Archives For patent

[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Daniel Takash,(Regulatory policy fellow at the Niskanen Center. He is the manager of Niskanen’s Captured Economy Project, https://capturedeconomy.com, and you can follow him @danieltakash or @capturedecon).]

The pharmaceutical industry should be one of the most well-regarded industries in America. It helps bring drugs to market that improve, and often save, people’s lives. Yet last year a Gallup poll found that of 25 major industries, the pharmaceutical industry was the most unpopular– trailing behind fossil fuels, lawyers, and even the federal government. The opioid crisis dominated the headlines for the past few years, but the high price of drugs is a top-of-mind issue that generates significant animosity toward the pharmaceutical industry. The effects of high drug prices are felt not just at every trip to the pharmacy, but also by those who are priced out of life-saving treatments. Many Americans simply can’t afford what their doctors prescribe. The pharmaceutical industry helps save lives, but it’s also been credibly accused of anticompetitive behavior–not just from generics, but even other brand manufacturers.

These extraordinary times are an opportunity to right the ship. AbbVie, roundly criticized for building a patent thicket around Humira, has donated its patent rights to a promising COVID-19 treatment. This is to be celebrated– yet pharma’s bad reputation is defined by its worst behaviors and the frequent apologetics for overusing the patent system. Hopefully corporate social responsibility will prevail, and such abuses will cease in the future.

The most effective long-term treatment for COVID-19 will be a vaccine. We also need drugs to treat those afflicted with COVID-19 to improve recovery and lower mortality rates for those that get sick before a vaccine is developed and widely available. This requires rapid drug development through effective public-private partnerships to bring these treatments to market.

Without a doubt, these solutions will come from the pharmaceutical industry. Increased funding for the National Institutes for Health, nonprofit research institutions, and private pharmaceutical researchers are likely needed to help accelerate the development of these treatments. But we must be careful to ensure whatever necessary upfront public support is given to these entities results in a fair trade-off for Americans. The U.S. taxpayer is one of the largest investors in early to mid-stage drug research, and we need to make sure that we are a good investor.

Basic research into the costs of drug development, especially when taxpayer subsidies are involved, is a necessary start. This is a feature of the We PAID Act, introduced by Senators Rick Scott (R-FL) and Chris Van Hollen (D-MD), which requires the Department of Health and Human Services to enter into a contract with the National Academy of Medicine to figure the reasonable price of drugs developed with taxpayer support. This reasonable price would include a suitable reward to the private companies that did the important work of finishing drug development and gaining FDA approval. This is important, as setting a price too low would reduce investments in indispensable research and development. But this must be balanced with the risk of using patents to charge prices above and beyond those necessary to finance research, development, and commercialization.

A little sunshine can go a long way. We should trust that pharmaceutical companies will develop a vaccine and treatments or coronavirus, but we must also verify these are affordable and accessible through public scrutiny. Take the drug manufacturer Gilead Science’s about-face on its application for orphan drug status on the possible COVID-19 treatment remdesivir. Remedesivir, developed in part with public funds and already covered by three Gilead patents, technically satisfied the definition of “orphan drug,” as COVID-19 (at the time of the application) afflicted fewer than 200,000 patents. In a pandemic that could infect tens of millions of Americans, this designation is obviously absurd, and public outcry led to Gilead to ask the FDA to rescind the application. Gilead claimed it sought the designation to speed up FDA review, and that might be true. Regardless, public attention meant that the FDA will give Gilead’s drug Remdesivir expedited review without Gilead needing a designation that looks unfair to the American people.

The success of this isolated effort is absolutely worth celebrating. But we need more research to better comprehend the pharmaceutical industry’s needs, and this is just what the study provisions of We PAID would provide.

There is indeed some existing research on this front. For example,the Pharmaceutical Researchers and Manufacturers of America (PhRMA) estimates it costs an average of $2.6 billion to bring a new drug to market, and research from the Journal of the American Medical Association finds this average to be closer to $1.3 billion, with the median cost of development to be $985 million.

But a thorough analysis provided under We PAID is the best way for us to fully understand just how much support the pharmaceutical industry needs, and just how successful it has been thus far. The NIH, one of the major sources of publicly funded research, invests about $41.7 billion annually in medical research. We need to better understand how these efforts link up, and how the torch is passed from public to private efforts.

Patents are essential to the functioning of the pharmaceutical industry by incentivizing drug development through temporary periods of exclusivity. But it is equally essential, in light of the considerable investment already made by taxpayers in drug research and development, to make sure we understand the effects of these incentives and calibrate them to balance the interests of patients and pharmaceutical companies. Most drugs require research funding from both public and private sources as well as patent protection. And the U.S. is one of the biggest investors of drug research worldwide (even compared to drug companies), yet Americans pay the highest prices in the world. Are these prices justified, and can we improve patent policy to bring these costs down without harming innovation?

Beyond a thorough analysis of drug pricing, what makes We PAID one of the most promising solutions to the problem of excessively high drug prices are the accountability mechanisms included. The bill, if made law, would establish a Drug Access and Affordability Committee. The Committee would use the methodology from the joint HHS and NAM study to determine a reasonable price for affected drugs (around 20 percent of drugs currently on the market, if the bill were law today). Any companies that price drugs granted exclusivity by a patent above the reasonable price would lose their exclusivity.

This may seem like a price control at first blush, but it isn’t–for two reasons. First, this only applies to drugs developed with taxpayer dollars, which any COVID-19 treatments or cures almost certainly would be considering the $785 million spent by the NIH since 2002 researching coronaviruses. It’s an accountability mechanism that would ensure the government is getting its money’s worth. This tool is akin to ensuring that a government contractor is not charging more than would be reasonable, lest it loses its contract.

Second, it is even less stringent than pulling a contract with a private firm overcharging the government for the services provided. Why? Losing a patent does not mean losing the ability to make a drug, or any other patented invention for that matter.This basic fact is often lost in the patent debate, but it cannot be stressed enough.

If patents functioned as licenses, then every patent expiration would mean another product going off the market. In reality, that means that any other firm can compete and use the patented design. Even if a firm violated the price regulations included in the bill and lost its patent, it could continue manufacturing the drug. And so could any other firm, bringing down prices for all consumers by opening up market competition.

The We PAID Act could be a dramatic change for the drug industry, and because of that many in Congress may want to first debate the particulars of the bill. This is fine, assuming  this promising legislation isn’t watered down beyond recognition. But any objections to the Drug Affordability and Access Committee and reasonable pricing regulations aren’t an excuse to not, at a bare minimum, pass the study included in the bill as part of future coronavirus packages, if not sooner. It is an inexpensive way to get good information in a single, reputable source that would allow us to shape good policy.

Good information is needed for good policy. When the government lays the groundwork for future innovations by financing research and development, it can be compared to a venture capitalist providing the financing necessary for an innovative product or service. But just like in the private sector, the government should know what it’s getting for its (read: taxpayers’) money and make recipients of such funding accountable to investors.

The COVID-19 outbreak will be the most pressing issue for the foreseeable future, but determining how pharmaceuticals developed with public research are priced is necessary in good times and bad. The final prices for these important drugs might be fair, but the public will never know without a trusted source examining this information. Trust, but verify. The pharmaceutical industry’s efforts in fighting the COVID-19 pandemic might be the first step to improving Americans’ relationship with the industry. But we need good information to make that happen. Americans need to know when they are being treated fairly, and that policymakers are able to protect them when they are treated unfairly. The government needs to become a better-informed investor, and that won’t happen without something like the We PAID Act.

A pending case in the U.S. Court of Appeals for the 3rd Circuit has raised several interesting questions about the FTC enforcement approach and patent litigation in the pharmaceutical industry.  The case, FTC v. AbbVie, involves allegations that AbbVie (and Besins) filed sham patent infringement cases against generic manufacturer Teva (and Perrigo) for the purpose of preventing or delaying entry into the testosterone gel market in which AbbVie’s AndroGel had a monopoly.  The FTC further alleges that AbbVie and Teva settled the testosterone gel litigation in AbbVie’s favor while making a large payment to Teva in an unrelated case, behavior that, considered together, amounted to an illegal reverse payment settlement. The district court dismissed the reverse payment claims, but concluded that the patent infringement cases were sham litigation. It ordered disgorgement damages of $448 million against AbbVie and Besins which was the profit they gained from maintaining the AndroGel monopoly.

The 3rd Circuit has been asked to review several elements of the district court’s decision including whether the original patent infringement cases amounted to sham litigation, whether the payment to Teva in a separate case amounted to an illegal reverse payment, and whether the FTC has the authority to seek disgorgement damages.  The decision will help to clarify outstanding issues relating to patent litigation and the FTC’s enforcement abilities, but it also has the potential to chill pro-competitive behavior in the pharmaceutical market encouraged under Hatch-Waxman. 

First, the 3rd Circuit will review whether AbbVie’s patent infringement case was sham litigation by asking whether the district court applied the right standard and how plaintiffs must prove that lawsuits are baseless.  The district court determined that the case was a sham because it was objectively baseless (AbbVie couldn’t reasonably expect to win) and subjectively baseless (AbbVie brought the cases solely to delay generic entry into the market).  AbbVie argues that the district court erred by not requiring affirmative evidence of bad faith and not requiring the FTC to present clear and convincing evidence that AbbVie and its attorneys believed the lawsuits were baseless.

While sham litigation should be penalized and deterred, especially when it produces anticompetitive effects, the 3rd Circuit’s decision, depending on how it comes out, also has the potential to deter brand drug makers from filing patent infringement cases in the first place.  This threatens to disrupt the delicate balance that Hatch-Waxman sought to establish between protecting generic entry while encouraging brand competition.

The 3rd Circuit will also determine whether AbbVie’s payment to Teva in a separate case involving cholesterol medicine was an illegal reverse payment, otherwise known as a “pay-for-delay” settlement.  The FTC asserts that the actions in the two cases—one involving testosterone gel and the other involving cholesterol medicine—should be considered together, but the district court disagreed and determined there was no illegal reverse payment.  True pay-for-delay settlements are anticompetitive and harm consumers by delaying their access to cheaper generic alternatives.  However, an overly-liberal definition of what constitutes an illegal reverse payment will deter legitimate settlements, thereby increasing expenses for all parties that choose to litigate and possibly dissuading generics from bringing patent challenges in the first place.  Moreover, FTC’s argument that two settlements occurring in separate cases around the same time is suspicious overlooks the reality that the pharmaceutical industry has become increasingly concentrated and drug companies often have more than one pending litigation matter against another company involving entirely different products and circumstances. 

Finally, the 3rd Circuit will determine whether the FTC has the authority to seek disgorgement damages on past acts like settled patent litigation.  AbbVie has argued that the agency has no right to disgorgement because it isn’t enumerated in the FTC Act and because courts can’t order injunctive relieve, including disgorgement, on completed past acts. 

The FTC has sought disgorgement damages only sparingly, but the frequency with which the agency seeks disgorgement and the amount of the damages have increased in recent years. Proponents of the FTC’s approach argue that the threat of large disgorgement damages provides a strong deterrent to anticompetitive behavior.  While true, FTC-ordered disgorgement (even if permissible) may go too far and end up chilling economic activity by exposing businesses to exorbitant liability without clear guidance on when disgorgement will be awarded. The 3rd Circuit will determine whether the FTC’s enforcement approach is authorized, a decision that has important implications for whether the agency’s enforcement can deter unfair practices without depressing economic activity.

Qualcomm is currently in the midst of a high-profile antitrust case against the FTC. At the heart of these proceedings lies Qualcomm’s so-called “No License, No Chips” (NLNC) policy, whereby it purportedly refuses to sell chips to OEMs that have not concluded a license agreement covering its underlying intellectual property. According to the FTC and Qualcomm’s opponents, this ultimately thwarts competition in the chipset market.

Against this backdrop, Mark Lemley, Douglas Melamed, and Steven Salop penned a high-profile amicus brief supporting the FTC’s stance. 

We responded to their brief in a Truth on the Market blog post, and this led to a series of blog exchanges between the amici and ourselves. 

This post summarizes these exchanges.

1. Amicus brief supporting the FTC’s stance, and ICLE brief in support of Qualcomm’s position

The starting point of this blog exchange was an Amicus brief written by Mark Lemley, Douglas Melamed, and Steven Salop (“the amici”) , and signed by 40 law and economics scholars. 

The amici made two key normative claims:

  • Qualcomm’s no license, no chips policy is unlawful under well-established antitrust principles: 
    Qualcomm uses the NLNC policy to make it more expensive for OEMs to purchase competitors’ chipsets, and thereby disadvantages rivals and creates artificial barriers to entry and competition in the chipset markets.”
  • Qualcomm’s refusal to license chip-set rivals reinforces the no license, no chips policy and violates the antitrust laws:
    Qualcomm’s refusal to license chipmakers is also unlawful, in part because it bolsters the NLNC policy.16 In addition, Qualcomm’s refusal to license chipmakers increases the costs of using rival chipsets, excludes rivals, and raises barriers to entry even if NLNC is not itself illegal.

It is important to note that ICLE also filed an amicus brief in these proceedings. Contrary to the amici, ICLE’s scholars concluded that Qualcomm’s behavior did not raise any antitrust concerns and was ultimately a matter of contract law and .

2. ICLE response to the Lemley, Melamed and Salop Amicus brief.

We responded to the amici in a first blog post

The post argued that the amici failed to convincingly show that Qualcomm’s NLNC policy was exclusionary. We notably highlighted two important factors.

  • First, Qualcomm could not use its chipset position and NLNC policy to avert the threat of FRAND litigation, thus extracting supracompetitve royalties:
    Qualcomm will be unable to charge a total price that is significantly above the price of rivals’ chips, plus the FRAND rate for its IP (and expected litigation costs).”
  • Second, Qualcomm’s behavior did not appear to fall within standard patterns of strategic behavior:
    The amici attempt to overcome this weakness by implicitly framing their argument in terms of exclusivity, strategic entry deterrence, and tying […]. But none of these arguments totally overcomes the flaw in their reasoning.” 

