December 2015

ISBN: 978-3-945185-03-2

The Viability of FRAND:

How the Seminal Microsoft Ruling Could Impact
the Value of Standard Essential Patents and theFuture of Telecom Standards
Bowman Heiden
Center for Intellectual Property (CIP)
Department of Technology Management andEconomics
Chalmers University of Technology
Gothenburg, Sweden

The Viability of FRAND:
How the Seminal Microsoft Ruling Could Impact the Value of Standard
Essential Patents and the Future of Telecom Standards

Bowman Heiden
Center for Intellectual Property (CIP)
Department of Technology Management and Economics
Chalmers University of Technology
Gothenburg, Sweden

11.

Introduction

Despite the widespread use of fair, reasonable and non-discriminatory policies(F/RAND) policies by the majority of SSOs for several decades, there has been
growing concern from certain actors on the judicial, political, and business arenas
that a lack of market consensus on the meaning of F/RAND could facilitate asystemic level of opportunism by standard essential patent (SEP) holders in themarket. This concern, while observable in specific cases, has not been empiricallyshown to have a systemic effect on the ICT market. One such case, involving adispute between Microsoft and Motorola over F/RAND royalty rates for SEPs in theH.264 and 802.11 standards led to a landmark ruling in the US Federal Court of theWestern District of Washington in 2013, which was affirmed by the US 9th Circuit
Court of Appeals in 2015.
This paper addresses the viability of F/RAND policies to regulate the equilibrium
between patent holdup and freeriding (or patent holdout) in the context oftelecommunication standards. As market transactions are executed in the shadow of
the norms of the court system, the relation between F/RAND and the judicial arenais the main focus. Using the landmark Microsoft ruling, this paper seeks toinvestigate (1) what were the state of the art valuation principles deployed by thecourt to determine FRAND royalty rates and (2) what were the key areas ofcontention regarding how the valuation principles are reduced to practice anddeployed as valuation methods by the court, (3) how generalizable are the decisions
by the court on other standardization contexts, and (4) what are the implications ofthese valuation methods on industry strategy and policy. These are particularly
important issues as they define the value of standard essential patents, which is oneof the key battleground issue in the struggle to define the agenda for a new patentera, where the role of patents as a tool to facilitate innovation and welfare is being
challenged. The full paper is under review and will be available in an academic
journal in the near future. Below is a short summary of the preliminary findings.

2.

Analysis of Microsoft Decision

The 207-page decision by Judge Robart in the Microsoft case highlighted thefollowing key factors in the valuation of SEPs in a F/RAND context:
1. Five guiding principles for SEP valuation of which four focused on static
efficiency and one on dynamic efficiency.
2. A F/RAND-modified version of the Georgia-Pacific factors adapted primarily
to accommodate the principle that a F/RAND royalty should be based on theeconomic value of the contribution of the patented invention apart from thevalue associated to its inclusion in the standard (i.e. the holdup value).
3. A qualitative SEP valuation analysis, including:2••An ex ante evaluation of the SEP portfolio in comparison to competing
technologies at the time of standardization.
An ex post evaluation of the SEP portfolio in relation to its use value inthe standard and the impact in the end products.

4. A quantitative SEP valuation analysis using multiple royalty bases andmethods, including:• Market comparable rates from both successful and unsuccessful
patent pools related to the standards in the case with an implied end
product royalty base.
• Market comparable rate from the computer chip industry on acomponent level royalty base.
• Feature Factor Method deployed in a prior valuation of the SEP
portfolio by a consultancy firm with an end product royalty base.

3.

Main Areas of Contention

Below are several areas of contention present in the Microsoft case that will likely
define the viability of F/RAND to facilitate collaboration among diverse stakeholders
in standardization settings.
1. Ex Ante Evaluations Applied Ex Post
The use of comparative analysis of competing technologies prior to thesetting of the standard (i.e. ex ante analysis) was deployed by the court
retrospectively as a means to eliminate the holdup value of the SEP portfolio
despite the fact that the court itself acknowledged that it “lacked real world
applicability” and cited its “impracticality with respects to implementation bycourts.” An important question is whether the comparison is made ex anteenough given the technology development decisions are made at the time of
R&D investment prior to competition in standards.
2. The Royalty Base and the Battle Over the Value Chain
The court in Microsoft deployed multiple methods using different royalty
bases to reach its decision. This implies that the logic of the apportionmentargument in the valuation method takes precedent over a fast rule on theposition of the royalty base. This ultimately will impact the distribution ofprofits in the value chain and the viability of IP-based business models.
3. Market Comparables – Transforming Apples into Oranges
The Microsoft court evaluated four different types of comparables to support
its F/RAND royalty determination – patent pool rates, previous licensing
agreements employing the SEPs in suit, similar industry licensing agreements,
and an expert valuation report. In addition, Motorola presented a number ofprior license agreements including the specific SEPs in suit, but the court
dismissed these. The varying contexts of these comparables leaves open awide range of objections and interpretations by future courts. As innovation
specialists typically don’t participate in patent pools, an important question is3

