Archives For standard-essential patent

Federal Trade Commission (FTC) Chair Lina Khan recently joined with FTC Commissioner Rebecca Slaughter to file a “written submission on the public interest” in the U.S. International Trade Commission (ITC) Section 337 proceeding concerning imports of certain cellular-telecommunications equipment covered by standard essential patents (SEPs). SEPs are patents that “read on” technology adopted for inclusion in a standard. Regrettably, the commissioners’ filing embodies advice that, if followed, would effectively preclude Section 337 relief to SEP holders. Such a result would substantially reduce the value of U.S. SEPs and thereby discourage investments in standards that help drive American innovation.

Section 337 of the Tariff Act authorizes the ITC to issue “exclusion orders” blocking the importation of products that infringe U.S. patents, subject to certain “public interest” exceptions. Specifically, before issuing an exclusion order, the ITC must consider:

  1. the public health and welfare;
  2. competitive conditions in the U.S. economy;
  3. production of like or directly competitive articles in the United States; and
  4. U.S. consumers.

The Khan-Slaughter filing urges the ITC to consider the impact that issuing an exclusion order against a willing licensee implementing a standard would have on competition and consumers in the United States. The filing concludes that “where a complainant seeks to license and can be made whole through remedies in a different U.S. forum [a federal district court], an exclusion order barring standardized products from the United States will harm consumers and other market participants without providing commensurate benefits.”

Khan and Slaughter’s filing takes a one-dimensional view of the competitive effects of SEP rights. In short, it emphasizes that:

  1. standardization empowers SEP owners to “hold up” licensees by demanding more for a technology than it would have been worth, absent the standard;
  2. “hold ups” lead to higher prices and may discourage standard-setting activities and collaboration, which can delay innovation;
  3. many standard-setting organizations require FRAND (fair, reasonable, and non-discriminatory) licensing commitments from SEP holders to preclude hold-up and encourage standards adoption;
  4. FRAND commitments ensure that SEP licenses will be available at rates limited to the SEP’s “true” value;
  5. the threat of ITC exclusion orders would empower SEP holders to coerce licensees into paying “anticompetitively high” supra-FRAND licensing rates, discouraging investments in standard-compliant products;
  6. inappropriate exclusion orders harm consumers in the short term by depriving them of desired products and, in the longer run, through reduced innovation, competition, quality, and choice;
  7. thus, where the standard implementer is a “willing licensee,” an exclusion order would be contrary to the public interest; and
  8. as a general matter, exclusionary relief is incongruent and against the public interest where a court has been asked to resolve FRAND terms and can make the SEP holder whole.

In essence, Khan and Slaughter recite a parade of theoretical horribles, centered on anticompetitive hold-ups, to call-for denying exclusion orders to SEP owners on public-interest grounds. Their filing’s analysis, however, fails as a matter of empirics, law, and sound economics. 

First, the filing fails to note that there is a lack of empirical support for anticompetitive hold-up being a problem at all (see, for example, here, here, and here). Indeed, a far more serious threat is “hold-out,” whereby the ability of implementers to infringe SEPs without facing serious consequences leads to an inefficient undervaluation of SEP rights (see, for example, here). (At worst, implementers will have to pay at some future time a “reasonable” licensing fee if held to be infringers in court, since U.S. case law (unlike foreign case law) has essentially eliminated SEP holders’ ability to obtain an injunction.)  

Second, as a legal matter, the filing’s logic would undercut the central statutory purpose of Section 337, which is to provide all U.S. patent holders a right to exclude infringing imports. Section 337 does not distinguish between SEPs and other patents—all are entitled to full statutory protection. Former ITC Chair Deanna Tanner Okun, in critiquing a draft administration policy statement that would severely curtail the rights of SEP holders, assessed the denigration of Section 337 statutory protections in a manner that is equally applicable to the Khan-Slaughter filing:

The Draft Policy Statement also circumvents Congress by upending the statutory framework and purpose of Section 337, which includes the ITC’s practice of evaluating all unfair acts equally. Although the draft disclaims any “unique set of legal rules for SEPs,” it does, in fact, create a special and unequal analysis for SEPs. The draft also implies that the ITC should focus on whether the patents asserted are SEPs when judging whether an exclusion order would adversely affect the public interest. The draft fundamentally misunderstands the ITC’s purpose, statutory mandates, and overriding consideration of safeguarding the U.S. public interest and would — again, without statutory approval — elevate SEP status of a single patent over other weighty public interest considerations. The draft also overlooks Presidential review requirements, agency consultation opportunities and the ITC’s ability to issue no remedies at all.

[Notable,] Section 337’s statutory language does not distinguish the types of relief available to patentees when SEPs are asserted.

Third, Khan and Slaughter not only assert theoretical competitive harms from hold-ups that have not been shown to exist (while ignoring the far more real threat of hold-out), they also ignore the foregone dynamic economic gains that would stem from limitations on SEP rights (see, generally, here). Denying SEP holders the right to obtain a Section 337 exclusion order, as advocated by the filing, deprives them of a key property right. It thereby establishes an SEP “liability rule” (SEP holder relegated to seeking damages), as opposed to a “property rule” (SEP holder may seek injunctive relief) as the SEP holder’s sole means to obtain recompense for patent infringement. As my colleague Andrew Mercado and I have explained, a liability-rule approach denies society the substantial economic benefits achievable through an SEP property rule:

[U]nder a property rule, as contrasted to a liability rule, innovation will rise and drive an increase in social surplus, to the benefit of innovators, implementers, and consumers. 

Innovators’ welfare will rise. … First, innovators already in the market will be able to receive higher licensing fees due to their improved negotiating position. Second, new innovators enticed into the market by the “demonstration effect” of incumbent innovators’ success will in turn engage in profitable R&D (to them) that brings forth new cycles of innovation.

Implementers will experience welfare gains as the flood of new innovations enhances their commercial opportunities. New technologies will enable implementers to expand their product offerings and decrease their marginal cost of production. Additionally, new implementers will enter the market as innovation accelerates. Seeing the opportunity to earn high returns, new implementers will be willing to pay innovators a high licensing fee in order to produce novel and improved products.

Finally, consumers will benefit from expanded product offerings and lower quality-adjusted prices. Initial high prices for new goods and services entering the market will fall as companies compete for customers and scale economies are realized. As such, more consumers will have access to new and better products, raising consumers’ surplus.

In conclusion, the ITC should accord zero weight to Khan and Slaughter’s fundamentally flawed filing in determining whether ITC exclusion orders should be available to SEP holders. Denying SEP holders a statutorily provided right to exclude would tend to undermine the value of their property, diminish investment in improved standards, reduce innovation, and ultimately harm consumers—all to the detriment, not the benefit, of the public interest.  

U.S. antitrust policy seeks to promote vigorous marketplace competition in order to enhance consumer welfare. For more than four decades, mainstream antitrust enforcers have taken their cue from the U.S. Supreme Court’s statement in Reiter v. Sonotone (1979) that antitrust is “a consumer welfare prescription.” Recent suggestions (see here and here) by new Biden administration Federal Trade Commission (FTC) and U.S. Justice Department (DOJ) leadership that antitrust should promote goals apart from consumer welfare have yet to be embodied in actual agency actions, and they have not been tested by the courts. (Given Supreme Court case law, judicial abandonment of the consumer welfare standard appears unlikely, unless new legislation that displaces it is enacted.)   

Assuming that the consumer welfare paradigm retains its primacy in U.S. antitrust, how do the goals of antitrust match up with those of national security? Consistent with federal government pronouncements, the “basic objective of U.S. national security policy is to preserve and enhance the security of the United States and its fundamental values and institutions.” Properly applied, antitrust can retain its consumer welfare focus in a manner consistent with national security interests. Indeed, sound antitrust and national-security policies generally go hand-in-hand. The FTC and the DOJ should keep that in mind in formulating their antitrust policies (spoiler alert: they sometimes have failed to do so).

Discussion

At first blush, it would seem odd that enlightened consumer-welfare-oriented antitrust enforcement and national-security policy would be in tension. After all, enlightened antitrust enforcement is concerned with targeting transactions that harmfully reduce output and undermine innovation, such as hard-core collusion and courses of conduct that inefficiently exclude competition and weaken marketplace competition. U.S. national security would seem to be promoted (or, at least, not harmed) by antitrust enforcement directed at supporting stronger, more vibrant American markets.

This initial instinct is correct, if antitrust-enforcement policy indeed reflects economically sound, consumer-welfare-centric principles. But are there examples where antitrust enforcement falls short and thereby is at odds with national security? An evaluation of three areas of interaction between the two American policy interests is instructive.

The degree of congruence between national security and appropriate consumer welfare-enhancing antitrust enforcement is illustrated by a brief discussion of:

  1. defense-industry mergers;
  2. the intellectual property-antitrust interface, with a focus on patent licensing; and
  3. proposed federal antitrust legislation.

The first topic presents an example of clear consistency between consumer-welfare-centric antitrust and national defense. In contrast, the second topic demonstrates that antitrust prosecutions (and policies) that inappropriately weaken intellectual-property protections are inconsistent with national defense interests. The second topic does not manifest a tension between antitrust and national security; rather, it illustrates a tension between national security and unsound antitrust enforcement. In a related vein, the third topic demonstrates how a change in the antitrust statutes that would undermine the consumer welfare paradigm would also threaten U.S. national security.

Defense-Industry Mergers

The consistency between antitrust goals and national security is relatively strong and straightforward in the field of defense-industry-related mergers and joint ventures. The FTC and DOJ traditionally have worked closely with the U.S. Defense Department (DOD) to promote competition and consumer welfare in evaluating business transactions that affect national defense needs.