3. Amici’s counterargument 

The amici wrote a thoughtful response to our post. Their piece rested on two main arguments:

  • The Amici underlined that their theory of anticompetitive harm did not imply any form of profit sacrifice on Qualcomm’s part (in the chip segment):
    Manne and Auer seem to think that the concern with the no license/no chips policy is that it enables inflated patent royalties to subsidize a profit sacrifice in chip sales, as if the issue were predatory pricing in chips.  But there is no such sacrifice.
  • The deleterious effects of Qualcomm’s behavior were merely a function of its NLNC policy and strong chipset position. In conjunction, these two factors deterred OEMs from pursuing FRAND litigation:
    Qualcomm is able to charge more than $2 for the license only because it uses the power of its chip monopoly to coerce the OEMs to give up the option of negotiating in light of the otherwise applicable constraints on the royalties it can charge.

4. ICLE rebuttal

We then responded to the amici with the following points:

  • We agreed that it would be a problem if Qualcomm could prevent OEMs from negotiating license agreements in the shadow of FRAND litigation:
    The critical question is whether there is a realistic threat of litigation to constrain the royalties commanded by Qualcomm (we believe that Lemley et al. agree with us on this point).”
  • However, Qualcomm’s behavior did not preclude OEMs from pursuing this type of strategy:
    We believe the following facts support our assertion:
    OEMs have pursued various litigation strategies in order to obtain lower rates on Qualcomm’s IP. […]
    For the most part, Qualcomm’s threats to cut off chip supplies were just that: threats. […]
    OEMs also wield powerful threats. […]
    Qualcomm’s chipsets might no longer be “must-buys” in the future.”

 5. Amici’s surrebuttal

The amici sent us a final response (reproduced here in full) :

In their original post, Manne and Auer argued that the antitrust argument against Qualcomm’s no license/no chips policy was based on bad economics and bad law.  They now seem to have abandoned that argument and claim instead – contrary to the extensive factual findings of the district court – that, while Qualcomm threatened to cut off chips, it was a paper tiger that OEMs could, and knew they could, ignore.  The implication is that the Ninth Circuit should affirm the district court on the no license/ no chips issue unless it sets aside the court’s fact findings.  That seems like agreement with the position of our amicus brief.

We will not in this post review the huge factual record.  We do note, however, that Manne and Auer cite in support of their factual argument only that 3 industry giants brought and then settled litigation against Qualcomm.  But all 3 brought antitrust litigation; their doing so hardly proves that contract litigation or what Manne and Auer call “holdout” were viable options for anyone, much less for smaller OEMs.  The fact that Qualcomm found it necessary to actually cut off only one OEM – and then it only took the OEM only 7 days to capitulate – certainly does not prove that Qualcomm’s threats lacked credibility.   Notably, Manne and Auer do not claim that any OEMs bought chips from competitors of Qualcomm (although Apple bought some chips from Intel for a short while). No license/no chips appears to have been a successful, coercive policy, not an easily ignored threat.                                                                                                                                              

6. Concluding remarks

First and foremost, we would like to thank the Amici for thoughtfully engaging with us. This is what the law & economics tradition is all about: moving the ball forward by taking part in vigorous, multidisciplinary, debates.

With that said, we do feel compelled to leave readers with two short remarks. 

First, contrary to what the amici claim, we believe that our position has remained the same throughout these debates. 

Second, and more importantly, we think that everyone agrees that the critical question is whether OEMs were prevented from negotiating licenses in the shadow of FRAND litigation. 

We leave it up to Truth on the Market readers to judge which side of this debate is correct.

[This guest post is authored by Mark A. Lemley, Professor of Law and the Director of Program in Law, Science & Technology at Stanford Law School; A. Douglas Melamed, Professor of the Practice of Law at Stanford Law School and Former Senior Vice President and General Counsel of Intel from 2009 to 2014; and Steven Salop, Professor of Economics and Law at Georgetown Law School. It is part of an ongoing debate between the authors, on one side, and Geoffrey Manne and Dirk Auer, on the other, and has been integrated into our ongoing series on the FTC v. Qualcomm case, where all of the posts in this exchange are collected.]

In their original post, Manne and Auer argued that the antitrust argument against Qualcomm’s no license/no chips policy was based on bad economics and bad law. They now seem to have abandoned that argument and claim instead – contrary to the extensive factual findings of the district court – that, while Qualcomm threatened to cut off chips, it was a paper tiger that OEMs could, and knew they could, ignore. The implication is that the Ninth Circuit should affirm the district court on the no license/ no chips issue unless it sets aside the court’s fact findings. That seems like agreement with the position of our amicus brief.

We will not in this post review the huge factual record. We do note, however, that Manne and Auer cite in support of their factual argument only that 3 industry giants brought and then settled litigation against Qualcomm. But all 3 brought antitrust litigation; their doing so hardly proves that contract litigation or what Manne and Auer call “holdout” were viable options for anyone, much less for smaller OEMs. The fact that Qualcomm found it necessary to actually cut off only one OEM – and then it only took the OEM only 7 days to capitulate – certainly does not prove that Qualcomm’s threats lacked credibility. Notably, Manne and Auer do not claim that any OEMs bought chips from competitors of Qualcomm (although Apple bought some chips from Intel for a short while). No license/no chips appears to have been a successful, coercive policy, not an easily ignored threat.

[This guest post is authored by Mark A. Lemley, Professor of Law and the Director of Program in Law, Science & Technology at Stanford Law School; A. Douglas Melamed, Professor of the Practice of Law at Stanford Law School and Former Senior Vice President and General Counsel of Intel from 2009 to 2014; and Steven Salop, Professor of Economics and Law at Georgetown Law School. It is a response to the post, “Exclusionary Pricing Without the Exclusion: Unpacking Qualcomm’s No License, No Chips Policy,” by Geoffrey Manne and Dirk Auer, which is itself a response to Lemley, Melamed, and Salop’s amicus brief in FTC v. Qualcomm.]

Geoffrey Manne and Dirk Auer’s defense of Qualcomm’s no license/no chips policy is based on a fundamental misunderstanding of how that policy harms competition.  The harm is straightforward in light of facts proven at trial. In a nutshell, OEMs must buy some chips from Qualcomm or else exit the handset business, even if they would also like to buy additional chips from other suppliers. OEMs must also buy a license to Qualcomm’s standard essential patents, whether they use Qualcomm’s chips or other chips implementing the same industry standards. There is a monopoly price for the package of Qualcomm’s chips plus patent license. Assume that the monopoly price is $20. Assume further that, if Qualcomm’s patents were licensed in a standalone transaction, as they would be if they were owned by a firm that did not also make chips, the market price for the patent license would be $2. In that event, the monopoly price for the chip would be $18, and a chip competitor could undersell Qualcomm if Qualcomm charged the monopoly price of $18 and the competitor could profitably sell chips for a lower price. If the competitor’s cost of producing and selling chips was $11, for example, it could easily undersell Qualcomm and force Qualcomm to lower its chip prices below $18, thereby reducing the price for the package to a level below $20.

However, the no license/no chips policy enables Qualcomm to allocate the package price of $20 any way it wishes. Because the OEMs must buy some chips from Qualcomm, Qualcomm is able to coerce the OEMs to accept any such allocation by threatening not to sell them chips if they do not agree to a license at the specified terms. The prices could thus be $18 and $2; or, for example, they could be $10 for the chips and $10 for the license. If Qualcomm sets the license price at $10 and a chip price of $10, it would continue to realize the monopoly package price of $20. But in that case, a competitor could profitably undersell Qualcomm only if its chip cost were less than 10. A competitor with a cost of $11 would then not be able to successfully enter the market, and Qualcomm would not need to lower its chip prices. That is how the no license/no chip policy blocks entry of chip competitors and maintains Qualcomm’s chip monopoly. 

Manne and Auer’s defense of the no license/no chips policy is deeply flawed. In the first place, Manne and Auer mischaracterize the problem as one in which “Qualcomm undercuts [chipset rivals] on chip prices and recoups its losses by charging supracompetitive royalty rates on its IP.” On the basis of this description of the issue, they argue that, if Qualcomm cannot charge more than $2 for the license, it cannot use license revenues to offset the chip price reduction. And if Qualcomm can charge more than $2 for the license, it does not need a chip monopoly in order to make supracompetitive licensing profits. This argument is wrong both factually and conceptually.  

As a factual matter, there are constraints on Qualcomm’s ability to charge more than $2 for the license if the license is sold by itself. If sold by itself, the license would be negotiated in the shadow of infringement litigation and the royalty would be constrained by the value of the technology claimed by the patent, the risk that the patent would be found to be invalid or not infringed, the “reasonable royalty” contemplated by the patent laws, and the contractual commitment to license on FRAND terms. But Qualcomm is able to circumvent those constraints by coercing OEMs to pay a higher price or else lose access to essential Qualcomm chips. In other words, Qualcomm’s ability to charge more than $2 for the license is not exogenous. Qualcomm is able to charge more than $2 for the license only because it uses the power of its chip monopoly to coerce the OEMs to give up the option of negotiating in light of the otherwise applicable constraints on the royalties it can charge. It is a simple story of bundling with simultaneous recoupment.  

As a conceptual matter, Manne and Auer seem to think that the concern with the no license/no chips policy is that it enables inflated patent royalties to subsidize a profit sacrifice in chip sales, as if the issue were predatory pricing in chips.  But there is no such sacrifice. Money is fungible, and Manne and Auer have it backwards. The problem is that the no license/no chips policy enables Qualcomm to make purely nominal changes by allocating some of its monopoly chip price to the license price. Qualcomm offsets that nominal license price increase when the OEM buys chips from it by lowering the chip price by that amount in order to maintain the package price at the monopoly price.  There is no profit sacrifice for Qualcomm because the lower chip price simply offsets the higher license price. Qualcomm offers no such offset when the OEM buys chips from other suppliers. To the contrary, by using its chip monopoly to increase the license price, it increases the cost to OEMs of using competitors’ chips and is thus able to perpetuate its chip monopoly and maintain its monopoly chip prices and profits. Absent this policy, OEMs would buy more chips from third parties; Qualcomm’s prices and profits would fall; and consumers would benefit.

At the end of the day, Manne and Auer rely on the old “single monopoly profit” or “double counting” idea that a monopolist cannot both charge a monopoly price and extract additional consideration as well. But, again, they have it backwards. Manne and Auer describe the issue as whether Qualcomm can leverage its patent position in the technology markets to increase its market power in chips. But that is not the issue. Qualcomm is not trying to increase profits by leveraging monopoly power from one market into a different market in order to gain additional monopoly profits in the second market. Instead, it is using its existing monopoly power in chips to maintain that monopoly power in the first place. Assuming Qualcomm has a chip monopoly, it is true that it earns the same revenue from OEMs regardless of how it allocates the all-in price of $20 to its chips versus its patents. But by allocating more of the all-in price to the patents (i.e., in our example, $10 instead of $2), Qualcomm is able to maintain its monopoly by preventing rival chipmakers from undercutting the $20 monopoly price of the package. That is how competition and consumers are harmed.

Qualcomm is currently in the midst of a high-profile antitrust case against the FTC. At the heart of these proceedings lies Qualcomm’s so-called “No License, No Chips” (NLNC) policy, whereby it purportedly refuses to sell chips to OEMs that have not concluded a license agreement covering its underlying intellectual property. According to the FTC and Qualcomm’s opponents, this ultimately thwarts competition in the chipset market.

But Qualcomm’s critics fail to convincingly explain how NLNC averts competition — a failing that is particularly evident in the short hypothetical put forward in the amicus brief penned by Mark Lemley, Douglas Melamed, and Steven Salop. This blog post responds to their brief. 

The amici’s hypothetical

In order to highlight the most salient features of the case against Qualcomm, the brief’s authors offer the following stylized example:

A hypothetical example can illustrate how Qualcomm’s strategy increases the royalties it is able to charge OEMs. Suppose that the reasonable royalty Qualcomm could charge OEMs if it licensed the patents separately from its chipsets is $2, and that the monopoly price of Qualcomm’s chips is $18 for an all-in monopoly cost to OEMs of $20. Suppose that a new chipmaker entrant is able to manufacture chipsets of comparable quality at a cost of $11 each. In that case, the rival chipmaker entrant could sell its chips to OEMs for slightly more than $11. An OEM’s all-in cost of buying from the new entrant would be slightly above $13 (i.e., the Qualcomm reasonable license royalty of $2 plus the entrant chipmaker’s price of slightly more than $11). This entry into the chipset market would induce price competition for chips. Qualcomm would still be entitled to its patent royalties of $2, but it would no longer be able to charge the monopoly all-in price of $20. The competition would force Qualcomm to reduce its chipset prices from $18 down to something closer to $11 and its all-in price from $20 down to something closer to $13.

Qualcomm’s NLNC policy prevents this competition. To illustrate, suppose instead that Qualcomm implements the NLNC policy, raising its patent royalty to $10 and cutting the chip price to $10. The all-in cost to an OEM that buys Qualcomm chips will be maintained at the monopoly level of $20. But the OEM’s cost of using the rival entrant’s chipsets now will increase to a level above $21 (i.e., the slightly higher than $11 price for the entrant’s chipset plus the $10 royalty that the OEM pays to Qualcomm of $10). Because the cost of using the entrant’s chipsets will exceed Qualcomm’s all-in monopoly price, Qualcomm will face no competitive pressure to reduce its chipset or all-in prices.

A close inspection reveals that this hypothetical is deeply flawed

There appear to be five steps in the amici’s reasoning:

  1. Chips and IP are complementary goods that are bought in fixed proportions. So buyers have a single reserve price for both; 
  2. Because of its FRAND pledges, Qualcomm is unable to directly charge a monopoly price for its IP;
  3. But, according to the amici, Qualcomm can obtain these monopoly profits by keeping competitors out of the chipset market [this would give Qualcomm a chipset monopoly and, theoretically at least, enable it to charge the combined (IP + chips) monopoly price for its chips alone, thus effectively evading its FRAND pledges]; 
  4. To keep rivals out of the chipset market, Qualcomm undercuts them on chip prices and recoups its losses by charging supracompetitive royalty rates on its IP.
  5. This is allegedly made possible by the “No License, No Chips” policy, which forces firms to obtain a license from Qualcomm, even when they purchase chips from rivals.

While points 1 and 3 of the amici’s reasoning are uncontroversial, points 2 and 4 are mutually exclusive. This flaw ultimately undermines their entire argument, notably point 5. 

The contradiction between points 2 and 4 is evident. The amici argue (using hypothetical but representative numbers) that its FRAND pledges should prevent Qualcomm from charging more than $2 in royalties per chip (“the reasonable royalty Qualcomm could charge OEMs if it licensed the patents separately from its chipsets is $2”), and that Qualcomm deters entry in the chip market by charging $10 in royalties per chip sold (“raising its patent royalty to $10 and cutting the chip price to $10”).

