The Royalty Rate for a Subset of Standard Essential Patents – What Is Reasonable?

how-much-calculatorDuring litigation about standard essential patents, the court sometimes tries to determine the reasonable royalty for a small number of essential patents. In Microsoft vs Motorola, for example, the court determined the RAND royalty rate for a subset of the patents that are essential for the Wi-Fi standard (IEEE 801.11).

Two of the aspects to look at when determining the royalty for a fraction of the essential patents are:

  1. The royalty rate for all essential patents together (we call that the ‘cumulative rate’ in this article) must meet RAND criteria. This should prevent that stacking of royalty payments to multiple holders of essential patents interferes with adoption of the standard.
  2. The fraction of the cumulative rate that can be assigned to the subset of essential patents that are licensed in each case.

In this article we focus on the second aspect and assume, optimistically, that it is possible to determine whether or not a cumulative royalty rate is reasonable.

What could be easier than simply count the total number of essential patents (Etotal) and assign each essential patent 1/Etotal of the cumulative rate? One could argue that if you have hundred essential patents, the royalty rate for a single patent would be one percent of the cumulative rate.

There are issues with simple counting:

  • Some essential patents are not infringed by all products. That may seem paradoxical but is quite common. Should these non-infringed essential patents also be counted?
  • Licensees may argue that the licensed patents contributed little to the success of the standard than other inventions. Should we give all patents equal weight?

The Struggle With Patents That Are Essential But Not Infringed

A patent that the patent owner considers essential is not necessarily infringed. See, for example, page 110, of Microsoft vs Motorola:

The court concludes that in a hypothetical negotiation, Microsoft would not take a license to any of the 13 Motorola SEPs that Motorola does not contend are used by the Xbox, despite the fact that Motorola argues that these 13 patents are “essential” to the 802.11 Standard. Because Motorola admits that Microsoft products do not use these patents in any way, Microsoft would not seek a license to them. Accordingly, the court will analyze only the 11 Motorola 802.11 SEPs that Motorola contends are used by Microsoft’s Xbox.

How can a patent that is deemed essential for a standard not be infringed in a product that implements that standard? One possible explanation could be that the claim of essentiality is incorrect. That’s why it is important to document essentiality with a claim chart and ask an independent expert to verify that infringement of the patent claim is prescribed by the standard. But an independent verification is still no guarantee that court will agree that such a patent is really infringed by a product.

Another explanation is that the patent is essential for an option in the standard and that the product does not implement this particular option. Most technical specifications of interface standards have options, describing alternative methods to implement the standard. Manufacturers can choose one of the options and will not infringe patents that are essential for implementing another option.

When collecting royalties on normal essential patents, you only need to know the sales volume of products that implement the standard. When collecting royalties on optional essential patents, you will also need to know which technical options are used in each product. That is tough because companies don’t necessarily keep track of the product features and technical options used in their products.

One way is to count optional essential patents just like essential patents and ignore the difference. That is simple and works well when optional essential patents constitute only a small fraction of all essential patents.

A possible alternative is to test random samples of products in the market and gather statistics on the use of options. A lot of work, not very accurate, but it is objective.

The Struggle With Allocating Value to the Different Technologies

Do all essential patents contribute equally to the success of a standard? It seems natural to assume that one invention can be more inventive than another, or addresses a more important technical challenge. See, for example, Microsoft vs Motorola on page 188:

Evidence at trial showed that each of the 11 patents provides very minimal technical contribution to the identified portions of the 802.11 Standard. Additionally, the record was clear that Motorola did not provide the inventive technology in any area of the 802.11 standard, but instead built upon already existing technology.”

Wouldn’t you agree that the break-through invention that made the standard possible is more valuable than patents on technologies for which alternatives existed at the time the standard was made?

Yet there is something odd about the idea that one essential patent adds less value than another essential patent. Each patent is, after all, essential. That implies that the interface does not work if any one of the essential patents is not used, even when there are thousands of other essential patents. There is no such thing as a patent that is more essential than another patent.

One of the methods considered in Microsoft vs Motorola, is the so-called “incremental method”. Microsoft’s expert Dr. Kevin M. Murphy describes this method on page 28 as:

What you’d ideally like to do is sit down and say: Okay, Kevin, you’ve contributed this piece of technology. Bob had this alternative piece of technology we could have used instead of yours. Yours was some increment better than his, that is the value you added, because we could have used his rather than yours, so your net contribution was that amount. And that’s what you should get as a reasonable royalty.”

This method has practical issues because you need to reconstruct what options were available at the time of standards development and what the consequences for the standard would have been if that alternative was selected. The court writes (page 27) “In practice, approaches linking the value of a patent to its incremental contribution to a standard are hard to implement”.

I also have an issue with the logic of the incremental method. Suppose you want to bake an apple pie. One grocer is selling Golden Delicious and another grocer is selling Cox’s Orange Pippin. Both are equally suitable for your pie. Would you argue with the grocer that he has to give you the Golden Delicious for free because you could also have chosen the equally suitable Cox’s Orange Pippin?

