworrythatitisnotclearhowfirmsorcourtsaremeanttointerpretthis

promise.

ProponentsofthecurrentsystemarguethatSSOsshouldfocusontechnicalissues;

intellectualpropertyownersshouldbecompensatedforthecostsandrisksof

technologydevelopment;andthatprospectivelicenseescanavoidthehold‐up

problembytakingaRANDlicenseorproposinganalternativetechnologywithinthe

SSO.Thesearevalidpoints,butthereisacounter‐argumenttoeach.Technical

decisionsshouldalwaysbeweighedagainstthelikelycostsofimplementation,

whichincludelicensing.AsdescribedintheFTC’sreporton“TheEvolvingIP

Marketplace”(FTC2011),overcompensatingpatentownershasrealsocialcosts.

Anditisunclearwhetherthepatentsystemorthedisclosurerulesadoptedbymany

SSOsprovidesufficientnoticeforprospectivestandardsimplementerstoengagein

exantenegotiation.

Thisshortessayarguesthatpatenthold‐upinstandardsettingisarealproblem,

andconsidersseveralstepsthatSSOs,courtsandpolicy‐makersmighttaketo

addresstheissue.

Standardsettingandpatenthold­up

Standard setting organizations serve as a forum where industry participants

perform collaborative research anddiscuss themerits of alternative technologies.

Thegoalistoidentifythebestavailablesolutiontoagiventechnicalproblemwhen

therearegains fromcoordinatingona commondesign.Ultimately, SSOschoosea

particulartechnologyandissueaformalendorsement.Thiscertificationismeantto

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signaltheendofdeliberationsandpromoteindustry‐wideinvestmentsinthenew

technology.2

Difficultiesarisewheninvestmentsinanewstandardaresunk(i.e.irreversibleor

technology‐specific),leadingtowhateconomistscalla“hold‐up”problem.3Sunk

investmentsmakeatechnologycheapertodeploy(onaforward‐lookingbasis)than

alternativesolutionsthatofferedapotentialsubstitutebeforestandardization.

Thus,whenthetechnologyinastandardispatented,theintellectual‐property

holdercanchargeroyaltiesuptothedifferenceinimplementationcostsbefore

vendorswillswitch–evenwhentheexantecoststructureoftwotechnologieswas

identical.4Inotherwords,apatentthatisworthlesspriortostandardization(given

theexistenceofaperfectsubstitute)maybecomequitevaluableifSSOendorsement

leadstosubstantialtechnology‐specificinvestments.5

Inprinciple,producersthatrecognizethepossibilityofhold‐upcouldprotect

themselvesbyconductingacomprehensivepatentsearchandsecuringthe

necessarylicensesbeforeimplementinganewstandard.Butfirmsinthe

informationandcommunicationstechnology(ICT)sectorrarelydothisgiventhe

largesearchandtransactionscostsassociatedwithup‐frontlicensing.Justfinding

therelevantpatentscanbehard,sinceamodernlaptoporsmart‐phonewill

implementhundredsofstandardsandinfringethousandsofpatents.Assuming

firmscanlocateallofthesepatents,theymightreasonablyhesitatetosignlicenses

whenthereisuncertaintyovereachpatent’sscopeandvalidity(FTC2011).Finally,

evenifallrelevantpatentscouldbelocatedandtheirscopeandvalidityaccurately

2 David and Greenstein (1990) and Shapiro and Varian (1998) describe the economic and business strategy issues associated with the formal standards process. Rysman and Simcoe (2008) provide some empirical evidence that SSO endorsements have an impact on the value of the underlying technology. 3 Williamson (1985) introduced the hold-up problem, which he called the “fundamental transformation.” Farrell et al (2004) provide a detailed discussion of hold-up problems in this context. 4 While policy debates often focus on “technically essential” patents, it is worth noting that the hold-up problem can also apply to so-called “commercially essential” patents, which are complementary to a standard, but not an inherent part of the specification. 5 Of course, this argument depends critically on the assumption that the patent is valid and enforceable. However, the threat of injunction may provide even “weak” patent owners with a very large stick in the bargaining process.

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assessed,transactioncostconsiderationsleadmanyICTfirmstopreferabroad

company‐widecrosslicenseoveranarrowlicensecoveringjustthosepatents

neededtoimplementaparticularstandard.