But these statements cannot both be true. Qualcomm either can or it cannot charge more than $2 in royalties per chip. 

There is, however, one important exception (discussed below): parties can mutually agree to depart from FRAND pricing. But let us momentarily ignore this limitation, and discuss two baseline scenarios: One where Qualcomm can evade its FRAND pledges and one where it cannot. Comparing these two settings reveals that Qualcomm cannot magically increase its profits by shifting revenue from chips to IP.

For a start, if Qualcomm cannot raise the price of its IP beyond the hypothetical FRAND benchmark ($2, in the amici’s hypo), then it cannot use its standard essential technology to compensate for foregone revenue in the chipset market. Any supracompetitive profits that it earns must thus result from its competitive position in the chipset market.

Conversely, if it can raise its IP revenue above the $2 benchmark, then it does not require a strong chipset position to earn supracompetitive profits. 

It is worth unpacking this second point. If Qualcomm can indeed evade its FRAND pledges and charge royalties of $10 per chip, then it need not exclude chipset rivals to obtain supracompetitive profits. 

Take the amici’s hypothetical numbers and assume further that Qualcomm has the same cost as its chipsets rivals (i.e. $11), and that there are 100 potential buyers with a uniform reserve price of $20 (the reserve price assumed by the amici). 

As the amici point out, Qualcomm can earn the full monopoly profits by charging $10 for IP and $10 for chips. Qualcomm would thus pocket a total of $900 in profits ((10+10-11)*100). What the amici brief fails to acknowledge is that Qualcomm could also earn the exact same profits by staying out of the chipset market. Qualcomm could let its rivals charge $11 per chip (their cost), and demand $9 for its IP. It would thus earn the same $900 of profits (9*100). 

In this hypothetical, the only reason for Qualcomm to enter the chip market is if it is a more efficient chipset producer than its chipset rivals, or if it can out-compete them with better chipsets. For instance, if Qualcomm’s costs are only $10 per chip, Qualcomm could earn a total of $1000 in profits by driving out these rivals ((10+10-10)*100). Or, if it can produce better chips, though at higher cost and price (say, $12 per chip), it could earn the same $1000 in profits ((10+12-12)*100). Both of the situations would benefit purchasers, of course. Conversely, at a higher production cost of $12 per chip, but without any quality improvement, Qualcomm would earn only $800 in profits ((10+10-12)*100) and would thus do better to exit the chipset market.

Let us recap:

  • If Qualcomm can easily evade its FRAND pledges, then it need not enter the chipset market to earn supracompetitive profits; 
  • If it cannot evade these FRAND obligations, then it will be hard-pressed to leverage its IP bottleneck so as to dominate chipsets. 

The upshot is that Qualcomm would need to benefit from exceptional circumstances in order to improperly leverage its FRAND-encumbered IP and impose anticompetitive harm by excluding its rivals in the chipset market

The NLNC policy

According to the amici, that exceptional circumstance is the NLNC policy. In their own words:

The competitive harm is a result of the royalty being higher than it would be absent the NLNC policy.

This is best understood by adding an important caveat to our previous hypothetical: The $2 FRAND benchmark of the amici’s hypothetical is only a fallback option that can be obtained via litigation. Parties are thus free to agree upon a higher rate, for instance $10. This could, notably, be the case if Qualcomm offsetted the IP increase by reducing its chipset price, such that OEMs who purchase both chipsets and IP from Qualcomm were indifferent between contracts with either of the two royalty rates.

At first sight, this caveat may appear to significantly improve the FTC’s case against Qualcomm — it raises the specter of Qualcomm charging predatory prices on its chips and then recouping its losses on IP. But further examination suggests that this is an unlikely scenario.

Though firms may nominally be paying $10 for Qualcomm’s IP and $10 for its chips, there is no escaping the fact that buyers have an outside option in both the IP and chip segments (respectively, litigation to obtain FRAND rates, and buying chips from rivals). As a result, Qualcomm will be unable to charge a total price that is significantly above the price of rivals’ chips, plus the FRAND rate for its IP (and expected litigation costs).

This is where the amici’s hypothetical is most flawed. 

It is one thing to argue that Qualcomm can charge $10 per chipset and $10 per license to firms that purchase all of their chips and IP from it (or, as the amici point out, charge a single price of $20 for the bundle). It is another matter entirely to argue — as the amici do — that Qualcomm can charge $10 for its IP to firms that receive little or no offset in the chip market because they purchase few or no chips from Qualcomm, and who have the option of suing Qualcomm, thus obtaining a license at $2 per chip (if that is, indeed, the maximum FRAND rate). Firms would have to be foolish to ignore this possibility and to acquiesce to contracts at substantially higher rates. 

Indeed, two of the largest and most powerful OEMs — Apple and Samsung — have entered into such contracts with Qualcomm. Given their ability (and, indeed, willingness) to sue for FRAND violations and to produce their own chips or assist other manufacturers in doing so, it is difficult to conclude that they have assented to supracompetitive terms. (The fact that they would prefer even lower rates, and have supported this and other antitrust suits against Qualcomm doesn’t, change this conclusion; it just means they see antitrust as a tool to reduce their costs. And the fact that Apple settled its own FRAND and antitrust suit against Qualcomm (and paid Qualcomm $4.5 billion and entered into a global licensing agreement with it) after just one day of trial further supports this conclusion).

Double counting

The amici attempt to overcome this weakness by implicitly framing their argument in terms of exclusivity, strategic entry deterrence, and tying:

An OEM cannot respond to Qualcomm’s NLNC policy by purchasing chipsets only from a rival chipset manufacturer and obtaining a license at the reasonable royalty level (i.e., $2 in the example). As the district court found, OEMs needed to procure at least some 3G CDMA and 4G LTE chipsets from Qualcomm.

* * *

The surcharge burdens rivals, leads to anticompetitive effects in the chipset markets, deters entry, and impedes follow-on innovation. 

* * *

As an economic matter, Qualcomm’s NLNC policy is analogous to the use of a tying arrangement to maintain monopoly power in the market for the tying product (here, chipsets).

But none of these arguments totally overcomes the flaw in their reasoning. Indeed, as Aldous Huxley once pointed out, “several excuses are always less convincing than one”.

For a start, the amici argue that Qualcomm uses its strong chipset position to force buyers into accepting its supracompetitive IP rates, even in those instances where they purchase chipsets from rivals. 

In making this point, the amici fall prey to the “double counting fallacy” that Robert Bork famously warned about in The Antitrust Paradox: Monopolists cannot simultaneously charge a monopoly price AND purchase exclusivity (or other contractual restrictions) from their buyers/suppliers.

The amici fail to recognize the important sacrifices that Qualcomm would have to make in order for the above strategy to be viable. In simple terms, Qualcomm would have to offset every dollar it charges above the FRAND benchmark in the IP segment with an equivalent price reduction in the chipset segment.

This has important ramifications for the FTC’s case.

Qualcomm would have to charge lower — not higher — IP fees to OEMs who purchased a large share of their chips from third party chipmakers. Otherwise, there would be no carrot to offset its greater-than-FRAND license fees, and these OEMs would have significant incentives to sue (especially in a post-eBay world where the threat of injunctions is reduced if they happen to lose). 

And yet, this is the exact opposite of what the FTC alleged:

Qualcomm sometimes expressly charged higher royalties on phones that used rivals’ chips. And even when it did not, its provision of incentive funds to offset its license fees when OEMs bought its chips effectively resulted in a discriminatory surcharge. (emphasis added)

The infeasibility of alternative explanations

One theoretical workaround would be for Qualcomm to purchase exclusivity from its OEMs, in an attempt to foreclose chipset rivals. 

Once again, Bork’s double counting argument suggests that this would be particularly onerous. By accepting exclusivity-type requirements, OEMs would not only be reducing potential competition in the chipset market, they would also be contributing to an outcome where Qualcomm could evade its FRAND pledges in the IP segment of the market. This is particularly true for pivotal OEMs (such as Apple and Samsung), who may single-handedly affect the market’s long-term trajectory. 

The amici completely overlook this possibility, while the FTC argues that this may explain the rebates that Qulacomm gave to Apple. 

But even if the rebates Qualcomm gave Apple amounted to de facto exclusivity, there are still important objections. Authorities would notably need to prove that Qualcomm could recoup its initial losses (i.e. that the rebate maximized Qualcomm’s long-term profits). If this was not the case, then the rebates may simply be due to either efficiency considerations or Apple’s significant bargaining power (Apple is routinely cited as a potential source of patent holdout; see, e.g., here and here). 

Another alternative would be for Qualcomm to evict its chipset rivals through strategic entry deterrence or limit pricing (see here and here, respectively). But while the economic literature suggests that incumbents may indeed forgo short-term profits in order to deter rivals from entering the market, these theories generally rest on assumptions of imperfect information and/or strategic commitments. Neither of these factors was alleged in the case at hand.

In particular, there is no sense that Qualcomm’s purported decision to shift royalties from chips to IP somehow harms its short-term profits, or that it is merely a strategic device used to deter the entry of rivals. As the amici themselves seem to acknowledge, the pricing structure maximizes Qualcomm’s short term revenue (even ignoring potential efficiency considerations). 

Note that this is not just a matter of economic policy. The case law relating to unilateral conduct infringements — be it Brooke Group, Alcoa, or Aspen Skiing — almost systematically requires some form of profit sacrifice on the part of the monopolist. (For a legal analysis of this issue in the Qualcomm case, see ICLE’s Amicus brief, and yesterday’s blog post on the topic).

The amici are thus left with the argument that Qualcomm could structure its prices differently, so as to maximize the profits of its rivals. Why it would choose to do so, or should indeed be forced to, is a whole other matter.

Finally, the amici refer to the strategic tying literature (here), typically associated with the Microsoft case and the so-called “platform threat”. But this analogy is highly problematic. 

Unlike Microsoft and its Internet Explorer browser, Qualcomm’s IP is de facto — and necessarily — tied to the chips that practice its technology. This is not a bug, it is a feature of the patent system. Qualcomm is entitled to royalties, whether it manufactures chips itself or leaves that task to rival manufacturers. In other words, there is no counterfactual world where OEMs could obtain Qualcomm-based chips without entering into some form of license agreement (whether directly or indirectly) with Qualcomm. The fact that OEMs must acquire a license that covers Qualcomm’s IP — even when they purchase chips from rivals — is part and parcel of the IP system.

In any case, there is little reason to believe that Qualcomm’s decision to license its IP at the OEM level is somehow exclusionary. The gist of the strategic tying literature is that incumbents may use their market power in a primary market to thwart entry in the market for a complementary good (and ultimately prevent rivals from using their newfound position in the complementary market in order to overthrow the incumbent in the primary market; Carlton & Waldman, 2002). But this is not the case here.

Qualcomm does not appear to be using what little power it might have in the IP segment in order to dominate its rivals in the chip market. As has already been explained above, doing so would imply some profit sacrifice in the IP segment in order to encourage OEMs to accept its IP/chipset bundle, rather than rivals’ offerings. This is the exact opposite of what the FTC and amici allege in the case at hand. The facts thus cut against a conjecture of strategic tying.

Conclusion

So where does this leave the amici and their brief? 

Absent further evidence, their conclusion that Qualcomm injured competition is untenable. There is no evidence that Qualcomm’s pricing structure — enacted through the NLNC policy — significantly harmed competition to the detriment of consumers. 

When all is done and dusted, the amici’s brief ultimately amounts to an assertion that Qualcomm should be made to license its intellectual property at a rate that — in their estimation — is closer to the FRAND benchmark. That judgment is a matter of contract law, not antitrust.

On November 22, the FTC filed its answering brief in the FTC v. Qualcomm litigation. As we’ve noted before, it has always seemed a little odd that the current FTC is so vigorously pursuing this case, given some of the precedents it might set and the Commission majority’s apparent views on such issues. But this may also help explain why the FTC has now opted to eschew the district court’s decision and pursue a novel, but ultimately baseless, legal theory in its brief.

The FTC’s decision to abandon the district court’s reasoning constitutes an important admission: contrary to the district court’s finding, there is no legal basis to find an antitrust duty to deal in this case. As Qualcomm stated in its reply brief (p. 12), “the FTC disclaims huge portions of the decision.” In its effort to try to salvage its case, however, the FTC reveals just how bad its arguments have been from the start, and why the case should be tossed out on its ear.

What the FTC now argues

The FTC’s new theory is that SEP holders that fail to honor their FRAND licensing commitments should be held liable under “traditional Section 2 standards,” even though they do not have an antitrust duty to deal with rivals who are members of the same standard-setting organizations (SSOs) under the “heightened” standard laid out by the Supreme Court in Aspen and Trinko:  

To be clear, the FTC does not contend that any breach of a FRAND commitment is a Sherman Act violation. But Section 2 liability is appropriate when, as here, a monopolist SEP holder commits to license its rivals on FRAND terms, and then implements a blanket policy of refusing to license those rivals on any terms, with the effect of substantially contributing to the acquisition or maintenance of monopoly power in the relevant market…. 

The FTC does not argue that Qualcomm had a duty to deal with its rivals under the Aspen/Trinko standard. But that heightened standard does not apply here, because—unlike the defendants in Aspen, Trinko, and the other duty-to-deal precedents on which it relies—Qualcomm entered into a voluntary contractual commitment to deal with its rivals as part of the SSO process, which is itself a derogation from normal market competition. And although the district court applied a different approach, this Court “may affirm on any ground finding support in the record.” Cigna Prop. & Cas. Ins. Co. v. Polaris Pictures Corp., 159 F.3d 412, 418-19 (9th Cir. 1998) (internal quotation marks omitted) (emphasis added) (pp.69-70).

In other words, according to the FTC, because Qualcomm engaged in the SSO process—which is itself “a derogation from normal market competition”—its evasion of the constraints of that process (i.e., the obligation to deal with all comers on FRAND terms) is “anticompetitive under traditional Section 2 standards.”

The most significant problem with this new standard is not that it deviates from the basis upon which the district court found Qualcomm liable; it’s that it is entirely made up and has no basis in law.

