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In a constructive development, the Federal Trade Commission has joined its British counterpart in investigating Nvidia’s proposed $40 billion acquisition of chip designer Arm, a subsidiary of Softbank. Arm provides the technological blueprints for wireless communications devices and, subject to a royalty fee, makes those crown-jewel assets available to all interested firms. Notwithstanding Nvidia’s stated commitment to keep the existing policy in place, there is an obvious risk that the new parent, one of the world’s leading chip makers, would at some time modify this policy with adverse competitive effects.

Ironically, the FTC is likely part of the reason that the Nvidia-Arm transaction is taking place.

Since the mid-2000s, the FTC and other leading competition regulators (except for the U.S. Department of Justice’s Antitrust Division under the leadership of former Assistant Attorney General Makan Delrahim) have intervened extensively in licensing arrangements in wireless device markets, culminating in the FTC’s recent failed suit against Qualcomm. The Nvidia-Arm transaction suggests that these actions may simply lead chip designers to abandon the licensing model and shift toward structures that monetize chip-design R&D through integrated hardware and software ecosystems. Amazon and Apple are already undertaking chip innovation through this model. Antitrust action that accelerates this movement toward in-house chip design is likely to have adverse effects for the competitive health of the wireless ecosystem.

How IP Licensing Promotes Market Access

Since its inception, the wireless communications market has relied on a handful of IP licensors to supply device producers and other intermediate users with a common suite of technology inputs. The result has been an efficient division of labor between firms that specialize in upstream innovation and firms that specialize in production and other downstream functions. Contrary to the standard assumption that IP rights limit access, this licensing-based model ensures technology access to any firm willing to pay the royalty fee.

Efforts by regulators to reengineer existing relationships between innovators and implementers endanger this market structure by inducing innovators to abandon licensing-based business models, which now operate under a cloud of legal insecurity, for integrated business models in which returns on R&D investments are captured internally through hardware and software products. Rather than expanding technology access and intensifying competition, antitrust restraints on licensing freedom are liable to limit technology access and increase market concentration.

Regulatory Intervention and Market Distortion

This interventionist approach has relied on the assertion that innovators can “lock in” producers and extract a disproportionate fee in exchange for access. This prediction has never found support in fact. Contrary to theoretical arguments that patent owners can impose double-digit “royalty stacks” on device producers, empirical researchers have repeatedly found that the estimated range of aggregate rates lies in the single digits. These findings are unsurprising given market performance over more than two decades: adoption has accelerated as quality-adjusted prices have fallen and innovation has never ceased. If rates were exorbitant, market growth would have been slow, and the smartphone would be a luxury for the rich.

Despite these empirical infirmities, the FTC and other competition regulators have persisted in taking action to mitigate “holdup risk” through policy statements and enforcement actions designed to preclude IP licensors from seeking injunctive relief. The result is a one-sided legal environment in which the world’s largest device producers can effectively infringe patents at will, knowing that the worst-case scenario is a “reasonable royalty” award determined by a court, plus attorneys’ fees. Without any credible threat to deny access even after a favorable adjudication on the merits, any IP licensor’s ability to negotiate a royalty rate that reflects the value of its technology contribution is constrained.

Assuming no change in IP licensing policy on the horizon, it is therefore not surprising that an IP licensor would seek to shift toward an integrated business model in which IP is not licensed but embedded within an integrated suite of products and services. Or alternatively, an IP licensor entity might seek to be acquired by a firm that already has such a model in place. Hence, FTC v. Qualcomm leads Arm to Nvidia.

The Error Costs of Non-Evidence-Based Antitrust

These counterproductive effects of antitrust intervention demonstrate the error costs that arise when regulators act based on unverified assertions of impending market failure. Relying on the somewhat improbable assumption that chip suppliers can dictate licensing terms to device producers that are among the world’s largest companies, competition regulators have placed at risk the legal predicates of IP rights and enforceable contracts that have made the wireless-device market an economic success. As antitrust risk intensifies, the return on licensing strategies falls and competitive advantage shifts toward integrated firms that can monetize R&D internally through stand-alone product and service ecosystems.

Far from increasing competitiveness, regulators’ current approach toward IP licensing in wireless markets is likely to reduce it.