The DOD has long supported policies to prevent overreliance on a single supplier for critical industrial-defense needs. Such a posture is consistent with the antitrust goal of preventing mergers to monopoly that reduce competition, raise prices, and diminish quality by creating or entrenching a dominant firm. As then-FTC Commissioner William Kovacic commented about an FTC settlement that permitted the United Launch Alliance (an American spacecraft launch service provider established in 2006 as a joint venture between Lockheed Martin and Boeing), “[i]n reviewing defense industry mergers, competition authorities and the DOD generally should apply a presumption that favors the maintenance of at least two suppliers for every weapon system or subsystem.”

Antitrust enforcers have, however, worked with DOD to allow the only two remaining suppliers of a defense-related product or service to combine their operations, subject to appropriate safeguards, when presented with scale economy and quality rationales that advanced national-security interests (see here).

Antitrust enforcers have also consulted and found common cause with DOD in opposing anticompetitive mergers that have national-security overtones. For example, antitrust enforcement actions targeting vertical defense-sector mergers that threaten anticompetitive input foreclosure or facilitate anticompetitive information exchanges are in line with the national-security goal of preserving vibrant markets that offer the federal government competitive, high-quality, innovative, and reasonably priced purchase options for its defense needs.

The FTC’s recent success in convincing Lockheed Martin to drop its proposed acquisition of Aerojet Rocketdyne holdings fits into this category. (I express no view on the merits of this matter; I merely cite it as an example of FTC-DOD cooperation in considering a merger challenge.) In its February 2022 press release announcing the abandonment of this merger, the FTC stated that “[t]he acquisition would have eliminated the country’s last independent supplier of key missile propulsion inputs and given Lockheed the ability to cut off its competitors’ access to these critical components.” The FTC also emphasized the full consistency between its enforcement action and national-security interests:

Simply put, the deal would have resulted in higher prices and diminished quality and innovation for programs that are critical to national security. The FTC’s enforcement action in this matter dovetails with the DoD report released this week recommending stronger merger oversight of the highly concentrated defense industrial base.

Intellectual-Property Licensing

Shifts in government IP-antitrust patent-licensing policy perspectives

Intellectual-property (IP) licensing, particularly involving patents, is highly important to the dynamic and efficient dissemination of new technologies throughout the economy, which, in turn, promotes innovation and increased welfare (consumers’ and producers’ surplus). See generally, for example, Daniel Spulber’s The Case for Patents and Jonathan Barnett’s Innovation, Firms, and Markets. Patents are a property right, and they do not necessarily convey market power, as the federal government has recognized (see 2017 DOJ-FTC Antitrust Guidelines for the Licensing of Intellectual Property).

Standard setting through standard setting organizations (SSOs) has been a particularly important means of spawning valuable benchmarks (standards) that have enabled new patent-backed technologies to drive innovation and enable mass distribution of new high-tech products, such as smartphones. The licensing of patents that cover and make possible valuable standards—“standard-essential patents” or SEPs—has played a crucial role in bringing to market these products and encouraging follow-on innovations that have driven fast-paced welfare-enhancing product and process quality improvements.

The DOJ and FTC have recognized specific efficiency benefits of IP licensing in their 2017 Antitrust Guidelines for the Licensing of Intellectual Property, stating (citations deleted):

Licensing, cross-licensing, or otherwise transferring intellectual property (hereinafter “licensing”) can facilitate integration of the licensed property with complementary factors of production. This integration can lead to more efficient exploitation of the intellectual property, benefiting consumers through the reduction of costs and the introduction of new products. Such arrangements increase the value of intellectual property to consumers and owners. Licensing can allow an innovator to capture returns from its investment in making and developing an invention through royalty payments from those that practice its invention, thus providing an incentive to invest in innovative efforts. …

[L]imitations on intellectual property licenses may serve procompetitive ends by allowing the licensor to exploit its property as efficiently and effectively as possible. These various forms of exclusivity can be used to give a licensee an incentive to invest in the commercialization and distribution of products embodying the licensed intellectual property and to develop additional applications for the licensed property. The restrictions may do so, for example, by protecting the licensee against free riding on the licensee’s investments by other licensees or by the licensor. They may also increase the licensor’s incentive to license, for example, by protecting the licensor from competition in the licensor’s own technology in a market niche that it prefers to keep to itself.

Unfortunately, however, FTC and DOJ antitrust policies over the last 15 years have too often belied this generally favorable view of licensing practices with respect to SEPs. (See generally here, here, and here). Notably, the antitrust agencies have at various times taken policy postures and enforcement actions indicating that SEP holders may face antitrust challenges if:

  1. they fail to license all comers, including competitors, on fair, reasonable, and nondiscriminatory (FRAND) terms; and
  2. seek to obtain injunctions against infringers.

In addition, antitrust policy officials (see 2011 FTC Report) have described FRAND price terms as cabined by the difference between the licensing rates for the first (included in the standard) and second (not included in the standard) best competing patented technologies available prior to the adoption of a standard. This pricing measure—based on the “incremental difference” between first and second-best technologies—has been described as necessary to prevent SEP holders from deriving artificial “monopoly rents” that reflect the market power conferred by a standard. (But see then FTC-Commissioner Joshua Wright’s 2013 essay to the contrary, based on the economics of incomplete contracts.)

This approach to SEPs undervalues them, harming the economy. Limitations on seeking injunctions (which are a classic property-right remedy) encourages opportunistic patent infringements and artificially disfavors SEP holders in bargaining over licensing terms with technology implementers, thereby reducing the value of SEPs. SEP holders are further disadvantaged by the presumption that they must license all comers. They also are harmed by the implication that they must be limited to a relatively low hypothetical “ex ante” licensing rate—a rate that totally fails to take into account the substantial economic welfare value that will accrue to the economy due to their contribution to the standard. Considered individually and as a whole, these negative factors discourage innovators from participating in standardization, to the detriment of standards quality. Lower-quality standards translate into inferior standardized produces and processes and reduced innovation.

Recognizing this problem, in 2018 DOJ, Assistant Attorney General for Antitrust Makan Delrahim announced a “New Madison Approach” (NMA) to SEP licensing, which recognized:

  1. antitrust remedies are inappropriate for patent-licensing disputes between SEP-holders and implementers of a standard;
  2. SSOs should not allow collective actions by standard-implementers to disfavor patent holders;
  3. SSOs and courts should be hesitant to restrict SEP holders’ right to exclude implementers from access to their patents by seeking injunctions; and
  4. unilateral and unconditional decisions not to license a patent should be per se legal. (See, for example, here and here.)

Acceptance of the NMA would have counter-acted the economically harmful degradation of SEPs stemming from prior government policies.

Regrettably, antitrust-enforcement-agency statements during the last year effectively have rejected the NMA. Most recently, in December 2021, the DOJ issued for public comment a Draft Policy Statement on Licensing Negotiations and Remedies, SEPs, which displaces a 2019 statement that had been in line with the NMA. Unless the FTC and Biden DOJ rethink their new position and decide instead to support the NMA, the anti-innovation approach to SEPs will once again prevail, with unfortunate consequences for American innovation.

The “weaker patents” implications of the draft policy statement would also prove detrimental to national security, as explained in a comment on the statement by a group of leading law, economics, and business scholars (including Nobel Laureate Vernon Smith) convened by the International Center for Law & Economics:

China routinely undermines U.S. intellectual property protections through its industrial policy. The government’s stated goal is to promote “fair and reasonable” international rules, but it is clear that China stretches its power over intellectual property around the world by granting “anti-suit injunctions” on behalf of Chinese smartphone makers, designed to curtail enforcement of foreign companies’ patent rights. …

Insufficient protections for intellectual property will hasten China’s objective of dominating collaborative standard development in the medium to long term. Simultaneously, this will engender a switch to greater reliance on proprietary, closed standards rather than collaborative, open standards. These harmful consequences are magnified in the context of the global technology landscape, and in light of China’s strategic effort to shape international technology standards. Chinese companies, directed by their government authorities, will gain significant control of the technologies that will underpin tomorrow’s digital goods and services.

A Center for Security and International Studies submission on the draft policy statement (signed by a former deputy secretary of the DOD, as well as former directors of the U.S. Patent and Trademark Office and the National Institute of Standards and Technology) also raised China-related national-security concerns:

[T]he largest short-term and long-term beneficiaries of the 2021 Draft Policy Statement are firms based in China. Currently, China is the world’s largest consumer of SEP-based technology, so weakening protection of American owned patents directly benefits Chinese manufacturers. The unintended effect of the 2021 Draft Policy Statement will be to support Chinese efforts to dominate critical technology standards and other advanced technologies, such as 5G. Put simply, devaluing U.S. patents is akin to a subsidized tech transfer to China.

Furthermore, in a more general vein, leading innovation economist David Teece also noted the negative national-security implications in his submission on the draft policy statement:

The US government, in reviewing competition policy issues that might impact standards, therefore needs to be aware that the issues at hand have tremendous geopolitical consequences and cannot be looked at in isolation. … Success in this regard will promote competition and is our best chance to maintain technological leadership—and, along with it, long-term economic growth and consumer welfare and national security.

That’s not all. In its public comment warning against precipitous finalization of the draft policy statement, the Innovation Alliance noted that, in recent years, major foreign jurisdictions have rejected the notion that SEP holders should be deprived the opportunity to seek injunctions. The Innovation Alliance opined in detail on the China national-security issues (footnotes omitted):

[T]he proposed shift in policy will undermine the confidence and clarity necessary to incentivize investments in important and risky research and development while simultaneously giving foreign competitors who do not rely on patents to drive investment in key technologies, like China, a distinct advantage. …

The draft policy statement … would devalue SEPs, and undermine the ability of U.S. firms to invest in the research and development needed to maintain global leadership in 5G and other critical technologies.