Absent an antitrust duty to deal, patent law grants patentees the right to exclude rivals from using patented technology

Part of the bundle of rights connected with the property right in patents is the right to exclude, and along with it, the right of a patent holder to decide whether, and on what terms, to sell licenses to rivals. The law curbs that right only in select circumstances. Under antitrust law, such a duty to deal, in the words of the Supreme Court in Trinko, “is at or near the outer boundary of §2 liability.” The district court’s ruling, however, is based on the presumption of harm arising from a SEP holder’s refusal to license, rather than an actual finding of anticompetitive effect under §2. The duty to deal it finds imposes upon patent holders an antitrust obligation to license their patents to competitors. (While, of course, participation in an SSO may contractually obligate an SEP-holder to license its patents to competitors, that is an entirely different issue than whether it operates under a mandatory requirement to do so as a matter of public policy).  

The right of patentees to exclude is well-established, and injunctions enforcing that right are regularly issued by courts. Although the rate of permanent injunctions has decreased since the Supreme Court’s eBay decision, research has found that federal district courts still grant them over 70% of the time after a patent holder prevails on the merits. And for patent litigation involving competitors, the same research finds that injunctions are granted 85% of the time.  In principle, even SEP holders can receive injunctions when infringers do not act in good faith in FRAND negotiations. See Microsoft Corp. v. Motorola, Inc., 795 F.3d 1024, 1049 n.19 (9th Cir. 2015):

We agree with the Federal Circuit that a RAND commitment does not always preclude an injunctive action to enforce the SEP. For example, if an infringer refused to accept an offer on RAND terms, seeking injunctive relief could be consistent with the RAND agreement, even where the commitment limits recourse to litigation. See Apple Inc., 757 F.3d at 1331–32

Aside from the FTC, federal agencies largely agree with this approach to the protection of intellectual property. For instance, the Department of Justice, the US Patent and Trademark Office, and the National Institute for Standards and Technology recently released their 2019 Joint Policy Statement on Remedies for Standards-Essential Patents Subject to Voluntary F/RAND Commitments, which clarifies that:

All remedies available under national law, including injunctive relief and adequate damages, should be available for infringement of standards-essential patents subject to a F/RAND commitment, if the facts of a given case warrant them. Consistent with the prevailing law and depending on the facts and forum, the remedies that may apply in a given patent case include injunctive relief, reasonable royalties, lost profits, enhanced damages for willful infringement, and exclusion orders issued by the U.S. International Trade Commission. These remedies are equally available in patent litigation involving standards-essential patents. While the existence of F/RAND or similar commitments, and conduct of the parties, are relevant and may inform the determination of appropriate remedies, the general framework for deciding these issues remains the same as in other patent cases. (emphasis added).

By broadening the antitrust duty to deal well beyond the bounds set by the Supreme Court, the district court opinion (and the FTC’s preferred approach, as well) eviscerates the right to exclude inherent in patent rights. In the words of retired Federal Circuit Judge Paul Michel in an amicus brief in the case: 

finding antitrust liability premised on the exercise of valid patent rights will fundamentally abrogate the patent system and its critical means for promoting and protecting important innovation.

And as we’ve noted elsewhere, this approach would seriously threaten consumer welfare:

Of course Qualcomm conditions the purchase of its chips on the licensing of its intellectual property; how could it be any other way? The alternative would require Qualcomm to actually facilitate the violation of its property rights by forcing it to sell its chips to device makers even if they refuse its patent license terms. In that world, what device maker would ever agree to pay more than a pittance for a patent license? The likely outcome is that Qualcomm charges more for its chips to compensate (or simply stops making them). Great, the FTC says; then competitors can fill the gap and — voila: the market is more competitive, prices will actually fall, and consumers will reap the benefits.

Except it doesn’t work that way. As many economists, including both the current [now former] and a prominent former chief economist of the FTC, have demonstrated, forcing royalty rates lower in such situations is at least as likely to harm competition as to benefit it. There is no sound theoretical or empirical basis for concluding that using antitrust to move royalty rates closer to some theoretical ideal will actually increase consumer welfare. All it does for certain is undermine patent holders’ property rights, virtually ensuring there will be less innovation.

The FTC realizes the district court doesn’t have the evidence to support its duty to deal analysis

Antitrust law does not abrogate the right of a patent holder to exclude and to choose when and how to deal with rivals, unless there is a proper finding of a duty to deal. In order to find a duty to deal, there must be a harm to competition, not just a competitor, which, under the Supreme Court’s Aspen and Trinko cases can be inferred in the duty-to-deal context only where the challenged conduct leads to a “profit sacrifice.” But the record does not support such a finding. As we wrote in our amicus brief:

[T]he Supreme Court has identified only a single scenario from which it may plausibly be inferred that defendant’s refusal to deal with rivals harms consumers: The existence of a prior, profitable course of dealing, and the termination and replacement of that arrangement with an alternative that not only harms rivals, but also is less profitable for defendant. 

A monopolist’s willingness to forego (short-term) profits plausibly permits an inference that conduct is not procompetitive, because harm to a rival caused by an increase in efficiency should lead to higher—not lower—profits for defendant. And “[i]f a firm has been ‘attempting to exclude rivals on some basis other than efficiency,’ it’s fair to characterize its behavior as predatory.” Aspen Skiing, 472 U.S. at 605 (quoting Robert Bork, The Antitrust Paradox 138 (1978)).

In an effort to satisfy this standard, the district court states that “because Qualcomm previously licensed its rivals, but voluntarily stopped licensing rivals even though doing so was profitable, Qualcomm terminated a voluntary and profitable course of dealing.” Slip op. at 137. 

But it is not enough merely that the prior arrangement was profitable. Rather, Trinko and Aspen Skiing hold that when a monopolist ends a profitable relationship with a rival, anticompetitive exclusion may be inferred only when it also refuses to engage in an ongoing arrangement that, in the short run, is more profitable than no relationship at all. The key is the relative value to the monopolist of the current options on offer, not the value to the monopolist of the terminated arrangement. See Trinko, 540 U.S. at 409 (“a willingness to forsake short-term profits”); Aspen Skiing, 472 U.S. at 610–11 (“it was willing to sacrifice short-run benefits”)…

The record here uniformly indicates Qualcomm expected to maximize its royalties by dealing with OEMs rather than rival chip makers; it neither anticipated nor endured short-term loss. As the district court itself concluded, Qualcomm’s licensing practices avoided patent exhaustion and earned it “humongously more lucrative” royalties. Slip op. at 1243–254. That Qualcomm anticipated greater profits from its conduct precludes an inference of anticompetitive harm.

Moreover, Qualcomm didn’t refuse to allow rivals to use its patents; it simply didn’t sell them explicit licenses to do so. As discussed in several places by the district court:

According to Andrew Hong (Legal Counsel at Samsung Intellectual Property Center), during license negotiations, Qualcomm made it clear to Samsung that “Qualcomm’s standard business practice was not to provide licenses to chip manufacturers.” Hong Depo. 161:16-19. Instead, Qualcomm had an “unwritten policy of not going after chip manufacturers.” Id. at 161:24-25… (p.123)

* * *

Alex Rogers (QTL President) testified at trial that as part of the 2018 Settlement Agreement between Samsung and Qualcomm, Qualcomm did not license Samsung, but instead promised only that Qualcomm would offer Samsung a FRAND license before suing Samsung: “Qualcomm gave Samsung an assurance that should Qualcomm ever seek to assert its cellular SEPs against that component business, against those components, we would first make Samsung an offer on fair, reasonable, and non-discriminatory terms.” Tr. at 1989:5-10. (p.124)

This is an important distinction. Qualcomm allows rivals to use its patented technology by not asserting its patent rights against them—which is to say: instead of licensing its technology for a fee, Qualcomm allows rivals to use its technology to develop their own chips royalty-free (and recoups its investment by licensing the technology to OEMs that choose to implement the technology in their devices). 

The irony of this analysis, of course, is that the district court effectively suggests that Qualcomm must charge rivals a positive, explicit price in exchange for a license in order to facilitate competition, while allowing rivals to use its patented technology for free (or at the “cost” of some small reduction in legal certainty, perhaps) is anticompetitive.

Nonetheless, the district court’s factual finding that Qualcomm’s licensing scheme was “humongously” profitable shows there was no profit sacrifice as required for a duty to deal finding. The general presumption that patent holders can exclude rivals is not subject to an antitrust duty to deal where there is no profit sacrifice by the patent holder. Here, however, Qualcomm did not sacrifice profits by adopting the challenged licensing scheme. 

It is perhaps unsurprising that the FTC chose not to support the district court’s duty-to-deal argument, even though its holding was in the FTC’s favor. But, while the FTC was correct not to countenance the district court’s flawed arguments, the FTC’s alternative argument in its reply brief is even worse.

The FTC’s novel theory of harm is unsupported and weak

As noted, the FTC’s alternative theory is that Qualcomm violated Section 2 simply by failing to live up to its contractual SSO obligations. For the FTC, because Qualcomm joined an SSO, it is no longer in a position to refuse to deal legally. Moreover, there is no need to engage in an Aspen/Trinko analysis in order to find liability. Instead, according to the FTC’s brief, liability arises because the evasion of an exogenous pricing constraint (such as an SSO’s FRAND obligation) constitutes an antitrust harm:

Of course, a breach of contract, “standing alone,” does not “give rise to antitrust liability.” City of Vernon v. S. Cal. Edison Co., 955 F.2d 1361, 1368 (9th Cir. 1992); cf. Br. 52 n.6. Instead, a monopolist’s conduct that breaches such a contractual commitment is anticompetitive only when it satisfies traditional Section 2 standards—that is, only when it “tends to impair the opportunities of rivals and either does not further competition on the merits or does so in an unnecessarily restrictive way.” Cascade Health, 515 F.3d at 894. The district court’s factual findings demonstrate that Qualcomm’s breach of its SSO commitments satisfies both elements of that traditional test. (emphasis added)

To begin, it must be noted that the operative language quoted by the FTC from Cascade Health is attributed in Cascade Health to Aspen Skiing. In other words, even Cascade Health recognizes that Aspen Skiing represents the Supreme Court’s interpretation of that language in the duty-to-deal context. And in that case—in contrast to the FTC’s argument in its brief—the Court required demonstration of such a standard to mean that a defendant “was not motivated by efficiency concerns and that it was willing to sacrifice short-run benefits and consumer goodwill in exchange for a perceived long-run impact on its… rival.” (Aspen Skiing at 610-11) (emphasis added).

The language quoted by the FTC cannot simultaneously justify an appeal to an entirely different legal standard separate from that laid out in Aspen Skiing. As such, rather than dispensing with the duty to deal requirements laid out in that case, Cascade Health actually reinforces them.

Second, to support its argument the FTC points to Broadcom v. Qualcomm, 501 F.3d 297 (3rd Cir. 2007) as an example of a court upholding an antitrust claim based on a defendant’s violation of FRAND terms. 

In Broadcom, relying on the FTC’s enforcement action against Rambus before it was overturned by the D.C. Circuit, the Third Circuit found that there was an actionable issue when Qualcomm deceived other members of an SSO by promising to

include its proprietary technology in the… standard by falsely agreeing to abide by the [FRAND policies], but then breached those agreements by licensing its technology on non-FRAND terms. The intentional acquisition of monopoly power through deception… violates antitrust law. (emphasis added)

Even assuming Broadcom were good law post-Rambus, the case is inapposite. In Broadcom the court found that Qualcomm could be held to violate antitrust law by deceiving the SSO (by falsely promising to abide by FRAND terms) in order to induce it to accept Qualcomm’s patent in the standard. The court’s concern was that, by falsely inducing the SSO to adopt its technology, Qualcomm deceptively acquired monopoly power and limited access to competing technology:

When a patented technology is incorporated in a standard, adoption of the standard eliminates alternatives to the patented technology…. Firms may become locked in to a standard requiring the use of a competitor’s patented technology. 

Key to the court’s finding was that the alleged deception induced the SSO to adopt the technology in its standard:

We hold that (1) in a consensus-oriented private standard-setting environment, (2) a patent holder’s intentionally false promise to license essential proprietary technology on FRAND terms, (3) coupled with an SDO’s reliance on that promise when including the technology in a standard, and (4) the patent holder’s subsequent breach of that promise, is actionable conduct. (emphasis added)

Here, the claim is different. There is no allegation that Qualcomm engaged in deceptive conduct that affected the incorporation of its technology into the relevant standard. Indeed, there is no allegation that Qualcomm’s alleged monopoly power arises from its challenged practices; only that it abused its lawful monopoly power to extract supracompetitive prices. Even if an SEP holder may be found liable for falsely promising not to evade a commitment to deal with rivals in order to acquire monopoly power from its inclusion in a technological standard under Broadcom, that does not mean that it can be held liable for evading a commitment to deal with rivals unrelated to its inclusion in a standard, nor that such a refusal to deal should be evaluated under any standard other than that laid out in Aspen Skiing.

Moreover, the FTC nowhere mentions the DC Circuit’s subsequent Rambus decision overturning the FTC and calling the holding in Broadcom into question, nor does it discuss the Supreme Court’s NYNEX decision in any depth. Yet these cases stand clearly for the opposite proposition: a court cannot infer competitive harm from a company’s evasion of a FRAND pricing constraint. As we wrote in our amicus brief

In Rambus Inc. v. FTC, 522 F.3d 456 (D.C. Cir. 2008), the D.C. Circuit, citing NYNEX, rejected the FTC’s contention that it may infer anticompetitive effect from defendant’s evasion of a constraint on its monopoly power in an analogous SEP-licensing case: “But again, as in NYNEX, an otherwise lawful monopolist’s end-run around price constraints, even when deceptive or fraudulent, does not alone present a harm to competition.” Id. at 466 (citation omitted). NYNEX and Rambus reinforce the Court’s repeated holding that an inference is permissible only where it points clearly to anticompetitive effect—and, bad as they may be, evading obligations under other laws or violating norms of “business morality” do not permit a court to undermine “[t]he freedom to switch suppliers [which] lies close to the heart of the competitive process that the antitrust laws seek to encourage. . . . Thus, this Court has refused to apply per se reasoning in cases involving that kind of activity.” NYNEX, 525 U.S. at 137 (citations omitted).

Essentially, the FTC’s brief alleges that Qualcomm’s conduct amounts to an evasion of the constraint imposed by FRAND terms—without which the SSO process itself is presumptively anticompetitive. Indeed, according to the FTC, it is only the FRAND obligation that saves the SSO agreement from being inherently anticompetitive. 

