ABSTRACT:
Courts are often required to determine the royalty to which the owner of a FRAND-encumbered standard essential patent (SEP) is entitled. We argue that courts should use the observed royalties charged by licensors, the market rental price of assets created by investments in R&D. This “comparables” technique is used to value virtually all classes of assets and is based on the standard theory of value and distribution, price theory. Price theory explains where value comes from, how it is distributed among inputs, and how monopoly power is exploited and measured.
We further argue that courts should discard the “bottom up” and the top down techniques. Both are based on the theory of patent holdup and royalty stacking. This theory assumes that any observed royalty is the result of “excessive royalties” wrought by the additional monopoly power conferred by standardization through patent holdup and royalty stacking. Nevertheless, the theory is incoherent and rejected by the available evidence.
Proponents of the “bottom up” technique claim that courts should value SEPs as the incremental value of the standardized technology compared with its next-best alternative, which was discarded when the SEP became part of the standard. This has never been operationalized, however, because competing technologies never made it to market. Also, the bottom up technique is based on faulty game theory that elides R&D, assumes that competing technologies are freely available, and has absurd antitrust implications for any proprietary standard and well beyond SEP intensive industries.
Proponents of the “top down” technique claim that courts should determine the value of SEPs by, first, determining the cumulative royalty that the entire suite of SEPs would have obtained competing with its next best alternative, and then apportioning it among SEP holders. The first step shares the conceptual and practical flaws of the bottom up technique. The second step assumes that each stage of production chain creates a fixed amount of value that is independent of the rest of the production chain and of consumer demand. This is contrary to the basic implications of standard economics.
Read the paper: SEP Royalties: What Theory of Value and Distribution Should Courts Apply?