Without robust American investments, China—which has clear aspirations to control and lead in critical standards and technologies that are essential to our national security—will be left without any competition. Since 2015, President Xi has declared “whoever controls the standards controls the world.” China has rolled out the “China Standards 2035” plan and has outspent the United States by approximately $24 billion in wireless communications infrastructure, while China’s five-year economic plan calls for $400 billion in 5G-related investment.

Simply put, the draft policy statement will give an edge to China in the standards race because, without injunctions, American companies will lose the incentive to invest in the research and development needed to lead in standards setting. Chinese companies, on the other hand, will continue to race forward, funded primarily not by license fees, but by the focused investment of the Chinese government. …

Public hearings are necessary to take into full account the uncertainty of issuing yet another policy on this subject in such a short time period.

A key part of those hearings and further discussions must be the national security implications of a further shift in patent enforceability policy. Our future safety depends on continued U.S. leadership in areas like 5G and artificial intelligence. Policies that undermine the enforceability of patent rights disincentivize the substantial private sector investment necessary for research and development in these areas. Without that investment, development of these key technologies will begin elsewhere—likely China. Before any policy is accepted, key national-security stakeholders in the U.S. government should be asked for their official input.

These are not the only comments that raised the negative national-security ramifications of the draft policy statement (see here and here). For example, current Republican and Democratic senators, prior International Trade Commissioners, and former top DOJ and FTC officials also noted concerns. What’s more, the Patent Protection Society of China, which represents leading Chinese corporate implementers, filed a rather nonanalytic submission in favor of the draft statement. As one leading patent-licensing lawyer explains: “UC Berkley Law Professor Mark Cohen, whose distinguished government service includes serving as the USPTO representative in China, submitted a thoughtful comment explaining how the draft Policy Statement plays into China’s industrial and strategic interests.”

Finally, by weakening patent protection, the draft policy statement is at odds with  the 2021 National Security Commission on Artificial Intelligence Report, which called for the United States to “[d]evelop and implement national IP policies to incentivize, expand, and protect emerging technologies[,]” in response to Chinese “leveraging and exploiting intellectual property (IP) policies as a critical tool within its national strategies for emerging technologies.”

In sum, adoption of the draft policy statement would raise antitrust risks, weaken key property rights protections for SEPs, and undercut U.S. technological innovation efforts vis-à-vis China, thereby undermining U.S. national security.

FTC v. Qualcomm: Misguided enforcement and national security

U.S. national-security interests have been threatened by more than just the recent SEP policy pronouncements. In filing a January 2017 antitrust suit (at the very end of the Obama administration) against Qualcomm’s patent-licensing practices, the FTC (by a partisan 2-1 vote) ignored the economic efficiencies that underpinned this highly successful American technology company’s practices. Had the suit succeeded, U.S. innovation in a critically important technology area would have needlessly suffered, with China as a major beneficiary. A recent Federalist Society Regulatory Transparency Project report on the New Madison Approach underscored the broad policy implications of FTC V. Qualcomm (citations deleted):

The FTC’s Qualcomm complaint reflected the anti-SEP bias present during the Obama administration. If it had been successful, the FTC’s prosecution would have seriously undermined the freedom of the company to engage in efficient licensing of its SEPs.

Qualcomm is perhaps the world’s leading wireless technology innovator. It has developed, patented, and licensed key technologies that power smartphones and other wireless devices, and continues to do so. Many of Qualcomm’s key patents are SEPs subject to FRAND, directed to communications standards adopted by wireless devices makers. Qualcomm also makes computer processors and chips embodied in cutting edge wireless devices. Thanks in large part to Qualcomm technology, those devices have improved dramatically over the last decade, offering consumers a vast array of new services at a lower and lower price, when quality is factored in. Qualcomm thus is the epitome of a high tech American success story that has greatly benefited consumers.

Qualcomm: (1) sells its chips to “downstream” original equipment manufacturers (OEMs, such as Samsung and Apple), on the condition that the OEMs obtain licenses to Qualcomm SEPs; and (2) refuses to license its FRAND-encumbered SEPs to rival chip makers, while allowing those rivals to create and sell chips embodying Qualcomm SEP technologies to those OEMS that have entered a licensing agreement with Qualcomm.

The FTC’s 2017 antitrust complaint, filed in federal district court in San Francisco, charged that Qualcomm’s “no license, no chips” policy allegedly “forced” OEM cell phone manufacturers to pay elevated royalties on products that use a competitor’s baseband processors. The FTC deemed this an illegal “anticompetitive tax” on the use of rivals’ processors, since phone manufacturers “could not run the risk” of declining licenses and thus losing all access to Qualcomm’s processors (which would be needed to sell phones on important cellular networks). The FTC also argued that Qualcomm’s refusal to license its rivals despite its SEP FRAND commitment violated the antitrust laws. Finally, the FTC asserted that a 2011-2016 Qualcomm exclusive dealing contract with Apple (in exchange for reduced patent royalties) had excluded business opportunities for Qualcomm competitors.

The federal district court held for the FTC. It ordered that Qualcomm end these supposedly anticompetitive practices and renegotiate its many contracts. [Among the beneficiaries of new pro-implementer contract terms would have been a leading Chinese licensee of Qualcomm’s, Huawei, the huge Chinese telecommunications company that has been accused by the U.S. government of using technological “back doors” to spy on the United States.]

Qualcomm appealed, and in August 2020 a panel of the Ninth Circuit Court of Appeals reversed the district court, holding for Qualcomm. Some of the key points underlying this holding were: (1) Qualcomm had no antitrust duty to deal with competitors, consistent with established Supreme Court precedent (a very narrow exception to this precedent did not apply); (2) Qualcomm’s rates were chip supplier neutral because all OEMs paid royalties, not just rivals’ customers; (3) the lower court failed to show how the “no license, no chips” policy harmed Qualcomm’s competitors; and (4) Qualcomm’s agreements with Apple did not have the effect of substantially foreclosing the market to competitors. The Ninth Circuit as a whole rejected the FTC’s “en banc” appeal for review of the panel decision.

The appellate decision in Qualcomm largely supports pillar four of the NMA, that unilateral and unconditional decisions not to license a patent should be deemed legal under the antitrust laws. More generally, the decision evinces a refusal to find anticompetitive harm in licensing markets without hard empirical support. The FTC and the lower court’s findings of “harm” had been essentially speculative and anecdotal at best. They had ignored the “big picture” that the markets in which Qualcomm operates had seen vigorous competition and the conferral of enormous and growing welfare benefits on consumers, year-by-year. The lower court and the FTC had also turned a deaf ear to a legitimate efficiency-related business rationale that explained Qualcomm’s “no license, no chips” policy – a fully justifiable desire to obtain a fair return on Qualcomm’s patented technology.

Qualcomm is well reasoned, and in line with sound modern antitrust precedent, but it is only one holding. The extent to which this case’s reasoning proves influential in other courts may in part depend on the policies advanced by DOJ and the FTC going forward. Thus, a preliminary examination of the Biden administration’s emerging patent-antitrust policy is warranted. [Subsequent discussion shows that the Biden administration apparently has rejected pro-consumer policies embodied in the 9th U.S. Circuit’s Qualcomm decision and in the NMA.]

Although the 9th Circuit did not comment on them, national-security-policy concerns weighed powerfully against the FTC v. Qualcomm suit. In a July 2019 Statement of Interest (SOI) filed with the circuit court, DOJ cogently set forth the antitrust flaws in the district court’s decision favoring the FTC. Furthermore, the SOI also explained that “the public interest” favored a stay of the district court holding, due to national-security concerns (described in some detail in statements by the departments of Defense and Energy, appended to the SOI):

[T]he public interest also takes account of national security concerns. Winter v. NRDC, 555 U.S. 7, 23-24 (2008). This case presents such concerns. In the view of the Executive Branch, diminishment of Qualcomm’s competitiveness in 5G innovation and standard-setting would significantly impact U.S. national security. A251-54 (CFIUS); LD ¶¶10-16 (Department of Defense); ED ¶¶9-10 (Department of Energy). Qualcomm is a trusted supplier of mission-critical products and services to the Department of Defense and the Department of Energy. LD ¶¶5-8; ED ¶¶8-9. Accordingly, the Department of Defense “is seriously concerned that any detrimental impact on Qualcomm’s position as global leader would adversely affect its ability to support national security.” LD ¶16.

The [district] court’s remedy [requiring the renegotiation of Qualcomm’s licensing contracts] is intended to deprive, and risks depriving, Qualcomm of substantial licensing revenue that could otherwise fund time-sensitive R&D and that Qualcomm cannot recover later if it prevails. See, e.g., Op. 227-28. To be sure, if Qualcomm ultimately prevails, vacatur of the injunction will limit the severity of Qualcomm’s revenue loss and the consequent impairment of its ability to perform functions critical to national security. The Department of Defense “firmly believes,” however, “that any measure that inappropriately limits Qualcomm’s technological leadership, ability to invest in [R&D], and market competitiveness, even in the short term, could harm national security. The risks to national security include the disruption of [the Department’s] supply chain and unsure U.S. leadership in 5G.” LD ¶3. Consequently, the public interest necessitates a stay pending this Court’s resolution of the merits. In these rare circumstances, the interest in preventing even a risk to national security—“an urgent objective of the highest order”—presents reason enough not to enforce the remedy immediately. Int’l Refugee Assistance Project, 137 S. Ct. at 2088 (internal quotations omitted).

Not all national-security arguments against antitrust enforcement may be well-grounded, of course. The key point is that the interests of national security and consumer-welfare-centric antitrust are fully aligned when antitrust suits would inefficiently undermine the competitive vigor of a firm or firms that play a major role in supporting U.S. national-security interests. Such was the case in FTC v. Qualcomm. More generally, heightened antitrust scrutiny of efficient patent-licensing practices (as threatened by the Biden administration) would tend to diminish innovation by U.S. patentees, particularly in areas covered by standards that are key to leading global technologies. Such a diminution in innovation will tend to weaken American advantages in important industry sectors that are vital to U.S. national-security interests.