Giventhelargesearchandtransactioncostsinmarketsforintellectualproperty,ICT

firmsoftendesign,buildandmarkettheirproductsbeforetryingtoclearallofthe

relevantpropertyrights,eventhoughtthisexposesthemtohold‐upbypatent

owners.Afewlargefirmsnegotiateup‐frontcross‐licenses,buteventhese

companiesmayfindthemselveslockedintoacounterparty’sproprietarytechnology

whenthoseagreementsarerenegotiated.6

Whileinefficientmarketsforintellectualpropertyareageneralproblem,hold‐up

problemsareespeciallyseverewhenfirmsholdpatentsinindustrystandards.Once

astandardhasbeenselected,SSOsworkhardtopromotecoordinatedinvestments

byabroadcommunityofimplementers,andtheseinvestmentsareoftenverycostly

toreverse.Thus,awidelydiffusedstandardprovidesalargepoolofpotential

licensors,reducescompetitionfromsubstitutetechnologiesandmakes

infringementeasytodetect.Simcoe,GrahamandFeldman(2009)providesome

evidenceonthispoint.TheirstudyfoundthatpatentsdeclaredtoSSOswere4to7

timesmorelikelytobelitigatedthanatypicalpatentwiththesameageand

technologyclass.Thesehighlitigationratesdonotimplywidespreadimplyhold‐up,

butareastrongindicationthatthemarketforstandards‐relatedintellectual

propertyisnotfunctioningwell.

Lookingforward,thereareseveralreasonstoworrythatconflictsoverstandards‐

relatedIPwillincreaseandintensify.First,thesecondarymarketforpatents

appearstobegrowing,withincreaseddemandcomingfrompatent‐assertion

entities(PAEs)whosemainbusinessistoacquireandassertpatents.Forexample,6 See Grindley and Teece (1997) for a discussion of broad cross-licensing practices. One example of a cross-license containing essential patents that fell apart at renegotiation is the deal between Motorola and Research in Motion (see Motorola, Inc vs. Research in Motion, Ltd et al., U.S District Court Northern District of Texas, 3:08-CV-0317-G).

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afternegotiationsbetweenNokiaandRobertBoschGmbHfailed,Boschsoldseveral

standards‐relatedpatentstoaPAEcalledIPCom,whosuccessfullyassertedthose

patentsinGermancourts.Thereisalsoabroadshifttowards“openinnovation”

businessmodels,wherefirmscommercializetechnologythroughout‐licensingas

opposedtomanufacturing.FirmslikeQualcomm,whodevelopnewtechnologythat

becomescentraltoanindustrystandard,canearnsubstantialroyaltiesfrom

licensingtheirstandards‐relatedIP.ThestudybySimcoe,GrahamandFeldman

(2009)showsthatwhensmallfirms(whoappeartobeamixofPAEsand

specializedtechnologydevelopers)declareessentialpatentstoanSSO,the

probabilityofsubsequentlitigationincreasessignificantlycomparedtoessential

patentsdeclaredbylargerfirms,whoaremorelikelytobemanufacturers.

Anothercauseforconcernistheincreasingimportanceofinter‐operability,and

particularlythepushforstandardstosupportthedeploymentofelectronichealth

recordsanda“smart”electricitygrid.Newstandardsareclearlyneededto

coordinatetheeffortsofdiversevendorsinrespondingtothesepotentiallylarge

marketopportunities.However,giventhehighlyinelasticconsumerdemandfor

healthandenergyservices,itisnotclearthatintermediarieslikehospitalsorpublic

utilitieshavetheabilityorincentivetobeanactiveSSOparticipantorengagein

protractedfightswithsophisticatedpatentlitigatorsiftheycansimplypassroyalty

costsontoconsumers.

Privatesolutions

MostSSOstakestepstomitigatethepatenthold‐upproblem,typicallybyadopting

intellectualpropertypoliciesthatimposecertainobligationsonmembers’behavior

duringandafterthestandardsettingprocess.Lemley(2002)surveyedthese

policiesatanumberofSSOs.Here,Idiscusesafewoftheirmainfeatures.

Disclosurerules

ManySSOshaverulesthatrequiremembersparticipatingintechnicaldeliberations

todiscloserelevantpatentsorpendingpatentapplications.Forinstance,thepatent

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policyguidelinesendorsedbytheAmericanNationalStandardsInstitute(ANSI

2011)encourageSSOstoadopt“procedureswherebyoneormorerequestsare

madetoparticipantsforthedisclosureofpatentsthatmayberequiredforuseof

standardsinprocess.”ManySSOsalsomaintainapublicrepositoryofpatent

disclosuresorlettersofassurance,whichcanbesearchedbyprospective

implementerswhowishtoseekalicensebeforecommittingtothestandard.

Inprinciple,disclosureallowsSSOparticipantstoevaluatetrade‐offsbetween

technicalqualityandtheexpectedcostofimplementation.Inpractice,thereare

severalreasonswhythedisclosureprocessmaynotworkwell.Oneproblemisthat

disclosurerulesrarelyrequirefirmstosearchforordisclosespecificpiecesofIP.As

aconsequence,manyfirmsissue“generic”or“blanket”disclosuresindicatingthat

theyholdessentialpatents,butwithoutprovidinganypublicationnumbers.Clearly,

thesedisclosuresprovidelittleguidancetostandardsdeveloperswhoaretryingto

understandwhatpartsofaspecificationareactuallycoveredbypatents,orwhether

thosepatentsarevalidandenforceable.Simcoe(2005)suggeststhatonethirdofall

disclosuresmadetoagroupofnineSSOsprovidenoreferencetospecificIP,with

muchhigherratesofblanketdisclosureatcertainSSOs.

