In the high-tech industry, it's common practice for a governing body to develop technical standards for any given technology. The goal is to promote widespread adoption and compatibility among various devices. The Bluetooth standard lets a Nokia headset communicate with an Apple iPhone or a Jaguar Land Rover, for instance, while the Universal Serial Bus (USB) helps standardize the connection of countless computer peripherals.
Intellectual property owners often strive to have their patents included in these standards, such that in order to comply with any given standard, it's necessary to license their patents. Such patents are known as standard-essential patents (SEPs). And it behooves the patent owners to charge fees to anyone wanting to comply with the standard requirements.
“Standards are really important to US competitiveness.”
Case in point is Qualcomm, a company that makes billions of dollars annually licensing patents for its code-division multiple access (CDMA) technology, which is the heart of several mobile communication standards.
Standards bodies often act as regulators, setting rules in order to prevent the owners of SEPs from abusing their newfound power. But the rules tend to be surprisingly nebulous, especially considering the precise technical specifications of the patents at hand. In part because of the potential profits at stake, SEPs have been at the center of several recent multibillion-dollar lawsuits that impede industry innovation.
The issue has prompted a new research paper that starts to investigate ways to make these patents less volatile and more efficient—and makes the case for increased government involvement. "Standards are ubiquitous and necessary," says Josh Lerner, the Jacob H. Schiff professor of investment banking at Harvard Business School and coauthor (with Jean Tirole of the Toulouse School of Economics) of the paper Standard Essential Patents.
"In the free market, where there's a lot of entry of new firms and new players, having the ability to sort things out with standards is really important," Lerner says. "It's not just an isolated technical issue. Standards are really important to US competitiveness. This line of research is about trying to figure out what's gone wrong, and whether there is a way to try to fix it."
Fair, Reasonable, And Nebulous
Many standard-setting organizations require only that patent owners grant licenses on a "fair, reasonable, and non-discriminatory" basis. (The requirement is ubiquitous enough that it's commonly shortened to the acronym FRAND.)
The problem is that the licensors and licensees tend to have differing opinions about what constitutes "fair" and "reasonable." Hence the spate of recent lawsuits. For instance, last September a federal jury ruled in favor of Microsoft and against Google-owned Motorola Mobility, after Microsoft sued Motorola for demanding "excessive" licensing royalties for SEPs related to Wi-Fi and video compression. Samsung, Apple, Nokia, and Ericsson also have been involved in major SEP-related litigation.
"A lot of the litigation has had to do with the ambiguity of the FRAND concept," Lerner says.
In December, for example, the Institute of Electrical and Electronics Engineers (IEEE) issued an amicus brief related to a case in which telecom equipment giant Ericsson sued Dell and six other hardware companies for patent infringement related to the IEEE's 802.11 (Wi-Fi) wireless standard. (The brief also touched on the aforementioned Microsoft vs. Motorola case.) One of the world's leading standards-setting bodies, the IEEE explained that after a patent is deemed "essential" to an IEEE standard, the patent-holder is asked to submit a letter of assurance (LOA) guaranteeing fair and reasonable terms.
"The LOA process [is] to ask patent holders if they are willing to grant licenses on Reasonable and Non Discriminatory … terms," the brief reads. "The term 'reasonable,' however, is inherently vague, and the ability of patent commitments to protect against hold up is thus imperfect.
"Sometimes this vagueness (and the consequent inability of parties to agree on a negotiated, 'reasonable' license) will lead to expensive litigation whose cost and risk can impede the adoption of a socially valuable standard," the brief continues. "Even without litigation, the ex post negotiation of license terms (that is, negotiations occurring after a technology's inclusion in a standard) can lead to higher royalty payments and ultimately higher prices to consumers."
And while standard setting was once comprised of a bunch of engineers taking their time to determine what was best for the technology, the process has become increasingly pressurized and competitive - a trend Lerner attributes to industry response to success of companies like Qualcomm in the licensing market. (The company's technology licensing business reported revenues of over $6.3 billion in fiscal 2012.) "Over the course of the 2000s the representation of executives [in standards-setting organizations] has gotten larger," Lerner says. "Standards bodies move slower and are more politicized than they used to be."
Simply allowing participants to discuss royalty rates would not be a cure-all. Not only would such discussions raise antitrust concerns about collusion, but as the authors explain in the paper, "price discussions within the standard setting process run the risk of expropriation of IP holders, as even balanced [standard-setting organizations] potentially will 'blackmail' IP owners to accept low prices in exchange for their functionalities being selected into the standard."
Structured Price Commitments
The paper goes on to explore and endorse the idea of "structured price commitments," wherein all holders of potentially relevant patents agree to a price cap on royalties just before a standard is set—after which the standard-setting body is prohibited from discussing pricing. Price commitments have the potential to create a scenario that is indeed fair, reasonable, and nondiscriminatory. But this model may not work unless everyone agrees to adopt it.
Oftentimes, more than one organization will compete to set standards for technologies with similar functions, each competing for market share in the standardization business—in other words, to set the most standardized standard. "Often when there's a hot technology you'll get multiple standards bodies fighting it out," Lerner says.
One way to compete for the best patents is to offer terms that are more relaxed than those of the competing standard-setting organization. And for an intellectual property owner, relaxed rules are more attractive than strict rules. "If you're a patent owner, and one SSO has a rule that makes you cap your price and the other doesn't, you can see why the temptation would be to decide not to take part in the standard with pricing commitment rules, and instead to go with a standard where you're free to price things as you wish," Lerner says.
Thus, the paper concludes, the only way to make structured pricing work is to enact a federal policy that mandates it—despite inevitable protestations from big firms with thousands of standards-potential patents.
"It's clear why these firms would protest," Lerner says. "But if such a policy is encouraged by antitrust bodies and courts, it could be beneficial for society as a whole and for technological regulation."