Proposed Federal Antitrust Legislation

Proposed federal antitrust legislation being considered by Congress (see here, here, and here for informed critiques) would prescriptively restrict certain large technology companies’ business transactions. If enacted, such legislation would thereby preclude case-specific analysis of potential transaction-specific efficiencies, thereby undermining the consumer welfare standard at the heart of current sound and principled antitrust enforcement. The legislation would also be at odds with our national-security interests, as a recent U.S. Chamber of Commerce paper explains:

Congress is considering new antitrust legislation which, perversely, would weaken leading U.S. technology companies by crafting special purpose regulations under the guise of antitrust to prohibit those firms from engaging in business conduct that is widely acceptable when engaged in by rival competitors.

A series of legislative proposals – some of which already have been approved by relevant Congressional committees – would, among other things: dismantle these companies; prohibit them from engaging in significant new acquisitions or investments; require them to disclose sensitive user data and sensitive IP and trade secrets to competitors, including those that are foreign-owned and controlled; facilitate foreign influence in the United States; and compromise cybersecurity.  These bills would fundamentally undermine American security interests while exempting from scrutiny Chinese and other foreign firms that do not meet arbitrary user and market capitalization thresholds specified in the legislation. …

The United States has never used legislation to punish success. In many industries, scale is important and has resulted in significant gains for the American economy, including small businesses.  U.S. competition law promotes the interests of consumers, not competitors. It should not be used to pick winners and losers in the market or to manage competitive outcomes to benefit select competitors.  Aggressive competition benefits consumers and society, for example by pushing down prices, disrupting existing business models, and introducing innovative products and services.

If enacted, the legislative proposals would drag the United States down in an unfolding global technological competition.  Companies captured by the legislation would be required to compete against integrated foreign rivals with one hand tied behind their backs.  Those firms that are the strongest drivers of U.S. innovation in AI, quantum computing, and other strategic technologies would be hamstrung or even broken apart, while foreign and state-backed producers of these same technologies would remain unscathed and seize the opportunity to increase market share, both in the U.S. and globally. …

Instead of warping antitrust law to punish a discrete group of American companies, the U.S. government should focus instead on vigorous enforcement of current law and on vocally opposing and effectively countering foreign regimes that deploy competition law and other legal and regulatory methods as industrial policy tools to unfairly target U.S. companies.  The U.S. should avoid self-inflicted wounds to our competitiveness and national security that would result from turning antitrust into a weapon against dynamic and successful U.S. firms.      

Consistent with this analysis, former Obama administration Defense Secretary Leon Panetta and former Trump administration Director of National Intelligence Dan Coats argued in a letter to U.S. House leadership (see here) that “imposing severe restrictions solely on U.S. giants will pave the way for a tech landscape dominated by China — echoing a position voiced by the Big Tech companies themselves.”

The national-security arguments against current antitrust legislative proposals, like the critiques of the unfounded FTC v. Qualcomm case, represent an alignment between sound antitrust policy and national-security analysis. Unfounded antitrust attacks on efficient business practices by large firms that help maintain U.S. technological leadership in key areas undermine both principled antitrust and national security.

Conclusion

Enlightened antitrust enforcement, centered on consumer welfare, can and should be read in a manner that is harmonious with national-security interests.

The cooperation between U.S. federal antitrust enforcers and the DOD in assessing defense-industry mergers and joint ventures is, generally speaking, an example of successful harmonization. This success reflects the fact that antitrust enforcers carry out their reviews of those transactions with an eye toward accommodating efficiencies that advance defense goals without sacrificing consumer welfare. Close antitrust-agency consultation with DOD is key to that approach.

Unfortunately, federal enforcement directed toward efficient intellectual-property licensing, as manifested in the Qualcomm case, reflects a disharmony between antitrust and national security. This disharmony could be eliminated if DOJ and the FTC adopted a dynamic view of intellectual property and the substantial economic-welfare benefits that flow from restrictive patent-licensing transactions.

In sum, a dynamic analysis reveals that consumer welfare is enhanced, not harmed, by not subjecting such licensing arrangements to antitrust threat. A more permissive approach to licensing is thus consistent with principled antitrust and with the national security interest of protecting and promoting strong American intellectual property (and, in particular, patent) protection. The DOJ and the FTC should keep this in mind and make appropriate changes to their IP-antitrust policies forthwith.

Finally, proposed federal antitrust legislation would bring about statutory changes that would simultaneously displace consumer welfare considerations and undercut national security interests. As such, national security is supported by rejecting unsound legislation, in order to keep in place consumer-welfare-based antitrust enforcement.

The leading contribution to sound competition policy made by former Assistant U.S. Attorney General Makan Delrahim was his enunciation of the “New Madison Approach” to patent-antitrust enforcement—and, in particular, to the antitrust treatment of standard essential patent licensing (see, for example, here, here, and here). In short (citations omitted):

The New Madison Approach (“NMA”) advanced by former Assistant Attorney General for Antitrust Makan Delrahim is a simple analytical framework for understanding the interplay between patents and antitrust law arising out of standard setting. A key aspect of the NMA is its rejection of the application of antitrust law to the “hold-up” problem, whereby patent holders demand supposedly supra-competitive licensing fees to grant access to their patents that “read on” a standard – standard essential patents (“SEPs”). This scenario is associated with an SEP holder’s prior commitment to a standard setting organization (“SSO”), that is: if its patented technology is included in a proposed new standard, it will license its patents on fair, reasonable, and non-discriminatory (“FRAND”) terms. “Hold-up” is said to arise subsequently, when the SEP holder reneges on its FRAND commitment and demands that a technology implementer pay higher-than-FRAND licensing fees to access its SEPs.

The NMA has four basic premises that are aimed at ensuring that patent holders have adequate incentives to innovate and create welfare-enhancing new technologies, and that licensees have appropriate incentives to implement those technologies:

1. Hold-up is not an antitrust problem. Accordingly, an antitrust remedy is not the correct tool to resolve patent licensing disputes between SEP-holders and implementers of a standard.

2. SSOs should not allow collective actions by standard-implementers to disfavor patent holders in setting the terms of access to patents that cover a new standard.

3. A fundamental element of patent rights is the right to exclude. As such, SSOs and courts should be hesitant to restrict SEP holders’ right to exclude implementers from access to their patents, by, for example, seeking injunctions.

4. Unilateral and unconditional decisions not to license a patent should be per se legal.

Delrahim emphasizes that the threat of antitrust liability, specifically treble damages, distorts the incentives associated with good faith negotiations with SSOs over patent inclusion. Contract law, he goes on to note, is perfectly capable of providing an ex post solution to licensing disputes between SEP holders and implementers of a standard. Unlike antitrust law, a contract law framework allows all parties equal leverage in licensing negotiations.

As I have explained elsewhere, the NMA is best seen as a set of policies designed to spark dynamic economic growth:

[P]atented technology serves as a catalyst for the wealth-creating diffusion of innovation. This occurs through numerous commercialization methods; in the context of standardized technologies, the development of standards is a process of discovery. At each [SSO], the process of discussion and negotiation between engineers, businesspersons, and all other relevant stakeholders reveals the relative value of alternative technologies and tends to result in the best patents being integrated into a standard.

The NMA supports this process of discovery and implementation of the best patented technology born of the labors of the innovators who created it. As a result, the NMA ensures SEP valuations that allow SEP holders to obtain an appropriate return for the new economic surplus that results from the commercialization of standard-engendered innovations. It recognizes that dynamic economic growth is fostered through the incentivization of innovative activities backed by patents.

In sum, the NMA seeks to promote innovation by offering incentives for SEP-driven technological improvements. As such, it rejects as ill-founded prior Federal Trade Commission (FTC) litigation settlements and Obama-era U.S. Justice Department (DOJ) Antitrust Division policy statements that artificially favored implementor licensees’ interests over those of SEP licensors (see here).

In light of the NMA, DOJ cooperated with the U.S. Patent and Trademark Office and National Institute of Standards and Technology (NIST) in issuing a 2019 SEP Policy Statement clarifying that an SEP holder’s promise to license a patent on fair, reasonable, and non-discriminatory (FRAND) terms does not bar it from seeking any available remedy for patent infringement, including an injunction. This signaled that SEPs and non-SEP patents enjoy equivalent legal status.

DOJ also issued a 2020 supplement to its 2015 Institute of Electrical and Electronics Engineers (IEEE) business review letter. The 2015 letter had found no legal fault with revised IEEE standard-setting policies that implicitly favored implementers of standardized technology over SEP holders. The 2020 supplement characterized key elements of the 2015 letter as “outdated,” and noted that the anti-SEP bias of that document could “harm competition and chill innovation.”   

Furthermore, DOJ issued a July 2019 Statement of Interest before the 9th U.S. Circuit Court of Appeals in FTC v. Qualcomm, explaining that unilateral and unconditional decisions not to license a patent are legal under the antitrust laws. In October 2020, the 9th Circuit reversed a district court decision and rejected the FTC’s monopolization suit against Qualcomm. The circuit court, among other findings, held that Qualcomm had no antitrust duty to license its SEPs to competitors.

Regrettably, the Biden Administration appears to be close to rejecting the NMA and to reinstituting the anti-strong patents SEP-skeptical views of the Obama administration (see here and here). DOJ already has effectively repudiated the 2020 supplement to the 2015 IEEE letter and the 2019 SEP Policy Statement. Furthermore, written responses to Senate Judiciary Committee questions by assistant attorney general nominee Jonathan Kanter suggest support for renewed antitrust scrutiny of SEP licensing. These developments are highly problematic if one supports dynamic economic growth.