Apart from the practical problems and the questionable logic, the incremental method also suffers from the misconception that standards are collections of pre-existing technologies, contributed by the participating companies and stapled together.

Maybe it helps to look how standards are developed and see how inventions help create standards.

The Reality of Standards Development – How Patents Become Essential

Technical specifications for interface standards such as Wi-Fi, DVD, or GSM are complicated. They take years to develop and fill hundreds of pages. Wi-Fi development started in 1990 with the establishment of the IEEE 802.11 group and the first standard was approved 7 years later, in 1997. It takes long because it is a major engineering effort.

The technical specifications for interface standards are typically developed as follows:

Standards Development Process

  1. Decide the requirements for the interface. Describe goals such as data rate, working distance, power consumption, etc.
  2. Decide the main technical principles for the interface and describe them in the first draft specification.
  3. Build prototype products for both sides of interface, test how the interface between the products performs compared with the commercial requirements.
  4. Decide on changes and additions in the draft specification that bring the interface closer to achieve the commercial requirements, and remove ambiguities.

And then go back to step C until the participants in the standard development group agree that the technical specification is ready. The Qi standard for wireless battery charging, one of the standards I worked on, went through 10 revisions before the 1.0 version of the technical specification was approved. Sometimes you have to go back to step B if you cannot achieve the requirements and another approach is likely to get you closer. You may even have to go back to step A (and settle for requirements that are easier to achieve) when you run out of ideas or out of time.

The choices made in steps B and D determine which patents become essential.

The patents that become essential in step B often relate to pre-existing technologies. The patents that become essential in step D, on the other hand, tend to be about solving problems in the draft specification. These improvements deal with problems that block adoption of the standard, or they deliver improvements that bring the performance of the interface closer to the requirements.

The idea that you need to determine the contribution of a patent to the value of the standard leads to problematic questions. For example: “What is the value of a patent that increases the data rate on a communication interface by 5%?” Is that 5% of the value of the standard, or ‘almost nothing’ because it builds on existing technology?

Or this question: “What is the value of an invention that solves a problem that blocks adoption of the standard?” That must be 100% of the value if there is no alternative solution available. But what about the value of other essential patents?

Calculating the value of the contribution of individual essential patents to the value of a standard is a hopeless exercise. The debate reminds me of attempts to calculate the value contribution of departments within a company. It does not help the company much when the R&D department and the sales department start debating who contributed more to the successful launch of a product.

Alternative Methods

Patent pools also assign value to individual essential patents because they need a method to split royalty income between the patent owners. I have, however, never seen a pool that tries to distinguish the value contributed by each individual patent on the basis of the technical contribution, the availability of technical alternatives, or the differences in ‘inventiveness’. Without a practical method to determine the technical contribution objectively such a calculation will lead to endless debate between the owners of the patents in the pool.

Counting patents is much easier. And to avoid discussions between the participants about the essentiality of each other’s patents, most patent pools only include patents that are deemed essential by an independent expert.  With that starting point you can fine-tune the rules for sharing royalty-income.

For a global license program, for example, it makes sense to count patent rights per country and split royalties depending on the number of patents in country of manufacture and country where the product is used.

To prevent patent owners from gaming the rules by artificially increasing their number of patents, you could decide to count all divisional patents, derived from one first filing, as one patent.  This still assumes that all essential patents are equal.

If you want to treat patents that are essential for an option in the standard differently, you can use market research to determine the percentage of products that implement that options, or ask licensees to report on the options that are used in each product they sell.

Patent pools can also allocate more value to essential patents that have been tested in court and found both valid and infringed by products that implement the standard. They can allocate more value to these ‘proven patents’ because patents that are declared essential by an independent expert are not necessarily valid, and not always infringed. The expert does not look at validity, and the expert may be wrong about infringement. Potential licensees can challenge both validity and infringement in court and may win that argument. A patent pool will have a hard time collecting royalties when none of its patents survive the inevitable validity and infringement challenges. On this basis one can argue that the royalties collected in the pool are predominantly generated by the pool’s proven patents.

If the participants in a pool would want to differentiate the value of individual essential patents, they could, hypothetically, count the patents as follows:

  • Essentiality confirmed by independent expert: 1 point
  • Patent essential for an option of the standard: correction factor ‘Opt’, with ‘Opt’ the percentage of products that implement this option.
  • Patent survives challenge of invalidity and non-infringement: correction factor ‘M’, with ‘M’ a multiplier that the patent pool feels comfortable with.

Here is an example for calculating the share with this method. Suppose this hypothetical pool has 1000 essential patents. 100 are optional and used in 10% of the products. 100 are optional and used in 40% of the products, five are always used, and validity and infringement has been tested and proven in court. This pool decides to value these patents 100 times more than unproven essential patents.

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This example illustrates one possible method to establish rules that objectively allocate value to individual essential patents, but only within a patent pool.