In fact, when a firm has made FRAND commitments to an SSO, requiring the firm to comply with its commitments mitigates the risk that the collaborative standard-setting process will harm competition. Product standards—implicit “agreement[s] not to manufacture, distribute, or purchase certain types of products”—“have a serious potential for anticompetitive harm.” Allied Tube, 486 U.S. at 500 (citation and footnote omitted). Accordingly, private SSOs “have traditionally been objects of antitrust scrutiny,” and the antitrust laws tolerate private standard-setting “only on the understanding that it will be conducted in a nonpartisan manner offering procompetitive benefits,” and in the presence of “meaningful safeguards” that prevent the standard-setting process from falling prey to “members with economic interests in stifling product competition.” Id. at 500- 01, 506-07; see Broadcom, 501 F.3d at 310, 314-15 (collecting cases). 

FRAND commitments are among the “meaningful safeguards” that SSOs have adopted to mitigate this serious risk to competition…. 

Courts have therefore recognized that conduct that breaches or otherwise “side-steps” these safeguards is appropriately subject to conventional Sherman Act scrutiny, not the heightened Aspen/Trinko standard… (p.83-84)

In defense of the proposition that courts apply “traditional antitrust standards to breaches of voluntary commitments made to mitigate antitrust concerns,” the FTC’s brief cites not only Broadcom, but also two other cases:

While this Court has long afforded firms latitude to “deal or refuse to deal with whomever [they] please[] without fear of violating the antitrust laws,” FountWip, Inc. v. Reddi-Wip, Inc., 568 F.2d 1296, 1300 (9th Cir. 1978) (citing Colgate, 250 U.S. at 307), it, too, has applied traditional antitrust standards to breaches of voluntary commitments made to mitigate antitrust concerns. In Mount Hood Stages, Inc. v. Greyhound Corp., 555 F.2d 687 (9th Cir. 1977), this Court upheld a judgment holding that Greyhound violated Section 2 by refusing to interchange bus traffic with a competing bus line after voluntarily committing to do so in order to secure antitrust approval from the Interstate Commerce Commission for proposed acquisitions. Id. at 69723; see also, e.g., Biovail Corp. Int’l v. Hoechst Aktiengesellschaft, 49 F. Supp. 2d 750, 759 (D.N.J. 1999) (breach of commitment to deal in violation of FTC merger consent decree exclusionary under Section 2). (p.85-86)

The cases the FTC cites to justify the proposition all deal with companies sidestepping obligations in order to falsely acquire monopoly power. The two cases cited above both involve companies making promises to government agencies to win merger approval and then failing to follow through. And, as noted, Broadcom deals with the acquisition of monopoly power by making false promises to an SSO to induce the choice of proprietary technology in a standard. While such conduct in the acquisition of monopoly power may be actionable under Broadcom (though this is highly dubious post-Rambus), none of these cases supports the FTC’s claim that an SEP holder violates antitrust law any time it evades an SSO obligation to license its technology to rivals. 

Conclusion

Put simply, the district court’s opinion in FTC v. Qualcomm runs headlong into the Supreme Court’s Aspen decision and founders there. This is why the FTC is trying to avoid analyzing the case under Aspen and subsequent duty-to-deal jurisprudence (including Trinko, the 9th Circuit’s MetroNet decision, and the 10th Circuit’s Novell decision): because it knows that if the appellate court applies those standards, the district court’s duty-to-deal analysis will fail. The FTC’s basis for applying a different standard is unsupportable, however. And even if its logic for applying a different standard were valid, the FTC’s proffered alternative theory is groundless in light of Rambus and NYNEX. The Ninth Circuit should vacate the district court’s finding of liability. 

FTC v. Qualcomm

Last week the International Center for Law & Economics (ICLE) and twelve noted law and economics scholars filed an amicus brief in the Ninth Circuit in FTC v. Qualcomm, in support of appellant (Qualcomm) and urging reversal of the district court’s decision. The brief was authored by Geoffrey A. Manne, President & founder of ICLE, and Ben Sperry, Associate Director, Legal Research of ICLE. Jarod M. Bona and Aaron R. Gott of Bona Law PC collaborated in drafting the brief and they and their team provided invaluable pro bono legal assistance, for which we are enormously grateful. Signatories on the brief are listed at the end of this post.

We’ve written about the case several times on Truth on the Market, as have a number of guest bloggers, in our ongoing blog series on the case here.   

The ICLE amicus brief focuses on the ways that the district court exceeded the “error cost” guardrails erected by the Supreme Court to minimize the risk and cost of mistaken antitrust decisions, particularly those that wrongly condemn procompetitive behavior. As the brief notes at the outset:

The district court’s decision is disconnected from the underlying economics of the case. It improperly applied antitrust doctrine to the facts, and the result subverts the economic rationale guiding monopolization jurisprudence. The decision—if it stands—will undercut the competitive values antitrust law was designed to protect.  

The antitrust error cost framework was most famously elaborated by Frank Easterbrook in his seminal article, The Limits of Antitrust (1984). It has since been squarely adopted by the Supreme Court—most significantly in Brooke Group (1986), Trinko (2003), and linkLine (2009).  

In essence, the Court’s monopolization case law implements the error cost framework by (among other things) obliging courts to operate under certain decision rules that limit the use of inferences about the consequences of a defendant’s conduct except when the circumstances create what game theorists call a “separating equilibrium.” A separating equilibrium is a 

solution to a game in which players of different types adopt different strategies and thereby allow an uninformed player to draw inferences about an informed player’s type from that player’s actions.

Baird, Gertner & Picker, Game Theory and the Law

The key problem in antitrust is that while the consequence of complained-of conduct for competition (i.e., consumers) is often ambiguous, its deleterious effect on competitors is typically quite evident—whether it is actually anticompetitive or not. The question is whether (and when) it is appropriate to infer anticompetitive effect from discernible harm to competitors. 

Except in the narrowly circumscribed (by Trinko) instance of a unilateral refusal to deal, anticompetitive harm under the rule of reason must be proven. It may not be inferred from harm to competitors, because such an inference is too likely to be mistaken—and “mistaken inferences are especially costly, because they chill the very conduct the antitrust laws are designed to protect.” (Brooke Group (quoting yet another key Supreme Court antitrust error cost case, Matsushita (1986)). 

Yet, as the brief discusses, in finding Qualcomm liable the district court did not demand or find proof of harm to competition. Instead, the court’s opinion relies on impermissible inferences from ambiguous evidence to find that Qualcomm had (and violated) an antitrust duty to deal with rival chip makers and that its conduct resulted in anticompetitive foreclosure of competition. 

We urge you to read the brief (it’s pretty short—maybe the length of three blogs posts) to get the whole argument. Below we draw attention to a few points we make in the brief that are especially significant. 

The district court bases its approach entirely on Microsoft — which it misinterprets in clear contravention of Supreme Court case law

The district court doesn’t stay within the strictures of the Supreme Court’s monopolization case law. In fact, although it obligingly recites some of the error cost language from Trinko, it quickly moves away from Supreme Court precedent and bases its approach entirely on its reading of the D.C. Circuit’s Microsoft (2001) decision. 

Unfortunately, the district court’s reading of Microsoft is mistaken and impermissible under Supreme Court precedent. Indeed, both the Supreme Court and the D.C. Circuit make clear that a finding of illegal monopolization may not rest on an inference of anticompetitive harm.

The district court cites Microsoft for the proposition that

Where a government agency seeks injunctive relief, the Court need only conclude that Qualcomm’s conduct made a “significant contribution” to Qualcomm’s maintenance of monopoly power. The plaintiff is not required to “present direct proof that a defendant’s continued monopoly power is precisely attributable to its anticompetitive conduct.”

It’s true Microsoft held that, in government actions seeking injunctions, “courts [may] infer ‘causation’ from the fact that a defendant has engaged in anticompetitive conduct that ‘reasonably appears capable of making a significant contribution to maintaining monopoly power.’” (Emphasis added). 

But Microsoft never suggested that anticompetitiveness itself may be inferred.

“Causation” and “anticompetitive effect” are not the same thing. Indeed, Microsoft addresses “anticompetitive conduct” and “causation” in separate sections of its decision. And whereas Microsoft allows that courts may infer “causation” in certain government actions, it makes no such allowance with respect to “anticompetitive effect.” In fact, it explicitly rules it out:

[T]he plaintiff… must demonstrate that the monopolist’s conduct indeed has the requisite anticompetitive effect…; no less in a case brought by the Government, it must demonstrate that the monopolist’s conduct harmed competition, not just a competitor.”

The D.C. Circuit subsequently reinforced this clear conclusion of its holding in Microsoft in Rambus

Deceptive conduct—like any other kind—must have an anticompetitive effect in order to form the basis of a monopolization claim…. In Microsoft… [t]he focus of our antitrust scrutiny was properly placed on the resulting harms to competition.

Finding causation entails connecting evidentiary dots, while finding anticompetitive effect requires an economic assessment. Without such analysis it’s impossible to distinguish procompetitive from anticompetitive conduct, and basing liability on such an inference effectively writes “anticompetitive” out of the law.

Thus, the district court is correct when it holds that it “need not conclude that Qualcomm’s conduct is the sole reason for its rivals’ exits or impaired status.” But it is simply wrong to hold—in the same sentence—that it can thus “conclude that Qualcomm’s practices harmed competition and consumers.” The former claim is consistent with Microsoft; the latter is emphatically not.

Under Trinko and Aspen Skiing the district court’s finding of an antitrust duty to deal is impermissible 

Because finding that a company operates under a duty to deal essentially permits a court to infer anticompetitive harm without proof, such a finding “comes dangerously close to being a form of ‘no-fault’ monopolization,” as Herbert Hovenkamp has written. It is also thus seriously disfavored by the Court’s error cost jurisprudence.

In Trinko the Supreme Court interprets its holding in Aspen Skiing to identify essentially a single scenario from which it may plausibly be inferred that a monopolist’s refusal to deal with rivals harms consumers: the existence of a prior, profitable course of dealing, and the termination and replacement of that arrangement with an alternative that not only harms rivals, but also is less profitable for the monopolist.

In an effort to satisfy this standard, the district court states that “because Qualcomm previously licensed its rivals, but voluntarily stopped licensing rivals even though doing so was profitable, Qualcomm terminated a voluntary and profitable course of dealing.”

But it’s not enough merely that the prior arrangement was profitable. Rather, Trinko and Aspen Skiing hold that when a monopolist ends a profitable relationship with a rival, anticompetitive exclusion may be inferred only when it also refuses to engage in an ongoing arrangement that, in the short run, is more profitable than no relationship at all. The key is the relative value to the monopolist of the current options on offer, not the value to the monopolist of the terminated arrangement. In a word, what the Court requires is that the defendant exhibit behavior that, but-for the expectation of future, anticompetitive returns, is irrational.

It should be noted, as John Lopatka (here) and Alan Meese (here) (both of whom joined the amicus brief) have written, that even the Supreme Court’s approach is likely insufficient to permit a court to distinguish between procompetitive and anticompetitive conduct. 

But what is certain is that the district court’s approach in no way permits such an inference.

“Evasion of a competitive constraint” is not an antitrust-relevant refusal to deal

In order to infer anticompetitive effect, it’s not enough that a firm may have a “duty” to deal, as that term is colloquially used, based on some obligation other than an antitrust duty, because it can in no way be inferred from the evasion of that obligation that conduct is anticompetitive.

The district court bases its determination that Qualcomm’s conduct is anticompetitive on the fact that it enables the company to avoid patent exhaustion, FRAND commitments, and thus price competition in the chip market. But this conclusion is directly precluded by the Supreme Court’s holding in NYNEX

Indeed, in Rambus, the D.C. Circuit, citing NYNEX, rejected the FTC’s contention that it may infer anticompetitive effect from defendant’s evasion of a constraint on its monopoly power in an analogous SEP-licensing case: “But again, as in NYNEX, an otherwise lawful monopolist’s end-run around price constraints, even when deceptive or fraudulent, does not alone present a harm to competition.”

As Josh Wright has noted:

[T]he objection to the “evasion” of any constraint approach is… that it opens the door to enforcement actions applied to business conduct that is not likely to harm competition and might be welfare increasing.

Thus NYNEX and Rambus (and linkLine) reinforce the Court’s repeated holding that an inference of harm to competition is permissible only where conduct points clearly to anticompetitive effect—and, bad as they may be, evading obligations under other laws or violating norms of “business morality” do not suffice.

The district court’s elaborate theory of harm rests fundamentally on the claim that Qualcomm injures rivals—and the record is devoid of evidence demonstrating actual harm to competition. Instead, the court infers it from what it labels “unreasonably high” royalty rates, enabled by Qualcomm’s evasion of competition from rivals. In turn, the court finds that that evasion of competition can be the source of liability if what Qualcomm evaded was an antitrust duty to deal. And, in impermissibly circular fashion, the court finds that Qualcomm indeed evaded an antitrust duty to deal—because its conduct allowed it to sustain “unreasonably high” prices. 

The Court’s antitrust error cost jurisprudence—from Brooke Group to NYNEX to Trinko & linkLine—stands for the proposition that no such circular inferences are permitted.

The district court’s foreclosure analysis also improperly relies on inferences in lieu of economic evidence

Because the district court doesn’t perform a competitive effects analysis, it fails to demonstrate the requisite “substantial” foreclosure of competition required to sustain a claim of anticompetitive exclusion. Instead the court once again infers anticompetitive harm from harm to competitors. 

The district court makes no effort to establish the quantity of competition foreclosed as required by the Supreme Court. Nor does the court demonstrate that the alleged foreclosure harms competition, as opposed to just rivals. Foreclosure per se is not impermissible and may be perfectly consistent with procompetitive conduct.

Again citing Microsoft, the district court asserts that a quantitative finding is not required. Yet, as the court’s citation to Microsoft should have made clear, in its stead a court must find actual anticompetitive effect; it may not simply assert it. As Microsoft held: 

It is clear that in all cases the plaintiff must… prove the degree of foreclosure. This is a prudential requirement; exclusivity provisions in contracts may serve many useful purposes. 

The court essentially infers substantiality from the fact that Qualcomm entered into exclusive deals with Apple (actually, volume discounts), from which the court concludes that Qualcomm foreclosed rivals’ access to a key customer. But its inference that this led to substantial foreclosure is based on internal business statements—so-called “hot docs”—characterizing the importance of Apple as a customer. Yet, as Geoffrey Manne and Marc Williamson explain, such documentary evidence is unreliable as a guide to economic significance or legal effect: 

Business people will often characterize information from a business perspective, and these characterizations may seem to have economic implications. However, business actors are subject to numerous forces that influence the rhetoric they use and the conclusions they draw….

