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Competition policy and intellectual property rights - legal and economic perspectives.

This symposium issue of The Antitrust Bulletin considers, from legal, economic, and historical perspectives, a number of topics at the juncture of antitrust policy and intellectual property rights. Intellectual property rights and competition policy can, and frequently do, act in harmony. The U.S. antitrust authorities have clearly articulated the central role of innovation in fostering competition. (1) The U.S. Constitution provides for intellectual property rights, such as patents, as a means of encouraging innovation. (2) Enforceable patent rights enable inventors to deter or stop others from misappropriating their creations, so that they may profit by licensing or selling their inventions. (3) In principle, this mechanism is simple: Patents afford their owners the right to exclude others from the right to use the patented technologies. This right of exclusion can be viewed as a necessary (but, as we shall see, not sufficient) condition for patent holders to successfully demand positive royalties from those who desire to practice their technologies.

Economists have long understood that inventors bear the explicit and opportunity costs of innovative activity in the hope of profits, which may prove elusive when intellectual property rights are weak because of the risk of misappropriation. Economists also have recognized that invention is a key aspect of the more general process of competition, as businesses battle to gain customers and sales by offering products that embody superior technologies. (4) Because the intellectual roughly equivalent in terms of their capabilities, quality, and costs of implementation net of licensing fees, the royalty rates charged to the users of the technology will also approach marginal cost (that is, they too will be relatively small). The situation will differ when the substitute technologies on offer are differentiated to a significant degree. When imperfect competition exists among the alternative technologies, it is possible to characterize a "competitive" royalty rate for the preferred intellectual property as a function of the incremental value of that technology relative to the next-best option. This is the fundamental economic basis for the view that "reasonable and nondiscriminatory" (RAND or FRAND) (6) royalty rates, which frequently are required by standards bodies when a patented technology is to be included in an industry standard, should be calculated on the basis of the incremental value of the preferred technology relative to its next-best alternative. (7)

Standard setting organizations (SSOs) often require contributed technologies to be provided at RAND (or FRAND) rates because including a technology in an industry standard can change the relative bargaining positions of the owners and users of the technology. When a technology is included in an industry standard and producers have committed resources to producing standard-compliant products, the latter can become locked in to using the patent holder's technology. This would occur when the producers have made significant and irreversible commitments to use of the patented technology. Such commitments may take the form of sizeable up-front investments in plant, equipment, or product design that would be lost (and would need to be replaced) if the patented technology was abandoned in favor of an alternative. Moreover, abandonment of an established standard-essential technology may cause new devices to be incompatible with pre-existing ones, reducing the positive network effects that frequently benefit users of high-technology products (such as mobile telephones) and so reducing consumer demand for the products and imposing an additional opportunity cost on the producers of these downstream products. If it is secure in the knowledge that practicing entities have already made significant and irreversible commitments to its technology, and so would face significant costs of switching to an alternative, the patent holder could therefore be in the position to demand supracompetitive royalties.

In this ex post situation, the intellectual property owner would enjoy an economic monopoly even when, ex ante (that is, before producers had made their sunk investments) there had been acceptable substitute technologies available to makers of standard-compliant products. The patent holder would, in principle, be able to demand a total royalty payment from each maker that is just less than its cost of abandoning its specific investments and switching to the production of goods based on alternative technologies. As suggested earlier, it is possible for this maximum royalty to be constrained by prior legal or contractual requirements. The product maker might, for example, elect to use the technology without paying the owner (that is, to willingly infringe the patent) in the expectation that the court would award a "reasonable" royalty well below the monopoly royalty rate. Knowing this is possible, the patent holder may be willing, prior to infringement, to negotiate a lower royalty rate with the product maker. Alternatively, the patentee may be bound by requirements to charge FRAND or RAND royalties, limiting the patent owner's liberty to charge supracompetitive royalties. It is common for SSOs to require such commitments from owners of technologies contributed to industry standards.

The foregoing discussion--ex ante competition as defined above, versus ex post monopoly or negotiation--does not, in itself, necessarily implicate antitrust concerns. Each can arise in a world where there has been no anticompetitive conduct. However, it can be possible for intellectual property owners to engage in strategies that prevent ex ante competition, leaving product makers to deal with ex post market power on the part of the intellectual property rights holders. Such conduct can arise, for example, from a patent holder's failure to disclose its patent rights to technology users or SSOs, with the aim of masking its ability to wield patent rights against practicing entities ex post, or its abrogation of commitments (such as FRAND or RAND commitments) made regarding the magnitude of the royalties it would require after users had become locked in to its patented technology. (8) The creation of ex post market power in such ways, when followed by efforts to charge supra-competitive royalty rates, is referred to as anticompetitive hold-up. (9) By increasing the marginal costs of production of firms that make products that rely on the technology, anticompetitive hold-up can lead not only to higher downstream product prices, but also reduced profits to product developers. Such an outcome could result not only in adverse price effects but also reduced downstream innovation, again harming consumers.

