Proponents of the patent-holdup conjecture implicitly model competition among different technologies for inclusion in a standard as a static Bertrand pricing game without (1) any capacity restraints, (2) any product differentiation, and (3) any outside option for the inventors. On the basis of those improbable assumptions, proponents of the patent-holdup conjecture suppose that the FRAND royalty for the technology chosen for inclusion in the standard will approach zero.
That conclusion is wrong. It violates the predictions and real-world observations of the economics of tournaments. I explain the similarities in the economics of tournaments and standard setting. I then examine the actual payouts that participants in real-world sports tournaments receive and find that the prize for winning the tournament does not approach zero. No firm would enter a tournament whose first-place prize is “effectively zero” if it cannot recoup its participation costs. Further, SSO members would not invest in developing a technology that might win the standard-setting tournament if the difference between the payoff from winning and the payoff from losing were negligible. Instead, modeling standard setting as a tournament whose winner receives a substantial first prize—that is, a significant FRAND royalty—is more likely to lead to legal rules for licensing disputes over standard-essential patents that encourage continued investment in innovation and continued participation in collective standard setting.
Read the paper: Tournaments and FRAND Royalties