Thelogicofblanketdisclosureiscloselytiedtotheproblemofpatentnotice.Given

longpendencylags,andthewidespreaduseofcontinuationsanddivisional

applicationstoamendclaimsovertime,itisoftenunclearwhetherapending

applicationwillbeessentialatthetimeastandardisendorsed.Thecostsoflocating

essentialpatentscanalsobelargeforfirmswithsizablepatentportfoliosthat

participateinmanySSOs.Ofcourse,theswitchtoblanketdisclosuredoesnot

actuallyreducethesesearchcosts;itmerelyshiftsthemontoprospective

implementersandotherstandardsdevelopers,whoarearguablylessinformed.

Simplymandatingdisclosurespecificitywillnotnecessarilysolvetheproblemof

poornoticeunderblanketdisclosurepolicies,sincelargepatentholderscanadopta

highlyinclusiveapproach,e.g.claimingthatnearlyalloftheirpatentsarepotentially

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essential.Forexample,ETSIrequiresexplicitdisclosureandsometimesgets

thousandsofdeclaredessentialpatentsforasingleproject.Ifonlyafewofthese

patentsaretrulyessential,implementersandstandardsdevelopersfaceessentially

thesamesearchanddiscoveryproblemasunderablanketpolicy.

AsecondproblemwithSSOs’disclosurerulesisthattheydonotguaranteetimely

informationprovision.Standardscommitteesmaytakeseveralyearstoagreeona

specification.Duringthattime,asconsensusbeginstoemergeonkeydesign

parameters,firmswilloftenbegintocommitdesignandmarketingresourcestothe

nascentspecification.WhileSSOsencourageparticipantstodisclosepatentsasearly

aspossible,thereisnothingtopreventanopportunisticpatent‐holderfromwaiting

untilthelastmoment.Atthatpoint,ifthereislittlechancethatthestandardwillbe

redesigned,thepatent‐holderhasmanagedtoputthemselvesinapositiontohold‐

upimplementerswithoutviolatingtheletteroftheSSOsdisclosurepolicy.

Moreover,toanoutsideobserver,theseopportunisticdelayswilloftenbe

indistinguishablefrom“late”disclosurescausedbylast‐minutechangestothe

standardthatmakeafirm’spreviouslyirrelevantIPessential.Effortstodefine

“timely”disclosurewouldlikelyencounterstrongresistance,giventhepractical

difficultiesofdistinguishingbenignfromopportunisticdelays.

WhiletimingandspecificityposedifficultproblemsforSSOs,disclosurepolicies

remainausefultoolfortheirmembers.Inparticular,thedisclosureprocess

providesaplacewherefirmscanmakeunilaterallicensingcommitments(perhaps

withaneyetowardsgainingacceptanceoftheirtechnology).Thedisclosureprocess

alsoprovidesaforumwherepatent‐holderscanplaceprospectiveimplementerson

noticethattheyexpecttobepaid.Finally,whenSSOsprovideapublicrepositoryof

disclosuresorlettersofassurance,itsimplifiestheprocessofmatchingfuture

implementerstokeyintellectualpropertyowners.

Perhapsthebestwaytoaddresstheproblemsofdisclosuretimingandspecificity

wouldbethroughreformstotheunderlyingpatentsystem.Highqualitypatents

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thatissuedmorequickly,andwhoseevolvingclaimswereeasiertopredict,would

makeitsimplerforSSOparticipantstoevaluatetrade‐offsamongsolutionswith

differentcost‐qualityprofilesonaforward‐lookingbasis.

LicensingCommitments

Inadditiontodisclosurerules,manySSOsrequireparticipantstomake

commitmentsregardingthetermsandconditionsofanylicensetheywillofferfor

patentsneededtoimplementastandard.AfewSSOsaskforveryspecificlicensing

commitments.Forinstance,theWorldWideWebConsortium(W3C)willonly

endorsetechnologiesthatcanbeimplementedonaroyalty‐freebasis,andtheHDMI

Consortiumasksimplementerstosignan“AdoptersAgreement”andpayanannual

feeof$10,000plusaroyaltyof$0.15perunitsold.7However,themostcommon

policyistorequireacommitmenttolicenseon“reasonableandnon‐discriminatory”

(RAND)or“fairreasonableandnon‐discriminatory”(FRAND)terms.

Whetherbecauseofantitrustfears,orconcernsthattheywillupsetcertain

members,SSOstypicallyshyawayfromprovidinganexplicitdefinitionofRAND,

leavingthemattertoindividualfirms,andultimatelycourts.Asaconsequence,

firmsoftentreatthiscommitmentasmerelyapromisetoenterlicensing

negotiations.Thereisnothingtopreventpatent‐holdersfromgoingbeyondaRAND

commitment,forinstancebypledgingtoofferaroyalty‐freelicense.Butasidefrom

unilateralcommitments,itisnotclearthataRANDpromiseplacesanyrestrictions

onprospectivepricesorlicensingterms,asidefromabanonexclusivity.8

Howthen,shouldweinterprettheRANDpromise?Economistshavesuggestedthat

a reasonable royalty will reflect the ex ante benefits of adopting a particular

technology as the industry standard, but not the additional switching and7 The W3C patent policy is published at http://www.w3.org/Consortium/Patent-Policy-20040205/ and the HDMI Adopters Agreement is published at http://www.hdmi.org/manufacturer/terms.aspx (both accessed July 8, 2011). 8 While there is considerable debate over the meaning of RAND, it is clear that firms cannot void their RAND pledge by selling the patent. See In the Matter of Negotiated Data Solutions LLC, FTC File No. 0510094, for a discussion of efforts to circumvent SSO licensing commitments through patent sales.