There are perfectly good reasons to expect to see “bad” documents in business settings when there is no antitrust violation lurking behind them.

Assuming such language has the requisite economic or legal significance is unsupportable—especially when, as here, the requisite standard demands a particular quantitative significance.

Moreover, the court’s “surcharge” theory of exclusionary harm rests on assumptions regarding the mechanism by which the alleged surcharge excludes rivals and harms consumers. But the court incorrectly asserts that only one mechanism operates—and it makes no effort to quantify it. 

The court cites “basic economics” via Mankiw’s Principles of Microeconomics text for its conclusion:

The surcharge affects demand for rivals’ chips because as a matter of basic economics, regardless of whether a surcharge is imposed on OEMs or directly on Qualcomm’s rivals, “the price paid by buyers rises, and the price received by sellers falls.” Thus, the surcharge “places a wedge between the price that buyers pay and the price that sellers receive,” and demand for such transactions decreases. Rivals see lower sales volumes and lower margins, and consumers see less advanced features as competition decreases.

But even assuming the court is correct that Qualcomm’s conduct entails such a surcharge, basic economics does not hold that decreased demand for rivals’ chips is the only possible outcome. 

In actuality, an increase in the cost of an input for OEMs can have three possible effects:

  1. OEMs can pass all or some of the cost increase on to consumers in the form of higher phone prices. Assuming some elasticity of demand, this would mean fewer phone sales and thus less demand by OEMs for chips, as the court asserts. But the extent of that effect would depend on consumers’ demand elasticity and the magnitude of the cost increase as a percentage of the phone price. If demand is highly inelastic at this price (i.e., relatively insensitive to the relevant price change), it may have a tiny effect on the number of phones sold and thus the number of chips purchased—approaching zero as price insensitivity increases.
  2. OEMs can absorb the cost increase and realize lower profits but continue to sell the same number of phones and purchase the same number of chips. This would not directly affect demand for chips or their prices.
  3. OEMs can respond to a price increase by purchasing fewer chips from rivals and more chips from Qualcomm. While this would affect rivals’ chip sales, it would not necessarily affect consumer prices, the total number of phones sold, or OEMs’ margins—that result would depend on whether Qualcomm’s chips cost more or less than its rivals’. If the latter, it would even increase OEMs’ margins and/or lower consumer prices and increase output.

Alternatively, of course, the effect could be some combination of these.

Whether any of these outcomes would substantially exclude rivals is inherently uncertain to begin with. But demonstrating a reduction in rivals’ chip sales is a necessary but not sufficient condition for proving anticompetitive foreclosure. The FTC didn’t even demonstrate that rivals were substantially harmed, let alone that there was any effect on consumers—nor did the district court make such findings. 

Doing so would entail consideration of whether decreased demand for rivals’ chips flows from reduced consumer demand or OEMs’ switching to Qualcomm for supply, how consumer demand elasticity affects rivals’ chip sales, and whether Qualcomm’s chips were actually less or more expensive than rivals’. Yet the court determined none of these. 

Conclusion

Contrary to established Supreme Court precedent, the district court’s decision relies on mere inferences to establish anticompetitive effect. The decision, if it stands, would render a wide range of potentially procompetitive conduct presumptively illegal and thus harm consumer welfare. It should be reversed by the Ninth Circuit.

Joining ICLE on the brief are:

  • Donald J. Boudreaux, Professor of Economics, George Mason University
  • Kenneth G. Elzinga, Robert C. Taylor Professor of Economics, University of Virginia
  • Janice Hauge, Professor of Economics, University of North Texas
  • Justin (Gus) Hurwitz, Associate Professor of Law, University of Nebraska College of Law; Director of Law & Economics Programs, ICLE
  • Thomas A. Lambert, Wall Chair in Corporate Law and Governance, University of Missouri Law School
  • John E. Lopatka, A. Robert Noll Distinguished Professor of Law, Penn State University Law School
  • Daniel Lyons, Professor of Law, Boston College Law School
  • Geoffrey A. Manne, President and Founder, International Center for Law & Economics; Distinguished Fellow, Northwestern University Center on Law, Business & Economics
  • Alan J. Meese, Ball Professor of Law, William & Mary Law School
  • Paul H. Rubin, Samuel Candler Dobbs Professor of Economics Emeritus, Emory University
  • Vernon L. Smith, George L. Argyros Endowed Chair in Finance and Economics, Chapman University School of Business; Nobel Laureate in Economics, 2002
  • Michael Sykuta, Associate Professor of Economics, University of Missouri


[TOTM: The following is the eighth in a series of posts by TOTM guests and authors on the FTC v. Qualcomm case recently decided by Judge Lucy Koh in the Northern District of California. Other posts in this series are here. The blog post is based on a forthcoming paper regarding patent holdup, co-authored by Dirk Auer and Julian Morris.]

Samsung SGH-F480V – controller board – Qualcomm MSM6280

In his latest book, Tyler Cowen calls big business an “American anti-hero”. Cowen argues that the growing animosity towards successful technology firms is to a large extent unwarranted. After all, these companies have generated tremendous prosperity and jobs.

Though it is less known to the public than its Silicon Valley counterparts, Qualcomm perfectly fits the anti-hero mold. Despite being a key contributor to the communications standards that enabled the proliferation of smartphones around the globe – an estimated 5 Billion people currently own a device – Qualcomm has been on the receiving end of considerable regulatory scrutiny on both sides of the Atlantic (including two in the EU; see here and here). 

In the US, Judge Lucy Koh recently ruled that a combination of anticompetitive practices had enabled Qualcomm to charge “unreasonably high royalty rates” for its CDMA and LTE cellular communications technology. Chief among these practices was Qualcomm’s so-called “no license, no chips” policy, whereby the firm refuses to sell baseband processors to implementers that have not taken out a license for its communications technology. Other grievances included Qualcomm’s purported refusal to license its patents to rival chipmakers, and allegations that it attempted to extract exclusivity obligations from large handset manufacturers, such as Apple. According to Judge Koh, these practices resulted in “unreasonably high” royalty rates that failed to comply with Qualcomm’s FRAND obligations.

Judge Koh’s ruling offers an unfortunate example of the numerous pitfalls that decisionmakers face when they second-guess the distributional outcomes achieved through market forces. This is particularly true in the complex standardization space.

The elephant in the room

The first striking feature of Judge Koh’s ruling is what it omits. Throughout the more than two-hundred-page long document, there is not a single reference to the concepts of holdup or holdout (crucial terms of art for a ruling that grapples with the prices charged by an SEP holder). 

At first sight, this might seem like a semantic quibble. But words are important. Patent holdup (along with the “unreasonable” royalties to which it arguably gives rise) is possible only when a number of cumulative conditions are met. Most importantly, the foundational literature on economic opportunism (here and here) shows that holdup (and holdout) mostly occur when parties have made asset-specific sunk investments. This focus on asset-specific investments is echoed by even the staunchest critics of the standardization status quo (here).

Though such investments may well have been present in the case at hand, there is no evidence that they played any part in the court’s decision. This is not without consequences. If parties did not make sunk relationship-specific investments, then the antitrust case against Qualcomm should have turned upon the alleged exclusion of competitors, not the level of Qualcomm’s royalties. The DOJ said this much in its statement of interest concerning Qualcomm’s motion for partial stay of injunction pending appeal. Conversely, if these investments existed, then patent holdout (whereby implementers refuse to license key pieces of intellectual property) was just as much of a risk as patent holdup (here and here). And yet the court completely overlooked this possibility.

The misguided push for component level pricing

The court also erred by objecting to Qualcomm’s practice of basing license fees on the value of handsets, rather than that of modem chips. In simplified terms, implementers paid Qualcomm a percentage of their devices’ resale price. The court found that this was against Federal Circuit law. Instead, it argued that royalties should be based on the value the smallest salable patent-practicing component (in this case, baseband chips). This conclusion is dubious both as a matter of law and of policy.

From a legal standpoint, the question of the appropriate royalty base seems far less clear-cut than Judge Koh’s ruling might suggest. For instance, Gregory Sidak observes that in TCL v. Ericsson Judge Selna used a device’s net selling price as a basis upon which to calculate FRAND royalties. Likewise, in CSIRO v. Cisco, the Court also declined to use the “smallest saleable practicing component” as a royalty base. And finally, as Jonathan Barnett observes, the Circuit Laser Dynamics case law cited  by Judge Koh relates to the calculation of damages in patent infringement suits. There is no legal reason to believe that its findings should hold any sway outside of that narrow context. It is one thing for courts to decide upon the methodology that they will use to calculate damages in infringement cases – even if it is a contested one. It is a whole other matter to shoehorn private parties into adopting this narrow methodology in their private dealings. 

More importantly, from a policy standpoint, there are important advantages to basing royalty rates on the price of an end-product, rather than that of an intermediate component. This type of pricing notably enables parties to better allocate the risk that is inherent in launching a new product. In simplified terms: implementers want to avoid paying large (fixed) license fees for failed devices; and patent holders want to share in the benefits of successful devices that rely on their inventions. The solution, as Alain Bousquet and his co-authors explain, is to agree on royalty payments that are contingent on success in the market:

Because the demand for a new product is uncertain and/or the potential cost reduction of a new technology is not perfectly known, both seller and buyer may be better off if the payment for the right to use an innovation includes a state-contingent royalty (rather than consisting of just a fixed fee). The inventor wants to benefit from a growing demand for a new product, and the licensee wishes to avoid high payments in case of disappointing sales.

While this explains why parties might opt for royalty-based payments over fixed fees, it does not entirely elucidate the practice of basing royalties on the price of an end device. One explanation is that a technology’s value will often stem from its combination with other goods or technologies. Basing royalties on the value of an end-device enables patent holders to more effectively capture the social benefits that flow from these complementarities.

Imagine the price of the smallest saleable component is identical across all industries, despite it being incorporated into highly heterogeneous devices. For instance, the same modem chip could be incorporated into smartphones (of various price ranges), tablets, vehicles, and other connected devices. The Bousquet line of reasoning (above) suggests that it is efficient for the patent holder to earn higher royalties (from the IP that underpins the modem chips) in those segments where market demand is strongest (i.e. where there are stronger complementarities between the modem chip and the end device).

One way to make royalties more contingent on market success is to use the price of the modem (which is presumably identical across all segments) as a royalty base and negotiate a separate royalty rate for each end device (charging a higher rate for devices that will presumably benefit from stronger consumer demand). But this has important drawbacks. For a start, identifying those segments (or devices) that are most likely to be successful is informationally cumbersome for the inventor. Moreover, this practice could land the patent holder in hot water. Antitrust authorities might naïvely conclude that these varying royalty rates violate the “non-discriminatory” part of FRAND.

A much simpler solution is to apply a single royalty rate (or at least attempt to do so) but use the price of the end device as a royalty base. This ensures that the patent holder’s rewards are not just contingent on the number of devices sold, but also on their value. Royalties will thus more closely track the end-device’s success in the marketplace.   

In short, basing royalties on the value of an end-device is an informationally light way for the inventor to capture some of the unforeseen value that might stem from the inclusion of its technology in an end device. Mandating that royalty rates be based on the value of the smallest saleable component ignores this complex reality.

Prices are almost impossible to reconstruct

Judge Koh was similarly imperceptive when assessing Qualcomm’s contribution to the value of key standards, such as LTE and CDMA. 

For a start, she reasoned that Qualcomm’s royalties were large compared to the number of patents it had contributed to these technologies:

Moreover, Qualcomm’s own documents also show that Qualcomm is not the top standards contributor, which confirms Qualcomm’s own statements that QCT’s monopoly chip market share rather than the value of QTL’s patents sustain QTL’s unreasonably high royalty rates.

Given the tremendous heterogeneity that usually exists between the different technologies that make up a standard, simply counting each firm’s contributions is a crude and misleading way to gauge the value of their patent portfolios. Accordingly, Qualcomm argued that it had made pioneering contributions to technologies such as CDMA, and 4G/5G. Though the value of Qualcomm’s technologies is ultimately an empirical question, the court’s crude patent counting  was unlikely to provide a satisfying answer.

Just as problematically, the court also concluded that Qualcomm’s royalties were unreasonably high because “modem chips do not drive handset value.” In its own words:

Qualcomm’s intellectual property is for communication, and Qualcomm does not own intellectual property on color TFT LCD panel, mega-pixel DSC module, user storage memory, decoration, and mechanical parts. The costs of these non-communication-related components have become more expensive and now contribute 60-70% of the phone value. The phone is not just for communication, but also for computing, movie-playing, video-taking, and data storage.

As Luke Froeb and his co-authors have also observed, the court’s reasoning on this point is particularly unfortunate. Though it is clearly true that superior LCD panels, cameras, and storage increase a handset’s value – regardless of the modem chip that is associated with them – it is equally obvious that improvements to these components are far more valuable to consumers when they are also associated with high-performance communications technology.

For example, though there is undoubtedly standalone value in being able to take improved pictures on a smartphone, this value is multiplied by the ability to instantly share these pictures with friends, and automatically back them up on the cloud. Likewise, improving a smartphone’s LCD panel is more valuable if the device is also equipped with a cutting edge modem (both are necessary for consumers to enjoy high-definition media online).

In more technical terms, the court fails to acknowledge that, in the presence of perfect complements, each good makes an incremental contribution of 100% to the value of the whole. A smartphone’s components would be far less valuable to consumers if they were not associated with a high-performance modem, and vice versa. The fallacy to which the court falls prey is perfectly encapsulated by a quote it cites from Apple’s COO:

Apple invests heavily in the handset’s physical design and enclosures to add value, and those physical handset features clearly have nothing to do with Qualcomm’s cellular patents, it is unfair for Qualcomm to receive royalty revenue on that added value.

The question the court should be asking, however, is whether Apple would have gone to the same lengths to improve its devices were it not for Qualcomm’s complementary communications technology. By ignoring this question, Judge Koh all but guaranteed that her assessment of Qualcomm’s royalty rates would be wide of the mark.

Concluding remarks

In short, the FTC v. Qualcomm case shows that courts will often struggle when they try to act as makeshift price regulators. It thus lends further credence to Gergory Werden and Luke Froeb’s conclusion that:

Nothing is more alien to antitrust than enquiring into the reasonableness of prices. 

