December 2015

ISBN: 978-3-945185-05-6

Re-Evaluating Patent Damages in theKnowledge Economy
The Determination of Royalty Base for Standard Essential
Patents from an Intellectual Value Chain Perspective
Bowman Heiden
Center for Intellectual Property (CIP)
Department of Technology Management and Economics
Chalmers University of Technology
Jens Andreasson
Center for Intellectual Property (CIP)
School of Business, Economics and Law
University of Gothenburg

Re-Evaluating Patent Damages in the Knowledge Economy
The Determination of Royalty Base for Standard Essential Patents froman Intellectual Value Chain Perspective
Bowman Heiden
Center for Intellectual Property (CIP)
Department of Technology Management and Economics
Chalmers University of Technology
Jens Andreasson
Center for Intellectual Property (CIP)
School of Business, Economics and Law
University of Gothenburg

1.

Introduction

Patent valuation is a complex and imprecise process exemplified by the long,contentious history regarding the determination of patent damages in US
jurisprudence. This process is made even more difficult as products increasingly
undergo technology convergence and market actors deploy divergent businessstrategies to extract value from their intellectual property. This has led to anincrease in patent litigation and a greater need for courts to more accurately
calculate patent value. Courts have deployed several procedural rules including theuse of the smallest saleable patent practicing unit (SSPPU) and the entire market
value rule (EMVR) as a means to reduce the complexity. However, as these rules
impact the determination of the royalty base, which can differ by orders ofmagnitude, the applicability of their use in different market contexts and norms
requires investigation as their use by the courts could have a systemic effect on
industrial dynamics and economic efficiency in specific markets, especially thosereliant on open standards. The goal of this study is to investigate the applicability
and implications of the current legal norms for the choice of royalty base in relation
to the prevailing market norms regarding SEP transactions in the telecommunicationindustry. The full paper will be available in an academic journal in the near future.
Below is a short summary of the preliminary findings.

2.

Value Creation in the Knowledge Economy

For this study the focus is on the key operational differences between competition
on a product market (i.e. a MVC) versus a technology market (i.e. an IVC), where theformer is primarily concerned with the production and sale of physical products andthe latter with the packaging of knowledge as intellectual property andcommercialization through license-based transactions. While the material value
chain (MVC) can be seen as a component of a more holistic intellectual value
creation process, this paper will define the two value chains as separate but
complementary as a means to better illustrate the different commercial logics andstrategies deployed by market actors – see figure 1 below. This is particularlyrelevant considering the changing role of IP licensing from being simply analternative to in-house production to a primary means of generating revenue andfacilitating access in standards-enabled markets with multi-technology products,
where IP ownership is often distributed among many actors. As technology/patent
licensing is often directed at producers of physical products, special interest will begiven to the intersection of the two value chains (i.e. the position in the materialvalue chain where licensing takes place) as this directly relates to the determinationof royalty base.

Intellectual Value Chain
Knowledge
Creation
Material Value Chain
Figure 1. Commercialization of knowledge on both a material and intellectual value chain

3.

Positioning of License Agreements in the Telecommunication
Value Chain

In the telecommunication industry the market norms for the location of SEP
licensing is typically at the position of the end product in the value chain as shown infigure 2 below. On the lower layer, the figure depicts a generic telecommunicationmaterial value chain consisting of component manufacturers (e.g. chipsetproducers), end product suppliers (e.g. brand owners and OEM/ODM), andcustomers (e.g. operators and/or end users). On the upper layer the figure shows
how the results of R&D activities (e.g SEPs) are managed as intellectual propertytransactions (e.g. SEP licenses) through the intellectual value chain towards end
product suppliers in the material value chain.

Figure 2. Position of SEP licensing in the telecommunication value chain

The choice of F/RAND licensing towards end product suppliers has evolved as thepredominant market norm based on the following reasons:
1. Historical norms
The history of cross-licensing among integrated firms in thetelecommunication industry has created a strong norm among actors tolicense SEPs at the end product supplier position in the value chain. Thisnorm has persisted even as the value chain has transformed and fragmented
to include new divisions of labor. This norm can be seen in how firms makeroyalty declarations, in the specification of “fully compliant” product licensing
in F/RAND commitments, in the licensing unit of patent pools, in recent ITC
rulings, and in the recent SEP court cases in the US, where the end productsupplier has typically been the defendant.

2. Risk Management
For integrated firms that maintain both strong SEP portfolios and produce
physical products, the position of SEP licensing is important for managing
their exposure to the SEP portfolios of other integrated firms.
3. Value capture
SEP holding firms are profit maximizers, the same as all commercial firms.
Given the opportunity to choose the position of the value chain in which tolicense SEP portfolios, a rational firm would choose a position that bestreflected the value of the contribution of their technology.

4.

Case studies

In order to better understand knowledge-based business models in the context ofthe telecommunication value chain, both the MVC and IVC, two short cases are
examined individually first and then collectively to illustrate their interaction. The
first case is Qualcomm, exemplifying a leading company originating from thetelecommunication sector that operates in both the MVC and IVC selling bothcomponents and licensing SEPs as separate but interrelated business models
towards OEM/ODMs. The second case is ARM, exemplifying a leading company
originating from the semiconductor/computer industry that operates exclusively in
the IVC through a pure IP-based business model towards semiconductor/chipproviders1.
While this study describes how different business models in the MVC and IVC
operate and interact, it is also helpful to illustrate how different knowledge-based
business models interact in the telecommunication value chain. Figure 3 below
shows how the ARM and Qualcomm IP-based business models interface in the IVC,
where ARM processor IP cores are licensed to Qualcomm, who integrates them
together with other technology blocks to provide full system-on-a-chip (SoC)
solutions for mobile devices. Qualcomm subsequently licenses its SEP portfolio toOEM/ODMs manufacturing end products.