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coordinationcostscreatedbystandard‐settingprocessandthetechnology‐specific

investmentsitencourages(e.g.SwansonandBaumol2005;Layne‐Farraretal2007;

Farrell et al 2007). But these proposals rarely specify how onemight calculate a

reasonablepriceafterinvestmentsaresunk,orinsettingswithsignificantnetwork

effects and complementarities among component technologies. As for non‐

discrimination, firms clearly do not interpret this to mean uniform pricing for a

stand‐alone license to essential patents. Perhaps non‐discrimination means that

essential patent holders cannot offer an exclusive license? But if licensors are

allowed to charge different rates to each licensee, and there is no cap on a

reasonableprice, itseemsthat licensorscouldofferdefactoexclusivity,orat least

substantialcompetitiveadvantage,withoutviolatingaFRANDcommitment.

Oneapproachtothe“reasonable”prongoftheRANDcommitmentistotreatitasa

promise to forgo lost profits as the approach to calculating damages in patent

infringementlitigation.Initsplace,courtswouldpresumablysetreasonableroyalty

damagesbasedonahypotheticalnegotiationbetweenawillinglicensorandwilling

licensee. The U.S Federal Trade Commission (FTC 2011) describes several

difficulties with such an analysis, and suggests that courts may systematically

overcompensatepatentholdersinapplyingthehypotheticalnegotiationframework.

Here,Isetasidethecontroversialquestionofexcessivedamagesandhighlightthe

economic importance of assuming that any hypothetical negotiation takes place

beforetheselectionanddiffusionofthestandard.

First, as emphasized by the economists cited above, an ex ante negotiation will

compensate licensors for thebenefits createdby selecting their technology as the

standard, but not the switching and coordination costs caused by implementers’

sunkinvestments.Second,inahypotheticalexantenegotiation,thereshouldbeno

presumption that the patents were known to be valid and infringed. Third, and

perhapsmostimportantly,theexistenceofalternativestothepatentedtechnology

placeanupperboundona licensees’willingnesstopay.Thelastpoint issubtle in

thestandardscontext.Itmaybedifficulttoviewtechnologiesthatlooklousyexpost

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as post as attractive ex ante substitutes, or to distinguish between a technology’s

innate benefits and the cumulative effect of sustained investment by a broad

communityofimplementers.Moreover,ahypotheticallicensee’sexantewillingness

topaywilldependnotonlyonthemeritsofthebestavailablesubstitute(asinthe

case of a bilateral negotiation), but on the anticipated actions of other firmswith

respect to the nascent standard. Thus, courts may need to consider the price at

which the substitute technology becomes a suitable choice for the pivotal SSO

participant (i.e. the SSO member who casts the deciding vote) and not just the

differenceinexantewillingnesstopayofthedefendantinaparticularcase.Despite

these complexities, it is important to recognize thatwhen there are closeex ante

substitutesforapatentedtechnology,areasonableroyaltymaybeverysmall.

Assumingthe“reasonable”prongofRANDdoesrefertothemethodofcomputing

infringementdamages,SSOscouldtakeseveralstepstoimprovethelikelihoodthat

courtsunderstandthesepoints,andreacheconomicallysoundconclusionswhen

calculatingreasonableroyaltydamages.Onesuchstepwouldbetoclarifythe

meaningofRANDbyexplicitlydefining“reasonable”asthepricereachedthroughex

antenegotiationbetweenawillinglicensorandwillinglicensee.Anotherusefulstep

wouldbetoclearlydocumentcaseswheretherewasaconsciouschoicebetween

competingsolutions,andprovidingsomeindicationofhowtherelativemeritsofthe

differentapproacheswereviewedatthetime.

SomeobserverstaketheviewthatRANDcommitmentsnotonlycommitpatent

holderstoaparticulardamagesrule,butalsowaivetheirrighttoseekinjunctive

reliefagainststandardsimplements.Forinstance,Miller(2007)writesthat,“by

adoptingaRANDpolicy…SSOparticipants…contractoutofaninjunction‐backed

propertyruleintoareasonable‐royaltyliabilityrule.”Whilethisisaninteresting

proposal,patentholdersmightreasonablyobjectthatwithoutthethreatof

injunctionitisverydifficulttobringanobstinateinfringertothenegotiatingtable.