This is especially true in complex industries, such as the standardization space. The colossal number of parameters that affect the price for a technology are almost impossible to reproduce in a top-down fashion, as the court attempted to do in the Qualcomm case. As a result, courts will routinely draw poor inferences from factors such as the royalty base agreed upon by parties, the number of patents contributed by a firm, and the complex manner in which an individual technology may contribute to the value of an end-product. Antitrust authorities and courts would thus do well to recall the wise words of Friedrich Hayek:

If we can agree that the economic problem of society is mainly one of rapid adaptation to changes in the particular circumstances of time and place, it would seem to follow that the ultimate decisions must be left to the people who are familiar with these circumstances, who know directly of the relevant changes and of the resources immediately available to meet them. We cannot expect that this problem will be solved by first communicating all this knowledge to a central board which, after integrating all knowledge, issues its orders. We must solve it by some form of decentralization.

Last week the Senate Judiciary Committee held a hearing, Intellectual Property and the Price of Prescription Drugs: Balancing Innovation and Competition, that explored whether changes to the pharmaceutical patent process could help lower drug prices.  The committee’s goal was to evaluate various legislative proposals that might facilitate the entry of cheaper generic drugs, while also recognizing that strong patent rights for branded drugs are essential to incentivize drug innovation.  As Committee Chairman Lindsey Graham explained:

One thing you don’t want to do is kill the goose who laid the golden egg, which is pharmaceutical development. But you also don’t want to have a system that extends unnecessarily beyond the ability to get your money back and make a profit, a patent system that drives up costs for the average consumer.

Several proposals that were discussed at the hearing have the potential to encourage competition in the pharmaceutical industry and help rein in drug prices. Below, I discuss these proposals, plus a few additional reforms. I also point out some of the language in the current draft proposals that goes a bit too far and threatens the ability of drug makers to remain innovative.  

1. Prevent brand drug makers from blocking generic companies’ access to drug samples. Some brand drug makers have attempted to delay generic entry by restricting generics’ access to the drug samples necessary to conduct FDA-required bioequivalence studies.  Some brand drug manufacturers have limited the ability of pharmacies or wholesalers to sell samples to generic companies or abused the REMS (Risk Evaluation Mitigation Strategy) program to refuse samples to generics under the auspices of REMS safety requirements.  The Creating and Restoring Equal Access To Equivalent Samples (CREATES) Act of 2019 would allow potential generic competitors to bring an action in federal court for both injunctive relief and damages when brand companies block access to drug samples.  It also gives the FDA discretion to approve alternative REMS safety protocols for generic competitors that have been denied samples under the brand companies’ REMS protocol.  Although the vast majority of brand drug companies do not engage in the delay tactics addressed by CREATES, the Act would prevent the handful that do from thwarting generic competition.  Increased generic competition should, in turn, reduce drug prices.

2. Restrict abuses of FDA Citizen Petitions.  The citizen petition process was created as a way for individuals and community groups to flag legitimate concerns about drugs awaiting FDA approval.  However, critics claim that the process has been misused by some brand drug makers who file petitions about specific generic drugs in the hopes of delaying their approval and market entry.  Although FDA has indicated that citizens petitions rarely delay the approval of generic drugs, there have been a few drug makers, such as Shire ViroPharma, that have clearly abused the process and put unnecessary strain on FDA resources. The Stop The Overuse of Petitions and Get Affordable Medicines to Enter Soon (STOP GAMES) Act is intended to prevent such abuses.  The Act reinforces the FDA and FTC’s ability to crack down on petitions meant to lengthen the approval process of a generic competitor, which should deter abuses of the system that can occasionally delay generic entry.  However, lawmakers should make sure that adopted legislation doesn’t limit the ability of stakeholders (including drug makers that often know more about the safety of drugs than ordinary citizens) to raise serious concerns with the FDA. 

3. Curtail Anticompetitive Pay-for-Delay Settlements.  The Hatch-Waxman Act incentivizes generic companies to challenge brand drug patents by granting the first successful generic challenger a period of marketing exclusivity. Like all litigation, many of these patent challenges result in settlements instead of trials.  The FTC and some courts have concluded that these settlements can be anticompetitive when the brand companies agree to pay the generic challenger in exchange for the generic company agreeing to forestall the launch of their lower-priced drug. Settlements that result in a cash payment are a red flag for anti-competitive behavior, so pay-for-delay settlements have evolved to involve other forms of consideration instead.  As a result, the Preserve Access to Affordable Generics and Biosimilars Act aims to make an exchange of anything of value presumptively anticompetitive if the terms include a delay in research, development, manufacturing, or marketing of a generic drug. Deterring obvious pay-for-delay settlements will prevent delays to generic entry, making cheaper drugs available as quickly as possible to patients. 

However, the Act’s rigid presumption that an exchange of anything of value is presumptively anticompetitive may also prevent legitimate settlements that ultimately benefit consumers.  Brand drug makers should be allowed to compensate generic challengers to eliminate litigation risk and escape litigation expenses, and many settlements result in the generic drug coming to market before the expiration of the brand patent and possibly earlier than if there was prolonged litigation between the generic and brand company.  A rigid presumption of anticompetitive behavior will deter these settlements, thereby increasing expenses for all parties that choose to litigate and possibly dissuading generics from bringing patent challenges in the first place.  Indeed, the U.S. Supreme Court has declined to define these settlements as per se anticompetitive, and the FTC’s most recent agreement involving such settlements exempts several forms of exchanges of value.  Any adopted legislation should follow the FTC’s lead and recognize that some exchanges of value are pro-consumer and pro-competitive.

4. Restore the balance established by Hatch-Waxman between branded drug innovators and generic drug challengers.  I have previously discussed how an unbalanced inter partes review (IPR) process for challenging patents threatens to stifle drug innovation.  Moreover, current law allows generic challengers to file duplicative claims in both federal court and through the IPR process.  And because IPR proceedings do not have a standing requirement, the process has been exploited  by entities that would never be granted standing in traditional patent litigation—hedge funds betting against a company by filing an IPR challenge in hopes of crashing the stock and profiting from the bet. The added expense to drug makers of defending both duplicative claims and claims against challengers that are exploiting the system increases litigation costs, which may be passed on to consumers in the form of higher prices. 

The Hatch-Waxman Integrity Act (HWIA) is designed to return the balance established by Hatch-Waxman between branded drug innovators and generic drug challengers. It requires generic challengers to choose between either Hatch-Waxman litigation (which saves considerable costs by allowing generics to rely on the brand company’s safety and efficacy studies for FDA approval) or an IPR proceeding (which is faster and provides certain pro-challenger provisions). The HWIA would also eliminate the ability of hedge funds and similar entities to file IPR claims while shorting the stock.  By reducing duplicative litigation and the exploitation of the IPR process, the HWIA will reduce costs and strengthen innovation incentives for drug makers.  This will ensure that patent owners achieve clarity on the validity of their patents, which will spur new drug innovation and make sure that consumers continue to have access to life-improving drugs.

5. Curb illegal product hopping and patent thickets.  Two drug maker tactics currently garnering a lot of attention are so-called “product hopping” and “patent thickets.”  At its worst, product hopping involves brand drug makers making minor changes to a drug nearing the end of its patent so that they gets a new patent on the slightly-tweaked drug, and then withdrawing the original drug from the market so that patients shift to the newly patented drug and pharmacists can’t substitute a generic version of the original drug.  Similarly, at their worst, patent thickets involve brand drug makers obtaining a web of patents on a single drug to extend the life of their exclusivity and make it too costly for other drug makers to challenge all of the patents associated with a drug.  The proposed Affordable Prescriptions for Patients Act of 2019 is meant to stop these abuses of the patent system, which would facilitate generic entry and help to lower drug prices.

However, the Act goes too far by also capturing many legitimate activities in its definitions. For example, the bill defines as anticompetitive product-hopping the selling of any improved version of a drug during a window which extends to a year after the launch of the first generic competitor.  Presently, to acquire a patent and FDA approval, the improved version of the drug must be different and innovative enough from the original drug, yet the Act would prevent the drug maker from selling such a product without satisfying a demanding three-pronged test before the FTC or a district court.  Similarly, the Act defines as anticompetitive patent thickets any new patents filed on a drug in the same general family as the original patent, and this presumption can only be rebutted by providing extensive evidence and satisfying demanding standards to the FTC or a district court.  As a result, the Act deters innovation activity that is at all related to an initial patent and, in doing so, ignores the fact that most important drug innovation is incremental innovation based on previous inventions.  Thus, the proposal should be redrafted to capture truly anticompetitive product hopping and patent thicket activity, while exempting behavior this is critical for drug innovation. 

Reforms that close loopholes in the current patent process should facilitate competition in the pharmaceutical industry and help to lower drug prices.  However, lawmakers need to be sure that they don’t restrict patent rights to the extent that they deter innovation because a significant body of research predicts that patients’ health outcomes will suffer as a result.

[TOTM: The following is the fourth in a series of posts by TOTM guests and authors on the FTC v. Qualcomm case, currently awaiting decision by Judge Lucy Koh in the Northern District of California. The entire series of posts is available here. This post originally appeared on the Federalist Society Blog.]

The courtroom trial in the Federal Trade Commission’s (FTC’s) antitrust case against Qualcomm ended in January with a promise from the judge in the case, Judge Lucy Koh, to issue a ruling as quickly as possible — caveated by her acknowledgement that the case is complicated and the evidence voluminous. Well, things have only gotten more complicated since the end of the trial. Not only did Apple and Qualcomm reach a settlement in the antitrust case against Qualcomm that Apple filed just three days after the FTC brought its suit, but the abbreviated trial in that case saw the presentation by Qualcomm of some damning evidence that, if accurate, seriously calls into (further) question the merits of the FTC’s case.

Apple v. Qualcomm settles — and the DOJ takes notice

The Apple v. Qualcomm case, which was based on substantially the same arguments brought by the FTC in its case, ended abruptly last month after only a day and a half of trial — just enough time for the parties to make their opening statements — when Apple and Qualcomm reached an out-of-court settlement. The settlement includes a six-year global patent licensing deal, a multi-year chip supplier agreement, an end to all of the patent disputes around the world between the two companies, and a $4.5 billion settlement payment from Apple to Qualcomm.

That alone complicates the economic environment into which Judge Koh will issue her ruling. But the Apple v. Qualcomm trial also appears to have induced the Department of Justice Antitrust Division (DOJ) to weigh in on the FTC’s case with a Statement of Interest requesting Judge Koh to use caution in fashioning a remedy in the case should she side with the FTC, followed by a somewhat snarky Reply from the FTC arguing the DOJ’s filing was untimely (and, reading the not-so-hidden subtext, unwelcome).

But buried in the DOJ’s Statement is an important indication of why it filed its Statement when it did, just about a week after the end of the Apple v. Qualcomm case, and a pointer to a much larger issue that calls the FTC’s case against Qualcomm even further into question (I previously wrote about the lack of theoretical and evidentiary merit in the FTC’s case here).

Footnote 6 of the DOJ’s Statement reads:

Internal Apple documents that recently became public describe how, in an effort to “[r]educe Apple’s net royalty to Qualcomm,” Apple planned to “[h]urt Qualcomm financially” and “[p]ut Qualcomm’s licensing model at risk,” including by filing lawsuits raising claims similar to the FTC’s claims in this case …. One commentator has observed that these documents “potentially reveal[] that Apple was engaging in a bad faith argument both in front of antitrust enforcers as well as the legal courts about the actual value and nature of Qualcomm’s patented innovation.” (Emphasis added).

Indeed, the slides presented by Qualcomm during that single day of trial in Apple v. Qualcomm are significant, not only for what they say about Apple’s conduct, but, more importantly, for what they say about the evidentiary basis for the FTC’s claims against the company.

The evidence presented by Qualcomm in its opening statement suggests some troubling conduct by Apple

Others have pointed to Qualcomm’s opening slides and the Apple internal documents they present to note Apple’s apparent bad conduct. As one commentator sums it up:

Although we really only managed to get a small glimpse of Qualcomm’s evidence demonstrating the extent of Apple’s coordinated strategy to manipulate the FRAND license rate, that glimpse was particularly enlightening. It demonstrated a decade-long coordinated effort within Apple to systematically engage in what can only fairly be described as manipulation (if not creation of evidence) and classic holdout.

Qualcomm showed during opening arguments that, dating back to at least 2009, Apple had been laying the foundation for challenging its longstanding relationship with Qualcomm. (Emphasis added).

The internal Apple documents presented by Qualcomm to corroborate this claim appear quite damning. Of course, absent explanation and cross-examination, it’s impossible to know for certain what the documents mean. But on their face they suggest Apple knowingly undertook a deliberate scheme (and knowingly took upon itself significant legal risk in doing so) to devalue comparable patent portfolios to Qualcomm’s:

The apparent purpose of this scheme was to devalue comparable patent licensing agreements where Apple had the power to do so (through litigation or the threat of litigation) in order to then use those agreements to argue that Qualcomm’s royalty rates were above the allowable, FRAND level, and to undermine the royalties Qualcomm would be awarded in courts adjudicating its FRAND disputes with the company. As one commentator put it:

Apple embarked upon a coordinated scheme to challenge weaker patents in order to beat down licensing prices. Once the challenges to those weaker patents were successful, and the licensing rates paid to those with weaker patent portfolios were minimized, Apple would use the lower prices paid for weaker patent portfolios as proof that Qualcomm was charging a super-competitive licensing price; a licensing price that violated Qualcomm’s FRAND obligations. (Emphasis added).

That alone is a startling revelation, if accurate, and one that would seem to undermine claims that patent holdout isn’t a real problem. It also would undermine Apple’s claims that it is a “willing licensee,” engaging with SEP licensors in good faith. (Indeed, this has been called into question before, and one Federal Circuit judge has noted in dissent that “[t]he record in this case shows evidence that Apple may have been a hold out.”). If the implications drawn from the Apple documents shown in Qualcomm’s opening statement are accurate, there is good reason to doubt that Apple has been acting in good faith.

Even more troubling is what it means for the strength of the FTC’s case

But the evidence offered in Qualcomm’s opening argument point to another, more troubling implication, as well. We know that Apple has been coordinating with the FTC and was likely an important impetus for the FTC’s decision to bring an action in the first place. It seems reasonable to assume that Apple used these “manipulated” agreements to help make its case.