This special symposium issue of The Antitrust Bulletin considers, from a variety of perspectives, the potential for anticompetitive and procompetitive effects arising from the use or control of patent rights, including, but not limited to, those considered above. Our authors also consider and assess approaches taken by standards bodies and triers of fact when addressing such issues.

Paul Saint-Antoine and Garrett Trego of the law firm of Drinker, Biddle & Reath provide an introduction to antitrust issues associated with patent hold-up in the standards-setting context. They also consider, among other things, difficulties introduced by the uncertain legal definitions of FRAND and RAND, and the competitive harms that may arise when holders of standard essential patents (SEPs) that are bound by FRAND or RAND commitments seek injunctive relief or exclusion orders after the makers of products have been locked in to the patented technologies. Saint-Antoine and Trego propose several legal or institutional changes that could reduce the potential for holdup by SEP owners that have entered into FRAND or RAND commitments with SSOs.

Bruce Abramson, an attorney and computer scientist whose experience includes service as a clerk to Judge Arthur Gajarsa of the U.S. Court of Appeals for the Federal Circuit, provides an historical and legal analysis of whether, and to what extent, the conduct of patent assertion entities (PAEs) and, in particular, nonpracticing entities (NPEs)--firms that develop or acquire, and in some cases, accumulate, patents only for the purpose of monetizing them rather than using the technologies to create products--poses a serious threat to innovation and competition, and how the American legal system has evolved over time to deal with such questions.

Some praise NPEs as providing small inventors, who lack the resources to protect their intellectual property rights through protracted litigation, with the ability to profit from their inventions. Others

have raised concerns that NPEs accumulate intellectual property to gain standing to sue technology users for patent infringement, with the goal of extracting large settlements. Critics contend that the cases brought by patent "trolls" (as "bad" PAEs or NPEs are often called) frequently lack merit, or perhaps even worse, are made possible by earlier acts intended to deceive practicing entities (PEs)--the makers of products--to commit to the technologies at issue by leading them to believe that the technologies are in the public domain or subject to binding restrictions on royalty rates (such as FRAND or royalty-free licensing provisions).

This intellectual divide is highlighted by the contributions of Professors Harris and Geradin. Dr. Robert Harris, Professor Emeritus of economics at the University of California at Berkeley and a Senior Consultant to Charles River Associates, explains risks to innovation and competition posed by the conduct of patent trolls. He considers patent trolls' rent-seeking incentives, especially in industries, such as telecommunications, that rely on a multiplicity of patented technologies. Harris describes how fundamental differences in the incentives of practicing and nonpracticing entities, existing patent enforcement and policy approaches, and even the ability of practicing entities to sell their intellectual property rights to NPEs, can create or exacerbate the potential for opportunistic and welfare-reducing conduct. Professor Damien Geradin, Professor of Law at the School of Law of George Mason University and a partner of the law firm of Covington & Burling, takes a different view. Professor Geradin focuses on what Harris would call a "patent-thick" industry--mobile telecommunications. While Professor Harris raises concerns that innovation and competition in such industries are threatened by the actions of patent trolls, Professor Geradin argues that theories of anticompetitive hold-up and related ills are not supported by empirical data.

The final contribution to this symposium is by Anne Layne-Farrar of Charles River Associates. Dr. Layne-Farrar's article is unlike the other articles of this symposium, which focus on how the law has, or should, treat the potentially anticompetitive conduct of holders of intellectual property, or the merits of policies intended to deal with such conduct. Taking as given the cases that have addressed such issues, Dr. Layne-Farrar considers, on the basis of a newly compiled body of evidence on SSO policies, whether and how standards bodies have changed their intellectual property rules in response.

Each of these authors has made an original and fascinating contribution to the literature on the interaction of antitrust and intellectual property. These articles are especially timely. The White House recently expressed concerns regarding patent assertion entities, (10) and the Federal Trade Commission has embarked on a Section 6(b) investigation of the conduct of such entities. (11) I hope that this symposium will provoke and inform debate on the important question of how competition policy should deal with issues raised when intellectual property rights and competition policy come into actual or perceived conflict.

(1) U.S. Dep't of Justice & Fed. Trade Comm'n, Antitrust Guidelines Tor the Licensing of Intellectual Property [section] 1.0 (Apr. 6, 1995), available at http:/ / [hereinafter DOJ/FTC IP Guidelines] ("The intellectual property laws and the antitrust laws share the common purpose of promoting innovation and enhancing consumer welfare. The intellectual property laws provide incentives for innovation and its dissemination and commercialization by establishing enforceable property rights for the creators of new and useful products, more efficient processes, and original works of expression. In the absence of intellectual property rights, imitators could more rapidly exploit the efforts of innovators and investors without compensation. Rapid imitation would reduce the commercial value of innovation and erode incentives to invest, ultimately to the detriment of consumers. The antitrust laws promote innovation and consumer welfare by prohibiting certain actions that may harm competition with respect to either existing or new ways of serving consumers.")

(2) U.S. Const, art. 1, [section] 8 ("The Congress shall have Power ... To promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.").