ThematterisripeforclarificationfromSSOs.Butregardlessoftherelationship

betweenRANDandinjunctiverelief,properapplicationofthehypothetical

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negotiationframeworkshouldnotrelyon“comparable”licensesthatwere

negotiatedintheshadowofaninjunction,sincethatthreatwouldnotbeavailableto

thepatentholderinanexanteworldwheretheessentiality,validityand

infringementofthepatentareunknown.

Whilemuchhasbeenwrittenonthedeterminationofreasonableroyalties,thenon‐

discriminationprongofaRANDcommitmenthasreceivedrelativelylittleattention.

OneinterpretationofNDmightbethatlicenseswillbemadeavailableatauniform

price.Butoutsideofroyalty‐freelicensing,itishardtoseehowthiswouldbe

practiced,sinceessentialpatentsareoftencoveredbybroadcross‐licenseswhose

termsvaryfromonedealtothenext.Anotherinterpretationofnon‐discrimination

isthatpatenteesmaynotadopt“divideandconquer”adoption‐forcingstrategies,

suchasanescalatingroyaltyratethatguaranteesearlylicenseesadecisivecost

advantageoverlaterones.AfinalinterpretationoftheNDrequirementisthatit

prohibitsexclusivelicensing,thoughthiswouldberedundantifthereasonable

prongofRANDimpliesawillinglicensor.PerhapsNDsimplyassuresaneasily

pronouncedacronym.

Sofar,courtshavemanagedtoavoidprovidingaclearinterpretationoftheRAND

standard.TheappealscourtinBroadcomv.Qualcommsuggestedthatthefifteen

GeorgiaPacificfactorsprovideausefulstartingpoint.9However,thoseguidelines

havelittletosayabouthowonecoulddetermineareasonablepriceinsettingswith

hundredsorthousandsofcomplementarypatentsperproduct,andwherefirms

makesubstantialirreversibleinvestmentstobringproductstomarketbefore

enteringintolicensingnegotiations.Moreover,astheFTC’sreportontheevolving

IPmarketplace(FTC2011)highlights,theGeorgiaPacificfactorsareonlyalistof

evidentiarycategories,andnotacoherentanalyticalframeworkthatcanbeusedto

calculateareasonableroyalty.Inmyview,thecurrentambiguitysurroundingRAND

commitmentscontributestothehighlitigationrateofdeclaredessentialpatents,

9 See Broadcom Corp. v. Qualcomm, Inc., 501 F.3d 297; 2007.

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makingitreasonableforcourtsandpolicy‐makerstopushSSOsformoreclarity

regardingthiskeydimensionoftheirintellectualpropertypolicies.

ExAnteNegotiations

OnewidelydiscussedalternativetoRANDcommitmentsisforpatent‐ownersto

actuallynegotiatespecificlicensingterms–includingprices–beforeirreversible

investmentsandcoordinationonaparticularsolutionmakesubstitutetechnologies

lessattractive.ThisisessentiallythemechanismproposedbySwansonandBaumol

(2005),Layne‐Farraretal(2007)andFarrelletal(2007)fordetermininga

reasonableprice.

Inprinciple (andperhaps inpractice), firmsmay conductbilateralexante license

negotiationsoutsideofanSSO (seeHerman,2010).Butwhen theoutcomeofany

bilateral negotiation is confidential, it provides no information to other

implementersaboutthetermsthataparticularpatent‐holderviewsasreasonable,

and therefore induces less ex ante price competition between substitute

technologies. For this reason, the recent policy discussion has focused on ex ante

policieswherepatentholderspubliclydiscloseamaximumroyaltyrateandsetof

mostrestrictiveterms.

Themainappealofexante disclosurepolicies is that theymimic thehypothetical

negotiation between a willing licensor and willing licensee that might take place

beforeastandardisadopted.Inparticular,inexantenegotiationsarationallicensor

would be unwilling to pay an unreasonable price, i.e. a price that exceeds the

difference in surplus between adopting a preferred technology and the next best

alternative (which could be an existing or as‐yet undeveloped substitute or a

decisiontonarrowthescopeofthestandard).

However, ex ante disclosure policies also have someweaknesses. The first one is

widely recognized: price setting and group negotiations among product market

competitorswithinanSSOraisesthespecterofantitrustlaw,particularlychargesof

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collusion. A second concern draws less attention: considering pricing requires a

changeofcultureandorganizationofSSOsthatmaydistractfromtheirprimarygoal

ofdeveloping technical standards. Finally, someargue that shifting toexantewill

reducetheincentivetoparticipate,orthatfirmswillbeabletogamethepolicy.

Withregardstothefirstconcern,aretheSSOs’antitrustfearsjustified?Thereisin

fact gathering support to have SSOs negotiate licensing fees simultaneously with

determining a standard (e.g. Majoras, 2005). The US Department of Justice has

issuedBusinessReviewLettersthatendorseapolicyofexantepricedisclosureat

VITA(anSSOthatpromotestheVMEbuscomputerarchitecture)andtheIEEE.10The

VITApolicyrequiresIPholderstocommittoa“pricecap”(i.e.amaximumroyalty

rateandmostrestrictivesetoflicensingterms),whichcanbeamendeddownwards,

whiletheIEEEpolicyallowsfirmstodisclosetheirmostrestrictivelicensingterms

onavoluntarybasis.Bothpoliciescontinuetoforbiddirectnegotiationsoverprices

withintheSSO.

