“Most entities do not explain how their per unit rates vary from one end user product to the next (i.e. from one royalty base to the next), instead opting to post rates for handsets along with some language about being flexible.”
This is the third in a series of articles analyzing statements made by various entities in the cellular industry regarding licensing Standard Essential Patents (SEPs) on a Fair, Reasonable and Non-Discriminatory (FRAND) basis. The previous article considered unconditional offers to license on a FRAND basis, arbitration of FRAND terms and conditions, specific FRAND rates, the application of such rates, and portfolio licensing. This article focuses on statements regarding the FRAND royalty base.
FRAND Royalty Base
Related to the issue of specific FRAND rates and how they are to be applied is the royalty base to which such rates apply. This topic can be divided into three sub-issues: (i) whether the royalty base should be an end user product or a component thereof; (ii) if the end user product is the appropriate royalty base, how the rates should vary, if at all, from one type of end user product to the next; and (iii) if the end user product is the appropriate royalty base, whether the rates for one type of end user product can vary as a function of the value of the end product (i.e. be percentage based).
End User Products v. Components
Several entities implicitly express their views on this first sub-issue by either noting their published per unit pricing is applicable to handset devices, as InterDigital does, or by expressing a dollar-based royalty that may be difficult for a wireless component to bear without impacting its price (see Philips’ rate disclosure). Others, however, go further by expressly advocating for a fair return for their innovations. See for example, the FRAND related statements of InterDigital, Qualcomm and Ericsson. InterDigital also expressly rejects component costs as the appropriate basis for FRAND rates and criticizes licensing at multiple levels as being “inefficient, increasing monitoring costs, creating uncertainty for both licensees and licensors and raising costs for both parties.”
In terms of legal pronouncements relating to this first sub-issue, Ericsson successfully moved for a ruling that the ETSI FRAND commitment does not require, as a matter of French law, an owner of SEPs to offer a license having a royalty based on the smallest saleable patent practicing unit (SSPPU) (see Memorandum Opinion and Order, HTC Corporation, HTC America Inc v. Telefonaktiebolaget LM Ericsson, Ericsson Inc, Case No: 6:18-CV-00243-JRG (E.D. Texas, January 7, 2019)). In the same case, Judge Gilstrap’s Memorandum of Finding of Fact and Conclusions of Law, HTC Corporation, HTC America Inc v. Telefonaktiebolaget LM Ericsson, Ericsson Inc, Case No: 6:18-CV-00243-JRG (E.D. Texas, May 23, 2019) noted that Ericsson presented evidence at trial that “the profit margin that a component supplier makes is not necessarily reflective of the value of the intellectual property embodied in that component, especially in a situation like the one presented here where the component supplier does not pay royalties for that intellectual property”, and that industry practice did not support licensing based on the SSPPU:
Finally, industry licensing practice is instructive in this regard. The Court views the rates contained in licenses as highly probative, given the sophistication of the market and the amount of resources and time that the industry devotes to negotiations. Ericsson established, and HTC’s own experts conceded, that there are no examples in the industry of licenses that have been negotiated based on the profit margin, or even the cost, of a baseband processor. HTC’s license expert, Dr. Perryman, was unable to identify a single industry license based on the profit margin of a chip.
More recently, in an antitrust case concerning Qualcomm’s SEP licensing practices (Federal Trade Commission v. Qualcomm Incorporated, D.C. No. 5:17-cv-00220-LHK (9th Cir., August 11, 2020)), the Court of Appeals for the Ninth Circuit said that “[n]o court has held that the SSPPU concept is a per se rule for ‘reasonable royalty’ calculations”, and further that “the Federal Circuit rejected the premise of the district court’s determination: that the SSPPU concept is required when calculating patent damages.” The Court of Appeals also overturned the District Court’s ruling that Qualcomm’s refusal to license rival chipmakers was an anti-trust violation stating that “Qualcomm is under no antitrust duty to license rival chip suppliers”. The Court declined on whether such conduct was a breach of any FRAND commitments, saying that was “a conclusion we need not and do not reach” given “the remedy for such a breach lies in contract and patent law.”
Apple’s FRAND statement, nevertheless, maintains that the proper FRAND royalty base “should be no more than the smallest saleable unit where all or substantially all of the inventive aspects of the SEP are practiced” which, for cellular standards, Apple says, is the baseband chip. The Fair Standards Alliance (FSA) also supports licensing based on the SSPPU, arguing in one of its Position Papers that “[w]hen inappropriately seeking royalties only from parties at the higher end of the value chain, SEP owners are potentially rewarded for innovations that have nothing to do with their SEPs.” According to a recent submission by PanOptis in its case against Apple, however, PanOptis claims that “Apple admitted on cross-examination that FRAND does not require that the royalty base be limited to the baseband processor” and notes the testimony of Apple’s representative acknowledging that she had no recollection that Apple ever entered into a license agreement expressly calculating payment with reference to the baseband chip. See Proposed Findings of Fact and Conclusions of Law Regarding PanOptis’ Count VIII and Apple’s Waiver Defense, Optis Wireless Technology, LLC, Optis Cellular Technology, LLC, Unwired Planet, LLC, Unwired Planet International Limited, and PanOptis Patent Management, LLC, v. Apple, Inc., Civil Action No. 2:19-cv-66-JRG (E.D. Texas, September 11, 2020).
FRAND Rates for Different End User Products
Most entities do not explain how their per unit rates vary from one end user product to the next, instead opting to post rates for handsets along with some language about being flexible to “accommodate the needs and circumstances of individual licensees” as InterDigital says in its FRAND statement for example.