1 Though ARM does not license SEPs, it does license IP and has become a major actor in thetelecommunication value chain through convergence of the mobile computing segment. It is usedhere to illustrate differences in IP licensing norms in relation to Qualcomm and other SEP licensing
telecommunication firms. It is a particularly relevant example given that ARM’s licensing practice wasused as a comparable industry license in determining the F/RAND royalty range and rate in thelandmark Microsoft ruling recently upheld on appeal by the US 9th Circuit Court of Appeals.

Figure 3. Interrelationship of ARM and Qualcomm IP-Based Business Models

The location of licensing in the telecommunication value chain (i.e. royalty base) ofboth the ARM and Qualcomm licensing models represents the influence of historicalnorms where ARM has its roots as a semiconductor company in the computerindustry and Qualcomm has its roots as fully integrated telecommunicationcompany. These different histories also manifest themselves in relation to the natureof the scope of their different IP portfolios. While ARM’s IP relates primarily to thefunction and implementation of processor-based chips, Qualcomm’s standard
essential IP relates to the entire telecommunication system (e.g. the 3G or WiFi
communication system) with some functionality implemented on the chip level andothers on the device and system level. Thus historical industry norms and the scopeof the relevant technical system together with strategic business considerations
based on bargaining power in the value chain have all impacted the current
configuration and roles played by ARM and Qualcomm in the telecommunication
value chain.

5.

Analysis of IVC-based principles and market norms in relation tocurrent legal norms for determination of royalty baseThis section analyzes the impact of IVC principles and prevailing market norms on
the interpretation of legal norms regarding apportionment and royalty basedeterminations in the adjudication of patent damages for standard-essential patents(SEPs). Five relevant areas of consideration have been highlighted to advise courts,
regulators, SSOs, and other policy-makers when interpreting and setting norms
related to SEPs, F/RAND, and standard-enabled markets. In particular, these fiveareas are meant to generate a better understanding of how the nature of the valueof knowledge and the evolution of market norms in the telecommunication value
chain should normatively influence the interpretation of legal norms to provide
greater equity and economic efficiency.
1. The Value of Knowledge is Not Constrained by the Material Value Chain
One key characteristic of a knowledge economy is the increased value of theknowledge component of value propositions. When we move from a MVC toIVC logic, one key challenge will be how to value different knowledge-based

contributions delivered through multiple interrelated value propositions,such as knowledge embedded in physical products and knowledge packaged
as license offers. In the context of patent damages, this would fall within thegeneral category of the challenge of apportionment where the court hasdeveloped several procedural rules to help manage the complexity, such as
SSPPU and EMVR. Therefore, the value of IP cannot always be defined simply
by looking into the MVC. For example, the market norms in thetelecommunication industry show that firms license SEPs separately fromphysical value propositions (e.g. chipsets) through the IVC towards end
product, making the component level inappropriate as the royalty basewithout a necessary adjustment to account for customary business practice.
2. Royalty Lacking – Components are Not Licensed in the Telecommunication
Value Chain
Building on the previous section above, the use of the SSPPU rule becomesincreasingly challenging when the IP in question has not been licensed on thecomponent level. As discussed previously, the norm in thetelecommunication industry is to license SEPs at the end product position in
the value chain, which effectively means that the component level is left
unlicensed. This creates a downward pressure on the price of components
creating what could be termed as a reverse royalty-stacking or “royaltylacking” problem if a component level royalty base is chosen in an industry
that doesn’t license SEPs at the component level.
3. Market Norms are to License SEPs on Fully-Compliant End Products
Based on historical norms and strategic behavior, SEP holders in thetelecommunication value chain primarily license SEPs on fully compliant
products sold by end product suppliers. This practice has existed now forquite some time, especially in cellular standards, though increasingly in Wi-Fistandards, however, with less evidence of traditional licensing activity. While
numerous antitrust inquires have examined SEP licensing practice, to date nocompetition authority has found the practice of SEP licensing to the end
product position of the value chain to be anti-competitive. However, it ispossible that different industries and industry segments may have different
norms as the Qualcomm and ARM cases in section 4 demonstrate.
4. Standards Drive Market Demand by Definition
For consortium-based telecommunication standards, it is particularly difficult
to separate the standard-setting process from the construction of themarket. However, different actors view standards in different ways. For
implementation firms the standard is a means to facilitate the sale ofproducts and services, while for innovation specialists and large SEP portfolio
holders, the standard is viewed as a product itself. The use of SSPPU andEMVR can be seen as a means by the court to manage the complexity ofdetermining patent damages in multi-technology products, however, thedistinction is too digital. The EMVR requirement that the end product cannot
be used as the base if the patents in suit are not proven to drive the demandfor the product is not applicable for standards that drive market demand bydefinition.
5. Market Norms are Embedded in SEP License Agreements
The use of the Georgia-Pacific Factors (GPFs) provide an opportunity formarket norms to be integrated into the determination of patent damages, inparticular, GPFs 1-2. It is not a coincidence that these are the first two factors
as courts have long acknowledged that the best measure of a reasonableroyalty is an established royalty rate in the industry (i.e. market norms).
Existing comparable licenses have market norms related to the royalty baseand apportionment embedded intrinsically within the agreements. Existing
licenses eliminate the need to determine these factors hypothetically as they
have been determined in practice through an actual market transaction. In
new areas where little case law exists, existing market agreements arevaluable resources in supplying courts with important information on market
norms. However, it is important that comparables are in fact comparable, socaution should be used when comparing transactions across different
standardization and market contexts.