So why do SSOs remain hesitant to allow ex ante negotiations? While Business

Review Letters insulate SSOs against public lawsuits, there would no doubt be

privateantitrustsuitsinthiscontext,anditremainstobeseenwhethercourtswill

view ex ante rate setting as legal. For example, Golden Bridge sued the 3GPP for

facilitatingcollusionafterthefirmdisclosedapatentandbegannegotiatinglicense

agreements, only to find that 3GPP members rewrote the standard so as not to

infringeGoldenBridge’spatents.Similarclaimsofmonopsonyandgroupboycotts

bySSOmemberswere litigated inSonyElectronicsvs.SoundviewTechnologiesand

Addamaxvs.OpenSourceSoftwareFoundation.11Farrellatal(2007)suggestthatthe

economicmeritsoftheseclaimsareweak:thedamagetoinnovationincentivesfrom

collectivenegotiationsarenogreaterthanwhentheinnovatormustnegotiatewith

10 These letters are available at http://www.usdoj.gov/atr/public/busreview/219380.htm and http://www.justice.gov/atr/public/busreview/222978.htm (accessed on October 19, 2010). 11 Golden Bridge, Inc. vs, Nokia, Inc., 416 F. Supp. 2d 525, 528 (E.D. Tex. 2006). Sony Electronics Inc. vs. Soundview Technologies, Inc., 157 F. Supp. 2d 180, 185 (D. Conn 2001). Addamax Corp. vs. Open Source Software Found., 888 F. Supp. 274, 278 (1995).

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asinglelargeuser.Nevertheless,SSOsareunderstandablyreluctanttoincurtherisk

oflitigation.

Withregardstothesecondconcern,standardsaretypicallydevelopedbyengineers

wholackthetrainingandauthoritytoconsiderprices.Businessexecutivesare

certainlyinvolvedinSSOsfromtimetotime.However,combiningtechnical

deliberationswithroyaltynegotiationswouldpresumablyleadtosignificant

changesinthewaysthatSSOsworkandinwhoattends.Suchchangeswouldbe

costlyanddifficult,andnotparticularlywelcomebymanySSOparticipants.Whileit

isdifficultsayhowmuchweightshouldplacedontheseconcerns,theyareclearly

important.

Athirdconcernwithexantepoliciesisthattheymightforcepatent‐holderstoprice

aproductthatnolicenseeactuallywants.Inparticular,mostICTlicensescovera

firm’sentirepatentportfolio,therebyensuringalicensee’sfreedomtooperatewith

respecttoaparticularcounterparty.Firmsrarelyofferanarrowlicensethatcovers

onlytheessentialpatentsforasinglestandard.12However,intheabsenceofa

stand‐alonelicensingoption,itishardtoknowwhethercurrentpracticereflectsthe

preferenceoflicenseesorlicensors.

Afinalconcernwithexantepoliciesisthattheywillbeineffective,orevenharmful.

Inparticular,firmsmightdeclareveryhighroyaltyratestopreserveflexibilityin

subsequentnegotiations(essentiallypreservingthestatusquo)orstop

participatinginanSSOratherthancommittopricesinadvance.Thesearguments

arenotespeciallystrong.Whilefirmscouldcertainlydeclarehighmaximum

royaltiesunderanexantepolicy,thiswouldstillremovesomeelementof

uncertainty.Whencombinedwithincentivestomaketimelydisclosures,itishardto

seehowmandatoryexantedisclosurewouldnotleadtosomepricecompetition

betweensubstitutetechnologies.

12 [[Note on technically vesus commercially essential patents.]]

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Concerningparticipation,themainreasonforafirmtoquitanSSOthatadoptsanex

antepolicyisthatitexpectstoearnlessroyaltyincome.Butifanexanteprocess

mimicsthehypotheticalnegotiationthatwouldleadtoareasonableprice,this

impliesthatthedepartingfirmexpectedtocollectunreasonableroyaltiesunderthe

RANDpolicy.Inthatcase,whatharmcomesfromhavingthemoutsidetheSSO?

Arguably,theexantepolicyscreensoutfirmswhoviewRANDasanemptypromise,

andreducesthechancethattheywillendupholdingtrulyessentialpatents.

Ultimately,theimpactofadoptinganexantedisclosurepolicyonSSOparticipation

isanempiricalquestion.Whilethereareonlyafewcasestostudy,theW3Cand

VITAaretwoexamplesofSSOsthathavestrengthenedtheirlicensingrequirements

withoutsufferingacatastrophicdeclineinmembership.