Conclusion

The NMA represents a pro-American, pro-growth innovation policy prescription. Its abandonment would reduce incentives to invest in patents and standard-setting activities, to the detriment of the U.S. economy. Such a development would be particularly unfortunate at a time when U.S. Supreme Court decisions have weakened American patent rights (see here); China is taking steps to strengthen Chinese patents and raise incentives to obtain Chinese patents (see here); and China is engaging in litigation to weaken key U.S. patents and undermine American technological leadership (see here).

The rejection of NMA would also be in tension with the logic of the 5th U.S. Circuit Court of Appeals’ 2021 HTC v. Ericsson decision, which held that the non-discrimination portion of the FRAND commitment required Ericsson to give HTC the same licensing terms as given to larger mobile-device manufacturers. Furthermore, recent important European court decisions are generally consistent with NMA principles (see here).

Given the importance of dynamic competition in an increasingly globalized world economy, Biden administration officials may wish to take a closer look at the economic arguments supporting the NMA before taking final action to condemn it. Among other things, the administration might take note that major U.S. digital platforms, which are the subject of multiple U.S. and foreign antitrust enforcement investigations, tend to firmly oppose strong patents rights. As one major innovation economist recently pointed out:

If policymakers and antitrust gurus are so concerned about stemming the rising power of Big Tech platforms, they should start by first stopping the relentless attack on IP. Without the IP system, only the big and powerful have the privilege to innovate[.]

Over the past decade and a half, virtually every branch of the federal government has taken steps to weaken the patent system. As reflected in President Joe Biden’s July 2021 executive order, these restraints on patent enforcement are now being coupled with antitrust policies that, in large part, adopt a “big is bad” approach in place of decades of economically grounded case law and agency guidelines.

This policy bundle is nothing new. It largely replicates the innovation policies pursued during the late New Deal and the postwar decades. That historical experience suggests that a “weak-patent/strong-antitrust” approach is likely to encourage neither innovation nor competition.

The Overlooked Shortfalls of New Deal Innovation Policy

Starting in the early 1930s, the U.S. Supreme Court issued a sequence of decisions that raised obstacles to patent enforcement. The Franklin Roosevelt administration sought to take this policy a step further, advocating compulsory licensing for all patents. While Congress did not adopt this proposal, it was partially implemented as a de facto matter through antitrust enforcement. Starting in the early 1940s and continuing throughout the postwar decades, the antitrust agencies secured judicial precedents that treated a broad range of licensing practices as per se illegal. Perhaps most dramatically, the U.S. Justice Department (DOJ) secured more than 100 compulsory licensing orders against some of the nation’s largest companies. 

The rationale behind these policies was straightforward. By compelling access to incumbents’ patented technologies, courts and regulators would lower barriers to entry and competition would intensify. The postwar economy declined to comply with policymakers’ expectations. Implementation of a weak-IP/strong-antitrust innovation policy over the course of four decades yielded the opposite of its intended outcome. 

Market concentration did not diminish, turnover in market leadership was slow, and private research and development (R&D) was confined mostly to the research labs of the largest corporations (who often relied on generous infusions of federal defense funding). These tendencies are illustrated by the dramatically unequal allocation of innovation capital in the postwar economy.  As of the late 1950s, small firms represented approximately 7% of all private U.S. R&D expenditures.  Two decades later, that figure had fallen even further. By the late 1970s, patenting rates had plunged, and entrepreneurship and innovation were in a state of widely lamented decline.

Why Weak IP Raises Entry Costs and Promotes Concentration

The decline in entrepreneurial innovation under a weak-IP regime was not accidental. Rather, this outcome can be derived logically from the economics of information markets.

Without secure IP rights to establish exclusivity, engage securely with business partners, and deter imitators, potential innovator-entrepreneurs had little hope to obtain funding from investors. In contrast, incumbents could fund R&D internally (or with federal funds that flowed mostly to the largest computing, communications, and aerospace firms) and, even under a weak-IP regime, were protected by difficult-to-match production and distribution efficiencies. As a result, R&D mostly took place inside the closed ecosystems maintained by incumbents such as AT&T, IBM, and GE.

Paradoxically, the antitrust campaign against patent “monopolies” most likely raised entry barriers and promoted industry concentration by removing a critical tool that smaller firms might have used to challenge incumbents that could outperform on every competitive parameter except innovation. While the large corporate labs of the postwar era are rightly credited with technological breakthroughs, incumbents such as AT&T were often slow in transforming breakthroughs in basic research into commercially viable products and services for consumers. Without an immediate competitive threat, there was no rush to do so. 

Back to the Future: Innovation Policy in the New New Deal

Policymakers are now at work reassembling almost the exact same policy bundle that ended in the innovation malaise of the 1970s, accompanied by a similar reliance on public R&D funding disbursed through administrative processes. However well-intentioned, these processes are inherently exposed to political distortions that are absent in an innovation environment that relies mostly on private R&D funding governed by price signals. 

This policy bundle has emerged incrementally since approximately the mid-2000s, through a sequence of complementary actions by every branch of the federal government.

  • In 2011, Congress enacted the America Invents Act, which enables any party to challenge the validity of an issued patent through the U.S. Patent and Trademark Office’s (USPTO) Patent Trial and Appeals Board (PTAB). Since PTAB’s establishment, large information-technology companies that advocated for the act have been among the leading challengers.
  • In May 2021, the Office of the U.S. Trade Representative (USTR) declared its support for a worldwide suspension of IP protections over Covid-19-related innovations (rather than adopting the more nuanced approach of preserving patent protections and expanding funding to accelerate vaccine distribution).  
  • President Biden’s July 2021 executive order states that “the Attorney General and the Secretary of Commerce are encouraged to consider whether to revise their position on the intersection of the intellectual property and antitrust laws, including by considering whether to revise the Policy Statement on Remedies for Standard-Essential Patents Subject to Voluntary F/RAND Commitments.” This suggests that the administration has already determined to retract or significantly modify the 2019 joint policy statement in which the DOJ, USPTO, and the National Institutes of Standards and Technology (NIST) had rejected the view that standard-essential patent owners posed a high risk of patent holdup, which would therefore justify special limitations on enforcement and licensing activities.

The history of U.S. technology markets and policies casts great doubt on the wisdom of this weak-IP policy trajectory. The repeated devaluation of IP rights is likely to be a “lose-lose” approach that does little to promote competition, while endangering the incentive and transactional structures that sustain robust innovation ecosystems. A weak-IP regime is particularly likely to disadvantage smaller firms in biotech, medical devices, and certain information-technology segments that rely on patents to secure funding from venture capital and to partner with larger firms that can accelerate progress toward market release. The BioNTech/Pfizer alliance in the production and distribution of a Covid-19 vaccine illustrates how patents can enable such partnerships to accelerate market release.  

The innovative contribution of BioNTech is hardly a one-off occurrence. The restoration of robust patent protection in the early 1980s was followed by a sharp increase in the percentage of private R&D expenditures attributable to small firms, which jumped from about 5% as of 1980 to 21% by 1992. This contrasts sharply with the unequal allocation of R&D activities during the postwar period.

Remarkably, the resurgence of small-firm innovation following the strong-IP policy shift, starting in the late 20th century, mimics tendencies observed during the late 19th and early-20th centuries, when U.S. courts provided a hospitable venue for patent enforcement; there were few antitrust constraints on licensing activities; and innovation was often led by small firms in partnership with outside investors. This historical pattern, encompassing more than a century of U.S. technology markets, strongly suggests that strengthening IP rights tends to yield a policy “win-win” that bolsters both innovative and competitive intensity. 

An Alternate Path: ‘Bottom-Up’ Innovation Policy

To be clear, the alternative to the policy bundle of weak-IP/strong antitrust does not consist of a simple reversion to blind enforcement of patents and lax administration of the antitrust laws. A nuanced innovation policy would couple modern antitrust’s commitment to evidence-based enforcement—which, in particular cases, supports vigorous intervention—with a renewed commitment to protecting IP rights for innovator-entrepreneurs. That would promote competition from the “bottom up” by bolstering maverick innovators who are well-positioned to challenge (or sometimes partner with) incumbents and maintaining the self-starting engine of creative disruption that has repeatedly driven entrepreneurial innovation environments. Tellingly, technology incumbents have often been among the leading advocates for limiting patent and copyright protections.  

Advocates of a weak-patent/strong-antitrust policy believe it will enhance competitive and innovative intensity in technology markets. History suggests that this combination is likely to produce the opposite outcome.  

Jonathan M. Barnett is the Torrey H. Webb Professor of Law at the University of Southern California, Gould School of Law. This post is based on the author’s recent publications, Innovators, Firms, and Markets: The Organizational Logic of Intellectual Property (Oxford University Press 2021) and “The Great Patent Grab,” in Battles Over Patents: History and the Politics of Innovation (eds. Stephen H. Haber and Naomi R. Lamoreaux, Oxford University Press 2021).

This blog post summarizes the findings of a paper published in Volume 21 of the Federalist Society Review. The paper was co-authored by Dirk Auer, Geoffrey A. Manne, Julian Morris, & Kristian Stout. It uses the analytical framework of law and economics to discuss recent patent law reforms in the US, and their negative ramifications for inventors. The full paper can be found on the Federalist Society’s website, here.

Property rights are a pillar of the free market. As Harold Demsetz famously argued, they spur specialization, investment and competition throughout the economy. And the same holds true for intellectual property rights (IPRs). 

However, despite the many social benefits that have been attributed to intellectual property protection, the past decades have witnessed the birth and growth of an powerful intellectual movement seeking to reduce the legal protections offered to inventors by patent law.

These critics argue that excessive patent protection is holding back western economies. For instance, they posit that the owners of the standard essential patents (“SEPs”) are charging their commercial partners too much for the rights to use their patents (this is referred to as patent holdup and royalty stacking). Furthermore, they argue that so-called patent trolls (“patent-assertion entities” or “PAEs”) are deterring innovation by small startups by employing “extortionate” litigation tactics.