But what is most troubling is the extent to which it appears to have worked.

The FTC’s action against Qualcomm rested in substantial part on arguments that Qualcomm’s rates were too high (even though the FTC constructed its case without coming right out and saying this, at least until trial). In its opening statement the FTC said:

Qualcomm’s practices, including no license, no chips, skewed negotiations towards the outcomes that favor Qualcomm and lead to higher royalties. Qualcomm is committed to license its standard essential patents on fair, reasonable, and non-discriminatory terms. But even before doing market comparison, we know that the license rates charged by Qualcomm are too high and above FRAND because Qualcomm uses its chip power to require a license.

* * *

Mr. Michael Lasinski [the FTC’s patent valuation expert] compared the royalty rates received by Qualcomm to … the range of FRAND rates that ordinarily would form the boundaries of a negotiation … Mr. Lasinski’s expert opinion … is that Qualcomm’s royalty rates are far above any indicators of fair and reasonable rates. (Emphasis added).

The key question is what constitutes the “range of FRAND rates that ordinarily would form the boundaries of a negotiation”?

Because they were discussed under seal, we don’t know the precise agreements that the FTC’s expert, Mr. Lasinski, used for his analysis. But we do know something about them: His analysis entailed a study of only eight licensing agreements; in six of them, the licensee was either Apple or Samsung; and in all of them the licensor was either Interdigital, Nokia, or Ericsson. We also know that Mr. Lasinski’s valuation study did not include any Qualcomm licenses, and that the eight agreements he looked at were all executed after the district court’s decision in Microsoft vs. Motorola in 2013.

A curiously small number of agreements

Right off the bat there is a curiosity in the FTC’s valuation analysis. Even though there are hundreds of SEP license agreements involving the relevant standards, the FTC’s analysis relied on only eight, three-quarters of which involved licensing by only two companies: Apple and Samsung.

Indeed, even since 2013 (a date to which we will return) there have been scads of licenses (see, e.g., herehere, and here). Not only Apple and Samsung make CDMA and LTE devices; there are — quite literally — hundreds of other manufacturers out there, all of them licensing essentially the same technology — including global giants like LG, Huawei, HTC, Oppo, Lenovo, and Xiaomi. Why were none of their licenses included in the analysis? 

At the same time, while Interdigital, Nokia, and Ericsson are among the largest holders of CDMA and LTE SEPs, several dozen companies have declared such patents, including Motorola (Alphabet), NEC, Huawei, Samsung, ZTE, NTT DOCOMO, etc. Again — why were none of their licenses included in the analysis?

All else equal, more data yields better results. This is particularly true where the data are complex license agreements which are often embedded in larger, even-more-complex commercial agreements and which incorporate widely varying patent portfolios, patent implementers, and terms.

Yet the FTC relied on just eight agreements in its comparability study, covering a tiny fraction of the industry’s licensors and licensees, and, notably, including primarily licenses taken by the two companies (Samsung and Apple) that have most aggressively litigated their way to lower royalty rates.

A curiously crabbed selection of licensors

And it is not just that the selected licensees represent a weirdly small and biased sample; it is also not necessarily even a particularly comparable sample.

One thing we can be fairly confident of, given what we know of the agreements used, is that at least one of the license agreements involved Nokia licensing to Apple, and another involved InterDigital licensing to Apple. But these companies’ patent portfolios are not exactly comparable to Qualcomm’s. About Nokia’s patents, Apple said:

And about InterDigital’s:

Meanwhile, Apple’s view of Qualcomm’s patent portfolio (despite its public comments to the contrary) was that it was considerably better than the others’:

The FTC’s choice of such a limited range of comparable license agreements is curious for another reason, as well: It includes no Qualcomm agreements. Qualcomm is certainly one of the biggest players in the cellular licensing space, and no doubt more than a few license agreements involve Qualcomm. While it might not make sense to include Qualcomm licenses that the FTC claims incorporate anticompetitive terms, that doesn’t describe the huge range of Qualcomm licenses with which the FTC has no quarrel. Among other things, Qualcomm licenses from before it began selling chips would not have been affected by its alleged “no license, no chips” scheme, nor would licenses granted to companies that didn’t also purchase Qualcomm chips. Furthermore, its licenses for technology reading on the WCDMA standard are not claimed to be anticompetitive by the FTC.

And yet none of these licenses were deemed “comparable” by the FTC’s expert, even though, on many dimensions — most notably, with respect to the underlying patent portfolio being valued — they would have been the most comparable (i.e., identical).

A curiously circumscribed timeframe

That the FTC’s expert should use the 2013 cut-off date is also questionable. According to Lasinski, he chose to use agreements after 2013 because it was in 2013 that the U.S. District Court for the Western District of Washington decided the Microsoft v. Motorola case. Among other things, the court in Microsoft v Motorola held that the proper value of a SEP is its “intrinsic” patent value, including its value to the standard, but not including the additional value it derives from being incorporated into a widely used standard.

According to the FTC’s expert,

prior to [Microsoft v. Motorola], people were trying to value … the standard and the license based on the value of the standard, not the value of the patents ….

Asked by Qualcomm’s counsel if his concern was that the “royalty rates derived in license agreements for cellular SEPs [before Microsoft v. Motorola] could very well have been above FRAND,” Mr. Lasinski concurred.

The problem with this approach is that it’s little better than arbitrary. The Motorola decision was an important one, to be sure, but the notion that sophisticated parties in a multi-billion dollar industry were systematically agreeing to improper terms until a single court in Washington suggested otherwise is absurd. To be sure, such agreements are negotiated in “the shadow of the law,” and judicial decisions like the one in Washington (later upheld by the Ninth Circuit) can affect the parties’ bargaining positions.

But even if it were true that the court’s decision had some effect on licensing rates, the decision would still have been only one of myriad factors determining parties’ relative bargaining  power and their assessment of the proper valuation of SEPs. There is no basis to support the assertion that the Motorola decision marked a sea-change between “improper” and “proper” patent valuations. And, even if it did, it was certainly not alone in doing so, and the FTC’s expert offers no justification for determining that agreements reached before, say, the European Commission’s decision against Qualcomm in 2018 were “proper,” or that the Korea FTC’s decision against Qualcomm in 2009 didn’t have the same sort of corrective effect as the Motorola court’s decision in 2013. 

At the same time, a review of a wider range of agreements suggested that Qualcomm’s licensing royalties weren’t inflated

Meanwhile, one of Qualcomm’s experts in the FTC case, former DOJ Chief Economist Aviv Nevo, looked at whether the FTC’s theory of anticompetitive harm was borne out by the data by looking at Qualcomm’s royalty rates across time periods and standards, and using a much larger set of agreements. Although his remit was different than Mr. Lasinski’s, and although he analyzed only Qualcomm licenses, his analysis still sheds light on Mr. Lasinski’s conclusions:

[S]pecifically what I looked at was the predictions from the theory to see if they’re actually borne in the data….

[O]ne of the clear predictions from the theory is that during periods of alleged market power, the theory predicts that we should see higher royalty rates.

So that’s a very clear prediction that you can take to data. You can look at the alleged market power period, you can look at the royalty rates and the agreements that were signed during that period and compare to other periods to see whether we actually see a difference in the rates.

Dr. Nevo’s analysis, which looked at royalty rates in Qualcomm’s SEP license agreements for CDMA, WCDMA, and LTE ranging from 1990 to 2017, found no differences in rates between periods when Qualcomm was alleged to have market power and when it was not alleged to have market power (or could not have market power, on the FTC’s theory, because it did not sell corresponding chips).

The reason this is relevant is that Mr. Lasinski’s assessment implies that Qualcomm’s higher royalty rates weren’t attributable to its superior patent portfolio, leaving either anticompetitive conduct or non-anticompetitive, superior bargaining ability as the explanation. No one thinks Qualcomm has cornered the market on exceptional negotiators, so really the only proffered explanation for the results of Mr. Lasinski’s analysis is anticompetitive conduct. But this assumes that his analysis is actually reliable. Prof. Nevo’s analysis offers some reason to think that it is not.

All of the agreements studied by Mr. Lasinski were drawn from the period when Qualcomm is alleged to have employed anticompetitive conduct to elevate its royalty rates above FRAND. But when the actual royalties charged by Qualcomm during its alleged exercise of market power are compared to those charged when and where it did not have market power, the evidence shows it received identical rates. Mr Lasinki’s results, then, would imply that Qualcomm’s royalties were “too high” not only while it was allegedly acting anticompetitively, but also when it was not. That simple fact suggests on its face that Mr. Lasinski’s analysis may have been flawed, and that it systematically under-valued Qualcomm’s patents.

Connecting the dots and calling into question the strength of the FTC’s case

In its closing argument, the FTC pulled together the implications of its allegations of anticompetitive conduct by pointing to Mr. Lasinski’s testimony:

Now, looking at the effect of all of this conduct, Qualcomm’s own documents show that it earned many times the licensing revenue of other major licensors, like Ericsson.

* * *

Mr. Lasinski analyzed whether this enormous difference in royalties could be explained by the relative quality and size of Qualcomm’s portfolio, but that massive disparity was not explained.

Qualcomm’s royalties are disproportionate to those of other SEP licensors and many times higher than any plausible calculation of a FRAND rate.

* * *

The overwhelming direct evidence, some of which is cited here, shows that Qualcomm’s conduct led licensees to pay higher royalties than they would have in fair negotiations.

It is possible, of course, that Lasinki’s methodology was flawed; indeed, at trial Qualcomm argued exactly this in challenging his testimony. But it is also possible that, whether his methodology was flawed or not, his underlying data was flawed.

It is impossible from the publicly available evidence to definitively draw this conclusion, but the subsequent revelation that Apple may well have manipulated at least a significant share of the eight agreements that constituted Mr. Lasinski’s data certainly increases the plausibility of this conclusion: We now know, following Qualcomm’s opening statement in Apple v. Qualcomm, that that stilted set of comparable agreements studied by the FTC’s expert also happens to be tailor-made to be dominated by agreements that Apple may have manipulated to reflect lower-than-FRAND rates.

What is most concerning is that the FTC may have built up its case on such questionable evidence, either by intentionally cherry picking the evidence upon which it relied, or inadvertently because it rested on such a needlessly limited range of data, some of which may have been tainted.

Intentionally or not, the FTC appears to have performed its valuation analysis using a needlessly circumscribed range of comparable agreements and justified its decision to do so using questionable assumptions. This seriously calls into question the strength of the FTC’s case.

On March 14, the Federal Circuit will hear oral arguments in the case of BTG International v. Amneal Pharmaceuticals that could dramatically influence the future of duplicative patent litigation in the pharmaceutical industry.  The court will determine whether the America Invents Act (AIA) bars patent challengers that succeed in invalidating patents in inter partes review (IPR) proceedings from repeating their winning arguments in district court.  Courts and litigants had previously assumed that the AIA’s estoppel provision only prevented unsuccessful challengers from reusing failed arguments.   However, in an amicus brief filed in the case last month, the U.S. Patent and Trade Office (USPTO) argued that, although it seems counterintuitive, under the AIA, even parties that succeed in getting patents invalidated in IPR cannot reuse their arguments. 

If the Federal Circuit agrees with the USPTO, patent challengers could be strongly deterred from bringing IPR proceedings because it would mean they couldn’t reuse any arguments in district court.  This deterrent effect would be especially strong for generic drug makers, who must prevail in district court in order to get approval for their Abbreviated New Drug Application from the FDA. 

Critics of the USPTO’s position assert that it will frustrate the AIA’s purpose of facilitating generic competition.  However, if the Federal Circuit adopts the position, it would also reduce the amount of duplicative litigation that plagues the pharmaceutical industry and threatens new drug innovation.  According to a 2017 analysis of over 6,500 IPR challenges filed between 2012 and 2017, approximately 80% of IPR challenges were filed during an ongoing district court case challenging the patent.   This duplicative litigation can increase costs for both challengers and patent holders; the median cost for an IPR proceeding that results in a final decision is $500,000 and the median cost for just filing an IPR petition is $100,000.  Moreover, because of duplicative litigation, pharmaceutical patent holders face persistent uncertainty about the validity of their patents. Uncertain patent rights will lead to less innovation because drug companies will not spend the billions of dollars it typically costs to bring a new drug to market when they cannot be certain if the patents for that drug can withstand IPR proceedings that are clearly stacked against them.   And if IPR causes drug innovation to decline, a significant body of research predicts that patients’ health outcomes will suffer as a result.

In addition, deterring IPR challenges would help to reestablish balance between drug patent owners and patent challengers.  As I’ve previously discussed here and here, the pro-challenger bias in IPR proceedings has led to significant deviation in patent invalidation rates under the two pathways; compared to district court challenges, patents are twice as likely to be found invalid in IPR challenges. The challenger is more likely to prevail in IPR proceedings because the Patent Trial and Appeal Board (PTAB) applies a lower standard of proof for invalidity in IPR proceedings than do federal courts. Furthermore, if the challenger prevails in the IPR proceedings, the PTAB’s decision to invalidate a patent can often “undo” a prior district court decision in favor of the patent holder.  Further, although both district court judgments and PTAB decisions are appealable to the Federal Circuit, the court applies a more deferential standard of review to PTAB decisions, increasing the likelihood that they will be upheld compared to the district court decision. 

However, the USPTO acknowledges that its position is counterintuitive because it means that a court could not consider invalidity arguments that the PTAB found persuasive.  It is unclear whether the Federal Circuit will refuse to adopt this counterintuitive position or whether Congress will amend the AIA to limit estoppel to failed invalidity claims.  As a result, a better and more permanent way to eliminate duplicative litigation would be for Congress to enact the Hatch-Waxman Integrity Act of 2019 (HWIA).  The HWIA was introduced by Senator Thom Tillis in the Senate and Congressman Bill Flores In the House, and proposed in the last Congress by Senator Orrin Hatch.  The HWIA eliminates the ability of drug patent challengers to file duplicative claims in both federal court and IPR proceedings.  Instead, they must choose between either district court litigation (which saves considerable costs by allowing generics to rely on the brand company’s safety and efficacy studies for FDA approval) and IPR proceedings (which are faster and provide certain pro-challenger provisions). 

Thus, the HWIA would reduce duplicative litigation that increases costs and uncertainty for drug patent owners.   This will ensure that patent owners achieve clarity on the validity of their patents, which will spur new drug innovation and ensure that consumers continue to have access to life-improving drugs.