OtherPolicies

WhilerecentdebatesonSSOintellectualpropertyruleshavefocusedonRAND

commitmentsandexantedisclosurerules,therearemanyotherpossibilities.One

alternativetoholdingup‐frontnegotiationswithinSSOsistoencouragemoreprice

competitionbetweenthem.Forexample,anumberofstandardsconsortiausea

“Promoter‐Adopter”modelwhereasmallgroupoffoundingmembers(Promoters)

contributethekeytechnologiesandagreetoanexplicitlicensingregimebefore

signingupimplementers(Adopters).Standardsdevelopedusingthisapproach

includetheUSB2.0andHDMIspecifications.Incomparingexantedisclosure

policiestothePromoter‐Adoptermodel,onecandiscernatrade‐offbetweenthe

proceduralcostsofcombiningtechnicalandlicensingnegotiationsinsideasingle

body,andthepossibilityofincreasedfragmentationandcoordinationfailurewhen

substitutetechnologiesarepromotedbycompetingSSOs.

TherearealsoseveralalternativepoliciesthatcouldbecarriedourwithinanSSO.

Forinstance,MarkLemley(2007)proposedseveralinterestingextensionstoex

antenegotiation.Oneoptionistocoupleexantedisclosurerequirementswithlow

“penaltydefault”royaltyrates.Underthispolicy,theSSOwouldsetaverylow

16

defaultroyaltyrate(perhapsfree)asthemaximumallowableroyaltyforfirmsthat

failedtoprovideexplicitpricingcommitmentsormaketimelydisclosures.

OneweaknessofaRANDorexantepolicywithpenaltydefaultsisthatitdoesnot

addresstheroyaltystackingproblem:evenwithalowdefaultrate,totalroyalties

mayaddupwhentherearehundredsofdeclaredessentialpatentsandhundredsof

standardsperproduct.Toaddressthisissue,LemleyproposedthatSSOscould

adoptastep‐downroyaltyprocedure.Underthispolicy,anSSOcouldcapthetotal

royaltiesassociatedwithastandardandawardasharetoeachessentialpatentor

firm.Thesesharescoulddeclineaspatentsareaddedtothepool,andmightbe

higherforthosewhodiscloseearlier.Whilethisstep‐downproceduremightnot

awardthemostroyaltiestothehighestvaluepatents,itwouldcertainlyprovidean

incentiveforearlydisclosure,whichwouldallowcommitteestomakebetter‐

informeddecisionsaboutanytrade‐offbetweenqualityandimplementationcost.

Finally,RysmanandSimcoe(2011)suggestanalternativepatentpolicythat

dispenseswithbothRANDcommitmentsandexantenegotiations.Theirproposalof

Non‐AssertionAfterSpecifiedTime(NAAST)wouldmimictheincentivesofthe

underlyingpatentsystembyallowingpatent‐holdersaperiodofunrestricted

licensing(i.e.theywouldnotbeboundbyRANDoranyothercommitment),but

forcingthemtogiveupallrightstoassertessentialpatentsaftersomepre‐

determinedperiodoftime.Thispolicywouldallowpatent‐holderstorecouptheir

investmentsininnovationduringtheassertionphase,butprovidefreedomofaccess

toimplementersandinnovatorswhowishtobuildonthestandardafterthenon‐

assertphasebegins.AmajorvirtueoftheNAASTpolicyisthatitwouldbeeasyto

adjudicate,sinceitdoesnotrelyoncomplexformulationsfordetermininga

reasonableprice.Itmightalsobringtheeffectivepatenttermforessentialpatents

intolinewiththelengthofICTproductlifecycles.Ontheotherhand,itishardto

knowtheappropriatelengthoftheNAASTassertionperiod,orwhenitshould

commence.

17

Penaltydefaults,step‐downroyaltiesandNAASTarenotperfectsolutionstothe

hold‐upproblem.RathertheyillustratethewiderangeoffeasibleoptionsforSSO

intellectualpropertypolicies.Giventhemanypossiblepolicies,onemightaskwhy

wecurrentlyobserverelativelylittlevariation,andwhetherweshouldexpect

competitionbetweenSSOstoleadtowardsthebestpossiblesetofIPRpolicies?Ido

notthinkweknowtheanswertothesequestions.

Tobesure,manySSOshavetweakedandtightenedtheirIPpoliciesinthewakeof

Rambusandothermajorantitrustcases.Therehavebeenexperimentswithexante

negotiationatVITAandtheIEEE;theW3Cswitchedtoaroyalty‐freepolicy,and

OASISallowsindividualtechnicalcommitteestodecideonthemostappropriateIPR

policy.However,manySSOscontinuetorelyonRANDpoliciesthatprovidelittle

clarityaboutdisclosuretimingandspecificity,orhowcourtscoulddeterminea

reasonableprice.ForsomeSSOsthatrunintofewpatentdisputes,stickingwith

RANDmaybeapragmaticapproachthatreflectsthecostsofcreatinganewIP

policyaswellasantitrustconcerns.Ontheotherhand,evenatSSOslikeETSI,which

havebeenembroiledinanumberofmajorpatentdisputes,effortstomoveaway

fromtheRANDregime(e.g.bydefining“timely”disclosure)haveencountered

strongresistance.Ultimately,itisnotobviouswhethercompetitionamongSSOs

takestheformofdevelopingmoreefficientrulesandprocedures,orofproviding

alternativevenuesthatfavortheinterestsofdifferentconstituencies.Theseissues

deservemoreresearch.