Unfortunately, this movement has led to a deterioration of appropriate remedies in patent disputes.

The many benefits of patent protection

While patents likely play an important role in providing inventors with incentives to innovate, their role in enabling the commercialization of ideas is probably even more important.

By creating a system of clearly defined property rights, patents empower market players to coordinate their efforts in order to collectively produce innovations. In other words, patents greatly reduce the cost of concluding mutually-advantageous deals, whereby firms specialize in various aspects of the innovation process. Critically, these deals occur in the shadow of patent litigation and injunctive relief. The threat of these ensures that all parties have an incentive to take a seat at the negotiating table.

This is arguably nowhere more apparent than in the standardization space. Many of the most high-profile modern technologies are the fruit of large-scale collaboration coordinated through standards developing organizations (SDOs). These include technologies such as Wi-Fi, 3G, 4G, 5G, Blu-Ray, USB-C, and Thunderbolt 3. The coordination necessary to produce technologies of this sort is hard to imagine without some form of enforceable property right in the resulting inventions.

The shift away from injunctive relief

Of the many recent reforms to patent law, the most significant has arguably been a significant limitation of patent holders’ availability to obtain permanent injunctions. This is particularly true in the case of so-called standard essential patents (SEPs). 

However, intellectual property laws are meaningless without the ability to enforce them and remedy breaches. And injunctions are almost certainly the most powerful, and important, of these remedies.

The significance of injunctions is perhaps best understood by highlighting the weakness of damages awards when applied to intangible assets. Indeed, it is often difficult to establish the appropriate size of an award of damages when intangible property—such as invention and innovation in the case of patents—is the core property being protected. This is because these assets are almost always highly idiosyncratic. By blocking all infringing uses of an invention, injunctions thus prevent courts from having to act as price regulators. In doing so, they also ensure that innovators are adequately rewarded for their technological contributions.

Unfortunately, the Supreme Court’s 2006 ruling in eBay Inc. v. MercExchange, LLC significantly narrowed the circumstances under which patent holders could obtain permanent injunctions. This predictably led lower courts to grant fewer permanent injunctions in patent litigation suits. 

But while critics of injunctions had hoped that reducing their availability would spur innovation, empirical evidence suggests that this has not been the case so far. 

Other reforms

And injunctions are not the only area of patent law that have witnessed a gradual shift against the interests of patent holders. Much of the same could be said about damages awards, revised fee shifting standards, and the introduction of Inter Partes Review.

Critically, the intellectual movement to soften patent protection has also had ramifications outside of the judicial sphere. It is notably behind several legislative reforms, particularly the America Invents Act. Moreover, it has led numerous private parties – most notably Standard Developing Organizations (SDOs) – to adopt stances that have advanced the interests of technology implementers at the expense of inventors.

For instance, one of the most noteworthy reforms has been IEEE’s sweeping reforms to its IP policy, in 2015. The new rules notably prevented SEP holders from seeking permanent injunctions against so-called “willing licensees”. They also mandated that royalties pertaining to SEPs should be based upon the value of the smallest saleable component that practices the patented technology. Both of these measures ultimately sought to tilt the bargaining range in license negotiations in favor of implementers.

Concluding remarks

The developments discussed in this article might seem like small details, but they are part of a wider trend whereby U.S. patent law is becoming increasingly inhospitable for inventors. This is particularly true when it comes to the enforcement of SEPs by means of injunction.

While the short-term effect of these various reforms has yet to be quantified, there is a real risk that, by decreasing the value of patents and increasing transaction costs, these changes may ultimately limit the diffusion of innovations and harm incentives to invent.

This likely explains why some legislators have recently put forward bills that seek to reinforce the U.S. patent system (here and here).

Despite these initiatives, the fact remains that there is today a strong undercurrent pushing for weaker or less certain patent protection. If left unchecked, this threatens to undermine the utility of patents in facilitating the efficient allocation of resources for innovation and its commercialization. Policymakers should thus pay careful attention to the changes this trend may bring about and move swiftly to recalibrate the patent system where needed in order to better protect the property rights of inventors and yield more innovation overall.

[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.

[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.

[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.

[TOTM: The following is the third 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 is authored by Douglas H. Ginsburg, Professor of Law, Antonin Scalia Law School at George Mason University; Senior Judge, United States Court of Appeals for the District of Columbia Circuit; and former Assistant Attorney General in charge of the Antitrust Division of the U.S. Department of Justice; and Joshua D. Wright, University Professor, Antonin Scalia Law School at George Mason University; Executive Director, Global Antitrust Institute; former U.S. Federal Trade Commissioner from 2013-15; and one of the founding bloggers at Truth on the Market.]

[Ginsburg & Wright: Professor Wright is recused from participation in the FTC litigation against Qualcomm, but has provided counseling advice to Qualcomm concerning other regulatory and competition matters. The views expressed here are our own and neither author received financial support.]

The Department of Justice Antitrust Division (DOJ) and Federal Trade Commission (FTC) have spent a significant amount of time in federal court litigating major cases premised upon an anticompetitive foreclosure theory of harm. Bargaining models, a tool used commonly in foreclosure cases, have been essential to the government’s theory of harm in these cases. In vertical merger or conduct cases, the core theory of harm is usually a variant of the claim that the transaction (or conduct) strengthens the firm’s incentives to engage in anticompetitive strategies that depend on negotiations with input suppliers. Bargaining models are a key element of the agency’s attempt to establish those claims and to predict whether and how firm incentives will affect negotiations with input suppliers, and, ultimately, the impact on equilibrium prices and output. Application of bargaining models played a key role in evaluating the anticompetitive foreclosure theories in the DOJ’s litigation to block the proposed merger of AT&T and Time Warner Cable. A similar model is at the center of the FTC’s antitrust claims against Qualcomm and its patent licensing business model.

Modern antitrust analysis does not condemn business practices as anticompetitive without solid economic evidence of an actual or likely harm to competition. This cautious approach was developed in the courts for two reasons. The first is that the difficulty of distinguishing between procompetitive and anticompetitive explanations for the same conduct suggests there is a high risk of error. The second is that those errors are more likely to be false positives than false negatives because empirical evidence and judicial learning have established that unilateral conduct is usually either procompetitive or competitively neutral. In other words, while the risk of anticompetitive foreclosure is real, courts have sensibly responded by requiring plaintiffs to substantiate their claims with more than just theory or scant evidence that rivals have been harmed.

An economic model can help establish the likelihood and/or magnitude of competitive harm when the model carefully captures the key institutional features of the competition it attempts to explain. Naturally, this tends to mean that the economic theories and models proffered by dueling economic experts to predict competitive effects take center stage in antitrust disputes. The persuasiveness of an economic model turns on the robustness of its assumptions about the underlying market. Model predictions that are inconsistent with actual market evidence give one serious pause before accepting the results as reliable.

For example, many industries are characterized by bargaining between providers and distributors. The Nash bargaining framework can be used to predict the outcomes of bilateral negotiations based upon each party’s bargaining leverage. The model assumes that both parties are better off if an agreement is reached, but that as the utility of one party’s outside option increases relative to the bargain, it will capture an increasing share of the surplus. Courts have had to reconcile these seemingly complicated economic models with prior case law and, in some cases, with direct evidence that is apparently inconsistent with the results of the model.

Indeed, Professor Carl Shapiro recently used bargaining models to analyze harm to competition in two prominent cases alleging anticompetitive foreclosure—one initiated by the DOJ and one by the FTC—in which he served as the government’s expert economist. In United States v. AT&T Inc., Dr. Shapiro testified that the proposed transaction between AT&T and Time Warner would give the vertically integrated company leverage to extract higher prices for content from AT&T’s rival, Dish Network. Soon after, Dr. Shapiro presented a similar bargaining model in FTC v. Qualcomm Inc. He testified that Qualcomm leveraged its monopoly power over chipsets to extract higher royalty rates from smartphone OEMs, such as Apple, wishing to license its standard essential patents (SEPs). In each case, Dr. Shapiro’s models were criticized heavily by the defendants’ expert economists for ignoring market realities that play an important role in determining whether the challenged conduct was likely to harm competition.

Judge Leon’s opinion in AT&T/Time Warner—recently upheld on appeal—concluded that Dr. Shapiro’s application of the bargaining model was significantly flawed, based upon unreliable inputs, and undermined by evidence about actual market performance presented by defendant’s expert, Dr. Dennis Carlton. Dr. Shapiro’s theory of harm posited that the combined company would increase its bargaining leverage and extract greater affiliate fees for Turner content from AT&T’s distributor rivals. The increase in bargaining leverage was made possible by the threat of a post-merger blackout of Turner content for AT&T’s rivals. This theory rested on the assumption that the combined firm would have reduced financial exposure from a long-term blackout of Turner content and would therefore have more leverage to threaten a blackout in content negotiations. The purpose of his bargaining model was to quantify how much AT&T could extract from competitors subjected to a long-term blackout of Turner content.

Judge Leon highlighted a number of reasons for rejecting the DOJ’s argument. First, Dr. Shapiro’s model failed to account for existing long-term affiliate contracts, post-litigation offers of arbitration agreements, and the increasing competitiveness of the video programming and distribution industry. Second, Dr. Carlton had demonstrated persuasively that previous vertical integration in the video programming and distribution industry did not have a significant effect on content prices. Finally, Dr. Shapiro’s model primarily relied upon three inputs: (1) the total number of subscribers the unaffiliated distributor would lose in the event of a long-term blackout of Turner content, (2) the percentage of the distributor’s lost subscribers who would switch to AT&T as a result of the blackout, and (3) the profit margin AT&T would derive from the subscribers it gained from the blackout. Many of Dr. Shapiro’s inputs necessarily relied on critical assumptions and/or third-party sources. Judge Leon considered and discredited each input in turn. 

