As the connected car market glows, LTE is becoming the main connectivity technology not only for the V2X (vehicle-to-vehicle, vehicle-to-person, vehicle-to- roadside unit) communications but also for providing value added services (e.g., infotainment). For example, the 2015 Audi A3 LTE connectivity service includes navigation with Google Earth and Street View, weather and event information. Thus, one may expect that the increasing use of LTE can make the automotive sector a new patent dispute battleground. For potential patent litigation risk regarding LTE, please see Increasing Monetization Activities Exploiting LTE Patents.
The main issue with the LTE patent dispute will be the reasonable royalty of LTE standard essential patents (SEPs) that can be used for damage evaluation regarding infringing LTE products. SEPs encompass intellectual property rights (IPRs) for the standardized technologies. Usually, all the essential aspects of standardized technologies are specified in standard specifications. Thus, SEPs can be defined as patents that include one or more claims that are infringed by the implementation of certain standard specifications. Consequently, any LTE standard-compatible products (e.g., LTE connectivity chipsets) may infringe SEPs.
Standards are often developed and set-up through the standardization process by the standard setting organizations (SSOs). If the adopted standards are covered by some patents owned by the members that proposed the adopted standards, the members become the patentees of SEPs. The patentee of SEPs may have market power in the relevant technology market because the industry may be locked-in to using the standard and the value of SEPs becomes significantly enhanced. Thus, the patentee can demand and obtain unreasonably high royalty payments – hold up value - due to very high switching cost to alternative technology the implementer should pay. Thus, the patent hold up occurs when a patentee of SEPs demands unreasonably higher license fees after the standard is widely adopted than could have been obtained before the standard was implemented.
To avoid the patent holdup problem, a majority of the SSOs require that the members participating in the standardization process to agree ex ante to license their SEPs under fair, reasonable, and nondiscriminatory (FRAND) terms ex post to any implementers of the standard. The members’ agreements to license their SEPs under FRAND terms are usually called FRAND commitments. In general, FRAND commitments are interpreted as enforceable contractual obligations between a member and an SSO. An implementer of the standard is a third-party beneficiary of FRAND commitments and therefore entitled to a license of SEPs.
Two important questions about the FRAND commitments are FRAND royalty base and rate. One may use a royalty base equal to the entire market value of an infringing product if “the patented feature is the basis for consumer demand” for the entire product. If the patented feature is not the basis for consumer demand for the entire product, the royalty base should reflect only the contribution of the patented feature to consumer demand. Thus, if a product consists of many components, the royalty base can be the market value of the relevant component to consumer demand created by the patented feature.
In LaserDynamics, Inc. v. Quanta Computer, Inc., 694 F.3d 51, 68 (Fed. Cir. 2012), the court ruled that the royalty base can be the smallest saleable component that embodies the patented feature. By this reasoning, the FRAND royalty base may be the smallest saleable component that embodies the relevant SEPs. After the FRAND royalty base was determined, a royalty rate for a specific SEP can be calculated by taking account of the economic contribution of the specific SEP to the smallest saleable component that is used in determination of the FRAND royalty base.
In Microsoft v. Motorola and Google, D.C. Nos.2:10-cv-01823-JLR; 2:11-cv-00343-JLR (9th Cir. 2015), the court affirmed the lower court ruling in determining the FRAND royalty. The district court provided basic guidelines for assessing FRAND royalty. The district court devised the guidelines based on the Georgia-Pacific analysis of the reasonable royalty modified to take into account SSOs’ primary goals for requiring FRAND commitments. The court provided five primary goals for adopting FRAND commitments: 1. Promotion of widespread adoption of SSOs’ standards; 2. Avoidance of patent hold-up; 3. Avoidance of royalty stacking; 4. Creation of valuable standards; 5. Exclusion of hold-up value in the reasonable royalty. The court, then, modified the Georgia-Pacific factors to account for the five primary goals for requiring FRAND commitments. The key modification to the Georgia-Pacific factors leads to the reasoning that a royalty in a patent pool for the specific SEPs at issue or comparable licensing transactions as a candidate for the royalty established through negotiation under FRAND commitments. Thus, the royalty rate in the recently formed LTE patent pool may provide expected FRAND licensing revenue.