(3) See DOJ / FTC IP Guidelines, supra note 1.

(4) This principle has most famously been articulated by the Austrian economist Joseph A. Schumpeter. Schumpeter argued that his "gale of creative destruction" was not only (improperly) unaccounted for in the model of perfect competition that was popular among the economists of the time, but more important than price competition as a source of competitive rivalry. Joseph A. Schumpeter, Capitalism, Socialism and Democracy 84-85 (Taylor & Francis e-Library 2003) (1943), available at ("[I]n capitalist reality as distinguished from its textbook picture, it is not [price] competition which counts but the competition from the new commodity, the new technology, the new source of supply ... competition which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives. This kind of competition ... is ... the powerful lever that in the long run expands output and brings down prices

(5) This is because the up-front costs of technology development have already been "sunk," and so have no bearing on the technology developers' costs going forward. Note, however, that licensing costs will likely exceed zero, owing, among other things, to incremental costs such as "costs of negotiation, contracting, accounting, monitoring and auditing." Daniel G. Swanson & William J. Baumol, Reasonable and Nondiscriminatory (RAND) Royalties, Standards Selection, and Control of Market Power, 73 Antitrust L.J. 1, 22 (2005).

(6) FRAND stands for "fair, reasonable, and nondiscriminatory." The term RAND (which omits the term "fair") has traditionally been used in the United States, while FRAND has been used in Europe and elsewhere. Differences in wording notwithstanding, FRAND and RAND are generally taken to convey the same meaning. (This is not to say that the meaning of FRAND and RAND is universally agreed; to the contrary, this remains a point of controversy.) Both terms are now used frequently in the United States.

(7) According to Swanson and Baumol, "One natural solution to the problem of ex post market power is for prospective licensees to negotiate contracts in advance of standard selection, when the market is at its most competitive and proponents of alternative technology are actively vying with each other for advantage." Swanson & Baumol, supra note 5, at 15. Swanson and Baumol model such competition as an "auction-like" process. Id. at 17. Under the assumptions of their model, they deduce that "the 'best' [intellectual property] option will be able to command a license fee equal to incremental cost plus the difference in value between the best and next-best alternatives." Id. at 23. This conclusion is reached in the context of their discussion of the "economic characteristics of a reasonable RAND royalty." Id. at 21-25. Swanson and Baumol argue that the incremental cost component should include the transactions costs associated with intellectual property licensing (see supra note 5) and also explicit and opportunity costs to the inventor if it is to competitively upgrade and improve its technologies. Id. at 22. It should be noted, however, that the Swanson and Baumol approach has been criticized as relying on overly restrictive assumptions. See, e.g., Anne Layne-Farrar, A. Jorge Padilla & Richard Schmalensee, Pricing Patents for Licensing in Standard-Setting Organizations: Making Sense of FRAND Commitments, 74 Antitrust L.J. 671, 685-93 (2007).

(8) Certain patent holders have been accused of concealing their intellectual property rights or engaging in other deceptive practices during the standards-setting process, or of allegedly reneging on such commitments after their technologies were included in a standard and lock in had occurred. The effect of such conduct would be to allow the patent holders to later defeat the expectations of technology users that had relied on FRAND, RAND or other licensing commitments when choosing which technology to employ. Such arguments have been used to motivate antitrust claims in the United States alleging actual or attempted monopolization and unfair methods of competition. Some noteworthy examples include Rambus v. FTC, 522 F.3d 456 (D.C. Cir. 2008), Broadcom Corp. v. Qualcomm Inc., No. 06-4292, slip op. (3rd. Cir., 2010), available at,.and In re N-Data, No. C-4234 (FTC Sept. 22, 2008).

(9) More generally, "[h]old-up can arise, in particular, when one party makes investments specific to a relationship before all the terms and conditions of the relationship are agreed. Hold-up generally leads to economic inefficiency that contracting parties, and courts interpreting contracts, often try to avoid. 'Bad' behavior (such as deception) is not logically necessary for such inefficiency, but hold-up can powerfully reward deception and concealment." Joseph Farrell, John Hayes, Carl Shapiro and Theresa Sullivan, Standard Setting, Patents, and Hold-Up, 74 Antitrust L.J. 603, 604 (2007).

(10) See Executive Office of the President, Patent Assertion and U.S. Innovation (June 2013) available at /default/files/docs/patent_report.pdf.

(11) See Press Release, Fed. Trade Comm'n, FTC Seeks to Examine Patent Assertion Entities and Their Impact on Innovation (Sept. 27, 2013), available at

Robert J. Levinson, Vice President, Antitrust and Competition Economics Practice, Charles River Associates.

AUTHOR'S NOTE: Robert Harris and Anne Layne-Farrar provided helpful comments on an earlier draft of this article. Any errors in this article are mine. The views expressed in this article are mine and do not purport to reflect those of Charles River Associates or any of its other officers, affiliates, or employees.
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Author:Levinson, Robert J.
Publication:Antitrust Bulletin
Date:Jun 22, 2014
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