One exception is Avanci, which not only provides separate pricing for different end user products (i.e. vehicles vs. smart meters) but also explains why it does so. Specifically, Avanci’s website states that its different pricing per product types reflects “the value the technology brings to the device”. In a White Paper titled “Accelerating IoT Connectivity” Avanci expands on these points noting three factors it took into consideration in setting its pricing: (1) the product’s need for the technology, (2) the frequency of use of the technology in the product; and (3) and the amount of bandwidth used by the product. With respect to the first factor, Avanci states that the value of the technology is less to products having lower mobility requirements than others, given such products do not use the full scope of the standards and alternative connectivity technologies exist. Regarding the second and third factors Avanci says that the value is also less to products that use the technology less frequently and that have lower bandwidth requirements given less of the standards features need to be utilized for such applications.
Nokia also touches on the issue of different rates for different product types in one of its FRAND related statements, but instead of setting forth specific pricing for products other than mobile phones, Nokia says that it will “determine its licensing rates separately.” Perhaps reflecting the fact that there is little to no prior licensing history for many product types that will use cellular technology going forward, Nokia adds that it “seeks to engage in constructive dialogue with relevant industry participants to define the licensing models best suited for those industries.”
In contrast to the views of Nokia and Avanci, and consistent with its views that the SSPPU is the proper royalty base, the FSA rejects the notion of FRAND rates differing by product type. For example, the FSA argues in its previously mentioned FRAND Position Paper that “the price of a brick should be independent of whether that brick is used for building a garage or a mansion – and the royalty for a SEP associated with a standard that enables an Internet of Things (IoT) devices to be wirelessly connect to other IoT devices (or the cloud) should be independent of whether that first IoT device is a smart watch, a refrigerator or a car. Apple similarly says in its FRAND statement that “SEP owners should not discriminate in the licensing of those SEPs — including by category, industry, or location in the supply chain”, seemingly suggesting that the highest rates that could be charged are those which would be tenable for component manufacturers.
FRAND Rates as a Function of the Value of an End User Product
A third sub-issue relating to the appropriate royalty base is whether the FRAND rate can differ for end user products of the same type. In other words, can the rate be percentage based and, therefore, a higher dollar amount paid for more expensive handsets? Or does the rate have to be independent of the value of the handset (i.e. a fixed dollar amount)?
Being a high-end handset vendor Apple, on the one hand, understandably favors the use of what it calls a “common royalty base”, saying on its website that FRAND rates should be “comparable among SEP licensees”. According to Apple “ASP or use-based methodologies for determining FRAND royalties are a back-door for SEP licensors to discriminate between licensees, to charge different royalties for the same SEPs, and to capture value attributable to licensee innovations.” Avanci’s White Paper also implicitly expresses support for the notion of a common royalty base, albeit for a given end user product type, by championing Avanci’s approach to FRAND licensing whereby all competitors are offered identical pricing.
InterDigital, on the other hand, disagrees with the notion of a common FRAND royalty base saying in its FRAND statement that “[t]he royalty base, combined with the other terms of the license such as per unit royalty caps and floors, should provide for fair and reasonable compensation to the SEP holder for the value of its portfolio while reflecting an appropriate apportionment for the contribution of the licensed patents to the licensed product.”
For an analysis of the appropriateness of percentage-based royalties as well as fixed dollars-per unit royalties in FRAND licensing, we refer the reader to an article by David Teece et al. titled On the “non-discrimination” aspect of FRAND licensing: A response to the Indian Commission’s recent orders.
The issue of FRAND rates being fixed versus a function of the price of the end user product was recently discussed during oral arguments in an appeal to the Court of Appeals for the Federal Circuit, with Judge Chen noting some confusion on this point starting at the 18:05 mark:
Getting back to FRAND… it feels like there was no actual standard industry practice in terms of what model of royalties there would be whether, and I’m talking pure percentages of some sale price, some percent mixed with caps and floors, or just a straight dollar per unit, is that fair to say? That it’s a bit all over the place?
Despite recognizing there is no “standard industry practice, Judge Chen nonetheless calls into question the appropriateness of percentage-based royalties starting at 28:53:
We have pretty well developed, I mean it could be more developed, law on patent damages and what we tend to focus on is what is the incremental value of the technical contribution of this patented technology and we try to… hit some kind of economic valuation of that technical contribution and so that does seem like some kind of fixed value. And so if you have some patented technology on a muffler then whether you’re Porche or you’re Kia you’re probably going to pay the same amount for that patented technology on that muffler. It’s not going to fluctuate based on the price of the car. And and so that’s one thing that makes me wonder about a pure percentage… assessment of what the royalty is going to be when you have a great disparity in sale price of the different kinds of phones here. And so, why is it reasonable if one company is paying a quarter another company is paying four dollars for the exact same thing?
Perhaps hedging its bets on this sub-issue, Ericsson discloses a rate of $5 per 5G/NR multimode compliant handset on its website, while at the same time noting that “[i]n order to encourage the adoption of the standardized technology also in market segments that will have low average sales prices for handsets, Ericsson has decided to voluntarily allow for even lower royalty rates on a case-by-case basis. In exceptional circumstances, Ericsson is prepared to allow for rates as low as, but not lower than, a floor of $2.5 per 5G/NR multimode compliant handset.”
In the next article of this series, we will analyze various FRAND statements relating to the FRAND licensing process generally and, in particular, the obligations of SEP owners / would-be licensors.