Another court’s guidelines for assessing FRAND royalty for SEPs can be found in In re INNOVATIO IP VENTURES, LLC, No. 1:11-cv-09308 (N.D. Ill. 2013), Dkt. No. 975. court calculated FRAND royalty (cap) of WiFi SEPs using the average profit margin of the WiFi chips that cover all the implemented features of the WiFi standard in the infringing products. Then, the court calculated FRAND royalty by multiplying the average profit margin to the contribution of patentee’s SEPs to the profit and pro rata share of patentee’s SEPs to the total number of WiFi SEPs providing similar contribution to the profit. Thus, LTE FRAND royalty can be evaluated as (average profit margin to the contribution of patentee’s SEPs) x (net profit of relating products) x (pro rata share of patentee’s SEPs to the total number of LTE SEPs providing similar contribution to the profit). For example evaluation of LTE royalty for a specific SEPs owner, please see How much will Apple need to pay to Ericsson for a reasonable licensing royalty of LTE patents?.
In response to the courts’ determination of FRAND Royalty, major SEPs owners such as Qualcomm, Nokia, Ericsson expressed their serious concerns about courts’ ruling to diminish the value of SEPs. Qualcomm insisted that there is nothing wrong with the licensing practice of using the price of the entire end product as the appropriate royalty base, because licensing at the end user device level has been an industry custom in the telecommunications sector. By the telecommunications industry custom, Qualcomm explained that patentees of SEPs usually did not enforce licensing obligation to component manufactures. Therefore, FRAND royalty base cannot be the smallest saleable component that embodies the relevant SEPs.
Additionally, Qualcomm reasoned that the contribution of the patented feature to consumer demand should not be limited to components of devices because extended consumers’ benefits are coming from the services provided by the network connecting devices. Therefore, the smallest saleable component that embodies the relevant SEPs is actually the device itself in the telecommunications sector. Furthermore, developing standard technology in mobile telecommunications is a high-risk business. Thus, without strong patent protection and return for R&D, there will be no encouragement for further investment in telecommunications standards. Consequently, artificially diminished royalties on mobile telecommunications standard-compatible products will impede innovation, and thus, harm to the industry and consumers ultimately.
On the other hand, Cisco, HP, Microsoft and several other IT companies argued that the use of the entire market value as a royalty base should not be used unless all of the profit of the infringing product is attributed to the features of SEPs. Thus, the value of SEPs should be determined by apportion to the contribution actually the patented features made to the accused product. They also insisted that patentees bear the burden of proof for the value of SEPs.
A method to resolve disagreement about FRAND royalty base may be a hybrid approach to royalty base that was suggested by the 3G licensing platform. The 3G licensing platform, which is the licensing organization for 3G mobile SEPs, adopted reference market value of the entire product as a royalty base, if the product consists of several functional blocks. For example, if the product performs 3G mobile communication and other functions that give values to the users of the product, the royalty base only take into account the value proportional to the 3G mobile communication function embedded in the entire product. Thus, if a mobile phone of price T includes a component of price A for mobile communication function and other components of price B for other independent functions and multiple components of price C for common functions supporting both mobile communication function and other independent functions, FRAND royalty base for mobile communication is A in the smallest saleable component approach and T in the entire market approach. In the hybrid approach to FRAND royalty, however, FRAND royalty base for mobile communication is A + C x [A/(A+B)] taking into account the net contribution of the multiple components for common functions to mobile communication. Consequently, FRAND royalty base is a compromise value between the two extremes such that it is the entire product value including only the smallest saleable function contributed by the patented feature of a SEP.