The parties in Qualcomm are, as of the time of this posting, still awaiting a ruling. Dr. Shapiro’s model in that case attempts to predict the effect of Qualcomm’s alleged “no license, no chips” policy. He compared the gains from trade OEMs receive when they purchase a chip from Qualcomm and pay Qualcomm a FRAND royalty to license its SEPs with the gains from trade OEMs receive when they purchase a chip from a rival manufacturer and pay a “royalty surcharge” to Qualcomm to license its SEPs. In other words, the FTC’s theory of harm is based upon the premise that Qualcomm is charging a supra-FRAND rate for its SEPs (the“royalty surcharge”) that squeezes the margins of OEMs. That margin squeeze, the FTC alleges, prevents rival chipset suppliers from obtaining a sufficient return when negotiating with OEMs. The FTC predicts the end result is a reduction in competition and an increase in the price of devices to consumers.

Qualcomm, like Judge Leon in AT&T, questioned the robustness of Dr. Shapiro’s model and its predictions in light of conflicting market realities. For example, Dr. Shapiro, argued that the

leverage that Qualcomm brought to bear on the chips shifted the licensing negotiations substantially in Qualcomm’s favor and led to a significantly higher royalty than Qualcomm would otherwise have been able to achieve.

Yet, on cross-examination, Dr. Shapiro declined to move from theory to empirics when asked if he had quantified the effects of Qualcomm’s practice on any other chip makers. Instead, Dr. Shapiro responded that he had not, but he had “reason to believe that the royalty surcharge was substantial” and had “inevitable consequences.” Under Dr. Shapiro’s theory, one would predict that royalty rates were higher after Qualcomm obtained market power.

As with Dr. Carlton’s testimony inviting Judge Leon to square the DOJ’s theory with conflicting historical facts in the industry, Qualcomm’s economic expert, Dr. Aviv Nevo, provided an analysis of Qualcomm’s royalty agreements from 1990-2017, confirming that there was no economic and meaningful difference between the royalty rates during the time frame when Qualcomm was alleged to have market power and the royalty rates outside of that time frame. He also presented evidence that ex ante royalty rates did not increase upon implementation of the CDMA standard or the LTE standard. Moreover, Dr.Nevo testified that the industry itself was characterized by declining prices and increasing output and quality.

Dr. Shapiro’s model in Qualcomm appears to suffer from many of the same flaws that ultimately discredited his model in AT&T/Time Warner: It is based upon assumptions that are contrary to real-world evidence and it does not robustly or persuasively identify anticompetitive effects. Some observers, including our Scalia Law School colleague and former FTC Chairman, Tim Muris, would apparently find it sufficient merely to allege a theoretical “ability to manipulate the marketplace.” But antitrust cases require actual evidence of harm. We think Professor Muris instead captured the appropriate standard in his important article rejecting attempts by the FTC to shortcut its requirement of proof in monopolization cases:

This article does reject, however, the FTC’s attempt to make it easier for the government to prevail in Section 2 litigation. Although the case law is hardly a model of clarity, one point that is settled is that injury to competitors by itself is not a sufficient basis to assume injury to competition …. Inferences of competitive injury are, of course, the heart of per se condemnation under the rule of reason. Although long a staple of Section 1, such truncation has never been a part of Section 2. In an economy as dynamic as ours, now is hardly the time to short-circuit Section 2 cases. The long, and often sorry, history of monopolization in the courts reveals far too many mistakes even without truncation.

Timothy J. Muris, The FTC and the Law of Monopolization, 67 Antitrust L. J. 693 (2000)

We agree. Proof of actual anticompetitive effects rather than speculation derived from models that are not robust to market realities are an important safeguard to ensure that Section 2 protects competition and not merely individual competitors.

The future of bargaining models in antitrust remains to be seen. Judge Leon certainly did not question the proposition that they could play an important role in other cases. Judge Leon closely dissected the testimony and models presented by both experts in AT&T/Time Warner. His opinion serves as an important reminder. As complex economic evidence like bargaining models become more common in antitrust litigation, judges must carefully engage with the experts on both sides to determine whether there is direct evidence on the likely competitive effects of the challenged conduct. Where “real-world evidence,” as Judge Leon called it, contradicts the predictions of a bargaining model, judges should reject the model rather than the reality. Bargaining models have many potentially important antitrust applications including horizontal mergers involving a bargaining component – such as hospital mergers, vertical mergers, and licensing disputes. The analysis of those models by the Ninth and D.C. Circuits will have important implications for how they will be deployed by the agencies and parties moving forward.

[TOTM: The following is the second 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 is authored by Luke Froeb (William C. Oehmig Chair in Free Enterprise and Entrepreneurship at the Owen Graduate School of Management at Vanderbilt University; former chief economist at the Antitrust Division of the US Department of Justice and the Federal Trade Commission), Michael Doane (Competition Economics, LLC) & Mikhael Shor (Associate Professor of Economics, University of Connecticut).]

[Froeb, Doane & Shor: This post does not attempt to answer the question of what the court should decide in FTC v. Qualcomm because we do not have access to the information that would allow us to make such a determination. Rather, we focus on economic issues confronting the court by drawing heavily from our writings in this area: Gregory Werden & Luke Froeb, Why Patent Hold-Up Does Not Violate Antitrust Law; Luke Froeb & Mikhael Shor, Innovators, Implementors and Two-sided Hold-up; Bernard Ganglmair, Luke Froeb & Gregory Werden, Patent Hold Up and Antitrust: How a Well-Intentioned Rule Could Retard Innovation.]

Not everything is “hold-up”

It is not uncommon—in fact it is expected—that parties to a negotiation would have different opinions about the reasonableness of any deal. Every buyer asks for a price as low as possible, and sellers naturally request prices at which buyers (feign to) balk. A recent movement among some lawyers and economists has been to label such disagreements in the context of standard-essential patents not as a natural part of bargaining, but as dispositive proof of “hold-up,” or the innovator’s purported abuse of newly gained market power to extort implementers. We have four primary issues with this hold-up fad.

First, such claims of “hold-up” are trotted out whenever an innovator’s royalty request offends the commentator’s sensibilities, and usually with reference to a theoretical hold-up possibility rather than any matter-specific evidence that hold-up is actually present. Second, as we have argued elsewhere, such arguments usually ignore the fact that implementers of innovations often possess significant countervailing power to “hold-out as well. This is especially true as implementers have successfully pushed to curtail injunctive relief in standard-essential patent cases. Third, as Greg Werden and Froeb have recently argued, it is not clear why patent holdup—even where it might exist—need implicate antitrust law rather than be adequately handled as a contractual dispute. Lastly, it is certainly not the case that every disagreement over the value of an innovation is an exercise in hold-up, as even economists and lawyers have not reached anything resembling a consensus on the correct interpretation of a “fair” royalty.

At the heart of this case (and many recent cases) is (1) an indictment of Qualcomm’s desire to charge royalties to the maker of consumer devices based on the value of its technology and (2) a lack (to the best of our knowledge from public documents) of well vetted theoretical models that can provide the underpinning for the theory of the case. We discuss these in turn.

The smallest component “principle”

In arguing that “Qualcomm’s royalties are disproportionately high relative to the value contributed by its patented inventions,” (Complaint, ¶ 77) a key issue is whether Qualcomm can calculate royalties as a percentage of the price of a device, rather than a small percentage of the price of a chip. (Complaint, ¶¶ 61-76).

So what is wrong with basing a royalty on the price of the final product? A fixed portion of the price is not a perfect proxy for the value of embedded intellectual property, but it is a reasonable first approximation, much like retailers use fixed markups for products rather than optimizing the price of each SKU if the cost of individual determinations negate any benefits to doing so. The FTC’s main issue appears to be that the price of a smartphone reflects “many features in addition to the cellular connectivity and associated voice and text capabilities provided by early feature phones.” (Complaint, ¶ 26). This completely misses the point. What would the value of an iPhone be if it contained all of those “many features” but without the phone’s communication abilities? We have some idea, as Apple has for years marketed its iPod Touch for a quarter of the price of its iPhone line. Yet, “[f]or most users, the choice between an iPhone 5s and an iPod touch will be a no-brainer: Being always connected is one of the key reasons anyone owns a smartphone.”

What the FTC and proponents of the smallest component principle miss is that some of the value of all components of a smartphone are derived directly from the phone’s communication ability. Smartphones didn’t initially replace small portable cameras because they were better at photography (in fact, smartphone cameras were and often continue to be much worse than devoted cameras). The value of a smartphone camera is that it combines picture taking with immediate sharing over text or through social media. Thus, unlike the FTC’s claim that most of the value of a smartphone comes from features that are not communication, many features on a smartphone derive much of their value from the communication powers of the phone.

In the alternative, what the FTC wants is for the royalty not to reflect the value of the intellectual property but instead to be a small portion of the cost of some chipset—akin to an author of a paperback negotiating royalties based on the cost of plain white paper. As a matter of economics, a single chipset royalty cannot allow an innovator to capture the value of its innovation. This, in turn, implies that innovators underinvest in future technologies. As we have previously written:

For example, imagine that the same component (incorporating the same essential patent) is used to help stabilize flight of both commercial airplanes and toy airplanes. Clearly, these industries are likely to have different values for the patent. By negotiating over a single royalty rate based on the component price, the innovator would either fail to realize the added value of its patent to commercial airlines, or (in the case that the component is targeted primary to the commercial airlines) would not realize the incremental market potential from the patent’s use in toy airplanes. In either case, the innovator will not be negotiating over the entirety of the value it creates, leading to too little innovation.