how the use of patent pool rates by courts impact the strategic behavior ofinnovation specialists and the rate on innovation in technology standards.

4.

Key Implications

The Microsoft case offers several potential implications for reflection by industry andpolicy makers that impact the viability F/RAND and telecom standards, of which
several key areas are described below.
1. A potential re-imbalancing of the value of SEPs from ad hoc holdup tosystemic freeriding (i.e. holdout). The results of landmark cases have great
potential to change the norms of how business is conducted. The fact thatMotorola only received a small fraction of what they had originallydemanded has already impacted the belief among many IP and licensing
professionals that SEPs are now of much less value. Thus the normative
impact of this landmark case could produce a downward pressure on all SEPs
regardless of the context, which could swing the pendulum from a fear ofholdup to a condition of systemic freeriding or holdout.
2. Innovation specialists may need to reconsider the risk profile of theirstandardization strategies and business models. The Microsoft ruling, incombination with a growing pressure on actors labeled as non-practicing
entities (NPEs), will require innovation specialist firms to rethink their modeof involvement in standards and their position in the value chain to manage
the risk of potentially increasing efforts to weaken the strength of SEPholders. This can impact innovation and overall economic efficiency byimpacting the development of a division of innovative labor in the market.
3. Firm strategy will continue to shift from winning the game to changing therules of the game. Implementation specialists, in particular, will beincentivized to delay negotiation of F/RAND licenses and instead focus on
weakening the concept of F/RAND through judicial, legislative, policy, andregulatory means. In this regard the Microsoft case exemplifies the potential
impact of affecting the norms of F/RAND on a systemic level.
4. Reinforcement of the fear of holdup leading to new policy proposals by
SSOs, regulatory bodies, and legislatures. While the Microsoft case could
certainly be characterized as an anecdotal case of patent holdup, there is still
no evidence of systematic patent holdup in either the H.264 or 802.11
standard, having been in use for 10 and 16 years, respectively, under
F/RAND-enabled IPR policies. This indicates that there is not sufficient
theoretical or empirical evidence to warrant major policy changes as thesystemic consequences of these changes could negatively impact economicefficiency, in particular, through an unfavorable tradeoff of static efficiency
for dynamic efficiency that only redistributes instead of enhances economicsurplus. Thus the Microsoft case is proof that isolated instances of patent4

holdup can be adjudicated by the US court system without the need ofsystemic policy reform that can have unintended systemic consequences.
5. Different standards will experience different dispute profiles. One maininsight from different levels of success of the patent pools in the Microsoft
case is that standards should not be treated as homogeneous (i.e. eachstandard has its own market context and norms). If this is true one might
expect very little if any litigation in respect to the H.264 standard in thefuture. The 802.11 standard on the other hand will likely experience greater
litigation as WiFi is a large industry of its own with a growing number ofinnovation specialists and other non-practicing entities in the form of current
and potential SEP holders.
6. Motorola lost but Google may have won. While the initial match-up
between Motorola and Microsoft represented two competing philosophieson the value of SEPs, the purchase of Motorola by Google changes thedynamic. It could be argued that neither Google nor Microsoft benefit fromstrong SEPs and high F/RAND royalties based on their current, predominate
business models. This exemplifies the complexity of the market environment
where different actors in the value chain use patents for completely different
purposes, meaning that the same patents can vary greatly in perceived valuebased on the business strategy of their owners. As new entrants into thetelecommunication sector develop their R&D capacity and SEP portfolios, thiswill lead to new rhetorical positions on the value of SEPs, thus requiring
courts and policy makers to view SEPs with a systemic, long-term view basedon longitudinal evidence, not short-term business interests.

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