Over the last two years, the Scalia Law School’s Global Antitrust Institute (GAI) has taken a leadership role in promoting sound antitrust analysis of intellectual property rights (IPRs), through its insightful analysis of IP-antitrust guidance proffered by governments around the world (including by the United States antitrust agencies).  Key concepts that inform the GAI’s IP commentaries are that IP rights are full-fledged property rights, and should be treated as such; that IP licensing typically is procompetitive and often generates substantial efficiencies; that antitrust agencies should compare the competitive effects of IP licensing restrictions against what would have happened in the “but for” world in which there is no license; and that special limiting rules should not be applied to patents that cover technologies essential to the implementation of standards (“standard-essential patents”).  The overarching theme of the GAI submissions is that IP licensing generally enhances economic welfare and promotes innovation.

On April 13, the GAI once again turned its eye to IP licensing issues, in commenting on the Draft Anti-Monopoly Guidelines on the Abuse of Intellectual Property Rights (Draft Guidelines) propounded by the Chinese Government’s State Council (see here).  This commentary is particularly timely and important, given the vast scale of the Chinese economy and the large number of major companies involved in IP licensing in China.  While the April 13 GAI commentary praises the Draft Guidelines’ stated intent of condemning only those acts that “have the effect of excluding or restricting competition,” it explains that various Draft Guidelines provisions would nevertheless undermine that desirable goal.  Specifically, the commentary makes five key points:

  1. First, the Draft Guidelines do not explicitly recognize an IPR holder’s core right to exclude. The right to exclude is a central feature of IPRs, and economic theory and empirical evidence show that IPRs incentivize the creation of inventions, ideas, and original works.  Relatedly, the Draft Guidelines also do not incorporate throughout the well-accepted methodological principle that, when assessing the possible competitive effects of the use of IPRs, agencies should compare the competitive effect of the IPR use against what would have happened in the “but for” world in which there is no license.  This important analytical approach, which has been used by the U.S. antitrust agencies for the last 20 years, is absent from the Draft Guidelines.
  2. Second, the Draft Guidelines do not incorporate throughout the point that licensing is generally procompetitive. This modern economic understanding of licensing has informed the approach of the U.S. agencies, for example, for more than 20 years. The result is an approach that, with the exception of naked restraints such as price fixing, requires an effects-based analysis under which licensing restraints will be condemned only when any anticompetitive effects outweigh any procompetitive benefits.
  3. Third, and relatedly, the Draft Guidelines appear to create a number of presumptions that certain conduct (such as charging for expired or invalid patents and prohibiting a licensee from challenging the validity of its IPR) will, or is likely to, eliminate or restrict competition. Thus the State Council would be well advised to eliminate such presumptions and to adopt instead an effects-based approach.  This approach would benefit Chinese consumers because presumptions that are not appropriately calibrated are likely to capture conduct that is procompetitive, which is likely to have a chilling effect on potentially beneficial conduct.  Adopting an approach that incorporates these revisions would best serve competition and consumers, as well as China’s goal of becoming an innovation society.
  4. Fourth, the Draft Guidelines appear to create special rules for conduct involving standard-essential patents (SEPs). The State Council would be wise to reconsider this approach.  Instead, antitrust enforcers should ask whether particular conduct involving SEPs, including evasion of a FRAND assurance, has net anticompetitive effects, and should apply the same case-by-case, fact-specific analysis that is employed for non-SEPs.  Imposing special rules for SEPs, including creating presumptions of harm based on breach of contractual commitments such as a FRAND assurance, is not only unwarranted as a matter of competition policy, but also likely to deter participation in standard setting.
  5. Lastly, the State Council should adopt a more compliance-based approach that sets forth basic principles that would allow parties to self-advise. The Draft Guidelines instead set forth a list of factors that the Chinese competition agencies will consider when analyzing specific conduct, yet do not explain the significance of each of the factors or how they will be weighed in the competition agencies’ overall decision-making process.  This approach allows the agencies broad discretion in enforcement decision-making without providing the guidance stakeholders need to protect incentives to innovate and transfer technology that could be subject to Chinese antitrust jurisdiction.  To this end, the GAI’s commentary recommends that the State Council include throughout the Guidelines examples similar to those found in other guidelines, for example the U.S. antitrust agencies’ recently updated 2017 Antitrust Guidelines for the Licensing of Intellectual Property and the Canadian Bureau of Competition’s Intellectual Property Enforcement Guidelines.  Inclusion of illustrative examples will help IP holders understand how the Chinese agencies will apply the basic principles.

In sum, the Chinese Government would be well advised to adopt the April 13 commentary’s recommendations in finalizing its Guidelines.  Acceptance of the GAI’s recommendations would benefit consumers and producers, and promote innovation in the Chinese economy.  Once again (as one would expect), a GAI antitrust commentary is spot on.