The role of economics

Modern antitrust practice is to use economic models to explain how one gets from the evidence presented in a case to an anticompetitive conclusion. As Froeb, et al. have discussed, by laying out a mapping from the evidence to the effects, the legal argument is made clear, and gains credibility because it becomes falsifiable. The FTC complaint hypothesizes that “Qualcomm has excluded competitors and harmed competition through a set of interrelated policies and practices.” (Complaint, ¶ 3). Although Qualcomm explains how each of these policies and practices, by themselves, have clear business justifications, the FTC claims that combining them leads to an anticompetitive outcome.

Without providing a formal mapping from the evidence to an effect, it becomes much more difficult for a court to determine whether the theory of harm is correct or how to weigh the evidence that feeds the conclusion. Without a model telling it “what matters, why it matters, and how much it matters,” it is much more difficult for a tribunal to evaluate the “interrelated policies and practices.” In previous work, we have modeled the bilateral bargaining between patentees and licensees and have shown that when bilateral patent contracts are subject to review by an antitrust court, bargaining in the shadow of such a court can reduce the incentive to invest and thereby reduce welfare.

Concluding policy thoughts

What the FTC makes sound nefarious seems like a simple policy: requiring companies to seek licenses to Qualcomm’s intellectual property independent of any hardware that those companies purchase, and basing the royalty of that intellectual property on (an admittedly crude measure of) the value the IP contributes to that product. High prices alone do not constitute harm to competition. The FTC must clearly explain why their complaint is not simply about the “fairness” of the outcome or its desire that Qualcomm employ different bargaining paradigms, but rather how Qualcomm’s behavior harms the process of competition.

In the late 1950s, Nobel Laureate Robert Solow attributed about seven-eighths of the growth in U.S. GDP to technical progress. As Solow later commented: “Adding a couple of tenths of a percentage point to the growth rate is an achievement that eventually dwarfs in welfare significance any of the standard goals of economic policy.” While he did not have antitrust in mind, the import of his comment is clear: whatever static gains antitrust litigation may achieve, they are likely dwarfed by the dynamic gains represented by innovation.

Patent law is designed to maintain a careful balance between the costs of short-term static losses and the benefits of long-term gains that result from new technology. The FTC should present a sound theoretical or empirical basis for believing that the proposed relief sufficiently rewards inventors and allows them to capture a reasonable share of the whole value their innovations bring to consumers, lest such antitrust intervention deter investments in innovation.

An important but unheralded announcement was made on October 10, 2018: The European Committee for Standardization (CEN) and the European Committee for Electrotechnical Standardization (CENELEC) released a draft CEN CENELAC Workshop Agreement (CWA) on the licensing of Standard Essential Patents (SEPs) for 5G/Internet of Things (IoT) applications. The final agreement, due to be published in early 2019, is likely to have significant implications for the development and roll-out of both 5G and IoT applications.

CEN and CENELAC, which along with the European Telecommunications Standards Institute (ETSI) are the officially recognized standard setting bodies in Europe, are private international non profit organizations with a widespread network consisting of technical experts from industry, public administrations, associations, academia and societal organizations. This first Workshop brought together representatives of the 5G/Internet of Things (IoT) technology user and provider communities to discuss licensing best practices and recommendations for a code of conduct for licensing of SEPs. The aim was to produce a CWA that reflects and balances the needs of both communities.

The final consensus outcome of the Workshop will be published as a CEN-CENELEC Workshop Agreement (CWA). The draft, which is available for public comments, comprises principles and guidelines that prepare a foundation for future licensing of standard essential patents for fifth generation (5G) technologies. The draft also contains a section on Q&A to help aid new implementers and patent holders.

The IoT ecosystem is likely to have over 20 billion interconnected devices by 2020 and represent a market of $17 trillion (about the same as the current GDP of the U.S.). The data collected by one device, such as a smart thermostat that learns what time the consumer is likely to be at home, can be used to increase the performance of another connected device, such as a smart fridge. Cellular technologies are a core component of the IoT ecosystem, alongside applications, devices, software etc., as they provide connectivity within the IoT system. 5G technology, in particular, is expected to play a key role in complex IoT deployments, which will transcend the usage of cellular networks from smart phones to smart home appliances, autonomous vehicles, health care facilities etc. in what has been aptly described as the fourth industrial revolution.

Indeed, the role of 5G to IoT is so significant that the proposed $117 billion takeover bid for U.S. tech giant Qualcomm by Singapore-based Broadcom was blocked by President Trump, citing national security concerns. (A letter sent by the Committee on Foreign Investment in the US suggested that Broadcom might starve Qualcomm of investment, preventing it from competing effectively against foreign competitors–implicitly those in China.)

While commercial roll-out of 5G technology has not yet fully begun, several efforts are being made by innovator companies, standard setting bodies and governments to maximize the benefits from such deployment.

The draft CWA Guidelines (hereinafter “the guidelines”) are consistent with some of the recent jurisprudence on SEPs on various issues. While there is relatively less guidance specifically in relation to 5G SEPs, it provides clarifications on several aspects of SEP licensing which will be useful, particularly, the negotiating process and conduct of both parties.

The guidelines contain 6 principles followed by some questions pertaining to SEP licensing. The principles deal with:

  1. The obligation of SEP holders to license the SEPs on Fair, Reasonable and Non-Discriminatory (FRAND) terms;
  2. The obligation on both parties to conduct negotiations in good faith;
  3. The obligation of both parties to provide necessary information (subject to confidentiality) to facilitate timely conclusion of the licensing negotiation;
  4. Compensation that is “fair and reasonable” and achieves the right balance between incentives to contribute technology and the cost of accessing that technology;
  5. A non-discriminatory obligation on the SEP holder for similarly situated licensees even though they don’t need to be identical; and
  6. Recourse to a third party FRAND determination either by court or arbitration if the negotiations fail to conclude in a timely manner.

There are 22 questions and answers, as well, which define basic terms and touch on issues such as: what amounts as good faith conduct of negotiating parties, global portfolio licensing, FRAND royalty rates, patent pooling, dispute resolution, injunctions, and other issues relevant to FRAND licensing policy in general.

Below are some significant contributions that the draft report makes on issues such as the supply chain level at which licensing is best done, treatment of small and medium enterprises (SMEs), non disclosure agreements, good faith negotiations and alternative dispute resolution.

Typically in the IoT ecosystem, many technologies will be adopted of which several will be standardized. The guidelines offer help to product and service developers in this regard and suggest that one may need to obtain licenses from SEP owners for product or services incorporating communications technology like 3G UMTS, 4G LTE, Wi-Fi, NB-IoT, 31 Cat-M or video codecs such as H.264. The guidelines, however, clarify that with the deployment of IoT, licenses for several other standards may be needed and developers should be mindful of these complexities when starting out in order to avoid potential infringements.

Notably, the guidelines suggest that in order to simplify licensing, reduce costs for all parties and maintain a level playing field between licensees, SEP holders should license at one level. While this may vary between different industries, for communications technology, the licensing point is often at the end-user equipment level. There has been a fair bit of debate on this issue and the recent order by Judge Koh granting FTC’s partial summary motion deals with some of this.

In the judgment delivered on November 6, Judge Koh relied primarily on the 9th circuit decisions in Microsoft v Motorola (2012 and 2015)  to rule on the core issue of the scope of the FRAND commitments–specifically on the question of whether licensing extends to all levels or is confined to the end device level. The court interpreted the pro- competitive principles behind the non-discrimination requirement to mean that such commitments are “sweeping” and essentially that an SEP holder has to license to anyone willing to offer a FRAND rate globally. It also cited Ericsson v D-Link, where the Federal Circuit held that “compliant devices necessarily infringe certain claims in patents that cover technology incorporated into the standard and so practice of the standard is impossible without licenses to all incorporated SEP technology.”

The guidelines speak about the importance of non-disclosure agreements (NDAs) in such licensing agreements given that some of the information exchanged between parties during negotiation, such as claim charts etc., may be sensitive and confidential. Therefore, an undue delay in agreeing to an NDA, without well-founded reasons, might be taken as evidence of a lack of good faith in negotiations rendering such a licensee as unwilling.

They also provide quite a boost for small and medium enterprises (SMEs) in licensing negotiations by addressing the duty of SEP owners to be mindful of SMEs that may be less experienced and therefore lack information from which to draw assurance that proposed terms are FRAND. The guidelines provide that SEP owners should provide whatever information they can under NDA to help the negotiation process. Equally, the same obligation applies on a licensee who is more experienced in dealing with a SEP owner who is an SME.

There is some clarity on time frames for negotiations and the guidelines provide a maximum time that parties should take to respond to offers and counter offers, which could extend up to several months in complex cases involving hundreds of patents. The guidelines also prescribe conduct of potential licensees on receiving an offer and how to make counter-offers in a timely manner.

Furthermore, the guidelines lay down the various ways in which royalty rates may be structured and clarify that there is no one fixed way in which this may be done. Similarly, they offer myriad ways in which potential licensees may be able to determine for themselves if the rates offered to them are fair and reasonable, such as third party patent landscape reports, public announcements, expert advice etc.

Finally, in the case that a negotiation reaches an impasse, the guidelines endorse an alternative dispute mechanism such as mediation or arbitration for the parties to resolve the issue. Bodies such as International Chamber of Commerce and World Intellectual Property Organization may provide useful platforms in this regard.

Almost 20 years have passed since technology pioneer Kevin Ashton first coined the phrase Internet of Things. While companies are gearing up to participate in the market of IoT, regulation and policy in the IoT world seems far from a predictable framework to follow. There are a lot of guesses about how rules and standards are likely to shape up, with little or no guidance for companies on how to prepare themselves for what faces them very soon. Therefore concrete efforts such as these are rather welcome. The draft guidelines do attempt to offer some much needed clarity and are now open for public comments due by December 13. It will be good to see what the final CWA report on licensing of SEPs for 5G and IoT looks like.