Publicpolicy

Howcanpublicpolicysupporttheemergenceofprivatesolutionstotheproblemof

patenthold‐upinindustrystandards?Oneroleforpublicagenciesistoprovidea

crediblethreatofdisciplineforfirmsthatviolateSSOpolicies.Standardsetting

organizationstypicallyhaveverylimitedenforcementpowers:whiletheycan

threatentowithdrawsupportforastandard,thishappensinfrequently,andwill

havelittleeffectwhenthespecificationalreadyhasalargeinstalledbase.However,

antitrustagencieshavebroughtactionsagainstDell,Unocal,Rambusandothersfor

18

seekingtolicensepatentsthatwerenotdisclosedduringthestandard‐setting

process.13Simcoe(2005)showsthattherewasasubstantialuptickinthenumberof

patentdisclosuresfollowingtheDellactionin1996.Thus,evenifthetermsof

individualpatentdisclosuresremainvague,theseantitrustactionshavearguably

increasedtheinformationavailabletostandardsdevelopersandimplementersby

makingtheenforcementofSSOpolicescredible.

AnotherproductivesteptakenbyantitrustagenciesintheUSandEuropehasbeen

toofferBusinessReviewLettersandpublicstatementsencouragingSSOstoallow

moreexantepricenegotiation.Inparticular,allowingtheVITAandIEEEexante

disclosurepoliciestomoveforwardclearlysignalsthatregulatorsunderstandthe

pro‐competitivepotentialofpoliciesthatleadtopublicpricecommitments.SSOs

maystillfearthatexantepolicieswillleadtoprivateantitrustactions.Thisisa

reasonableconcern,particularlyinthewakeoftheGoldenBridgev.Nokiarulingthat

groupboycottsinSSObargainingcanbefoundperseillegal.However,statements

bytheDOJandFTCsuggestthatconductinexantepricenegotiationswilltypically

bejudgedunderaruleofreasonstandard,reflectingboththecoordinationbenefits

associatedwithjointtechnicaldecisionmakinginsideSSOsandthepotentialforex

antenegotiationstothwartpatenthold‐up.

Amorecontroversialrecommendationisthatpolicy‐makersnudgeSSOstowards

providingmoreexplicitguidanceondisclosurerulesandlicensingcommitmentsas

partoftheirIPRpolicies.14Onewayforpolicy‐makerstoencouragemoreclarity

mightbetoindicateapreferenceforexplicitIPRpoliciesandproceduresin

governmentpurchasingguidelines,suchasOMBCircularA‐119.Thecurrent

guidelinesindicatethevoluntaryconsensusstandardsmust“includeprovisions

requiring[that]intellectualproperty[bemade]availableonanon‐discriminatory,

13See Dell Computer Corp., 121 F.T.C. 616 (1996); Union Oil Co. of Cal., FTC Docket No. 9305, and Rambus, Inc., FTC Docket No. 9302. 14 The Rambus court made several disparaging remarks about the lack of clarity in VITA’s IPR policies. However, my impression is that subsequent efforts at many SSOs have focused on clarifying procedural requirements as opposed to the substance of these rules.

19

royalty‐freeorreasonableroyaltybasistoallinterestedparties”andencourage

agenciestouseofvoluntarystandardswhereverpractical.Buttheseguidelinessay

verylittleaboutthechoiceamongcompetingprivatestandards.Whengovernment

agenciesactasconsumers,itwouldbequitereasonableforthemtofavorstandards

thatinvolvemorecertaintyandlessriskofexpostpatenthold‐up.Andsincethese

purchasingguidelinesleaveagencieswithconsiderablediscretion,thereislittlerisk

thatsuchachangewouldleadtoexcessiveuniformityofSSOpoliciesand

proceduresshouldvaguenessbetheoptimalIPRpolicyforcertaintechnologiesor

markets.

Finally,thoughitisoutsidethescopeofthisessay,hold‐upproblemscouldbe

mitigatedthroughpatentsystemreformsthatreducethemyriadsearchand

transactioncoststhatmakemarketsforintellectualpropertyfunctionratherpoorly

intheICTsector.Inparticular,thepatenthold‐upproblemwoulddisappearifit

werepracticalforfirmstoidentifyrelevantpatentsandtake‐outallofthenecessary

licensesbeforedesigning,buildingandmarketingnewproducts.Thisisfarfromthe

currentreality.WhileprivatesolutionssuchasSSOsandpatentpoolsmayprovidea

work‐aroundtotheproblemsofpatenthold‐upandroyalty‐stacking,thisessayhas

highlightedsomeoftheinherentcosts,limitationsandtrade‐offsoftheprimarily

privateapproach.

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