“SEP deal-making is a complex and challenging process riddled with technicalities that can make or break a deal…. It heavily relies on reaching a conclusion as to how much a particular SEP portfolio is worth and how each party valuates it. And these can be rough waters to navigate.”
In this article, we’re going back to basics and discussing why our smartphones work everywhere, doing things closer to science fiction of the 1960s or 70s than anyone would have believed, as well as the role that Standard Essential Patents (SEPs) play in making this happen. We are going to examine inherent conflict between innovators and inventors that create new products and services, patent their inventions, and the implementors that leverage and deploy those inventions. Most of all, we’re going to discuss the process that converts these inventions and patents into money. A lot of money. Millions, tens of millions, and sometimes even billions of dollars. Why? Because your smartphone would be a paperweight without these innovations and patents. And soon vehicles, home appliances, production lines, meters, healthcare devices and many more industries will follow.
SEPs and the Cycle of Innovation
Cash flows from contentious intellectual property deals power, fund, and enable the innovation cycles that drive the products and services we use daily. Deals that are ultimately done when two parties, with very different objectives, surrounded by a cast of characters with different objectives and motivations, actually get to the end of the process and sign a deal. To accomplish that objective, companies need to find a way to get to “Just Right,” which is another way of saying that companies need to find a way to value a deal that they can both sign and live with for years to come. This leads us to consider the countless lawsuits around SEPs over the past decades, aggregate legal fees in the billions, and the endless distraction, acrimony and FUD (fear, uncertainty, and doubt) sown by all sides in the process. All of which are driven by a fundamental disagreement on what is “just right” in relation to the value of SEPs underlying our wireless devices, or more typically, portfolios of SEPs. The bottom line, however, is that all patents are property rights. This is true for a new product, chemical, pharmaceutical, or methods of shipping wireless bits of data through the air. In functional terms, patents are an asset, just like the rights to a song, a movie, or physical assets like owning a car or piece of art. By definition, an SEP, or portfolios of thousands of SEPs or more, that is part of an accepted wireless standard has value, with the big question being: “How much is that patent or that portfolio worth?”. Various sources show that patent license revenues for wireless phones, in aggregate, funding the R&D, innovation, and standards globally, are estimated to be about $15-$20 billion a year, with this paper describing some dynamics. On one hand, this is a big number, and finding a way to do this more efficiently and transparently is important. However, on the other hand, this $15-20 billion a year is the engine that powers hundreds of billions of revenues a year from handset, infrastructure, and application providers, as well as trillions in market capitalization of those companies.
The smartphone in your hand, pocket, or purse works on any carrier and almost anywhere on the globe due to tens of billions of R&D spending and mind-boggling efforts by some of the brightest engineers on the planet in the United States, China, Japan, South Korea, EU, UK, and elsewhere. Over decades, they have worked collaboratively to develop the “Wireless Standards” we now know as “3G”, “4G”, and “5G” (and others). And believe it or not, investment and research has already been happening for years on innovations and technology that will ultimately be called “6G”. These wireless standards are codified by groups such as ETSI, the European Technical Standards Institute, which has been the primary global driver for Telecommunications standards for the last several decades. Early standards (think 1980s or early 1990s) did not fully standardize, harmonize, or coordinate features and capabilities across borders, regions, and sometimes cities. Often taken for granted, it is bogglingly complex to have standards that function on a global basis for billions of phones, on thousands of wireless networks, in hundreds of countries.
FRAND and Why Determining ‘Just Right’ is Challenging
Standards developing companies need to “disclose” which innovations and inventions contributed to the Standards Setting Organization (such as ETSI) they intend to patent, even though that innovation/standard might not be implemented in “live” networks or devices for many, many years to come. And if an essential innovation/invention ends up part of a final standard, it can turn into an SEP. Meaning that innovation is part of the standard, and that every device and service using that standard will be touching that SEP. Here is the actual language from the ETSI IPR Policy that defines these disclosures:
“Subject to Clause 4.2 below, each MEMBER shall use its reasonable endeavors, in particular during the development of a STANDARD or TECHNICAL SPECIFICATION where it participates, to inform ETSI of ESSENTIAL IPRs in a timely fashion. In particular, a MEMBER submitting a technical proposal for a STANDARD or TECHNICAL SPECIFICATION shall, on a bona fide basis, draw the attention of ETSI to any of that MEMBER’s IPR which might be ESSENTIAL if that proposal is adopted.”
In exchange for participating in the standards bodies, companies and other participating institutions need to agree that any SEPs that are part of a future standard will be licensed on “FRAND” terms. What is FRAND? A commitment to license the contributed innovations/inventions to anyone on “Fair, Reasonable, And Non-Discriminatory” terms.
“IPR shall mean any intellectual property right conferred by statute law including applications therefor other than trademarks. For the avoidance of doubt rights relating to get-up, confidential information, trade secrets or the like are excluded from the definition of IPR”.
And more importantly, ETSI defines FRAND as:
“Disclosure of Standard Essential Patents (SEP) holders are requested to provide an irrevocable undertaking in writing that they are prepared to grant irrevocable licenses on Fair, Reasonable and Non-Discriminatory (“FRAND”) terms and conditions”
Although some courts and governments have attempted to bound FRAND, there is no clear-cut definition for FRAND. It’s an amorphous, ethereal concept where involved parties understand what FRAND is (kind of), but can’t fully define it in relation to what FRAND means for any specific licensing transaction.
