FTC Proposal for Regulating IP Will Harm Consumers

In its recent report entitled “The Evolving IP Marketplace,” the Federal Trade Commission (FTC) advances a far-reaching regulatory approach (Proposal) whose likely effect would be to distort the operation of the intellectual property (IP) marketplace in ways that will hamper the innovation and commercialization of new technologies. The gist of the FTC Proposal is to rely on highly non-standard and misguided definitions of economic terms of art such as “ex ante” and “hold-up,” while urging new inefficient rules for calculating damages for patent infringement.

To be sure, the FTC Proposal does not seek to confer upon the agency any direct power to set the price of licenses. But if implemented, the FTC Proposal would achieve that end through a long process that runs as follows. At the first step, the FTC Rules all suggest that the currently observed prices in licensing arrangements are too high, and should instead be set in accordance with the FTC’s own untested—but evidently unwise approach to “reasonable royalties” and “incremental damages,” which are nowhere observed in the extensive practice within the industry. So long as such new approaches are made available to potential licensees as of right, they will have a strong incentive to abandon the voluntary market in order to obtain the benefit of such judicial pricing rules that are systematically more favorable to their interests.

Stripped of the technicalities, the FTC Proposal would so reduce the costs of infringement by downstream users that the rate of infringement would unduly increase, as potential infringers find it in their interest to abandon the voluntary market in favor of a more attractive system of judicial pricing. As the number of nonmarket transactions increases, the courts will play an ever larger role in deciding the terms on which the patents of one party may be used by another party. The adverse effects of this new trend will do more than reduce the incentives for innovation; it will upset the current set of well-functioning private coordination activities in the IP marketplace that are needed to accomplish the commercialization of new technologies. Such a trend would seriously undermine capital formation, job growth, competition, and the consumer welfare the FTC seeks to promote.

In a newly released paper titled The FTC’s Proposal for Regulating IP through SSOs Would Replace Private Coordination with Government Hold-Up we examine how these consequences play out in the context of standard-setting organizations (SSOs), whose activities are key to bringing standardized technologies to market. If the FTC’s proposed definitions of “reasonable royalties” and “incremental damages” become the rules for calculating damages in patent infringement cases, the stage will be set to allow the FTC and private actors to attack, after the fact, all standard pricing methods through some combination of antitrust litigation or direct regulation on the ground that such time-honored royalty arrangements involve the use of monopoly power by patent licensors.

We conclude that the FTC has not identified sufficient evidence to raise serious doubt about the current efficiencies of the IP marketplace. The default assumption should be that that the consensus SSO IP licensing policies and practices are well-tuned to ensure balanced incentives to all necessary participants in the chain of innovation and commercialization, both to make necessary investments, and to participate in the standardization process.

Indeed, the available empirical evidence suggests that these existing rules and practices work well. If sound empirical evidence of a problem requiring legal intervention did emerge, then responses should be far more carefully targeted than the approaches in the FTC Report. They also should be far more attentive, through careful dynamic analysis, to the risks of unintended consequences such as creating perverse incentives for infringement, against licensing, and against the investment essential for later rounds of innovation.

The FTC advances no evidence for the alleged problems of patents and SSOs and fails to address the considerable evidence that markets and SSOs function effectively. The interests of consumers are well represented by SSOs and competition among technology implementers who at the end of the day must make goods and services that people wish to purchase. Government interference with SSOs and innovation will only harm the interests of consumers.

In consequence, the FTC’s Proposal, if adopted, could well encourage potential licensees to adopt the very holdout strategies the FTC purports to address and that well-organized SSOs routinely counteract today. Simply put, the FTC’s proposal for regulating IP by limiting the freedom of SSOs to set their own terms would replace private coordination with government hold-up. The FTC should instead abandon its preliminary recommendations and support the current set of licensing tools that have fueled effective innovation and dissemination in the IP marketplace. FTC forbearance from its unwise Proposal will improve bargaining incentives, reduce administrative costs, and remove unnecessary elements of legal uncertainty in the IP system, thereby allowing effective marketplace transactions to advance consumer welfare.