Establishing the royalty rate for a sub-set of  essential patents is much more complicated when each patent owner licenses its standard essential patents separately. If the cumulative rate (sum of the royalty rates of all programs) is not obviously reasonable, potential licensees can more easily argue that the royalty rate for each sub-set of essential patents is too high and keep negotiating until the patents expire. Individual patent owners will need to substantiate that the cumulative rate is reasonable, or be pressed to provide proof that another patent owner’s royalty rate is unreasonable.

Interestingly, if you apply this method to calculate the share of a cumulative royalty, a patent owner licensing a small sub-set of all essential patents can try to justify setting a rate close to the maximum reasonable cumulative rate when other patent owners are not asking for royalty payments, or not enforcing their patents.


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Join the Discussion

2 comments so far.

  • [Avatar for Thomas Gabriel]
    Thomas Gabriel
    July 18, 2016 10:28 am

    In the above commentary regarding standard essential patents, Menno Treffers discusses patent pools and how such pools assign value to individual essential patents in the allocation of royalties between the pool patent owners. Mr. Treffers suggests that he is unaware of a “pool that tries to distinguish the value contributed by each individual patent on the basis of the technical contribution, the availability of technical alternative, or the difference in ‘inventiveness’”. Mr. Treffers’ assumption is incorrect and ignores some of the innovative and unique features of the One-Blue patent pool for Blu-ray Disc products as explained more fully below.

    One-Blue LLC is an independent licensing company that operates a pool to license patents that are essential to the Blu-Ray, DVD and CD optical standards used for Blu-ray Disc products, including players, recorders, video discs, recordable and rewritable discs, drives and software. Currently, the One-Blue patent pool comprises approximately ten thousand essential patents world-wide from seventeen different licensors.

    Its founding fathers – Cyberlink, Hitachi, Panasonic, Philips, Samsung and Sony – have worked hard to create an impartial environment for both licensees and licensors, to create a better level playing field for market participants, to reduce overall costs for everyone involved by increased efficiencies and to foster proper use of the patent system. To this end, the One-Blue founders have incorporated many innovative features in its licensing program, including how patents are valued for royalty allocation purposes.

    Historically, patent pools attach the same value to each individual essential patent. This simplistic approach is often the result of the difficulty in obtaining consensus among pool licensors on objective criteria to be used to determine the specific value of each individual patent in comparison to others, particularly in pools with large patent portfolio and numerous licensors each having a lot at stake in royalty allocations. As Mr. Treffers correctly points out, the problem with this one patent, one dollar approach is that it encourages companies to ‘game the rules’ to artificially inflate patent counts by obtaining a high number of separate essential patents for an invention – the classic way to achieve this is to file as many divisional patents or continuation patents as possible for one invention covered by a parent patent.

    One-Blue took the bold step of differentiating between patents when valuing patents in the pool for allocation purposes, deciding that some patents are more equal than others. Most notably, One-Blue assigns greater value or importance to physical format patents than to application format patents in recognition of the fact that, in general, costlier research is needed for physical format inventions than application format inventions. Moreover, physical format technology is continuously used in the product, whereas application format technology is often used more incidentally.

    For each parent patent, we take a maximum number of divisionals and continuations into account for royalty sharing purposes. Additionally, the total weighting of all divisionals and continuations related to one parent patent cannot exceed the weighting of their parent. Exceptions are made only in instances where a divisional or continuation includes an invention that is distinct from the parent patent in that it represents a significant technical contribution to the standard relative to the parent patent as supported inter alia by non-unity decisions by patent offices.

    We believe, as a result of One-Blue’s innovative approach to patent pool licensing, that we have significantly raised the bar in patent pooling compared to earlier patent pools. We remain convinced that other technology sectors than the optical disc industry can learn from our approach, and that future patent pools can make even further strides at creating a level playing field, reducing transaction costs and fostering a fair patent system.

    Thomas Gabriel, Licensing Counsel at One-Blue.

  • [Avatar for Concerned]
    May 23, 2016 08:31 am

    I agree that is very difficult to objectively determine the value of one SEP over another that works over the universe of SEP patents for a given standard. But it should be clear to folks that have worked with SEP patents that not all SEP patents are created equal. Many SEPs represent incremental improvements like the format of a packet header, and some can be truly foundational like a novel modulation type adopted by the standard. Admittedly, were a patent pool or its independent surrogate to make this determination it would incite mayhem!
    So what would an objective process that assigns weights to SEPs that is fair to all look like? Here’s a couple to consider.
    1) Would it be fair to assign a higher weight to a patent found essential when it is also determined that the patent holder was an active contributor and member to the standard setting organizations (SSO)?
    2) Would it be acceptable to assign a higher weight to a patent found essential based on the date the patent was filed using the ratification of the standard as a reference point? For example, a SEP patent is assigned a higher weight when the patent was filed 36 months before the standard was ratified as opposed to one month.
    After writing this it becomes pretty clear that there are many other weighting factors that could be considered and it begins to feel like the processing of setting the thermostat in the office – some are comfortable and others are left in the cold. So maybe the KISS (Keep it Simple Stupid) principle currently employed by patent pools works best.