The amorphousness of FRAND is both a feature and bug in the system. The concept of FRAND is to get two parties across the table from one another and negotiate a deal for the value of a portfolio of SEPs. However, this process often goes awry, as both sides have differing views of what is the value of the SEP patent portfolio which becomes the basis for the decades of acrimonious legal battles surrounding SEPs, licensing, and FRAND. Players across the standards process make decisions to dedicate huge amounts of R&D resources and R&D dollars to develop technologies and capabilities that not obvious, innovations that are way over the horizon, sometimes 6–8 years out or more. These companies, and other perennial SEP creators, such as Nokia, Ericsson, Samsung, Qualcomm, Interdigital, Huawei, ZTE and a myriad of others, help define the standards, contribute technology, with a desire to be appropriately compensated. That compensation can take many forms over time, including (but not limited to) generating future licensing revenues, partnering, helping their existing products, sale/trading of IP, or business leverage as defined (or not defined, as the case may be) by FRAND.
An abstract to a Stanford article on standards has a great quote illustrating the complex realities:
Part V offers a theory of SSO intellectual property rules as a sort of messy private ordering, allowing companies to bargain in the shadow of patent law in those industries in which it is most important that they do so.
Now think about being an engineer doing a contribution to a standard, and working with other engineers and patent attorneys to write a patent around that contribution with hopes the contribution meets the technical bar her/his peers set for a given target technical capability, with the ultimate goal of being accepted and recognized as an SEP. In this case, innovators and inventors contribute “over the horizon” technology, somehow anticipating exact language that can hold up in a court (or several courts) years from now for a patent being filed today. This quote from an excellent IEEE Spectrum article on Kodak patents sums up the problem: “You can’t tell at the time of a patent grant precisely what it covers”, says Feldman of the University of California. “You’re using language that’s going to be compared to something that doesn’t exist at the time you write it”.
And that’s for one patent. Now, how does a company or court evaluate and value an entity’s portfolio with tens, hundreds, thousands, or even more than 10,000 SEPs? Patents that apply to not only the ‘latest’ technology standards, but encompass continued future use of existing technology standards such as 3G and 4G? Yet somehow, two parties, the innovator and the implementor need to find a way to get to “Just Right” for portfolios of thousands or tens of thousands of SEPs, covering multiple generations of wireless technology and find a way to a deal. So, what could go wrong? A lot! But somehow, for the most part, companies end up doing deals. Deals which over time, and in the aggregate, end up largely making sense in the context of “who gets what” for their inventions. The “messy private ordering” is often an incredibly inefficient allocation of industry brainpower and dollars, but somehow gets there. However, it could potentially get there a lot faster and efficient. How? By companies collectively recognizing that more transparency and bilateral negotiation are necessary attributes.
SEP Determination and Transparency
The lack of transparency is the main reason for FUD (fear, uncertainty, and doubt), yielding long and often complex discussions. With increasing complexity e.g. licensing SEPs in new industry verticals outside of the smartphone world, also the importance of transparency increases. The matter of transparency starts with publicly available data on potentially essential patents where some standards organizations such as ETSI provide specific lists of self-declared patents, while other standards organizations such the IEEE (Institute of Electrical and Electronics Engineers), the organization responsible for developing the Wi-Fi (802.11) generations, or ITUT (International Telecommunication Union Telecommunication), responsible for the video and audio compression standards e.g. AVC, HEVC, VVC or AAC, allow companies to submit so called blanket declarations, where patent holders must not disclose the actual lists of patents but only provide a broad statement to license under FRAND. Consequently, for some standards the list of potentially essential patents is not available.
For the case of 3G, 4G or 5G, ETSI provides a pretty good starting point, offering a very complete list of all patents that are potentially essential. Still, with such a list, a lot more work is needed beyond what’s publicly available. To refine public declaration patent lists, access to extended worldwide patent offices’ data is needed to understand in which jurisdictions these patents have been granted, which patents changed ownership, or which patents are still active and have not been lapsed or expired. Also, data on past litigation is helpful where some of the patents were confirmed essential by a court, but also where some patents were found to be not infringing or even invalid. Finally, the hardest part is determining which of the self-declared patents are essential; in other words, are necessary for the implementation of the standard. Claim charting is the most obvious approach, however commissioning subject matter experts is expensive and takes time, where mapping just one patent may take 1-2 days up to a whole week spending $5,000-$10,000 to determine if one single patent is essential or not. When negotiating patent portfolios of hundreds, sometimes thousands of patents, the manual claim charting approach is not feasible. Therefore, negotiating parties often agree on determining essentiality only for smaller samples of larger portfolios. Still, the question remains how large and valuable a given portfolio is compared to the overall existing number of SEPs for standards such as 3G, 4G and 5G. The valuation of a SEP portfolio needs both the determination of the numerator (the licensors portfolio) and determination of the denominator (the overall number of verified SEPs). However, with about 280,000 patents hosted at ETSI, breaking down to over 60,000 world-wide patent families, it is impossible to value and determine essentialities for all declared patents.
Better tools for exploring and measuring the value of portfolios are desperately needed, recognizing that the engine of innovation and growth that SEPs continue to power is essential, not just to the stakeholders, but to the place that wireless networks, devices, and applications have cemented in the daily lives of us all. SEP deal-making is a complex and challenging process riddled with technicalities that can make or break a deal. Closing an SEP deal can often take years, lots of lawyers, and plenty of acrimonies. It heavily relies on reaching a conclusion as to how much a particular SEP portfolio is worth and how each party valuates it. And these can be rough waters to navigate.
An upcoming IPWatchdog listed webinar will discuss SEP licensing practices of the past and present, identifying similarities and differences for handsets, IoT, or automotive industries. The webinar will host three industry veterans who have spent years and years perfecting the art of negotiating and closing SEP deals. Speakers will elaborate on patent processes in determining what to assert and why, determining portfolio/license values, setting value parameters, and negotiating deals, as well as discussing recent litigation and why finding a win-win to drive more “deals” and avoid unnecessary litigation is so challenging.
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